url
stringlengths 53
59
| text
stringlengths 0
917k
| downloaded_timestamp
stringclasses 1
value | created_timestamp
stringlengths 10
10
|
|---|---|---|---|
https://www.courtlistener.com/api/rest/v3/opinions/4624792/ | MODERNAGE DEVELOPERS, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentModernage Developers v. CommissionerDocket No. 26308-91United States Tax CourtT.C. Memo 1993-591; 1993 Tax Ct. Memo LEXIS 607; 66 T.C.M. (CCH) 1575; December 15, 1993, Filed *607 Decision will be entered under Rule 155. P was a closely held corporation engaged in residential development in New England. R disallowed as unreasonable a portion of the sec. 162, I.R.C., deduction for compensation claimed by P with respect to amounts paid to its two shareholder-officers. Held: R's determination that a portion of the payments made by P to its two shareholder-officers during its 1988 and 1989 taxable years did not constitute reasonable compensation is sustained. For petitioner: Howard I. Rosen. For respondent: Robert E. Marum. HALPERNHALPERNMEMORANDUM FINDINGS OF FACT AND OPINION HALPERN, Judge: By notice of deficiency dated August 23, 1991, respondent determined deficiencies and additions to tax against Modernage as follows: Tax Year EndingAddition to TaxJune 30DeficiencySec. 6651(a) 1988$ 32,847-- 1989729,892$ 36,495Unless otherwise indicated, all 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. Certain issues having been conceded, the only issue for decision is the reasonableness of compensation paid*608 by petitioner Modernage Developers, Inc. (Modernage), to two of its employees, Rejean and Yvon Carrier (Rejean and Yvon), during the years in issue. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts filed by the parties and attached exhibits are incorporated herein by this reference. Background of the Carrier BrothersRejean and Yvon, brothers, came to the United States from Canada when they were in their late teens or early twenties. They have little formal education; Rejean attended school through the ninth grade, while Yvon completed the fifth grade. The two brothers' mother tongue is French, and they did not learn English until they arrived in the United States. Initially, they worked in the home framing business; in 1973, they went into business for themselves, organizing Modernage (a Connecticut corporation). Over the years, the brothers have organized many other corporations, one to construct single-family houses, others to hold land, and still others to assist with financing. Formation and Operation of ModernageAt the time the petition in the instant case was filed, Modernage's principal place of business*609 was in Southington, Connecticut. Modernage computes its income on the basis of a fiscal year ending on June 30. For its 1980 through 1989 taxable years, Modernage was the common parent corporation of an affiliated group of corporations (the group) making a consolidated return of income. At various times during that period, the following were among members of the group: (1) CAC Development, Inc., (2) R & C Construction, Inc., and (3) Carrier Enterprises, Inc. During the years in issue, the group was engaged in various aspects of the home construction business. The group's activities included acquiring land, obtaining the necessary government approvals for development, improving acquired land by constructing residential units thereon, marketing the finished units, and financing purchases thereof. Rejean's and Yvon's Relationship to ModernageFrom the incorporation of Modernage in 1973 until September 23, 1988, Rejean and Yvon were the equal, sole owners of Modernage. From July 1, 1979, through September 23, 1988, they were its only directors and officers. Yvon's stock in Modernage was redeemed on September 23, 1988; thereafter, Rejean remained as its sole shareholder. *610 The brothers performed a variety of duties in the business of the group, which, in many other businesses, would have been undertaken by several additional individuals. The brothers' typical weekday began at 5:30 a.m., when they met with their work crews. They would then spend most of the remainder of the day at various job sites. In the afternoon, the brothers would return to their office to review paperwork and perform other administrative functions. They would also meet with bankers, lawyers, and engineers, and attend government hearings. A typical workday for the brothers would end at 6:30 p.m. In addition, they would meet with potential buyers of their residential units in the evenings and on weekends. For the most part, the brothers did not keep formal business records of their substantive decisions with respect to Modernage, since they trusted each other and saw little need for such records. The brothers viewed Modernage and its subsidiaries as a single business organization, and did not differentiate many of their activities as being on behalf of one member of the group or another. Modernage's Financial StatusDuring the years in issue, the group constructed*611 homes of about 1,200 to 1,500 square feet, selling for between $ 180,000 and $ 225,000. The brothers sold about 25-30 homes each year. The gross receipts derived from home sales were in excess of $ 2 million for 1988 and $ 5 million for 1989. During the years in issue, the group employed between 25 and 30 employees. Consolidated returns filed by the group for Modernage's 1981 through 1989 taxable years report consolidated income as follows: Table 1 Taxable yearEnding June 30Gross IncomeTaxable Income1989$ 4,122,974($ 159,258)19883,952,756(98,372)19873,272,077184,833 19863,576,420242,651 19851,729,877100,333 19841,331,312104,258 19831,350,71540,036 1982709,657(129,344)1981632,34791,006 Members of the group borrowed money to finance ventures of the group. The brothers stood as guarantors for those liabilities. The sum of liabilities guaranteed by the brothers peaked in 1988 at over $ 20 million. From its incorporation through the years in issue, Modernage declared no dividends. CompensationThe brothers are each calendar year taxpayers. From 1980 through 1989, on their Federal income tax returns, the*612 brothers each reported three categories of compensation for their services to the group. They reported commissions, management fees, and salaries. Both the commissions and the management fees were paid by members of the group to the brothers, although it is unknown which member made any particular payment. For 1980 through 1985, the brothers reported salary payments received from CAC Development, Inc. 1 For 1986 through 1988, the brothers reported salary payments received from Modernage. 2 For 1989, Rejean reported salary payments received from Modernage and R & C Construction, Inc., and Yvon reported salary payments received from Modernage. 3 The following table shows such compensation: Table 2Rejean Yvon Comms. &Comms. &YearMgmt. FeesSalaryTotal Mgmt. FeesSalaryTotal 1980$ 71,500$ 86,700$ 158,200$ 71,500$ 86,000$ 157,500198194,25078,000172,25094,25078,000172,2501982051,70051,700044,00044,000198310,00066,00076,00010,00043,00053,000198428,75052,00080,75028,75052,00080,750198573,03678,000151,03670,98778,000148,987198674,979679,000753,97974,605679,000753,605198760,000713,000773,00060,000641,000701,000198840,0001,150,0001,190,00040,0001,189,1941,229,19419892,2502,622,0002,624,2502,250150,000152,250*613 For its fiscal years ending June 30, 1988 and 1989, the group paid salaries to the brothers as follows: 4Table 3YearRejean Yvon Total1988$ 1,060,000$ 1,095,775$ 2,155,77519892,732,000150,0002,882,000*614 Modernage claimed deductions on its 1988 and 1989 returns for amounts less than the salaries it paid to the brothers. That is because it treated a portion of such payments as capital expenditures, for which a deduction in full was not immediately claimed. Respondent has made adjustments to the amounts capitalized for each year. Modernage has conceded the correctness of those adjustments. Taking into account those adjustments, the amounts paid, capitalized, and deducted as salaries paid to Rejean and Yvon for each of Modernage's taxable years in issue are as follows: Table 4Rejean Yvon YearCapitalizedDeductedTotal CapitalizedDeductedTotal 1988$ 215,578$ 844,422$ 1,060,000$ 215,578$ 880,197$ 1,095,775198977,4602,654,5402,732,000--150,000150,000The corporate minutes book of Modernage for the years in issue contains no minutes relating to the compensation to be afforded its officers. ULTIMATE FINDINGS OF FACT Reasonable allowances for current year services rendered by Rejean and Yvon to the group for Modernage's taxable years 1988 and 1989 do not exceed the following: YearRejean Yvon 1988$ 558,000$ 558,0001989519,000119,441*615 Deductions claimed by Modernage for its 1988 and 1989 taxable years for salaries paid to Rejean and Yvon exceeded reasonable allowances for services actually rendered by them by the amounts of $ 403,005 for 1988 and $ 1,968,856 for 1989. OPINION This case requires that we determine the reasonableness of salaries paid Rejean and Yvon Carrier for services rendered to corporations owned directly or indirectly by them. To the extent we find such salaries to exceed a reasonable allowance for personal services actually rendered to such corporations, we must sustain respondent's disallowance of deductions. See sec. 162(a). 5 The taxable years in question are Modernage's 1988 and 1989 fiscal years ending on June 30. The salaries in question, and their tax treatment, both by Modernage and respondent, are as follows: Table 5 1988RejeanYvonPetitioner Respondent Petitioner Respondent Capitalized$ 215,578$ 215,578$ 215,578$ 215,578Deducted844,422880,197Allowed660,807660,807Unreasonable183,615219,390Total$ 1,060,000$ 1,060,000$ 1,095,775$ 1,095,7751989RejeanYvonPetitioner Respondent Petitioner Respondent Capitalized$ 77,460$ 77,460Deducted2,654,540$ 150,000Allowed708,184$ 127,500Unreasonable1,946,35622,500Total$ 2,732,000$ 2,732,000$ 150,000$ 150,000*616 Reasonable Compensation: A Question of Facts and CircumstancesThe question of whether compensation is reasonable is to be resolved upon a consideration of all of the facts and circumstances of the case. E.g., Home Interiors & Gifts, Inc. v. Commissioner, 73 T.C. 1142">73 T.C. 1142, 1155 (1980). Modernage bears the burden of proving reasonableness. Rule 142(a); Home Interiors & Gifts, Inc. v. Commissioner, supra.The factors considered relevant in determining reasonableness of compensation include: (1) The employee's qualifications, (2) the nature, extent and scope of the employee's work, (3) *617 the size and complexities of the business, (4) a comparison of salaries paid with the gross income and the net income of the payor, (5) the prevailing general economic conditions, (6) comparison of salaries with distributions to stockholders, (7) the prevailing rates of compensation for comparable positions in comparable concerns, (8) the salary policy of the taxpayer as to all employees, and (9) in the case of small corporations with a limited number of officers, the amount of compensation paid to a particular employee in previous years. Home Interiors & Gifts, Inc. v. Commissioner, supra; Nelson Bros., Inc. v. Commissioner, T.C. Memo. 1992-726. Where shareholder-officers who are in control of a corporation set their own compensation, careful scrutiny is required to determine whether the alleged compensation is in fact a distribution of profits. Home Interiors & Gifts, Inc. v. Commissioner, supra at 1156. Focus on Prior YearsAs will be made clear, our concentration here is on the ninth factor listed above: the amount of compensation paid in prior years. 6 At trial, Modernage*618 presented two expert reports in support of its contention that it was deducting no more than a reasonable allowance for salaries paid to Rejean and Yvon. One expert report was prepared by the firm of Deloitte and Touche (the Deloitte and Touche report) and includes tables showing the market value of the services rendered by the brothers to the group for each year from 1980 through 1989. Such market values constitute the current year component of the total compensation package that, for each year in question, Deloitte and Touche opines is reasonable. Such current year amounts are as follows: Table 6YearRejeanYvon1980$ 295,000$ 295,0001981341,000341,0001982399,000399,0001983450,000450,0001984496,000496,0001985533,000533,0001986552,000552,0001987588,000588,0001988558,000558,0001989519,0001 519,000As shown by table 5, above, for both of the years*619 in issue (1988 and 1989), respondent allowed deductions in excess of Deloitte and Touche's determinations of the current year components for such years. We do not understand Modernage to be arguing that any amounts in excess of the amounts set forth in table 6 for 1988 and 1989 would be reasonable compensation for current year services rendered to the group for those years. In any event, we have found that reasonable allowances for current year services rendered by Rejean and Yvon to the group for Modernage's taxable years 1988 and 1989 do not exceed the amounts for such years set forth in table 6. That finding, however, does not end our inquiry, since the focus of Modernage's argument is that the allowances for salaries paid during the years in question were reasonable because Rejean and Yvon were undercompensated in prior years (i.e., that reasonable compensation for each year in question properly included not only a current year component but also a prior year component). *620 Compensating for Past ServicesIt is well established that a corporation may deduct as reasonable compensation payments made to an employee for both current and undercompensated past services. Lucas v. Ox Fibre Brush Co., 281 U.S. 115">281 U.S. 115 (1930). As a general rule, in order for a corporation to be entitled to a deduction for compensation payments made to an employee for undercompensated past services, it must establish (1) the amount of undercompensation, American Foundry v. Commissioner, 59 T.C. 231">59 T.C. 231, 239 (1972), affd. on this issue and revd. on other issues 536 F.2d 289">536 F.2d 289 (9th Cir. 1976), and (2) that current payments were intended as compensation for past services, Perlmutter v. Commissioner, 44 T.C. 382">44 T.C. 382, 403 (1965), affd. 373 F.2d 45">373 F.2d 45 (10th Cir. 1967); see also Bickes-Wilbert Burial Vault Co. v. Commissioner, T.C. Memo. 1986-172; R.J. Kremer Co. v. Commissioner, T.C. Memo. 1980-69. We find that Modernage has established neither the amount of past undercompensation *621 nor that the current payments were intended to rectify past undercompensation. Failure To Establish Fact of UndercompensationWith regard to the first factor -- the amount of undercompensation -- Rejean did testify that he should have been paid "half a million dollars and above" for each year, beginning in 1980. He testified that his brother was in the same position. His brother agreed. We do not find that testimony persuasive. Clearly, however, Modernage does not rely primarily on that testimony to establish the amount of undercompensation of Rejean and Yvon for 1980 through 1987. To establish that, Modernage relies primarily on the expert opinion of Deloitte and Touche. As set forth above (table 6), Deloitte and Touche has an opinion as to the market value of the services rendered by the brothers to the group for each year from 1980 through 1989. The basis of that opinion is set forth in the Deloitte and Touche report. That basis was additionally explained by Jeffrey N. Perrone, a partner of that firm, who signed the Deloitte and Touche report on behalf of the firm. It is clear from both Mr. Perrone's testimony and the Deloitte and Touche report itself that, *622 in forming its opinion as to the market value of the brothers' services for each of the years dealt with in the report, Deloitte and Touche directly established the appropriate amount of base compensation for 1 out of the 10 years in question (viz, 1988; see transcript, pp. 176, 177). Deloitte and Touche then extrapolated to each of the other years, adjusting base compensation solely to take into account inflation (at a constant rate of 5 percent). 7 See transcript, p. 177; Deloitte and Touche report, exhibits 3 and 4, NN.1. Indeed, it is clear from Mr. Perrone's testimony that Deloitte and Touche believed the 1988 level of compensation (adjusted for inflation) to be the appropriate level for all of the years addressed by the report. See transcript, pp. 177, 178. Simply put, we cannot agree with that assumption, given (1) certain other aspects of Deloitte and Touche's opinion and (2) the second expert opinion presented to us by Modernage: that of David Schwartzman and Edward Nell (the Schwartzman and Nell report). *623 The Ups and Downs of the Business CycleBoth the Deloitte and Touche report and the Schwartzman and Nell report present Modernage as facing a business cycle from 1980 through 1989 that was at a low point in the beginning and at a high point at the end. "The early years [of that cycle] represent a dormant period characterized by high interest rates and a slow economy." Deloitte and Touche report 8. The Schwartzman and Nell report characterizes the cycle in stronger, more graphic terms: [T]he early years of the 1980s were difficult years, in which business was poor * * * * * * In the early 1980s residential construction was in a deep slump, and in Connecticut and the Northeast, had been in a weakened state for almost a decade. * * * The upswing was long and slow; it began in 1982 and even two years later it had only reached the level of 1978. It was not until 1985 that the level of 1972 was reached. By 1986 and 87, however, the cycle had reached a peak, and a downturn was just around the corner, although it would be two more years before the actual downswing in spending. * * *Schwartzman and Nell report 2,9. Parity Not EstablishedConsidering the*624 business cycle described by the experts, what we cannot accept of Deloitte and Touche's opinion is the parity between base compensation for (1) 1988 (admittedly an excellent year for petitioner's business) and (2) the earlier years of the cycle (a "dormant period"; "residential construction * * * in a deep slump"). Indeed, in discussing general trends in executive compensation, the Deloitte and Touche report states that total annual compensation (and, in particular, the short-term component thereof) is determined in direct response to, among other things, "ability to pay". Deloitte and Touche report 6-7. Clearly, Modernage's ability to pay was considerably weaker during the early eighties (the down part of the business cycle) than it was during the late eighties (the up part of the business cycle). Nevertheless, the Deloitte and Touche report is not sensitive to changes in Modernage's ability to pay. Yes, inflation is taken into consideration; nevertheless, Deloitte and Touche have not argued (nor would we necessarily accept) that the constant adjustment for inflation (5 percent a year) is an adequate substitute for the effects of the business cycle described by them and Schwartzman*625 and Nell on Modernage's ability to pay. Deloitte and Touche have not otherwise taken account of Modernage's ability to pay. Thus, the report does not adequately explain why the brothers' base pay in the early eighties would have been the same (but for inflation) as it should have been in the late eighties. While we do not reject the premise in each expert's report that an executive's compensation in years of fat may be set with an eye to his past service during years of lean, we are unconvinced here by Deloitte and Touche as to what the brothers should have earned during the years of lean (in the early eighties). The particular business conditions faced by Modernage during any particular year (other than 1988, the base year) appear to play no role whatsoever (except as expressed in the constant adjustment for inflation and by the level of required loan guarantees) in Deloitte and Touche's hypothesis as to what Modernage should have paid the brothers for that year. We thus accord little weight to Deloitte and Touche's opinion as to the amount of the brothers' compensation paid during Modernage's 1988 and 1989 years that represented compensation for past services. Failure *626 To Establish Intent To Make Up for UndercompensationEven granting some prior undercompensation, we are also unconvinced that Modernage intended some component of the compensation paid the brothers in 1988 and 1989 to make up therefor. First, corporate records contemporaneous to 1988 and 1989 contain no indication of such intent. Second, even in retrospect, Modernage's agent, Rejean, was unable to testify with any exactitude how (if at all) his and his brother's compensation for 1988 and 1989 was divided up between past and present compensation: Q How did you arrive at the compensation figure * * * for 1989 * * * A Okay. By looking, without going to the specific of it, in detail which it's 1989, what I was getting in 1980, '81 and all those years, you know, that I was unable to pay myself what I felt I was underpaid, basically. That's how I arrived at that figure and now the money was available, you know, for the corporation to be able to do that.Simply put, Modernage has not carried its burden of showing that any portion of the brothers' compensation paid in 1988 or 1989 constituted compensation for past services. Findings and HoldingFinally, *627 respondent has allowed for each year in issue a deduction for compensation in excess of what Modernage's expert, Deloitte and Touche, opined was appropriate market compensation for the brothers for that year (the current year component). (See table 5). Such excesses may well represent respondent's concession that the brothers deserved, and were paid, some compensation for past services (a prior year component). We are not convinced that any allowances in excess of the amounts allowed were reasonable, and we have found that they were not. We hold that deductions claimed by Modernage for 1988 and 1989 for salaries paid to the brothers exceeded reasonable allowances for services actually rendered by them by the amounts of $ 403,005 and $ 1,968,856, respectively, and that such amounts, therefore, are not deductible under section 162(a)(1). Decision will be entered under Rule 155. Footnotes1. CAC Development, Inc., did not file as part of the affiliated group for Modernage Developers, Inc.'s (Modernage's) 1980 and 1981 tax years.↩2. In 1988, Yvon reported $ 1,189,194 of salary income. His Form W-2 from Modernage for that year, however, reflects only $ 1,185,774. Nothing in the record explains that disparity.↩3. Yvon also reported $ 1,004,315 of income from Carrier Enterprises, Inc. Since that corporation was not a part of the affiliated group, however, we do not consider that income in our analysis.↩4. All salaries during those years were paid to the brothers by Modernage, save in 1989, when $ 2,582,000 of Rejean's salary was paid by R & C Construction, Inc., a subsidiary of Modernage.↩5. In pertinent part, sec. 162(a) provides: (a) In General. -- There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including -- (1) a reasonable allowance↩ for salaries or other compensation for personal services actually rendered; [Emphasis added.]6. Because of the way this case has been presented, we need not rely heavily on the remaining factors. We note, however, that during its entire history, up to and including the years in issue, petitioner neither declared nor paid any dividends. "The absence of any dividends raises the inference that some of the compensation was a distribution of profits, rather than payments purely for services." R.J. Kremer Co., v. Commissioner, T.C. Memo. 1980-69↩.1. Yvon actually worked for the group for only 84 days during its 1989 taxable year. Accordingly, the market value of his services to the group for that year, if prorated on the basis of the days worked, would be $ 119,441 (84/365 x $ 519,000 = $ 119,441).↩7. For each year, to reach market compensation, base compensation is increased (1) by a 50-percent bonus and (2) on account of certain qualifying factors. Except for a qualifying factor to take account of loan guarantees by the particular brother, the qualifying factors increase base compensation by a constant percentage for each year. E.g., the following table, exhibit 3 to the Deloitte and Touche report, calculates adjusted market compensation for Rejean. REJEAN($ IN 000S) ActualAdjusted MarketMarketplace ConditionsQualifiersAdjustedYearTotalBase (1)50% BonusTotalABCDTotal1980$ 87$ 141$ 71$ 21215%10%5%$ 20$ 2951981781487422215%10%5%523411982521567823315%10%5%963991983661638224515%10%5%131450198452172 8625715%10%5%1614961985781809027015%10%5%18253319866791899528415%10%5%18355219877131999929815%10%5%20158819881,00020910431315%10%5%15155819892,60521911032915%10%5%92519(1) Assumes annual escalation of 5%. (A) Job responsibility adjustment with Modern Age Developers due to: - Varying levels of responsibility - Job title activities performed equivalent to a full-time equivalent not otherwise hired (B) Job responsibility in managing apartments. (C) Location indices for the Northeastern United States. (D) Loan guarantee fee typically used as additional compensation (risk - reward). based upon % of liabilities guaranteed.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624794/ | Joseph Calcaterra v. Commissioner.Calcaterra v. CommissionerDocket No. 15170.United States Tax Court1948 Tax Ct. Memo LEXIS 52; 7 T.C.M. (CCH) 803; T.C.M. (RIA) 48220; October 28, 1948*52 William H. West, Jr., Esq., 522 Fifth Ave., New York, N. Y., for the petitioner. John E. Mahoney, Esq., for the respondent. KERN Memorandum Findings of Fact and Opinion The Commissioner determined a deficiency in income tax of petitioner for the taxable year 1944 in the amount of $7,130.24. In his original return for the taxable year, petitioner made a mathematical error in the computation of his tax payable, by reason of which his payment of tax was $1,000 in excess of the amount which would have been paid had his computations been mathematically correct. The Commissioner concedes that the deficiency determined fails to give credit to petitioner for the payment of $1,000 due to this mistake. Credit for this payment will be given in computations under Rule 50. The sole issue remaining is whether petitioner and his wife conducted a business as partners during the taxable years under such circumstances that the partnership should be recognized as having reality and validity for tax purposes. Findings of Fact Petitioner, Joseph Calcaterra, and his wife, Gladys, were married January 14, 1925. The income tax returns in question were filed with the collector of*53 internal revenue at Newark, New Jersey. Prior to the marriage, the wife Gladys worked as a clerk and bookkeeper for a loan office in New York. At the time of their marriage the wife had approximately $500 in savings, the greater part of which she deposited in a joint bank account which was opened in the name of her and her husband. For all the subsequent years the bank accounts of petitioner and his wife were maintained jointly and used both for business and living expenses. All property, with one exception which will be hereinafter mentioned, was also held jointly. In 1932 petitioner and his wife established a catalogue distribution service. This consisted of featuring manufacturers' booklets in several magazines. Upon request, these booklets were supplied by petitioner and his wife by mail and the respective manufacturers were then billed accordingly. The business was conducted almost entirely by the wife from their home. The petitioner also engaged in some free lance advertising and in making up catalogues and booklets. As early as 1932 Gladys agreed to assist petitioner and to devote all necessary time to the business. They had agreed that any profits which might result from*54 the business would be shared equally. Gladys never received compensation or reimbursement for the services she performed. All of the proceeds of the business were placed in the joint bank accounts. In 1934 petitioner and Gladys began the business of printing small labels. The smallest label was five-eighths of an inch by onefourth of an inch, and the largest label was not over one and one-half inches in length. These labels were intended by radio parts manufacturers to be used to "anchor" parts and to identify the particular part and the name of the maker. Ninety per cent of this printing was performed for three manufacturers. In 1934 or 1935 the petitioner bought a printing press for approximately $2,000. Payments for the press were made over a period of ten years. In order to meet some of the payments on the press, to purchase supplies, and to meet other expenses, Gladys borrowed $250 from her father and $175 on her life insurance, which sums were placed in the joint bank accounts in 1936. A cutter, used to cut the labels to size after they had been printed, cost from $250 to $400 when purchased in late 1941. In 1941 land of the value of $1,750 was purchased and a building constructed*55 costing $17,444. This building contained a first floor, a basement, and an attic. There were four rooms on the first floor, which were used for living purposes. The basement was specially devoted to the printing business. Records were kept in the attic. By 1944, the tax year in question, the label business, operated under the name of The Calcaterra Service, was the only business of petitioner and his wife. The business required very little activity away from the home. The petitioner customarily set up the form and laid the type for the labels. The form was then placed in the printing press, and the wife ran the press. She put on the paper, saw that it was running, kept it properly inked, and saw that the flamedrying process did not start fires. Petitioner then used the cutter, of the guillotine type, to cut the labels. First the length separation was cut; then the cross cut reduced the labels to the proper size. The paper was cut in stacks of 500. The wife then checked the labels against the orders, and packed them in corrugated boxes. She then mailed the shipment through the United States Mails. Orders were usually received by mail or phone. The three principal customers knew and*56 discussed their business with both the petitioner and his wife. The three principal customers paid The Calcaterra Service by check through the mail when they were billed. The wife customarily made the deposits of the checks. The petitioner kept no formal bookkeeping records. For the operation of the business, the petitioner customarily kept supplies of gummed paper, print and ink. The expense of these items was small. The expense of mailing amounted to approximately $500 for the taxable year in question. Little correspondence was necessary. The bills and letterheads read "The Calcaterra Service." The entire business was carried on in the home. In the taxable year in question the petitioner required full-time help. He only succeeded in finding such help for approximately three months out of the taxable year when one man did work full time. The service was also assisted by two part-time employees. The petitioner and his wife spent from 8 to 12 hours a day in the operation of the business in 1943; and 12 to 15 hours a day 6 and 7 days a week during the taxable year in question, which was their most productive year, and from 8 to 12 hours a day in 1945. Sometimes the wife did not leave*57 the house for several weeks. The windows of their house were washed by an outside agency, and food was secured from a grocery truck which periodically came to the door. The husband and wife both made whatever decisions were necessary in the operation of the business. Few decisions were required since the business was limited by their facilities and their physical abilities. All expenses and payments were made from the joint account. Both the husband and the wife drew checks on this account. In early 1943 the bank informed the parties that in order to protect the bank the parties should file a certificate with the County Clerk designating the assumed name under which the business was conducted and setting forth the true name of the operators and owners of the business. The petitioner certified with the County Clerk that he, Joseph Calcaterra, was the sole owner and proprietor of the business entitled "The Calcaterra Service." In late 1943 the petitioner read, discussed with his bankers, and determined for the first time that the creation of a partnership by husband and wife was legal. He was told that there need be no written articles, nor any need for the services of an attorney. *58 The petitioner and his wife had always felt that they operated as a partnership. However, to conform to what they understood the law to be, they formally told each other at the end of 1943 that henceforth, after January 1, 1944, they would operate as equal partners, that they would pool all resources, and share all profits and losses equally. The business had not produced distributable profits prior to late 1943. In 1944, the tax year in question, the business reached its peak period of operation and earned approximately $20,000. This amount was reported for the first time on separate returns of the partners. The greater part of profits of late 1943 and 1944 was used to pay off an outstanding mortgage and to purchase an equal amount of U.S. Bonds for each partner in his and her separate name. As of January 1, 1944, petitioner listed the assets of "The Calcaterra Service" partnership as follows: Basement printshop$8,700Cash2,800Fixtures and printing equipment5,000Supplies, paper and ink1,000 The partnership return disclosed ordinary net income of $22,275.68, distributable $11,137.84 to each partner. During the taxable year petitioner and his wife intended, *59 in good faith, to carry on business as a partnership, the wife contributed services of a vital nature to such business, and a valid partnership existed for "tax purposes." Opinion KERN, Judge: The legal criteria for determining whether a purported partnership agreement between husband and wife has such reality as to be accorded validity for tax purposes have been by this time adequately stated in opinions of the Supreme Court, the Circuit Courts of Appeal and this Court. Neither a restatemet of those criteria nor a catalogue of those decisions is necessary in this opinion. The problem of the instant case has been to apply those criteria, already well-established, to the facts shown by the record herein. Having found the evidentiary facts, and having attempted to give the proper weight to the various factors involved in the application of the criteria above referred to, we have come to the conclusion, already stated as an ultimate finding of fact, that the partnership between petitioner and his wife during the taxable year had reality and should be accorded validity for tax purposes. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624795/ | Fred W. Smith and Grace Hobson Smith, Petitioners, v. Commissioner of Internal Revenue, RespondentSmith v. CommissionerDocket No. 50113United States Tax Court25 T.C. 143; 1955 U.S. Tax Ct. LEXIS 65; October 27, 1955, Filed *65 Decision will be entered under Rule 50. Taxpayer is income beneficiary of two separate testamentary trusts established by her father, the same trustees being named for such trusts. One of the trusts sustained a net loss. Held, the net loss of that trust may not be offset by taxpayer against income distributable to her from the other trust, notwithstanding that the trustees filed a single amended return on Form 1041 consolidating the operations of both trusts pursuant to section 29.142-3, Regulations 111. Harrison Harkins, Esq., for the petitioners.Thomas J. Sullivan, Esq., for the respondent. Raum, Judge. RAUM*144 OPINION.The Commissioner determined a deficiency in income tax against petitioners, husband and wife, in the amount of $ 27,071.87 for the year 1948. All of the facts have been stipulated; they are rather complicated, but a simplified summary will be sufficient to bring into focus the only question for decision.A. L. Hobson, the father of Grace Hobson Smith, died in 1929. By his will he created certain trusts, naming petitioners as co-trustees in each of them. The sole income beneficiary of one of them, the Aliso-Ross-Hill Ranches Trust (referred to hereinafter as the *66 Aliso trust), was his daughter, Grace Hobson Smith, one of the petitioners in this proceeding. A fiduciary income tax return for this trust for 1948 was filed by petitioners as trustees on Form 1041 in March 1949, reporting a net loss from the operation of business in the amount of $ 34,524.73 as "distributable" to the beneficiary.Another trust established by the will was created out of the residue of the estate and is referred to as the A. L. Hobson Residue Estate, or the residue trust. It provided for distribution of income in a specified manner: (a) 10 per cent to petitioners, as trustees, for certain eleemosynary purposes; (b) 45 per cent to decedent's widow, with provisions for other disposition in the event of her death; and (c) the remaining 45 per cent to pay annuities for life to 5 persons, and the remainder to Grace Hobson Smith. During 1948 the residue trust realized a total of $ 252,859.77 ordinary net income and $ 21,660.24 long-term capital gain. The widow had died some years prior thereto, and her 45 per cent share was distributable in its entirety to Grace Hobson Smith. Also, 4 of the 5 annuitants had died prior to 1948, and, as a result, only $ 1,200 out of the *67 remaining 45 per cent was payable to someone other than Grace Hobson Smith. In March 1948, petitioners filed certain partnership and fiduciary returns, in connection with the foregoing, which are described in the margin. 1*68 In petitioners' joint individual income tax returns for 1948, also filed in March 1949, there was reported, in addition to certain long-term *145 capital gains, "Income from Partnerships and Trusts" as follows:Aliso-Ross-Hill Ranches Trust1 ($ 34,612.23)A. L. Hobson Estate Trust112,586.89 A. L. Hobson Residue Estate113,786.90 Grace Hobson Smith -- separate$ 191,761.56 The deficiency notice for 1948 was mailed to petitioners on June 10, 1953. The deficiency resulted from the respondent's determination that the net operating loss of the Aliso trust could not be used to offset the income distributable to Grace Hobson Smith which had its source in the residue trust.After receiving the deficiency notice, but prior to filing their petition herein, the petitioners, as co-trustees of trusts created by A. L. Hobson undertook to file an "Amended" return on Form 1041 for 1948, in which the operations of the Aliso trust were *69 consolidated with those of the residue estate, with the result that the net income ultimately shown on the return reflected the net loss of the Aliso trust.The Government contends that the income payable to Grace Hobson Smith from the trust or trusts created out of the residue are taxable to her under section 162 (b) of the Internal Revenue Code of 1939, 2*70 and that there is no provision of the Code under which the loss of the Aliso trust can be offset against such income. Apart from the effect of a regulation, to be considered shortly, petitioners do not challenge the Government's position.Under our tax law, a trust is a separate juristic entity, and its income and deductions are not consolidated with those of other trusts or *146 entities. Cf. U. S. Trust Co. v. Commissioner, 296 U.S. 481">296 U.S. 481. Thus, even where there is the same beneficiary of two separate trusts created by the same grantor, the losses of one may not be offset against the income of the other. Such is the square holding of Gertrude Thompson, 40 B. T. A. 891.Petitioner seeks to overcome the effect of the foregoing by reliance upon section 29.142-3 of Regulations 111, which provides:Returns in Case of Two Trusts. -- In the case of two or more trusts the income of which is taxable to the beneficiaries, which were created by the same person and for which the same trustee acts, the trustee shall make a single return on Form 1041 for all such trusts, notwithstanding that they may arise from different instruments. If, however, one person acts as trustee for trusts created by different persons for the benefit of the same beneficiary, he shall make a return on Form 1041 for each trust separately.We cannot agree that this regulation effectively neutralizes the general rule required by the Code and *71 applied in the Thompson case that the losses of one trust may not be used by the beneficiary to offset income distributable by another trust.Although the regulation has been in existence a long time, 3 its purpose and scope are shrouded in obscurity. It will be noted that the regulation, in terms, deals only with the return to be filed by the fiduciary; it does not undertake to spell out the tax consequences of that return to the beneficiary. If petitioners' version of the regulation were adopted, unusual results would follow that could not possibly be justified under the statute. Suppose that the same grantor created two trusts naming the same trustees but with different beneficiaries, and suppose further that one trust realized distributable income in a given amount but that the other trust sustained a net loss in the same amount. In such situation, if the regulation were applied as contended for petitioners, the beneficiary of the profitable trust would have no taxable income to report therefrom, even though his trust in fact earned income that was actually distributed to him. He would thus obtain the benefit of a loss sustained by a trust in which he had no interest whatever. *72 We cannot believe that Congress intended any such bizarre result. Again, if petitioners' position is correct, there would be only one exemption for several trusts created by the same grantor where the same trustees are named; yet the statute plainly gives a separate exemption for each trust, and the Commissioner would be wholly powerless to deprive the trusts of such exemptions, whether he attempted to do so by regulation or otherwise.*147 Petitioners rely upon the fact that the regulation has been in effect over a number of years and that the applicable statute has been reenacted a number of times during that period. We would ordinarily be very slow to put aside such a regulation, where there has been an administrative history showing that the regulation had been applied consistently over the years to cases comparable to the one before the Court. However, *73 we have no way of knowing whether such is the situation here. By its terms, the regulation does not specifically call for the result upon which petitioners insist, and the respondent explains its purpose so as not to require that result. Respondent argues that the regulation was intended to cover only those situations in which all the income of the various trusts was distributable, thereby, in effect, rendering the trustees' returns merely information returns without affecting the substantive rights or obligations of the distributees. Whether we accept or reject respondent's explanation, there is nothing before us to show that the regulation had ever been applied in the manner contended for by petitioner. The only reference supplied to us by counsel bearing upon the administrative history of the regulation is a 1936 letter signed by a section chief on behalf of a deputy commissioner, which appears in one of the tax services, 4 but which has no relevance to the problem before us.In the circumstances, we cannot say that we have any long continued, or even any administrative practice with respect to the point in issue. And since the application of *74 the regulation in accordance with petitioners' position would, in our judgment, be contrary to the statute, we hold that the loss of the Aliso trust may not be used by Grace Hobson Smith to offset income distributable to her from the residue estate.Decision will be entered under Rule 50. Footnotes1. They filed, first, a partnership return on Form 1065 as co-trustees of the A. L. Hobson Residue Trust, reporting ordinary net income of $ 252,859.77 and net long-term capital gain of $ 21,660.24, shown to be distributable as follows:OrdinaryLong-termDistributeePer centnet incomecapital gainA. L. Hobson Trust Fund10$ 25,285.98$ 2,166.02Grace Hobson Smith45113,786.909,747.11A. L. Hobson Estate Trust45113,786.899,747.11Totals$ 252,859.77$ 21,660.24The first 45 per cent listed above represents the interest originally allocable to the decedent's widow, and the second 45 per cent represents the interest out of which the five annuities with remainders to Grace Hobson Smith were to be paid.Petitioners also filed at that time two other returns for 1948, as trustees, each on Form 1041: one for the "A. L. Hobson Trust Fund," and the other for the "A. L. Hobson Estate Trust." On the return for the latter, $ 112,586.89 out of a total of $ 113,786.89 ordinary income was reported as distributable to Grace Hobson Smith and the remaining $ 1,200 to the last surviving annuitant.1. The loss as reported in the return of the Aliso-Ross-Hill Ranches Trust was $ 34,524.73 ($ 34,612.23 less a net taxable capital gain of $ 87.50 from sale of a horse and scrap iron).↩2. Sec. 162 (b). There shall be allowed as an additional deduction in computing the net income of the * * * trust the amount of the income of the * * * trust for its taxable year which is to be distributed currently by the fiduciary to the * * * beneficiaries, but the amount so allowed as a deduction shall be included in computing the net income of the * * * beneficiaries whether distributed to them or not. As used in this subsection, "income which is to be distributed currently" includes income for the taxable year of the * * * trust which, within the taxable year, becomes payable to the * * * beneficiary. * * *3. See art. 423, Regs. 45; art. 423, Regs. 62; art. 423, Regs. 65; art. 423, Regs. 69; art. 743, Regs. 74; art. 743, Regs. 77; art. 142-3, Regs. 86; art. 142-3, Regs. 94; art. 142-3, Regs. 101; sec. 19.142-3, Regs. 103; sec. 29.142-3, Regs. 111; sec. 39.142-3, Regs. 118. See also sec. 7807, I. R. C. 1954; T. D. 6091, 1954-2 C. B. 47↩.4. See 1955 P-H vol. 2, par. 17,636.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624797/ | ST. LOUIS MALLEABLE CASTING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.St. Louis Mallaeable Casting Co. v. CommissionerDocket Nos. 5490, 15168.United States Board of Tax Appeals9 B.T.A. 110; 1927 BTA LEXIS 2658; November 15, 1927, Promulgated *2658 1. Fair market value of patents and patterns for purpose of the deduction for exhaustion, wear and tear determined. 2. Cost of assets to be used for depreciation and invested capital determined. R. M. O'Hara, Esq., N. B. Landreau, Esq., and Beach P. Burlingham, Esq., for the petitioner. L. L. Hight, Esq., and Granville S. Borden, Esq., for the respondent. LITTLETON*110 The Commissioner has determined deficiencies of $17,081.80 for 1917, $17,612.72 for 1918, and $4,165.75 for 1920. For the year 1918 the Commissioner originally assessed an additional tax of $19,622.86, of which amount an abatement was allowed to the extent of $2,010.14. The year 1919 is not involved in this proceeding since no deficiency was asserted by the Commissioner for that year. The petitioner alleges error on the part of the Commissioner (1) in allowing an inadequate value at March 1, 1913, for patterns as a basis for depreciation; (2) in allowing an inadequate value at March 1, 1913, for patents as a basis for depreciation; (3) in computing depreciation of plant and equipment upon a basis less than the cost thereof; (4) in allowing inadequate rates*2659 of depreciation in the years 1920 and 1921 on ovens and furnaces, and office furniture and fixtures; (5) in failing to restore to capital account in 1920 both for depreciation and invested capital purposes the cost of patterns, amounting to $10,025.52, originally charged off by the taxpayer in 1917 but disallowed by the Commissioner; (6) in failing to allow deductions in 1920 for depreciation on the new buildings erected and operated during a part of the year 1920; (7) in failing to allow as a deduction depreciation on various expenditures made during 1920, originally charged to expense but restored to capital account by the Commissioner. The petition originally contained an allegation that the Commissioner erred in refusing to allow a March 1, 1913, value of plant and equipment, as a basis for depreciation, in excess of the cost thereof as shown by the books. This contention was withdrawn by the petitioner at the hearing. FINDINGS OF FACT. Petitioner is a corporation, organized under the laws of the State of Missouri, and had its principal office at 7701 Conduit Avenue, St. Louis, Mo. Petitioner engaged in the manufacture and sale of devices connected with electrical transmission*2660 lines. It was organized about 1902, and for a few subsequent years was engaged in *111 producing castings for the St. Louis Car Co. During 1908 the St. Louis Car Co. became financially involved, resulting in the loss of this business to the petitioner. It therefore became necessary for the petitioner to secure other outlets for its business; in accomplishing this object it manufactured a large number of patterns for the devices which it desired to make in addition to the patterns which it already owned. At March 1, 1913, petitioner was the owner of the following patents which were issued on the dates indicated: Patent No.Issued905414Dec. 1, 1908906003Dec. 8, 1908906787Dec. 15, 1908908082Dec. 29, 1908919840Apr. 29, 1909995123June 13, 1911The petitioner manufactured devices covered by these patents both prior and subsequent to March 1, 1913, but also manufactured and sold a large number of devices not covered by patents. The book records of the petitioner show the sales of patented and nonpatented articles, as follows: SalesPatented articlesNonpatented articlesTotal salesPercentage patent sales to total sales1908$178,821.74$178,821.741909$38,668.65266,741.37305,410.0212.66191043,804.62421,679.82465,484.449.41191146,574.69278,909.10325,483.7914.31191262,188.97341,290.95403,479.9215.41191396,948.65460,025.22556,973.8717.41191459,900.64291,177.20351,077.8417.06191563,252.12277,279.85340,531.9718.57191697,595.46473,979.72571,575.1817.071917147,717.68865,644.911,013,362.5914.57191844,402.75974,370.521,018,773.274.35191963,973.61806,359.25870,332.867.351920167,710.811,399,486.711,567,197.5210.70932,738.657,035,766.367,968,505.0111.71*2661 By applying average cost per hundred pounds of petitioner's entire production to ascertain the cost of producing the patented articles, the following result is reflected: Profit from sale of patented articles compared to net income from entire businessYearWeightAverage cost per 100 poundsCost of salesSalesProfit on patent salesTotal net income for the year as per books1908$57,502.201909$642,378$4.125$26,497.69$38,668.65$12,170.965,748.681910583,6684.00023,346.7243,804.6220,457.9018,610.081911566,4564.29324,307.9746,574.6922,266.7235,444.251912781,3033.84428,767.5662,188.9733,421.4142,240.2319131,198,6114.15749,826.2396,948.6547,122.4265,399.081914686,6434.45930,617.4159,900.6429,283.2326,859.881915770,2384.51034,737.5563,252.1228,514.5726,691.381916919,9694.63142,603.7697,595.4654,991.7057,877.301917976,0995.93957,970.52147,717.6889,747.16174,943.241918304,7497.94824,221.4544,402.7520,181.3040,154.021919396,2518.33633,031.4963,973.6130,942.1255,399.971920713,44410.66176,060.25167,710.8191,650.56317,142.27*2662 *112 The profits prior to 1913 thus attributed to the patented articles have been apportioned to the various patents by the petitioner, as follows: Patent No.YearsTotal salesCost of salesProfitAverage profit9054141909$5.00$4.62$0.381910637.72512.12125.601911760.98559.51201.471912832.74644.79187.952,236.441,721.04515.40$128.85906003190931,337.4820,654.1310,683.35191039,215.6120,926.5218,289.09191142,212.9121,580.7820,632.13191257,943.7927,741.5730,202.22170,709.7990,903.0079,806.7919,951.69906787190928,2616.8311.43191043.5119.8423.67191165.1214.0051.12191255.1130.5924.52192.0081.26110.7427.6890808219095,303.924,447.25856.6719102,339.77931.201,408.57191190.8132.9357.881912345.21124.08221.138,079.715,535.462,544.25636.0691984019091,993.991,374.86619.1319101,568.01957.04610.9719112,813.981,725.361,088.6219122,154.801,032.421,122.388,530.785,089.683,441.10860.279951231911630.89395.39235.501912857.32459.82397.501,488.21855.21633.00158.25*2663 The fair market value of these patents at March 1, 1913, was $90,284.94. During the year 1924 the petitioner engaged the services of an appraisal company to make a retrospective appraisal of its assets as at March 1, 1913. In this appraisal the reconstruction cost at March 1, 1913, of patterns owned by the petitioner on that date has been included. The appraiser visited the vaults in which the patterns were contained and made a more or less superficial inspection. He then took from the books of the petitioner, year by year, the costs of patterns as shown therein, and by a method of calculation and percentage, determined the number of labor hours and cost of material entering into the production of the petitioner's patterns as opposed to patterns manufactured by it but owned by its customers. Having ascertained the number of hours of labor and the cost of material, the appraiser adjusted the costs thereof to a basis of cost at March 1, 1913, including in such adjusted costs 60 per cent for overhead. This 60 per cent for overhead expenses was an estimate which corresponded to the rate the petitioner used in billing patterns to its customers. The appraiser did not take each*2664 pattern found in the vaults and storerooms and appraise such pattern in accordance with *113 the method employed in the balance of the appraisal of the petitioner's plant and equipment. The fair market value at March 1, 1913, of the petitioner's patterns was $33,932.04, the cost thereof as shown by its books. For the years 1917 and 1918 the Commissioner determined depreciation on the petitioner's plant and equipment by using the amounts determined by the revenue agent in a report dated October 30, 1920. In this report it is shown that the revenue agent took from the books the costs applicable to the various groups of assets and applied depreciation rates thereon, all of which were acceptable to the petitioner with the exception of the rates used on ovens and furnaces. In computing the cost to which these rates should be applied at December 31, 1916, the revenue agent eliminated from the total costs as shown by the books the cost of the assets which, in accordance with the rate of depreciation applied, would have been entirely depreciated prior to that date. This also resulted in a reserve for depreciation on December 31, 1916, of $93,597.13 in excess of the amount which*2665 the petitioner had taken up to that time, which excess if entered in the balance sheet would have resulted in a corresponding reduction of surplus. The Commissioner, in determining the deficiency for the years 1917 and 1918, did not make such deduction in the surplus of petitioner, but left the surplus as shown by the books undisturbed. For the year 1920 the Commissioner used as a deduction for depreciation amounts determined by the revenue agent as shown in his report dated April 6, 1925. In this report the revenue agent ignored the method employed by the previous revenue agent and, instead of using as a basis the total cost of assets as shown by the books less the items entirely depreciated, started his computation with the amounts shown in the balance sheet at December 31, 1916, for each of the group of assets, using the same rates of depreciation as in the previous report except in the case of office furniture and fixtures. The balance sheet of the petitioner at December 31, 1916, showed the net value of assets after the sustained depreciation had been deducted from the cost of the asset and no depreciation reserve was set up as a liability. The books of the petitioner reflect*2666 the following: Machine and equipment, December 31, 1916$62,968.48Depreciation which had been credited to the account: 1912$10,000.0019138,000.0019142,209.1919156,875.0019167,000.00Total of depreciation34,084.19Adjusted balance in depreciation restored97,052.67Buildings, balance, December 31, 1916104,244.08Depreciation which had been credited to the accounts prior to December 31, 1916:1913$5,000.0019168,000.00Total13,000.00Adjusted balance, December 31, 1916, with depreciation restored117,244.08Tools and flasks, balance December 31, 191636,138.47Depreciation credited to the account in 1912416.64Adjusted balance with depreciation restored36,555.11Patterns, balance, December 31, 191617,165.89Depreciation credited to the account prior to December 31, 1916:1912$10,000.0019138,000.0019142,300.1619155,000.0019165,000.00Total depreciation30,300.16Adjusted balance December 31, 1916, with depreciation restored47,433.05Ovens and furnaces, December 31, 191631,305.24Prior depreciation credited to the account:1913$3,000.0019166,000.00Total depreciation9,000.00Adjusted balance December 31, 1916, with depreciation restored40,305.24Office furniture and fixtures, balance December 31, 1916300.00Prior depreciation credited to the account:1913$1,677.361916291.11Total depreciation1,968.47Adjusted balance, December 31, 1916, with depreciation restored2,268.47*2667 *114 For the year 1920 the revenue agent also failed to restore to the pattern account the amount of $10,025.52, which had been disallowed as an expense in 1917 and restored to capital account by the previous revenue agent. During the year 1918 the petitioner purchased some heating units, consisting of square boxes about 10 by 8 feet, containing motors and fans. This item was added to the building account by the revenue agent in his report for that year. During the years 1920 and 1921 the petitioner engaged in a new building program, expending $253,181.62 in 1920 and $108,120.48 in *115 1921. The buildings were crected in sections, and one section was completed and put into use in the early part of July, 1920. The total floor area of both sections was 70,715 square feet and that of the section completed in July, 1920, was 38,860 square feet. During the year 1920 the Commissioner disallowed as deductions for repairs various items aggregating $11,254.59, and restored such amount to the capital account. The character of the expenditure, the amount spent, and the date when the asset was put into use, were as follows: ItemAccountAmountDate put into useNew plumbing in old buildingsBuildings$1,856.84May 15, 1920New wall, plus salvage value of old brick useddo4,696.45Dec. 1, 1920Moving and re-erecting flask shed and carpenter shopdo2,201.30Apr. 1, 1920New style lights in old buildingdo2,500.00May 1, 1920*2668 OPINION. LITTLETON: The first issue is the value at March 1, 1913, of the patterns owned by the petitioner on that date. As set forth in the findings of fact, a value has been assigned to these patterns at March 1, 1913, in the report of the appraisal company which purported to be the reconstruction cost of the patterns then on hand, less its estimate of depreciation sustained prior to that date. The so-called retrospective appraisal of patterns was at best a rough segregation of the working hours and material applicable to patterns as shown by the petitioner's records into working hours and material applicable to patterns owned by the petitioner and those owned by customers. This was done on a percentage basis by calculating the cost of all pattern labor and materials, adding 60 per cent overhead and 20 per cent profit, and comparing this total amount with the amount actually charged on the books to customers. In order for this calculation to be correct all patterns must be of equal size and weight and of equal ease of manufacture, which, of course, was not a fact. The appraiser did not take each pattern and determine the reconstruction cost thereof nor did he eliminate*2669 obsolete, discarded or worthless patterns, nor did he check over the patterns to ascertain if all of the patterns which were made by the petitioner from 1903 to March 1, 1913, were still in existence. If a large part of the labor and materials on the books of the petitioner had been extravagantly or wastefully spent or wholly wasted, the appraisal would not eliminate such waste, but would magnify the amount by applying increased costs thereto. *116 Therefore the figures set forth in the appraisal applicable to patterns do not represent an appraisal of patterns but an appreciation of book costs and are therefore of little value in arriving at the fair market value of the petitioner's patterns at March 1, 1913. The only additional evidence contained in the record as to the value of these patterns was an expression of opinion by Martin B. Hammell, who is secretary and treasurer of the petitioner company. He testified that in his opinion the patterns of the petitioner were worth at least the amount shown in the appraisal company's report. However, it was not shown that Mr. Hammell had ever examined all of the patterns owned by the petitioner, nor had he any personal knowledge*2670 of the cost of constructing patterns other than a general knowledge from examining the accounts of the company. We do not feel that Mr. Hammell had a sufficiently intimate knowledge of the patterns owned by the petitioner and the cost or market value thereof at March 1, 1913, to make more than an unsupported guess as to the value. Furthermore, since the petitioner is claiming a value for patents based upon the net profits derived from the manufacture and sale of patented articles, any value in excess of cost of the patterns would be reflected in the value of patents thus determined. In computing the overhead expenses used in determining the cost of producing patented articles, it is not apparent that the petitioner increased the pattern value over cost as shown by the books. From a consideration of all the evidence submitted we approve the Commissioner's determination of the March 1, 1913, value of patterns for the purpose of depreciation deduction. The next issue is the value of patents owned by the petitioner on March 1, 1913. The average profits ascribed to the various patents by an analysis of the petitioner's records for the years 1911 and 1912 and the remaining life as*2671 at March 1, 1913, are as follows: Patent numberAverage profit, 1911 and 1912Remaining life after Mar. 1, 1913Years905414$194.7112 3/490600325,417.1712 3/490678737.8212 3/4908082139.5112 5/69198401,105.5013 1/12995123316.7514 1/3From a consideration of all the evidence, we are of opinion that the fair market value of these patents on March 1, 1913, was as follows: Patent No.March 1, 1913, value905414$6,073.7890600379,285.46906787117.99908082438.039198403,349.039951231,020.65Total$90,284.94*117 These amounts represent the fair market value of petitioner's patents at March 1, 1913, and the amount to which the petitioner is entitled as a deduction for each patent in the years in question is an aliquot part of such value equal to the patent value divided by the years of life remaining after March 1, 1913. The petitioner alleges error on the part of the Commissioner in computing depreciation for the years 1917 and 1918, by eliminating from the asset account, used as a basis for depreciation, certain amounts representing items of equipment claimed to be wholly*2672 depreciated. For example, the total cost of all items of the machinery and fixtures account up to December 31, 1916, as shown by the books of the petitioner, was $97,052.67. The revenue agent, whose action upon this issue was followed by the Commissioner, reduced this cost to $43,088.38. The difference is due to the elimination of the earliest purchases which, on the basis of the rates of depreciation used, would be entirely depreciated by December 31, 1916. The petitioner asks that depreciation for 1917 and 1918 be based upon a cost at December 31, 1916, of $97,152.67 instead of the $43,088.38 used by the Commissioner. No objection is raised by the petitioner to the rates used by the Commissioner for the prior years, nor is evidence presented to show that repairs or maintenance increased the life of the assets beyond the years indicated by the rates used. The application of the method proposed by the petitioner would produce results which are inconsistent with the theory of a depreciation charge. Obviously, unless there is error on the part of the Commissioner in the rates of depreciation used, the assets which were fully depreciated at the end of their expected life should*2673 not remain in the asset account and be depreciated over years when they are no longer in existence. To do so would be to permit a double recovery of the same assets. Accordingly, on the basis of the evidence presented, we must sustain the action of the Commissioner in computing the depreciation allowance only on assets which his determination showed had not yet been fully depreciated. The next contention of the petitioner is that the Commissioner, in computing the depreciation for 1920 and 1921, used as a basis the net amounts appearing in the petitioner's balance sheet for December *118 31, 1916, instead of the total cost of the assets, and also used inadequate rates of depreciation. An examination of the revenue agents' reports which were followed by the Commissioner shows that in the report for 1917, 1918, and 1919 depreciation was computed on the basis of the total cost of the assets, whereas in the report for 1920 and 1921 depreciation was computed on the balances of the assets as shown by petitioner's books, which balances represented the total costs less the various depreciation charges which the petitioner had made against the assets. In both reports the same*2674 rates of depreciation were used, except in the case of office furniture and fixtures where the report for the later years used a lower rate. Under the previous issue we sustained the action of the Commissioner with respect to the basis of depreciation for 1917 and 1918, which action was based on the revenue agent's report for these years and which provided for depreciation on the total cost of the assets, less proper eliminations for fully depreciated assets. We are of the opinion that the same method should be applied for 1920. An examination of the petitioner's record shows that it did not employ a consistent method of computing depreciation prior to 1917. It took no depreciation whatever prior to 1912, in which year it deducted some $40,000. In 1914 and 1915 no depreciation was written off except on patterns and on machinery and fixtures. The record further shows that on an investment of $39,305.24 for furnaces and ovens up to 1916, only $3,000 was written off as depreciation. In respect to these assets the petitioner introduced testimony to the effect that the proper annual rate of depreciation was 7 1/2 per cent and that the two furnaces purchased in 1903 and a third*2675 purchased in 1907 became entirely worthless in 1920. In view of this testimony, it is evident that the asset value of furnaces and ovens, on the books at December 31, 1916, was erroneous and would result in having a large balance still remaining on the books in 1920 when the assets were entirely depreciated. The same appears to be true of other depreciable assets. For example, in the case of patterns, testimony was introduced as to their useful life, including an allowance both for wear and tear and also for obsolescence which agrees with the rates used by the Commissioner. It further appears that no objection is raised to the rates of depreciation used prior to December 31, 1916, the controversy being over the resultant effect of the application of the rates. In view of the foregoing, the Board is of the opinion that not only should the respective rates of depreciation be applied to total costs of assets, after proper adjustment for assets fully depreciated, for the purpose of determining a reasonable allowance for depreciation in *119 the various years, but also surplus should be adjusted in conformity therewith for all years on appeal. The application of the foregoing*2676 principle also disposes of the issue raised as to $10,025.52 written off in 1917 on account of obsolete patterns, since the 10 per cent depreciation rate on this class of assets includes an allowance for obsolescence. The foregoing amount was disallowed as a deduction by the Commissioner for 1917 and restored to the asset account for depreciation and invested capital purposes for 1917 and 1918, but the evidence shows that this adjustment was not carried through into 1920, and we are, accordingly, of the opinion that the determination in 1920 with respect to this item should be consistent with the action for 1917 and 1918. We are also satisfied that the depreciation rate of 10 per cent on office furniture and fixtures which was used by the respondent in the determination of the deficiencies for 1917 and 1918 should likewise be applied in 1920. During the year 1918 an amount of $9,879.93 was spent for heating units, consisting of square boxes about 10 feet by 8 feet, containing motors and fans. This item was added to building account by the revenue agent, but should properly have been added to machinery and fixtures account. Therefore, this amount should be excluded from the*2677 building account and added to machinery and fixtures account. The depreciation rate on ovens and furnaces has been established at 7 1/2 per cent. Therefore, that account should be revised beginning with 1903 so as to reflect this rate. The depreciation rates applied fixtures account. Therefore, this amount should be excluded from the During the years 1920 and 1921 the petitioner engaged in a new building program, expending $253,181.62 in 1920 and $108,120.48 in 1921, a total of $381,302.10. The buildings were erected in sections, and one section was completed and put in use in the early part of July, 1920. The cost of the completed section is not shown in the record and evidently was not segregated on the books. The petitioner apparently desires that a segregation be made on the basis of square feet of floor area of the completed section as compared with the total floor area. The petitioner's witness testified that the construction to all assets in 1918 and prior years should also be applied in 1920. cost per square foot in each case would be the same. The total floor area of both sections was 70,715 square feet and that of the section completed in July, 1920, was 38,860*2678 square feet. While this manner of segregating costs is only an approximation and not generally acceptable in determinations of this character, we believe that in this instance we are justified in computing a cost on this basis. It is of general knowledge that building costs reached a peak about the middle of 1920 and thereafter declined to the close *120 of 1921. Consequently, with similar types of construction of the two sections, the second section would not normally have cost more per square foot than the first section, and may have cost less. We are, therefore, of the opinion that the cost of the first section should be determined on this basis and depreciation be allowed thereon for 1920, beginning with July, 1920. During 1920 the Commissioner disallowed as deductions for repairs various items aggregating $11,254.59, on the ground that such expenditures were capital investments, but allowed no depreciation thereon for the year 1920. The evidence shows that these expenditures were made on improvements to buildings and were put into use during 1920. The petitioner is entitled to depreciation on these assets during 1920 for the portion of the year that they*2679 were in use as indicated in the following schedule: ItemAccountAmountDate put into useNew plumbing in old buildingsBuildings$1,856.84May 15, 1920New wall, plus salvage value of old brick useddo4,696.45Dec. 1, 1920Moving and reerecting flask shed and carpenter shopdo2,201.30Apr. 1, 1920New skylights in old buildingsdo2,500.00May 1, 192011,254.59Judgment will be entered on 15 days' notice, under Rule 50.Considered by SMITH, TRUSSELL, and LOVE. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624798/ | Roger M. Dolese and Susan B. Dolese, Petitioners v. Commissioner of Internal Revenue, RespondentDolese v. CommissionerDocket No. 29240-81United States Tax Court82 T.C. 830; 1984 U.S. Tax Ct. LEXIS 64; 82 T.C. No. 64; May 30, 1984, Filed *64 Decision will be entered for the respondent. An individual (R) and his wholly owned corporation (D) caused a partnership (P), in which R held a 49-percent interest and D a 51-percent interest, to distribute a 160-acre tract of land in two tracts (of approximate equal value but not of equal size) to them in ownership percentages disproportionate to their respective partnership interests. As a result of the distribution, R had a 76-percent interest in tract I and a 24-percent interest in tract II; D had a 24-percent interest in tract I and a 76-percent interest in tract II. Immediately following the distribution (which admittedly was done solely for tax purposes), tract I was contributed to the city for use as a public park, and the city acquired options to purchase substantially all of tract II. The city subsequently exercised its purchase options. R claimed a deduction for the contribution of tract I to the city on the basis of a 76-percent ownership interest therein; he reported 24-percent of the gain from the sale of substantially all of tract II to the city. Held, based on the stipulated facts of this case, R and D, in their individual capacities and not on behalf *65 of P, contributed and sold the property to the city; therefore, the substance and form of the transaction were as one. Held, further, the Commissioner could, and properly did, apply sec. 482, I.R.C. 1954, to reallocate the amount of the charitable contribution deduction, and the amount of the capital gains, between R and D, on the basis of their respective percentage interests in P. Edward H. Moler, for the petitioners.Osmun R. Latrobe and Michael O'Brien, for the respondent. Jacobs, *66 Judge. *JACOBS*830 Respondent determined the following deficiencies in petitioners' Federal income tax:YearDeficiency1976$ 57,455.121977151,077.00*831 This case involves the distribution of two tracts of land by a partnership to its two partners (an individual and his wholly owned corporation) followed by a partial gift/partial sale of the tracts to Oklahoma City (hereinafter sometimes referred to as the city). The distribution of each tract was disproportionate to the partners' interests in the partnership, and was made for the purpose of adjusting the partners' ownership interests in the land prior to their contribution and sale of such land to the city. The purpose of the disproportionate distribution was to maximize the available tax benefits flowing from the charitable contribution deduction available under section 170 to the partners. 1 Thus, the issues to be decided, after concession by the petitioners, are:(1) Whether the respondent properly disregarded a disproportionate distribution of land by a partnership*67 to its partners where such distribution was made solely to avoid the statutory limitations imposed on the charitable contribution deduction by a corporation;(2) Whether the respondent properly reallocated between an individual and his wholly owned corporation gain from sales of land by such individual and corporation.FINDINGS OF FACTThe facts in this case have been fully stipulated and are so found.The petitioners are Roger M. Dolese (hereinafter referred to as Roger) and his wife, Susan B. Dolese. Roger and his wife resided in Oklahoma City, Okla., at the time of filing the petition herein, and timely filed joint returns for the years at issue with the Internal Revenue Service Center at Austin, Tex.At all times material hereto, (1) Roger owned all of the stock of the Dolese Co. (hereinafter referred to as the corporation), (2) Roger and the corporation were the only partners in Dolese*68 Bros. Co. (hereinafter referred to as the partnership), and (3) the corporation held a 51-percent interest in the partnership, and Roger held the remaining 49-percent interest.From 1973 until March 29, 1976, the partnership held title to approximately 160 acres of undeveloped land located at the *832 northwest corner of N.W. 50th and Meridian, Oklahoma City, Okla. (hereinafter referred to as the property). 2In November 1974, the partnership engaged an engineering firm to devise a plan for the development of the property and to obtain the necessary zoning. *69 The firm developed a master development plan involving different uses of various parts of the property. In April 1975, the partnership submitted to the city a proposed community unit plan and an application requesting zoning for the master development plan. The community unit plan and zoning request provided for development of the property (except for approximately 3 acres to be used for an elderly housing project site) as duplexes, single-family homes, condominiums, and commercial areas, together with recreational 3 and common areas. The plan and the zoning request were approved by the Oklahoma City Council on September 20, 1975.*70 In the late summer of 1975, representatives of Roger and the corporation discussed with the director of parks of the city a possible gift by Roger and the corporation to the city of the east half of the property (containing approximately 67 acres and having a value of $ 1,376,240) and the simultaneous sale of the west half of the property (containing approximately 90 acres) to the city for its appraised value of $ 1,387,560. Hereinafter the west half of the property will be referred to as tract I and the east half as tract II.Although Roger and the corporation were willing to contribute approximately one-half of the property to the city for use as a park, they desired to do so only if the amount of such a large contribution could be fully utilized as charitable deductions by the two donors. Roger and a vice president of the corporation discussed the proposed gift with tax advisers, and *833 were advised that the corporation could only claim a charitable contribution equal to 5 percent of its net income before contributions, certain special deductions and loss carrybacks. Roger, on the other hand, could deduct up to 30 percent of his contribution base. Although it was anticipated*71 that the corporation's fiscal year ending March 31, 1976, would be exceptionally profitable, it was doubtful, based on the corporation's earnings history, that the net income of the corporation for 1976 and the succeeding 5 taxable years would be sufficient to utilize the full amount of the charitable contribution deduction if the property were owned by Roger and the corporation in the ratio of 49 percent and 51 percent, respectively. 4 Roger and the corporation were therefore advised that the portion of the property to be contributed to the city should first be distributed from the partnership to the two partners in the ratio of 75 percent to Roger and 25 percent to the corporation. On the basis of this advice, no consideration was ever given to the possibility of having the partnership make the contribution.*72 The city proposed to finance the purchase of tract I with Federal funds obtainable through the Bureau of Outdoor Recreation of the U.S. Department of Interior. On September 15, 1975, the city applied for such Federal funds. Prior to March 27, 1976, discussions between the city and representatives of Roger and the corporation had been with regard to the sale of tract I to the city for its appraised value, or $ 1,387,560, and a simultaneous gift of tract II to the city, both of which were to be consummated prior to March 31, 1976 (the last day of the corporation's fiscal year). On March 26, 1976, the mayor of the city informed a representative of Roger and the corporation that the city would not be able to obtain the *834 necessary funds to purchase tract I by March 31, 1976; therefore, it appeared the proposed partial sale/partial contribution of the property would not be consummated.On March 27, 1976, a representative of Roger and the corporation discussed with the mayor the possibility of the city's acquiring tract I by gift, with no requirement that the city purchase the remainder of the property. During the next several days, the further discussions of the gift that ensued*73 were expanded to include discussion of the possibility of the city's acquiring through purchase options the remainder of the property. During this same period, Roger and a representative of the corporation met with their tax advisers and counsel.On March 29, 1976, the property was distributed by the partnership to Roger and the corporation by a warranty deed which divided the property into tract I (consisting of approximately 90 acres) and tract II (consisting of approximately 70 acres). The property, as so divided, was distributed to Roger and the corporation, as tenants in common, as follows:Tract I -76% to Roger24% to the corporationTract II -76% to the corporation24% to RogerOn March 29, 1976, the date of the distribution, the partnership owned other properties and assets.On March 30, the warranty deed was recorded; and immediately thereafter, Roger and the corporation contributed tract I to the city, with no commitment on the part of the city to purchase any part of tract II. On the date of the contribution, tract I had a fair market value of $ 1,387,560.On May 4, 1976, Roger and the corporation granted the city options to purchase the remainder of the*74 property, except for approximately 3 acres to be used for an elderly housing project. The options covered three parcels -- one parcel containing approximately 51 acres, and the other two parcels containing 8 acres each.In July 1976, Roger and the corporation sold the 51-acre parcel to the city pursuant to the city's option. The sales price for that parcel was $ 700,000, resulting in a long-term capital gain of $ 685,415.55.*835 In August 1977, Roger and the corporation sold the other two parcels (aggregating 16 acres) to the city. The sales price for those two parcels was $ 676,240, resulting in a total long-term capital gain of $ 667,508.The petitioners' 1976 income tax return reflected a $ 1,054,546 contribution by Roger to the city, based on Roger's ownership of a 76-percent interest in tract I. The respondent determined that Roger's share of the gift to the city was $ 679,904, based on Roger's ownership of a 49-percent interest in tract I. In determining the alleged deficiency in 1977, the respondent reduced the amount of the charitable contribution carryover from 1976 to 1977 because of the aforesaid reallocation of Roger's ownership in tract I from 76 percent to*75 49 percent.In addition to the aforesaid adjustments, the respondent increased petitioners' 1976 and 1977 incomes to reflect Roger's share of the capital gain from the sale of the 51-acre parcel to the city in July 1976, and from the sale of 16 acres to the city in August 1977 from 24 percent to 49 percent.OPINIONIn order to avoid the potential loss of the tax benefit of a substantial charitable contribution deduction, 5 Roger caused the partnership (in which he and his wholly owned corporation were the only partners) to distribute in 1976 a 160-acre parcel of land in two tracts (of approximately equal value but not of equal size) to the two partners in ownership percentages disproportionate to their partnership interests. Prior to the distribution, Roger had (as a result of his interest in the partnership) a 49-percent interest in the land, and the corporation had (as a result of its interest in the partnership) a 51-percent interest. After the distribution, Roger had a 76-percent interest in tract I and a 24-percent interest in tract II; the corporation had a 24-percent interest in tract I and a 76-percent interest in tract II. Following the distribution (which *836 admittedly*76 was done solely for tax purposes), tract I was contributed to the city, and the city acquired options to purchase substantially all of tract II. The city exercised one of its options in 1976 and another in 1977.The petitioners contend that the disproportionate distribution of the tracts to Roger and the corporation should be respected for tax purposes, *77 with the result that they would be entitled to a deduction for the contribution of tract I to the city on the basis of a 76-percent ownership interest in the donated tract and would recognize capital gains from the sale of tract II to the city on the basis of a 24-percent ownership interest. The respondent disagrees and has asserted deficiencies by decreasing the charitable contribution deduction claimed by the petitioners and by increasing their share of capital gains on the sale of the land to the city.The respondent argues that the disproportionate distribution of the property by the partnership to its two partners should be disregarded for two reasons. First, he argues that the substance of the transaction, rather than its form, controls; and, therefore, the transaction should be viewed as if the contribution and sale to the city had been made by the partnership, as opposed to its partners. Roger's charitable contribution deduction and capital gain would then be determined in accordance with his 49-percent interest in the partnership. Second, the respondent argues that under section 482, he has the right to reallocate the amount of the charitable contribution deduction, and*78 the amount of the capital gains, between the partners on the basis of their respective percentage interests in the partnership. A discussion of each of these two arguments follows.Substance Over Form"The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted." Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 469 (1935). But as has often been stated, "A given result at the end of a straight path is not made a different result because reached by following a devious path." Minnesota Tea Co. v. Helvering, 302 U.S. 609">302 U.S. 609, 613 (1938).*837 The respondent argues that the partnership, rather than its partners, contributed and sold the property to the city. The facts in this case are otherwise.The stipulated facts are: (1) Roger and the corporation always intended that they, in their individual capacities, would make a partial contribution/partial sale of the property to the city, and all discussions with the city were in the context of the contribution and sale being made by Roger and the corporation, as opposed to the partnership; *79 (2) no consideration was ever given to having the partnership make the contribution or sale of the property to, the city; and (3) the partnership never committed itself, either orally or in writing, to make a gift or sale of the property to, the city.Since the facts show clearly and beyond question that Roger and the corporation in their individual capacities, and not on behalf of the partnership, contributed and sold the property to the city, we conclude that the respondent's first argument must be rejected. The Supreme Court's decision in United States v. Cumberland Public Service Co., 338 U.S. 451">338 U.S. 451 (1950), is apposite to our conclusion. That case involved an in-kind partial liquidation distribution from a closely held corporation to its shareholders followed by a sale of the distributed assets by the shareholders to a third party. A similar situation was involved in Commissioner v. Court Holding Co., 324 U.S. 331">324 U.S. 331 (1945). In both cases, the Commissioner argued that tax at the corporate level resulting from the asset sale could not be avoided by using the shareholders "as a conduit through which to pass title." In *80 Cumberland, the taxpayer prevailed because it was found that the corporation never negotiated the sale but rather the sale was negotiated by the shareholders. In Court Holding, the Commissioner prevailed because it was found that the corporation had in fact negotiated the sale but "called off" the sale at the last moment.As previously stated, in the present case it is indisputable that Roger and the corporation acted on their own behalf, and not as a conduit on behalf of the partnership, in making the contribution and sale to the city. Simply because the parties for tax reasons rearranged their respective ownership interests in the property through the vehicle of a disproportionate distribution from the partnership prior to the contribution/sale to the city does not change the fact that Roger and the *838 corporation, and not the partnership, contributed and sold the property to the city. As Justice Black stated in Cumberland:Whatever the motive and however relevant it may be in determining whether the transaction was real or a sham, sales of physical properties by shareholders following a genuine liquidation distribution [here, a contribution and sale of land*81 by partners following a genuine withdrawal of land from a partnership] cannot be attributed to the corporation [here, the partnership] for tax purposes. [338 U.S. at 455.]We are convinced that the substance and form of the transactions involved in this case were as one; hence the Commissioner's first argument is rejected. Bolker v. Commissioner, 81 T.C. 782">81 T.C. 782, 794-803 (1983).Section 482Section 4826 grants the Commissioner broad discretion to scrutinize closely transactions between mutually controlled taxpayers and, to allocate items of income, deductions, and credits where necessary to prevent the evasion of taxes or to ensure the clear reflection of each taxpayer's income. Spicer Theatre, Inc. v. Commissioner, 346 F.2d 704">346 F.2d 704, 706 (6th Cir. 1965), affg. 44 T.C. 198">44 T.C. 198 (1964); Ballentine Motor Co. v. Commissioner, 321 F.2d 796">321 F.2d 796, 800 (4th Cir. 1963), affg. 39 T.C. 348">39 T.C. 348 (1962); Foster v. Commissioner, 80 T.C. 34">80 T.C. 34, 142-143 (1983). Where the Commissioner determines that an allocation*82 under section 482 is necessary to prevent either tax evasion or the distortion of a taxpayer's income, his determination must stand unless the taxpayer proves that the determination is "unreasonable, arbitrary, or capricious." Ballentine Motor Co. v. Commissioner, supra;Foster v. Commissioner, supra;Ach v. Commissioner, 42 T.C. 114">42 T.C. 114, 125-126 (1964), affd. 358 F.2d 342">358 F.2d 342 (6th Cir. 1966). A taxpayer contesting a section 482 allocation bears a "heavier than normal burden of proving arbitrariness." *839 Foster v. Commissioner, supra;Young & Rubicam, Inc. v. United States, 187 Ct. Cl. 635">187 Ct. Cl. 635, 410 F.2d 1233">410 F.2d 1233, 1245 (1969).*83 In the present case, the respondent determined that the charitable contribution deduction and capital gain resulting from the contribution/sale of the property must be allocated in accordance with Roger's and the corporation's interest in the partnership in order to reflect clearly the petitioners' income. There is no dispute regarding the existence of the control relationship, and the petitioners admit that the disproportionate distribution was effected to allow the petitioners a larger tax deduction than would otherwise have been available. Petitioners, however, resist the application of section 482 on four other grounds.Petitioners' first argument is that section 482 only applies where there are two or more "organizations, trades or businesses," and that this dual business requirement has not been met herein. Specifically, petitioners contend that Roger, as an employee of the corporation, has no independent trade or business under Whipple v. Commissioner, 373 U.S. 193 (1963), and Foglesong v. Commissioner, 691 F.2d 848 (7th Cir. 1982), revg. 77 T.C. 1102">77 T.C. 1102 (1981), and therefore cannot be *84 subjected to a section 482 allocation. We disagree.In the first place, petitioners overstate the Supreme Court's holding in Whipple. The taxpayer in Whipple sought a business bad debt deduction under section 165 for worthless loans to a corporation of which the taxpayer was the dominant shareholder. In holding that the debt was a nonbusiness bad debt, the Court concluded that the taxpayer's expected reward from the corporation was that of a return on his investment, and that the management services the taxpayer rendered the corporation, for which he received no salary, did not amount to a trade or business. 373 U.S. at 203. The Court, however, expressly stated that its holding did not extend to the question of whether the services rendered by a salaried corporate employee amount to a trade or business. 373 U.S. at 204.We believe that a corporate executive who receives a salary for his services is engaged in a trade or business for the purposes of section 482. Keller v. Commissioner, 77 T.C. 1014">77 T.C. 1014, 1023-1024 (1981), affd. 723 F.2d 58">723 F.2d 58 (10th Cir. 1983). See Primuth v. Commissioner, 54 T.C. 374">54 T.C. 374 (1970);*85 Mitchell v. United States, 187 Ct. Cl. 342">187 Ct. Cl. 342, 408 F.2d 435">408 F.2d 435 (1969). Roger, who *840 listed his occupation as "Executive" on his returns, received a salary from the corporation during the years in question, and therefore had income from a business (as opposed to investment) activity for section 482 purposes.Petitioners, however, argue that the Seventh Circuit's opinion in Foglesong precludes a finding that Roger had a separate trade or business for the purpose of the dual business requirement of section 482. In Foglesong, the Seventh Circuit held that a section 482 allocation of income from a one-man personal service corporation to the shareholder-employee was improper because the dual business requirement was not satisfied where the shareholder-employee worked exclusively for the corporation and was engaged in the identical business as the corporation. Without expressing any views upon the merits of the Seventh Circuit's opinion in Foglesong, we believe that Foglesong does not apply to the present case. The respondent's determination does not involve an allocation of income and deductions from a corporation to*86 its sole shareholder-employee as in Foglesong. Rather, the respondent here has allocated income and a deduction from Roger, as a partner, to the partnership. Roger is an investor in, and not a salaried employee of, the partnership. Roger's trade or business, that of rendering services to the corporation for a salary, is therefore separate and independent from the partnership's business activity.The petitioners also argue that there was a "sound business purpose" for realigning the partners' interests in the tracts through the disproportionate distribution, and that, under W. Braun Co. v. Commissioner, 396 F.2d 264">396 F.2d 264 (2d Cir. 1968), revg. a Memorandum Opinion of this Court, the existence of a "business purpose" deprives the Commissioner of his authority to reallocate income and deductions under section 482. Petitioners maintain that the "desire to avoid a contribution by the corporation that would have far exceeded the amount that the corporation could expect to utilize as a tax deduction" represents a "business purpose." While we are fully aware that many business decisions are animated, either in whole or in part, by tax considerations, it is*87 clear that the desire to maximize the benefit of a deduction is not the sort of non-tax motive that the term "business purpose" denotes in this *841 context. Aiken Drive-In Theatre Corp. v. United States, 281 F.2d 7">281 F.2d 7, 10 (4th Cir. 1960).The petitioners' third argument is that section 482 does not apply because the transaction meets the "arm's length" test set forth in the regulations. Sec. 1.482-1(b)(1), Income Tax Regs. Petitioners contend that the restructuring of the partners' interests in the property by means of the disproportionate distribution was in effect an exchange that was economically beneficial to both partners and therefore would have been adopted by unrelated and uncontrolled entities. In support of their contention, petitioners point to the facts that the reduction of the corporation's interest in tract I (the portion donated to the city) had no detrimental effect upon the corporation, because the corporation could not have fully utilized the deduction for a charitable contribution of a 51-percent interest in the property, and that the corresponding increase in the corporation's interest in tract II (the portion sold to the *88 city) resulted in the corporation's receiving a greater share of after-tax dollars. We disagree with this argument.The petitioners' argument that a hypothetical, unrelated and uncontrolled 51-percent partner would have acquiesced in the disproportionate distribution assumes that the hypothetical partner would have made a charitable contribution to the city of its interest in the property. 7 The validity of petitioners' assumption is doubtful, to say the least, where the hypothetical, unrelated and uncontrolled entity would have derived a greater economic or after-tax benefit by an outright sale of its 51-percent interest in the property rather than by participating in the contribution/sale.Northwestern National Bank of Minneapolis v. Commissioner, an unreported case (*89 D. Minn. 1976, 37 AFTR 2d 76-1400, 76-1 USTC par. 9408), affd. 556 F.2d 889">556 F.2d 889 (8th Cir. 1977), presented a situation analogous to the present one. In that case, a bank owned all the stock of a bank building company which in turn owned 10-percent of the stock of Center, Inc., a corporation owning a valuable building complex. The bank's directors were informed of a possible sale by Center, Inc., of its *842 building complex which had substantially appreciated in value. The possible sale would in turn considerably increase the value of Center, Inc., stock. The bank's comptroller outlined to the bank's president three alternatives to deal with the bank building company's investment in Center, Inc. These alternatives were (1) bank building company could sell its stock in Center, Inc., and pay the capital gains tax; (2) bank building company could donate its stock in Center, Inc., to a charitable foundation sponsored by the bank, and the foundation could then sell the stock; or (3) bank building company could distribute its stock in Center, Inc., as a dividend to bank followed by a contribution to and sale by the*90 charitable foundation of the Center, Inc., stock. The third alternative provided the best tax consequences because a charitable contribution by the bank would result in a far greater tax saving than a similar contribution by the bank building company, and therefore was adopted.Pursuant to section 482, the Commissioner disallowed the charitable contribution deduction claimed by the bank for its donation of the stock in Center, Inc., to the charitable foundation and allocated the deduction to the bank building company. As a result of the Commissioner's actions, the bank building company received a refund of approximately $ 11,000, plus interest; however, the disallowance of the charitable contribution deduction to the bank resulted in tax deficiencies of approximately $ 190,000, plus interest. The court sustained the Commissioner, reasoning that the tax consequences of the plan, which resulted in a tax loss to the bank building company and a tax gain to the bank, were clearly different from those that would ensue in the case of two uncontrolled taxpayers dealing at arm's length.The petitioners' final argument is that, while section 482 authorizes the allocation of income, deductions, *91 and credits, the Commissioner has no authority under the statute to allocate "assets." The petitioners claim that the respondent has improperly exercised his authority under section 482 because he has reallocated assets, i.e., the interests of Roger and the corporation in the property prior to the contribution/sale to the city. The simple answer to this argument is that the Commissioner has allocated income (capital gain) and a *843 deduction (charitable contribution), and not assets, from Roger to the partnership.To reflect the foregoing,Decision will be entered for the respondent. Footnotes*. This case was reassigned from Judge Darrell D. Wiles to Judge Julian I. Jacobs for disposition by order dated Apr. 2, 1984.↩1. All section references are to the Internal Revenue Code of 1954 as amended and in effect during the taxable years in issue.↩2. The corporation acquired the property on Sept. 29, 1948, for the purpose of removing sand for construction materials and related business uses. Excavation and concrete ready-mix batch plant operations on the site ceased during the 1960's, and the property was thereafter used only for open storage. The corporation contributed the property to the partnership by warranty deed, dated Dec. 1, 1972, and recorded with the clerk of Oklahoma County on Jan. 11, 1973.↩3. The Kerr Foundation, a philanthropic organization in Oklahoma City, became interested in developing a public park on a portion of the property. It approached officials of the city, on its own initiative and without the knowledge of Roger or the corporation, with regard to the city's acquiring the property and developing a park on it. Thereafter, the Kerr Foundation, on its own initiative and without the knowledge of Roger or the corporation, contacted the South Central Regional Office of the Bureau of Outdoor Recreation of the U.S. Department of the Interior with regard to obtaining a Federal grant to purchase that portion of the property to be developed as a public park.↩4. The following schedule sets forth the taxable income and the charitable contributions reflected on the income tax returns of the Dolese Co. for the taxable years ending Mar. 31, 1970, through Mar. 31, 1975:↩Taxable income,Contributions,Taxable income,per return as filedper returnbefore contribution1970$ 719,838.32 $ 37,886.23$ 757,724.55 19712,083,100.37 29,914.352,113,014.72 1972935,108.48 21,331.39956,439.87 1973(42,670.28)0 (42,670.28)1974794,109.49 41,795.24835,904.73 1975(193,368.34)0 (193,368.34)19762,490,315.94 131,069.262,621,385.20 5. As applicable for 1976, sec. 170 of the Internal Revenue Code of 1954↩ limited the amount of the charitable contribution deduction for a corporation to 5 percent of its taxable income for the year, with a 5-year carryover to subsequent years for any excess amount. For the years 1970-75, the aggregate maximum charitable contribution deduction available to the corporation would have been $ 221,352.26. A 51-percent ownership in tract I would have resulted in $ 707,655.60 ($ 1,387,560 x 51%) being potentially available as a contribution by the corporation to the city; whereas, a 24-percent ownership interest resulted in a $ 333,014.42 ($ 1,387,560 x 24%) contribution.6. 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 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 such organizations, trades, or businesses.↩7. While we commend Roger's generosity, we note that the gift of the land to the city was conditioned upon its being used exclusively as a public park and that the official name to be given the park was to include Roger's family name, "Dolese."↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624799/ | ROBERT R. HENDRICKSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHendrickson v. CommissionerDocket No. 8115-84.United States Tax CourtT.C. Memo 1985-176; 1985 Tax Ct. Memo LEXIS 458; 49 T.C.M. (CCH) 1208; T.C.M. (RIA) 85176; April 8, 1985. Robert R. Hendrickson, pro se. Michael L. Boman, for the respondent. PARKERMEMORANDUM FINDINGS OF FACT AND OPINION PARKER, Judge: Respondent determined deficiencies in petitioner's Federal income taxes and additions*460 to tax under sections 6653(b) 1 and 6654 as follows: AdditionsYearDeficiency§ 6653(b)(1)§ 6653(b)(2)§ 66541981$ 8,059.00$4,029.50$270.481982$10,653.00$5,326.50 *$666.84This case is before the Court on respondent's motion for summary judgment pursuant to Rule 121, filed on January 28, 1985. PROCEDURAL BACKGROUND In this statutory notice of deficiency dated January 5, 1984, respondent determined that petitioner received gross income from wages and tax table income for 1981 and 1982 as follows: Item19811982Gross income from wages$27,579.28$34,683.51Less personal exemption deduction1,000.001,000.00Tax table income$26,579.28$33,683.51From these figures respondent determined the deficiencies (using married filing*461 separate status) and additions to tax set forth above. On March 26, 1984, the Court filed as a petition a letter from petitioner requesting that he be sent a petition form. On May 30, 1984, the Court filed as an amended petition the petition form received from petitioner. Petitioner filled out paragraphs 1 through 3 but did not sign the petition form nor did he set forth therein any basis for opposing respondent's determinations or allege any facts. Paragraph 4 of the petition form reads "Set forth those adjustments, i.e. changes, in the NOTICE OF DEFICIENCY with which you disagree and why you disagree." Petitioner left that portion of the petition form completely blank. However, he placed an "X" in the box at the bottom of the petition form to indicate that he did not want to elect the "small tax case" procedures. In his answer, which was filed on July 23, 1984, respondent alleged numerous facts in support of his determinations that petitioner's underpayments of tax for 1981 and 1982 were due to fraud. Respondent alternatively alleged in the answer that petitioner was liable for the additions to tax under sections 6651 and 6653(a) for delinquency and negligence, if we determine*462 that petitioner is not liable for the additions to tax under section 6653(b). Respondent set out additional factual allegations in support of that alternative position. Petitioner filed no reply to respondent's answer. On October 9, 1984, pursuant to Rule 37(c), respondent filed a motion for entry of an order that the undenied allegations in the answer be deemed admitted. On the same date, the Court served on petitioner a notice of respondent's motion, along with a copy of the motion. That notice indicated that the motion would be granted if petitioner did not file a reply on or before October 29, 1984.Petitioner filed no reply. Therefore, by order dated November 7, 1984, the Court granted respondent's motion, and deemed the undenied affirmative allegations of fact set forth in paragraphs 6(a) through 6(p) and 7(a) through 7(h) of respondent's answer to be admitted for purposes of this case. Upon entry of our order, the pleadings herein were closed and the case was at issue. See Rules 34, 36, 37, 38, and 121. On January 28, 1985, respondent filed the motion for summary judgment presently under consideration. On February 1, 1985, the Court served petitioner with a notice*463 of filing along with a copy of the motion. That notice of filing indicated that if there was an objection, a notice of objection, setting forth the basis for the objection, was to be filed on or before February 21, 1985. Petitioner did not file any objection or any notice of any objection to respondent's motion for summary judgment. The following findings of fact are based on the record as a whole, allegations in respondent's answer admitting allegations in the amended petition, and those facts in respondent's answer deemed admitted by our order of November 7, 1984. FINDINGS OF FACT Petitioner Robert Randall Hendrickson (petitioner) resided in Emporia, Kansas, at the time he filed the petition herein. Petitioner did not file Federal income tax returns with the Internal Revenue Service for 1981 or 1982. During 1981 and 1982, petitioner was employed by Davis Electrical Constructors, Inc. Petitioner's wage income from his employer, income tax liabilities, and income taxes withheld from his wages during 1981 and 1982 were as follows: WageIncome TaxIncomeYearIncomeLiabilityTax Withheld1981$27,579.28$ 8,059.00$3,621.901982$34,683.51$10,653.00$3,043.75*464 Petitioner did not pay any portion of his Federal income tax liabilities for 1981 and 1982 in excess of the amounts withheld from his wages during those years. Petitioner knew and was well aware that he was required to file timely Federal individual income tax returns and that he had realized taxable income and had income tax liabilities for 1981 and 1982. Until 1981, petitioner had filed joint Federal income tax returns with his wife, Sandra L. Hendrickson, on which petitioner's income and income tax liabilities were duly reported. Nevertheless, petitioner failed to file income tax returns for 1981 and 1982. Instead, for 1981, petitioner filed a Form 1040 document purporting to be a return with the Internal Revenue Service Center in Austin, Texas.No financial information was provided on such document (except the amount of tax withheld) and each request for financial information was unanswered or answered with the words "object--self incrimination." Petitioner did not sign the Form 1040 purporting to be his tax return. Attached to this document were petitioner's affidavits signed April 17, 1976 in which petitioner, inter alia, acknowledged that persons with gross income*465 in excess of $750 must file income tax returns. 2During 1979 through 1983, *466 petitioner, with the intent to evade and defeat Federal income taxes, fraudulently filed with his employment false Employee's Withholding Allowance Certificates (Forms W-4), in which petitioner falsely certified under penalties of perjury that he was entitled to withholding allowances or exemptions form withholding as follows: Date of CertificateNo. of Allowances or Exemption ClaimedNovember 26, 197914 allowancesJuly 21, 19809 allowancesMay 27, 198120 allowancesDecember 30, 1981ExemptionJune 2, 19829 allowancesJune 29, 1982ExemptionOctober 28, 198214 allowancesJanuary 4, 1983ExemptionFor each of those W-4's in which petitioner claimed exemption, he falsely certified, under penalties of perjury, that he had incurred no liability for Federal income taxes for the preceding year, that he had a right to a full refund of all income tax withheld in the preceding year, and that he did not expect to owe any Federal income tax for the current year. At the time he made each of those false certifications, petitioner knew and was well aware that he had in fact incurred a liability for Federal income taxes for the preceding year, that he*467 did not have a right to a full refund of all taxes withheld for the preceding year, and that he would owe taxes for the current year. Petitioner, with the intent to evade and defeat Federal income taxes, refused to submit his books and records of account and records of his income-producing activities for 1981 and 1982 to respondent for examination. Petitioner's failure to file Federal income tax returns and to report and pay his Federal income tax liabilities for 1981 and 1982 was due to fraud with the intent to evade tax. All or part of petitioner's underpayment of tax for 1981 was due to fraud. All of petitioner's underpayment of tax for 1982 was due to fraud. OPINION It is clear from the affirmative allegations of fact that have been deemed admitted that respondent correctly determined the deficiencies in petitioner's Federal income taxes and the additions to tax under section 6654 3 for 1981 and 1982. Thus, those determinations warrant no further comment. *468 We must next determine whether the underpayment of tax for each year in issue was due to fraud within the meaning of section 6653(b). The fraud envisioned by section 6653(b) is actual, intentional wrongdoing, and the intent required is a specific purpose to evade a tax believed to be owing. Stoltzfus v. United States,398 F. 2d 1002, 1004 (3d Cir. 1968), cert. denied 393 U.S. 1020">393 U.S. 1020 (1969); Powell v. Granquist,252 F. 2d 56, 60 (9th Cir. 1958); Mitchell v. Commissioner,118 F. 2d 308 (5th Cir. 1941), revg. 40 B.T.A. 424">40 B.T.A. 424 (1939), followed on remand 45 B.T.A. 822">45 B.T.A. 822 (1941). Respondent bears the burden of proving, by clear and convincing evidence, that some part of the underpayment for each year in issue was due to fraud. 4 Sec. 7454(a); Rule 142(b). Respondent can satisfy his burden by showing that petitioner intended to evade taxes known to be owing by conduct calculated to conceal, mislead, or otherwise prevent the collection of such taxes. Stoltzfus v. United States,supra,398 F. 2d at 1004; Webb v. Commissioner,394 F.2d 366">394 F. 2d 366, 377 (5th Cir. 1968), affg. *469 a Memorandum Opinion of this Court; Rowlee v. Commissioner,80 T.C. 1111">80 T.C. 1111, 1123 (1983); Acker v. Commissioner,26 T.C. 107">26 T.C. 107, 111-113 (1956). *470 Fraud is a question of fact to be determined on the basis of the entire record. Mensik v. Commissioner,328 F. 2d 147, 150 (7th Cir. 1964), cert. denied 389 U.S. 912">389 U.S. 912 (1967), affg. 37 T.C. 703">37 T.C. 703 (1962); Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181, 199 (1976), affd. without published opinion 578 F. 2d 1383 (8th Cir. 1978); Otsuki v. Commissioner,53 T.C. 96">53 T.C. 96, 105-106 (1969). Fraud is never presumed, but rather must be established by affirmative evidence. Beaver v. Commissioner,55 T.C. 85">55 T.C. 85, 92 (1970). Direct proof of the taxpayer's intent is rarely available; therefore, the taxpayer's entire course of conduct must be considered and the requisite fraudulent intent can be established by circumstantial evidence. Spies v. United States,317 U.S. 492">317 U.S. 492 (1943); Rowlee v. Commissioner,supra,80 T.C. at 1123; Gajewski v. Commissioner,supra,67 T.C. at 200; Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 223-224 (1971); Otsuki v. Commissioner,supra,53 T.C. at 105-106. Willful failure to file a timely return*471 does not in itself and without more establish liability for the fraud addition. Cirillo v. Commissioner,314 F. 2d 478, 482 (3d Cir. 1963), revg. in part and affg. in part a Memorandum Opinion of this Court. However, an intent to evade taxes may be inferred from the circumstances attending a particular failure to file, Cirillo v. Commissioner,supra, at 482, and a pattern of nonfiling, when coupled with affirmative evidence of intent to defraud, warrants imposition of the fraud addition. Stoltzfus v. United States,supra,398 F. 2d at 1005; Grosshandler v. Commissioner,75 T.C. 1">75 T.C. 1, 19 (1980). The filing of false withholding certificates is clear evidence of fraud. See Hebrank v. Commissioner,81 T.C. 640">81 T.C. 640, 642 (1983); Rowlee v. Commissioner,supra,80 T.C. at 1125, 1126; Stephenson v. Commissioner,79 T.C. 995">79 T.C. 995, 1007 (1982), affd. 748 F.2d 331">748 F.2d 331 (6th Cir. 1984); Habersham-Bey v. Commissioner,78 T.C. 304">78 T.C. 304, 313-314 (1982). A taxpayer's refusal to cooperate with respondent's attempt to determine his correct tax liability can be*472 a further indicium of fraud. Millikin v. Commissioner,298 F. 2d 830, 836 (4th Cir. 1962); Powell v. Granquist,supra,252 F. 2d at 61; Rowlee v. Commissioner,supra,80 T.C. at 1125; Grosshandler v. Commissioner,supra,75 T.C. at 20; Gajewski v. Commissioner,supra,67 T.C. at 200. Respondent can satisfy his burden of proving fraud through undenied facts deemed admitted under Rule 37(c). Doncaster v. Commissioner,77 T.C. 334">77 T.C. 334, 337 (1981) (Court reviewed); Marcus v. Commissioner,70 T.C. 562">70 T.C. 562, 577 (1978), affd. in an unpublished opinion 621 F. 2d 439 (5th Cir. 1980); Gilday v. Commissioner,62 T.C. 260">62 T.C. 260, 262 (1974). Here, material factual allegations in the answer regarding fraud with intent to evade tax have been deemed admitted by our order of November 7, 1984. They establish that: (1) For years prior to 1981 petitioner filed joint returns with his wife; (2) Petitioner failed to file returns for 1981 and 1982; (3) For 1981 petitioner filed a document purporting to be a return but which provided no financial information;*473 (4) During the years 1979 through 1983 petitioner filed eight false withholding certificates claiming exemptions from withholding or withholding allowances in excess of the number to which he was entitled; (5) Petitioner refused to submit his books and records to respondent for examination; (6) All or part of petitioner's underpayment of tax for 1981 was due to fraud; and (7) All of petitioner's underpayment of tax for 1982 was due to fraud. These facts clearly and convincingly establish that all or part of petitioner's underpayment of tax for 1981 and all of petitioner's underpayment of tax for 1982 were due to fraud with intent to evade tax. Thus, we sustain respondent's imposition of the section 6653(b) additions. See n. 4, supra.Rule 121 provides that a party may move for summary judgment upon all or any part of the legal issues in controvery so long as there are no genuine issues of material fact. Rule 121(b) states that a decision shall be rendered "if the pleadings * * * and any other acceptable materials, together with the affidavits, if any, whow that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law. *474 " In addition to those facts deemed admitted by our order of November 7, 1984, this record contains a complete copy of the notice of deficiency, the petition, the amended petition, and the answer. Respondent has amply demonstrated that there is no genuine issue as to any material fact present in this record and, thus, that respondent is entitled to a decision as a matter of law. In such posture, summary judgment is a proper procedure for disposition of this case. therefore, respondent's motion for summary judgment will be granted in every respect. Finally, we consider whether we should, on our own motion, award damages to the United States under section 6673. 5 Under that provision, when this Court determines that the proceeding before it has been instituted or maintained by the taxpayer primarily for delay or that the taxpayer's position therein is frivolus or groundless, the Court, in its discretion, may award damages up to $5,000 to the United States. *475 Neither the petition nor the amended petition herein sets forth any basis for opposing respondent's determinations. Petitioner has not alleged a single justiciable fact. Petitioner has not alleged any facts, must less any facts that would support a claim that respondent's determinations are erroneous. Petitioner did not file a reply to respondent's answer. Petitioner did not file a reply or any objection to respondent's motion under Rule 37(c). Petitioner did not file a reply or any objection to respondent's motion for summary judgment, or any other document indicating petitioner's position in this case. The only hint of a position comes from the two tax protester-type documents attached to the essentially blank Form 1040 that petitioner filed as his purported tax return for 1981. 6 Those two documents, affidavits signed by petitioner in 1976, contain only frivolous or groundless contentions. See n. 2, supra. Petitioner has no basis for opposing respondent's determinations so far as this Court can discern from the record. Consequently, the only inference we can draw from the record as a whole is that not only is petitioner's position, if any, frivolous and*476 groundless, but this proceeding was instituted and maintained by petitioner primarily for delay. Thus, we award damages in the amount of $3,000 to the United States under section 6673. See Coulter v. Commissioner,82 T.C. 580">82 T.C. 580 (1984); Abrams v. Commissioner,82 T.C. 403">82 T.C. 403 (1984); Grimes v. Commissioner,82 T.C. 235">82 T.C. 235 (1984). To reflect the foregoing, An appropriate order and decision will be entered.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. * Fifty percent of the interest payable under section 6601 with respect to the portion of the underpayment attributable to fraud.↩2. One of the affidavits was a preprinted tax protester form purporting to explain why he did not sign his return and why he claimed the Fifth Amendment. The other affidavit form (AFFIDAVIT OF MY UNDERSTANDING OF A UNITED STATES "DOLLAR") is another preprinted tax protester form containing frivolous arguments about what constitutes a "dollar." Such arguments that Federal Reserve Notes are not "dollars" or not "legal tender" are legally frivolous. United States v. Ware,608 F. 2d 400 (10th Cir. 1979); United States v. Benson,592 F. 2d 257 (5th Cir. 1979); United States v. Anderson,584 F. 2d 369 (10th Cir. 1978); Mathes v. Commissioner,576 F. 2d 70↩ (5th Cir. 1978). In this affidavit, petitioner says he does not understand what constitutes a dollar and argues that he has not earned any of what he calls "gold-dollars." However, he knows, just as any other taxpayer knows, that the Internal Revenue Service, like the corner grocer, is not asking him to report his income or pay his taxes in "gold-dollars" but in Federal Reserve Notes.3. The additions to tax under section 6654 are mandatory because petitioner made no payment of estimated tax during the years in issue. See Durovic v. Commissioner,84 T.C. 101">84 T.C. 101, 117-118 (1985); Grosshandler v. Commissioner,75 T.C. 1">75 T.C. 1, 20-21↩ (1980).4. Under section 6653(b)(1), if "any part" of the underpayment of tax is "due to fraud," the 50 percent fraud addition applies to the entire underpayment. Under section 6653(b)(2), there is a further addition of 50 percent of the interest payable under section 6601 "with respect to the portion of the underpayment" which is attributable to fraud. See sec. 6653(b)(2)(A). The term "underpayment" for purposes of either section 6653(b)(1) or section 6653(b)(2) is defined in section 6653(c)(1) as the "deficiency" as defined in section 6211, but with an exception. The parenthetical exception reads except that, for this purpose, the tax shown on a return referred to in section 6211(a)(1)(A) shall be taken into account only if such return was filed on or before the last day prescribed for the filing of such return, determined with regard to any extension of time for such filing * * *. (Emphasis added.) Also section 6211(b)(1) expressly provides that the "deficiency" is determined without regard to the credit under section 31 [withheld taxes]. Petitioner failed to file any return for 1982 and therefore any "deficiency" and consequently any "underpayment" will not be reduced by the amount of taxes actually withheld for the year. Compare the late filing addition under section 6651 which is imposed on the net amount due, rather than on the deficiency or underpayment. See sec. 6651(b). However, for purposes of the interest computation under section 6601, interest applies to the tax unpaid on or before the last date prescribed for payment. Sec. 6601(a). Under section 6513(b)(1) tax actually deducted and withheld at the source is deemed paid "on the 15th day of the fourth month following the close of [the taxpayer's] taxable year with respect to which such tax is allowable as a credit under section 31" (i.e. April 15). Further, section 6653(b)(2)(B) itself prescribes the period for computing the additional amount (50 percent of interest payable under section 6601) as * * * the period beginning on the last day prescribed by law for payment of such underpayment (determined without regard to any extension) and ending on the date of the assessment of the tax (or, if earlier, the date of the payment of the tax). Thus, if the Court determines that some portion of petitioner's underpayment of tax for each year is due to fraud, the 50 percent fraud addition will apply to the entire underpayment for each year. If the Court further determines, as respondent urges, that the entire underpayment of taxes for 1982 (the total deficiency amount of $10,653) is the portion attributable to fraud under section 6653(b)(2), nonetheless in computing interest under section 6601, it would seem that any interest for purposes of section 6601 or section 6653(b)(2) would be computed on the remaining unpaid tax of $7,609.25 and that the withheld tax of $3,043.75 would be deemed to have been paid on April 15, 1983, when the 1982 return was due.↩5. As applicable to this case, section 6673 provides as follows: SEC. 6673. DAMAGES ASSESSABLE FOR INSTITUTING PROCEEDINGS BEFORE THE TAX COURT PRIMARILY FOR DELAY, ETC. Whenever it appears to the Tax Court that proceedings before it have been instituted or maintained by the taxpayer primarily for delay or that the taxpayer's position in such proceedings is frivolous or groundless, damages in an amount not in excess of $5,000 shall be awarded to the United States by the Tax Court in its decision. Damages so awarded shall be assessed at the same time as the deficiency and shall be paid upon notice and demand from the Secretary and shall be collected as a part of the tax.↩6. That essentially blank Form 1040 does not constitute a tax return. See Edwards v. Commissioner,680 F. 2d 1268 (9th Cir. 1982) and cases collated at p. 1270; United States v. Porth,426 F. 2d 519, 523 (10th Cir. 1970), cert. denied 400 U.S. 824">400 U.S. 824↩ (1970). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624800/ | The Norbury Sanatorium Co., Petitioner, v. Commissioner of Internal Revenue, RespondentNorbury Sanatorium Co. v. CommissionerDocket No. 12957United States Tax Court9 T.C. 586; 1947 U.S. Tax Ct. LEXIS 77; October 6, 1947, Promulgated *77 Decision will be entered for respondent. Petitioner is an institution specializing in the care of the mentally ill for profit, and keeps its books on an accrual basis. In 1924 it undertook the care of William, the mentally defective son of Victor Gauss. Victor was 69 years old and of limited financial means. For the primary purpose of insuring the care of William during his lifetime and after the death of Victor, Victor entered into an agreement in 1924 with petitioner and with a bank as trustee. Pursuant to this agreement Victor gave bonds of a value of $ 28,000 to the trustee. After Victor's death the trustee was to pay the trust income to petitioner, or, if petitioner had not given to William proper care, then to some other institution in which the trustee had placed William, and at William's death the trustee was to hand over all the bonds to petitioner or to such other institution having the care of William for 6 months prior to his death. Victor died in 1931. William died in 1944, while still in the care of petitioner. In the latter year petitioner was entitled to have delivered to it by the bank the bonds having a value of $ 28,000. Held, petitioner received*78 income in that amount in 1944. Stanley Worth, Esq., for the petitioner.A. H. Moorman, Esq., for the respondent. Kern, Judge. KERN *586 Respondent determined a deficiency in petitioner's income tax for the year 1944 of $ 12,421.72, and a deficiency in declared value excess profits tax for the same year of $ 3,167.72. These deficiencies result from respondent's holding that petitioner realized taxable income in 1944 in an amount representing the value of the assets of a trust of which, respondent contends, petitioner became the owner in that year.FINDINGS OF FACT.Petitioner is an Illinois corporation which filed its tax returns for the year 1944 with the collector of internal revenue at Springfield, Illinois. During all the years here material it kept its books and filed its returns on the accrual basis. Its business was and is, to a large extent, the treatment and care of nervous and mental cases.On September 28, 1924, William Gauss was admitted as a patient to petitioner's sanatorium. He was the only surviving child of Victor Gauss, who was 69 years old and had lost his wife and 3 other children *587 from tuberculosis. William was at that time 32 years*79 old, but had the mentality of a 3-year old child. He weighed 89 pounds, had been losing weight, would not eat, and required forced feeding.In addition to being mentally defective, with the mentality of a three-year old child, William Gauss showed definite organic signs of brain involvement and physical involvement of both the heart and the lungs, his diagnosis at the time of said admission being:Mental defective; probably suffering from affective oculation at the present time. Physical: Underdeveloped, undernourished. Microcephalic type of head; pupils do not respond to light; pyorrhea; whistling cystolic murmur transmitted to axilla; slight peripheral thickening of vessels; plus 100; blood pressure 120 over 70; dullness of both apices; rare crackles on inspiration; increased fremitus over dull area; simian type of growth of hair over lower back; bilateral Babinski, Gordon and Oppenheim.Victor Gauss realized that his son would require institutional care throughout his life. Because of his own advanced age he was especially concerned about the care of William in the event William survived him many years, since his financial resources were limited. He was anxious to make some*80 arrangement by which the proper care of William might be assured during William's lifetime, even though he (Victor) should predecease him and leave a negligible estate. William was his only remaining obligation.After some negotiations with the president of petitioner a contract and trust agreement was entered into by Victor, petitioner, and the First National Bank of Belleville, Illinois. This reads as follows:This Agreement made and entered into the 30th day of October A. D. 1924, between Victor Gauss of the first part, The Norbury Sanitorium Company, an Illinois Corporation of the second part, and the First National Bank of Belleville, Illinois, of the third part;Witnesseth: That Whereas, the second party is operating a sanitorium in and near the City of Jacksonville, Illinois, for the treatment of persons afflicted with nervous diseases and other mental troubles; and,Whereas, the second party has been caring for, maintaining and treating William Gauss, son of the first party, for some time past; and,Whereas, it is realized by the parties hereto that in all probability the physical and mental health of said William Gauss will never be fully restored and that he will require*81 hospitalization and treatment for the term of his life; and,Whereas, the first party is unable to personally care for his son, but is willing and anxious that some suitable arrangements be made whereby the son may have as much medical treatment, comfort and happiness as the circumstances will justify; and,Whereas, the services rendered by the second party to the first party for and on behalf of said William Gauss have been satisfactory to said first party, and it is the desire of said first party that said second party shall continue to care for said son so long as he lives, and is desirous of creating a trust fund that the expense for such care and treatment may always be forthcoming irrespective of what may happen to the first party, and is willing to reward the said second party for its faithful services;*588 Now Therefore: Said first party has this day deposited with the party of the third part, as trustee, bonds of the par value of twenty-eight thousand dollars ($ 28,000.00) and of the approximate market value of twenty-eight thousand dollars ($ 28,000.00), which said bonds are to be held in trust on the conditions hereafter mentioned.(1) The second party hereby agrees*82 to take care of said William Gauss, that is to say, to room and board him, laundry his clothes, give him necessary medical attention and render such other services as might reasonably be expected and be necessary for his comfort and welfare so long as the said William Gauss lives, or so long as this contract remains in full force as hereinafter provided; the said William Gauss to have the very best and highest degree of care and attention.(2) In consideration of the services rendered by the second party to the said William Gauss, the first party agrees to pay the second party the sum of one hundred dollars ($ 100.00) on the first day of each and every calendar month from the date of this contract, and shall continue to pay said amount on the first day of each and every month during the lifetime of said William Gauss; said payment to be made from the funds of private resources of said first party, exclusive of the trust funds hereinafter mentioned. And it is further agreed that in case the said William Gauss precedes the first party in death, that bonds in the sum of five thousand dollars ($ 5,000.00) of the then market value, shall also be paid over to said second party by the party*83 of the third part, which said bonds shall be the absolute property of said second party, and the remainder of said trust fund shall be paid over immediately to the first party, his heirs, executors, administrators or assigns.(3) In the event that the first party precedes the said William Gauss in death, it is further agreed that the income from the twenty-eight thousand dollars ($ 28,000.00) in bonds so held by said Trustee, shall, after paying the expense of said trusteeship, be paid to the second party in annual, semi-annual or quarterly payments as may be designated by said second party, and upon the death of said William Gauss, said trustee shall turn over and transfer to the second party said bonds, or other securities, which might be in said trustee's hands of the approximate market value of twenty-eight thousand dollars ($ 28,000.00) and said bonds or securities shall be the absolute property of the second party; it being the intention of the first party that said twenty-eight thousand dollars ($ 28,000.00) shall be a reward and proper compensation to said second party for having rendered care and treatment to the said William Gauss during his lifetime.(4) So long as the *84 said first party and his son, William Gauss, are living, the income from the bonds of the par value of twenty-eight thousand dollars ($ 28,000.00) shall be paid to said first party in annual, semi-annual or quarterly installments as may be designated by said first party, but that in case of the death of William Gauss prior to the death of the first party, then bonds of the market value of five thousand dollars ($ 5,000.00) shall be transferred to said second party, and the remainder of said trust fund shall be paid to the first party as hereinbefore set forth, and, in the event of the death of William Gauss subsequent to the death of the first party, then the income from said trust fund of twenty-eight thousand dollars ($ 28,000.00) shall be paid to the second party during the lifetime of said William Gauss, and at his death, the whole of said bond fund shall be paid to said second party as hereinbefore set forth.(5) It is further understood and agreed between the parties that the first party may, at any time prior to his death, withdraw his son, William Gauss, from said sanitorium upon the payment of a lump sum of money which would produce an equivalent of three hundred dollars ($ *85 300.00) per month from the date of this contract to the date of such withdrawal, less, however, the payment of one hundred dollars ($ 100.00) heretofore paid by the first party under this contract, *589 and this contract shall thereupon become null and void and said trustee shall be allowed to return the bonds held in trust by him whenever said first party exhibits receipts signed by said The Norbury Sanitorium and its duly authorized officers, showing full receipt of payments made to it by said first party as provided herein.(6) In case, however, the second party should mistreat the said William Gauss, or should wilfully neglect him after the death of said first party, it is further understood that the trustee may, after the Board of Arbitration so awards, remove said William Gauss from the sanitorium of the second party and transfer said William Gauss to another institution or to some person or persons whereby he can properly be cared for, and the income from said twenty-eight thousand dollars ($ 28,000.00) in bonds shall be paid to such other institution or person or persons who shall have the care of said William Gauss, and, in the event such other institution or person *86 or persons have properly kept said William Gauss for a continuous period of six (6) months prior to his death, then upon the death of said William Gauss, the bonds of the approximate market value of twenty-eight thousand dollars ($ 28,000.00) shall be transferred by said trustee to such other institution or person or persons, and such other institution or person or persons shall be the absolute owner thereof.But, in case such other institution or person or persons has not kept said William Gauss for a continuous period of six (6) months prior to his death, then said entire bond fund shall revert to the estate of the party of the first part and shall be distributed according to the terms of the will of said first party, or descend according to the laws of descent as provided by statutes of the State of Illinois for persons dying intestate. It is further agreed that said trustee shall not be the judge as to the degree of care and treatment which shall be rendered by said second party to said William Gauss, and, in the event of a dispute between the second party and the said trustees as to the kind of care and treatment that is given to said William Gauss after the death of the first*87 party, and such difference cannot be amicably adjusted, that said controversy shall be referred to the arbitration of three disinterested persons who shall be selected by the President of the Illinois State Medical Society, and, in case there is no such President or any such organization, or such President refuses to appoint such Board of Arbitration, then three persons composed of persons selected by the then President of the American Medical Association shall form such Board of Arbitration. Said arbiters shall not be related nor connected directly or indirectly with any of the parties who might be directly or indirectly interested in said trust fund, nor shall the members of said Board of Arbitration be residents of Morgan County, Illinois, or St. Clair County, Illinois, nor any other county which lies contiguous to either of said counties. Said Board shall have the right to meet and hear such evidence as they may consider proper and appropriate and make any other investigation as they see fit, and the written award or determination of such Board of arbitration, or a majority of the membership thereof, as to whether or not said William Gauss has received proper care and treatment, *88 shall be final and binding upon the parties hereto respectively and their respective heirs, executors, administrators, successors or assigns; that the expense of said Board of Arbitration shall be paid by said trustee from funds in his hands.(7) It is further agreed that the bonds or securities placed in the hands of the trustee by said first party may be withdrawn from time to time by said first party and other bonds or securities substituted therefor, provided such withdrawal or substitution is consented to in writing by said second party. After the death of Victor Gauss and prior to the death of William Gauss, the bonds or securities in the hands of said trustee may be withdrawn from time to time by *590 said trustee and other bonds or securities substituted therefor, provided such withdrawal or substitution is consented to in writing by said second party.(8) It is further agreed that upon the death of William Gauss, the second party will ship his remains to the party of the first part at Belleville, Illinois, or in case said first party is not living, then to the nearest next relative of the first party as may be living.(9) It is further agreed that the trustee shall *89 be paid the sum of $ 50.00 per year for services rendered as such trustee and said third party represents that it is authorized to act as trustee and will accept the responsibilities therefor.In Witness Whereof said first party has hereunto set his hand and seal the day and year first above written, and the second and third parties have, in pursuance of a resolution of the Board of Directors, caused this contract to be signed by its President and the seal of the corporation has been placed thereon the day and year first above written.Victor Gauss lived until October 24, 1931, and William lived and remained a patient of petitioner until December 5, 1944.At the date of this agreement, the petitioner had two general classes of patients, namely, custodial and noncustodial. The former required less intensive care than did the latter, which were the acute cases. The customary rates charged by petitioner at that time were $ 40 per week for custodial patients and $ 50 per week for noncustodial patients. Later, the rates were increased and the same rate is now charged for all patients, namely $ 75 per week for the first four weeks and $ 65 per week thereafter. These rates included medical*90 care, i. e., services of a staff physician, general nursing, room and board, but did not include laundry or barber services or other incidentals, which were billed to the patient.During the period 1924 to 1944, inclusive, petitioner accepted patients other than William Gauss at rates less than petitioner's customary charges for similar patients. The number of patients receiving the benefit of a special rate was not large and would average 3 or 4 per cent of petitioner's total number of cases. The account of William Gauss and the accounts of other special rate patients were kept in the same manner on the books of petitioner.Petitioner operated its sanatorium for profit and received no financial assistance of a state or public character. The sanatorium's profitable operation depends entirely on revenue from services rendered. The stock of petitioner is closely held, and Dr. Dollear, its president, has been the majority stockholder for many years. For the period 1932 to 1937 petitioner operated at a loss.After the death of Victor Gauss, a representative of the bank would visit the sanatorium at least once, and sometimes twice, a year. The bank representative would observe the*91 patient, William Gauss, look about the sanatorium, and confer with some member of the staff. The distance between Belleville, Illinois, where the First National Bank is located, and petitioner's sanatorium is about 125 miles. The visits were usually unannounced, surprise visits made for the purpose *591 of ascertaining William Gauss' condition and the care he was receiving. The bank felt that its duties and responsibilities as trustee required it to make such visits. On one occasion when the bank received a letter stating that the writer had information regarding William Gauss, the bank requested and obtained a conference with Dr. Dollear, president of petitioner. The conference related to the question whether petitioner was providing proper care to William Gauss. Petitioner regularly submitted written reports to the trustee relating to the physical condition and welfare of William Gauss. Such reports were submitted to the trustee on the average of twice a month.Between the date of the agreement in 1924 and the date of his death in 1931, Victor paid the petitioner the sum of $ 100 per month for the care of William, and also paid for incidental charges, other than for *92 laundry, as provided in the agreement. Following the death of Victor, the trustee under the agreement reimbursed petitioner for incidental charges for William (not including laundry and barber service) and paid currently to the petitioner the balance of the income from the bonds which it held, after deducting its annual fee of $ 50.After the death of Victor in 1931, the petitioner continued to accrue income for the care of William at the rate of $ 100 per month just as it had during the lifetime of Victor. Periodically, when a debit balance in the account had accumulated by reason of the fact that such accruals exceeded the income from the bonds which was remitted to petitioner by the trustee, certain credits were made to the account, the credits being designated "Rebates to adjust rate to conform to revenue from interest on bonds held in Trust Fund." These credits were made for the purpose of adjusting the charges made to the account to correspond with the amounts actually received.Petitioner reported as income for each year with respect to the account of William the amount actually received by it in such year.It is admitted by the pleadings that when William died on December*93 5, 1944, the petitioner was entitled to have delivered to it by the trustee bonds having a fair market value of $ 28,162.20.OPINION.The decision of this case turns upon the construction to be given to the contract of October 30, 1924, which is set out in its entirety in our findings.It is petitioner's contention that it became the equitable owner of the bonds held in trust pursuant to that contract in 1931, and therefore, the market value of those bonds was taxable income to it in that year rather than in 1944, when William Gauss died. In the alternative, petitioner contends that it should have accrued its regular charges for the care of William commencing with the date of his admission *592 to petitioner's institution and should have charged the excess of such accruals over the income from the bonds actually received, to the corpus of the bonds held by the trustee.Respondent contends that, since petitioner was not entitled to receive the bonds from the trustee until William's death in 1944, the fair market value of the bonds on that date was taxable income to petitioner in 1944 and in no other year.The unusual arrangement made by petitioner Victor Gauss and the bank, as*94 trustee, must be construed as a whole and in the light of all the facts disclosed by the record.In 1924 Victor Gauss was approaching the age of three score years and ten. He was a man of limited financial means. His wife and three of his children had died from tuberculosis. His one surviving child was a son, who was so completely defective mentally and physically that he would need specialized care throughout his life. Victor Gauss felt that petitioner could give to his son such care. His great concern was to arrange for the care of his son after his own death and to arrange for the payment of this care with the limited funds which he had for this purpose.Petitioner was willing to furnish the care for William, but, of course, desired to be adequately compensated for its services.The contract in question covered all possible eventualities. During Victor's life he agreed to pay to petitioner $ 100 per month (an amount somewhat below the usual charge made by petitioner in 1924 for the care of patients). If, during Victor's lifetime William was withdrawn from petitioner, then Victor agreed to make additional payments to petitioner so that the total amount paid would be equivalent*95 to $ 300 per month for the time William was in petitioner's care. At the time the contract was executed Victor gave to a bank, as trustee, bonds having a fair market value of $ 28,000. If William died during Victor's life, then petitioner was to receive from the trustee, in addition to the $ 100 per month paid by Victor, bonds of the market value of $ 5,000. If Victor should predecease William, then petitioner was to receive, in lieu of the $ 100 per month paid by Victor, the income from the bonds held in trust, and upon the death of William (after the death of Victor) was to receive these bonds from the trustee as "a reward and proper compensation * * * for having rendered care and treatment to the said William during his lifetime." If, after Victor's death, it should be determined that petitioner mistreated William or willfully neglected him, then William was to be transferred to another institution, which, if it cared for William for six months before his death, would be entitled to receive the bonds.Thus, after Victor's death petitioner was obligated by this contract to furnish care and attention to William during his life and was entitled to receive as compensation the current*96 income from the bonds *593 put in trust by Victor to accomplish the purposes of the contract and to receive the bonds themselves (the corpus of the trust) at the end of William's lifetime if William was being cared for by petitioner at that time.While petitioner had certain rights under the contract of 1924 contingent upon its furnishing proper care to William, it is apparent that the real beneficiary of the trust referred to in the contract and created contemporaneously with its execution was Victor's defective son William. It was primarily for his benefit that the trust was created. The purpose of the trust was to provide and insure proper care for William during his lifetime. It was contemplated that petitioner would furnish this care, but the possibility was also contemplated that petitioner could not, or would not, furnish the proper care for William. The income of the trust during William's life was to be expended for William's benefit. It was to be paid to petitioner or any other institution caring for William. Since this income would not, in all probability, be sufficient to pay charges usually made for institutional care, it was provided, for the purpose of inducing*97 petitioner or another similar institution to furnish proper care to William at a rate of compensation below the customary charges, that upon William's death the corpus of the trust was to be distributed either to petitioner or to such other institution which had cared for William for six months prior to his death.Petitioner's principal contention is that its rights after the death of Victor in 1931 were analogous to those of a vendee in situations where the possession of or the legal title to property is placed in escrow for the purpose of securing the payment of the purchase price, and it points out authorities holding, for tax purposes, that the vendee obtains equitable and beneficial ownership of the property when it is placed in escrow, subject only to the possibility of losing that ownership upon failure to pay the purchase price agreed upon. ; ; ; ; .*98 Petitioner argues that upon Victor's death it became the beneficial and equitable owner of the bonds forming the corpus of the trust, legal title to which was held by the trustee to secure the performance of petitioner's obligation to care for William, and that it was only subject to be divested of this ownership upon the occurrence of a condition subsequent, viz., its failure to furnish proper care to William. Therefore, petitioner concludes, it was taxable upon the fair market value of the bonds held by the trustee as income received by it in 1931, and not in 1944, the year of William's death.We do not agree with petitioner's argument. In our opinion, Victor did not intend by the arrangement entered into in 1924 to transfer to *594 petitioner upon his death the beneficial ownership of the bonds forming the corpus of the trust, subject to being divested of this beneficial ownership upon the occurrence of a condition subsequent, viz., petitioner's failure to furnish proper care to William during William's lifetime. William was the real beneficiary of the trust; it was for the purpose of obtaining proper care for him during his lifetime and after the death of his father, that*99 the trust was created. As compensation for its services rendered to the trust in caring for William, petitioner was to receive the current trust income; and as additional compensation and an inducement to petitioner to comply faithfully with its undertaking to care for William, even though the currently distributable compensation was less than the charges customarily made for similar services, it was provided that upon William's death while still in petitioner's institution, and upon the consequent termination of the trust, petitioner was to receive the trust corpus.We conclude, after an examination of the 1924 contract as a whole and in the light of all the surrounding facts, that petitioner became the beneficial owner of the bonds held by the trust only at the end of William's life, when the trust terminated and when petitioner completed its undertaking to properly care for William during his lifetime.We are also unable to agree with petitioner's alternative contention that the bonds constituted accrued income in years prior to 1944. In connection with this contention, petitioner suggests that it should have accrued its regular charges for the care of patients as charges for*100 William's care and, in so far as they would have been in excess of the trust income, this excess should have been charged to the corpus of the bonds held by the trustee. In our opinion such an accrual method was not justified under the terms of the contract.Decision will be entered for respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624801/ | RAYMOND F. DIXON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDixon v. CommissionerDocket No. 34839-84.United States Tax CourtT.C. Memo 1986-563; 1986 Tax Ct. Memo LEXIS 46; 52 T.C.M. (CCH) 1076; T.C.M. (RIA) 86563; November 24, 1986. Raymond F. Dixon, pro se. Roslyn G. Taylor, for the respondent. PATEMEMORANDUM OPINION PATE, Special Trial Judge: This case was heard pursuant to the*48 provisions of section 7456(d) [redesignated as sec. 7443A by the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. ] and Rules 180, 181 and 182. 1Respondent determined the following deficiency in and additions to petitioner's Federal income tax for the year 1982: Deficiency$5,923.00Additions to Taxsec. 6653(a)(1)296.16sec. 6653(a)(2)*sec. 6661(a)592.00In addition, respondent asks this Court to award damages to the United States under section 6673. Petitioner filed a timely Federal income tax return for the year 1982 reporting thereon wages of $24,298.83 and deducting therefrom $19,773.83 as the cost of his labor. On a notice of deficiency dated July 19, 1984, respondent disallowed the deduction for petitioner's labor, allowed deductions for sales taxes and income taxes and computed the tax using rates applicable to persons married filing separately. Petitioner filed a timely*49 petition with this Court on October 9, 1984. 2 He resided in Hopkins, South Carolina at the time his petition was filed. He was married in 1982 but did not file a joint return with his wife. Petitioner does not dispute that he received the income that he included on his income tax return as filed. However, he now contends that he does not owe any tax because (1) the income tax laws are unconstitutional; (2) an individual is not required to file a return; (3) the cost of supplying his labor to earn his wages is deductible; (4) wealthy persons and corporations pay little or no tax, and therefore, it is unfair for him to be taxed at a much higher rate; and (5) his constitutional rights were violated when he was not provided with free legal counsel to represent him before this Court. 3 These arguments have been rejected by this and other courts on innumerable occasions. Nevertheless, we briefly address each of them in turn. *50 The Federal income tax laws are constitutional. Since the ratification of the Sixteenth Amendment, it is immaterial with respect to income taxes whether the tax is a direct or indirect tax. Brushaber v. Union Pac. R.R. Co.,240 U.S. 1">240 U.S. 1 (1916). See Hayward v. Day,619 F.2d 716">619 F.2d 716 (8th Cir. 1980). There is no doubt that petitioner was required to file an income tax return for the year 1982 and that he was required to pay taxes on his wages. See secs. 1, 61, 6011, 6012(a)(1)(A), and 7701(a)(1); sec. 1.6012-1, Income Tax Regs.; Rowlee v. Commissioner,80 T.C. 1111">80 T.C. 1111 (1983), and the cases cited therein. Further, petitioner may not deduct the $19,723.83 as the cost of his labor. Deductions are a matter of legislative grace and may be taken only when specifically allowed by Congress. White v. United States,305 U.S. 281">305 U.S. 281 (1938); Helvering v. Independent Life Ins. Co.,292 U.S. 371">292 U.S. 371, 381 (1934). We can find no statutory authority for such a deduction. Reading v. Commissioner,70 T.C. 730">70 T.C. 730, 734 (1978), affd. 614 F.2d 159">614 F.2d 159 (8th Cir. 1980). Petitioner further argues that he should*51 not have to pay Federal income tax because some wealthy individuals and corporations pay little or no tax and it is unfair for the government to tax him at such a high rate. Again, stated simply, this Court has no power with which to award judgment to petitioner on these grounds. New Colonial Ice Co. v. Helvering,292 U.S. 435">292 U.S. 435, 440 (1934). For petitioner to qualify for any exemption, deduction or credit, he must prove that he comes within the terms of a particular statute. Deputy v. duPont,308 U.S. 488">308 U.S. 488, 493 (1940). This, petitioner has failed to do. 4Lastly, petitioner complains that his constitutional rights were violated when he was not afforded free counsel to represent him in this lawsuit. Based on petitioner's reported income for the year in issue we know of no reason why, if petitioner had desired representation, he could not have obtained it. Nevertheless, the Sixth*52 Amendment of the Constitution of the United States only deals with criminal cases and is not applicable to the civil proceeding here. Cupp v. Commissioner,65 T.C. 68">65 T.C. 68, 85-86 (1975), affd. without published opinion 559 F.2d 1207">559 F.2d 1207 (3d Cir. 1977). Further, petitioner was afforded a full opportunity to be heard and none of his rights were violated. See Ginter v. Southern,611 F.2d 1226">611 F.2d 1226, 1229 (8th Cir. 1979), cert. denied 446 U.S. 967">446 U.S. 967 (1980). Respondent has also asserted additions to tax under section 6653(a)(1) and (2) and section 6661(a). Petitioner has the burden of proving that respondent's determination is erroneous. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Petitioner has failed to contest these additions with any evidence or arguments except for the meritless arguments discussed above. Accordingly, we hold for respondent as to the deficiency and additions to tax shown on the notice of deficiency. Catalano v. Commissioner,81 T.C. 8">81 T.C. 8 (1983), affd. without published opinion sub nom. Knoll v. Commissioner,735 F.2d 1370">735 F.2d 1370 (9th Cir. 1984). Finally, we must*53 consider whether to award damages to the United States pursuant to section 6673. This Court is permitted to award damages up to $5,000 where we find that the proceedings were instituted or maintained by the taxpayer primarily for delay or where the taxpayer's position in such proceedings is frivolous or groundless. Sydnes v. Commissioner,74 T.C. 864">74 T.C. 864, 870-873 (1980), affd. 647 F.2d 813">647 F.2d 813 (8th Cir. 1981). Having reviewed the record, we can only conclude that the positions petitioner maintained herein are frivolous and groundless. See Abrams v. Commissioner,82 T.C. 403">82 T.C. 403 (1984). Accordingly, we award the United States damages in the amount of $4,000. Decision will be entered for the respondent.Footnotes1. Unless otherwise stated, all section references are to the Internal Revenue Code of 1954, as amended, and all rule references are to the Tax Court Rules of Practice and Procedure.↩*. Fifty percent of the interest due on the underpayment of $5,923.00.↩2. The petition was mailed on October 6, 1984. A petition mailed within 90 days of the issuance of the notice of deficiency is deemed to be timely filed. See secs. 6213 and 7502.↩3. Petitioner raised other issues in his petition but abandoned them at trial.↩4. If petitioner believes his tax to be unfair we advise him to direct his energies toward attempting to influence Congress to change provisions which he perceives to be inequitable. They must be changed by properly enacted legislation before we can grant relief.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624803/ | BERTHA M. PENNINGTON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentPennington v. CommissionerDocket No. 30830-86United States Tax CourtT.C. Memo 1990-446; 1990 Tax Ct. Memo LEXIS 472; 60 T.C.M. (CCH) 559; T.C.M. (RIA) 90446; August 20, 1990, Filed *472 Decision will be entered under Rule 155. D. Derrell Davis, for the petitioner. Paul M. Kohlhoff, for the respondent. SWIFT, Judge. SWIFTMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies in petitioner's Federal income taxes as follows: YearDeficiency1980$ 2,705.00198150,022.7519823,871.00After various concessions by respondent, the issue for decision is whether, for capital gains tax purposes, petitioner received property (under a property settlement agreement with her former husband) as part of a nontaxable division of marital property or as part of a taxable sale of petitioner's interests in the property. The briefs of the parties focus primarily on the legal*474 aspects of this question. FINDINGS OF FACT At the time her petition in this case was filed, petitioner resided in Ola, Arkansas. Petitioner was married to James O. Pennington from August 30, 1941 until October 12, 1976, when they were granted a divorce by the Chancery Court of Yell County, Arkansas ("Chancery Court"). During the marriage, petitioner and Mr. Pennington individually and jointly accumulated substantial assets, among which were Mr. Pennington's medical practice and the building out of which it operated, corporate stocks, an Arkansas real estate sales corporation named Pennington Real Estate, Inc. ("Pennington Real Estate"), two residences, a farm, and approximately 34 other parcels of real estate. Some of these assets (such as the building out of which the medical practice operated, the marital residence, and some of the other parcels of real estate) petitioner and Mr. Pennington owned jointly as tenants by the entirety. Other assets were held in Mr. Pennington's name only, such as the stock of Pennington Real Estate. Unfortunately, neither the nature of the ownership interests of petitioner and Mr. Pennington in many of the assets nor the name(s) under which title*475 to many of the assets was held is completely clear. For several years following the divorce, petitioner and her attorney negotiated with Mr. Pennington over a property settlement agreement. Finally, after approximately four years, a property settlement agreement was signed. On March 11, 1980, the Chancery Court issued an order approving the agreement between petitioner and Mr. Pennington. In April of 1980, Mr. Pennington began making monthly payments of $ 1,250 to petitioner under the agreement. On May 13, 1980, the above property settlement agreement was amended, and on August 12, 1980, it was set aside. On October 17, 1980, the Chancery Court issued an order directing Mr. Pennington to convey to petitioner one-half of certain stocks that were jointly owned by petitioner and Mr. Pennington. Mr. Pennington apparently never complied with this order. On February 6, 1981, petitioner and Mr. Pennington entered into a revised property settlement agreement under which certain property was to be divided between petitioner and Mr. Pennington in settlement of all claims either party had against the other arising out of the marriage. The value of the properties subject to the revised*476 property settlement agreement was to be determined as of August 10, 1976. Under the revised property settlement agreement, Mr. Pennington was to convey to petitioner free and clear of all liens and encumbrances the home in which petitioner was then living. He was to pay $ 110,000 in cash to petitioner, and he was to assume and pay outstanding indebtedness totaling $ 260,000 on unspecified jointly held property. Apparently the home referred to was known as "the Cobb property" which had been purchased in 1977 for $ 60,000 by Mr. Pennington or by Pennington Real Estate. Also under the revised property settlement agreement, Mr. Pennington was required to pay petitioner a total of $ 150,000 in monthly installments of $ 1,250, with credit to be given for payments made since April of 1980. Mr. Pennington was to execute a promissory note and mortgage as security for payment of the $ 150,000, and his obligation to pay the $ 150,000 was to be unaffected by either the remarriage of petitioner or by Mr. Pennington's death. In exchange for Mr. Pennington's agreement to transfer to petitioner the above-described property as part of the revised property settlement agreement, petitioner agreed*477 to relinquish her dower rights in the property that Mr. Pennington had held in his separate name during the marriage, and petitioner agreed to relinquish her interests in the property that had been jointly held during the marriage. In March of 1981, Mr. Pennington executed a promissory note in favor of petitioner in the amount of $ 135,000. Although the revised property settlement agreement specified that the note was to be in the amount of $ 150,000, the parties have stipulated that the actual amount of the promissory note was $ 135,000. On March 6, 1981, Mr. Pennington paid petitioner $ 110,000. Also in March of 1981, Mr. Pennington assumed all the liabilities on the property held jointly during the marriage. Although the revised property settlement agreement reflects that Mr. Pennington was to assume liabilities in the amount of $ 260,000, the financial statements prepared by his personal accountant as of August 10, 1976, show total liabilities of $ 165,000 on the jointly held property. Without explanation, both petitioner and respondent in their trial memoranda assert that the amount of joint liabilities assumed by Mr. Pennington was $ 89,000. In April of 1981, Mr. Pennington*478 individually and as president of Pennington Real Estate executed a quitclaim deed to the Cobb property in favor of petitioner. During 1981 and 1982, Mr. Pennington paid petitioner the monthly installment payments due of $ 1,250. On her individual Federal income tax returns for 1980, 1981, and 1982, petitioner did not report any gain relating to the relinquishment or exchange of her marital dower rights or her interests in the jointly held property for the various interests in the property received from Mr. Pennington under the revised property settlement agreement. On audit, respondent apparently determined that petitioner's relinquishment or exchange of all of her interests in the property she transferred incident to the divorce constituted a taxable sale, giving rise to $ 249,958 in capital gain income for 1981. Respondent's computation was based on petitioner's receipt of property from Mr. Pennington with an alleged value of $ 364,268 in exchange for petitioner's interests in the marital and jointly held property in which petitioner allegedly had a tax basis of $ 114,310. OPINION Section 61 1 provides that gross income includes all income from whatever source derived. *479 Section 1001(a) provides that gain from the sale or disposition of property is the excess of the amount realized over the adjusted basis of the property. Section 1001(b) provides that the amount realized includes money plus the value of property received in the exchange. Section 1001(c) provides that, unless otherwise provided, the entire amount of gain or loss shall be recognized. For the years before us, a wife's release or transfer of her dower rights in her husband's separate property in exchange for property or other consideration is regarded as an exchange that does not result in taxable gain or loss to the wife. United States v. Davis, 370 U.S. 65">370 U.S. 65, 73 n.7 (1962); 2*481 Howard v. Commissioner, 447 F.2d 152">447 F.2d 152, 159 (5th Cir. 1971),*480 revg. on other grounds 54 T.C. 855">54 T.C. 855, 858 (1970); Carrieres v. Commissioner, 64 T.C. 959">64 T.C. 959, 965 n.2 (1975), affd. 552 F.2d 1350">552 F.2d 1350 (9th Cir. 1977). This is the case regardless of the type of property the wife receives in the exchange and regardless of how much time elapses between the divorce date and the date of the settlement agreement (where the property interests exchanged are based on values as of the date of the divorce). The fair market value of the dower rights the wife relinquishes are presumed to be equal in value to the property she receives in the exchange. United States v. Davis, supra at 72. 3 Thus, there is no taxable gain or loss to the wife, and the wife takes as her basis in the property received the fair market value of such property as of the time of the divorce. Cook v. Commissioner, 904 F.2d 107">904 F.2d 107, 112 (1st Cir. 1990). Where the wife gives up her interests in property that, during the marriage, was held with her former husband jointly (or as tenants by the entirety), the wife is taxable on the exchange of the property interests depending on the type of property interests the wife receives. If the wife receives in the exchange interests in property that was, during the marriage, the separate property of her former husband, the exchange is regarded as a taxable event. Hornback v. United States, 298 F. Supp. 977">298 F. Supp. 977, 981-983 (W.D. Mo. 1969);*482 Carrieres v. Commissioner, 64 T.C. at 965-966; Edwards v. Commissioner, 22 T.C. 65 (1954). The amount of the gain is the difference between the value of the new property interests the wife receives and her tax basis in the formerly jointly held property. If the wife relinquishes her interests in jointly held property and receives a fee interest in property that was jointly held prior to the divorce, the exchange generally is regarded as a nontaxable division or partition of property. United States v. Davis, 370 U.S. at 70-71; Carrieres v. Commissioner, 64 T.C. at 964. Arkansas is not a community property state. Under Arkansas law as in effect for 1976 and prior years (i.e., during petitioner's marriage to Mr. Pennington), a wife's interest in her husband's separate real and personal property is inchoate and does not vest until the marriage is dissolved by divorce or death of the husband. LeCroy v. Cook, 211 Ark. 966">211 Ark. 966, 204 S.W.2d 173">204 S.W.2d 173, 174-175 (1947). Upon vesting of this dower interest, a wife is entitled to a one-third interest in all of her husband's separate real property for her life (i.e. *483 , a life estate) and to a one-third interest in all of his separate personal property outright. Ark. Rev. Stat. Ann. 34-1214 (1962). Property held by husband and wife as tenants by the entirety during the marriage is deemed upon divorce to be held as tenants in common, giving the wife a one-half joint ownership interest. Ark. Rev. Stat. Ann. 34-1215 (1962). Based on the above law, as in effect for the years before us, and on the facts of this case, we hold that to the extent the property interests petitioner received under the revised property settlement agreement were in exchange for petitioner's dower rights, the exchange must be regarded as a nontaxable exchange. Also, to the extent the property interests petitioner received were held as joint property prior to the divorce, the exchange must be regarded as a nontaxable partition or division of jointly held property. To the extent, however, that the property interests petitioner received under the revised property settlement agreement had been the separate property of Mr. Pennington and were received by petitioner in exchange for her interests in property that, during the marriage, had been jointly owned or owned as tenants*484 by the entirety, a taxable sale occurred, and petitioner must recognize the capital gain associated therewith. The parties are to attempt jointly to make the appropriate calculations as to what portion of the property interests petitioner received represented a nontaxable exchange for petitioner's dower interests, a nontaxable division of jointly held property, and a taxable sale of petitioner's interests in jointly held property for interests in her former husband's separate property, as well as the appropriate allocations of basis and computations of capital gain to be recognized, and thereafter to submit their Rule 155 computations. Respondent's only objection to petitioner's argument, in the alternative, that she is entitled to section 1034 nonrecognition treatment in connection with the disposition of the marital residence and her receipt of the Cobb property is that it was not properly raised. We deem the pleadings to be amended to raise this argument. Rule 41(b). We hold that petitioner is entitled to section 1034 treatment with respect to her disposition of the marital residence and her receipt of the Cobb property. Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as in effect for 1976, the year of the divorce, and for 1981, the year of the purported taxable exchange in question, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. United States v. Davis, 370 U.S. 65">370 U.S. 65 (1962), was legislatively overruled by the Tax Reform Act of 1984, Pub. L. 98-369, section 421, 98 Stat. 494. Section 1041 of the Internal Revenue Code currently provides that property transfers between spouses incident to divorce do not result in the recognition of gain or loss. Rather, the transfer is treated as a gift and the transferee takes the adjusted basis of the transferor. However, as the divorce at issue here took place in 1976, United States v. Davis↩ controls.3. Rev. Rul. 67-221, 2 C.B. 63">1967-2 C.B. 63, describes a property settlement agreement incident to divorce under which the husband transfers his separate real property to his former wife in exchange for the wife's relinquishment of her dower rights. The real property is regarded as equal in value to the dower rights, and there is therefore no gain or loss to the wife on the exchange. The wife takes as her basis in the real property the property's fair market value on the date of exchange. See Howard v. Commissioner, 447 F.2d 152">447 F.2d 152, 159 (5th Cir. 1971), revg. on other grounds 54 T.C. 855">54 T.C. 855, 858↩ (1970). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624804/ | William H. Malone v. Commissioner.William H. Malone v. CommissionerDocket Nos. 76350, 76855, 77029.United States Tax Court1945 Tax Ct. Memo LEXIS 13; 4 T.C.M. (CCH) 1133; T.C.M. (RIA) 45373; December 17, 1945*13 During each of the years 1926 to 1932, inclusive, taxpayer made large currency deposits, the source of which was not disclosed on his books and which he failed to report for income tax purposes and did not satisfactorily explain. Held, such amounts constituted taxable income to the taxpayer in each year. Held, further, the fraud penalties are approved. S. J. Konenkamp, Esq., and Oscar W. Harman, Esq., for the petitioner. John D. Kiley, Esq., and Richard L. Greene, Esq., for the respondent. VAN FOSSAN Memorandum Findings of Fact and Opinion These proceedings involve deficiencies in income tax, together with fraud penalties and interest, determined by the respondent against William H. Malone for the years and in the amounts stated, as follows: YearDeficiencyPenaltyInterestTotal1926$28,063.87$14,031.94$42,095.81192729,866.3014,933.1544,799.45192860,112.3630,056.1890,168.54192959,287.4529,643.73$14,176.19103,107.3719301,266.40633.20226.822,126.4219312,586.721,293.36308.104,188.181932140.5270.268.30219.08The principal issues are: (1) Whether the petitioner*14 received income during each of the years in controversy which he failed to report for Federal income tax purposes, and (2) whether the respondent properly asserted a 50 per cent fraud penalty for each of the years involved. The respondent also made several other adjustments in the petitioner's income for each of the years in question, all of which were put in issue by the petitioner. In addition, the petitioner raised several new matters in his petition. He now concedes that the adjustments for the year 1932 are correct, with the exception of the determination that he received unreported "other income" for that year. He also concedes certain minor adjustments for the years 1927 and 1930. While none of the other issues are specifically abandoned or conceded by the petitioner, evidence was introduced with respect to the following only: (3) Whether or not the petitioner may eliminate from his income for 1926 an amount representing a partial duplication of gain reported on his 1925 return. (4) Whether or not the petitioner is entitled to a deduction for 1926 in the amount of $3,680 for charitable contributions alleged to have been made in that year; and (5) whether or not the*15 petitioner sustained a deductible loss in 1927 of $19,070.43 upon the liquidation of a corporation known as home Realty Company. Findings of Fact The petitioner is an individual residing in Park Ridge, Illinois. The returns for the years in controversy were prepared on the cash basis and were filed with the collector of internal revenue for the first district of Illinois. The petitioner moved to Chicago about 1901 and was first employed in a drugstore. Subsequently he was employed for about a year and a half by Carlton & Hovey Company, a manufacturer of pharmaceuticals. He then went to Tiffin, Ohio, where he entered an organization for the making of pharmaceutical remedies. After the dissolution of that firm, the petitioner returned to Chicago where he entered the sand and gravel business. This venture failed about 1911 or 1912. The petitioner has lived in Park Ridge for about 40 years. Around 1910 he was elected mayor of that city and served one term. In 1912 the petitioner was elected to the Board of Equalization of the State of Illinois, a position he held until 1918, when the Board was abolished by legislative act. He received a salary of $1,000 per year as a member of*16 the Board. In 1914 the petitioner was an unsuccessful candidate for the United States Congress. The petitioner, in 1917, became a broker in road oil and flux oil. Some time prior to 1919 this business was incorporated under the name of Illinois Petroleum Products Company. In 1921 the name of the corporation was changed to American-Mexican Refining Company. The petitioner held a majority stock interest in both companies until about 1929. He also served as president, for which he received a salary of $12,000 per year, from which office he resigned prior to 1926. During the years 1926 to 1929, inclusive, he received a salary of $12,000 per year from the company, the same salary he had theretofore received as president. In addition to his oil brokerage business, the petitioner had at various times engaged in the real estate business and in building and construction. In 1921 the petitioner was appointed to the Illinois State Tax Commission, hereinafter called the Tax Commission. He was a member of the Tax Commission continuously from the time of his appointment until he resigned in January, 1931. He served as chairman from 1925 until his resignation. His salary during the entire*17 period was $6,000 per year. In 1931 petitioner was an unsuccessful candidate for nomination for Governor of Illinois. During the taxable years here involved the petitioner was a customer of several banks, including the Norwood Park Trust and Savings Bank, Park Ridge State Bank, Citizens State Bank of Park Ridge of which he was president, Greenebaum Sons Bank and Trust Company, National Bank of the Republic, Boulevard State Savings Bank, Foreman National Bank, East Side Bank of Milwaukee, and Jefferson Park National Bank. During the same years the petitioner made numerous deposits of currency at various banks, made unidentified bank deposits, used currency in the payment of notes, to purchase cashier's checks, to purchase a certificate of deposit, securities, stock, to make various payments and a loan, all of which represents funds not accounted for or reflected in his income tax returns for those years, in the following manner and amounts: 1926192719281929193019311932Currency deposits at: Jefferson Pk. Nat'l Bank$36,235$76,700.00$62,906.00$100,037.50$22,550$50,493.75$13,000Greenebaum Sons Bank &Trust Co.18,50012,600.00200.00National Bank of the Re-public65,000.00Park Ridge State Bank14,855Citizens State Bank5,130.001,965750.0030,590Norwood Park Trust &Savings Bank581,438.50702.001,508.00Currency deposits, accountPickwick Athletic Club atCitizens State Bank993.75Currency deposits in MaloneBuilding Account at Jeffer-son Park National Bank6,625.001,462.50Currency deposits in Pick-wick Building Co. Accountin Jefferson Park Nat'l Bk.11,375.00Currency deposits at Jeffer-son Park National Co.60,000.00Unidentified deposit 11/5/26at Greenebaum Sons Bank& Trust Co.15,000Unidentified deposit 4/7/26 atPark Ridge State Bank3,000Unidentified checks depos-ited at Jefferson Park Na-tional Bank8,000.00Currency used in payment ofnotes at Jefferson Park Na-tional Bank$22,000$20,000.00$18,000.00$10,000.00$32,800$11,327.51Currency used in payment ofnotes at Norwood ParkTrust & Savings Bank15,000.003,0503,000.00$ 500Currency used to purchasecashier's checks20,500.0048,600.002,445.007001,821.251,135Currency used to purchasecertificate of deposit at Citi-zens State Bank50,000.00Currency used to purchasesecurities45,545.83Currency used to purchasestock of Jefferson Park Na-tional Bank4,000Currency paid to architect,W. F. McCaughey600Currency used in paymentof mortgages4,273.00Currency loaned to Fred H.Esdohr15,000.00Totals$109,648$131,238.50$242,578.83$269,958.00$65,665$87,659.26$45,225*18 There was no account in the petitioner's books showing the sources of the foregoing currency deposits and other transactions. An accountant was employed who examined the petitioner's income tax returns from 1917 or 1918 to 1929 and prepared the 1930 return. He examined the petitioner's books and bank records. He endeavored to discover the sources of the bank deposits but was told merely that they were not income but came from accumulations on hand. The petitioner's books in 1926 did not reflect the currency deposits for that year. Only a portion of those made in 1927 was entered therein. They were not entered as cash receipts. The currency deposits made in 1928 and subsequent years were charged on the petitioner's books to the banks in which the deposits were made and were credited to the petitioner's property account or his investment account. These entries were not reflected currently but were made at a later date. The petitioner's bookkeeper made the entries either at the advice of the accountant or she would take them from the bank statements she received. Petitioner's total assets and net worth per books on December 31 of each of the years 1925 to 1932, inclusive, were as*19 follows: YearTotal AssetsNet Worth1925 *$ 12,969.17$ 10,279.93192684,363.7584,337.071927294,360.33294,107.2919281,145,153.18570,167.2419291,287,392.05792,861.9819301,402,496.23733,690.8719311,476,894.75694,467.4019321,483,345.96613,653.54In the course of his business, the petitioner borrowed extensively from various banks and from individuals. In 1924 he borrowed $124,000 from Jefferson Park National Company, the real estate department of Jefferson Park National Bank. In 1928 he borrowed $350,000 from the same company. The outstanding balance on these loans on December 31, 1932, was $361,961. On November 26, 1928, the petitioner received a mortgage loan from East Side Bank, Milwaukee, Wisconsin, in the amount of $80,000. Payments were made on this loan as follows: August 5, 1929$20,000November 19, 192920,000January 6, 193020,000November 22, 193220,000(* by transfer toM. E. White)*20 In 1930, 1931 and 1932 the petitioner borrowed certain amounts from one M. E. White, for which he executed demand notes on the dates and in the amounts following: July 3, 1930$25,000September 19, 19306,500December 17, 193020,000January 3, 193110,000May 27, 193125,000July 1, 193120,000July 30, 193225,000November 22, 193220,000(transferred from EastSide Bank, Milwaukee.) No payments had been made on these loans as of December 31, 1932, and the balance outstanding on that date was $151,500. On November 22, 1930, and July 1, 1931, the petitioner borrowed from and executed notes to N. O. Johnson in the respective amounts of $2,000 and $10,000. No payments had been made on these notes as of December 31, 1932, and the balance outstanding on that date was $12,000. On April 13, 1932, the petitioner borrowed from and executed*21 a note to Central Republic Bank & Trust Company, Chicago, Illinois, in the amount of $15,000. No payments had been made on this note as of December 31, 1932, and the balance on that date was $15,000. On May 17, 1932, the petitioner borrowed $4,000 from Citizens State Bank, Park Ridge, Illinois, executing a note therefor. This amount was paid on May 26, 1932. In addition to these specific loans, the petitioner borrowed extensively from Jefferson Park National Bank and Norwood Park Trust and Savings Bank in amounts totaling several hundred thousand dollars in the years 1924 through 1932. The petitioner paid substantial amounts of interest during some of the years here involved. In his returns for the years 1926 through 1929 he claimed interest deductions in the total amount of $38,651.72. From September 21, 1928 to December 31, 1931, inclusive, the petitioner had an account with Brunswick Balke Co. against which various charges and payments were made. The charges total $19,568.65, which were paid as follows: 1928$ 500.0019299,765.6719306,000.0019313,303.08On September 26, 1928, the petitioner had an account with Rudolf Wurlitzer Company representing*22 a charge of $25,000 for an organ. He paid $10,300 on this account in 1928 and thereafter in 1929, 1930 and 1931 he paid at the rate of $150 per week, as follows: 1929, $7,800; 1930, $6,600, 1931, $300, thereby completing payment. The petitioner's books reflected cash in banks as of December 31 of each of the years 1925 to 1932, inclusive, as follows: 1925$ 4,650.7519263,028.241927119.291928(16,519.28)19292,007.091930( 111.51)19311,879.791932688.80During 1928 the petitioner's account at Jefferson Park National Bank was overdrawn on 93 days and in 1929, 1930 and 1931 his account was overdrawn on 65, 70 and 30 days, respectively. Thirty-six of the overdrafts were in excess of $1,000 each, the largest being in the amount of $10,365.04. Prior to and during the taxable period the petitioner was a close personal friend of Henry L. Blim, an attorney practicing in Chicago. In 1919 Blim became associated with the petitioner in the Illinois Petroleum Products Company and acted as secretary, treasurer and director of that company. He continued in the same capacity with the American-Mexican Refining Company until 1927. During this period Blim*23 and the petitioner shared the office maintained for the respective companies. During the period 1919 to 1927 Blim acted as the petitioner's advisor and personal secretary and became closely associated with him in connection with his activities as a member of the Board of Equalization and of the Tax Commission. While the petitioner was chairman of the Tax Commission, Blim supervised his clerical office and had charge of the records. He attended all the meetings of the Board and of the Tax Commission in Springfield and also attended some private conferences. While performing these duties Blim became familiar with the tentative assessments on capital stock for various corporations. While Blim was connected with the petitioner in these activities tentative capital stock tax assessments were made by the Tax Commission against the Chicago Surface Lines which, in 1927, were represented before the Tax Commission by the law firm of Huff and Cook. In the spring of 1927 Blim severed his connections with American-Mexican Refining Company and became associated with Huff and Cook in that firm's activities on behalf of the Chicago Surface Lines, which were then having trouble with their tax assessments. *24 On October 13, 1927, the firm of Huff and Cook was paid by check the sum of $25,000 for representing the Chicago Surface Lines before the Tax Commission. One-half of this fee, or $12,500, was paid to Blim, who received a check for that amount from Huff and Cook on October 17, 1927. Blim deposited this amount in his bank account and on October 21, 1927, or between October 19 and October 21, he withdrew $7,500 in currency from this account. On October 21, 1927, the petitioner deposited $7,500 in currency in his account in Jefferson Park National Bank. On October 20, 1927, Cook disbursed part of the proceeds of the $25,000 payment received from the Chicago Surface Lines on October 13, 1927, by drawing a check on the firm in the amount of $7,500, payable to himself. Cook cashed the check on October 20, 1927, and received currency for it. The amount of the check was charged to the suspense account of the firm but Cook did not inform Huff as to what he did with the currency. Huff and Cook handled the capital stock tax assessment of the Chicago Surface Lines before the Tax Commission for the years 1928 and 1929, as well as for 1927. On December 4, 1928, that firm was paid $25,000*25 by the Chicago Surface Lines for representing them with respect to their 1928 capital stock tax assessments. The payment was by check, which was deposited on December 5, 1928. On December 7, 1928, the proceeds thereof were partially disposed of by Cook's drawing a firm check for $16,000 which was cashed and was received in currency. Huff did not receive any part of this currency, although one-half of it was charged to his account on the firm's books. Cook did not tell Huff what he did with the $16,000. The Chicago Surface Lines paid Huff and Cook $20,000 with respect to the former's 1929 capital stock tax assessments. Payment was made by check dated January 3, 1930, which was deposited in the firm's account on the following day. On January 4, 1930, a check for cash in the amount of $16,000, representing disbursement of part of the $20,000, was drawn on the firm's account. Pursuant to Cook's request, Huff cashed the $16,000 check, receiving sixteen $1,000 bills. Huff placed the bills in an envelope, which was put in a strong box and held there for Cook. This amount was later handed by Huff to Cook, who immediately left the office. Huff was charged with one-half of the $16,000, although*26 he did not receive it and never saw the money thereafter. Cook died on June 7, 1930, and thereafter Thomas D. Huff, the other member of the firm, handled the Chicago Surface Lines' capital stock tax assessment matters for 1930. Huff saw the petitioner several times prior to the receipt of the final assessment letters for 1930. At one of their meetings the petitioner stated that he assumed the matter would be handled the same as theretofore. When Huff asked for an explanation he was told that Cook had made "a campaign contribution" of $15,000 the year before. Through his efforts Huff succeeded in having reduced by $100,000 the assessed value of one of the companies making up the Chicago Surface Lines. On September 10, 1930, Huff received a letter from the petitioner fixing the final capital stock tax assessments for the Chicago Surface Lines for that year. He was paid a fee of $20,000 by check dated September 11, 1930. Huff deposited the check in his bank and drew against it a check for $15,000 dated September 16, 1930. He cashed this check on the same day, receiving fifteen $1,000 bills, which he placed in a strong box in his office. He told the petitioner he could give him only*27 $10,000 and was informed that "for old friendship's sake" that would be satisfactory. A few days later Huff delivered the $10,000 in cash in person at the Tax Commission offices. For about 25 years the petitioner had known John W. Ellis, an attorney practicing in Illinois. In 1925 and 1926, Ellis represented the Pullman Company, among others, before the Tax Commission. Ellis received a fee of $15,000 for representing the Pullman Company before the Tax Commission in 1925. Of this amount he retained $5,000 and with the balance made a political "donation" to a "fund" which the petitioner was collecting. On January 7, 1927, Ellis received a check from the Pullman Company in the amount of $15,000 for handling its capital stock matters in the year 1926. Ellis cashed the check, receiving fifteen $1,000 bills. He retained $5,000 and delivered the balance to the petitioner's messenger. Prior to the receipt by Ellis of the second Pullman check, there were conversations between the petitioner and Ellis as to when the Pullman check would be in. After Ellis had contributed the $10,000 the petitioner called him in and told him he wanted the entire $15,000. Ellis refused to contribute the remainder. *28 On December 31, 1929, a certificate of deposit in the amount of $50,000 was issued by Citizens State Bank of Park Ridge to one W. F. McCaughey, Jr., an architect and a neighbor of the petitioner. The money represented by the certificate of deposit was actually deposited by the petitioner, who did not wish to make the deposit in his own name. Thereafter the petitioner used the money so deposited for his own purposes as he saw fit. McCaughey reported the sum on his income tax return but due to some offsetting losses, paid tax on only about one-half of it. In April, 1930, a formal conference was held in the office of the internal revenue agent in charge in Chicago concerning the petitioner's tax liability for the years 1926, 1927 and 1928. At the conference there were present Louis H. Wilson, head of the Fraud Section in the agent's office, special agent Clarence L. Converse, internal revenue agent Irving Bussey, the petitioner, his auditor, and a stenographer. The petitioner was asked to explain his currency deposits in those years and to give their sources. He did not answer the questions put to him relating thereto except to state that he did not care to discuss it. The petitioner*29 was also questioned with respect to the substantial increase in his net worth but gave no explanation. Shortly after the formal conference was concluded the petitioner was again questioned as to the sources of his currency deposits by Converse. Again the petitioner gave no explanation. At another conference the petitioner was shown deposit slips representing three deposits aggregating $120,000. He was asked to explain these deposits but was silent and asked that he be excused, saying he would give an explanation later. On or about June 8, 1922, the petitioner executed and filed a financial statement with Greenebaum Sons Bank and Trust Company, Chicago, in which he stated the amount of his cash on hand and in banks as of that date to be $6,000. On October 13, 1933, the petitioner was indicted in United States District Court for the Northern District of Illinois, Eastern Division, for unlawfully, wilfully and knowingly attempting to defeat and evade income taxes for each of the years 1929 and 1930 in the respective amounts of $58,478.32 and $1,101.58. The petitioner was tried before a jury and a verdict of guilty was rendered in July 1937 with respect to both years. Pursuant to such*30 verdict, judgment was entered by the court on July 29, 1937, and petitioner was sentenced to pay a fine of $5,000 and to be confined in the penitentiary for a period of two years. This judgment was subsequently affirmed by the United States Circuit Court of Appeals for the Seventh Circuit on January 6, 1938. Petitioner's application for certiorari to the United States Supreme Court was denied. The petitioner filed income tax returns for the taxable years 1926 to 1932, inclusive, in which he disclosed net income or losses and upon which he paid tax, all as follows: Net IncomeYearor LossTax Paid1926$ 43,405.62$3,878.64192724,476.221,205.89192819,968.47242.5719296,228.675.231930(57,107.30)None1931(56,436.98)None1932(39,458.25)NoneThe respondent determined in the notices of deficiency that petitioner realized during the taxable years "other income", represented by unidentified currency deposits, notes and mortgages paid with currency, and cashier's checks purchased with currency, and other currency transactions, the source of which was unexplained, in the following amounts: 1926$109,648.001927131,238.501928242,578.831929269,958.00193065,665.00193187,659.26193245,225.00*31 In his return for 1925 the petitioner reported capital gain of $55,000 realized from the sale of vacant property. The gain was computed as follows: Amount received, $90,000; cost, $35,000; gain, $55,000. In his return for 1926 the petitioner reported gain from the sale of vacant property as follows: Amount received, $90,000; cost, $55,000; gain, $35,000. This was the same transaction which had been reported in the 1925 return and was a duplication to the extent of $35,000 of the gain so reported in the earlier return. In his return for 1926, the petitioner claimed a charitable deduction for an alleged gift of $1,000 to the First Methodist Church of Park Ridge, Illinois. This deduction was disallowed by the respondent in its entirety. In 1926 members of the Mal Tierney Post of the American Legion of Park Ridge requested permission to use a hall which the petitioner owned, for their meetings. The petitioner did not wish to allow them to use this hall, which was furnished for women's club meetings, and suggested that they build their own home. He offered them a lot as a start. A few weeks later they returned with tentative plans for a home built of lumber. The petitioner recommended*32 that it be built of brick and offered to pay the difference in the cost. The difference amounted to $1,300, which amount the petitioner paid. In his return for 1926 the petitioner claimed a deduction of $2,680 representing the cost of the lot donated, plus the cash paid by the petitioner. The deduction was disallowed in its entirety. The petitioner was a stockholder in Home Realty Company, a corporation organized in December, 1922. Its authorized capital stock was $5,000, of which $2,500 was issued to the petitioner. The other $2,500 remained unissued. In January 1927, Home Realty Company was indebted to the petitioner in the sum of $125,521. In that month the corporation ceased to function and its assets were taken over by the petitioner. The assets at that time had a book value of $108,950.90. A part of the deficiency for each of the years in controversy was due to fraud with intent to evade tax. Opinion VAN FOSSAN, Judge: In this case there are two principal questions: (1) did the petitioner in the taxable years receive large amounts of income which he failed to report for taxation, and (2) was petitioner's failure to report such income due to fraud? The burden of proof*33 of error as to the first issue rests on the petitioner. The burden of proof of fraud rests on the respondent. The voluminous record herein contains many contradictions and inconsistencies. In the discharge of our duty of weighing the evidence and passing upon the credibility of witnesses, we have found it necessary to omit from our findings much of the evidence relied on by the petitioner. For the years 1926 to 1932, inclusive, the respondent added to the petitioner's income the respective amounts of $109,640; $131,238.50; $242,578.83; $269,958; $65,665; $87,659.26; and $45,225 which he designated "other income". Such sums were computed chiefly by resort to large unexplained bank deposits made in each of the years in question and to transactions in which notes and mortgages were paid off in currency, a method of ascertaining income which has been approved in many cases under comparable facts. See ; ; affirmed, ; ; . In the instant case all the deposits in question*34 were made in currency in the amounts set forth in our findings of fact. There was nothing on petitioner's books to indicate the source of such funds. Deposits were not entered on the books at all for 1926. In 1927 some of them were entered and from 1928 they appeared regularly on the books but in no case was there an explanation of the source. They were not entered as cash receipts but were credited to petitioner's "property account" or his "investment account". When called on by the revenue agents for an explanation of the source of the funds, no explanation was forthcoming. Faced with the facts as they found them, the Commissioner's agents were fully justified in treating the bank deposits as income, thereby placing on the petitioner the burden of proving that such deposits were not income. The petitioner testified repeatedly at the hearing before us that he had never looked inside hisbooks in his life. Nevertheless, he maintained that he had no income except what appeared on his books. At the hearing petitioner offered a fantastic explanation as to the source of these currency deposits, which explanation we are compelled to reject as untrue. His story of the source of the large*35 deposits in currency was to the following effect: Early in 1920 the petitioner was persuaded by a Colonel Proctor to go to South Dakota to oppose the candidacy of Frank O. Lowden for nomination as a candidate for the Presidency of the United States and to further the campaign for the election of delegates to the Republican National Convention pledged to General Leonard Wood. The petitioner's efforts were successful and upon his return to Chicago, Colonel Proctor gave him $500,000 in currency. Sometime in April or May of the same year, Colonel Proctor made a second donation to the petitioner in the sum of $200,000 as a reward for carrying Cook County for Wood. These amounts, together with the savings of other years, were placed in a safety deposit box in Greenebaum Sons Bank in Chicago. The petitioner continued to keep these sums in the deposit box, using it as a principal depository and from time to time clearing through the banks such amounts as were needed by him. The amounts so cleared accounts for the bank deposits and other unexplained items in controversy. In our opinion, one would have to be naive indeed to accept and believe the foregoing explanation. With the failure of*36 this explanation to carry conviction, petitioner's case falls to the ground. The petitioner testified that he received the major portion of the amounts involved in 1920, and that on December 31, 1925, he had about $1,000,000 in cash and securities in his safety deposit box. Despite this asserted fact, in a financial statement filed with Greenebaum Sons Bank and Trust Company petitioner stated the amount of his cash on hand and in banks as of June 8, 1922, to be only $6,000. Such divergent statements are utterly irreconcilable. Likewise irreconcilable with the Proctor story are petitioner's borrowings. During the years in controversy petitioner borrowed extensively, paying large amounts of interest on the loans. In some of the years here involved his account at the Jefferson Park National Bank was frequently overdrawn, often in large amounts. We find it impossible to believe that such a course of conduct would have been pursued by the petitioner had he in fact been in possession of such large amounts of cash which could readily have been used in his business transactions or transferred to his bank account. It is significant also that the petitioner's net worth as reflected on his*37 books increased commensurately with the bank deposits. The petitioner's refusal to give any explanation of these deposits to the revenue agents casts an even greater doubt upon the explanation now offered. In 1930, several conferences were held with the petitioner by the revenue agents at which they attempted to discover the source of these deposits. At that time the petitioner refused to give any explanation whatever. He did not answer questions relating thereto except to state that he did not care to discuss it. At one of the conferences, to questions concerning substantial increases in his net worth, the petitioner replied: "I guess you got me baffled. If I don't understand it, I don't know [that] I should talk." After the formal conference had ended, the petitioner was again questioned by Special Agent Converse as to the source of the currency deposits. At first the petitioner made no reply. When the question was repeated he said: "Mr. Converse, do you want me to dig a hole and jump into it?" The revenue agents knew nothing of the alleged gifts from Colonel Proctor until 1937, when the petitioner testified concerning them at the trial following his indictment for income tax*38 evasion for the years 1929 and 1930. The respondent undertook to prove by his evidence that the amounts involved represented bribes accepted by the petitioner while he was chairman of the Tax Commission. The record establishes that the petitioner received from attorneys representing various clients before the Tax Commission the amounts of $10,000 in 1925 or 1926; $15,000 in 1927; $16,000 in 1928, $15,000 in 1929, and $10,000 in 1930. Whether or not all the sums in question came from these sources is a question we need not decide. The respondent has determined that they constitute income to the petitioner. The petitioner has not brought forth any competent or convincing proof to the contrary. The evidence of record supports the respondent's determination. Disbelieving and discarding petitioner's explanation of the source of the deposits as we must, we hold that the petitioner has not proved respondent to be in error in holding that the petitioner received "other income" for each of the taxable years in controversy in the amounts determined. The second issue is to determine whether or not a part of the deficiency for each year was due to fraud with inten to evade tax. Fraud, as the*39 petitioner points out, is not to be presumed, nor is it lightly to be found. ; ; . In the last cited case we said: To establish fraud by direct proof of intention is seldom possible. Usually it must be gleaned from the several transactions in question and the conduct of the taxpayer relative thereto. Moreover, in assaying evidence to determine the presence or absence of fraud, the scales of justice must dip more heavily than in the ordinary civil case - a mere preponderance is not enough, the evidence of fraud must be clear and convincing. In the instant proceedings, we think fraud clearly appears. Much of our discussion above applies equally to the question of fraud and need not be repeated. In each of the years in controversy the petitioner made large currency deposits which he failed to report for income tax purposes. He resisted all attempts on the part of the Government to ascertain the source of these deposits until he was brought to trial for income tax evasion, at which time he offered the explanation which he has here put in evidence. This story we have*40 rejected as unworthy of belief. Under such circumstances, it is impossible for us to believe that the petitioner was actuated by other than fraudulent motives in failing to report these amounts for each year. As was said in the Gano case, supra: A failure to report for taxation income unquestionably received, such action being predicated on a patently lame and untenable excuse, would seem to permit of no difference of opinion. It evidences a fraudulent purpose. Consequently, the fraud penalties for each of the years in controversy are approved. Of the other issues in controversy, the first involves the alleged duplication in 1926 of gain realized on the sale of vacant property in 1925 and reported on the petitioner's return for that year. The evidence amply proves that, through an account's error, the gain on the sale of this property in 1925, which was reported in the petitioner's return for that year, was duplicated on his return for 1926 to the extent of $35,000. No evidence to the contrary was introduced by the respondent. Consequently, the petitioner is entitled to eliminate the amount of this duplication from his income for 1926. In his return for 1926 the petitioner*41 claimed a deduction for an alleged contribution of $1,000 to the First Methodist Church of Park Ridge, Illinois. This deduction was disallowed by the respondent upon the ground that the petitioner had received a bond in exchange for that amount. At the hearing the only evidence introduced on behalf of the petitioner was his own denial that he received anything in exchange for such sum. Under the circumstances of this case and the conclusions reached as to the untruthworthiness of petitioner's testimony, his denial is not sufficient to establish the truth of the matter. We can perceive no reason why other more competent evidence could not have been introduced to prove that the petitioner received nothing in exchange for his payment of $1,000, if such were indeed the fact. In the absence of such evidence or a showing that it was not available, we must sustain the respondent's disallowance of the deduction. The petitioner also claimed a deduction for 1926 in the amount of $2,680 as a contribution to Mal Tierney Post of the American Legion at Park Ridge. The deduction was disallowed by the respondent upon the ground that the contribution consisted of a vacant lot acquired at no cost*42 to the petitioner. The evidence of record, as set forth in our findings, sufficiently shows, we think, that in addition to the lot the petitioner contributed $1,300 in cash. No evidence was introduced, however, as to the value of the lot or its cost to the petitioner. Consequently, the deduction must be limited to the amount of cash so contributed. The last issue concerns the petitioner's right to a deduction for the year 1927 in the amount of $19,070.43, representing an alleged loss by the petitioner in that year on the liquidation of Home Realty Company. The petitioner did not claim a deduction therefor in his return for 1927 but now contends that such a deduction should be allowed. The evidence concerning this item is set forth in our findings of fact. It consisted solely in the testimony of an accountant who, in addition to stating the facts, expressed his opinion that the loss was deductible in 1927. We need not discuss the issue in detail. The evidence is clearly insufficient for the allowance of the deduction. From the meager facts of record, we are unable to determine the character of the loss arising from the amount of $125,521 for which the corporation was indebted*43 to the petitioner. There is no evidence of the actual value of the assets taken over by the petitioner. Likewise, there is no evidence as to the year in which the stock became worthless, except the stated opinion of the accountant that the loss was deductible in 1927. In the absence of more specific evidence, the deduction cannot be allowed. Cf. . Decisions will be entered under Rule 50. Footnotes*. The petitioner's books apparently did not correctly reflect his entire assets, liabilities and net worth as of December 31, 1925. The record does not disclose what the correct amount should be. A bank statement executed and filed by the petitioner showed his net worth as of June 8, 1922, to be $237,500.↩*. The petitioner's books apparently did not correctly reflect his entire assets, liabilities and net worth as of December 31, 1925. The record does not disclose what the correct amount should be. A bank statement executed and filed by the petitioner showed his net worth as of June 8, 1922, to be $237,500.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624805/ | CONSUMERS' ICE & COLD STORAGE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Consumers' Ice & Cold Storage Co. v. CommissionerDocket No. 8551.United States Board of Tax Appeals6 B.T.A. 1269; 1927 BTA LEXIS 3295; May 10, 1927, Promulgated *3295 Edwin E. Gano, C.P.A., for the petitioner. J. L. Deveney, Esq., for the respondent. MURDOCK *1269 MURDOCK: Income and excess-profits taxes for the calendar years 1919, 1920, and 1921, are in controversy. The Commissioner determined a deficiency for 1919, amounting to $2,826.30 and overassessments for the other two years in the amount of $281.04 for 1920 and $72.90 for 1921. The petitioner alleges that the Commissioner charged certain expenditures totaling $7,484 to capital account, whereas he should have allowed them as deductions for ordinary and necessary expense. FINDINGS OF FACT. The petitioner is a New Jersey corporation, with its principal office at Elizabeth. Wooden beams in the cooler house were badly sagged and were replaced by iron girders in 1919. *1270 Old boiler fronts wrre cracked and warped and could not be repaired or used any longer. They were replaced by three cast-iron fronts in 1919. Boilers had been in use for thirteen years. The brick work had many cracks in it. It was necessary for the first time since the boilers were installed to reset them. They had had little repair and were dangerous. In 1919, *3296 the walls were taken down. The boilers were blocked up by a rigger and reset. At this time the boilers were raised about three feet higher than formerly in order to get better results from bituminous coal, which was used to fire them. These were general repairs and were not such as were ordinarily made from year to year. After these improvements the boilers were in condition to last for at least ten years, whereas before they would not have lasted another year. This work was all paid for during 1919. It was begun in the fall and all completed before the next year. The board of directors at a regular meeting approved rebuilding the boilers. The petitioner expended $7,484 in making all of the improvements which are in dispute. In 1919, the petitioner had an unusual demand for ice and pushed its plant to the utmost. Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624807/ | W. D. Bradley v. Commissioner.Bradley v. CommissionerDocket No. 56419.United States Tax CourtT.C. Memo 1956-189; 1956 Tax Ct. Memo LEXIS 104; 15 T.C.M. (CCH) 1001; T.C.M. (RIA) 56189; August 17, 1956*104 Held, the losses sustained by petitioner in 1948 as the result of the uncollectibility of amounts which he had advanced to two corporations constituted nonbusiness bad debts. W. D. Bradley, Hagan, Ga., pro se. Frederick T. Carney, Esq., for the respondent. RICEMemorandum Findings of Fact and Opinion This proceeding involves deficiencies in income tax determined against W. D. Bradley (hereinafter referred to as petitioner) in the amounts of $4,812.13 and $246.14 for the years 1946 and 1947, respectively. The sole issue to be decided is whether petitioner is entitled to deduct in full certain losses which he sustained as the result of the uncollectibility of amounts which he had advanced to two corporations. Some of the facts were stipulated. Findings of Fact The stipulated facts are so found and are incorporated herein by this reference. Petitioner is an individual residing in Hagan, Georgia. He filed individual income tax returns for the calendar years 1946, 1947, and 1948 with the then collector of internal revenue for the district of Georgia. In 1906, at the age of 15, petitioner started to work in his father's tie and timber business. During*105 subsequent periods of his business career, he has been both an employee and employer, having engaged in, at various times, such business ventures as the operation of saw mills, the operation of jitney busses, a produce business, and a dry kiln and planing mill. From 1942 until 1946, petitioner was engaged in the business of cutting timber for piling. In 1948, petitioner, his son, W. D. Bradley, Jr., and W. H. Dowling organized three corporations in the State of Florida for the purpose of engaging in various aspects of the timber business. The Florida Pine Lumber Mfg. Co., Inc., was organized on January 1, 1948, for the purpose of sawing, dressing, and selling lumber; the Florida Logging and Contracting Co., Inc., on February 2, 1948, for the purpose of cutting and hauling logs to a saw mill; and the Putman Land and Timber Co., Inc., on February 6, 1948, for the purpose of purchasing timber rights. The business was organized into three separate corporations so that the stockholders could determine whether or not each of the operations was profitable. Each of the aforementioned organizers was an officer in each corporation and contributed one-third of the $5,001 capitalization of*106 each corporation. In addition, each of them contributed the use of certain equipment, such as trucks, tractors, a planing mill, and a power unit. Sometime after the corporations were organized, petitioner and the other stockholders each made additional contributions of some $3,000 or $4,000 to be used by the corporations as working capital. Even after these additions to capital, the business required more money to operate. Petitioner subsequently advanced to the Florida Pine Lumber Mfg. Co., Inc., various amounts aggregating $18,102.29, and the sum of $19 to the Florida Logging and Contracting Co., Inc., for payrolls and other expenses. The corporations encountered financial reverses from the very beginning and no salaries were ever paid to the officers and there were never any distributions of profits. The amounts owed petitioner by the corporations became worthless during the taxable year 1948. On August 31, 1948, the Putman Land and Timber Co., Inc., was liquidated and each stockholder received $1,250.19 as a return on his original investment. The Florida Logging and Contracting Co., Inc., was liquidated on September 3, 1948, with no distribution of capital to its stockholders. *107 In 1949, the Florida Pine Lumber Mfg. Co., Inc., was also liquidated, and here also there was no distribution of capital to the stockholders. Petitioner's only investments were in businesses in which he was actively interested as owner, part owner, or manager. He was never engaged in the business of organizing, lending to, or financing corporations or other businesses. On his income tax return for the calendar year 1948, petitioner claimed bad debt losses aggregating $18,121.29 with respect to the aforementioned loans which had become worthless during that year. This deduction resulted in a net operating loss for the year 1948, and, after the carry-back of such net operating loss to the years 1946 and 1947, income tax refunds were made to petitioner for these latter two years. Respondent has now determined that the aforementioned loans resulted in nonbusiness bad debts and, as such, are to be treated as short term capital losses. Accordingly, he has determined that petitioner is not entitled to the net operating loss carry-back which was originally allowed for the years 1946 and 1947 and that there are now deficiencies in income tax for such years. The loans made by petitioner*108 to the Florida Pine Lumber Mfg. Co., Inc., and the Florida Logging and Contracting Co., Inc., were nonbusiness bad debts. Opinion RICE, Judge: We must decide whether petitioner is entitled to deduct in full on his return for 1948 the losses which he sustained during that year as the result of the uncollectibility of various advances to two corporations which he had helped organize and operate. Petitioner was not represented by counsel at the hearing, nor did he file a brief. However, he has submitted various informal memoranda regarding the cases upon which he relies. We have given careful consideration to the record and to each of the cases cited by petitioner and are convinced that respondent's determination is correct. Petitioner was not in the business of lending money or organizing and financing corporations. ; . He was not engaged in any business to which these losses can be attributed, for the business of a corporation cannot be treated as that of its stockholder or officer. . Consequently, the debts upon which petitioner*109 failed to recover must be considered as nonbusiness bad debts. ; ; . Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624808/ | Edwin A. Gallun and Jane W. Gallun v. Commissioner.Gallun v. CommissionerDocket No. 89500.United States Tax CourtT.C. Memo 1963-167; 1963 Tax Ct. Memo LEXIS 177; 22 T.C.M. (CCH) 798; T.C.M. (RIA) 63167; June 14, 1963Richard S. Gibbs and W. J. Roper for the petitioners. Vernon R. Balmes for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: Respondent determined a deficiency in the income tax of the petitioners for the calendar year 1956 in the amount of $19,827.19. Petitioners have conceded the issue raised in their petition with respect to the treatment of a loss sustained by them during the taxable year on an investment in a limited partnership. The two issues remaining for decision are: 1. Whether the petitioner, Edwin A. Gallun, realized long-term capital gains or*179 ordinary income upon assignments made by him of four paid-up life insurance policies to A. F. Gallun & Sons Corporation. 2. If the petitioner realized ordinary income, whether the increments (net gain over cost) on the policies are fully taxable in 1956, the year in which the assignments were made, or whether the petitioner is entitled to use the averaging provisions of section 72(c)(3), Internal Revenue Code of 1954, so that the gain is spread ratably over 1956 and the two preceding years. Findings of Fact Most of the facts have been stipulated by the parties. The stipulation of facts and exhibits attached thereto are incorporated herein by reference. Edwin A. Gallun and Jane W. Gallun will be referred to jointly as "petitioners." Edwin A. Gallun individually will be called "petitioner." The petitioners were divorced by a decree entered on December 17, 1957, in Washoe County, Nevada. Petitioners filed their joint U.S. individual income tax return for the year 1956 with the district director of internal revenue, Milwaukee, Wisconsin. They sustained no net short-term capital loss during that year. During 1956 petitioner was the president, principal*180 executive officer, and owner of 37.1 percent of the outstanding capital stock of A. F. Gallun & Sons Corporation, which is a Wisconsin corporation engaged in the leather tanning business with its principal office at 1818 North Water Street, Milwaukee, Wisconsin. The petitioner purchased and was the owner of four life insurance policies on his own life as follows: KansasMutualNorthwesternNorthwesternCity LifeBenefitMutual LifeMutual LifeIns. Co.Life Ins. Co.Ins. Co.Ins. Co.Type of CompanyStockMutualMutualMutualPolicy No.680514183191221212502852125Date of Issue4-15-351-6-391-1-2912-31-37Face amount of policy$25,000.00$75,000.00$100,000.00$50,000.00Kind or TypeSingleSingle20-year10-yearpremiumpremiumlifelifelifelifeMaturityDate ofDate ofDate ofDate ofdeathdeathdeathdeathSingle premiums paid$ 9,639.00$37,735.50Total premuims paid$ 70,028.43$32,232.68Dates premiums paid4-15-351-6-391-1-2912-31-37thruthru1-6-4812-21-46Dividends received orcred-ited$ 1,288.25$ 4,071.00$ 17,068.00$ 5,560.00Net cost8,350.7533,664.5052,960.4326,672.68Cash Surrender Value: 5-10-5663,656.0031,829.505-22-5649,607.815-28-5614,755.50Difference between costandcash surrender value$ 6,404.75$15,943.31$ 10,695.57$ 5,156.82*181 The Kansas City Life Insurance Co. policy provides that at any time after the end of the second policy year the policy could be surrendered for its cash surrender value in accordance with the following schedule: At the EndCash Loanof Policy Yearor Surrender Value2nd$ 9,212.203rd9,603.204th10,000.705th10,342.206th10,690.507th10,920.208th11,157.009th11,400.0010th11,650.0011th11,906.5012th12,169.2013th12,438.0014th12,712.2015th12,991.7016th13,276.0017th13,564.5018th13,857.5019th14,153.70TWENTIETH14,453.20 The reserve on this policy is computed according to the American Experience Table of Mortality with interest at 3 1/2 percent per annum. The Mutual Benefit Life Insurance Co. policy provides that at the end of any policy year, the policy may be surrendered for the following cash surrender values: Cash Surrender ValueLoan ValueAt End of YearPer $1,000 Insurance1st$458.002nd471.803rd485.834th495.105th504.596th514.307th524.238th534.379th$544.7010th555.2211th565.8912th576.7113th587.6714th598.7415th609.9216th621.1817th632.5118th643.8919th655.3020th666.7225th723.2430th776.7335th824.9340th869.06*182 All calculations of such reserves were made on the basis of the American Experience Table of Mortality with interest at 3 percent yearly, and according to the attained age of the insured. Northwestern policy No. 2121250 was originally issued as an ordinary life policy. The annual premium was $2,331.00. Premiums at this rate were paid in the total sum of $32,634.00. In January 1943, the policy was converted to a 20-payment life policy, and at that time a conversion premium of $20,674.43 was paid. The premium rate then became $3,344.00 per year and a total of $16,720.00 was paid at that basis, the last such premium being paid January 6, 1948. Thus, total gross premiums on the policy were $70,028.43. Northwestern policy No. 2121250 provided that after the payment of premiums for two full years the petitioner would have the option of taking the cash surrender value or having it applied to non-participating term insurance, or participating paid-up life insurance, as follows: LoanPaid-upAt End ofor Cash ValueExtendedTermInsuranceInsuranceof Policy YearPer $1,000YearsDaysPer $1,000 InsuredInsured2$ 30.173270$ 76356.29753139483.14102632015105.74132212526129.13161143027153.30182633528178.32202924039204.182221245310230.94243950311258.612515755312287.232621860213316.852723765214347.492823370215379.192922875216412.013024780117445.973132285118481.123314390019517.523521995020555.22Policyfull-paid21565.8922576.71*183 The values in the foregoing table after the third policy year are equal to the full reserve according to the American Experience Table of Mortality with interest at 3 percent. The basis upon which the table is constructed will apply if this policy is continued in force beyond the twenty-second year. Northwestern policy No. 2852125 also was issued originally as an ordinary life policy on which the annual premium was $1,526.00 and $7,630.00 in premiums were paid on that basis. This policy was also converted in January 1943, to a 10-payment life policy, and a conversion premium paid of $11,748.68. Thereafter, four annual premimums of $3,213.50 were paid, aggregating $12,854.00. The last such premium was paid December 21, 1946. The total gross premiums paid on the policy were $32,232.68. Northwestern policy No. 2852125 provided that after the end of the second policy year the petitioner would have the option of taking the cash surrender value or having it applied to non-participating term insurance, or particpating paid-up insurance, as follows: LoanPaid-upAt End ofor Cash ValueExtendedTermInsuranceInsuranceof Policy YearPer $1,000 InsuredYearsDaysPer $1,000 Insured2$ 77.808121$1663129.2513932714182.51171513765237.65203214806294.74233155847353.90262266888415.20291837929478.76335789610544.70Policyfull-paid11555.2212565.8913576.7114587.6715598.7416609.9217621.1818632.5119613.8920655.3021666.7222678.1326723.24*184 The values in the foregoing table after the ninth policy year are equal to the full reserve according to the American Experience Table of Mortality with interest at 3 percent. The basis upon which the table is constructed will apply if the policy is continued in force beyond the twenty-second year. On May 10, 1956, petitioner transferred and assigned all of his interests in policy No. 2121250 to A. F. Gallun & Sons Corporation for an amount equal to its cash surender value in the sum of $63,656.00 and thereby realized a net gain over his cost of $10,695.57. On May 10, 1956, petitioner transferred and assigned all of his interests in policy No. 2852125 to A. F. Gallun & Sons Corporation for an amount equal to its cash surrender value in the sum of $31,829.50 and thereby realized a net gain over his cost of $5,156.82. On May 22, 1956, petitioner transferred and assigned all of his interests in policy No. 1831912 to A. F. Gallun & Sons Corporation for an amount equal to its cash surrender value in the sum of $49,607.81 and thereby realized a net gain over his cost of $15,943.31. On May 28, 1956, petitioner transferred and assigned all of his interests in policy No. 680514 to A. *185 F. Gallun & Sons Corporation for an amount equal to its cash surrender value in the sum of $14,755.50 and thereby realized a net gain over his cost of $6,404.75. The rate tables in effect in May 1956, when these policies were assigned to the Gallun corporation show that the following annual premiums with anticipated dividends applied to a person of the then insurance age of the petitioner, that is 58 years: AnnualAnticipatedPremiumDividendType of PolicyPer ThousandPer Thousand10-pay lifeNorthwestern Mutual$105.91$13.71Mutual Benefit107.0913.94Kansas City Life99.88Non-participating20-pay lifeNorthwestern Mutual72.0713.10Mutual Benefit74.5314.27Kansas City Life64.59Non-participatingOrdinary lifeNorthwestern Mutual65.7912.95Mutual Benefit66.1912.04Kansas City Life52.88Non-participatingSingle premium life insurance policies issued by Northwestern Mutual Life Insurance Co. on the life of petitioner at his attained age of 58 years for a face amount of $100,000.00 and $50,000.00 would have had costs of $82,213.00 and $41,106.50, respectively, on May 10, 1956, and would*186 have had cash surrender values on that date in the respective amounts of $73,513.00 and $36,756.50 and anticipated annual dividends for 1957 in the respective amounts of $1,133.00 and $566.50. A single premium life insurance policy issued by the Mutual Benefit Life Insurance Company on the life of petitioner at his attained age of 58 years for a face amount of $75,000.00 would have cost $57,636.75 on May 22, 1956, and would have had a cash surrender value on that date of $53,889.56 and anticipated annual dividends of $684.00. The Kansas City Life Insurance Co. would have charged $18,633.25 for a single premium life insurance policy in the face amount of $25,000.00 on the life of petitioner at his attained age of 58 years in May 1956, and such policy would have had a cash surrender value on that date of $17,108.50 and anticipated annual dividends of $203.00. The cash surrender values of the policies were computed by using the American Experience Table of Mortality and interest at the rates specified in the policies compounded annually. At the time the annual net premium for each policy was determined, a provision was made for assumed administrative costs to be incurred by the*187 company which was added to annual net mathematical premium to establish the gross premium. The reserve established for the cash surrender value of each policy was increased each year by an amount represented by the sum of the net mathematical premium (gross premium less tabularly assumed expenses) plus interest on the total value of the reserve computed at the annual rate provided in the policy. From this amount the cost of mortality at the tabular rate, that is the cost assumed in the tables, was deducted to cover expected deaths in that year of all insured persons of the same age as petitioner, computed in accordance with the American Experience Table of Mortality. Each insurance policy, with the exception of that issued by Mutual Benefit, provided with respect to the cash surrender value that the company had the right in the event of surrender of the policy to defer payment of the cash surrender value for a period not in excess of 90 days. The policy issued by Mutual Benefit specified that the values provided in the surrender value table were the "minimum values guaranteed" by the company. Each insurance policy also provided that no assignment of the policy would be binding upon*188 the company until filed at its home office. If the rate of mortality among the company's insureds was less than that assumed, if the company's earnings were greater than those assumed, and if the costs of administration were less than that assumed and, as a result of these factors the premium receipts were in excess of the amounts needed for the conduct of its business, the companies declared "dividends" to the holders of participating policies. Petitioners received so-called dividends on the policies, either in the form of credits against premiums or in the form of direct cash payments. At the time of the transferring of said policies to A. F. Gallun & Sons Corporation, there were no accumulated dividends. Annual dividends had been previously paid on the policies at yearly intervals beginning two years after the dates of issuance. A. F. Gallun & Sons Corporation had an insurable interest in the life of petitioner during 1956. The corporation has retained the four life insurance policies and has kept them in full force and effect since the date of their assignments by petitioner. Opinion Petitioners begin by asserting that there were bona fide assignments of the insurance*189 policies to the corporation and, therefore, a "sale or exchange" of capital assets within the meaning of section 1222(3) of the Internal Revenue Code of 1954. 1We recognize, as does the respondent, that these were bona fide transfers which were not primarily motivated by tax avoidance. We acknowledge that the transaction was designed to give the corporation the benefits of long existing insurance policies on the life of its key executive officer. Unlike Theodore H. Cohen, 39 T.C. - (March 27, 1963), this is not a situation where the assignee was merely a conduit for surrendering the policies. Here too, there was no "rigging," as with some other cases, under which the purchaser of the insurance contracts almost immediately surrendered*190 them to the insurance company and realized their full cash values. The facts in instant case are perhaps even stronger than they were in those cases in which we have previously held such transfers to constitute bona fide sales. See Bolling Jones, Jr., 39 T.C. 404">39 T.C. 404 (1962); Estate of Gertrude H. Crocker, 37 T.C. 605">37 T.C. 605 (1962); and Harry Roff, 36 T.C. 818">36 T.C. 818 (1961), affd., 304 F. 2d 450 (C.A. 3, 1962). However, that is not dispositive of the problem. While these insurance policies technically fall within the definition of capital assets contained in section 1221, the courts have often concluded that not everything having the outward appearance of a capital asset qualifies as such for the purposes of the capital gains provisions. See Commissioner v. P. G. Lake, Inc., 356 U.S. 260">356 U.S. 260 (1958); Nat Holt, 35 T.C. 588">35 T.C. 588 (1961), affd. 303 F. 2d 687 (C.A. 9, 1962); Harry Roff, supra; Simon Jaglom, 36 T.C. 126">36 T.C. 126 (1961), affd. 303 F. 2d 847 (C.A. 2, 1962); and Hallcraft Homes, *191 Inc., 40 T.C. - (April 30, 1963). The main thrust of petitioners' contention is an impassioned plea that this Court should take "the opportunity to return to the fundamentals recognized by it" in Phillips v. Commissioner, 30 T.C. 866">30 T.C. 866 (1958), reversed 275 F. 2d 33 (C.A. 4, 1960), and cease "burying [our] heads in the sands of judicial precedent." The most obvious answer to this is that our American system of jurisprudence has not yet abandoned the doctrine of stare decisis. Nor do we find anything of substance in petitioners' arguments which would cause us to cast it aside here. Their points are not new and they are not persuasive. This same ground has been plowed many times before. We reconsidered our Phillips decision in Bolling Jones, Jr., supra, and decided that the Court of Appeals properly reversed us. Consequently, it would serve no useful purpose to review the authorities again, especially since the petitioners cite no decision of any court holding otherwise. Despite the factual differences, we think this case is controlled by the following decisions: Commissioner v. Phillips, supra, Arnfeld v. United States, 163 F. Supp. 865">163 F. Supp. 865*192 (Ct. Cls., 1958); Harry Roff, supra; Bolling Jones, Jr., supra; and First National Bank of Kansas City v. Commissioner, 309 F. 2d 587 (C.A. 8, 1962), affirming Michael H. Katz, a Memorandum Opinion of this Court. Under these circumstances we will not disregard this array of judicial precedents. We have carefully analyzed the cases relied on by petitioners and found them to be either inapposite or distinguishable. It is agreed that the petitioner transferred and assigned four life insurance policies to the Gallun corporation for amounts equal to their cash surrender values and thereby realized an increment of $38,200.45 over his cost. If he had exercised his right to surrender these policies to the insurance companies, the increments would certainly have been taxable as ordinary income under section 72(e)(1). 2 In the light of this provision it is evident that Congress did not intend to permit, even through the medium of a bona fide sale, the conversion of what is the equivalent of ordinary income into a capital gain. Furthermore, the reserve established for the cash surrender value of each policy was increased each year by an amount represented*193 by the sum of the net annual premium less assumed administrative expenses, plus interest computed at 3 or 3 1/2 percent. Each year the cash surrender value was increased by a specified amount after deducting assumed mortality costs. Thus the increments realized upon the assignment were primarily attributable to accumulated interest, taxable to petitioners as ordinary income upon receipt under section 61(a)(4). We therefore hold that the entire gain realized on the assignments was ordinary income. See Estate of Gertrude H. Crocker, supra.*194 Alternatively, petitioners contend that, if the increments realized upon the assignments are taxable as ordinary income, then such amounts should be included in their gross income ratably in the years 1956 and the two preceding years under the provisions of section 72(e)(3). 3 This same argument was made and rejected in Harry Roff, supra. At page 826 of the opinion we said: Section 72(e) provides specifically for lump-sum amounts "received under an annuity * * * contract." Nothing in this section or in the congressional comments thereon (see H. Rept. No. 1337 and S. Rept. No. 1622, to accompany H. R. 8300 (Pub. L. 591), 83d Cong., 2d Sess., both at p. 11 (1954)) justifies application of the section to amounts not received "under an annuity * * * contract." Clearly, the amounts received on the sales of the contracts here involved were not so received. The section is applicable to lump-sum payments made by the insurer in discharge of all contractual obliations. See 1 Mertens, Law of Federal Income Taxation, sec. 6A.07, p. 22. *195 Petitioners argue that if the receipts are ordinary income because of section 72(e)(1), then it follows that they are ordinary income for the purposes of all of section 72, including the income-spreading provisions contained in section 72(e)(3). We disagree. It is clear that amounts paid by the Gallun corporation on the assignments of the four life insurance policies were not received by petitioners "under" the life insurance contracts. Petitioners say there is no justification for permitting the respondent to "pick and choose." But, as we see it, the petitioners, not the respondent, cast the mold of this transaction by transferring the policies to the corporation rather than surrendering them to the insurance companies. Accordingly, we hold that the amounts realized by petitioners upon the assignments are fully taxable in the year 1956 since they were not received upon the surrender, redemption or maturity of life insurance contracts. Decision will be entered for the respondent. Footnotes1. SEC. 1222. OTHER TERMS RELATING TO CAPITAL GAINS AND LOSSES. For purposes of this subtitle - * * *(3) Long-Term Capital Gain. - The term "longterm capital gain" means gain from the sale or exchange of a capital asset held for more than 6 months, if and to the extent such gain is taken into account in computing gross income.↩2. SEC. 72. ANNUITIES: CERTAIN PROCEEDS OF ENDOWMENT AND LIFE INSURANCE CONTRACTS. (e) Amounts Not Received as Annuities. - (1) General Rule. - If any amount is received under an annuity, endowment, or life insurance contract, if such amount is not received as an annuity, and if no other provision of this subtitle applies, then such amount - (A) if received on or after the annuity starting date, shall be included in gross income; or (B) if subparagraph (A) does not apply, shall be included in gross income, but only to the extent that it (when added to amounts previously received under the contract which were excludable from gross income under this subtitle or prior income tax laws) exceeds the aggregate premiums or other consideration paid. For purposes of this section, any amount received which is in the nature of a dividend or similar distribution shall be treated as an amount not received as an annuity.↩3. SEC. 72. ANNUITIES: CERTAIN PROCEEDS OF ENDOWMENT AND LIFE INSURANCE CONTRACTS. (e) Amounts Not Received as Annuities. - (3) Limit on Tax Attributable to Receipt of Lump Sum. - If a lump sum is received under an annuity, endowment, or life insurance contract, and the part which is includible in gross income is determined under paragraph (1), then the tax attributable to the inclusion of such part in gross income for the taxable year shall not be greater than the aggregate of the taxes attributable to such part had it been included in the gross income of the taxpayer ratably over the taxable year in which received and the preceding 2 taxable years.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624809/ | HERMAN M. RHODES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Rhodes v. CommissionerDocket No. 54899.United States Board of Tax Appeals34 B.T.A. 212; 1936 BTA LEXIS 733; March 25, 1936, Promulgated *733 1. During the taxable year petitioner, the president and principal stockholder of a corporation, made certain withdrawals of money from it which were treated by him and the corporation as loans and were subsequently repaid in full. Held, that such withdrawals constituted loans to petitioner and not the payment of dividends. 2. In September 1927 petitioner decided that a certain contract to purchase Florida real estate was worthless and charged off as a loss the amounts previously paid, amounting to $15,762.50. In the spring of 1928 he sold his interest under the contract for $1,000 to $1,100. Held, that the contract was not shown to have been worthless in 1927 and petitioner is not entitled to a loss deduction in that year of the amounts paid under the contract. 3. In 1927 Florida real estate to which the petitioner had taken title was sold for taxes. In the same year the petitioner decided to abandon the property as worthless and charged off as a loss the amount of his investment in it. Held, that the deduction claimed is not allowable. Frederick Krauss,30 B.T.A. 62">30 B.T.A. 62, followed. F. E. Hagler, Esq., for the petitioner. Frank*734 B. Schlosser, Esq., for the respondent. TURNER *213 This proceeding is for the redetermination of a deficiency in income tax of $9,314.53 for 1927. The matters presented for determination are the correctness of the respondent's action (1) in determining that certain withdrawals made by petitioner during the taxable year from a corporation of which he was president and principal stockholder constituted dividends, and (2) in disallowing deductions taken by petitioner as losses sustained during the year with respect to certain parcels of Florida real estate. FINDINGS OF FACT. Petitioner is an individual residing at Memphis, Tennessee. In 1924 he organized a corporation known as the Rhodes-Jennings Furniture Co., with a capital stock of $200,000 divided into 2,000 shares. He acquired 1,005 shares of the stock and his wife acquired the remaining 995 shares. Petitioner was president of the corporation and managed its affairs. In addition to his activities in connection with the corporation, he owned and operated a farm known as the Bass Plantation and conducted as a sole proprietorship a business known as the Rhodes Furniture Co.Prior to and during*735 1927 petitioner made withdrawals of money from the corporation. Some of the withdrawals were charged on the books of the corporation to his personal account, while others were charged to the accounts designated as Bass Plantation and Rhodes Furniture Co. In making these withdrawals petitioner considered them as loans, intended to repay them, and instructed the corporation's bookkeeper to treat them as loans. The withdrawals were carried as accounts receivable on the books of the corporation and were shown as such in its balance sheets, which were furnished to credit agencies and to the bank with which it did business. The withdrawals were not in proportion to petitioner's holdings of stock in the corporation. *214 From time to time petitioner made payments on the accounts by way of credits of his salary from the corporation, by turning over corporate securities, and by the payment of money. The following is a statement of the unpaid balances of the accounts at January 1, 1927, the withdrawals made during 1927 and charged to the respective accounts, the payments made during the year and credited to the accounts, and the unpaid balances of the accounts at December 31, 1927: *736 Balance January 1, 1927WithdrawalsPaymentsBalance December 31, 1927H. M. Rhodes, personal$15,000.00$56,795.83$97,855.39(Credit) $26,059.56Rhodes Furniture Co17,951.2921,653.005,129.41(Debit) 34,474.88Bass Plantation19,010.2517,974.49(Debit) 36,984.74Total51,961.5496,423.32102,984.8045,400.06All withdrawals by petitioner were repaid either in the years made or in years subsequent to 1927. On January 1, 1927, petitioner executed a note to the corporation as security for the unpaid balances. On December 31, 1927, the account "H. M. Rhodes, Personal," was charged with $3,000 representing interest at 6 percent on the note. This amount is included in the amount shown above as withdrawals during 1927 and was reported by the corporation in its Federal income tax return for that year and in the income tax return filed by it with the State of Tennessee. At the time petitioner was making withdrawals from the corporation, he was also borrowing money from other sources. He was solvent and able to repay the amounts withdrawn upon demand. No dividends were declared by the corporation prior to or during 1927, but*737 since 1927 dividends have been declared. The surplus of the corporation at the beginning of 1927 was $79,183.27 and at the end of 1927 was $65,294.87. On August 10, 1925, petitioner entered into a contract to purchase, for $20,000, lot 4, block 18, La Gorce Subdivision, in the city of Miami Beach, Dade County, Florida, hereinafter designated as the Davis property. The terms of purchase were $13,250 cash within 30 days, a mortgage for $1,500 payable $500 annually for three years, and the assumption of a then existing contract on the property for $5,250. A down payment of $1,000 was credited to the cash payment required. Petitioner entered into the contract for the purpose of reselling the property at a profit. He made payments pursuant to the contract in a total amount of $15,762.50 and on April 29, 1927, paid state and county taxes on the property for the year 1926. He never obtained a deed to the property. *215 In September 1926 a hurricane struck the section in which the property was located. In 1927 petitioner made several trips to Florida to look after his real estate interests and while there in September of that year another hurricane struck the section. At*738 that time he concluded that there was no chance for the property to return to near its former value and, being of the opinion that the property was not worth what was due on his contract, he decided the contract was worthless and that he would make no further payments. In the spring of 1928 petitioner received an offer of $1,000 or $1,100 for his interest under the contract, which he accepted. Since that transaction he has had nothing further to do with the property. In determining the deficiency the respondent denied a deduction taken by petitioner as a loss sustained on the transaction involving the Davis property. On August 13, 1925, petitioner, acting for himself and an associate, J. A. Carroll, purchased from one Spann and his wife lots 1 and 2 in block 13 of the Dixie Highway Tract, situated in Dade County, Florida, on the Dixie Highway about 16 miles north of Miami, and hereinafter referred to as the Spann property. The lots were small, vacant, and sandy, with palmetto brush on them, and of a type not suitable or valuable for farming purposes. There were no buildings near the lots. The lots were purchased solely for the purpose of speculation. The purchase price*739 was $60,000, payable $12,500 cash, assumption of a first mortgage for $5,500 and a second mortgage for $2,500, and the balance of $39,500 to be represented by four notes for $9,875 each, due in one, two, three, and four years and to be secured by a third mortgage on the property running to the sellers. While petitioner's interest in the property was three fourths, and Carroll's was one fourth, title to the property was taken in the name of petitioner only in order to facilitate its transfer in event of sale. The third mortgage and the notes for the balance of the purchase price likewise were executed only by petitioner. Carroll, however, bore his proportionate part of all payments made with respect to the property. In 1926 and 1927 payments were made on the mortgage indebtedness assumed, but when the first of the notes given the Spanns became due in August 1926 it was not paid. As a result of the nonpayment they sued petitioner in December 1926 on all of the notes and obtained a judgment against him, which he paid. On the occasion of his trip to Florida in September 1927, referred to above, petitioner and Carroll made an investigation as to the Spann property and concluded*740 that it was worthless. The boom in Florida real estate had burst, a second hurricane had come, and things were on the decline. They did not see any prospect for real *216 estate values to increase materially and decided that they would spend no more money on the property. Since then they have had nothing to do with it. In the latter part of December 1927 petitioner charged off as a loss the amount he had expended in connection with his interest in the property. In 1927 the Spann property was sold for unpaid 1926 taxes due the city of Miami and tax certificates were issued on June 6, 1927. In the same year the property was also sold for unpaid state and county taxes due for 1926, and tax certificates were issued on August 1, 1927. In determining the deficiency the respondent disallowed a deduction taken by petitioner as a loss sustained in respect of the Spann property. OPINION. TURNER: Petitioner contends that the respondent erred in determining that a portion of the withdrawals made by him during the taxable year from the Rhodes-Jennings Furniture Co. constituted dividends instead of loans. He urges that the circumstances under which the withdrawals were made*741 and the manner in which they were treated by him and the corporation sustain his contention. We think it is clear that both petitioner and the corporation regarded the withdrawals as loans. The corporation carried them as accounts receivable on its books and showed them as such in its balance sheet which it submitted to third parties for credit purposes. At the beginning of the taxable year petitioner gave to the corporation as collateral a note for approximately the amount of the unpaid withdrawals. During the year interest was paid on the note at the rate of 6 percent per annum. Withdrawals made during the taxable year amounted to $96,423.32, while repayments amounted to $102,984.80, or $6,561.48 in excess of the withdrawals. Petitioner was able financially to repay the amounts withdrawn. The evidence not only shows that the withdrawals were regarded as loans and were to be repaid, but that in a later year they were paid in full. On these facts we hold that the amounts in controversy constituted loans and not dividends. *742 ; ; . Petitioner contends that the contract to purchase the Davis property became worthless in 1927, resulting in a loss to him in that year of $15,762.50, which he is entitled to take as a deduction. The respondent contends that the contract did not become worthless in 1927 and that any loss sustained by petitioner was sustained in 1928 when petitioner sold his interest thereunder. There is no controversy as to the amount allowable in the event we hold that petitioner sustained *217 a loss in 1927, the parties having stipulated the amount paid on the purchase price of the property. As a result of his investigation in September 1927, petitioner decided that the property covered by the contract was not worth the balance owing thereon and that the contract therefore was worthless. In the spring of 1928, however, he sold his interest under the contract for $1,000 or $1,100. Petitioner stated that he was surprised when he received the offer, but there is nothing in the record to indicate that the value of the property or*743 of other real estate in that vicinity had improved to any extent after September 1927. It would thus appear that the value of the property was as much in 1927 as in 1928 when petitioner disposed of his interest under the contract. This being true, we are unable to find that the contract became worthless in 1927 as petitioner contends. Cf. ; ; affd., . Petitioner also contends that he sustained a deductible loss of $28,875 on the Spann property during the taxable year, and the parties have stipulated that the foregoing amount is correct if petitioner is entitled to a loss deduction in respect of the said property. Petitioner took title to the Spann property in 1925, assuming first and second mortgages, and gave the sellers a third mortgage thereon to secure payment of certain purchase price notes. Upon nonpayment of the notes, the sellers, without resorting to foreclosure of the mortgage, brought suit and obtained judgment on the notes. Petitioner subsequently paid the judgment. What action, if any, the holders of the two prior*744 mortgages have taken is not disclosed by the record. The situation, therefore, is not one involving a loss resulting from the foreclosure of a mortgage. Petitioner claims that the loss deductions should be allowed on the ground that he determined the property to be worthless and abandoned it during the taxable year, and for the further reason that the property was sold during that year for unpaid state, county, and city taxes. We have considered the claim of abandonment of real estate as the basis for a loss deduction in respect thereto in numerous cases and have decided the issue adversely to the claim of the petitioner herein. ; ; affd., ; . The question as to whether a sale of Florida real estate for taxes is such an event as to give rise to a deductible loss has also been carefully and fully considered in , and determined adversely to the petitioner. We accordingly hold that petitioner is not entitled to the loss deduction claimed in respect of the*745 Spann property. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624810/ | George W. Wise and Lu Celia Wise v. Commissioner.Wise v. CommissionerDocket No. 3569-67.United States Tax CourtT.C. Memo 1971-38; 1971 Tax Ct. Memo LEXIS 295; 30 T.C.M. (CCH) 169; T.C.M. (RIA) 71038; February 24, 1971, Filed *295 Held, petitioners' share of the net operating loss of a small business corporation limited to the adjusted basis in their stock, as determined by the Commissioner; held further, petitioners are not allowed an adjusted basis in an indebtedness owed by the corporation for purposes of computing their share of the net operating loss, since being on the cash basis, they had not reported any part of such debt as income, and did not have a basis therein. Held further, due to lack of proof no deduction is allowable for depreciation or operating expenses of an automobile alleged to have been used in petitioner-husband's insurance business. Held further, medical expense deduction adjusted. Held further, petitioners are liable for addition to tax under sec 6651(a), I.R.C. 1954, for delinquent filing. No reasonable cause for delay shown. Charles C. Dunn, 1954 Utica Square, Tulsa, Okla., for the petitioners. F. Timothy Nicholls, for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: The Commissioner determined a deficiency in petitioner's Federal income tax for the year 1964 in the amount of $2,697.34. He also determined an addition to tax for the late filing of *296 petitioners' 1964 Federal income tax return in the amount of $74.06. There are four issues to be decided. First, is whether petitioners' deduction of Lu Celia's pro rata share of a small 170 business corporation's net operating loss should be limited to $19.66 - the amount determined by the Commissioner to be her adjusted basis in her share of the corporation's stock. Second, is whether George operated and maintained, in his business, an automobile, so as to allow petitioners to deduct depreciation and operating expense deductions therefor. Third, are petitioners liable for an addition to tax for the late filing of their 1964 return? Fourth, did the petitioners overstate their medical expense deduction? 1Findings of Fact Some of the facts have been stipulated. The stipulation and the exhibits attached thereto are incorporated herein by this reference. Petitioners, George W. Wise and Lu Celia Wise, were residents of Tulsa, Oklahoma at the time their petition was filed herein. They filed a joint 1964 Federal income tax return with the district director of *297 internal revenue, Oklahoma City, Oklahoma on May 24, 1965. In May of 1959, Lu Celia began operation of a proprietorship, known as Oil Originals by Lu Celia Wise, which continued operations until March 18, 1963. Oil Originals by Lu Celia, Inc. (hereinafter referred to as the corporation), was incorporated in Oklahoma on March 17, 1963, and chartered to engage in the business of manufacturing, fabricating, distributing, and selling executive gifts and associated products pertaining to the oil and gas industry. The corporation used a fiscal year ending February 28, and an accrual method of accounting for Federal income tax purposes. On March 18, 1963, Lu Celia transferred all existing assets and outstanding liabilities of the proprietorship to the corporation in a tax-free exchange pursuant to the terms of section 351, Internal Revenue Code of 19542*298 Immediately after consummation of the tax-free exchange on March 18, 1963, Lu Celia owned 25,500 shares of the corporation's 28,500 outstanding shares of capital stock. During the fiscal year ending February 28, 1964, Lu Celia was the president, treasurer and general manager of the corporation as well as its controlling shareholder. As of March 18, 1963, the following entries were made in Oil Originals by Lu Celia, Inc's general journal and posted to the individual ledger accounts: Boulder Bank & Trust$ 304.76Accounts receivable723.43Mdse. for manufacturer's representative792.00Inventory in process500.00Furniture & equipment539.96Vehicles1,000.00Molds, dies & tooling9,055.40Patent and patent application, market testing, goodwill26,992.67Incorporation expense358.00National Bank of Tulsa - note payable$ 600.00Boulder State Bank - note payable2,100.00Accounts payable2,057.45Accounts payable - office1,400.00Capital stock, issued and outstanding28,500.00L. Wise 25,500 sharesA. Gisler 500 sharesD. Blue 2,500 sharesContributed surplus5,608.77 $40,266.22$40,266.22 For its fiscal year ending February 28, 1964, the corporation made a timely and valid election under section 1372 to be treated as a small business corporation for Federal income tax purposes. For that fiscal year the corporation sustained a net operating loss. On their joint 1964 Federal income tax return, the petitioners deducted $12,003.60 as Lu Celia's pro rata share *299 of the net operating loss sustained by the corporation for its fiscal year ending February 28, 1964. The petitioners have always used the 171 calendar year and cash basis method of accounting for Federal income tax purposes. On February 28, 1964, the corporation was indebted to Lu Celia in the amount of $2,021.08 for salary due her for fiscal year ended February 28, 1964. None of said amount had been reported by Lu Celia prior to the taxable year 1964. Lu Celia had a basis of $304.76 in the cash in bank credited on March 18, 1963, in the Boulder Bank & Trust to the account of the corporation. She had a basis of $358 in the "Incorporation Expense" recorded on the books of the corporation, and had a basis of $1,363.58 in the "Inventory In Process" which she transferred on March 18, 1963 to the corporation in exchange for stock of the corporation. Lu Celia had a basis of $875.73 in the "Furniture & Equipment" which she transferred to the corporation in exchange for stock of the corporation. She also exchanged a 1958 Dodge automobile for stock of the corporation. As of the close of their taxable year 1962, the petitioners had been allowed depreciation deductions totaling $2,443.50 for *300 the 1958 Dodge automobile which George used in his insurance business. On March 18, 1963, the unrecovered cost or adjusted basis of the 1958 Dodge automobile was $271.50. In 1960, Lu Celia purchased for her proprietorship, "Equipment & Dies" for an alleged cost of $3,190 and claimed a depreciation deduction of $1,063.33 on these assets for that year. In 1961, the cost and useful life of these assets were adjusted and for 1961, 1962, and 1963, the petitioners claimed depreciation deductions totaling $523.13. The petitioners did not seek to depreciate the cost of a patent on any of their individual Federal income tax returns for the taxable years 1959 through 1963. On their 1961 and 1962 Federal income tax returns, ordinary expense deductions totaling $245 were claimed by the petitioners for "Patent Expense" incurred in the operation of Mrs. Wise's proprietorship. On their 1961 and 1962 Federal income tax returns, ordinary expense deductions totaling $457.38 were claimed by the petitioners for "Marketing" incurred in the operation of Lu Celia's proprietorship. As part of the consideration to Lu Celia in the March 18, 1963 tax-free exchange, the corporation assumed liabilities of Lu *301 Celia, or acquired from her property subject to a liability in the amount of $4,757.45. During 1964, George was primarily employed as an engineer. In 1964, he also was engaged in the business of selling general insurance. In conducting his insurance business he drove a 1958 Dodge automobile. George kept no record as to the number of miles he drove in 1964 in conducting his insurance business. The only evidence as to the claimed business usage in 1964 of the 1958 Dodge automobile is uncorroborated estimates by him as to the number of miles he drove on weekdays and weekends while conducting his insurance business. Opinion As heretofore stated, there are four issues to be decided. The extent of Lu Celia's share of the net operating loss of a small business corporation; whether George operated and maintained an automobile in his business so as to allow the petitioners a deduction for depreciation and operating expenses thereon; whether the petitioners negligently filed their 1964 Federal tax return beyond the date prescribed; and whether they overstated their medical expense deduction. We preface our decision herein with the following comment. Our task has been made no easier due to the *302 failure of petitioners to submit briefs or substantial evidence in support of their position. In fact, the only evidence presented, aside from petitioners' testimony, was the general ledger for the corporation, a copy of the minutes of the first stockholders meeting, a copy of the stock subscription agreement, and several schedules showing amounts expended, the date, the payee and an all too brief explanation thereof. The guilding principle herein has oft been stated. The Commissioner's determination is presumed to be correct and the burden is on the petitioners to prove the contrary. Rule 32, Tax Court Rules of Practice; Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Helvering v. Taylor, 293 U.S. 507">293 U.S. 507 (1935). The Commissioner determined that a portion of the net operating loss sustained by the corporation for fiscal year ended February 28, 1964 should be disallowed, thereby reducing Lu Celia's pro rata share thereof. In accordance with section 1374(c)(2)(A)(B), 3172 it was determined that petitioners' deduction should be further reduced to the sum of $19.16 (the adjusted basis of her stock as of February 28, 1964) and $2,021.08 (the indebtedness allegedly owed to Lu Celia as of February *303 28, 1964.) 4*304 The question for decision first is whether or not petitioners' pro rata share of the net operating loss is properly limited to $19.66. In arriving at his eventual determination, the Commissioner made numerous preliminary inquiries in regard to the basis of the various assets and liabilities reflected on the books *305 of the corporation as of March 18, 1963, for which Lu Celia had received her stock in the corporation. Applying the pertinent basis provisions of the Code to the various items, the Commissioner arrived at the following values: AdjustedAssetBasisLiabilityAmountCash in bank$ 304.76National Bank of Tulsa$ 600.00Accounts receivableBoulder State Bank2,100.00Merchandise for manufacturer's repre- sentativeAccounts payable2,057.45Inventory in process1,363.58Furniture and equipment875.73Vehicles271.50Molds, dies and tooling1,603.54Patent and patent application, market testing, goodwillIncorporation expense 358.00 $4,777.11$4,757.45 As to the various items, the Commissioner accepted the figures for cash in bank and "Incorporation Expense" and allowed a basis higher than that claimed for "Inventory in Process" and for "Furniture & Equipment" on the corporation's books. However, he determined that "Accounts Receivable" and "Mdse. for Manufacturer's Representative" had a zero basis rather than that appearing on the corporation's books of $723.43 and $792, respectively. Petitioners presented no evidence that bears on these two items. Further, since petitioners were cash basis taxpayers, it is apparent *306 that the $723.43 of accounts receivable had not been included in their prior year's income, and so could not afford Lu Celia a basis to be carried over to her stock. P.A. Birren & Son v. Commissioner 116 F. 2d 718 (C.A. 7, 1940), affirming a Memorandum Opinion of this Court. Therefore, the Commissioner's determination is sustained. The item listed on the corporation's books under "Vehicles" is a 1958 Dodge automobile. The Commissioner determined that Lu Celia had an adjusted basis of only $271.50 in this asset when she exchanged it for stock. Petitioners' tax returns disclose a cost figure of $2,715 for the automobile, purchased in 1958. At the close of their taxable year 1962, the petitioners had been allowed depreciation deductions totaling $2,443.50 for the 1958 Dodge which George 173 claims he used in his insurance business. The Commissioner treated the unrecovered cost of $271.50 as Lu Celia's adjusted basis in the Dodge on March 18, 1963. We sustain his determination in the absence of proof to the contrary. The next item is the Commissioner's determination with respect to the item "Molds, Dies & Tooling." His position is that Lu Celia had an adjusted basis of $1,603.54 in the *307 "Molds, Dies & Tooling" which she exchanged for stock. Petitioners' 1960 tax return and specifically Schedule C-1 thereof, pertaining to her proprietorship, shows a purchase in 1960 of "Equipment & Dies" for $3,190 and a depreciation deduction of $1,063.33 for that year. However, for the taxable year 1961, it appears that the petitioners adjusted the cost and useful life of these assets and claimed depreciation deductions totaling $523.13 for the taxable years 1961 through 1963. By deducting the total depreciation claimed by the petitioners on these assets for the years 1960 through 1963 ($1,586.46) from the $3,190 originally stated as the cost, the Commissioner arrived at an adjusted basis of $1,603.54 to Lu Celia on March 18, 1963. This adjusted basis computed and allowed by the Commissioner is in excess of the adjusted basis ($1,104.37) which results if the figures used are those the petitioners show on their 1963 tax return as the cost ($1,860) and total allowed depreciation ($755.63) of these assets. We come next to the item "Patent and Patent Application, Market Testing, Goodwill," which was given a value of $26,992.67 on the corporation's books. With regard to the alleged patent, *308 petitioners have presented no evidence of Lu Celia's adjusted basis in any patent at March 18, 1963. Further, the existence of any patent is doubtful since the petitioners never sought to depreciate the cost of a patent on any of their returns for 1959 through 1963. The evidence pertaining to "Patent Application" and "Market Testing" is to the effect that if Lu Celia ever incurred any expenditures in operating her proprietorship, which might have constituted the basis of either item, the petitioners deducted these expenses annually on their returns. Thus, for 1961 and 1962, ordinary expense deductions totaling $245 were claimed for "Patent Expense" and $457.38 for "Marketing." As to goodwill, the petitioners have produced no evidence to show that Lu Celia had a basis in "Goodwill" at the time the proprietorship's assets were exchanged for stock. There is no showing that the proprietorship maintained such an account on its books, or had any other basis for claiming such an item. As to both of the above classes of assets, we again uphold the Commissioner's determination in the absence of competent proof to the contrary. Thus the Commissioner determined that on March 18, 1963, Lu Celia *309 had a basis of $4,777.11 in the assets which she transferred to the corporation in exchange for its capital stock. The Commissioner deducted from this amount those liabilities of Lu Celia which the corporation had agreed to assume ($4,757.45), and arrived at the net figure of $19.66, which he ascertained to be the adjusted basis in her stock as of March 18, 1963. Since the petitioners have not shown that between March 18, 1963 and February 28, 1964, Lu Celia made any further contributions to capital, which would increase her stock basis, the Commissioner concluded that her adjusted stock basis, at the close of the corporation's first taxable year, was $19.66. Accordingly, we sustain the Commissioner's determinations discussed above, on the basis of the presumption of correctness attaching to them. The second aspect of this issue, the amount of petitioners' share of the corporation's net operating loss, is the question of the basis, if any, which Lu Celia had in the $2,021.08 owed her by the corporation. The identical issue was involved in the case of Joe E. Borg, 50 T.C. 257">50 T.C. 257 (1968). The only factual difference, which is not material, is that in Borg, the taxpayers were given written *310 evidences of indebtedness for unpaid salaries, whereas here the indebtedness was represented by an open account. We held in Joe E. Borg, supra, that the taxpayers could not consider such indebtedness as available for the limitations of section 1374(c)(2). We stated there, that with cash basis taxpayers, who had properly not reported any of the unpaid salary on their returns: Where a taxpayer has not previously reported, recognized, or even realized income, it cannot be said that he has a basis for a note evidencing his right to receive such income at some time in the future. * * * the performance of services, involving neither the realization of taxable income nor a capital outlay, is not the kind of cost that would be shown in a cash receipts and disbursements system of income accounting. * * * Since the services performed by petitioner Joe E. Borg had no cost within the meaning of section 1012, his notes for unpaid salary had a basis of zero and, therefore, added 174 nothing to the adjusted basis for indebtedness for the purpose of computing the section 1374(c)(2) limitation on net operating loss deductions. We find further support for our conclusion in the fact that allowing petitioners *311 a deduction for the 1962 net operating loss by treating the salary claim as indebtedness with a basis equal to the face amounts of the notes for purposes of the section 1374(c)(2) limitation would apparently require a double inclusion of the salary in petitioners' income in the year when paid, once as salary received under Code section 61, and again on account of the recovery of sums due on the notes in excess of their basis. See Joe M. Smith, 48 T.C. 872">48 T.C. 872, 878-879 (1967). We do not think Congress intended subchapter S of the Code to produce such a result. Joe E. Borg, supra, at 263, 264. We find no difference in the case herein, and hold that Lu Celia had no basis in the sum owed by the corporation on account of her services thereto. The next issue concerns the deduction for automobile depreciation and operating expenses. The automobile involved is the 1958 Dodge described above, which was alleged to have been used by George in his general insurance business. Petitioners claimed $748.45 for depreciation on their 1964 tax return. However, this amount relates to a 1963 Oldsmobile which was used solely by Lu Celia. We have no evidence which would properly allow George to claim depreciation *312 for the use of that automobile in his insurance business. Sec. 167(a); sec. 1.167(a)-1, Income Tax Regs. Petitioners also claimed an operating expense deduction of $583.72 representing 90 percent of the total $648.58 expended by George in operating and maintaining an automobile. The Commissioner does not place in issue the amount of the expenses incurred, rather, he takes issue with petitioners' contention that George incurred 90 percent of the total expenses. Petitioners presented no evidence of any sort as to the miles driven by George and he kept no record thereof. The only evidence is George's own estimates. Such proof is not sufficient to sustain petitioners' burden. We come now to the addition to tax of $74.06, under section 6651(a), for delinquent filing. The return discloses it was received on May 24, 1965. As to the original penalty asserted of $36.64, petitioners have not met their burden of showing that any delay was due to reasonable cause. Accordingly, the Commissioner's determination is sustained. Ivan D. Pomeroy, 54 T.C. 1716">54 T.C. 1716 (1970); Lawrence Sunbrock, 48 T.C. 55">48 T.C. 55 (1967). As to the increase of the penalty, there is evidence of record to show that the return was delinquently *313 filed. We think this fact is adequate to place the burden on the petitioners to show that any delay was due to reasonable cause. No evidence bearing on this point has been introduced and the total penalty is also sustained. Decision will be entered under Rule 50. Footnotes1. This issue is dependent on a determination of the preceding issues and its resolution will flow from a computation under Rule 50.↩2. All statutory references are to the Internal Revenue Code of 1954 unless otherwise specified.3. SEC. 1374(c)(2). Limitation. - A shareholder's portion of the net operating loss of an electing small business corporation for any taxable year shall not exceed the sum of - (A) the adjusted basis (determined without regard to any adjustment under section 1376 for the taxable year) of the shareholder's stock in the electing small business corporation, determined as of the close of the taxable year of the corporation (or, in respect of stock sold or otherwise disposed of during such taxable year, as of the day before the day of such sale or other disposition), and (B) the adjusted basis (determined without regard to any adjustment under section 1376↩ for the taxable year) of any indebtedness of the corporation to the shareholder, determined as of the close of the taxable year of the corporation (or, if the shareholder is not a shareholder as of the close of such taxable year, as of the close of the last day in such taxable year on which the shareholder was a shareholder in the corporation). 4. Subsequent to the issuance of the notice of deficiency, however, the Commissioner filed an amendment to his answer wherein he asked the Court to limit the petitioners' deduction to $19.16, it being his position that Lu Celia had no basis in the $2,021.08 indebtedness at the close of the corporation's first fiscal year. The question of whether there was a basis in the indebtedness will be treated later on in this opinion. Because of his amended position, the Commissioner asked for an increase in the deficiency and addition to the tax. Since the time this case was tried, a computation error favorable to the petitioners was discovered, hence, the Commissioner concedes that on February 28, 1964, the adjusted basis of Mrs. Wise's stock of Oil Originals was $19.66 rather than $19.16 as set forth in the notice of deficiency. Regardless of who has the burden of proof, we think that on this record the existence of the $2,021.08 indebtedness has been established and the basic issue is one of law, i.e. whether the indebtedness can be included in Lu Celia's basis. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624811/ | The Foote-Burt Company, Petitioner, v. Commissioner of Internal Revenue, RespondentFoote-Burt Co. v. CommissionerDocket No. 13445United States Tax Court10 T.C. 948; 1948 U.S. Tax Ct. LEXIS 181; May 24, 1948, Promulgated *181 Decision will be entered for the respondent. Shares of stock of a wholly owned subsidiary corporation which the petitioner purchased for the purpose of increasing its wartime production capacity, held, not "emergency facilities" subject to amortization deductions under section 124, Internal Revenue Code. Theodore R. Colborn, Esq., for the petitioner.Clarence E. Price, Esq., for the respondent. LeMire, Judge. LEMIRE *948 The respondent determined deficiencies against the petitioner in income and excess profits taxes for the calendar year 1941 in the respective amounts of $ 1,672.46 and $ 9,486.47. These deficiencies arise from the disallowance of a deduction of $ 13,500 claimed as amortization, under section 124 of the Internal Revenue Code, of the cost of the capital stock of a wholly owned subsidiary corporation. *182 The sole question presented to the Court is whether the petitioner is *949 entitled to a deduction for accelerated amortization of this stock as an emergency facility under the aforesaid section. The facts were stipulated in part and other evidence was adduced at the hearing.FINDINGS OF FACT.The stipulated facts are incorporated herein by reference. They, and the other facts of record, may be summarized as follows:The petitioner is an Ohio corporation, with its principal office at Cleveland, Ohio. Its income and excess profits tax returns for the calendar year 1941 were filed with the collector for the eighteenth district of Ohio.For several years prior to, and including, the taxable year 1941, the petitioner operated a manufacturing plant at 13000 St. Clair Avenue, N. E., Cleveland, Ohio, where it engaged in the manufacture of machine tools such as drilling, reaming, and tapping machines, surface broaching machines, rifling machines, and single spindle automatic screw machines, and equipment for all such machines. During the latter half of 1940, and throughout 1941, and for several years thereafter during World War II, petitioner manufactured said products for customers*183 having prime contracts and subcontracts with the United States Government or for the Purchasing Commissions of Great Britain, Canada, and Australia, and from time to time it also manufactured smaller amounts of such products directly for the United States Government.On November 20, 1940, petitioner acquired for cash in the amount of $ 67,500 all of the outstanding capital stock of the Hammond Manufacturing Co., an Ohio corporation occupying a plant on East 80th Street, Cleveland, Ohio, where it manufactured precision surface grinders and sensitive radial drills. Shortly after such acquisition the name of the corporation was changed to the Foote-Burt Machine Co. To save confusion the company will be referred to hereinafter as Hammond. The balance sheet of Hammond, as of October 31, 1940, showed the following assets and liabilities:Assets:Cash$ 16,518.27Accounts receivable10,416.90Inventory21,418.40Property, plant, and equipment:Land$ 9,400.00Building$ 39,077.85Less reserve for depreciation10,165.3528,912.50Machinery and equipment, etc72,311.99Less reserves for depreciation67,114.025,197.9743,510.47Total91,864.04Liabilities and capital:Notes payable$ 42,500.00Accounts payable8,681.99Accrued local taxes602.90Accrued Federal taxes on income6,699.51Capital stock and deficit:Capital stock$ 41,300.00Deficit7,920.3633,379.64Total91,864.04*184 *950 Immediately following acquisition of the Hammond stock, T. H. Doan, president, and S. E. Gross, secretary-treasurer of the petitioner, were elected to the same respective offices in that company. The general manager of Hammond remained with that company as its general manager. During the ensuing period, through December 1941, the subsidiary's production and sales of machinery and parts therefor were increased to the limit of the practical capacity of its plant.The stock of Hammond was carried on the books of the petitioner as a capital investment, in the amount of $ 67,500, until 1943, when the company was liquidated.Upon application of the petitioner, filed on November 29, 1941, the Secretary of War issued his necessity certificate (No. WD-N-5657), dated March 10, 1942. The certificate of necessity reads as follows:Mar 10 1942No. WD-N-5657War DepartmentNecessity CertificateTo the Commissioner of Internal Revenue:Pursuant to Section 124 of the Internal Revenue Code, particularly subsection (f) thereof, and in response to the application filed by The Foote-Burt Company, 13000 St. Clair Avenue, Cleveland, OhioIt Is Hereby Certified that the facilities described*185 in the attached Appendix A (consisting of twelve pages * * *) are necessary in the interest of national defense during the emergency period, up to 100% of the cost attributable to the construction, reconstruction, erection, installation or acquisition thereof, and that the application for this Certificate was filed on November 29, 1941.By direction of the Under Secretary of War:[Signed] George H. Foster,Lt. Col., Signal Corps,Chief, Tax Amortization Division,Office of the Under Secretary of War.Certified true copy.[Signed] J. T. Ashworth,1st Lt., Specialist, Office Assistant,Tax Amortization Division.In its application for such certificate of necessity the petitioner stated, after describing in detail the facilities of Hammond:Applicant believes the acquisition of the capital stock of Hammond Manufacturing Company for the sum of $ 67,500.00 necessary in the interests of national *951 defense and requests a certificate of necessity for this investment if the regulations so permit.The petitioner's purpose in acquiring Hammond was to utilize the facilities of that company to their fullest extent in order to meet the demand of the United States Government*186 for increased production of equipment essential to the war effort. The petitioner did not acquire Hammond as a permanent addition to its own plant. That company was operated as a completely separate unit at all times after its acquisition by the petitioner.The petitioner's production in terms of dollars increased from approximately $ 3,276,000 in 1940 to approximately $ 6,093,000 in 1942, while that of Hammond increased from $ 150,254 in 1940 to $ 793,351 in 1942. Most of the production of Hammond was of grinders and radial drills, completely manufactured at its plant. The company also did contract work for the petitioner, on materials which the petitioner furnished, of approximately $ 78,600 in 1941 and $ 52,200 in 1942.Upon its liquidation in 1943 all of Hammond's assets were sold for cash, which was distributed to the petitioner in exchange for its capital stock. The petitioner realized a capital gain on this transaction.In its income and declared value excess profits tax return for 1941 the petitioner elected to amortize its cost of Hammond stock over a sixty-month period, commencing with the month of January 1941, and claimed a deduction on account thereof in the amount*187 of $ 13,500. The respondent disallowed the deduction in determining the deficiency herein.OPINION.The petitioner's sole contention here is that the capital stock of Hammond, which it purchased in 1940, was an "emergency facility" within the meaning of section 124, Internal Revenue Code, the cost of which it is entitled, at its election, to amortize at the rate specified in the statute. Apparently, this question is one of first impression.The material provisions of section 124 are as follows:SEC. 124. AMORTIZATION DEDUCTION.(a) General Rule. -- Every person, at his election, shall be entitled to a deduction with respect to the amortization of the adjusted basis (for determining gain) of any emergency facility (as defined in subsection (e)), based on a period of sixty months. Such amortization deduction shall be an amount, with respect to each month of such period within the taxable year, equal to the adjusted basis of the facility at the end of such month divided by the number of months (including the month for which the deduction is computed) remaining in the period. Such adjusted basis at the end of the month shall be computed without regard to the amortization deduction*188 for such month. The amortization deduction above provided with respect to any month shall, except to the extent provided in subsection (g) of this section, be in lieu of the deduction with respect to such facility for such month provided by section 23 (l), relating to exhaustion, wear *952 and tear, and obsolescence. The sixty-month period shall begin as to any emergency facility, at the election of the taxpayer, with the month following the month in which the facility was completed or acquired, or with the succeeding taxable year.* * * *(e) Definitions. --(1) Emergency facility. -- As used in this section, the term "emergency facility" means any facility, land, building, machinery, or equipment, or part thereof, the construction, reconstruction, erection, installation, or acquisition of which was completed after December 31, 1939, and with respect to which a certificate under subsection (f) has been made. * * *The Commissioner's regulations (sec. 29.124-0 of Regulations 111, as amended by T. D. 5432, 1945 C. B., p. 180) define "emergency facility" as follows:(b) "Emergency facility" means any facility, land, building, machinery, *189 or equipment, or any part thereof --(1) the acquisition of which occurred after December 31, 1939, or the construction, reconstruction, erection, or installation of which was completed after such date, and(2) any part of the construction, reconstruction, erection, installation, or acquisition of which has, under such regulations as may be prescribed by the Secretary of War and the Secretary of the Navy, or the Chairman of the War Production Board, or his duly authorized representative, with the approval of the President, been certified by the certifying officer as necessary in the interest of national defense during the emergency period.The word "facility" is defined in Webster's New International Dictionary, 2d ed., as "A thing that promotes the ease of any action, operation, transaction, or course of conduct."In Corona Coal Co. v. United States, 21 Fed. (2d) 489; affd., 23 Fed. (2d) 673 (C. C. A., 5th Cir.), the court said that "'Convenient means' is perhaps a complete definition of 'facility.'" The court there had under consideration the question of whether the openings and development of coal mines were facilities*190 contributing to the prosecution of the war within the meaning of section 234 (a) (8) of the Revenue Act of 1918. The statute there under consideration permitted a "reasonable deduction" for the amortization of "buildings, machinery, equipment, or other facilities, constructed, erected, installed, or acquired" for the prosecution of the first World War. The mine openings and developments were held to be within the meaning of the term "facilities." The court there rejected the Commissioner's effort "to place a technical limitation on the operation of the statute by the application of the doctrine of ejusdem generis * * * and the maxim noscitur a sociis," as the Commissioner proposes in the instant case, saying that these were not fixed rules of statutory construction; that, since the particular words, "buildings, machinery, and equipment" exhausted the class, full import should be accorded the general term "other facilities"; and that:*953 The manifest purpose of the act was to afford relief to taxpayers who increased production of articles contributing to the prosecution of war. The means adopted by the act were to permit a deduction measured by proper amortization of the *191 cost to the taxpayer of appropriate facilities. There is no limitation of "articles" to a kind or class. Neither is there a limitation of "facilities." The facilities, then, may differ as widely as the articles. * * *The court further pointed out that the statutory provision under consideration was a relief measure and therefore must be liberally construed in favor of the taxpayer.In Briggs Mfg. Co. v. United States, 30 Fed. (2d) 962, the court said of this same provision of the statute (sec. 234 (a) (8) of the Revenue Act of 1918) that: "The scope of the statute, as I read it, almost defies limitation," and that no "instrumentality" for the production of articles of war is excluded from the operation of the statute.Assuming that the statutory term "facility" can be given a sufficiently broad construction to include shares of stock, there still remains unanswered our question, whether such a construction would conform to the congressional intent.Turning to the legislative history of the enactment, we find that in the draft of the House bill (H. R. 10413), as presented to the Senate, and also in the bill as reported by the Senate Finance Committee, *192 the word "facility" did not appear in the definition of "emergency facility," contained in section 124 (e). The bill then read: "As used in this section, the term 'emergency facility' means any land, building, machinery, or equipment, or part thereof."The report of the Committee on Ways and Means on this provision of the bill reads, in part, as follows:Title II of the bill adds to the Internal Revenue Code a new section to be designated as section 124 and a new subsection designated section 23 (t) to authorize the allowance of a deduction for the cost of certain facilities necessary in the interest of national defense during the present emergency. Section 124 provides that a corporation shall be allowed a deduction for income and excess-profits tax purposes for the amortization of certain facilities which the Advisory Commission to the Council of National Defense and either the Secretary of War or the Secretary of the Navy certify as necessary in the interest of national defense during the present emergency. Such facilities are land, buildings, machinery and equipment or parts thereof acquired after July 10, 1940, or the construction, reconstruction, erection, or installation*193 of which was completed after July 10, 1940. In order to be effective for the purpose of the amortization allowance, such certification must have been made before (1) the beginning of such construction, reconstruction, erection, or installation, or the date of such acquisition, or (2) the sixtieth day after the date of the enactment of the bill, whichever of such dates is the later. Although a facility may be an emergency facility even though its construction was begun on or before July 10, 1940, only so much of its adjusted basis as is attributable to certified construction taking place after July 10, 1940, is subject to amortization. The remainder of the adjusted basis is subject to depreciation. Capital additions, whether or not the cost thereof is covered by a certificate, may not be added to the adjusted basis for amortization as determined under a prior certificate. If certified, a new amortization period *954 begins relative to the cost of such capital additions. The amortization of the adjusted basis of such facilities is to be spread over a period of 60 months, the deduction to be in lieu of the present deduction for exhaustion, wear, and tear, and obsolescence *194 provided for in section 23 (l) of the Internal Revenue Code. The 60-month period shall begin as to any emergency facility, at the election of the taxpayer, with the month following the month in which the facility was completed or acquired, or with the succeeding taxable year.The Senate Finance Committee report states that: "Your committee extended the amortization deduction benefits to certified construction after January 1, 1940, in place of July 10, 1940, as provided in the House Bill." [Italics supplied.]The word "facility" was inserted before the word "land" on the proposal of Senator Harrison, Chairman of the Finance Committee, as a "clarifying amendment." This amendment was referred to in the conference report as follows:This is a clarifying amendment expanding the definition of the term "emergency facility" to include any facility which meets the required conditions, as well as land, buildings, machinery, or equipment, in terms of which the definition in the House bill was phrased. This is to make certain that the cost of dry docks, channels, airports, and similar facilities may be amortized. The House recedes.We think that the history of the enactment of the statute*195 shows clearly that shares of corporate stock are not the type of property to which Congress intended the wartime amortization deduction provisions to apply. A share of stock in a corporation is not in itself a thing, or a "facility," which can be used for producing anything. It merely symbolizes ownership of such facilities. It is not something to be constructed or created or utilized in the process of manufacturing or producing any war commodity. It does not suffer deterioration through usage and is not subject to depreciation or exhaustion. In this connection it is especially significant that the amortization deductions are to be taken "in lieu of the deduction with respect to such facility for such month provided by section 23 (l), relating to exhaustion, wear and tear, and obsolescence." (Sec. 124 (a), supra.)It is not shown or even claimed here that the full statutory depreciation or exhaustion deductions allowable on the assets of the subsidiary corporation were not allowed, or were not allowable, in the subsidiary's returns for the taxable year involved in this proceeding. To permit the petitioner additional amortization deduction on the shares of stock evidencing*196 the ownership of these assets would be to allow a double deduction, which Congress expressly forbade. The petitioner did not suffer any loss on its investment in the subsidiary stock, but actually realized a capital gain.We think that the petitioner's claim for an amortization deduction, based on the cost of the stock, is without merit.Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624813/ | Fred W. Amend Co., Petitioner v. Commissioner of Internal Revenue, RespondentFred W. Amend Co. v. CommissionerDocket No. 5385-67United States Tax Court55 T.C. 320; 1970 U.S. Tax Ct. LEXIS 29; November 19, 1970, Filed *29 Decision will be entered for the respondent. Held, amounts expended for the retention of a Christian Science practitioner whose services, during the years in issue, were availed of solely by petitioner's treasurer-board chairman, were not properly deductible by petitioner as an ordinary and necessary expense of its business. John Enrietto, for the petitioner.Robert H. Burgess, for the *30 respondent. Irwin, Judge. IRWIN*320 Respondent determined deficiencies in petitioner's income tax for fiscal years 1964 and 1965 in the amounts of $ 2,768 and $ 2,998, respectively. The only question presented is whether amounts *321 paid to a Christian Science practitioner and taken as business expenses for "professional services" on petitioner's income tax returns are deductible under section 162 of the Code. 1FINDINGS OF FACTSome of the facts have been stipulated by the parties. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.The Fred W. Amend Co. (hereinafter referred to as petitioner or Amend) is a corporation, having been organized under the laws of the State of Illinois on January 12, 1921. Its principal office and factory were located in Danville, Ill., at the time the petition herein was filed. Its administrative*31 and sales offices were, however, located in Evanston, Ill.For the fiscal years ending October 31, 1964, and October 31, 1965, petitioner filed its U.S. corporation income tax returns with the district director of internal revenue, Springfield, Ill.Petitioner is a manufacturer and distributor of jellied candies which it sells in various sized packages under the trade name of "Chuckles." During the years in issue, petitioner employed approximately 173 hourly paid employees at its plant in Danville. Additionally, during fiscal year 1964 and 1965, 41 and 44 persons, respectively, were hired on a salary basis. Through Continental Insurance Co., petitioner provided full-scale hospital and health benefits for all of these employees.Until 1956, Fred W. Amend (hereinafter Fred) presided over petitioner as president and treasurer. However, in that year his son-in-law, A. F. Rathbun, was made president. Fred remained as treasurer, and in 1959 also assumed the office of chairman of the board of directors -- both of which offices he occupied at the time of the within proceeding. The following table reflects the ownership interest in petitioner held by Fred and his family during each of*32 the years in issue:Number of shares issued of all classes 2PreferredPercentCommonPercentFred W. Amend846.8013,18237.63Mrs. Tulita H. Amend, wife967.773,4539.86Mrs. Dorothy Chamberlain, daughter2,5007.14Mrs. Jane Nitschke, daughter2,5007.14Mrs. Marjorie Rathbun, daughter2,5007.14Fred A. Rathbun, son-in-law635.107272.08Unrelated stockholders (74 at 10/31/64)(73 at 10/31/65)99380.3310,16429.011,236100.0035,026100.00*322 As treasurer and board member, Fred played an active role in supervisory aspects of petitioner's business activities. Armed with daily report sheets and monthly financial statements, Fred was also able to keep abreast of all matters relating to cash flow, inventory status, and customer payments. Fred was also chairman of the corporation's executive committee. As such, he was responsible for convening meetings of the committee, during which time problems exposed by the daily*33 report sheets were discussed by Fred and the other members of the committee.Fred's annual salary, as well as the salaries paid to other Amend executives for the years indicated were as follows:Fiscal years ended Oct. 31 --19611962196319641965Fred W. Amend: Director,chairman of the board,treasurer, and member of theexecutive committee$ 36,515$ 40,187$ 38,241$ 37,825$ 32,800A. F. Rathbun: Director,president, and member of theexecutive committee35,10740,55747,10347,41240,544J. C. Miller: Director,executive vice president,and member of the executivecommittee29,46233,63733,99335,99631,412Carl W. Werner: Controllerand member of the executivecommittee13,90413,230R. M. Halverstadt (hereinafter Halverstadt) was, during the years in issue, a Christian Scientist practitioner and teacher. Halverstadt, a graduate of the University of Chicago where he had majored in economics, had become a full-time Christian Science practitioner around 1923, and had uninterruptedly practiced that calling, in the Chicago, Ill., area, up to the time of the trial herein. As a Christian Science practitioner, *34 Halverstadt's services were made available to many members of the Chicago Christian Science community.Halverstadt was first contacted by Fred in 1954. Thereafter, Fred, a non-Christian Scientist who, nevertheless, contributed 10 percent of his income to the Christian Science Church, regularly sought spiritual assistance from Halverstadt in matters pertinent to both his (Fred's) personal and business endeavors. Typically, their meetings and telephone consultations would begin with Fred defining a problem with which he was faced. Halverstadt would then ask a series of questions designed to give Fred a fuller appreciation of the requirements of the problem. With the insight provided by Halverstadt's counsel, Fred was often able to return to his business or private affairs, and approach problems with detachment and new understanding.Halverstadt never offered concrete solutions to any of the matters he discussed. Instead, Halverstadt, after exploring a problem via the questioning process mentioned above, would devote his energies to invoking the presence of the Divine Mind.*323 By way of background, it is the belief of the Christian Science Church that God -- the Divine Mind*35 -- is spiritually present in all things, and that the universality of His presence is felt by all men since they are the collective embodiment of His spiritual fullness. If, therefore, man -- being the paradigm of this divine omnipresence -- is to succeed in his temporal endeavors, he must strive to achieve an awareness consonant with the universal spirituality with which all men have been endowed. Accordingly, Halverstadt, as a Christian Science practitioner, sought to bring to his followers the spiritual awareness needed for success in their day-to-day activities. This he attempted to do by "prayerful consideration," in which he prayed to and sought guidance from the Divine Mind, and by "spiritual clarification" -- the term used by Fred to describe the nature of the service provided to him by Halverstadt.As indicated earlier, Fred consulted Halverstadt on a regular basis. During such consultations, Fred sought counsel on matters germane to both his personal and business life. For his assistance, Halverstadt charged Fred $ 3 for each consultation; and though such fees were initially paid by Fred, Amend reimbursed him for all payments attributable to consultations in which Amend's*36 business matters were discussed. Such reimbursements were paid to Fred through the Evanston office. However, in 1961, Fred decided that, from an accounting standpoint, payments to Halverstadt for consultations which were business (Amend) oriented ought to be paid directly to Halverstadt through the corporation's accounting office in Danville. It was also decided that Halverstadt should be placed on retainer so that he would be available whenever a problem relating to the business arose. With these considerations in mind, the following resolution was adopted by the corporation on April 11, 1961:Whereas, in the opinion of the members of this Board the services of a Christian Science Practitioner, as a consultant for employees with respect to matters which so disturb them as to handicap them in performing their services for the company, and also as a consultant of the officers as to the best approach to corporate problems, would be to the corporation's advantage and further the corporate enterprise.Resolved, that Fred W. Amend, the Chairman of the Board of Directors of this corporation be authorized to arrange for the employment of a Christian Science Practitioner by the Company*37 on such terms as he considers appropriate and in the best interests of this corporation.As consideration for the retainer arrangement, Halverstadt was to be paid a monthly stipend of $ 400 a month -- an amount unilaterally arrived at by Fred.Although Halverstadt's services could have been utilized by various members of Amend's supervisory staff, Fred was the only Amend *324 employee to avail himself of such services. Indeed, lower-ranking Amend employees were not even advised of his availability. During the years in issue, Fred and Halverstadt considered a broad spectrum of problems relating to Amend's business. Among such problems considered were matters dealing with machine output, labor-management relations, and the type of packaging to be used in the production of Amend's candy products. Consultations which were of a personal nature were independently billed at the customary rate of $ 3 per session, and were paid for by Fred out of his personal funds.For the years in issue, Fred, who was 73 years of age in 1964, enjoyed good health. During this period he spent his summers in Michigan and his winters in Florida. The duration of his visits to either of these places*38 was not disclosed.The retainer arrangement with Halverstadt continued uninterruptedly during the years subsequent to 1961, and as Fred's estimation of the value of his services to Amend increased, so did the terms of the retainer. For the 2 years in question, Amend paid Halverstadt amounts of $ 5,500 and $ 6,200, respectively. The deduction of these amounts as "professional services" on Amend's U.S. corporation income tax returns led to the deficiency assessment herein.OPINIONDuring the years in issue petitioner authorized the retention of a Christian Science practitioner purportedly to counsel its employees on matters germane to their well-being and the well-being of the petitioner's business. At the behest of Fred Amend, petitioner's treasurer and founder, the resolution authorizing the retention of a Christian Science practitioner was enacted in 1961, and empowered Fred to retain a person of his choosing. The man employed, R. M. Halverstadt, was an obvious choice in that Fred had utilized his services for many years.Whether by design or happenstance, once retained, Halverstadt saw only Fred. The "spiritual clarifications" provided by such visits enabled Fred to tackle *39 corporate problems with objectivity and resolve. The cost of the retainer was charged to an account called "professional services," and was taken as a deduction on the corporation's income tax returns for each of the years under review. The primary question presented is whether, under section 162, the amounts paid to Halverstadt constituted "ordinary and necessary" expenses of petitioner's business of manufacturing and distributing candy.To characterize as vexatious the task of determining whether an expenditure is "ordinary and necessary" to a taxpayer's business is to define in mild terms a problem as convoluted as the scope of human *325 experience is wide. Welch v. Helvering, 290 U.S. 111 (1933); General Bancshares Corp. v. Commissioner, 326 F. 2d 712 (C.A. 8, 1964), affirming 39 T.C. 423">39 T.C. 423 (1962). What may be an absolutely indispensable expenditure in the trade or business of taxpayer A may prove to be only incidentally related to the business of taxpayer B. Compare J. Raymond Dyer, 36 T.C. 456 (1961) (cost of instituting a libel suit deductible*40 where primary purpose was to protect taxpayer's reputation as an entertainer) with Lewis v. Commissioner, 253 F. 2d 821 (C.A. 2, 1958), affirming 27 T.C. 158">27 T.C. 158 (1956) (author's defense of wife's suit to declare him incompetent not proximately related to the business of being an author). Hence all that can be done is to review each case on its own facts in an effort to determine whether the expenditures involved comport with the mandate of the statute as illuminated by the decisional law.In the case at bar, petitioner is a corporation. Nevertheless, the services which gave rise to the expenditures it incurred were primarily for the benefit of one of its key executives. Even so, it is argued that the derivative benefits gained by it as a result of these expenditures provided the essential nexus needed for deductibility under section 162(a). We disagree.Although it is clear that some expenditures which are helpful to an executive in the fulfillment of his corporate duties are deductible, Stephen Hexter, 47 B.T.A. 483">47 B.T.A. 483 (1942), it is also clear that where a corporation is merely the incidental*41 beneficiary of corporate expenditures designed to further ends primarily personal to one of its executives, the deductibility of such expenditures will be disallowed. Compare Pantages Theatre Co. v. Welch, 71 F. 2d 68 (C.A. 9, 1934). Accordingly, the crucial question, as we see it, is whether within the realm of "commercial reality," Canton Cotton Mills v. United States, 94 F. Supp. 561">94 F. Supp. 561 (Ct. Cl. 1951), the expenditures incurred were not only "sufficiently related to [petitioner's] business to qualify as true business expenses," Robert J. Wallendal, 31 T.C. 1249 (1959), but were also so nonpersonal in nature as to avoid the far-reaching proscription of section 262. Paul Bakewell, Jr., 23 T.C. 803">23 T.C. 803 (1955). In the instant proceeding, we believe this last-mentioned consideration is enough to preclude the deductions sought.Over the years, much has been said in an effort to reconcile the business expense provisions of section 162 with the provisions of section 262 which prohibit the deduction of "personal, living or family" expenses, even if related to one's*42 occupation. See Henry C. Smith, 40 B.T.A. 1038">40 B.T.A. 1038 (1939), affirmed per curiam 113 F. 2d 114 (C.A. 2, 1940); Ralph D. Hubbart, 4 T.C. 121">4 T.C. 121 (1944); M. D. Harrison, 18 T.C. 540 (1952); Paul Bakewell, Jr., supra; and Ronald D. Kroll, 49 T.C. 557">49 T.C. 557 (1968). However, the common thread which seems to bind the cases *326 together is the notion that some expenses are so inherently personal that they simply cannot qualify for section 162 treatment irrespective of the role played by such expenditures in the overall scheme of the taxpayers' trade or business. The following language from Paul Bakewell, Jr., supra, in which the cost of maintaining a hearing aid was disallowed as a business deduction, poignantly brings this thought to the fore:We believe that a hearing aid is so personal as to come within the meaning of section 24(a)(1). Even if it is used in petitioner's business, in fact even if it is necessary for his successful law practice, the device is so personal as to preclude*43 it from being a business expense. A businessman's suit, a saleslady's dress, the accountant's glasses are necessary for their business but the necessity does not overcome the personal nature of these items and make them a deductible business expense. The same must be said of the hearing aid. * * * [23 T.C. at 8053]In the instant case, we believe the "spiritual clarification" provided to Fred by Halverstadt was so personal as to come within the injunction of section 262. Granted, the spiritual balance which Fred experienced after each consultation rendered him better able to cope with the day-to-day strain of supervising a large business. It is similarly acknowledged that those meetings with Halverstadt not paid for *44 by personal check were probably devoted to a consideration of Fred's handling of business problems. However, the very function served by these meetings -- that of imparting spiritual equanimity to the person seeking assistance so that he might pursue matters common to all men with a greater awareness and understanding -- militates against their being treated as something particularly suited to the business, in this case, of manufacturing candy. At no time during his consultations with Fred did Halverstadt even offer an observation or solution to a given problem. Instead, his function was served by asking questions calculated to heighten Fred's level of awareness. With new awareness thus imbued, Fred, it was hoped, would then be able to call upon business skills already possessed, and tackle Amend's problems with a greater sense of clarity and understanding.Hence, it can be seen that it was not Fred's skills as a businessman which Halverstadt sought to enhance. Rather, what was sought was a state of harmony in which Fred's business thinking would be brought into conformity with an ordered universe governed by the Christian Science Church's concept of the Divine Mind. As such, *45 if our understanding *327 of this very difficult question is correct, we see little difference between the services provided by Halverstadt and those regularly provided by the duly ordained representative of any other faith whose task it is to bring spiritual understanding to man in his temporal surroundings. In each case we believe the benefits derived from the services rendered by such men are inherently personal, and, therefore, not susceptible to treatment under section 162.Having arrived at the conclusion stated above, we now turn to petitioner's alternate claim in which it is contended that if Halverstadt's services are found to have been conferred on Fred as a personal benefit, then the value of such service should be treated as additional salary deductible under section 162(a)(1). 4*46 It is a well-established maxim that where a corporation assumes the cost of benefits which are personal to one of its shareholders, the value of such benefits may constitute a distribution taxable to the shareholder as a dividend and not deductible by the corporation. Challenge Manufacturing Co., 37 T.C. 650">37 T.C. 650, 663 (1962); A. A. Emmerson, 44 T.C. 86">44 T.C. 86, 91 (1965); Irving Sachs, 32 T.C. 815">32 T.C. 815, 820 (1959), affd. 277 F. 2d 879 (C.A. 8, 1960); and John L. Ashby, 50 T.C. 409">50 T.C. 409, 417, (1968). Indeed, where the facts of a given case indicate that constructive dividend treatment is warranted, it matters not that there was no formal dividend declaration. Clark v. Commissioner, 266 F. 2d 698 (C.A. 9, 1959), affirming on this issue a Memorandum Opinion of this Court. Nor is there any requirement that the distribution be pro rata among the shareholders or that all shareholders participate in it. Commissioner *328 v. Riss, 374 F. 2d 161 (C.A. 8, 1967), affirming a Memorandum Opinion*47 of this Court; and cases cited in Irving Sachs, supra.Accordingly, where, as here, it is held that benefits personal to petitioner's shareholder-employee were paid for by petitioner, the burden of proving that such benefits were intended as salary, and were not intended as distributions in the nature of a dividend, rests with the petitioner. 5 This, we believe, petitioner has failed to do.In addition to the fact that petitioner has failed to establish any intent on its part to provide Fred with additional remuneration during the years in issue, cf. Pantages Theatre Co. v. Welch, supra, it has altogether failed to prove that the salary paid to*48 Fred during such period, when coupled with the amounts paid to Halverstadt, would have represented reasonable compensation for Fred's services as treasurer and board chairman. This is particularly crucial in light of the fact that Fred, a man in his seventies who had some years earlier passed the reins of the corporation over to his son-in-law, appears to have spent a considerable amount of his time vacationing in Florida and Michigan.Petitioner cites respondent's Rev. Rul. 57-130, 1 C.B. 108">1957-1 C.B. 108, 6 as support for the position that the value of the services performed by Halverstadt should be treated as additional salary payments as opposed to a constructive dividend. However, we do not regard respondent's ruling as being of any benefit to petitioner since nowhere therein is there any indication that the corporate executive to whom additional salary was being attributed was also a shareholder of the corporation.*49 Basing our determination on the record as a whole, we conclude that the amounts in question were not intended as additional salary to Fred. Accordingly, such amounts are not deductible by petitioner under either of its theories.Decision will be entered for the respondent. Footnotes1. All statutory references, unless otherwise indicated, are to the Internal Revenue Code of 1954, as amended.↩2. All voting stock.↩3. SEC. 24. ITEMS NOT DEDUCTIBLE. [I.R.C. 1939](a) General Rule. -- In computing net income no deduction shall in any case be allowed in respect of -- (1) Personal, living, or family expenses, except extraordinary medical expenses deductible under section 23(x).↩4. Petitioner, for the first time in its brief, also argues that the cost of Halverstadt's retention and, accordingly, the cost of the services performed by him qualify as medical expenditures within the meaning of Rev. Rul. 55-261, 1 C.B. 307">1955-1 C.B. 307, Rev. Rul. 63-91, 1 C.B. 54">1963-1 C.B. 54, and sec. 1.162-10(a), Income Tax Regs., and are, therefore, deductible under sec. 162. Apart from the fact that issues not raised by the pleadings, but argued for the first time on brief, should not be considered by this Court, William Greenberg, 25 T.C. 534 (1955), we believe this argument is, in any event, without foundation.Fred's testimony indicates that during the years in issue he enjoyed very good health. Furthermore, Fred, though believing in the benefits of "spiritual clarification" was not a practicing Christian Scientist; and, it is, therefore, not altogether certain that Fred would have approached Halverstadt with respect to problems affecting his (Fred's) health. Moreover, while it is arguable that the services provided by Halverstadt could be characterized as psychotherapeutic in nature, see Namrow v. Commissioner, 288 F.2d 648">288 F. 2d 648, 649 (C.A. 4, 1961), in which the term psychotherapy is defined, Halverstadt, in his testimony, specifically repudiated the existence of any such relationship. Accordingly, even if the services of a person such as Halverstadt might, under the appropriate circumstances, be regarded as "medical care," we do not believe that, in the context of this case, the services provided by him warrant such a conclusion. See George B. Wendell, 161">12 T.C. 161 (1949), cited in Rev. Rul. 63-91, supra, wherein it was said that the "issue [of whether medical care was administered] turns on the nature of the services rendered, not on the experiences or qualifications or title of the person employed." As such, it is unnecessary to consider whether the resolution of Apr. 11, 1961, can be regarded as a medical expense "plan" within the meaning of secs. 1.105-5(a) and 1.162-10(a), Income Tax Regs. (For cases dealing with this question see Samuel Levine, 50 T.C. 422">50 T.C. 422 (1968), and Alan B. Larkin, 48 T.C. 29 (1967), affd. 394 F. 2d 494↩ (C.A. 1, 1968).)5. The record does not reveal the amount of earnings and profits which the corporation had available for the payment of dividends during each of the years in issue. However, the burden of proof with respect to this matter rests with the petitioner. Irving Sachs, 32 T.C. at 821↩.6. "Advice has been requested with respect to the tax treatment of amounts expended by an executive, or an employer on behalf of an executive, who avails himself of reconditioning and health-restoring services afforded by certain resort hotels and athletic clubs.* * * *"Where an employer pays the expenses of one of its executives incurred in connection with securing the benefits of the reconditioning program offered by a resort of the type mentioned above, such expenditures generally constitute additional compensation to the executive and he is required to include the amount thereof in gross income for Federal income tax purposes. Expenditures which are compensatory in nature are deductible by an employer under section 162↩ of the Code, provided the total amount expended, plus other compensation paid to the executive, is no more than reasonable compensation for personal services actually rendered by him." | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624814/ | COMMISSIONER OF INTERNAL REVENUE, RespondentMarks v. Comm'rDocket No. 6116-81.United States Tax CourtT.C. Memo 1985-179; 1985 Tax Ct. Memo LEXIS 453; 49 T.C.M. (CCH) 1222; T.C.M. (RIA) 85179; April 10, 1985. *453 A, a partnership, purchased the leased fee interest in a shopping center. Held, the proper allocation of A's cost basis in the shopping center between land and depreciable improvements in determined. Morton L. Friedman, for the petitioners. Claire Priestley-Cady, for the respondent. SIMPSONMEMORANDUM FINDINGS OF FACT AND OPINION SIMPSON, Judge: The Commissioner determined deficiencies in the petitioners' Federal income taxes of $4,130 for 1975, $19,788 for 1976, and $18,824 for 1977. The sole issue for decision is how the basis in a shopping center should be allocated between land and improvements for the purpose of determining the amount of depreciation allowable on the improvements. FINDINGS*454 OF FACT Some of the facts have been stipulated, and those facts are so found. Furthermore, some facts and evidence, set forth in the Commissioner's motion to compel stipulation, have been deemed accepted and established by our order dated June 2, 1982. The petitioners, Dennis N. and Nancy S. Marks, husband and wife, maintained their legal residence in Carmichael, Calif., at the time they filed their petition in this case. They filed their joint Federal income tax returns for 1975 through 1977 with the Internal Revenue Service Center, Fresno, Calif. Mr. Marks will sometimes be referred to as the petitioner. During the years in issue, the petitioner owned a 33-1/3 percent share of Arden Fair Associates (the partnership), a partnership formed in May 1975 for the purpose of purchasing the Arden Fair Shopping Center (shopping center). Ernest Johnson and Morton Friedman were the only other partners in the partnership, and each owned a 33-1/3 percent interest during the period in issue. Mr. Friedman is the petitioners' attorney in this case. The shopping center is situated in Sacramento, Calif., approximately 4 miles northeast of the city's central business district. The shopping*455 center fronts on Arden Way, a major, four-lane traffic corridor, and is about one-quarter mile east of the interchange of Interstate Highway 80 and Arden Way. Directly across from the shopping center, on the south side of Arden Way, is the Point West development. Point West is a large, mixed-use development of office buildings, motels, strip shopping centers, and apartments, which, despite the economic recession of 1975, was at that time one of Sacramento's growing real estate markets. Properties in the Point West neighborhood were appreciating at a rate of about 5 percent a year in the mid-1970s. The shopping center is a regional shopping facility anchored by a Sears store and a Weinstock's department store. The portion of the shopping center purchased by the partnership does not include the Sears and Weinstock's stores; it consists of two buildings and landscaped parking areas lying on either side of the Weinstock's store. The building lying to the west of the Weinstock's store (and to the east of the Sears store) contains a total of 258,671 square feet, including basement retail and storage areas, and has an air conditioned central mall. The building lying to the east of*456 the Weinstock's store contains a total of 126,334 square feet, including a basement area, but has no central mall. Originally constructed in 1962, the two buildings had been expanded over the years preceding their sale to the partnership by the addition of new stores and the enclosed mall. However, the record does not reveal the exact dates on which such improvements were made. The partnership further improved the buildings after it acquired the shopping center by enclosing an open-air mall between the Weinstock's store and the mall building lying to the west of it, by remodeling the existing enclosed mall, and by adding movie theaters and more stores. The entire property purchased encompasses approximately 280,314 square feet of leasable building space and 1,122,159 square feet (about 25.76 acres) of land. In mid-1975, the shopping center had a vacancy rate of about 8 percent. The vacancy rate subsequently dropped to 4.1 percent by March 1976 and to 3.8 percent by September 1976. In 1975, the shopping center generated rental income, including tax escalation charges, of approximately $926,000, and other income, including common area fees and mall charges, of about $134,000. Operating*457 expenses and real estate taxes amounted to about 45 percent of total income in that year. The partnership purchased the shopping center from Kavanau Real Estate Trust (Kavanau) on May 15, 1975, for $6,399,454.31. The sale agreement was executed by Mr. Friedman on behalf of the partnership. Under the terms of the agreement, the purchase price was allocated as follows: Land$ 773,020.00Building5,586,673.31Furniture, equipment,and fixtures39,761.00Total$6,399,454.31Prior to the sale, neither party to the sale obtained an appraisal of the property which allocated the purchase price between land and improvements. The partnership did not secure an appraisal allocating the purchase price between land and improvements until September 1983 when preparing for the trial of this case. The partnership acquired a leased fee interest in the shopping center because the property was encumbered by valuable leasehold interests possessed by some pre-existing tenants. A leasehold interest has value when the contract rent which a tenant is obligated to pay is less than the fair market rent which the leased property could command in a competitive real estate market. *458 A leased fee interest in property refers to the property rights of an owner of commercial or income-producing property, which generally consist of the right to receive the actual contract rent that the property is generating over the remaining terms of the outstanding leases on the property, plus the reversionary right to receive the property back upon the expiration of the leases; whereas, a fee simple absolute (or fee simple unencumbered) interest in property includes all property rights that an owner can have in property, exclusive of governmental restrictions on the property, such as the powers of taxation, condemnation, or eminent domain. In other words, the value of a leased fee interest is the fair market value of the property in fee simple absolute, less the value of any leasehold interests which affect the property. For real property tax purposes, the Sacramento County Assessor's Office (the assessor's office) appraised the fee simple absolute value of the shopping center and allocated such value between land and improvements. The property purchased by the partnership consists of four parcels for property tax assessment purposes. The assessor's office maintains a separate, *459 written appraisal record for each of the four parcels. The following table summarizes the records of the appraiser's office concerning the value of the four parcels: Value ofValue ofTotal ValueYearLandImprovementsof Fee Simple1975$1,128,000$4,350,000$5,478,00019761,128,0005,875,0007,003,00019782,490,0004,517,0007,007,000The appraised land value in 1975 and 1976 of $1,128,000 was originally established in 1967. The land value was not altered during the years between 1967 and 1978 because real property tax equalization laws would have required the assessor's office to reappraise the land value of all commercial properties in the surrounding area at the same time. Consequently, during the intervening years, any increase in the property's appraised value was allocated to improvements. During 1975, the assessor's office reappraised many of the shopping centers in Sacramento County, including the Arden Fair Shopping Center. Darrel Holmes, a senior real property appraiser in the assessor's office, reappraised three of the four parcels purchased by the partnership (the 1975 reappraisal).1 The reappraised value was effective*460 March 1, 1976. Using three different appraisal methods, including two versions of the income approach and a gross rent multiplier approach, he calculated values of the fee simple ranging from $7,000,000 to $7,470,000. He concluded that the fee simple absolute value of the three parcels was $7,000,000. The partnership appealed the 1975 reappraisal to the Sacramento County Assessment Appeals Board. In its appeal, the partnership contended that there were no leasehold interests in the property and that, consequently, the fee simple value of the parcels did not exceed $6,399,454.31, the amount which the partnership had paid for the property in 1975. However, the appeals board upheld the assessor's valuation of $7,000,000. In the 1975 reappraisal, Mr. Holmes did not attempt to separately determine the fair market value of the land and improvements. *461 The overall increase in the appraised value of the shopping center was allocated solely to the improvements because the assessor's office did not wish to reappraise the land in all surrounding commercial properties. However, in 1978, due to the passage of Proposition 13 in California, the assessor's office was required to appraise land and improvements at their fair market value as of March 1, 1975, or, if later, as of the date of the most recent transfer, sale, or new construction. Since the shopping center was sold in May 1975 and since such date roughly coincided with the 1975 reappraisal of the three parcels, the assessor's office retained its overall assessment of $7,000,000 for the three parcels. The fourth parcel's value as of May 1975 was appraised at $7,000. Mr. Holmes, on behalf of the assessor's office, then allocated the fair market value of the fee simple absolute ($7,007,000) between land and improvements (the Proposition 13 reallocation). Applying the comparable sales (or market) approach to valuation, he appraised the fair market value of the land if vacant at $2.25 per square foot, or $2,490,000, in May 1975. 2 Subtracting the value of the land from $7,007,000, *462 he concluded that the improvements had a fair market value in May 1975 of $4,517,000. On its partnership returns of income for the years in issue, the partnership claimed a depreciable basis in, and depreciation deductions on, the shopping center buildings and improvements made to the buildings after their acquisition, as follows: YearCost Basis 3Depreciation1975$5,705,647.30$141,104.6719765,965,222.43250,106.7919774 6,022,168.00223,494.00The buildings were depreciated under the straight-line method, using a 25-year useful life. On each of its returns for the years 1975 through 1977, the partnership claimed depreciation deductions for machinery and other equipment in addition to the depreciation claimed for buildings and improvements. *463 On their Federal income tax returns for 1975 through 1977, the petitioners claimed a distributive share of losses sustained by the partnership in those years. In his notice of deficiency, the Commissioner disallowed a portion of the petitioners' claimed distributive share of the partnership losses in such years on the ground that the partnership's depreciation deductions for the improvements were not allowable in the amounts claimed. He determined that the buildings had a 37-year useful life and that the partnership had a cost basis in the shopping center improvements and land of $6,359,693.00, of which $3,257,132.00 was allocable to improvements and $3,102,561.00 was allocable to land. He did not contest that $39,761.00 of the $6,399,454.31 paid by the partnership for the shopping center was allocable to furniture, equipment, and fixtures, as stated in the sale agreement between the partnership and Kavanau. On brief, the Commissioner had conceded that the shopping center improvements have a 25-year useful life. The partnership has a cost basis in the shopping center property of $6,399,454.31. Of its total cost basis, $6,359,693.31 is allocable to land and improvements, and*464 such amount was the fair market value in May 1975 of the leased fee interest acquired by the partnership in the shopping center. OPINION The sole issue for decision is the amount deductible by the partnership during the years in issue for depreciation of the improvements located on its shopping center property. The resolution of this issue depends on the allocation of $6,359,693.31 of the purchase price of the property between land and the depreciable improvements. For purposes of the depreciation deduction, where improvements and land are purchased for a lump sum, the basis or cost must be allocated between the depreciable and nondepreciable property according to their respective fair market values at the time of acquisition. Secs. 1.167(a)-2 and -5, Income Tax Regs. The parties agree that the fair market value of the leased fee interest acquired by the partnership in the shopping center was $6,359,693.31 in May 1975, the time of acquisition. Thus, our inquiry focuses on the value in May 1975 of the partnership's leased fee interest in the property's component parts, i.e., land and improvements. The petitioners have abandoned the allocation made on the partnership's tax*465 returns. They now contend that the allocation of the purchase price to land and buildings contained in the sale agreement between Kavanau and the partnership accurately reflects the respective fair market values of the land and improvements. They maintain that the sale agreement allocation was the product of arm's-length negotiations and is supported by the appraisal of their expert witness, David E. Lane. Neither the Commissioner nor this Court is bound to accept an allocation of a lump-sum purchase price made under a contract of sale. Generally, a contractual allocation will be upheld if it has "some independent basis in fact or some arguable relationship with business reality such that reasonable men, genuinely concerned with their economic future, might bargain for such an agreement." , affg. . An allocation by the buyer and the seller will be ignored if it is unrealistic ( , affg. on this issue a Memorandum Opinion of this Court; ,*466 affg. or is not a result of arm's-length negotiations between parties with adverse tax motivations ( ; . In the present case, the only evidence that the allocation between land and buildings made in the sale agreement was the result of arm's-length negotiations is the uncorroborated testimony of petitioners' counsel and partner in the partnership, Mr. Friedman. No one representing Kavanau, the other party to the sale, testified at trial, and even Mr. Friedman's testimony on this issue was sketchy. He gave no details of the negotiations. He merely made the conclusory statement that the parties to the sale negotiated the allocation at arm's length.There is no evidence to indicate whether Kavanau had any interest in negotiating a different allocation more beneficial to its interests, or whether Kavanau had any opposing tax interests at all. We simply cannot conclude on such meager evidence that the allocation made in the sale agreement was the product of arm's - length negotiations. Furthermore, there is*467 no evidence to indicate that either party to the sale possessed any expertise in valuing properties, and the fact that neither party to the sale obtained an independent appraisal of the relative values of the land and improvements prior to the sale indicates that the economic reality of the allocation is questionable at best. . In fact, as an examination of the evidence and the experts' appraisals reveals, the allocation does not reflect economic reality. Both the petitioners and the Commissioner engaged independent, professional appraisers to estimate the proper allocation of the purchase price. The Commissioner also called Mr. Holmes of the assessor's office to testify to the appraisals which he made in 1975 and 1978 on behalf of that office. Both appraisers employed by the parties have received the M.A.I. (Member of the American Institute of Real Estate Appraisers) designation, and all three appraisers were well qualified to assess the property involved here. As already stated, the parties agree that the purchase price of $6,359,693.31 was within the range of the fair market value of the leased fee*468 interest acquired by the partnership. The primary disagreement between the parties (and their experts) concerns the proper appraisal method to be used to determine the portion of the purchase price allocable to the depreciable improvements. The allocation in the present case is complicated by the fact that the partnership acquired a leased fee interest rather than a fee simple absolute (or fee simple unencumbered) interest in the property. A leased fee interest is less valuable than a fee simple absolute interest when there exist valuable leasehold interests possessed by lessees enjoying long-term leases at below-market rents. See . Where rental property is unencumbered by such leasehold interests, the fair market value of the lessor's fee simple absolute interest, if known, can be allocated between land and improvements by determining the fair market value of the land, at its highest and best use and as though vacant, and then simply subtracting the value of the land from the total value of the fee to arrive at the portion of the fee's value allocable to improvements. .*469 It is the Commissioner's position that the same method may be applied here even though the partnership purchased a leased fee interest in the shopping center. He maintains that any reduction in the value of the property resulting from the existence of leasehold interests affects the value of building improvements only and, consequently, that the purchase price of the leased fee interest may be allocated between land and improvements by subtracting the fair market value of the land as though vacant from the purchase price to arrive at the value of the improvements as encumbered by the leaseholds. This valuation approach was utilized by his expert, Thomas W. Clark. However, though the Commissioner urges us to adopt Mr. Clark's appraisal method, he does not rely upon Mr. Clark's appraisal of the land at $1.55 per square foot, or $1,750,000. 5 The Commissioner contends that the land's fair market value was actually equivalent to its assessed value of $2,490,000 (approximately $2.22 per square foot), as determined by Mr. Holmes of the assessor's office in the Proposition 13 reallocation.Subtracting $2,490,000.00 from the purchase price, the Commissioner maintains that the partnership*470 has a cost basis in the improvements of $3,869,693.31. 6It is the petitioners' position that leasehold interests reduce the value of the lessor's interest in the land as well as the improvements. To reflect this mutual reduction in his allocation of the purchase price of the leased fee interest, Mr. Lane, the petitioners' expert, first computed the fair market value of a hypothetical fee simple absolute interest in the shopping center. He concluded that the fair market value of a fee simple absolute interest was $8,300,000 in May 1975. Mr. Lane then estimated that the value of the land if vacant was*471 $1,130,000 ($1 per square foot) 7 in May 1975, or 13.6 percent of the fair market value of a fee simple absolute interest. Once he determined that the price which the partnership paid for the leased fee interest was in fact within the range of its fair market value, Mr. Lane multiplied the purchase price by 13.6 percent to arrive at the portion of such price allocable to land, $864,918. The remainder of the purchase price, $5,494,771, was allocated to improvements. As in many valuation cases, neither party's position is entirely persuasive. With respect to the primary point of disagreement, the question of whether a leasehold interests reduces the value of the lessor's fee interest in improvements alone or in both improvements and land, we agree with the petitioners. The shopping center property was encumbered by several long-term leases at below-market contract rents. The tenants possessing such leases*472 occupy the land on which their particular stores are located in addition to the store buildings themselves. The leasehold interests possessed by these tenants reduce the value of the partnership's interest in the land as well as the buildings because their contractual right to occupy the land and buildings prevents the partnership from re-renting such properties at market rates or from destroying the buildings and using the land for another, perhaps more profitable, purpose. The Commissioner's contention that the leaseholds do not affect land value because "land value always exists" ignores the fact that the partnership is prevented by the existence of long-term leases from currently receiving a fair market return on the land. Consequently, it is unrealistic to contend that the value of the partnership's interest in the land is equivalent to the value of the land at its highest and best use and as though vacant. See American Institute of Real Estate Appraisers, The Appraisal of Real Estate, 251 (8th ed. 1983). We shall accordingly apply the approach of the petitioners' expert. In order to apply such approach, we must first determine the value of a hypothetical fee simple absolute*473 interest in the shopping center and the portion thereof allocable to land. Of the three appraisers, only Mr. Lane and Mr. Holmes appraised a fee simple absolute interest. Mr. Lane and Mr. Holmes each used three different methods of appraisal, the results of which are summarized below: Value of Fee Simple Absolute Interest Mr. LaneIncome approach--expenses of 40%(including real estate taxes),capitalization rate of 10%$8,150,000Cost approach$8,655,000Gross rent multiplier approach 8$8,300,000Conclusion--weighted average of threeestimates$8,300,000Mr. HolmesIncome approach--expenses of 45%(including real estate taxes),capitalization rate of 9.5%$7,200,000Income approach--expenses of 26%(excluding real estate taxes),capitalization rate of 13.1%$7,000,000Gross rent multiplier approach$7,470,000Conclusion$7,000,000For the reasons stated below, we find that a fee simple absolute interest in the shopping center would have had a value of $8,193,000 in May 1975. *474 Our valuation is based on the income, or capitalization of earnings, approach. Both Mr. Lane and Mr. Holmes agree that an income approach is the most reliable method of appraisal for commercial properties, including the shopping center involved here. By determining a property's value through the capitalization of its anticipated annual income at a market rate of return, the income approach reflects the fact that an investor generally purchases property for the income which it is expected to produce. See Encyclopedia of Real Estate Appraising 41 (3d ed. 1978). The cost approach, applied by Mr. Lane, is of questionable accuracy when the property is no longer new (see Encyclopedia of Real Estate Appraising, supra at 443), and the gross rent multiplier approach, applied by both Mr. Lane and Mr. Holmes, requires that the appraiser have access to the earnings information of comparable shopping centers, information which is generally unavailable (see American Institute of Real Estate Appraisers, The Appraisal of Real Estate, supra at 358). Mr. Lane acknowledged that he felt the gross rent multiplier approach to be "quite weak, because most of the sales [of shopping centers] *475 that are found have some of the same problems regarding leasehold estates and you virtually have to appraise the sale in order to get any data that would be meaningful for the subject property." Application of the income (capitalization of earnings) approach has been approved by this Court. ; , affd. on this issue ; . Furthermore, we are more comfortable applying the income approach in the present case because the record contains more evidence pertinent to the application of such method than to the other methods. The valuation of a fee simple absolute interest under the income approach is based on the market rent that the property could achieve in a competitive real estate market. The annual gross rental income, as computed at market rates, is added to any other income which the property generates to arrive at annual gross income. Net operating income is calculated by adjusting gross income for estimated vacancies and expenses, and*476 it is then capitalized at an appropriate rate. American Institute of Real Estate Appraisers, The Appraisal of Real Estate, supra at 357, 359; Encyclopedia of Real Estate Appraising, supra at 41-44. In applying the income approach, the appraisers have differed on every figure involved in the computation. We accept neither appraisser's computation in its entirety. We estimate an average market rent of $4.75 per square foot of leasable space per year, essentially splitting the difference between the average market rents employed by Mr. Lane and Mr. Holmes, who both claimed to have based their estimates on the most recent leases negotiated in the shopping center itself. 9 The annual gross income figure must also include $134,000 of other income, such as common area and mall charges, which was included by Mr. Holmes in his computation, but overlooked by Mr. Lane. In calculating the shopping center's net operating income, we conclude that allowances of 7-1/2 percent for estimated vacancies and 40 percent for expenses (including real estate taxes) are appropriate. The 7-1/2 percent vacancy rate, used by Mr. Lane, is closer to the property's actual vacancy rate in 1975. Although*477 the actual vacancy rate dropped below 4 percent by late 1976, the drop is unexplained and may have been caused by additional partnership expenditures for improvements. 10 The 45-percent expense rate, used by Mr. Holmes, was the property's actual rate of expenses in 1976, but since the market rent exceeded the actual rent, we have concluded that the lower percentage, 40 percent, suggested by Mr. Lane, is more appropriate. Finally, we conclude that net operating income should be capitalized at an overall rate of 10 percent. A 10-percent capitalization rate was applied by Mr. Lane and supported by the Commissioner's expert, Mr. Clark, who testified that a 10-percent rate was appropriate in 1975. 11*478 Having determined that a fee simple absolute interest in the shopping center would have been worth $8,193,000, it is now necessary to calculate the portion thereof allocable to land. All three appraisers estimated the value of the land as though vacant in May 1975 by use of the comparable sales approach. All agreed that a comparable property would be similar in size to the subject parcel, which contained 25.76 acres, because small parcels generally sell at a higher price per square foot than large parcels, and would be similarly zoned for commercial use, preferably shopping centers. Upon a careful examination of their respective appraisal reports and testimony, we adopt Mr. Clark's valuation of the land as though vacant of $1.55 per square foot. Mr. Clark considered eight sales, the first three of which were, of all the parcels relied upon by the appraisers, the most comparable to the property in question. These three parcels were comparable in size (they ranged in size from 10.0 acres to 49.8 acres), in location (they were situated directly across Arden Way), and in zoning (two were zoned for shopping centers, and the third was zoned agricultural but was eventually rezoned for*479 commercial development). They were sold during the period of November 1972 to August 1973 for prices ranging from $1.33 to $1.47 per square foot. After adjusting the prices of the largest and smallest for size, and allowing for a 5-percent per year rate of appreciation, Mr. Clark determined that the three properties had values in 1975 ranging from $1.50 to $1.70 per square foot. Mr. Lane appraised the land at $1.00 per square foot, but the sale which he primarily relied upon, the K-Mart site, was not sufficiently comparable to the property in question. The K-Mart site contained 14.356 acres and was zoned commercial, but it was located about 8 miles from the shopping center. None of the other sales used by the appraisers was located so far away. The other three sales mentioned by Mr. Lane 12 were close to the shopping center, and if adjusted for location, size, and time of sale, would, in our opinion, yield prices very close to Mr. Clark's estimate of $1.55. Mr. Holmes estimated that the land*480 had a value of $2.25 per square foot. However, most of the sales which he relied upon involved parcels much smaller than the shopping center site or parcels located outside the Point West neighborhood. Of the four sales in that neighborhood (sales numbered 1, 2, 3, and 7), two involved much smaller properties, and the other two involved parcels zoned for office buildings rather than shopping centers. Applying a value of $1.55 per square foot, we conclude that the land acquired by the partnership had a value, if vacant, of $1,739,000.00 in May 1975. 13 Such amount is 21.22 percent of the value of a fee simple absolute interest in the property. Therefore, we hold that an identical percentage of the fair market value of the partnership's leased fee interest in the property is allocable to land. Since the partnership's cost basis in the land and improvements is equivalent to their fair market value, we hold that $1,349,526.00 of its basis is allocable to land and $5,010,167.31 of its basis is allocable to depreciable improvements. *481 Decision will be entered under Rule 155.Footnotes1. In reappraising the property acquired by the partnership, Mr. Holmes inadvertently overlooked one of the parcels. The overlooked parcel is 3,000 square feet in size and contains parking lot improvements but no buildings. In 1967, it was appraised by the assessor's office at $3,000, and its value was not adjusted again until 1978.↩2. Although Mr. Holmes concluded that the land was worth $2.25 per square foot, his total valuation of $2,490,000, when divided by 1,122,159 square feet, results in a value per square foot of approximately $2.22. The discrepancy is due to the fact that Mr. Holmes separately calculated the land value of each parcel and then "rounded" each figure.↩3. The cost basis figures in the table for 1976 and 1977 have not been adjusted by the amount of depreciation claimed in prior years. From an examination of the partnership's returns for 1975 through 1977, it appears that the difference between the cost basis claimed on the 1975 and 1976 returns and the amount of the shopping center's purchase price allocated to buildings in the sale agreement ($5,586,673.31) may be attributable to amounts expended by the partnership for improvements to the buildings after their acquisition. However, there is no evidence in the record of the exact nature or cost of such improvements, and in their petition and briefs, the petitioners have not contended that their cost basis in the buildings should be increased by the cost of any improvements made by the partnership. ↩4. On its 1977 return, the partnership allocated $5,587,347 of the cost basis shown in the table to buildings and allocated $434,821 of such basis to improvements made after the partnership's acquisition of the shopping center. The partnership claimed depreciation deductions in 1977 for these new improvements separately from its claimed depreciation for the buildings, and the Commissioner did not challenge such deductions in the notice of deficiency.↩5. Mr. Clark estimated that the property acquired by the partnership contained 25.939 acres (1,129,903 square feet) of land, and he calculated the land's value by multiplying 1,129,903 by $1.55. He "rounded" the result of $1,751,350 to $1,750,000. We have found that, in fact, the land contained 25.76 acres, or 1,122,159 square feet, based on the records in the assessor's office; there is no explanation of the difference. ↩6. The Commissioner has abandoned his position, taken in the notice of deficiency, that the partnership's cost basis in the improvements is $3,257,132.↩7. Like Mr. Clark, Mr. Lane estimated that the property purchased contained 25.939 acres, or 1,129,903 square feet. He computed the value of the land if vacant by multiplying $1.00 by 1,129,903, to arrive at a value of $1,129,903, which he then "rounded" to $1,130,000.↩8. In his appraisal report and testimony, Mr. Lane referred to his gross rent multiplier approach as a "market data" approach because the selection of a gross rent multiplier requires that the appraiser examine the income and values of comparable shopping centers.↩9. We have examined their studies, and since we cannot ascertain which result is more reliable, we have adopted a compromise. ↩10. See footnote 3, supra.↩11. We have calculated the value of a fee simple absolute interest in the property as follows: Gross rental income: 280,314 sq. ft. at$4.75 per sq. ft.$1,331,491Other income134,000Annual gross income$1,465,491Less: 7-1/2% vacancy rate99,861Annual effective gross income$1,365,630Less: Expenses at 40%546,252Annual net operating income$ 819,378Annual net operating income capitalized at 10% = $8,193,780 "rounded" to $8,193,000.↩12. Mr. Lane testified that he could not verify the sales price of the third parcel on his comparables list and that he did not rely upon it. Therefore, we also do not rely upon it.↩13. The land's value has been calculated by multiplying $1.55 by 1,122,159 square feet, the size of the property acquired. The result was "rounded" to $1,739,000.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624853/ | Alexandre R. Tarsey and Tanja B. R. Tarsey, Petitioners v. Commissioner of Internal Revenue, RespondentTarsey v. CommissionerDocket No. 876-70SCUnited States Tax Court56 T.C. 553; 1971 U.S. Tax Ct. LEXIS 115; June 21, 1971, Filed *115 Decision will be entered for the respondent. Petitioners were involved in an auto accident which rendered their auto a total loss, save salvage. They filed suit to recover. The other driver cross-complained and petitioners settled. They deducted the value of their auto, attorney fees, filing fees, and the settlement as a casualty loss. Held, the only amount allowable is the value of the auto. Sec. 165(c)(3), I.R.C. 1954; sec. 1.165-7(b), Income Tax Regs.Alexandre R. Tarsey and Tanja B. R. Tarsey, pro se.Norman H. McNeil, for the respondent. Tietjens, Judge. TIETJENS*553 The Commissioner determined a deficiency in petitioners' 1967 Federal income tax in the amount of $ 123.70. The only issue before us is whether fees paid to file suit to recover for property damages and the amount paid in settlement of a counterclaim for property damages are properly deductible as a casualty loss under section 165(c)(3), I.R.C. 1954. 1FINDINGS OF FACTAll of the facts have been stipulated and the case has been submitted under Rule 30. The stipulation and exhibits attached thereto are incorporated herein by this reference and the facts are found accordingly. Briefly summarized the facts are *117 as follows.The petitioners are husband and wife, whose legal residence on the date of the filing of the petition herein was Tarzana, Calif. They filed a joint income tax return for the taxable year 1967 with the district director, Los Angeles, Calif.At 7:45 in the morning on September 28, 1967, petitioner Alexandre and one Ashcraft of Burbank, Calif., were driving their respective automobiles in the vicinity of Sherman Oaks, Calif. The automobiles collided with each other. The petitioners' automobile was damaged beyond repair and was towed away by a scrap iron dealer who paid Alexandre $ 20 for the remains. At the time of the collision, he was enroute from his residence to his job. The petitioners were not insured against damage caused to or by their automobile.Alexandre filed a claim for damages to his automobile with Ashcraft's insurance carrier but the claim was rejected. He then employed an attorney who filed a complaint in the Superior Court alleging damages to his automobile due to Ashcraft's negligence. In 1967 petitioners paid their attorney $ 250 as a retainer fee and $ 23 costs for filing *554 the complaint. Ashcraft answered petitioners' complaint, denying*118 liability and cross-complained for damages to his automobile in the amount of $ 756 arising upon Alexandre's alleged negligence.Since petitioners were uninsured and in order to retain his California driving license, Alexandre was required to post a cash bond of $ 400 with the department of motor vehicles. Ashcraft offered to settle his case for about one-half of the amount of his counterclaim (or $ 377.81), providing petitioners abandoned their claim. Petitioners accepted and directed payment of $ 377.81 out of the cash bond to Ashcraft in full settlement of the case.In their return for 1967, petitioners claimed a casualty loss deduction based on the above facts in the net amount of $ 1,206, computed as follows:Fair market value of their auto$ 675Less scrap value received20Total$ 655Add: 1Attorney's fees250Filing fee23Mr. Ashcraft378Subtotal651Gross loss1,306Exclusion100Net loss1,206In his statutory notice of deficiency, the Commissioner disallowed the $ 651 portion of the claimed casualty loss pertaining to the lawsuit, i.e., the $ 250 for attorney's*119 fees, $ 23 for filing fees, and the $ 378 settlement paid to Ashcraft. As a consequence, the Commissioner determined a deficiency in income tax for 1967 in the amount of $ 123.70.OPINIONThe issue facing us is simply whether petitioners can deduct as a casualty loss under section 165(c)(3)2 those amounts expended for *555 attorney and filing fees and an amount in settlement of a counterclaim for damages. The decision herein must be for the Commissioner.*120 The Code provides for only one measure of loss: the difference between the fair market value of the property before and after the casualty. Sec. 165(c)(3); sec. 1.165-7(b)(i), Income Tax Regs. And from the wording of the statute, the loss must be of or to property belonging to the taxpayer.Petitioners argue that the full measure of their loss is the economic detriment suffered by them as a result of the automobile accident. This encompasses the loss to their car plus the other amounts here at issue.The amounts contended for by petitioners are not considered by the Code or regulations, and we find no authority for allowing them. To the contrary, we find authority which prohibits these amounts from qualifying as a casualty loss. B. M. Peyton, 1129">10 B.T.A. 1129 (1928). The claimed loss, except as already allowed, is not deductible.If it should be thought that this conclusion runs counter to Katherine Ander, 47 T.C. 592">47 T.C. 592, we do not think that is the case. In Ander, where litigation costs were allowed as a deduction, the fact of the casualty itself (theft) was in issue as well as the amount of the loss. A settlement*121 ensued; $ 15,000 was established as the amount of the loss and a $ 6,250 attorney fee was paid by the taxpayer. The $ 15,000 was recovered by the taxpayer and, of course, could not be deducted as it was compensation for the loss. We did allow a deduction of the legal fee, saying at page 595: "However, it seems clear that the costs of recovery or salvage are so clearly identified and connected with the theft [casualty] loss itself as to be further or additional or collateral theft losses." We do not think the case of Ticket office Equipment Co., 20 T.C. 272">20 T.C. 272, affd. 213 F. 2d 318 (C.A. 2, 1954), relied on in part in Ander, is necessarily applicable here. In that case the costs of hiring attorneys and adjusters to collect an insurance claim were held to be deductible. But the ground for deductibility there was that the purpose of the expenditure "arose in the ordinary course of petitioner's business," though some doubt is thrown on this ground in footnote 6. Under no circumstance can the litigation here be held to have been connected *556 with petitioner's business. It arose only in connection with petitioner's personal*122 use of his auto.In this case there was no necessity for establishing the fact that a casualty loss had been suffered. There is and was no dispute that the fair market value of the automobile at the time of the accident was $ 675 and the salvage value was $ 20 and that the difference, minus the $ 100 exclusion, or $ 555, was deductible.At the risk of repetition, so far as we can see (leaving it to petitioners to otherwise question our shortsightedness, acuity, or astigmatism) the amount of the loss here had already been established according to the statute and the regulations -- i.e., the property loss (the difference between the basis of the property before the casualty and its fair market value after the casualty). This the Commissioner has allowed and there is no question in that respect. Nevertheless, petitioner brought suit for damages against the alleged perpetrator of the loss. Again, as we see it, the costs of this suit cannot affect the amount of the casualty loss itself. They could, of course, have decreased the amount of that loss for tax purposes, because the statute only allows a deduction for the amount of any casualty loss which is not compensated for by insurance*123 or otherwise. If petitioners had recovered any amount for the damage to their automobile, under the statute this amount would have diminished their casualty deduction. It could not have increased it. It can make no difference that they recovered nothing. Here, to the contrary, they paid out more to the other involved party. The amounts paid out for attorney fees, filing fees, and damages to the other party do not increase the claimable deduction. They do not have any effect on the amount of the casualty loss allowable, i.e., the loss in the value of taxpayer's damaged property. Of course the amounts expended were out-of-pocket expenses, but we are at a loss ourselves to find any statutory provision which would characterize them as a casualty loss. Accordingly,Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated.↩1. The purposes for the disbursements are set forth above.↩2. 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 -- * * * *(3) losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. A loss described in this paragraph shall be allowed only to the extent that the amount of loss * * * exceeds $ 100. * * * Income Tax Regs.:Sec. 1.165-7(b)Amount deductible. -- (1) General rule. -- In the case of any casualty loss whether or not incurred in a trade or business or in any transaction entered into for profit, the amount of loss to be taken into account for purposes of section 165(a) shall be the lesser of either --(i) The amount which is equal to the fair market value of the property immediately before the casualty reduced by the fair market value of the property immediately after the casualty; or(ii) The amount of the adjusted basis prescribed in § 1.1011-1 for determining the loss from the sale * * *.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624856/ | A. P. GIANNINI, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. CLORINDA A. GIANNINI, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Giannini v. CommissionerDocket Nos. 87128, 87127.United States Board of Tax Appeals42 B.T.A. 546; 1940 BTA LEXIS 985; August 15, 1940, Promulgated *985 1. Petitioner refused to accept a certain amount declared by resolution to be due to him from the Bancitaly Corporation as compensation for services performed from January 1, 1927, to January 20, 1928, inclusive. After the later date, the corporation donated the amount to the University of California to establish the Giannini Foundation of Agricultural Economics. All negotiations and details relating to the gift were carried on between the corporation and the regents of the University of California. Held, the amount of the donation was not income to petitioner. 2. The inclusion of $78,739.50 in petitioner's income, reported by him as earned under a profit-sharing contract with the A. P. Giannini Co. and approved by the Commissioner as a proper item of income, raises no issue to be decided by the Board since the purpose of presenting it was to obtain a construction of the contract as it may be applicable to losses sustained in later years, which years are not before us. Andrew F. Burke, Esq., Harry Friedman, Esq., and George H. Koster, Esq., for the petitioners. T. M. Mather, Esq., for the respondent. VAN FOSSAN *546 These proceedings*986 were brought to redetermine deficiencies in the income taxes of the petitioners, A. P. Giannini and Clorinda A. Giannini, for the year 1928 in the sums of $137,343.50 and $123,402.71, respectively. The primary issue is whether or not, under the circumstances of the transaction, a donation of $1,357,607.40 made by the Bancitaly Corporation to the regents of the University of California constituted compensation to petitioner A. P. Giannini. A subsidiary question, termed an issue by both the petitioner and the respondent, is whether or not the sum of $78,739.50, credited to petitioner A. P. Giannini by the A. P. Giannini Co., pursuant to an alleged profit-sharing agreement between him and the company, was properly included in his income. In effect, the petitioner requests *547 a construction of that agreement applicable to losses sustained in subsequent years. FINDINGS OF FACT. Certain facts were stipulated substantially as follows: A. P. Giannini and Clorinda A. Giannini, the petitioners, are and at all times hereinafter mentioned, were husband and wife and live in San Francisco, California. For the year 1928, the petitioners filed their respective Federal income*987 tax returns on a community property basis and each of them reported income and deductions on a cash receipts and disbursements basis. The return of each of the petitioners for that year was filed with the United States collector of internal revenue at San Francisco, California. Prior to October 17, 1924, A. P. Giannini, hereinafter called the petitioner, was president of the Bank of Italy, a corporation organized and existing under and by virtue of the laws of the State of California. He resigned as president of that corporation on October 17, 1924. The petitioner was one of the organizers of Bancitaly Corporation, hereinafter called Bancitaly, a corporation formed under the laws of the State of New York in 1919, and was the president of that corporation from 1919 until its dissolution in the year 1929. At a meeting of the board of directors of Bancitaly, duly and regularly called and held on January 22, 1925, the following motion was adopted: Upon motion duly made and seconded, P. C. Hale, J. J. Fagan and H. C. Capwell were appointed a committee to devise a plan to compensate A. P. Giannini for his services, as President, based upon a share or percentage of the net earnings*988 of the Corporation, it being understood, pending decision of the committee, that Mr. Giannini is to have the privilege of drawing his current expenditures and having same charged to himself on the books of the Corporation. The committee appointed, pursuant to such motion, made the following report to the corporation at a meeting of its board of directors held on June 27, 1927: The committee as above met on Wednesday, April 13, 1927, at 2:00 o'clock, in Mr. Fagan's office, in the Crocker First National Bank, San Francisco, and unanimously agreed to, and hereby do, recommend to the directors of the Bancitaly Corporation that Mr. A. P. Giannini, for his services as President of your Corporation, be given 5% of the net profits each year, with a guaranteed minimum of $100,000 per year, commencing January 1, 1927, in lieu of salary. Thereupon the board of directors unanimously approved the report. The following directors were present: J. A. Bacigalupi H. Cartan L. M. Giannini N. A. Pellerano R. B. Teefy O. J. Woodward H. C. Capwell Joseph P. Grace J. A. Lagomarsino J. A. Migliavacca *548 Throughout the year 1927 and both before and after the adoption*989 of the report, the petitioner withdrew various sums of money from Bancitaly for his services to that corporation and such moneys were charged to his account on the books of the corporation. On November 30, 1927, the account of the petitioner with the corporation showed an indebtedness on his part to the corporation of $215,603.76. On that date his account was credited and the salary account in the books of the corporation was debited with the amount of $445,704.20, a sum equivalent to 5 percent of the net profits of Bancitaly from January 1 to July 22, 1927. As of December 31, 1927, the books of Bancitaly showed an indebtedness of the corporation to the petitioner in the sum of $199,797.50. No sums of money were credited to the petitioner on the books of Bancitaly in the year ended December 31, 1927, except those above mentioned. On January 20, 1928, a meeting of the board of directors of Bancitaly was duly and regularly called and held, at which more than a quorum of the directors were present. At that meeting the following resolution was unanimously adopted: WHEREAS, this Corporation is prepared now to pay to Mr. A. P. GIANNINI for his services as its President and General*990 Manager five per cent (5%) of the net profits of this Corporation computed from July 23, 1927 to the close of business January 20, 1928, which five per cent (5%) amounts to the sum of One Million Five Hundred Thousand Dollars ($1,500,000.00); and WHEREAS, Mr. A. P. GIANNINI refuses to accept any part of said sum but has indicated that if the Corporation is so minded he would find keen satisfaction in seeing it devote such a sum or any lesser adequate sum to the objects below enumerated or kindred purposes: and WHEREAS, we believe that this Corporation would do a great good and derive a great benefit from the establishment of a Foundation of Agricultural Economics at the University of California, and we believe that something should be done by this Corporation to evidence its appreciation of the fact that without the general confidence and hearty cooperation of the people of the State of California the great success of this Corporation would not have been possible; and WHEREAS, we believe that untold good will flow to this Corporation as well as to all the people of the State of California by a sustained and disinterested study of ways and means of insuring a fair return to the*991 farmers and fruit growers of our State for their products: NOW, THEREFORE, BE IT RESOLVED, by the Board of Directors of this Corporation, that the aforesaid sum of One Million Five Hundred Thousand Dollars ($1,500,000.00) be set apart from the undivided profits of this Corporation in a Special Reserve Account for the purpose hereinafter described, and the whole of said sum be donated to the Regents of the University of California for the purpose of establishing a Foundation of Agricultural Economics; and BE IT FURTHER RESOLVED, that said donation be made in honor of Mr. A. P. GIANNINI, and that said Foundation shall be named after him; and BE IT FURTHER RESOLVED, that a Committee consisting of James A. Bacigalupi, P. C. Hale and A. Pedrini be appointed to confer with the President of the University of California, for the purpose of discussing and determining upon *549 the general scope of said Foundation, and with full power of settling all details in connection therewith; and BE IT FURTHER RESOLVED, that said Committee is hereby vested with full power and authority to expend all of the moneys in the Special Reserve Account aforesaid in the matter of the establishment*992 of said Foundation, in the manner that the majority of said Committee may hereafter determine. On February 10, 1928, Bancitaly submitted a written offer to the regents of the University of California, in part as follows: TO THE REGENTS OF THE UNIVERSITY OF CALIFORNIA: Bancitaly Corporation, headquarters in the City and County of San Francisco, State of California, by virtue of action taken by the Board of Directors of Bancitaly Corporation on Friday, January 20, 1928, herewith offers to your honorable body, in tribute to A. P. Giannini, of San Francisco, and to be named after him, a gift of One Million Five Hundred Thousand ($1,500,000) Dollars, the proceeds of said gift to be used for the purposes described and on the general terms specified in the following paragraphs. (1) There shall be established in the University of CaliforniaTHE GIANNINI FOUNDATION OF AGRICULTURAL ECONOMICS The activities of this FOUNDATION shall be embraced by the great field of Agricultural Economics, and relate to such subjects as: (a) the economic consequences of increased production which result from improved seed grains, improved nursery stock, improved live stock, improved machinery, and*993 improved methods of farming; (b) the economic consequences of overproduction arising from unusually favorable seasons or unusually unfavorable seasons as to weather and other conditions in the producing nations; (c) the relations between conditions existing in the farming industry and the general economic conditions prevailing in the nation, and internationally; (d) the acquiring of such knowledge concerning soil qualities and climatic and other conditions in any or all parts of the State of California, and of such knowledge concerning existing or prospective supply and demand conditions for the various agricultural products of this State, as will enable the appropriate representatives of the FOUNDATION to advise the farmers of California as to wise plantings, sowings, breedings, etc., in relation to areas and kinds; (e) the methods and problems of disposing of farm products on terms or conditions giving maximum degree of satisfaction to the producers; (f) any economic questions which concern the individual farmer and the members of his family, and affect their living conditions; and so on. However, it should be understood that the activities of the FOUNDATION are to be regarded as*994 chiefly: (a) those of research, with purpose to find the facts and conditions which will promise or threaten to affect the economic status of California agriculturalists; and (b) those of formulating ways and means of enabling the agriculturalists of California to profit from the existence of favorable facts and conditions, and to protect themselves as well as possible from adverse facts and conditions. Teaching activities will undoubtedly be called for, certainly to prepare promising students to assist in carrying on the work of this FOUNDATION, and also for service in wider spheres; but it is understood that said teaching service will be conducted largely and if practicable wholly upon the basis of funds made available to the College of Agriculture from other sources. The offer also specified that the foundation and its principal activities should be housed on the campus in a building to be named "Giannini Hall" and costing approximately $500,000. Provision was *550 made for periodic payments of the various portions of the donation and other immaterial suggestions were added. On February 14, 1928, the regents of the University of California adopted the following resolution: *995 WHEREAS, Bancitaly Corporation, headquarters in the City and County of San Francisco, has recently offered to the Regents of the University of California, in tribute to Mr. A. P. Giannini, and to be named after him, a gift of One Million Five Hundred Thousand ($1,500,000) Dollars, the proceeds of said gift to be used to establish and administer THE GIANNINI FOUNDATION OF AGRICULTURAL ECONOMICS in the University of California, as follows: (A) Two-thirds of the total gift, or $1,000,000, to constitute the endowment fund of the Foundation, the income therefrom to be expended, under the direction of The Regents, in the field of Agricultural Economics, for the benefit of the agriculturalists of California, as described in the letter of gift dated February 10, 1928, and signed by James A. Bacigalupi, Vice-President Bancitaly Corporation, and Edward C. Aldwell, Assistant Secretary Bancitaly Corporation; and (B) One-third of the total gift, or $500,000, to be expended, under the direction of The Regents, in constructing and furnishing a building on the campus of the University of Berkeley, to be known as Giannini Hall, said Hall to house the activities of THE GIANNINI FOUNDATION*996 OF AGRICULTURAL ECONOMICS, this Hall to be erected as the third structure in the main College-Agriculture group of buildings; therefore, We, The Regents of the University of California, herewith accept the gift made by Bancitaly Corporation in tribute to A. P. Giannini, with great pleasure and pride, and we undertake to administer the trust in accordance with the terms thereof. We, The Regents, are firmly of the opinion that THE GIANNINI FOUNDATION represents in investment of enormous potential value to the farmers of the State of California. We regard it as a significant and gratifying circumstance that a native son of California should have his name borne by a foundation destined to provide benefits of great value, in perpetuity, to millions of his fellow citizens in this commonwealth, and we congratulate Mr. Giannini most heartily upon the remarkable investment in behalf of others which has been made in his honor by Bancitaly Corporation. On February 15, 1928, the board of regents of the University of California, by L. A. Nichols, its assistant secretary, wrote the petitioner, president of Bancitaly, as follows: At the meeting of The Regents of the University of California*997 held on February 14, 1928, President Campbell reported the gift of the Bancitaly Corporation of One Million Five Hundred Thousand Dollars to establish and administer the Giannini Foundation and to construct and furnish a building to be known as Giannini Hall. The Regents voted to accept the gift and adopted the following resolution of appreciation: [Here follows a copy of the resolution of February 14, 1928.] On February 15, 1928, the regents of the University of California wrote to James A. Bacigalupi, vice president of Bancitaly, a letter in all respects similar to the above letter written by it to petitioner on the same date. *551 Subsequent to the adoption of the resolution of January 20, 1928, and on the same day, Bancitaly charged the said sum of $1,500,000 to its undivided profits account and credited the same sum to an account on its books designated as "Foundation of Agricultural Economics, University of California." The said sum of $1,500,000 was paid to the University of California by checks as follows: Date of paymentPayorAmountFebruary 10, 1928Bancitaly Corporation$25,000September 17, 1928Bancitaly Corporation350,000November 14, 1928Bancitaly Corporation300,000January 29, 1929Americommercial Corporation325,000October 11, 1929Americommercial Corporation300,000June 25, 1931Transamerica Service Co200,000Total1,500,000*998 The Americommercial Corporation and Transamerica Service Co. were successors or affiliates of Bancitaly. Five percent of the amount of the net profits of Bancitaly for the period January 1, 1927, to January 20, 1928, less the sum of $445,704.20 which was credited on the books of the corporation to the account of the petitioner on November 30, 1927, amounted to $1,357,607.40. The difference between the latter amount and $1,500,000, or $142,392.60, was charged to suspense on the books of Bancitaly on January 28, 1928, and on the same date the undivided profits account of the corporation was credited with the sum of $142,392.60. On July 19, 1928, the sum of $142,392.60 was credited to the suspense account on the books of Bancitaly and on the same date was charged to the personal account of petitioner on the books of the corporation. No part of the said sum of $1,357,607.40 paid to the University of California was claimed as a deduction on the income tax return of Bancitaly for the year 1928, but such sum was reported in its return as an unallowable deduction in the analysis of surplus schedule in the return. On subsequent audits of Federal tax returns of Bancitaly the Commissioner*999 of Internal Revenue has made no adjustment of the item of $1,357,607.40 so listed by the corporation as an "unallowable deduction" in its income tax return for the year 1928. The record discloses the following additional facts: The action of June 27, 1927, by Bancitaly's board of directors authorizing the payment of 5 percent of the yearly net profits to the petitioner for his services was his only arrangement of that character with Bancitaly. *552 No part of the $1,357,607.40 heretofore described was ever received by or set apart for the use of either petitioner nor credited in any way to either of them. That sum, together with the $142,392.60 needed to make up the $1,500,000 donated to the University of California, was the property of Bancitaly and the petitioner had no right, title, or interest therein. Sometime in the fall of 1928 it was apparent that 5 percent of the net profits of Bancitaly would not amount to the $1,500,000 estimated by the petitioner, but Bancitaly paid the University of California the full amount of the donation and was thereafter reimbursed by the petitioner for the amount of the shortage, or $142,392.60. In 1927 and prior to December*1000 31 thereof, the petitioner definitely and absolutely refused to accept for his services for that year more than the $445,704.20 credited to him on the books of Bancitaly on November 30, 1927. In 1928 the petitioner, the members of his immediate family, and the A. P. Giannini Co. owned in the aggregate 10,446 shares of the capital stock of Bancitaly out of 5,200,000 such shares then outstanding. During the years 1925 to 1934, inclusive, the petitioner was an officer of the A. P. Giannini Co., a California corporation, hereinafter called the Giannini Co. The mintes of a meeting of the directors of the Giannini Co. held on January 25, 1926, show the following action: President L. M. Giannini then stated that during the past year this corporation has purchased and sold stock on the open market and that all of said purchases and sales were made on the advice of A. P. Giannini and that without his advice the profits resulting from such transactions would have been considerably less than shown by the records of this corporation. He stated that he had directed the treasurer to pay unto A. P. Giannini a sum amounting to approximately fifty percent of the profits derived from the purchase*1001 and sale of such trading stocks and he stated that in his opinion the amount thus paid was a fair and reasonable compensation for the services rendered by A. P. Giannini. Thereupon the following resolutions were introduced and unanimously adopted: WHEREAS A. P. Giannini has during the past year performed extra services for and on behalf of this corporation through the medium of which said services, particularly in the purchase and sale of stocks and securities, this corporation has been enabled to earn large profits; and WHEREAS the president of this corporation has fixed the value of said services thus performed by said A. P. Giannini at the total sum of twenty three thousand one hundred thirty and 85/100 and has authorized the payment of the same to said A. P. Giannini for services performed during the year 1925; now therefore BE IT RESOLVED that the action of the president of this corporation in authorizing the payment unto said A. P. Giannini of the sum of twenty three thousand one hundred thirty and 85/100 dollars for services rendered, as hereinabove set forth, be and the same is hereby ratified, confirmed and approved. BE IT FURTHER RESOLVED that this corporation*1002 shall during the year 1926 and thereafter until these resolutions shall have been rescinded pay unto said *553 A. P. Giannini a sum equivalent to fifty percent of the net profits derived from the purchase and sale of trading stocks and securities. The following resolution was passed on January 28, 1929: The president next stated that pursuant to the terms of a resolution duly passed at a meeting of the board of directors held on the 25th day of January, 1926, the sum of seventy eight thousand seven hundred thirty nine and 50/100 dollars had been credited to the account of A. P. Giannini being equivalent to fifty percent of the net profits derived from the purchase and sale of trading stocks and securities during the year 1928, now therefore, BE IT RESOLVED that the action of the president in authorizing the payment unto A. P. Giannini of the sum of seventy eight thousand seven hundred thirty nine and 50/100 dollars for services rendered, be and the same is hereby ratified, confirmed and approved. The following resolution was passed on January 26, 1931, and similar resolutions were adopted on January 25, 1932, January 30, 1933, and January 29, 1934, relating to losses*1003 sustained during those years, one-half of which was charged to the petitioner: WHEREAS this corporation has heretofore entered into an agreement with A. P. Giannini, under the terms of which said A. P. Giannini is to receive from this corporation as compensation for services rendered one-half of all profits earned from the purchase, sale and trading in of stocks, bonds and other securities and is to reimburse this corporation for one-half of all losses sustained in such trading transactions; and WHEREAS pursuant to said agreement said A. P. Giannini has received from this corporation one-half of such net profits earned by this corporation; and WHEREAS the loss sustained from such trading operations during the year 1929 amount to the sum of $18,519.39, one-half of which has been charged to the personal account of A. P. Giannini with this corporation; now therefore, BE IT RESOLVED that the charging of the sum of $9,259.66, being one-half of the loss sustained by this corporation in its stock and security trading operations during the year 1929, to the account of A. P. Giannini be and the same is hereby approved and confirmed. Thereupon the following resolutions were introduced*1004 and unanimously adopted: WHEREAS this corporation has heretofore entered into an agreement with A. P. Giannini, under the terms of which he is to receive from this corporation one-half of all profits earned or derived from the purchase, sale and trading in of stocks, bonds and other securities, and under the terms of which he is to reimburse this corporation for one-half of the losses sustained from such trading operations, which said agreement now is and for some years last past has been in force and has been carried on and performed by said A. P. Giannini and this corporation; and WHEREAS the losses incurred in such trading operations during the year 1930 amount to the sum of $330,236.26, one-half of which is to be charged to the account carried in the books of the A. P. Giannini Co., in the name of A. P. and C. A. Giannini; and WHEREAS said A. P. Giannini during said year of 1930 has performed extraordinary services for and on behalf of this corporation, which services were of great value to this corporation; now therefore BE IT RESOLVED that in consideration of the said extraordinary services rendered by said A. P. Giannini and other good and valuable consideration received*1005 *554 by this corporation that the account carried with this corporation in the name of A. P. and C. A. Giannini shall be charged with one-fifth instead of one-half of the losses sustained in said trading operations. BE IT FURTHER RESOLVED that these resolutions shall in no way affect, alter or amend the agreement existing between this corporation and said A. P. Giannini except as to the year 1930 and that in the future said A. P. Giannini shall be entitled to receive one-half of all profits earned from the purchase, sale and trading in of stocks, bonds and other securities and is to reimburse this corporation for one-half of all losses sustained in such trading transactions. The amounts representing the petitioner's share of gains were credited to him on the Giannini Co. books and amounts representing his share of losses were also charged to him for the respective years. In his income tax returns for 1925 to 1928, inclusive, the petitioner reported his gains and paid taxes thereon and in his returns for 1929 to 1934, inclusive, he claimed corresponding losses under the said agreement. The respondent accepted the taxes paid by the petitioner on the gains reported but*1006 refused to allow the deductions claimed on losses in the later years. OPINION. VAN FOSSAN: The first issue is essentially one of fact. Briefly it may be outlined thus: Early in 1925 a committee was appointed to determine the proper compensation of the petitioner for his services as president of Bancitaly, of whose stock of 5,200,000 outstanding shares he and his family interests owned only 10,446 shares. Prior thereto petitioner had received no compensation for services from Bancitaly. The committee recommended to the directors on June 27, 1927, that from January 1, 1927, the petitioner should receive, in lieu of salary, 5 percent of the yearly net profits, with a guaranteed minimum of $100,000. From January 1 to July 22, 1927, that percentage amounted to the sum of $445,704.20, which, on November 30, 1927, was credited to his account, offset by certain advances and indebtednesses debited to him by Bancitaly. On repeated occasions during 1927 the petitioner unequivocally refused to accept any compensation for his services rendered during that year in addition to the $445,704.20 already credited, although such further compensation was estimated by petitioner to amount to*1007 $1,500,000. Upon his refusal, and adopting a suggestion made by petitioner, the Bancitaly directors decided to donate the $1,500,000 to the University of California for the establishment of the Giannini Foundation of Agricultural Economics, so named in honor of the petitioner. That action was predicated on their belief that the foundation would be of great use to the public in general and would benefit Bancitaly specifically because of the farmers' loans held by its subsidiary, and also on their desire to pay tribute to the petitioner. The regents of the University of California accepted the gift with observations commendatory to the petitioner. *555 All proposals and negotiations relating to the donation were carried on exclusively between Bancitaly and the regents. The petitioner's participation in the transaction was confined solely to his suggestions relating to the nature and purpose of the contribution and to his expression of satisfaction "if the corporation should be so minded." In 1928 it was found that the $1,500,000 estimated to be the amount of the petitioner's compensation for 1927 which he had refused to accept, would not be reached from Bancitaly's net*1008 profits. However, Bancitaly paid to the regents the full amount of its offer, with the approval of the petitioner, who assumed responsibility for the miscalculation. The deficiency, $142,392.60, at petitioner's suggestion was charged to the petitioner on Bancitaly's books on July 19, 1928, and was paid from compensation from Bancitaly earned by him subsequent to January 20, 1928. Upon and subsequent to the petitioner's refusal to accept the $1,357,607.40 representing his percentage of net profits earned from July 23, 1927, to January 20, 1928, neither he nor his wife received any part of that sum by way of cash, credit, or other method of payment or allocation to them and they had no right, title, or interest therein. The respondent's position seems to be based on the assumption that the petitioner directed and compelled Bancitaly to make the donation, an act which, the respondent asserts, was wholly ultra vires. He argues that in January 1928 the petitioner was entitled to receive the $1,357,607.40 as a part of his compensation and, therefore, the diversion of that sum to the University of California constituted, in reality, a gift by petitioner. We are of the opinion, *1009 and have found as a fact, that the petitioner unqualifiedly refused to accept any compensation for the year 1927 in excess of the $445,704.20 credited to him on November 30, 1927, and covering the period from January 1 to July 22, 1927. His first refusal was made shortly after the net earnings of Bancitaly for that period were tentatively ascertained and he repeated that refusal at numerous times thereafter. His refusal was subject to no condition or contingency and relieved Bancitaly of any obligation to pay petitioner the sum in question. The amount in excess of the $445,704.20, thereafter belonged to Bancitaly to dispose of as it saw fit. There is nothing in the record in any way impugning or discrediting petitioner's testimony and his exposition of the matter is fully and adequately corroborated by the unrefuted statements of disinterested witnesses and by the records of Bancitaly and of the regents of the University of California. We have no reason to doubt that he declined absolutely to accept the excess compensation for the period from July 23, 1927, to the end of the year. Bancitaly*556 accepted his decision as final and treated the excess as its own on its*1010 books and in its subsequent actions. It is elemental that an individual may refuse to enforce a right, forswear a debt due him, or relinquish a claim. After such action it is equally basic that his debtor retains full possession and ownership of the thing renounced. It is obvious also that no one is compelled to accept compensation or payment for services or goods. When he refuses to do so he can not be charged with the amount so refused and abandoned, as an item of income. Under no theory of constructive receipt can it be compensation within the meaning and definition of income. It matters not that the suggestion to make the donation to the University of California came from petitioner. The offer was made by Bancitaly and all details were carried on by its officers and agents. The petitioner took no part whatever in the negotiations or in the completion of the gift. The respondent challenges the right of Bancitaly to make such a donation. We are not concerned with that phase of the matter. It has no bearing on our question. The respondent further argues that there is no difference between the $1,357,607.40 refused by the petitioner and the $142,392.60 required to*1011 complete the $1,500,000, the latter sum being charged to him by Bancitaly and ultimately paid by him out of compensation later earned and credited to him on Bancitaly's books. The two amounts are in wholly different categories and are not comparable. The first was never paid to petitioner but was donated by Bancitaly to the University. The item of $142,392.60 was paid by Bancitaly but was ultimately assumed and paid by petitioner out of other earnings. The petitioner felt morally responsible for his inaccurate calculation or estimate of Bancitaly's probable profits for 1927 and, therefore, personally made good the deficiency. Such sequential action on his part had no effect on that part of the compensation for 1927 which he had previously renounced and in which he had abandoned all interest. The second issue presents an unusual situation. The petitioner received from the Giannini Co. during the year 1928 the sum of $78,749.50 pursuant to the action of its board of directors dated January 28, 1929, which in turn referred to the original agreement created by its action on January 25, 1926. Both the petitioner and the respondent agree that the amount should be included in*1012 the petitioner's income for 1928, but both designate and term the question an issue in the present case. As is frankly stated by the petitioner's counsel, we are asked to construe the so-called "profit-sharing contract," in order that its effect upon the sharing of losses thereunder in subsequent years may be determined. *557 We do not have the later years before us and, hence, confine ourselves to approving the action of the respondent. There is no controversy over the respondent's determination as to the instant year. Whether or not the petitioner later sustained losses under his agreement with the Giannini Co. and the tax effect of such losses, if sustained, must await decision when, if ever, the later years are before us. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624857/ | William A. Lull and Helen M. Lull, Petitioners v. Commissioner of Internal Revenue, Respondent; William H. Simpson and Dorothy Simpson, Petitioners v. Commissioner of Internal Revenue, RespondentLull v. CommissionerDocket Nos. 2882-66, 3527-66United States Tax Court51 T.C. 841; 1969 U.S. Tax Ct. LEXIS 184; February 26, 1969, Filed *184 Decisions will be entered under Rule 50. Petitioners were transferred by their employer, IBM, to other posts of duty. They were reimbursed for all expenses related to the move, and for the difference between sale price of their residence and its appraised value. Held, the reimbursements are includable in gross income except allowance for moving petitioners' immediate family, household goods, and personal effects. Joseph H. Trethewey, for the petitioners.Walter John Howard, Jr., for the respondent. Bruce, Judge. Dawson, J., dissenting in part. Raum, Fay, and Simpson, JJ., agree with this dissent. BRUCE *841 Respondent determined deficiencies in income tax of the petitioners and additions to tax pursuant to section 6653(a) of the Internal Revenue Code of 1954 for negligence or intentional disregard of rules and regulations, as follows:Addition toDocket No.PetitionerYearDeficiencytax sec.6653(a)2882-66William A. Lull and Helen M. Lull1960$ 3,350.78$ 167.541961329.9616.503527-66William H. Simpson and Dorothy19596,008.52300.43Simpson19612,724.67The cases were consolidated because of common issues involving the tax treatment of certain amounts received by each of the petitioners in reimbursement of moving and living expenses and for the difference*186 between the sale price and the appraised value of his residence *842 when transferred by his employer from one place of employment to another.Respondent has conceded the additions to tax and certain other issues have been settled by stipulation.FINDINGS OF FACTThe stipulation of facts and the exhibits attached to the stipulation are incorporated by this reference.William A. Lull and Helen M. Lull are husband and wife. They resided in Seattle, Wash., at the time their petition was filed. They filed joint Federal income tax returns for the calendar year 1960 with the district director of internal revenue at Los Angeles, Calif., and for the year 1961 with the district director of internal revenue at Tacoma, Wash.William H. Simpson and Dorothy Simpson are husband and wife. They resided at Mercer Island, Wash., at the time their petition was filed. They filed joint Federal income tax returns for the year 1959 with the district director of internal revenue at Los Angeles, and for the year 1961 with the district director of internal revenue at Tacoma, Wash.William A. Lull and William H. Simpson were employed during the years 1957 through 1961 by International Business Machines*187 Corp., herein referred to as IBM.Lull has been employed by IBM as a salesman. In 1960 he was transferred by his employer from Honolulu, Hawaii, to Seattle, Wash.Simpson was IBM's regional manager for industry and marketing for 11 Western States and resided in Los Angeles from January 1957 to February 1959. He was then transferred to New York as the divisional manager of advertising and promotion in the home office at White Plains, N.Y. In May 1961 he was transferred to Seattle as district manager for that office.At the time of these transfers, IBM had a stated policy concerning reimbursement of expenses incurred by its employees in moving. The general scope of this policy was stated as follows:MOVING AND LIVING POLICYGeneral. -- When an employee is transferred at the Company's request from one IBM location to another on a permanent basis, the Company will pay all normal expenses for moving household effects, expenses incurred while en route to the new location and living expenses as explained below.The allowances for Moving and Living are divided in three basic areas:I. Travel and Living Expense, including temporary living costs.II. Moving Expense which covers the*188 mover's charges and authorized miscellaneous expenses.III. Home Guarantee Policy which covers authorized assistance in selling present home and purchasing new home.*843 The Moving and Living Policy will govern the transfer of all employees and, in addition, where applicable, the Home Guarantee Policy will govern the transfer of employees entering into the Home Guarantee and/or the Home Purchase Loan Agreements.* * * *I. A. 2. Living Advance. -- Upon arrival at the new location the employee may be granted an advance not exceeding a maximum of $ 200.00 for temporary living expenses. This advance is to take the form of a living advance in that it is to be accounted for on the final living expense account. When an employee has a living advance, all Moving and Living Expense Accounts submitted prior to the final living expense account are to be reimbursed in full. Except in unusual circumstances, no additional advance is to be made, and then only after settlement of the original advance.* * * *B. Allowances for Travel Expenses. -- Travel Expenses will commence at the time of the employee's departure from his prior assignment. He should record all allowable expenses*189 and retain supporting receipts during this period. Mileage at the current rate will be allowed for use of a personal car in traveling to the new location. Other means of transportation and allowable expenses as detailed in the Travel Expense section will also be authorized. Travel expenses will end as soon as the employee arrives at his new location.C. Allowances for Living Expenses. -- When the first Moving and Living Expense Account is submitted, it is to include in the appropriate section under summary an estimate of the total number of weeks the employee will require Living Expenses for himself and for his family. This section is also to be completed on all future Moving and Living Expense Accounts indicating the original estimate and the present estimate.Living expenses include meals, room, laundry, etc., incurred by the employee and his dependents at the new location prior to securing residence in accordance with the following time limits.* * * *II. Moving ExpensesA. General. -- Immediately upon notification of the transfer the employee is to secure a bid from a reputable national mover covering the moving of his personal household goods to the new location. *190 It is not necessary to have a specific address but should indicate the general area in which he is to settle. In the case of intra-state transfers, two bids should be secured covering the physical move. Out of state moves require only one bid. The bid or bids are to be held and presented to the Manager at the new location who will authorize one of the bids.* * * *B. Allowable Expense in Connection with Move. -- Listed below are the expenses that are allowable under the IBM Moving and Living Expense Policy. Items not listed as allowable will not be honored.1. Automobile Registration. -- Expense as a result of transferring an automobile registration from one state to another will be allowed on a net basis. Any refund from the previous state is to be deducted before computing the cost.2. Use of Personal Car. -- Mileage at the current rate will be allowed for use of a personal car in seeking a new residence.3. Auto Rental. -- If considered necessary, the use of a rented automobile will be allowed in seeking a new residence; however, each day's usage must have the prior approval of the Manager at the new location.4. Cleaning Services. -- Actual expenses*191 for Domestic labor for purposes of *844 cleaning the old and new residence will be reimbursed to a maximum of $ 25.00 at each location.5. Arrangements for Disconnecting and Reconnecting Appliances. -- If the Mover arranges with a firm or mechanic to disconnect and reconnect home appliances in connection with the move, IBM will reimburse the Mover for completing the arrangements a fee up to 10% of the service charge of the firm or mechanic when such fee is charged by the Mover. This 10% maximum charge is payable only to the Mover and should be included on the Movers invoice as part of the contractual arrangements.6. Plumbing and Electrical Line for Appliances. -- IBM will allow expenses for the necessary labor and materials to connect major appliances in the new residence provided the necessary facilities are available within the house. Expenses to bring electrical powerlines, gas lines or water pipes from the street to the house are considered house improvements and will not be allowed. Installation expenses and electrical and plumbing work are allowable only for those or similar appliances that were previously installed in the residence the employee is leaving. *192 This allowance is not to cover kitchen cabinet work or other finishing work necessary as a result of the appliance installation. It is to cover necessary plumbing and electrical work only.7. Fees for Custodial Care. -- Employees who have dependents that require custodial care (babysitters, practical nurses, etc.) while such employees are moving or house hunting, may be reimbursed for reasonable expenses in connection therewith to the extent considered necessary by the local Manager.8. Installing and Altering Carpets and Drapes. -- Expenses incurred to install and/or alter carpets or drapes to fit the new residence will be allowed provided the same items were installed previously in the residence the employee is leaving. Cleaning of drapes or carpets is not authorized.9. Tuning of TV Set and Piano. -- Expenses in connection with tuning TV sets and pianos required as a result of the move will be allowed. This includes installation of an aerial but does not include the purchase of an aerial. This does not include expenses for parts replacement caused by damage in transit. Such expenses should be processed in accordance with instructions for damage in transit. *193 10. Miscellaneous Expense. -- IBM will reimburse an employee with resident dependents $ 100.00 and an employee without resident dependents $ 35.00 to cover all other miscellaneous expense not listed. This expense reimbursement is to be requested on the same Moving and Living Expense Account that covers the mover's invoice and is to be shown as Miscellaneous Expense as indicated on exhibit in this section.The home guarantee policy, if agreed upon by the employee, provided for an appraisal of the home and guaranty that if the net selling price is less than the appraisal IBM will reimburse the employee for the difference.In connection with Lull's transfer from Hawaii to Seattle in August 1960, he applied for and received reimbursement in 1960 for expenses in the amount of $ 3,370.10 and in 1961 in the amount of $ 3,521.01. These expenses were for mover's fee, air fares, room and meals, babysitting, car rentals, appliances, water and gardener service, interest, real estate taxes, house insurance, miscellaneous expenses, and closing costs.*845 When the Lulls moved from Hawaii to Seattle, the family, six persons, located in a motel about August 7, 1960, and began to look *194 for housing. Within a week they located and offered to purchase a house, which offer was accepted. They could not move immediately because their furniture did not arrive until after Labor Day. They remained in the motel until then. They incurred room and meals expenses during this period, also car rentals, babysitting expenses, and others. The expenses claimed for real estate taxes, interest, house insurance, and garden services were in connection with their house in Hawaii.The Lulls' home in Hawaii had a cost basis of $ 22,724. Under IBM's House Guaranty Policy, this was appraised at $ 28,166 in July 1960. IBM estimated that these petitioners would receive an equity of $ 7,500 upon the sale and advanced that amount to Lull in August 1960 for use in acquiring a new residence near Seattle. The Lulls purchased a home in Bellevue, Wash., in September 1960 for $ 30,000. The house in Hawaii was sold in July 1961 for $ 22,500 with expenses of $ 1,185. The Lulls realized $ 6,851 from this transaction and remitted $ 649 to IBM, the difference between $ 7,500 advanced and $ 6,851 realized.The petitioners did not report as income on their tax returns any of the reimbursements described*195 above.In the Lull case respondent determined (1) that $ 891.37 of the expense reimbursement of $ 3,370.10 to Lull in 1960 was properly excludable from income and $ 2,478.73 was includable, subject to allowance of deductions for real estate taxes of $ 74.71 and interest of $ 367.91 as itemized nonbusiness deductions, and (2) that the $ 7,500 indemnification for loss on residence constituted taxable income in 1960, the $ 649 refund of a part thereof in 1961 being treated as deductible in 1961, and (3) that $ 1,928.93 of the expense reimbursement of $ 3,521.01 in 1961 was properly excludable and $ 1,592.08 was includable as income, subject to deductions of $ 700.33 for interest and $ 177.31 for real estate taxes. These interest and real estate tax items were among the reimbursed amounts in each year.The exclusions allowed by respondent in the Lull case were for --1960 Air transportation$ 830.321960 Room and meals51.051960 Taxi fares10.001961 Moving furniture1,928.93Lull received reimbursement for room and meals in 1960 in the amount of $ 920.12 and for car rental and taxi $ 24.25, which respondent treated as personal expenses except as shown above.In connection*196 with Simpson's transfer from Los Angeles to White Plains in 1959 he applied for and received reimbursement of expenses aggregating $ 10,155.64. These expenses were for mover's fee, freight on shipment of auto, air transportation, meals and tips, lodging, auto *846 expense for house hunting, babysitting, miscellaneous expenses, and expenses relating to the disposition of the home at Los Angeles and installation of equipment and drapes at the new home in Darien, Conn.In connection with Simpson's transfer from White Plains to Seattle in 1961, he applied for and received reimbursement of expenses aggregating $ 8,764.34. These expenses were for mover's fee, auto expense driving across country, air transportation, lodging, meals and tips, auto expense for house hunting, dog shipment, babysitting while house hunting, miscellaneous expenses, and expenses relating to the disposition of the home at Darien, and acquisition of a home near Seattle and installation of equipment there. Among these was $ 146.38 for interest on the mortgage on the property at Darien.The Simpsons had purchased their home in Los Angeles for $ 47,857. Upon the transfer of Simpson to White Plains the home was*197 appraised at $ 51,750 pursuant to IBM's Home Guaranty Policy. It was sold April 24, 1959, for $ 49,500, with the selling costs of $ 2,575. The difference, $ 4,825, was paid Simpson by IBM in 1959.After arriving at White Plains, the Simpsons purchased a home at Darien for $ 54,000 in February 1959. Upon the transfer to Seattle, this home was appraised at $ 58,000 pursuant to the Home Guaranty Policy. It was sold in June 1961 for $ 56,000, with selling costs of $ 162.70. The difference of $ 2,162.70 was paid Simpson by IBM in 1961.The Simpsons acquired a residence at Mercer Island, Wash., in June 1961 at a cost of $ 74,000.The petitioners did not report as income on their tax returns any of the reimbursements described above.In the Simpson case respondent determined (1) that $ 5,417.13 of the expense reimbursement of $ 10,155.64 to Simpson in 1959 was properly excludable from income and $ 4,738.51 constituted taxable income, (2) that $ 4,668.87 of the expense reimbursement of $ 8,764.34 in 1961 was properly excludable and $ 4,095.47 constituted taxable income, (3) that the indemnification in 1959 on sale of the residence in Los Angeles in the amount of $ 4,825 and in 1961 on*198 the sale of the residence in Darien in the amount of $ 2,162.70 constituted taxable income.In the Simpson case respondent treated as excludable reimbursements in 1959 the following items:Mover's fee$ 3,847.22Air transportation1,016.25Freight, auto shipment533.16Meals10.00Carfare and taxi7.50Car mileage3.00Total5,417.13*847 In the Simpson case respondent treated as excludable reimbursements in 1961 the following items:Mover's fee$ 3,900.51Auto transportation207.74Air transportation399.20Lodging57.02Meals90.00Parking14.40Total4,668.87In connection with each move, the Simpsons made several air trips to the new location for house hunting and incurred lodging expenses and babysitting expenses at these times. Respondent treated one air trip for each person as an excludable item, all other such expenses as personal except as shown above.OPINIONInternational Business Machines Corp., in its nationwide scope of operations, finds it necessary to transfer some of its able employees from one city to another for its own convenience. This occurs so frequently that the corporation has developed a policy with respect*199 to payments to these employees to ease the burdens of moving, to reduce their concern over possible loss on the sale of the old home, and to help them in acquiring a new one. The principal issue for decision is to what extent are the employer's payments in reimbursement of the employee's expenses incurred in connection with the move includable in the gross income of the employee.Payments by an employer to an employee which are compensation for services are taxable income under section 61, I.R.C. 1954. An employee is entitled to certain deductions from gross income authorized in section 62(2), which include expenses incurred in connection with the performance of services as an employee under a reimbursement arrangement, travel expenses while away from home incurred in the performance of services, and transportation expenses so incurred. Section 262 provides that no deductions are allowable for personal, living, or family expenses, except as expressly provided.Respondent's position is that the payment or reimbursement by an employer of the cost of moving an employee, his immediate family, household goods, and personal effects from one place of employment to another, primarily for*200 the benefit of the employer, is not compensatory in nature and such payments are not includable in the gross income of the employee if the total amount is expended for such purposes, but that amounts paid for expenses in excess of those items, even though related to and occasioned by the transfer, are essentially for personal, family, or living expenses and represent compensation *848 for services. This position is stated in Rev. Rul. 54-429, 2 C.B. 53">1954-2 C.B. 53, and amplified in Rev. Rul. 65-158, 1 C.B. 34">1965-1 C.B. 34.Respondent has treated the amounts paid by IBM for actual travel, movement of families, furniture, and household effects, as excludable from gross income of the petitioner-employees. The expenses here in issue are referred to by respondent as "indirect" moving expenses, and include payments for babysitting, laundry, telephone, house-hunting trips, carpet or drapery alterations, also interest, real estate taxes, house insurance, garden service, and mortgage costs. These, says respondent, are essentially living expenses, even though occasioned by the transfer of the employee. Respondent *201 determined that reimbursements for these items are includable in the gross income of the employees. The employees also had the benefit of the employer's assistance in selling their homes or acquiring new ones. This took the form of a guaranty to receive appraised value on sale and an advance of estimated equity to facilitate a purchase. Respondent has determined that the money payments or advances on this account are includable in gross income of the employees.Petitioners contend that reimbursements for the contested expenses incident to the moving are not compensatory, have not resulted in any economic gain or benefit to them, and should be excludable from gross income. In the alternative, if these payments are includable, petitioners argue that they should be entitled to a corresponding deduction of such amounts as business expenses incurred in connection with their employment.Petitioners contend that the payments by IBM with respect to the home guaranty are gain from the sale or other disposition of property under section 1001 of the 1954 Code, and are a part of the "amount realized" upon such sale. They say that since in each case they purchased a new home at a price in *202 excess of the adjusted basis of the prior home, the payment, pursuant to section 1034 (providing for nonrecognition of gain on the sale of a residence under certain circumstances), is not taxable. They cite Otto Sorg Schairer, 9 T.C. 549">9 T.C. 549 (1947), in which it was held that an amount paid by an employer in reimbursement of the loss sustained on the sale by an employee of his home when moving at the direction of his employer to a different city was to be treated as a part of the "amount realized" upon the sale and was not includable in the gross income of the employee.In Harris W. Bradley, 39 T.C. 652 (1963), affd. 324 F. 2d 610 (C.A. 4, 1963), this Court held that a payment by the taxpayer's employer in reimbursement of the employee's loss on the sale of his residence in connection with his accepting employment at a different location was taxable to the employee as additional compensation. The Court declined to follow the Schairer case.*849 In Willis B. Ferebee, 39 T.C. 801">39 T.C. 801 (1963), it was held that the payment by the taxpayer's employer of the real estate*203 sales commission on the sale of his residence when moving to accept a new job at a different location, was taxable as compensation to the employee.The Bradley and Ferebee cases concerned new employees, while Schairer had been an employee for several years. In Ernest A. Pederson, Jr., 46 T.C. 155">46 T.C. 155 (1966), a case involving an old employee, the Court held that an amount paid by the employer in reimbursement of the expenses of selling the employee's residence upon being transferred for the convenience of the employer constituted taxable income to the employee. See, to the same effect, Harvey v. Commissioner, F. 2d (C.A. 6, Oct. 21, 1968), affirming a Memorandum Opinion of this Court, a case also involving an old employee, whose employer paid him for a part of the loss sustained on the sale of his residence below its cost to him, as a result of a transfer to a new location. This was held to be includable in the employee's gross income.In Jesse S. Rinehart, 18 T.C. 672">18 T.C. 672 (1952), it was held that an amount paid an employee to assist him in purchasing a new residence following a transfer at the instance *204 of his employer, was taxable as compensation for services.The amounts paid to the employee in such cases, and in the present cases, are not part of the "amounts realized" upon the sale. They are not paid by the purchaser. The employer does not purchase the house. The payments are not made pursuant to the sales contract, but pursuant to the employment contract. They are made to secure better services from the employee by relieving him of concern over the sale. Payments to secure better services represent compensation. Commissioner v. LoBue, 351 U.S. 243">351 U.S. 243, 247 (1956).The petitioners' contention that these payments are not taxable because of the application of section 1034, 1 providing for nonrecognition of gain on the sale of a taxpayer's residence under certain circumstances, depends upon whether the payments under the home guaranty policy were a part of the "amount realized" upon the sale, thereby being a part of the gain subject to nonrecognition under that section. Since we hold that these payments were not a part of the "amount realized" upon the sale, the petitioners' contention is without merit.*205 In the sale of the Simpson's house in Darien, the petitioners received a net selling price in excess of their adjusted basis in the property. *850 Nonrecognition of their gain was allowed because they purchased another residence in the same year for a greater price. In the sales of the Simpson's house in Los Angeles and the Lull's home in Honolulu the net selling prices were less than the adjusted cost basis of each property, and each of the petitioners had a loss. Such losses upon sale of a residence are personal and nondeductible. Income Tax Regs., sec. 1.165-9(a).We conclude that the amounts received by petitioners pursuant to the home guaranty policy are taxable as compensation.The Lulls incurred certain expenses in house hunting and for temporary quarters and meals while awaiting availability for occupancy of the new residence. The Simpsons made various trips for house hunting and incurred expenses for altering carpets and drapes to fit the new residences. These expenses were included among the items reimbursed by IBM. Such expenses have been held to be personal and living expenses, reimbursement of which represents additional compensation to the employee. England v. United States, 345 F. 2d 414*206 (C.A. 7, (1965); Light v. Commissioner, 310 F. 2d 716 (C.A. 5, 1962), affirming a Memorandum Opinion of this Court.Petitioners cite and rely upon Homer H. Starr, 46 T.C. 743 (1966), in which this Court held that an amount received by an employee in reimbursement of expenses incidental to his transfer at the behest of his employer did not constitute taxable income to him. The reimbursement was for Starr's meals, lodging, and incidental expenses at the new location prior to the arrival of his family.The decision of this Court in Starr was reversed by the Court of Appeals for the Tenth Circuit, Commissioner v. Starr, 399 F. 2d 675 (1968), which held that the reimbursement of the expenses in question was income to the employee and that the temporary living expenses were not deductible business expenses. The Court followed its earlier opinion in United States v. Woodall, 255 F. 2d 370 (C.A. 10, 1958). The Woodall case was likewise followed by the Ninth Circuit Court of Appeals in Koons v. United States, 315 F. 2d 542 (1963).*207 The decision of the Court of Appeals in Commissioner v. Starr, supra, was followed by this Court in Norvel Jeff McLellan, 51 T.C. 462">51 T.C. 462.Ritter v. United States, 393 F. 2d 823 (Ct. Cl. 1968), certiorari denied 393 U.S. 844">393 U.S. 844, involved facts substantially similar to those involved in the present Lull and Simpson cases. Riter was likewise an employe of IBM. He was transferred from San Francisco to Los Angeles in 1958 and received reimbursements from IBM under the same company policies as are involved in the present cases, for moving and related expenses, and for the loss on the sale of his residence in the San Francisco area. The Court of Claims held that the reimbursed amounts in dispute were includable as ordinary income and *851 that the "indirect" expenses were not deductible by the taxpayer as ordinary and necessary business expenses. We think similar conclusions are required in the present cases.We hold that the reimbursements and advances in question are taxable as additional compensation to the petitioners and that they are not entitled to deductions*208 for the corresponding expenses.Decisions will be entered under Rule 50. DAWSON (In Part) Dawson, J., dissenting in part: I am in agreement with the majority's holding which includes in gross income the difference between the selling prices of petitioners' residences and their appraised values. However, I disagree with the majority opinion insofar as it holds that reimbursement for incidental and reasonable moving expenses should be taxable to petitioners. The reasons for this view are succinctly stated in Judge Simpson's concurring opinion in Norvel Jeff McLellan, 51 T.C. 462">51 T.C. 462 (1968). I do not regard the opinion of the Court of Appeals for the Ninth Circuit in Koons v. United States, 315 F.2d 542">315 F. 2d 542, as controlling in this case. Footnotes1. SEC. 1034. SALE OR EXCHANGE OF RESIDENCE.(a) Nonrecognition of Gain. -- If property (in this section called "old residence") used by the taxpayer as his principal residence is sold by him after December 31, 1953, and, within a period beginning 1 year before the date of such sale and ending 1 year after such date, property (in this section called "new residence") is purchased and used by the taxpayer as his principal residence, gain (if any) from such sale shall be recognized only to the extent that the taxpayer's adjusted sales price (as defined in subsection (b)) of the old residence exceeds the taxpayer's cost of purchasing the new residence.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624858/ | HARRY H. MITCHELL AND JUNE H. MITCHELL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMitchell v. CommissionerDocket No. 31051-87United States Tax CourtT.C. Memo 1990-617; 1990 Tax Ct. Memo LEXIS 692; 60 T.C.M. (CCH) 1368; T.C.M. (RIA) 90617; December 6, 1990, Filed *692 Decision will be entered under Rule 155. Bruce I. Hochman, Jerome A. Busch and Harry H. Mitchell, for the petitioners. Charles O. Cobb and Richard Stack, for the respondent. WRIGHT, Judge. WRIGHT*1985 MEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined the following deficiencies in petitioners' Federal income tax: Additions to TaxYearDeficiencySec. 6653(a) 11973$ 33,577$ 1,679197426,3371,317197510,146-- 1976109,383-- 19774,193-- 197825,831-- 198016,244-- *695 After concessions by both parties, the remaining issues for decision are: (1) whether petitioners are entitled to a business expense deduction in taxable year 1973 for a portion of the purchase price of a stock warrant; (2) whether petitioners must recognize income as determined by respondent in taxable year 1976 due to the exchange of such warrant for stock; (3) whether amounts received by petitioner Harry H. Mitchell in taxable year 1980 in connection with the settlement of litigation are excludable from gross income under section 104(a)(2); (4) whether the Leslie Investment Company, which is owned by petitioners and their children, is entitled to carry back a net operating loss incurred in taxable year 1981, a year in which the company was a subchapter C corporation, to taxable year 1980, a year in which the corporation was a subchapter S corporation. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and the accompanying exhibits are incorporated herein. I. Warrant IssuesPetitioners resided in Palm Desert, California, when they filed their petition. In 1970, petitioner became the chief executive officer,*696 and, in 1971, chairman of the board of directors, of the California Life Corporation (hereinafter referred to as CLC) and the California Life Insurance Company (hereinafter referred to as CLIC). CLIC was CLC's principal operating subsidiary. The outstanding stock of CLC was listed on the American Stock Exchange. There were approximately 1,000,000 shares of its common stock outstanding from January of 1973 through May of 1976. In June of 1972, CLC acquired individual and group life insurance (hereinafter referred to as the ITT Hamilton insurance) in the face amount of $ 9,380,000 from ITT Hamilton Life Insurance Company of St. Louis (hereinafter referred to as "ITT Hamilton") for $ 9,336,001. A cash payment of $ 600,210 was made to ITT Hamilton by CLC in June. The remainder of the purchase price was discharged through long-term borrowings of $ 5,000,000 and execution of a short-term note payable to ITT Hamilton for $ 3,735,791. The short-term note was due on December 31, 1972, but was extended at the request of CLC to March 31, 1973. ITT Hamilton informed CLC that no further extensions should be expected. CLC would risk losing the ITT Hamilton insurance if external financing*697 was not arranged with which to repay the ITT Hamilton note by March 31, 1973. As a result, CLC intensified discussions with institutional investors and lenders, seeking an investment or loan large enough to pay off the note due to ITT Hamilton. However, *1986 the investors and banks contacted by CLC felt that some kind of personal investment in CLC by petitioner was necessary before they would consider a loan. The investors and banks considered it critical to assure ongoing, professional management of CLC's insurance operations before committing funds to CLC. An employment contract and related restricted stock options were not regarded as sufficient to bind petitioner to CLC. A. Issuance of the WarrantOn February 16, 1973, CLC offered petitioner a warrant (hereinafter referred to as the warrant) to purchase 90,000 shares of CLC common stock for $ 8 per share, such warrant to be exercisable for 10 years from the date of its issuance. The purchase price for the warrant, $ 103,500, was paid by petitioner from his own funds on March 27, 1973. The warrant required that it and shares received upon its exercise be stamped or otherwise imprinted with a legend substantially in the*698 following form: Neither this warrant nor the shares of Common Stock issuable upon exercise of the warrant have been registered under the Securities Act of 1933, and thus cannot be exercised, sold or transferred, and the shares of Common Stock issuable upon exercise of this warrant cannot be sold or transferred, unless they are so registered or unless an exemption is then available.The warrant also contained anti-dilution provisions. In the case of issuance by CLC of additional common stock or securities convertible into common shares for a price less than the exercise price of the warrant or the stock exchange price of the stock, adjustments to the warrant would be made reducing the purchase price of the shares subject to the warrant and increasing the number of shares available for purchase. On CLC's 1973 financial statement, the $ 103,500 paid by petitioner for the warrant was credited to paid-in capital. Warrants to purchase CLC stock such as the one issued to petitioner were not actively traded on an established market during the years at issue.The reasons for the issuance of the warrant to petitioner were described in a 1976 proxy statement of CLC as follows: *699 At the time of the refinancing the Board of Directors determined that in order to assimilate the business obtained from ITT Hamilton and continue the restructuring of the Company began in 1971, it was vital that Mitchell continue to serve as the Chief Executive Officer of the Company, and that this would best be accomplished by his expectation of becoming a substantial equity holder in the relatively near future. In addition, the Company's outside financial advisors, and potential investors approached with respect to the refinancing, were reluctant to finance or invest in the Company unless it was apparent that Mitchell's continued association was, as far as possible, assured by his ownership of a substantial equity-type interest in the Company.The balance of the purchase price of the ITT Hamilton insurance was refinanced in February of 1973. Part of the funds came from the sale by CLC of one of its subsidiaries. The rest ($6,750,000) was borrowed from the Wells Fargo Bank on February 16, 1973. During 1972, closing prices on the American Stock Exchange for the stock of CLC ranged from a high of $ 3.50, to a low of $ 1.50. In December of 1972 there was a reverse*700 split of 1-for-5. The price of the stock immediately rose to $ 11 per share and a few public sales were recorded at a high of $ 11.50. During February and March of 1973, closing prices for the stock of CLC ranged from $ 8.75 to $ 7.12. On February 16, 1973, the day petitioner was offered the warrant, the closing price of CLC stock was $ 8.50. On March 27, 1973, the day petitioner purchased the warrant, the closing price was $ 7.50. Over the succeeding years the price of CLC stock declined. During this period the high and low closing prices for CLC stock were as follows: YearHighLow19739-3/8th2-1/4th19744-1/2th1-7/8th19753-5/8th2-3/8th197652-5/8thB. Exchange of the WarrantAs of February 13, 1976 the warrant had not been exercised in whole or in part. On February 13, 1976, petitioner and CLC entered into an agreement to exchange the warrant for 90,000 shares of unregistered CLC common stock. The proposed transaction was set for approval at a meeting of shareholders scheduled for May 21, 1976. The proxy statement issued by the board of directors for this meeting summarized the reasons for the exchange as follows: *701 the Board of Directors believes that the Company has made substantial progress in implementing the program of restructuring and development begun in 1971. It believes that this progress is largely attributable to the efforts of Harry H. Mitchell ("Mitchell"), who became a director and the Chief Executive Officer of the Company in 1970 and Chairman of the Board of Directors in 1971. Furthermore, the Board continues to believe that it is in the best interest of the Company to be assured, insofar as possible, that Mitchell devote his efforts to the Company's program of growth and development. In 1973, the Board of Directors determined that this assurance could best be secured by providing *1987 Mitchell with an immediate and substantial equity interest in the Company. However, the Warrant to purchase up to 90,000 shares of the Company's Common Stock (a copy of which is attached as Exhibit C to this Proxy Statement) issued to Mitchell in 1973 for a cash price of $ 103,500 as the vehicle to effect this equity position has proven, in view of the Board, to be an unsuitable method of providing this interest. This unsuitability arises because, among other things, the unforeseen depression*702 in the market price of the Company's Common Stock has (1) made its exercise in the relatively near future most unlikely, and (2) brought into consideration anti-dilution provisions which pose a substantial problem for the Company in light of its announced policy of aggressive expansion through appropriate acquisitions and external growth. Therefore, on February 13, 1976, the Company agreed with Mitchell, subject to approval by the shareholders as described in this Proxy Statement (1) to cancel the Warrant to purchase 90,000 shares of the Company's Common Stock and all of the rights pertaining thereto (including all anti-dilution and registration rights relating to future issuance of securities, as described below), and (2) in consideration therefor and in order to provide Mitchell with a more appropriate and immediate equity interest in the Company, to issue to him 90,000 shares of the Company's Common Stock (before adjustment for the 4-for-3 stock split described above). The proposed exchange was approved and took place on May 21, 1976. Immediately after the transaction, CLC's common stock was split 4-for-3, so that petitioner held 120,000 shares. During the first*703 three months of 1976, the closing price of CLC stock on the American Stock Exchange ranged from $ 2.75 to $ 5.00. On May 21, 1976, the date the exchange was approved and took place, the average price of the common stock of CLC on the American Stock Exchange was $ 4.375. The value of the 90,000 shares of stock received by petitioner on May 21, 1976, was $ 393,750, not taking into account its lack of registration, and $ 287,437.50, taking into account its lack of registration. Petitioners did not report any gain in connection with the acquisition or disposition of the warrant on their 1973 or 1976 Federal income tax returns. CLC and CLIC earnings declined after 1977 and there were increasing losses through 1982. In 1983, CLC was merged into a company owned by a third party. The common shareholders of CLC, including petitioner, received $ 0.35 per share in the merger. In 1986 the California Insurance Department took possession of CLIC under its statutory powers on the ground that CLIC was insolvent. II. Exclusion From Gross Income Under Section 104(a)(2)On April 21, 1978, petitioner entered into a new employment agreement with CLC and CLIC. The agreement provided*704 for salary payments in an amount of not less than $ 125,000 per year for a term of 7 years. The agreement also provided for additional compensation of $ 12,500 per year for a period of 20 years, payable to petitioner or his beneficiary. Under the terms of the agreement, petitioner's employment could be terminated on breach by petitioner of his obligations. On May 12, 1979, following a dispute regarding CLC's 1978 financial statement and Form 10K, the board of directors removed petitioner from his position as chief executive officer of CLC. On May 19, 1979, he was removed from his position as chief executive officer of CLIC. Six weeks later, he was removed from his position as chairman of the board of directors. CLC and CLIC ceased paying petitioner his salary under his employment agreement on June 30, 1979. In 1979, a stockholders' suit was filed against CLC, CLIC, and various corporate officers, including petitioner, alleging securities act violations, conspiracy to falsify financial records, and breach of contract. The lawsuits were consolidated into an action before the United States District Court for the Central District of California titled In Re California Life Securities*705 Litigation, Multi District Litigation No. 400. The consolidated action was commonly referred to as the "MDL No. 400 litigation." On November 13, 1979, petitioner filed an action in the Superior Court of the State of California for the County of Los Angeles, titled Mitchell v. California Life Corporation, No. C304161, requesting declaratory relief as to his rights under the 1978 employment agreement. On June 18, 1980, petitioner filed an action in the Superior Court titled Mitchell v. California Life Corporation, No. C 326694, accusing CLC, its board of directors, and certain employees and directors of CLC, of libel, slander, and conspiracy. The action was never served on any of the named defendants. The board of directors of CLC never discussed the action, and CLC's chief executive officer considered it frivolous. On September 12, 1980, petitioner met with Timothy F. Kennedy, who was counsel for CLC. The meeting was for the purpose of entering into negotiations for the settlement of outstanding lawsuits between Mitchell and CLC. At the meeting petitioner delivered to Kennedy a document titled "Principles of Settlement" which stated that petitioner would settle*706 all claims and litigation with CLC and CLIC provided they accepted all of the principles. The Principles of Settlement provides that "of the three payments of $ 50,000 mentioned in paragraph 1, $ 100,000 *1988 will be deemed to be in settlement of employee's lawsuit against CLC, CLIC and various officers and directors for compensatory damages for slander and libel * * *." The Principles of Settlement was not signed by Kennedy or any of CLC's officers, and was not approved by its board of directors. By letter dated September 15, 1980, Kennedy notified petitioner that the Principles of Settlement for settling all claims between petitioner and CLC was acceptable to CLC, but that petitioner must become a settling defendant in the MDL 400 litigation and must also cooperate with CLC in any pending or future litigation. The letter does not specifically address the libel and slander action. On September 15, 1980, petitioner appeared before the United States District Court for the Central District of California and notified the court that he would become a settling defendant in the MDL 400 litigation. On September 22, 1980, petitioner and CLC executed a settlement agreement. The settlement*707 agreement consisted of several documents, including a Memorandum of Understanding, a Revised Restricted Stock Agreement, a Release, and an Amended Employment Agreement. The libel and slander action was not a consideration of CLC in executing the settlement agreement.The Memorandum of Understanding referred to the other documents and provided, among other things, that all pending litigation between the parties would be dismissed with prejudice. The only exception was the Superior Court action brought by petitioner with respect to his employment agreement. The Memorandum of Understanding provided that with respect to this action dismissal with prejudice would not be entered until the parties fully performed their respective obligations under the Memorandum of Understanding, the Revised Restricted Stock Agreement, and the Amended Employment Agreement.Paragraph 1 of the Amended Employment Agreement provided that the 1978 Employment Agreement between petitioner and CLC would be cancelled. Paragraph 2 provided, among other things, that petitioner would agree to act as a consultant to the company. Paragraph 3 of the Amended Employment Agreement provided as follows: Unless the*708 Agreement shall be terminated by the Company by reason of a Termination Event, as such term is defined in Section 4 below, Mitchell shall receive total compensation hereunder of $ 192,511, payable as follows: (a) on September 30, 1980, the sum of $ 50,511; (b) on December 1, 1980, the sum of $ 50,000; (c) on June 30, 1981, the sum of $ 50,000; and (d) in addition to the forgoing, on the first day of each month commencing the first day of January 1, 1981, and continuing to and including February 1, 1982, the sum of $ 3,000. The payments referred to in subparagraph (b) and (c) above shall be deemed due on September 30, 1980, but at the election of the Company may be deferred, without payment of interest, to the dates set forth above. Such payments represent a full discharge of such payments owing to Mitchell under the Original Employment Agreement. The agreement was terminable on a variety of grounds, including breach by petitioner of any part of the settlement agreement.The libel, slander, and conspiracy action was dismissed by petitioner with prejudice on October 1, 1980. The declaratory relief action relating to petitioner's employment agreement was dismissed without*709 prejudice on the same date. The first two payments called for by the Amended Employment Agreement were made to petitioner before the end of 1980. CLC and CLIC issued petitioner a Form W-2 reflecting the full $ 100,511 in payments as "wages, tips, or other compensation." Federal income tax and FICA tax were withheld. Petitioner reported the payment of $ 50,511 as wage income on his 1980 Federal tax return. 2 The remaining payment of $ 50,000 was excluded from income. The third payment of $ 50,000 due to petitioner on or before June 30, 1981, was never made. In April of 1981, CLC informed petitioner that he was in default, and that CLC was terminating the agreement. On August 13, 1981, petitioner filed an action in the Superior Court titled Mitchell v. Monge*710 , No. C 378525, in which he alleged breach of the Amended Employment Agreement. In the pleadings and motions filed by petitioner in the Mitchell v. Monge action, petitioner described the Amended Employment Agreement and negotiations leading up to the Amended Employment Agreement as follows: The said $ 50,000 payment is to be made in partial discharge of payments owing the plaintiff under the original Employment Agreement of April 21, 1978 * * * The Agreement of September 22, 1980, was an employment agreement between plaintiff, on the one hand and CLC and CLIC (severally), on the other hand, and each of them. *1989 In return for signing such an agreement, Mitchell would receive in full settlement of the six-year period remaining on his employment contract (from mid 1979 to mid 1985), the sum of $ 150,000, payable in installments over a nine-months period, and $ 3,000 per month as an employee/consultant of CLC.III. Net Operating Loss Carry BackLeslie Investment Corporation (Leslie) was a corporation formed by petitioner in 1980. During 1980 and 1981, the stock of Leslie was owned 98.7 percent by petitioners and 1.3 percent by their minor children. The assets*711 of the corporation consisted of real property, a proprietary lease, and a limited partnership interest in a dairy operation. In 1980, Leslie was an electing small business corporation under subchapter S. In 1981, Leslie revoked its subchapter S election and became a subchapter C corporation. The Form 1120 filed by Leslie for that year reported a loss of $ 12,320.In an amended return for 1980, petitioners sought to carry back the 1981 net operating loss of Leslie to Leslie's 1980 taxable year, and to pass through its share of the loss to petitioners' 1980 Federal income tax return. OPINION I. Business Expense DeductionSection 162(a) provides that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Petitioner argues that the purchase of the warrant in 1973 for $ 103,500 was an ordinary and necessary business expense under section 162(a) incurred in carrying on his trade or business of being an employee, entitling petitioner to a deduction to be measured by the amount*712 of the premium over market value paid for the warrant. Respondent argues that: (1) petitioner has failed to prove that he paid a premium for the warrant; (2) petitioner has failed to prove that any such premium would be an ordinary and necessary business expense; and (3) the purchase of the warrant was a non-deductible capital expenditure for which any loss must be claimed upon realization. A. Fair Market Value of the WarrantWe conclude that petitioner did not pay a premium over fair market value for the warrant. Petitioner's expert witness, Robert F. Howard, testified and submitted an appraisal report concluding that the value of the warrant as of March 27, 1973, was $ 30,000. Respondent contends that the warrant was worth at least $ 103,500, its purchase price. In valuing the warrant, Howard relied primarily on the future anticipated performance of CLC's common stock. He reasoned that "To attempt to value the Warrant by relating it to the then market price of the Company's common stock or by comparing the ratio of publicly traded warrants to their respective stock prices and relating back to the Company, is not, in our opinion applicable in this particular case. *713 " Howard began with an estimated midpoint of CLC's common stock of $ 4.76 - $ 4.96 per share as of December 31, 1973, and then estimated the future performance of the stock over the next ten years. From these estimates Howard estimated the value of the warrant itself. Howard also took into account his opinion that CLC was "on the verge of bankruptcy." We find Howard's testimony and appraisal unpersuasive due to his failure to take into account the fact that on the day petitioner was offered the warrant the closing price of CLC stock was $ 8.50, and on the date he purchased the warrant the closing price was $ 7.50. During 1973, the highest closing price of CLC stock was $ 9.38. As respondent's expert, Herbert T. Spiro, testified, an investor considering the purchase of the warrant would have taken into account the current and recent values of CLC common stock in valuing the warrant. Had Howard done so, we feel he would have arrived at a much higher fair market value for the warrant. Because of Howard's failure to do so, we reject his estimate of the warrant's fair market value. We also reject Howard's contention that, at the time petitioner purchased the warrant, CLC was*714 on the brink of bankruptcy because of its inability to finance the ITT Hamilton insurance purchase. Specifically, Howard argues that because CLC may have been unable to satisfy the short-term note due ITT Hamilton on March 31, 1973, the future of the company, as well as the value of the warrant, were in doubt. However, we note that petitioner was offered the warrant on February 16, 1973, and the purchase was closed on March 27, 1973. On February 16, 1973, CLC borrowed $ 6,750,000 from Wells Fargo Bank. Thus, at the time petitioner was offered the warrant, as well as when he actually purchased it, CLC had already secured funds to satisfy the short term note due ITT Hamilton on March 31, 1973. Because we have found that Howard's testimony and appraisal report lacks credibility, petitioner has failed to prove that he paid a premium for the warrant. We therefore reject his argument that any such premium is deductible as an ordinary and necessary business expense. B. Ordinary and Necessary Business ExpenseHowever, even if petitioner had paid a premium for the warrant, we reject petitioner's argument that any premium which he may have paid for the warrant was an ordinary*715 and necessary business expense under section 162. While he has established that it was beneficial to CLC, *1990 and to himself as its chief executive officer, that he have an equity interest in the company, he has not established that it was ordinary and necessary for him to pay a premium for such equity interest. C. Nondeductible Capital ExpenditureFinally, we conclude that the purchase of the warrant was a nondeductible capital expenditure. When a capital expenditure is incurred, to the extent that a deduction is allowable, the cost of the expenditure must be recouped under the provisions which permit deduction for amortization, depreciation, depletion, or loss, rather than under section 162(a). See Howard v. Commissioner, 39 T.C. 833">39 T.C. 833 (1963); Clark Thread Co. v. Commissioner, 28 B.T.A. 1128">28 B.T.A. 1128, affd. 100 F.2d 257">100 F.2d 257 (3d Cir. 1938); W. B. Harbeson Co. v. Commissioner, 24 B.T.A. 542">24 B.T.A. 542 (1931). Generally the purchase of stock is to be considered a capital transaction under section 263 for which no deduction is allowable under*716 section 162(a). Harder Services, Inc. v. Commissioner, 67 T.C. 585">67 T.C. 585 (1976), affd. without opinion 573 F.2d 1290">573 F.2d 1290 (2nd Cir. 1977). Petitioner contends, however, that an exception to the general rule exists where the acquisition of the corporation's stock is made necessary in order to assure the corporation's continued existence, citing Five Star Manufacturing Co. v. Commissioner, 355 F.2d 724">355 F.2d 724 (5th Cir. 1966), revg. 40 T.C. 379">40 T.C. 379 (1963). In Five Star Manufacturing Co. v. Commissioner the taxpayer corporation, whose central income producing asset was its license to manufacture and sell an article under a patent held by a third party, found itself in a situation where the patent holder had cancelled the license to the taxpayer, and had attached, through court proceedings, two-thirds of its inventory of finished goods. The corporation had no working capital and no credit. The patent holder would consent to renew the license and release his hold on the corporate assets only if one of the two shareholders was eliminated from any interest in the corporation. The taxpayer therefore purchased the stock of one shareholder*717 and it survived and continued in business. Under these circumstances, the Court of Appeals for the Fifth Circuit concluded that the corporation's expenditures in buying the stock of the shareholder should be considered as ordinary and necessary and deductible under section 162(a), since without such purchase the corporation would have been put out of business. The Fifth Circuit Court of Appeals, author of Five Star Manufacturing Co. v. Commissioner, has limited that case to its own facts and to those extraordinary situations where the purchasing corporation was faced with extinction absent the purchase in question. In Jim Walter Corp. v. United States, 498 F.2d 631">498 F.2d 631, 639 (5th Cir. 1974), the Fifth Circuit held that Five Star Manufacturing Co. did not establish a general principle that a primary business purpose can convert into a deductible expense an expenditure which is a capital transaction in nature and origin. This Court has followed the rationale of Jim Walter Corp v. United States, supra. In Harder Services, Inc. v. Commissioner, supra, the taxpayer corporation repurchased an employee's stock as*718 part of terminating his employment, all of which was done in order to extricate the taxpayer from an unfavorable financial and management situation. The taxpayer, relying on Five Star Manufacturing Co., claimed the right to an ordinary deduction under section 162(a) with respect to the amounts paid to redeem its stock. We refused to extend the authority of Five Star Manufacturing Co. beyond the extreme situation where corporate survival is at stake, and held that the expenditure was capital in nature. Petitioner was in the trade or business of being an employee. Primuth v. Commissioner, 54 T.C. 374">54 T.C. 374, 377 (1970). To be entitled to a trade or business deduction, he must show that his payment of a corporate expense was made to protect his own separate trade or business. Petitioner must also show that his survival as an employee of CLC was at stake. Centel Communications Co. v. Commissioner, 92 T.C. 612">92 T.C. 612, 636 (1989). We conclude that petitioner has failed to establish that he purchased the warrant because his survival as an employee of CLC was at*719 stake. While his investment in CLC was instrumental in obtaining financing for the ITT Hamilton insurance purchase, and was therefore beneficial to both CLC and to petitioner as its employee, petitioner introduced no evidence that such an investment was a precondition to his continued employment by CLC. We therefore hold that Five Star Manufacturing Co. is inapplicable to the instant case, and that the purchase of the warrant was a nondeductible capital expenditure. II. Recognition of Gain on Transfer of the Warrant for Stock Pursuant to Section 83(a)Respondent determined that petitioner must recognize gain on the transfer of the warrant for CLC stock in an amount equal to the difference between the fair market value of the stock on the date of transfer and the purchase price of the warrant. Respondent's determination that petitioner must recognize gain of the transfer of the warrant for CLC stock is based on his argument that section 1.83-7, Income Tax Regs., applies to the purchase of the warrant, resulting in section 83(a) applying to the transfer of the warrant for stock. Petitioner argues that there was no transfer "in connection*720 with the performance *1991 of services," and section 83(a) is therefore inapplicable. Section 83(a) provides that if, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of the fair market value of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over the amount, if any, paid for such property, shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable. A transfer of property occurs for purposes of section 83 when an employee acquires the beneficial ownership interest in such property. Sec. 1.83-3(a)(1), Income Tax Regs.*721 A "restriction which by its terms will never lapse" (also referred to as a "non-lapse restriction") is a permanent limitation on the transferability of property which: (1) will require the transferee of the property to sell, or offer to sell, such property at a price determined under a formula; and (2) will continue to apply to and be enforced against the transferee or any subsequent holder. Section 1.83-3(h), Income Tax Regs. A limitation subjecting the property to a permanent right of first refusal in a particular person at a price determined under a formula is a permanent nonlapse restriction. Limitations imposed by registration requirements of State or Federal security laws or similar laws imposed with respect to sales or other dispositions of stock or securities are not nonlapse restrictions. Sec. 1.83-3(h), Income Tax Regs. Thus, such limitations are not taken into account in determining the fair market value of the property received. A. Transfer in Connection with the Performance of Services*722 Section 83 applies only where property is transferred in connection with the performance of services. For purposes of section 83, a transfer in "recognition of" the performance of services is synonymous with a transfer in "connection with" the performance of services. Sec. 1.83-3(f), Income Tax Regs. Petitioner argues that the purchase of the warrant was made solely for investment purposes, and was therefore unconnected with the performance of services to CLC. Respondent contends that the transfer was made for the purpose of insuring the continued performance of petitioner's services as chief executive officer of CLC, and that therefore the warrant was transferred in connection with the performance of services. Whether property is transferred in connection with services is a question of fact. Bagley v. Commissioner, 806 F.2d 169 (8th Cir. 1986), affg. 85 T.C. 663">85 T.C. 663 (1985). The transfer*723 of property is subject to section 83 whether such transfer is in respect of past, present, or future services. Sec. 1.83-3(f), Income Tax Regs. In addition, where property is transferred in connection with services, section 83 is applicable even though the property was purchased at its fair market value at the date of purchase. Alves v. Commissioner, 734 F.2d 478 (9th Cir. 1984), affg. 79 T.C. 864">79 T.C. 864 (1982). We conclude that in the instant case the warrant was transferred in connection with the performance of services. As the proxy statement explaining the issuance of the warrant makes clear, the warrant was transferred to petitioner in order to assure his continuing services as chief executive officer of CLC. Therefore, the transfer was made in anticipation of future services by petitioner to CLC. B. Applicability of Section 83 to a Stock WarrantWith respect to stock options, the regulations provide that if there is granted to an employee in connection with the performance of services an option to which section 421 (relating*724 generally to certain qualified and other options) does not apply, section 83(a) shall apply to such grant if the option has a readily ascertainable fair market value, determined in accordance with the regulations, at the time the option is granted. Sec. 1.83-7(a), Income Tax Regs. For purposes of the regulation, a stock warrant is an option. Pagel, Inc. v. Commissioner, 91 T.C. 200">91 T.C. 200, 205 (1988). Section 421 does not apply to the warrant purchased by petitioner, and it is therefore governed by section 83(a).Where a stock option is governed by section 83, the person who performed the services realizes compensation upon such grant at the time and in the amount determined under section 83(a). Sec. 1.83-7(a), Income Tax Regs. For options that do not have a readily ascertainable fair market value at the time of grant, the regulations contemplate that the compensation element of the transaction will be held open until the option is exercised or disposed of. If the option is exercised, section 83(a) applies to the transfer*725 of property pursuant to such exercise, and the employee realizes compensation upon such transfer at the time and in the amount determined under section 83(a). If the option is sold or otherwise disposed of in an arm's-length transaction, section 83(a) applies to the transfer of money or other property received in the same manner as it would have applied to the transfer of property pursuant to an exercise of the option. Sec. 1.83-7(a), Income Tax Regs. In order to determine the tax consequences of the *1992 exchange of the warrant for stock, we must first determine whether the warrant had a readily ascertainable fair market value at the time of grant. C. Readily Ascertainable Fair Market ValueOptions have a value at the time they are granted, but that value is ordinarily not readily ascertainable unless the option is actively traded on an established market. Section 1.83-7(b)(1), Income Tax Regs. In the instant case the warrant was not actively traded on an established market. *726 If an option is not actively traded on an established market, the option does not have a readily ascertainable fair market value when granted unless the taxpayer can show that all of the following conditions exist: (1) the option is transferable by the optionee; (2) the option is exercisable immediately in full by the optionee; (3) the option or the property subject to the option is not subject to any restriction or condition (other than a lien or other condition to secure the payment of the purchase price) which has a significant effect upon the fair market value of the option; and (4) the fair market value of the "option privilege" is readily ascertainable in accordance with section 1.83-7(b)(3), Income Tax Regs.Sec. 1.83-7(b)(2), Income Tax Regs.We find that petitioner has failed to establish the fourth condition, that the fair market value of the "option privilege" is readily ascertainable. The "option privilege" in the case of an option to buy is the opportunity to benefit during the option's exercise period from any*727 increase in the value of property subject to the option during such period, without risking any capital. Sec. 1.83-7(b)(2), Income Tax Regs.In determining whether the value of the option privilege is readily ascertainable, and in determining the amount of such value when such value is readily ascertainable, it is necessary to consider: (1) whether the value of the property subject to the option can be ascertained; (2) the probability of any ascertainable value of such property increasing or decreasing; and (3) the length of the period during which the option can be exercised. Section 1.83-7(b)(3), Income Tax Regs.In Morrison v. Commissioner, 59 T.C. 248">59 T.C. 248, 260 (1972), this Court held that the option privilege of the warrants before us did had a readily ascertainable value. In so holding, we emphasized the fact that the warrants provided for the receipt of valuable stock by payment of a nominal sum, leading to the conclusion that the warrants, although they had three year terms, would*728 be exercised immediately. In Frank v. Commissioner, 54 T.C. 75">54 T.C. 75, 89-94 (1970), affd. 447 F.2d 552">447 F.2d 552 (7th Cir. 1971), this Court held that the option privilege of the warrant before us did not have a readily ascertainable value. In so holding, we noted the uncertainty in measuring the future prospects for success of the company to which the warrant related. Morrison v. Commissioner is distinguishable from the instant case because the sum which was payable by petitioner for stock of CLC was not nominal. The instant case, we conclude, is comparable to Frank v. Commissioner, in that there existed a great deal of uncertainty in measuring the future prospects for success by CLC. We therefore find that the value of the option privilege was not ascertainable, and as a result the warrant did not have a readily ascertainable fair market value at the time it was granted. Because the warrant did not have a readily ascertainable fair market value at the time it was granted, the compensation element of the transaction is held open until the warrant is disposed of. In the instant case, the warrant was disposed of when it was exchanged for 90,000 shares*729 of CLC stock. We must therefore apply section 83(a) to the transfer of the CLC stock for the warrant. D. Amount of Income Recognized Under Section 83(a)1. Arm's-Length TransactionAs a preliminary matter we reject petitioner's contention that the exchange of the warrant for stock was not an arm's length transaction, and that section 1.83-7(a), Income Tax Regs., is therefore inapplicable. Because the exchange was approved by the shareholders of CLC, we find that it was conducted at arm's length. 2. "Amount Paid" for CLC StockThe term "amount paid" refers to the value of any money or property paid for the transfer of property to which section 83 applies. When section 83 applies to the transfer of property pursuant to the exercise of an option, the term "amount paid" refers to any amount paid for the grant of the option plus any amount paid as the exercise of the option. Sec. 1.83-3(g), Income Tax Regs. In the instant case the warrant was not exercised, and therefore the "amount paid" is the $ 103,500 which petitioner*730 paid for the warrant. 3. Fair Market Value of CLC StockIn order to determine the amount of income which petitioner must recognize under section 83(a), we must determine the fair market value of the 90,000 shares of CLC stock on the date of the exchange. Both parties introduced the testimony *1993 and reports of expert witnesses with respect to such fair market value. As a preliminary matter, we note that limitations imposed by registration requirements of State or Federal security laws or similar laws imposed with respect to sales or other dispositions of stock are not non-lapse restrictions, and therefore such limitations are not taken into account in determining the fair market value of the property received for the warrant. However, in his notice of deficiency respondent reduced the fair market value of the CLC stock 27 percent on account of its lack of registration, which in turn reduced the amount of gain which, according to respondent, petitioner must recognize. Respondent did not argue for a larger fair market value, and therefore a larger deficiency, at trial or in brief. a. Petitioner's ExpertPetitioner's expert witness, Robert F. Howard, began his analysis*731 of the value of the 90,000 shares of CLC stock received in the exchange with the market value of the shares as of May 21, 1976, or $ 393,750 ($ 4.375 per share). Howard then applied three separate discounts in determining that the fair market value of the restricted stock as of May 21, 1976, was $ 22,500 ($ 0.25 per share). Howard first determined that an appropriate discount for lack of marketability of the shares is 35 percent. Such a discount is necessary, Howard concluded, because the shares are not registered. In computing the appropriate discount for lack of marketability, Howard relied in large part on previous opinions of this Court in which we had found a discount for lack of registration to be appropriate. Howard determined the average discount in these cases and used such average in determining the appropriate discount in the instant case. The cases on which Howard relies date as far back as 1942. Howard next determined a blockage discount. Because the share block is substantial relative to the number of shares traded, Howard reasons, an attempt to sell the shares would tend to flood the market and to depress the market price of the shares. Based on his experience*732 in dealing with investment bankers and market makers, Howard arrived at a blockage discount of 10 percent.Finally, Howard determined that a discount for alienability is appropriate. This discount is not attributable to a restriction on the share block, Howard reasons, but is due to the circumstances under which petitioner received the shares. Howard states that the board of directors of CLC did not authorize the issuance of the shares under its own authority, but instead had the shareholders authorize the issuance. Under these circumstances, Howard states, "we are informed that if Mr. Mitchell attempted to sell the Share Block on May 21, 1976, or shortly thereafter, any shareholder could bring suit to rescind the sale under California common law or Federal securities laws on grounds that the proxy statement was false and misleading." Howard also states that "we are further informed that such a suit would have a good chance of success." Based on these assumptions, Howard concludes that the 90,000 shares had only a speculative value of $ 0.25 per share. We do not accept petitioner's appraisal. First, we reject his method of determining the discount for lack of registration. Any*733 such discount must be determined by examining the specific facts of the instant case, not by reference to past decisions of this Court involving totally different facts. Next, we reject his method of determining the 10 percent discount for blockage. Howard did not provide any specific facts on which to base such a discount. Finally, we reject Howard's conclusion that a discount for alienability is appropriate. Petitioner introduced no evidence which would indicate that such a discount would be appropriate in the instant case. b. Respondent's ExpertRespondent's expert witness, Herbert T. Spiro, also began his analysis with the market value of the 90,000 shares as of May 21, 1976. Spiro then tabulated information from four entities publishing data on the valuation of restricted securities for 1976 (Claremont Capital Corporation, New America Fund, Inc., Source Capital, Inc., Value Line Development Capital Corp.), and arrived at an average discount for restricted securities in 1976 of 27 percent. Spiro then applied the 27 percent discount to the market value of the shares and arrived at a fair market value for the restricted shares of $ 287,437.50. The 27 percent discount*734 took into account any necessary discount for blockage. We conclude that the fair market value of the restricted stock issued to petitioner was $ 287,437.50 as of May 21, 1976, as determined by respondent's expert witness. Having determined the price paid for the warrant and the fair market value of the 90,000 shares of CLC stock, we sustain respondent's determination that the difference between them is taxable to petitioner as ordinary income in 1976.IV. Exclusion of Damages Received On Account of Personal InjuryUnder section 61(a) "gross income" means all income from whatever source derived, unless otherwise provided. Section 104(a)(2) excludes from gross income damages received on account of personal injuries or sickness. "Damages received" means an amount received through prosecution of a legal action based on tort-type rights, or through a settlement agreement entered into in lieu of such prosecution. Sec. 1.104-1(c), Income Tax Regs.*1994 *735 In the context of a settlement agreement, the availability of the section 104(a)(2) exclusion from gross income depends on the nature of the claim settled, not on the validity of the claim. Seay v. Commissioner, 58 T.C. 32">58 T.C. 32, 37 (1972). This determination is a factual one, and petitioner bears the burden of proving that respondent's determination is erroneous. Rule 142(a). In the absence of an express personal injury settlement agreement, the most important factor in applying section 104(a)(2) is the intent of the payor in making the payment. Metzger v. Commissioner, 88 T.C. 834">88 T.C. 834, 847-848 (1987), affd. without published opinion 845 F.2d 1013">845 F.2d 1013 (3d Cir. 1988). Petitioner relies on Seay v. Commissioner, supra, in arguing that the $ 100;511 he received from CLC during 1980 are excludable from gross income under section 104(a)(2) as damages for personal injuries. In Seay v. Commissioner the taxpayer made claims against his former employer for breach of contract and personal injuries arising out of the termination of his employment. He received $ 105,000 in settlement*736 of his claims. At the time of the settlement, both the attorney for the taxpayer and the employer's attorney agreed in writing that $ 45,000 had been allocated to the personal injury claim. We held that the taxpayer had shown that $ 45,000 of the payment was made on account of personal injuries and was excludable from gross income under section 104(a)(2). In arguing that the instant case is indistinguishable from Seay v. Commissioner, petitioner relies on the "Principles of Settlement" which he drafted and which state that "of the three payments of $ 50,000 * * * $ 100,000 will be deemed to be in settlement of employee's lawsuit against CLC, CLIC and various officers and directors for compensatory damages for slander and libel * * *." For several reasons we find that the "Principles of Settlement" are insufficient to establish that the payments are excludable under section 104(a)(2). First, we note that the complaint for libel and slander was never served on the defendants. Second, we note that the "Principles of Settlement" were never signed by CLC's attorney or approved by its board of directors. In addition, two members of CLC's board of directors testified that they*737 did not consider the libel action in approving the settlement agreement with petitioner, and stated that they considered the action a mere nuisance suit. Next, we note that the Amended Employment Agreement which was executed pursuant to the settlement agreement refers to the payments at issue as "compensation." We also note that CLC issued petitioner a Form W-2 reflecting the full $ 100,511 in payments as "wages, tips, or other compensation." Finally, in the pleadings for the action which petitioner filed in 1981 for an alleged breach of the Amended Employment Agreement, petitioner declared that in return for signing the settlement agreement with CLC, petitioner was to receive "in full settlement of the six-year period remaining on his employment contract * * * the sum of $ 150,000 payable in installments over a nine-months period." We find that the payments at issue were made in settlement of petitioner's employment agreement, rather than in settlement of the libel and slander action. Therefore, such payments are not excludable under section 104(a)(2), and respondent's determination is sustained. V. Net Operating Loss Carry BackCongress substantially revised the*738 Subchapter S Internal Revenue Code sections in the Subchapter S Revision Act of 1982. As part of the revision Congress enacted section 1371(b), providing that "[n]o carryforward, and no carryback, arising for a taxable year for which a corporation is a C corporation may be carried to a taxable year for which such corporation is an S corporation," and "No carryforward, and no carryback shall arise at the corporate level for a taxable year for which a corporation is an S corporation." However, section 1371(b) applies to taxable years beginning after December 31, 1982. Thus, section 1371(b) is inapplicable to the years at issue. Petitioners argue that prior to the enactment of section 1371(b) there was no prohibition against the carry back of a net operating loss to a year for which a corporation is an S corporation. Respondent argues that such a prohibition was implicit in section 1374 and the regulations thereunder. Deductions from income are allowable as a matter of legislative grace, and petitioners bear the burden of proving they are entitled to them. Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435 (1934);*739 Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). With regard to the inability of a corporation in a subchapter S year to take advantage of a loss generated in a subchapter C year, the regulations provide, in relevant part: Under section 1373(d), an electing small business corporation is not allowed a deduction for a net operating loss. Under section 172(h), a net operating loss sustained in taxable years in which a corporation is an electing small business corporation is disregarded in computing the net operating loss deduction of the corporation for taxable years in which it is not an electing small business corporation. In applying section 172(b)(1) and (2) to a net operating loss sustained in a taxable year in which the corporation was not an electing small business corporation, a taxable year in which the corporation was an electing small business corporation is counted as a taxable year to which such net operating loss is carried back or over. However, the taxable income*740 for such year as determined under *1995 section 172(b)(2) is treated as if it were zero for purposes of computing the balance of the loss available to the corporation as a carryback or carryover to other taxable years in which the corporation is not an electing small business corporation. Section 1.1374-1(a), Income Tax Regs.Under these regulations, a subchapter S year will be counted as a year for purposes of the carry back and carry forward periods. However, income in the subchapter S year will be regarded as zero, resulting in no part of the net operating loss carry back or carry forward being absorbed. Because no part of the net operating loss carry back is absorbed, no part of the carry back passes through to the shareholders. We agree with respondent that section 1371(b)'s prohibition of a carryback from a C year to an S year was implicit in the regulations prior to the enactment of that statute. We therefore sustain respondent's determination that no part of Leslie Investment Company's 1981 loss passed through to petitioners in 1980, a year in which Leslie Investment Company was an electing small business corporation. In light of*741 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 at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Though petitioner reported the initial payment of $ 50,511 as compensation on his 1980 Federal income tax return, petitioner now argues that both payments made in 1980, totaling $ 100,511, are excludable from gross income under section 104(a)(2)↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624859/ | RICHARD C. HUNSAKER and VIRGINIA A. HUNSAKER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent HUNSAKER DEVELOPMENT CO., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHunsaker v. CommissionerDocket Nos. 9133-72 and 9134-72.United States Tax CourtT.C. Memo 1975-225; 1975 Tax Ct. Memo LEXIS 141; 34 T.C.M. (CCH) 985; T.C.M. (RIA) 750225; July 14, 1975, Filed Thomas E. O'Sullivan and Gerard C. Tracy for*143 the petitioners. H. Lloyd Nearing, for the respondent. IRWINMEMORANDUM FINDINGS OF FACT AND OPINION IRWIN, Judge: In these consolidated proceedings respondent determined the following deficiencies in petitioners' income taxes: TaxableDocketYear PetitionerNo.EndingDeficiencyRichard C. Hunsaker and9133-7212-31-68$63,953.39Virginia A. Hunsaker12-31-6991,710.3512-31-7023,110.20Hunsaker Development Co.9134-7210-31-7010,983.81In docket No. 9133-72 the issues, after certain concessions, are as follows: (1) Whether losses sustained by Richard C. Hunsaker from certain loans and from certain payments made as guarantor are deductible in full under either section 162, 1165, 166(a)(1), or 166(f), or are deductible only as nonbusiness bad debts under section 166(d); (2) Whether respondent erred in redetermining the useful life of certain property for the purpose of depreciation. In docket No. 9134-72 the issue is whether respondent erred in disallowing $34,400 of Hunsaker*144 Development Co.'s bad debt loss deduction. FINDINGS OF FACT Some of the facts have been stipulated and these stipulations are adopted as a part of our findings. Petitioners Richard C. Hunsaker (hereinafter sometimes referred to as petitioner) and Virginia A. Hunsaker are husband and wife and resided in Corona Del Mar, Calif., at the time of the filing of their petition with this Court. During the taxable years 1968, 1969 and 1970 joint returns were timely filed with the Internal Revenue Service Center at Ogden, Utah. Petitioner Hunsaker Development Co. (hereinafter referred to as HDC) is a California corporation having its principal office in Santa Ana, Calif., at the time of the filing of its petition with this Court. For the fiscal years ending October 31, 1969, and October 31, 1970, HDC timely filed its income tax returns with the Internal Revenue Service Center at Ogden, Utah. During the years in issue and prior thereto petitioner, a licensed general contractor and real estate broker, was engaged in the real estate development business. Between 1954 and 1961 he and his father, S. V. Hunsaker, Sr., through joint ventures, partnerships and corporations, acquired, developed*145 and sold real estate, and built and sold over 5,000 homes and other buildings. In addition to associating with his father, petitioner also associated with S. V. Hunsaker, Jr. (his brother), Frank D. Patty (hereinafter referred to as Patty) and A. Douglas Martin in the subdividing of land and the building of homes. In the selling of tract homes built by the various businesses in which petitioner had an interest, two methods of financing were used: (1) a conditional sales contract or (2) a direct sale with financing. Under the former method the property is subject to a first loan from a financial institution secured by a deed of trust, with petitioner or his business retaining title for the duration of the contract and its obligation under the first loan. The purchaser takes immediate possession and makes single monthly payments to petitioner or his business, who then makes the payments on the first trust deed, pays the taxes and insurance, and applies the balance toward their equity. Under the latter method the purchaser takes title and assumes the obligations under the trust deed securing the first loan. If the purchaser is unable to supply the difference between the purchase price*146 and the first loan, petitioner or his business will take back a second trust deed from the purchaser covering this difference. In 1957 petitioner, his father and his brother formed a partnership known as SRS Investments with each partner owning a one-third interest. The partnership was formed to engage in real estate investments. In 1967 petitioner purchased his father's one-third interest. In 1959 petitioner and his father formed a partnership known as S. V. and R. C. Company. This partnership subdivided land and built and sold single family residences. In 1961 this partnership and petitioner formed a joint venture known as Cienega Homes which also subdivided land and built and sold single family residences. In January 1962 The Hunsaker Corporation was formed under California law to acquire the assets of twelve corporations and two partnerships (one engaged in real estate development and the other in the wholesale and retail sale of lumber). All of the corporations and partnerships were owned by petitioner, his father and his brother. In April 1962 the corporation changed its name to S. V. Hunsaker & Sons. S. V. Hunsaker & Sons went public in May 1963. Petitioner became president*147 of the corporation in 1962 and remained in that capacity until May 31, 1964, when the corporation's assets were acquired by Occidental Petroleum Corporation (Occidental) in exchange for stock in a section 368(a)(1)(C) reorganization. In connection with acquisition of the assets, Occidental and petitioner entered into an employment agreement whereby petitioner remained as president and chief operating officer of S. V. Hunsaker & Sons, now a subsidiary of Occidental. In 1965 he became chief executive officer. On July 21, 1966, the employment agreement was terminated and petitioner returned to activities related to general real estate development. In September 1966 petitioner caused the incorporation of Jenkin Construction Co. This California corporation, owned 50 percent by petitioner and 50 percent by William R. Jenkin, was formed to provide general engineering services and to engage in heavy construction enterprises. In October 1966 petitioner formed Rich Service Co., a partnership owned 75 percent by him and 25 percent by James Sax, to engage in the coin operated laundry business. This partnership was still in existence at the time of the trial. In February 1967 petitioner*148 formed a joint venture known as Paramount Properties with Dewain R. Butler for the development of industrial property. In addition to a capital contribution of $29,042.68, petitioner loaned the joint venture $89,100 in 1968. On November 1, 1969, this joint venture was dissolved. In January 1968 petitioner became the general partner of a limited partnership known as Polynesian Apartments. In addition to a 20 percent interest as general partner, he also invested $72,000 to acquire a 40 percent limited interest in the partnership. This partnership was formed to acquire 138 apartment units in Pomona, Calif.Between July 1966 when petitioner's employment agreement with Occidental was terminated and the end of 1970, petitioner operated approximately 1,300 apartment units of which he owned approximately 1,000. In June 1965 petitioner's father organized a corporation known as S. V. H. Investments (hereinafter referred to as SVH). This California corporation, of which petitioner's father owned an 89.52 percent interest, commenced development of land projects in Quail Mountain, Joshua Tree and Serene Lakes, Calif., shortly after its formation. Petitioner did not own any stock in SVH. *149 On May 11, 1967, petitioner purchased an irrevocable letter of Credit from Crocker-Citizens National Bank (now Crocker National Bank) in the amount of $223,811 and deposited it as collateral security with the General Insurance Company of America to protect that company against loss in connection with faithful performance bonds executed by that company in favor of the County of Placer and Sierra Lakes County Water District concerning SVH's Serene Lakes project. The principals on the faithful performance bonds for the subdivision improvements on the Serene Lakes project were petitioner's father and Patty. Patty is not related to the Hunsakers; nor was he shareholder of SVH. His name appeared on the faithful performance bonds only because he was the record owner of the property to be developed by SVH. Placer County and Sierra Lakes County Water District required that the record owner's name appear on the bonds. Patty had acquired title to the undeveloped property at the Serene Lakes project from SVH as security for loans he had advanced to the corporation. It was agreed that he would be held harmless from any liability on the improvements. Patty also extended options, mostly oral, to*150 SVH and petitioner to repurchase the undeveloped land. These options were never exercised. Patty died in December 1969. In 1969 and 1970 petitioner was required to pay $45,129.28 and $82,528, respectively, under the terms of the abovementioned collateral agreement, for expenses SVH could not pay. He did not attempt to recover any of the expenses of completing the improvements at Serene Lakes from Patty since he had agreed, by letter dated January 19, 1968, 2 to indemnify Patty and his wife against any such expense. *151 For the taxable years 1968, 1969 and 1970 petitioners reported the following amounts of income on Schedule C of their income tax returns: Ordinary IncomeBusiness Interest YearFrom Sale of PropertyIncome1968$35,532$ 73,207196914,043115,742197014,098119,019For these same taxable years petitioner reported the following profits (or losses) from their rental operations: YearProfit (or Loss)1968[11,212)1969131,126197048,191For these same taxable years petitioners claimed depreciation deductions on certain apartment and industrial buildings. Respondent decreased the deductions by increasing the useful life of the buildings as follows: Buildings - ApartmentsLife ClaimedLife DeterminedCompton2530San Gabriel2530Santa Barbara2530Laurelwood2030Buildings - Industrial733 E. Edna2535808 E. Edna2535828-842 E. Edna2535846-852 E. Edna2535804 E. Edna25351267 E. Edna25351223 E. Edna25351238 Cypress25351202 E. Edna2535803 Glendora2535*152 During the years in issue HDC was wholly owned by petitioner who was the corporation's president and one of its directors. In July 1968 HDC gave an unsecured promissory note to petitioner in the amount of $34,400. This represented a loan petitioner had previously made directly to SVH. HDC also loaned SVH $100,000 and in return received a promissory note for $134,400, covering the $100,000 it advanced and the $34,400 advanced by petitioner. This note was secured by a grant deed to the remaining unsold lots in Unit 2 of the Serene Lakes subdivision. For the fiscal year ending October 31, 1969, HDC deducted $142,400 as bad debts of which respondent disallowed the $34,400 mentioned above. This disallowance also caused respondent to reduce HDS's net operating loss deduction for its fiscal year ending October 31, 1970, by $34,400. OPINION We will first consider the treatment to be accorded the losses suffered by petitioner from the uncollectibility of certain loans made to his father and his father's corporation, and the payments made as guarantor of one of his father's notes and as guarantor of a performance bond relating to the Serene Lakes project. Neither the classification as*153 debt, the amount, nor the fact of uncollectibility (except as to the guarantor on the performance bond) is in dispute. A loss attributable to the worthlessness of a debt must be regarded as a bad debt loss, deductible as such or not at all. Putnam v. Commissioner,352 U.S. 82">352 U.S. 82, 88 (1956); Estate of Martha M. Byers,57 T.C. 568">57 T.C. 568, 574 (1972), affd. per curiam 472 F. 2d 590 (6th Cir. 1973). Thus the only applicable provision is section 166; 4sections 162 and 165 are not applicable. It is also immaterial whether the obligations arose by operation of the law of subrogation or by direct advances as both are accorded equal dignity as "debts" within the meaning of section 166. Putnam v. Commissioner,supra;Robert E. Gillespie,54 T.C. 1025">54 T.C. 1025, 1031 (1970). Consequently, the loans and guarantees will be treated together. *154 In this instance the question is whether petitioner is entitled to a business bad debt deduction under section 166(a)(1) or a nonbusiness bad debt deduction under section 166(d). With respect to the payments made as guarantor, we must also consider the applicability of section 166(f). Whether a debt is a business bad debt or nonbusiness bad debt is essentially a question of fact, the resolution of which depends upon whether the debt is "proximately" related to the trade or business of the taxpayer. Section 1.166-5(b), Income Tax Regs.5Robert E. Imel,61 T.C. 318">61 T.C. 318, 323 (1973). In determining whether a bad debt has a "proximate" relationship to the taxpayer's trade or business, the proper measure is that of the Dominant motive of the taxpayer; significant motivation is not enough. United States v. Generes,405 U.S. 93">405 U.S. 93 (1972). *155 Petitioner broadly claims that the loans and guarantees were made in the course of his trade or business as a real estate developer. He also claims that he was in the trade or business of lending money. He further asserts that a joint venture between SVH and himself existed with respect to the Serene Lakes project. Although petitioner, his father and SVH were all engaged in real estate development, petitioner has not shown that his loans to his father and SVH were directly related to his trade or business. The dominant motive was to aid his father, either through direct loans or through loans to his father's corporation, with the expectation of enabling that corporation to become a financial success. Petitioner had no financial interest in SVH except for the loans. Although petitioner's own companies dealt in real estate development these companies were not directly affected by the success or failure of petitioner's father or SVH. 6 Furthermore, the fact that petitioner financed many of his own real estate developments does not result in a finding that petitioner was in a trade or business of lending money. Petitioner's financing endeavors were integral to his real estate*156 development. Petitioner was not in the general trade or business of lending money. Lastly, petitioner submits that a joint venture existed with SVH with respect to the Serene Lakes project. Although there may have been discussion between petitioner and his father with respect to forming a joint venture, the fact remains that a joint venture never materialized. As far as we can determine from the record, all the discussion remained at the preliminary stage. We have no evidence of decisions relating to capital contributions, the sharing of profits and losses, etc. While petitioner had a history of forming partnerships and other ventures with respect to real estate development, there is no evidence to support a finding that such a venture existed in this instance. See generally Hubert M. Luna,42 T.C. 1067">42 T.C. 1067 (1964); compare Beck Chemical Equipment Corporation,27 T.C. 840">27 T.C. 840 (1957). We believe the record supports a finding that but*157 for the fact of petitioner's father's involvement, the loans would not have been made. While it is true that profit was the sole motive in making the loans, petitioner fails to acknowledge that it is his father's profit that is at stake, not his own. Although we can hypothesize that had the project become successful, it would be likely that petitioner might get a greater return than that of a mere lender, the fact remains that a joint venture never materialized. Consequently, we have no choice but to find that the debts resulting from the loans to petitioner's father and to SVH were nonbusiness bad debts deductible only under section 166(d). United States v. Generes,supra.We turn now to the petitioner's losses resulting from his status as a guarantor, analyzing the guarantee of his father's $125,000 loan from the Crocker Bank first. Section 166(f) is the only applicable provision available which would allow an ordinary deduction. However, as petitioner has conceded on brief that he does not meet the requirements of that provision with respect to the $125,000 guarantee, we have no choice but to hold for respondent on this point. This loss, therefore, is*158 deductible as a loss resulting from a nonbusiness bad debt. With respect to payments as guarantor of the bond we reach a contrary conclusion. Respondent's only contention is that petitioner has not established that the debt upon which the guarantee was made was worthless. We disagree. Although the named principals on the bonds were petitioner's father and Patty, it is our opinion that, in substance, the only principal was petitioner's father, and it has been shown that his estate was insolvent. Petitioner did not have to demonstrate the insolvency of Patty's estate since the evidence clearly indicates that Patty was to be held harmless from any liability resulting from the bonds. Patty was a principal in name only, to comply with local law. Consequently, the liability fell upon petitioner when his father became insolvent, and in our judgment section 166(f) is applicable, all of its requirements having been met. With respect to the depreciation adjustments, we must sustain respondent's determinations. The burden of proof with respect to useful life is upon petitioner. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933);*159 Rule 142, Tax Court Rules of Practice and Procedure.Petitioner's unsubstantiated oral testimony as to the estimated useful lives of the buildings in issue is insufficient to carry his burden. The final issue presented concerns respondent's disallowance of $34,400 of HDC's bad debt deduction for its taxable year ending October 31, 1969. In our judgment respondent erred in this disallowance. Respondent's action in this regard is based upon the theory that the $34,400 receivable had no value when acquired by HDC and thus was already worthless. The evidence indicates that HDC agreed to take over petitioner's loan of $34,400 to SVH and in addition to loan SVH $100,000. In return SVH would execute a secured note to HDC for $134,400. There is nothing in the record to indicate that the $34,400 receivable was worthless when acquired by HDC. In fact, the record indicates that the entire $134,400 did not become worthless until sometime in HDC's taxable year ending October 31, 1969. Consequently, the entire $134,400 should have been allowed as a bad debt deduction, not just the $100,000. To reflect the various concessions and adjustments, Decisions will be entered under Rule 155.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Mr. and Mrs. Frank D. Patty 596 Winston Avenue San Marino, CaliforniaDear Frank: RE: BONDS 582885 AND 582886, ISSUED BY GENERAL INSURANCE COMPANY OF AMERICA, SERENE LAKE SUBDIVISION UNIT #2 - 100 LOTS On or about May 7, 1967, you and your wife executed bonds and applications referred to above in the aggregate sum of $223,811. I am writing this letter to hold you and your wife harmless from any liability in connection with these bonds. I have posted a letter of credit, dated May 11, 1967, from Crocker-Citizens National Bank with General Insurance Company of America and in the event SVH Investments fails to install improvements in the above referenced subdivision, I will install same at no cost whatsoever to you. I will do so however, only if General Insurance Company of America makes demand on me to install said improvements. Sincerely yours, Richard C. Hunsaker On June 1, 1967, petitioner guaranteed his father's note in the amount of $125,000 in favor of Crocker-Citizens National Bank. This $125,000 was advanced by petitioner's father to SVH. Petitioner's father suffered a stroke in November 1968 which rendered him almost speechless until March 1969. Because of his father's incapacity, petitioner became a director of SVH in December 1968 and a vice president and chief operating officer in January 1969, thus taking "over the reins of his [father's] business." Petitioner never received a salary or fee for these services. During the summer of 1969 petitioner's father suffered another stroke and died in August 1969. His estate was insolvent. In 1969 petitioner paid Crocker-Citizens National Bank $125,000 as guarantor of his father's note. The amount was not collectible from his father or his estate. Petitioner's records reflect the following activity in "Accounts Receivable--S. V. Hunsaker, Sr." for the years 1968 and 1969: ChargesCreditsBalance$330,500.001968January 31$ 5,000.00January 3115,000.00350,500.00March 3119,400.00369,900.00April 3013,525.00383,425.00May 31$ 13,525.00May 317,000.00376,900.00June 3020,000.00June 308,000.00404,900.00July 3120,000.00384,900.00December 315,500.00390,400.00December 3134,400.00December 3137,949.69318,050.311969$318,050.31January 31$318,050.310January 31957.06(957.06)February 28$ 7,985.227,028.16March 315,175.0012,203.16April 3015,296.7527,499.91May 311,260.5028,760.41June 3065.0028,825.41July 311,200.00July 311,200.0031,225.41August 31550.00August 311,360.0033,135.41December 315,079.39December 3138,214.800 The amounts loaned by petitioner to his father were evidenced by unsecured promissory notes bearing eight percent interest. At the end of December 1968 petitioner's father owed him $390,400. Of this amount $318,050.31 was canceled by petitioner's purchase of certain secured notes and land contracts receivable owned by his father. Of the amounts advanced by petitioner to his father, $37,949.69 became uncollectible in 1968 and $38,214.80 became uncollectible in 1969. Petitioner's records reflect the following activity in "Accounts Receivable--S.V.H. Investments" for the years 1968 and 1969: ChargesCreditsBalance19680November 30$10,000.00$ 10,000.00December 3125,000.0035,000.00December 31$ 35,000.0001969January 31$25,000.00$ 25,000.00February 2821,000.0046,000.00March 3134,950.0080,950.00April 3027,700.00108,650.00May 317,650.00116,300.00June 303,550.00119,850.00July 313,100.00122,950.00August 31400.00123,350.00September 30$ 4,300.00September 306,775.00$134,425.00October 31250.00134,675.00December 31$ 3,100.00131,575.00December 31131,575.000 The amounts loaned to SVH were also evidenced by unsecured promissory notes bearing eight percent interest. Any repayments by SVH to petitioner depended upon its success in land development. Of the amounts advanced to SVH by petitioner $35,000 became uncollectible in 1968 and $131,575 became uncollectible in 1969. Petitioner also advanced an additional $1,679 to SVH in 1969 and this amount also became uncollectible in 1969. On its tax returns SVH reported losses (before applying net operating loss carryforwards) and retained earnings (deficits) as follows: Retained YearGain/(Loss)Earnings/(Deficits)1965($ 45,933.00)($ 45,933.00)1966(322,688.09)194,447.001967(894,088.59)(111,414.51)1968(544,468.11)(180,640.15)1969(2,545,124.03)(3,300,309.00)1970(150,273.62)(3,715,986.00)SVH carried the following amounts as loans from shareholders: Loans from YearShareholders1965$ 530,00019661,546,00019673,677,81419683,677,81419693,565,23619703,571,433Petitioner's father received the following amounts as salary from SVH: YearSalary1965$ 7,500196618,000196718,000196818,000 At his death he had made advances totaling over $3,500,000 to SVH. Although SVH had a book profit in 1966, it operated with a negative cash flow during each of the years 1965 through 1970. This weak financial position of SVH during the years in issue was due to a lack of working capital, a failure to maintain a strong sales operation and problems with environmental requirements relating to the development of Serene Lakes. It was the occurrence of his father's stroke that caused petitioner to become active in the Serene Lakes project on behalf of SVH. His purpose in taking over from his father was to protect his and his father's investments. The active involvement was clearly profit oriented. Although petitioner and his father had discussed the creation of a joint venture with respect to the Serene Lakes project, no joint venture was ever entered into. The Serene Lakes project became economically unfeasible and was eventually abandoned by SVH. On January 1, 1968, petitioner owned two notes receivable secured by second deeds of trust and 55 land contracts receivable with a total face value of $805,277.31. During 1968 he acquired one additional note secured by a deed of trust and one other note. $15,016.25 in principal and $52,638.49 in interest were collected during the year. On January 1, 1969, petitioner owned three notes receivable secured by second deeds of trust, 55 land contracts receivable and one additional note receivable with a total face value of $883,696.06. During the year 1969 he acquired the 86 notes from his father and another note receivable with a total face value of $1,155,305.63 so that his total portfolio of notes and land contracts receivable had a face value of $1,949,901.91. $375,747.25 in principal and $110,563.91 in interest were collected during the year. On January 1, 1970, petitioner owned three notes receivable secured by second deeds of trust, 121 land contracts and one other note receivable with a total face value of $1,663,254.44. $112,868.23 in principal and $108,154.14 in interest were collected during 1970. The contracts receivable and promissory notes secured by second trust deeds resulted mainly from the acceptance of negotiable instruments in exchange for part of the purchase price of houses built and sold by petitioner's various businesses. However, we also note, as previously stated, that $318,050.31 of these contracts were acquired from petitioner's father in 1968 which in effect canceled some of his debts to petitioner.3↩4. SEC. 166. BAD DEBTS. (a) General Rule.-- (1) Wholly worthless debts.--There shall be allowed as a deduction any debt which becomes worthless within the taxable year. (2) Partially worthless debts.--When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. (b) Amount of Deduction.--For purposes of subsection (a), the basis for determining the amount of the deduction for any bad debt shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property. (c) Reserve for Bad Debts.--In lieu of any deduction under subsection (a), there shall be allowed (in the discretion of the Secretary or his delegate) a deduction for a reasonable addition to a reserve for bad debts. (d) Nonbusiness Debts.-- (1) General rule.--In the case of a taxpayer other than a corporation-- (A) subsections (a) and (c) shall not apply to any nonbusiness debt; and (B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. (2) Nonbusiness debt defined.--For purposes of paragraph (1), the term "nonbusiness debt" means a debt other than-- (A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business. (e) Worthless Securities.--This section shall not apply to a debt which is evidenced by a security as defined in section 165(g)(2)(C). (f) Guarantor of Certain Noncorporate Obligations.--A payment by the taxpayer (other than a corporation) in discharge of part or all of his obligation as a guarantor, endorser, or indemnitor of a noncorporate obligation the proceeds of which were used in the trade or business of the borrower shall be treated as a debt becoming worthless within such taxable year for purposes of this section (except that subsection (d) shall not apply), but only if the obligation of the borrower to the person to whom such payment was made was worthless (without regard to such guaranty, endorsement, or indemnity) at the time of such payment.↩5. § 1.166-5 Nonbusiness debts. * * *(b) Nonbusiness debt defined. For purposes of section 166 and this section, a nonbusiness debt is any debt other than-- (1) A debt which is created, or acquired, in the course of a trade or business of the taxpayer, determined without regard to the relationship of the debt to a trade or business of the taxpayer at the time when the debt becomes worthless; or (2) A debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business. The question whether a debt is a nonbusiness debt is a question of fact in each particular case. The determination of whether the loss on a debt's becoming worthless has been incurred in a trade or business of the taxpayer shall, for this purpose, be made in substantially the same manner for determining whether a loss has been incurred in a trade or business for purposes of section 165(c)(1). For purposes of subparagraph (2) of this paragraph, the character of the debt is to be determined by the relation which the loss resulting from the debt's becoming worthless bears to the trade or business of the taxpayer. If that relation is a proximate one in the conduct of the trade or business in which the taxpayer is engaged at the time the debt becomes worthless, the debt comes within the exception provided by that subparagraph. The use to which the borrowed funds are put by the debtor is of no consequence in making a determination under this paragraph. For purposes of section 166 and this section, a nonbusiness debt does not include a debt described in section 165(g)(2)(C)↩. See § 1.165-5, relating to losses on worthless securities.6. In this regard we note that HDC also loaned funds to SVH. This factor, by itself, however, does not cause petitioner's loans to become business bad debts. The success or failure of HDC was not dependent upon SVH.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624860/ | CATHLEEN M. SMITH HANDEL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHandelDocket No. 19316-90United States Tax CourtT.C. Memo 1992-355; 1992 Tax Ct. Memo LEXIS 380; 63 T.C.M. (CCH) 3168; June 23, 1992, Filed *380 Decision will be entered for respondent. R. D. Worsley, for petitioner. Valerie N. Larson, for respondent. COHENCOHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined deficiencies in and additions to petitioner's Federal income tax as follows: Additions to TaxYearDeficiencySec. 6653(a)Sec. 6653(a)(1)Sec. 6653(a)(2)1979$ 2,682.00$ 134.0019802,859.00143.0019814,128.00$ 206.4050% of the interest dueon $ 4,128.0019822,391.00120.0050% of the interest dueon $ 2,391.00Unless otherwise indicated, all 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. The issues for decision are: (1) Whether petitioner is entitled to an investment tax credit in the amount of $ 12,060 for 1982 and (2) whether petitioner is liable for additions to tax for negligence. (The amounts in issue for the other years are the result of carrybacks from 1982.) FINDINGS OF FACT Some of the facts have been stipulated, and the stipulated facts are incorporated*381 in our findings by this reference. Cathleen M. Smith Handel (petitioner) resided in Rancho Penasquitos, California, at the time she filed her petition. On September 1, 1982, petitioner and Hollis R. Bowden (Bowden) signed a partnership agreement to form Newport Vending. The stated purpose of Newport Vending was to own and rent water vending machines. Petitioner held a 25-percent interest in Newport Vending. On September 1, 1982, Newport Vending entered into a purchase agreement with The Water Doctor, Inc. (Water Doctor), in which Water Doctor agreed to sell to Newport Vending 24 water vending machines (the vending machines) for $ 482,400. Pursuant to the purchase agreement, $ 4,800 was to be paid to Water Doctor at the time of the signing of the purchase agreement, and the balance was to be paid in the form of two promissory notes. Water Doctor agreed to reimburse Newport Vending $ 100 per vending machine in order to cover various charges associated with the purchase agreement. The amount owed to Newport Vending by Water Doctor was divided evenly between Bowden and petitioner. Consequently, the amount owed to petitioner by Water Doctor was $ 1,200. Water Doctor offered to*382 credit this amount to petitioner's account in lieu of her making an initial cash contribution pursuant to the purchase agreement. Petitioner accepted the offer. The credit would not be applied, however, until the promissory notes were paid in full. The first promissory note was for $ 67,560, with no interest payable until January 1, 1984, whereupon 9-percent interest would accrue on the outstanding balance of the promissory note. The second promissory note was for $ 410,040, with interest to accrue from September 1, 1982, at the rate of 9 percent. Principal and interest were due on December 31, 1989. If $ 61,506 were paid by December 31, 1989, the second promissory note would be extended to December 31, 1996. If an additional $ 61,506 were paid by December 31, 1996, the second promissory note would be extended to December 31, 1999. No interim schedule of payments on either promissory note was instituted. All outstanding note balances were to be deemed fully paid in the event that Water Doctor assigned the contract for the benefit of unsecured creditors or was adjudged a bankrupt. The purchase agreement further provided: 3. Seller [Water Doctor] agrees to place subject*383 machines on rental locations * * * * * * 5. Purchaser [Newport Vending] agrees to reimburse Seller his out of pocket payments for location owner's fees estimated to be approximately 35% of gross revenues. 6. Seller agrees to furnish all necessary Management required to supervise the business of rental of Coin-Operated Water Vending Machines. The charges for management costs to the Purchaser shall be 5% of gross revenue. 7. Seller agrees to furnish all Maintenance, including labor and materials * * * necessary to maintain said equipment in working order necessary for the production of income. This would include costs to repair as a result of any vandalism. The charges for Maintenance costs to the Purchaser shall be 10% of gross revenues. 8. Seller agrees to furnish all Accounting and Legal services required to support the Administrative functions. The charge for Accounting & Legal, to the Purchaser shall be 5% of gross revenues. 9. Seller agrees to develop Insurance and Tax reduction programs to protect Purchaser against property loss, liability claims and minimization of property and sales taxes. The charge for Insurance and Taxes (not including State or*384 Federal), to the Purchaser shall be Seller's out of pocket costs relative to these items of cost, estimated to not exceed 3% of gross revenue. In the event that Water Doctor was unable to place the vending machines on rental locations on or prior to December 1, 1982, Water Doctor agreed to pay to Newport Vending an amount that was to be an equivalent of the lost rental fees. Water Doctor was to apply the profits from the rental of the vending machines against the balance due on the promissory notes. Title to the vending machines was to remain with Water Doctor until the promissory notes, including interest, were paid in full. At that time, and upon Newport Vending's payment to Water Doctor of $ 1 per vending machine, title to the vending machines was to pass to Newport Vending. Newport Vending could then operate the vending machines for its own account or negotiate another agreement with Water Doctor. Newport Vending and Water Doctor also entered into a security agreement that gave Water Doctor a security interest in, and a general lien upon, the vending machines. In 1982, Water Doctor credited profits from the rental of the vending machines against the promissory notes in *385 the amount of $ 2,400. Petitioner calculated an investment tax credit with respect to the vending machines of $ 12,060 on her Federal income tax return for 1982. Petitioner claimed $ 2,391 of the investment tax credit on her Federal income tax return for 1982 and carried back to 1979, 1980, and 1981 the unused portion of the credit. For the years 1983 through 1990, profits from the rental of the vending machines were credited against the promissory notes. Subsequent to 1982, petitioner made cash payments with respect to the promissory notes. In the notice of deficiency, respondent disallowed the investment tax credit because petitioner had not "established the basis * * * [of nor] acquired and placed into service during the taxable year any qualifying property". OPINION Section 46 provided for an investment tax credit with respect to any taxable year for the applicable percentage of the basis of each new section 38 property placed in service by the taxpayer during such taxable year. The dispute between the parties can be resolved by the determination of whether Newport Vending became the owner of the vending machines for Federal tax purposes in 1982. Respondent contends that*386 petitioner is not entitled to the investment tax credit because Newport Vending was not the actual owner of the vending machines, but, rather, Water Doctor retained ownership of the vending machines. Petitioner contends that respondent has raised a new issue in her opening brief that should not be considered by the Court or that, at least, the burden of proof is on respondent. In the notice of deficiency, respondent determined that petitioner was not entitled to an investment tax credit with respect to the vending machines because petitioner had not "established the basis * * * [of nor] acquired and placed into service during the taxable year any qualifying property". At trial, respondent's counsel narrowed the issue of whether petitioner was entitled to the investment tax credit by explaining that she would attempt to prove "that the Water Doctor is the actual owner of these vending machines." Respondent argues that no sale took place because Water Doctor retained the benefits and burdens of ownership of the vending machines. "Proceeding from the broad to the specific, as the respondent has in this case, does not destroy the presumptive correctness of the respondent's determination*387 of deficiency and shift the burden of proof to the respondent, much less bar * * * [those] contentions from consideration." Big "D" Development Corp. v. Commissioner, T.C. Memo. 1971-148, affd. per curiam 453 F.2d 1365">453 F.2d 1365 (5th Cir. 1972). We therefore consider whether Newport Vending became the owner of the vending machines for Federal tax purposes in 1982. Events occurring subsequent to 1982 do not affect our determination. Regardless of the burden of proof on this issue, the preponderance of the evidence favors respondent's position. Petitioner argues that the existence of the purchase agreement and security agreement indicates that the transaction in this case was a sale on credit in which the seller retained a security interest in the goods sold. Formal documents, however, do not control for "tax purposes when the objective economic realities are to the contrary." Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 573 (1978). To determine whether a sale has occurred, the substance of the transaction, rather than its form, governs. Id. at 572-573. In Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221 (1981),*388 we stated: The term "sale" is given its ordinary meaning for Federal income tax purposes and is generally defined as a transfer of property for money or a promise to pay money. Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, 570-571 (1965). The key to deciding whether * * * [a taxpayer's transaction is a sale] is to determine whether the benefits and burdens of ownership have passed * * * to * * * [the taxpayer]. This is a question of fact which must be ascertained from the intention of the parties as evidenced by the written agreements read in light of the attending facts and circumstances. Haggard v. Commissioner, 24 T.C. 1124">24 T.C. 1124, 1129 (1955), affd. 241 F.2d 288">241 F.2d 288 (9th Cir. 1956). * * * [Grodt & McKay Realty, Inc. v. Commissioner, supra at 1237; fn. ref. omitted.] Among the factors to be considered are: (1) Whether legal title passes; (2) how the parties treat the transaction; (3) whether an equity was acquired in the property; (4) whether 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; (5) whether the right*389 of possession is vested in the purchaser; (6) which party pays the property taxes; (7) which party bears the risk of loss or damage to the property; and (8) which party receives the profits from the operation and sale of the property. * * * [Id. at 1237-1238; citations omitted.] Not all of the factors are relevant in every case, and the weight to be given to any one factor may vary depending on the circumstances. We will consider the factors that are relevant to petitioner's transaction. Title to the vending machines would not pass to Newport Vending until the promissory notes were paid in full. The first promissory note had no due date, and the second promissory note did not have to be paid in full until 17 years after the parties entered into the transaction. Legal title, therefore, would not pass to Newport Vending until an undetermined time in the future. The terms of the purchase agreement suggest that the parties did not treat the transaction as a sale. In the event that Water Doctor assigned the contract for the benefit of unsecured creditors or was adjudged a bankrupt, the promissory notes would be deemed fully paid. Further, if Water Doctor were*390 unable to place the vending machines in rental locations, Water Doctor would pay to Newport Vending an amount that was to be an equivalent of the lost rental fees. In a bona fide sale, Newport Vending would have had the burden of paying for the vending machines in any event and would have borne the risk if they were unable to be placed on rental locations. Newport Vending was to pay for the vending machines through an initial down payment and two promissory notes. Petitioner's portion of the $ 4,800 down payment was to be paid from moneys owed to her by Water Doctor but would be credited to her account only after the promissory notes were paid in full. The first required payment on either of the promissory notes was not due until 7 years after the parties entered into the transaction. The contract therefore created no present obligation of Newport Vending to make payments for the vending machines. Water Doctor was required to develop an insurance program to protect Newport Vending from property loss and liability claims. Water Doctor was also required to manage the rental of the vending machines, maintain them in working condition, and furnish necessary accounting and legal*391 services. Each of these services provided by Water Doctor is indicative of its ownership of the vending machines. Although Water Doctor was to receive fees for the provision of these services, the fees were to be paid out of gross revenues from the rental of the vending machines. The fees were therefore directly related to Water Doctor's maintenance and operation of the vending machines. Water Doctor, in effect, owned the vending machines and rented them for its own account. Payments on the promissory notes were to be made out of the profits from the rental of the vending machines. Only after the notes were paid in full could Newport Vending operate the vending machines for its own account and receive the profits therefrom. The vending machines were therefore to be rented for the benefit of Water Doctor until the promissory notes were paid. Cf. Grodt & McKay Realty, Inc. v. Commissioner, supra at 1242-1243 (holding that the possibility of a purchaser's receiving speculative future profits is inadequate to support the finding of a sale for Federal tax purposes). Based on the foregoing, we conclude that Newport Vending did not acquire the benefits and*392 burdens of ownership of the vending machines in 1982. Because there was no sale of, and Newport Vending was not the owner of, the vending machines for Federal tax purposes, petitioner is not entitled to an investment tax credit based thereon. Having reached this conclusion, we need not address the other arguments set forth by the parties on this issue. Section 6653(a) as in effect in 1979 and 1980 and section 6653(a)(1) and (2) as in effect in 1981 and 1982 provide for additions to tax if an underpayment is due to negligence. Negligence is defined as the lack of due care or the failure to do what a reasonable and ordinarily prudent person would do under similar circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Petitioner bears the burden of proof. Rule 142(a). Petitioner has presented neither argument nor evidence to negate respondent's determination. Petitioner has not met her burden of proof and is therefore liable for the additions to tax for negligence. To reflect the foregoing, Decision will be entered for respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624863/ | DONALD W. FIGURA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentFigura v. CommissionerDocket No. 30279-83.United States Tax CourtT.C. Memo 1984-567; 1984 Tax Ct. Memo LEXIS 107; 48 T.C.M. (CCH) 1469; T.C.M. (RIA) 84567; October 23, 1984. *107 Petitioner has totally failed to produce documents and answer interrogatories despite a specific order of this Court directing him to do so. Held, petitioner's failure constitutes a default under the circumstances of this case. Respondent's Motion to Impose Sanctions, seeking a judgment for default under Rule 104(c)(3), Tax Court Rules of Practice and Procedure, is granted Donald W. Figura, pro se. Julia M. Dewey and Phyllis*108 Greenblum, for the respondent. CANTREL MEMORANDUM OPINION CANTREL, Special Trial Judge: This case is before the Court on respondent's Motion to Impose Sanctions under Rule 104(c), 1 filed on September 4, 1984, and respondent's oral motion for an award of damages pursuant to section 6673, 2 made at the hearing at Washington, D.C. on October 10, 1984. 3Respondent, in his notice of deficiency issued to petitioner on July 25, 1983, determined deficiencies in petitioner's Federal income tax for the taxable calendar years 1980 and 1981 in the respective amounts of $2,700.47 and $1,712.00. Respondent, in his deficiency notice, determined the following adjustments to petitioner's income: 19801981Contributions 4$10,266.10 $8,255.00 Standard-Itemized Deductions(1,067.10)(1,023.30)Credit for Personal Exemptions(1,000.00)*109 Petitioner resided at 8B Dundee Quarter #304, Palatine, Illinois on the date he filed his petition. He filed individual 1980 and 1981 Federal income tax returns with the Internal Revenue service. The petition was timely mailed and, thus, timely filed on October 25, 1983. See section 7502. Respondent filed his answer on December 16, 1983, on which date the pleadings were closed. More than 30 days thereafter respondent commenced discovery. See Rules 34, 36, 38 and 70(a)(2). Petitioner, at paragraph 4 of his petition,recites -- I am in disagreement*110 with the proposed adjustments to my income made by the IRS on forms 4089, 1902-B, and 3547 (attached). 1980 contributions for the sum of $10,266.10. I have the proper documentation to verify these deductions.1981 contributions for the sum of $8,255.00. I have the proper documentation to verify these deductions.5 (Emphasis added.) SANCTIONSWe are fully satisfied that respondent attempted to attain the objectives of formal discovery through informal requests, consultation or communication with petitioner as required by this Court's Rules and the mandates of its opinions. 6 When those attempts proved fruitless respondent, on April 4, 1984, served on petitioner a 13 paragraph interrogatory request and a 5 paragraph document request. A review of those requests reveals that they seek information and documents which are highly relevant and material to the issues at dispute in this case. *111 The purpose of the pleadings and discovery is to give the parties and the Court fair notice of the matters in controversy and the basis for their respective positions. See Rule 31(a) and Kabbaby v. Commissioner,64 T.C. 393">64 T.C. 393, 394 (1975). All of the pertinent and relevant facts necessary to the disposition of a case should see the light of day prior to the trial of a case. The basic purpose of discovery is to reduce surprise by providing a means for the parties to obtain knowledge of all relevant facts in sufficient time to perfect a proper record for the Court if a case must be tried. "For purposes of discovery, the standard of relevancy is liberal.Rule 70(b) permits discovery of information relevant not only to the issues of the pending case, but to the entire 'subject matter' of the case". Zaentz v. Commissioner,73 T.C. 469">73 T.C. 469, 471 (1979). When petitioner totally failed to respond to respondent's discovery requests, respondent submitted a motion to compel compliance therewith, which the Court filed on June 18, 1984. Respondent made service of his motion on petitioner on June 15, 1984. 7 The Court, on June 20, 1984, served on the*112 parties a notice which gave petitioner until July 10, 1984 in which to file an objection to respondent's motion. When petitioner did nothing the Court, on July 18, 1984, served on the parties an order which recites in pertinent part-- * * * ORDERED that respondent's above-referenced motion [i.e., motion to compel] is granted in that petitioner shall, on or before August 24, 1984, (1) serve on counsel for respondent answers to each interrogatory served upon petitioner on April 4, 1984, and (2) produce to counsel for respondent those documents requested in respondent's request for production of documents served on petitioner on April 4, 1984.It is further ORDERED that in the event petitioner does not fully comply with the provisions of this order, this Court will be inclined to impose sanctions pursuant to Tax Court Rule 104, which may include dismissal of this case and entry of a decision against petitioner for the full amount of the deficiencies as set forth in the notice of deficiency dated July 25, 1983. *113 Petitioner did nothing, and respondent filed the motion we now consider. A copy of that motion together with a copy of a Notice of Hearing, calendaring respondent's motion for hearing at Washington, D.C. on October 10, 1984, were served on petitioner by the Court on September 7, 1984. When the case was called on October 10, 1984 petitioner did not appear, no response to respondent's motion was filed nor had the discovery requests been responded to. Our rules of practice and our orders mean exactly what they say and we intend that they be complied with. Rosenfeld v. Commissioner,82 T.C. 105">82 T.C. 105, 111 (1984); Odend'hal v. Commissioner,75 T.C. 400">75 T.C. 400, 404 (1980); Branerton Corp. v. Commissioner,61 T.C. 691">61 T.C. 691, 692 (1974). Although given more than an ample opportunity to comply with our Rules and an order of this Court petitioner has not done so and there is not one valid reason extant in this record to explain his total failure to comply. He has, in essence, ignored and defied our order of July 17, 1984, and, by his inexcusable conduct, shown complete and utter disrespect for our Rules and an order of this Court. Indeed, *114 petitioner's total failure to act has worked to his detriment. As we view this record, respondent's discovery requests sought information and documents relevant and material to the issues at dispute. Petitioner simply made no attempt to comply with those requests despite a specific order of this Court directing him to do so. Rule 104, respecting enforcement actions and sanctions, provides in pertinent part as follows: (c) Sanctions: If a party ** *fails to obey an order made by the Court with respect to the provisions of Rule 71, 72 * * * the Court may make such orders as to the failure as are just, and among others the following: * * * (3) An order striking out pleadings or parts thereof, or staying further proceedings until the order is obeyed, or dismissing the case or any part thereof, or rendering a judgment by default against the disobedient party. Rule 104(a) and (c) provide various sanctions for failure to respond to discovery requests and for failure to comply with discovery orders. The sanctions for each are the same and are enumerated in Rule 104(c). Where no discovery order is outstanding dismissal is appropriate only upon total failure to respond*115 to discovery requests. However, where a party fails to comply with a Court order dismissal may be appropriate even though there has been a partial response. Dusha v. Commissioner,82 T.C. 592">82 T.C. 592, 602-604 (1984), which was reviewed by the Court. Here, petitioner has, without justification, totally refused to respond to respondent's discovery requests in spite of a specific order of this Court directing him to do so. Among the sanctions available, dismissal is one of the most severe and should not be ordered indiscriminately. Dusha v. Commissioner,supra at 605.Nevertheless, it must be available under appropriate circumstances not merely to penalize the party for failure to comply with a Court order but also to deter other petitioners from engaging in similar conduct. Dusha v. Commissioner,supra at 605-606; National Hockey League v. Met Hockey Club,427 U.S. 639">427 U.S. 639, 643 (1976). Dismissal is proper for failure to comply with this Court's discovery orders where such failure is due to willfulness, bad faith or other fault of the party. Dusha v. Commissioner,supra at 604;*116 Societe Internationale, Etc. v. Rogers,357 U.S. 197">357 U.S. 197, 212 (1958). Where the evidence requested is material, failure to produce it constitutes an admission of the lack of merit in the party's position. Dusha v. Commissioner,supra at 605; Hammond Packing Co. v. Arkansas,212 U.S. 322">212 U.S. 322 (1909). In the circumstances of this case we conclude that petitioner's persistent, stubborn and, thus, unwarranted and unjustified conduct constitutes a default and that dismissal of this case for failure to comply with our Rules and a specific order of this Court is, albeit a severe sanction, appropriate under Rule 104(c)(3). See Steinbrecher v. Commissioner,712 F.2d 195">712 F.2d 195 (5th Cir. 1983), affg. T.C. Memo. 1983-12; Miller v. Commissioner,741 F.2d 198">741 F.2d 198 (8th Cir. 1984), affg. per curiam an order of dismissal and decision of this Court; Hart v. Commissioner,730 F.2d 1206">730 F.2d 1206 (8th Cir. 1984), affg. per curiam an order of dismissal and decision of this Court; Rechtzugel v. Commissioner,79 T.C. 132">79 T.C. 132 (1982), affd. 703 F.2d 1063">703 F.2d 1063 (8th Cir. 1983); McCoy v. Commissioner,696 F.2d 1234">696 F.2d 1234 (9th Cir. 1983),*117 affg. 76 T.C. 1027">76 T.C. 1027 (1981); Eisele v. Commissioner,580 F.2d 805">580 F.2d 805 (5th Cir. 1978); Burton v. Commissioner,T.C. Memo 1984-99">T.C. Memo. 1984-99; Douglas v. Commissioner,T.C. Memo. 1983-786; Kuever v. Commissioner,T.C. Memo. 1983-58; Murmes v. Commissioner,T.C. Memo. 1983-55; Riehle v. Commissioner,T.C. Memo. 1982-141, appeal dismissed (7th Cir., Jan. 13, 1983); Farley v. Commissioner,T.C. Memo 1981-606">T.C. Memo. 1981-606; Gaar v. Commissioner,T.C. Memo. 1981-595, appeal dismissed (11th Cir., June 30, 1982). Moreover, we find on this record that petitioner's total failure to comply with discovery was undertaken willfully and in bad faith. Fox v. Commissioner,718 F.2d 251">718 F.2d 251 (7th Cir. 1983).8 Respondent's Motion to Impose Sanctions will be granted. DAMAGESThe Congress of the United States in its expressed desire to stem "the ever-increasing caseload of the Tax Court" amended section 6673 and made that amendment applicable*118 "to Tax Court cases begun on or after January 1, 1983." 9Section 6673, as amended, and as applicable to this case, provides-- Whenever it appears to the Tax Court that proceedings before it have been instituted or maintained by the taxpayer primarily for delay or that the taxpayer's position in such proceedings is frivolous or groundless, damages in an amount not in excess of $5,000 shall be awarded to the United States by the Tax Court in its decision. Damages so awarded shall be assessed at the same time as the deficiency and shall be paid upon notice and demand from the Secretary and shall be collected as a part of the tax. Thus, when this Court, in its discretion, *119 determines that a proceeding has been instituted or maintained by the taxpayer primarily for delay or that a taxpayer's position in a proceeding before this Court is frivolous or groundless damages of up to $5,000 "* * * shall be awarded to the United States * * *" under the clear mandate of the statute. We have decided not to impose damages under section 6673 in this case. However, we issue this warning to petitioner. In the event he should institute another case in this Court and maintain it as he has the present case, the Court will seriously consider a damage award which could run as high as $5,000.00. 10 Respondent's oral motion for damages will be denied. An appropriate order and decision will be entered.Footnotes1. All Rule references are to the Tax Court Rules of Practice and Procedure. ↩2. All section references are to the Internal Revenue Code of 1954, as amended. ↩3. This case was assigned pursuant to sec. 7456(c) and (d) and Delegation Order No. 8 of this Court, 81 T.C. XXV (1983).↩4. These represent claimed contributions to the Universal Life Church, Inc. of Modesto, California or an auxiliary thereof. We note that on August 28, 1984 the Office of the District Director, Internal Revenue Service at San Francisco, California, issued a News Release, which took effect on August 28, 1984, and which recites in pertinent part--"Universal Life Church, Inc., also known as the Universal Life Church of Modesto, California (ULCModesto), no longer qualifies for advanced assurance of the deductibility of contributions, according to Michael Sassi, Director of the Internal Revenue Service in San Francisco."↩5. This is the sum and substance of petitioner's case. He has filed no other paper in this proceeding.↩6. See International Air Conditioning Corp. v. Commissioner,67 T.C. 89">67 T.C. 89, 93 (1976); Branerton Corp. v. Commissioner,61 T.C. 691">61 T.C. 691, 692↩ (1974); Rule 70(a)(1).7. Attached to respondent's motion are copies of three letters he sent to petitioner in an attempt to get him to comply with the Court's discovery Rules. With one of those letters respondent enclosed a copy of the Court's Rules and copies of the following opinions of this Court-- Davis v. Commissioner,81 T.C. 806">81 T.C. 806 (1983); McCoy v. Commissioner,76 T.C. 1027">76 T.C. 1027 (1981), affd. 696 F.2d 1234">696 F.2d 1234 (9th Cir. 1983); Murphy v. Commissioner,T.C. Memo 1983-59">T.C. Memo. 1983-59; Swift v. Commissioner,T.C. Memo. 1981-713↩, all of which cases are on point here.8. We observe that venue on appeal of this case lies in the United States Court of Appeals for Seventh Circuit.↩9. The Committee Reports to sec. 292(b), Pub. L. 97-248, state, in pertinent part-- "[T]he committee is concerned with the ever-increasing caseload of the Tax Court and the impact that this legislation may have on that caseload.* * * In addition, the committee decided to increase the damages, i.e., penalty, that may be assessed against a taxpayer when proceedings are instituted for delay, and to expand the circumstances under which the Tax Court may assess those damages." [H. Rept. No. 97-404, p. 11.]↩10. This is intended to warn all persons who would institute similar proceedings and maintain them in a manner such as we see here.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624864/ | M. I. Moore v. Commissioner.Moore v. CommissionerDocket No. 77435.United States Tax CourtT.C. Memo 1959-233; 1959 Tax Ct. Memo LEXIS 12; 18 T.C.M. (CCH) 1119; T.C.M. (RIA) 59233; December 14, 1959*12 Lyman G. Friedman, Esq., and Fred Mitchelson, Esq., National Bank Building, Pittsburg, Kan., for the petitioner. Sylvan Siegler, Esq., for the respondent. WITHEYMemorandum Findings of Fact and Opinion WITHEY, Judge: The Commissioner determined a deficiency in the income tax of petitioner for the taxable year 1954 in the amount of $2,890.30. Petitioner claims an overpayment in her income tax for the year 1954 in the amount of $2,012.87. The issue for determination is whether the fair market value of an undivided onehalf interest in certain real property received by petitioner as a liquidating dividend on October 30, 1954, was not less than $50,125. Findings of Fact Petitioner is a widow and a resident of Pittsburg, Kansas. Her Federal income tax return for the taxable year 1954 was filed with the district director of internal revenue at Wichita, Kansas. Petitioner was the owner of 50 per cent of the capital stock of The Pittsburg Improvement Company, hereinafter sometimes referred to as the corporation. The remaining 50 per cent of the corporation's stock was owned by Arilla R. Moore, petitioner's sister-in-law, and Edwina King, the daughter of Arilla Moore. *13 Among the assets owned by the corporation were the land and building located at the northeast corner of Seventh and Broadway Streets, Pittsburg, Kansas. The building was a two-story brick structure and was commonly known as the Syndicate Building. During the year 1954 the lower floor of the building was occupied by the Kansas Gas and Electric Company, a Western Auto Supply Company store, and other business tenants, and the upper floor was rented to various residential tenants. The Syndicate Building is located in the business district of Pittsburg, a city with a population of approximately 21,000. The area in which the building is located was served by excellent transportation facilities during the year involved herein, and the building was within easy walking distance of the municipal parking lot. Sometime during the year 1954 the three stockholders of The Pittsburg Improvement Company decided to liquidate the corporation and distribute its assets to themselves. It was also decided that the stockholders would attempt to segregate their interests in the corporate properties, and that Arilla Moore and Edwina King would either purchase petitioner's interest in the Syndicate Building*14 or sell their interest in the building to petitioner. On September 27, 1954, the parties met in the office of the attorney representing Arilla Moore and Edwina King for the purpose of submitting and receiving bids on their respective interests in the Syndicate Building. Although both parties made bids based upon the price of the entire property, each party understood that only one-half of the amount bid would ultimately be paid for the other party's interest in the property. Bidding for the petitioner was conducted by her attorney. Prior to such bidding petitioner had instructed him in effect to outbid Arilla Moore and Edwina King; that regardless of the price bid by her opponents they "will find my pocketbook quite deep"; that "she was going to buy it"; that out of all the property her deceased husband and his partner had accumulated it was the only piece of such property she was going to be able to acquire and that therefore she was going to buy it. Petitioner opened the bidding with an offer of $70,000. Arilla Moore and Edwina King then bid $72,500, and the following bids were thereafter made by the parties: Amount of BidParty Making Bid$ 75,000Petitioner77,500Arilla Moore and Edwina King80,000Petitioner82,500Arilla Moore and Edwina King85,000Petitioner87,500Arilla Moore and Edwina King90,000Petitioner92,000Arilla Moore and Edwina King93,000Petitioner94,000Arilla Moore and Edwina King95,000Petitioner96,000Arilla Moore and Edwina King97,000Petitioner98,000Arilla Moore and Edwina King99,000Petitioner100,000Arilla Moore and Edwina King*15 After the $100,000 bid had been made by Arilla Moore and Edwina King, petitioner offered $100,250 for the property. No further bids were thereafter made, and it was agreed that petitioner was to acquire the interest of Arilla Moore and Edwina King in the property for $50,125, one-half of the total amount bid by petitioner. On October 30, 1954, the corporation was dissolved and all of its assets were distributed to the stockholders in exchange for their stock. On the same date petitioner purchased the one-half interest of Arilla Moore and Edwina King in the Syndicate Building for $50,125. In petitioner's income tax return for the taxable year 1954 a value of $40,000 was assigned to petitioner's interest in the Syndicate Building representing one-half of the alleged value thereof. In determining the deficiency herein the Commissioner has assigned as the fair market value of petitioner's interest in that property an amount not less than $50,125. The fair market value ascribed to the building on petitioner's income tax return was based upon an appraisal made on October 5, 1953, by three individuals, who did not appear as witnesses in this case, in which they had determined the*16 fair market value of the property here involved as being $80,000. Subsequent thereto and shortly prior to the hearing of this case a qualified appraiser of real estate who was acquainted with the premises as of October 30, 1954, the date of its sale to petitioner, determined the fair market value of the Syndicate Building and the land upon which it stood to be $65,000 as of that date. The fair market value of the Syndicate Building and land which it occupied as of the date of its sale to petitioner was $100,000, and the fair market value of petitioner's interest therein on said date was $50,000. Opinion Respondent's computation of a deficiency in this case is based upon a determination of fair market value of petitioner's interest in the Syndicate Building and the land it occupied in accordance with the price petitioner paid to acquire the same as shown by our findings of fact. Petitioner contends that because of her emotional involvement with respect to acquisition of the property, arising because of a sentimental value she placed thereon, she cannot be said to have been a willing purchaser acting without compulsion and, therefore, that the sales price relied upon by the respondent*17 is not evidence of the fair market value. It is true that we have held that a sale wherein peculiar circumstances tended to inflate the price at which property is sold is not a proper measure of fair market value. See Estate of A. Plumer Austin, 10 B.T.A. 1055">10 B.T.A. 1055. However, it is not true, as is contended by petitioner, that there is no evidence of fair market value in this case other than that provided by petitioner's expert appraiser. We think the crucial evidence here is the offer to purchase made by Arilla Moore and Edwina King at the time of the bidding for the property. They bid $100,000. There is no showing here that they made other than a willing offer to purchase or that they were under any such compulsion as petitioner has been shown to have been. Nor are they shown to have been without full information concerning the property. We conclude, therefore, that had the petitioner failed to increase her bid by $250, an arm's-length sales transaction would have occurred at that time based upon sale price of $100,000. It is reasonable to conclude also in the absence of any proof by petitioner to the contrary that the offer to purchase by Arilla Moore and Edwina King was*18 not inflated because of any knowledge on their part of petitioner's intention to acquire the property at any price. In fact, it seems clear to us that the true measure of such compulsion as did operate upon the petitioner with respect to her bid of $100,250 is represented by the $250 by which her bid exceeded the last bid of Arilla Moore and Edwina King. It is also worthy of note that the opening bid of $72,500 by Arilla Moore and Edwina King exceeded by $7,500 the fair market value placed upon the premises by petitioner's expert witness and that petitioner's opening bid exceeded that appraisal by $5,000. We are unable to give any significant weight to the appraisal of the fair market value of the premises made by the three individuals upon whose appraisal petitioner based the value of her interest therein in her income tax return. The record does not disclose the qualifications of those appraisers to value the property involved nor does it disclose the purpose of such valuation. We have therefore found as a fact that the fair market value of the Syndicate Building together with the land it occupied as of October 30, 1954, was $100,000, and that the fair market value of petitioner's*19 interest therein on that date was $50,000. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624865/ | CONSUMERS ICE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Consumers Ice Co. v. CommissionerDocket No. 12704.United States Board of Tax Appeals11 B.T.A. 144; 1928 BTA LEXIS 3860; March 22, 1928, Promulgated *3860 1. Evidence held insufficient to show that more than $5,775 should be included in invested capital on account of riparian rights. 2. Special assessment denied. 3. Deficiencies held not barred. Jacob S. Seidman, Esq., and Frank E. Seidman, C.P.A., for the petitioner. John F. Greaney, Esq., for the respondent. SIEFKIN*144 This is a proceeding for the redetermination of income and profits taxes for the fiscal years ended November 30, 1920, and 1921, in the amounts of $6,480.56 and $7,440.86. The only issue raised by the original petition was the exclusion from invested capital of $26,492.46 alleged to have been the cost of riparian rights. By amended petition issues of special assessment and the statute of limitations are also raised. FINDINGS OF FACT. In 1894 petitioner acquired certain riparian rights by issuing therefor $34,200 par value of its stock. Such riparian rights were on Reid's Lake and Fisk's Lake, three and one-half to four miles from Grand Rapids, Mich. In 1894 these lakes were the only points to which there were hard roads by which ice could readily be transported to that city. The total frontage*3861 around Reid's Lake was between four and five miles and around Fisk's Lake about a mile and a half. In 1894 much of the frontage was swampy and much too high for harvesting ice. The commercially advantageous parts of the frontage were owned by six companies engaged in competition in the ice business in Grand Rapids. Five of the companies consolidated to form the petitioner in 1894, appraisals were made of the property of each, and capital stock in the par value of $34,200 was issued for the riparian rights acquired. Prior to the consolidation, it was contemplated that it would result in the elimination of duplication of service in distribution of ice in Grand Rapids and that the volume of business would justify a railroad extension to the lakes to transport the ice to the city. Both these hopes were realized and a railroad line was built in the fall of 1894 and a contract was made with the railroad for hauling at $2 a car. Prior to that it cost 50 cents a ton to haul ice by wagon over the roads. Subsequent to that date, petitioner acquired other riparian rights on these lakes and paid cash therefor as follows: VendorDatePrice paidD. C. UnderwoodNov. 7, 1894$2,500J. Pauldo2,000F. BonnellNov. 30, 1900500H. CollinsDec. 21, 1900$100Pioneer ClubApr. 29, 1903425H. L. SawyerOct. 19, 1911250*3862 *145 The income and profits-tax return of petitioner for the fiscal year ended November 30, 1920, was filed February 3, 1921. On or about January 4, 1926, petitioner executed and filed an instrument entitled "Income and Profits Tax Waiver" for the year 1920, which, by its terms, was in effect until December 31, 1926, except that if a notice of deficiency should be sent petitioner before that date the time should be further extended. The income and profits-tax return of petitioner for the fiscal year ended November 30, 1921, was filed February 7, 1922, and an instrument in all respects, except the year covered, similar to the above "waiver," was signed and filed by petitioner for that year. Both "waivers" introduced in evidence were produced from the files of respondent and each bore a signature purporting to be that of "D. H. Blair, Commissioner." The deficiency letter was dated February 11, 1926. OPINION. SIEFKIN: The principal question at issue is at what amount the riparian rights acquired by the petitioner in and after 1894 may be included in invested capital. The evidence is clear that the amount of $5,775 paid in cash for various properties between 1894 and*3863 1910 should be included, and to the extent that the respondent excluded that amount he is in error. The evidence as to the value of the riparian rights paid in to the corporation for stock, however, in our opinion, falls far short of proving "actual cash value" called for in section 326(a)(4) of the Revenue Act of 1918 and 1921. The petitioner contends that it is entitled to have its excess-profits tax computed as directed by section 328 of the Revenue Acts of 1918 and 1921, respectively, because its invested capital can not be satisfactorily ascertained, and because of the abnormal conditions affecting its invested capital. Before the six ice companies consolidated and formed the petitioner, a representative from each of the companies met and appointed a committee of three to make an appraisal of the value of the riparian rights, sheds and other buildings. The balance of the property of the various companies was appraised by independent appraisers. Two of the members of the riparian rights appraisal committee were Hiram Collins and Frank Bonnell. A witness did not know who the third was. Collins and Bonnell are now dead. The petitioner acquired the riparian rights for*3864 $34,200 of its capital stock, *146 but no evidence was introduced as to the value of the riparian rights as of the time the petitioner acquired them nor of the value of the stock issued therefor. Mere failure on the part of the petitioner to introduce evidence as to the amount of stock issued for intangibles, the value of such stock, and the value of the intangibles at the time of acquisition does not warrant our finding for special assessment. The petitioner advances the further ground for special assessment that abnormal conditions affected its capital and worked upon it an exceptional hardship. The evidence discloses that subsequent to organization the petitioner constructed ice houses, sheds and other additions and betterments to its plant, and such was accomplished by company labor. Prior to 1913 this labor was charged to expense. The salary of the manager, who superintended such work, was never charged to the building account. The petitioner contends that since these amounts can not be now ascertained, thereby precluding their restoration to invested capital, the petitioner is entitled to relief by special assessment. No evidence whatsoever as to the salary*3865 of the manager or the other amounts expended was introduced, and while we have previously allowed special assessment where like items were charged to expense in unknown amounts, yet this alone was not the sole ground. We are of the opinion that insufficient evidence has been introduced to warrant special assessment. The petitioner maintains that the assessment and collection of the proposed deficiencies for the fiscal years 1920 and 1921 are now barred by the statute of limitations. The returns were filed on February 3, 1921, and February 3, 1922, and the deficiency letter was dated February 11, 1926. The petitioner states that since the "waivers" introduced by the respondent, which extended the time for assessment to December 31, 1926, were not shown to have been signed by the respondent and the date of signing was not shown, they do not constitute valid consents to later assessments of the tax. This contention of the petitioner is not well taken. See ; ; *3866 . However, petitioner states that since the instrument executed with regard to taxes for 1920 refers simply to the year 1920, and as it does not designate a "taxable year" or a "fiscal year," it refers only to the calendar year 1920, and that consequently no waiver covers the period December 1, 1919, to December 31, 1919. The primary consideration with regard to waivers is the intent of the parties. It is only reasonable to suppose that when the agreement was entered into the parties intended it to cover the *147 taxable year, and since no showing is made to the contrary, we hold that the waiver in question covered the entire taxable year and assessment of the taxes is not barred. Reviewed by the Board. Judgment will be entered on 15 days' notice, under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624866/ | EDWARD AND KATHLEEN HOLBROOK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentHolbrook v. CommissionerDocket No. 1898-92United States Tax CourtT.C. Memo 1993-383; 1993 Tax Ct. Memo LEXIS 388; 66 T.C.M. (CCH) 484; August 24, 1993, Filed *388 Decision will be entered under Rule 155. Ps operated a farm on which they bred, trained, and sold horses. Ps personally did all the work on the farm, sought and followed expert advice, and kept detailed records. Ps intended to make a profit, but incurred an uninterrupted series of losses. Held: Based on the facts and circumstances of the case, the horse farm was an activity engaged in for profit under sec. 183. For petitioners: Nicholas J. Harding 1 and Robert J. Percy. 1For respondent: Tracy Ann Murphy. LAROLAROMEMORANDUM FINDINGS OF FACT AND OPINION LARO, Judge: Respondent determined deficiencies in and additions to the Federal income taxes of petitioners as follows: Additions to Tax Sec. Sec.YearDeficiency6653(a)6653(a)(1)1979$ 454-- -- 19803,598$ 180-- 19814,702-- $ 23519829,849-- 492198312,861-- 643198410,488-- 524198510,929-- 54619867,832-- --Additions to Tax Sec.Sec.Sec. Year6653(a)(2)6653(a)(1)(A)6653(a)(1)(B) 1979-- -- -- 1980-- -- -- 19811-- -- 19821-- -- 19831-- -- 19841-- -- 19851-- -- 1986-- $ 3921*389 Following concessions by the parties, the issues for decision are: (1) Whether petitioners' horse breeding, training, and sales activity during the taxable years at issue was an activity "not engaged in for profit" within the meaning of section 183 and (2) whether petitioners are liable for additions to tax for negligence for the 1980 through 1986 taxable years under section 6653(a). 2*390 We hold for petitioners on both issues. 3 Unless otherwise indicated, all 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. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations and exhibits attached thereto are incorporated herein by this reference. Edward and Kathleen Holbrook are husband and wife. They filed Federal income tax returns for the years at issue using the status of "Married filing joint return". At the time the petition was filed, they resided in Averill Park, New York. Hereinafter, Edward and Kathleen Holbrook are collectively referred to as petitioners and are separately referred to*391 as Dr. Holbrook and Mrs. Holbrook, respectively. Background of the Horse FarmPetitioners were born in England and moved to the United States in 1974. They have three children: Samantha, born on May 12, 1965; Morgan, born on August 18, 1971; and Courtney, born on May 6, 1977. During the taxable years at issue, petitioners' main source of income was wages earned by Dr. Holbrook. Mrs. Holbrook is an expert in the care, training, breeding, and showing of horses. She began riding horses in England when she was a child. In 1973, she and her daughter Samantha received formal training at the Askern Riding School in England. After moving to the United States in 1974, Mrs. Holbrook and Samantha continued training at the 20-horse stable owned by Carol Northrup (Northrup) in Manlius, New York. In 1977, Mrs. Holbrook's son, Morgan, began training at Northrup's stable. Mrs. Holbrook, Samantha, and Morgan trained at Northrup's stable until 1979. During 1975 through 1979, petitioners became interested in starting a stable similar to Northrup's and discussed this interest with her. Northrup introduced petitioners to horse dealers. In addition, Mrs. Holbrook bought and read voluminous*392 writings with respect to horse breeding and training. Petitioners formed Holly Hill Farms, a horse breeding and training farm (the Farm), in April 1979. Under the tutelage of Northrup, petitioners purchased two horses, Peg O'Me Heart (Peg) and Max. In June 1979, petitioners moved their home and the Farm to approximately 40 acres of land in Killingworth, Connecticut. Mrs. Holbrook continued consulting with Northrup about horse training, horse care, and stables in general. In October 1979, Dr. Holbrook built a barn on the land with the assistance of his father-in-law. In 1983, Dr. Holbrook and his father-in-law extended the barn to accommodate additional stalls, a hayloft, and additional storage space. The property and barn were functional and not for show. The fences and the barn were unpainted. The barn was private and not visible from the main road. The HorsesMax was a 3-year-old gelding purchased for $ 1,250 and Peg was a 4-year-old broodmare purchased for $ 1,250. In 1981, petitioners purchased another gelding (Rebel) for $ 570. Petitioners bought Max and Rebel to train and sell at a profit; Max was sold in 1986 for $ 4,500. Petitioners purchased Peg to breed*393 as a quarter horse; they trained Peg before breeding her. In June 1982, petitioners unsuccessfully attempted to breed Peg. In 1982, petitioners purchased another broodmare, Redhead Judy. Redhead Judy, a thoroughbred, was previously a racing horse, and petitioners retrained Redhead Judy before breeding. In 1983, Peg and Redhead Judy were successfully bred to a stallion recommended by an adviser. The stallion had a respectable lineage and had a stud fee of $ 800 to $ 1,000. In 1984, the mares gave birth. Redhead Judy's foal was sold in 1988, but Peg's foal contracted a disease and died 2 months after birth. In 1985, Peg and Redhead Judy again were successfully bred; in 1986, each gave birth. One of the foals, however, was subsequently destroyed after contracting a disease. Also in 1985, petitioners leased a horse already in foal. In 1986, petitioners attempted to breed one of their mares by artificial insemination. In 1983, petitioners purchased a Shetland pony for $ 500; they sold the pony a few months later for $ 600. Petitioners also purchased two Welsh gelding ponies: (1) Tamarack Sel, a 12-year-old purchased for $ 400, and (2) Liseter Mister Fox, a 4-year-old thoroughbred*394 purchased for $ 6,000. 4 Petitioners sold Tamarack Sel in 1984 for $ 1,400 after petitioners' daughter Courtney earned a good reputation for the horse by showing him on the circuit. In 1984, petitioners purchased and attempted to sell two 4-year-old Welsh gelding ponies: (1) Dan Y Lan Deminuendo, purchased for $ 4,000, and (2) Dan Y Lan Merry Ronnie (Ronnie), purchased for $ 3,365. Both ponies were bought unbroken and had good bloodlines. Courtney trained and showed Ronnie. Mrs. Holbrook took Ronnie to a Florida show for wider exposure. To minimize expenses, Mrs. Holbrook, Samantha, and Courtney drove to Florida, towing the pony by trailer instead of shipping him commercially. In addition, Mrs. *395 Holbrook, Courtney, and Samantha stayed on the show grounds during the 2-1/2 weeks they were in Florida. Through this showing and petitioners' further efforts, Ronnie was subsequently sold for $ 5,500. 5At one point in 1986, petitioners had a total of 10 horses. Of these, seven were purchased, while three were foaled by petitioners' broodmares and sired by stallions owned by others. During the operation of the Farm, petitioners' mares and one leased mare collectively lost two foals to disease, had one spontaneous abortion, and delivered one stillborn. Petitioners' Efforts With the HorsesMrs. Holbrook usually started work on the Farm at 5:30 a.m.; she cleaned the barn and cleaned, fed, groomed, and trained the horses. The children worked several hours a day riding and performing barn work; their weekends were spent showing*396 the horses. Petitioners and the children derived some pleasure from the activity in the warmer months, but found the activity unpleasant in the winter months. Petitioners showed their horses in various shows. Showing the horses made them more salable; the value of the horses would increase if they were successful on the show circuit. During the years at issue, petitioners' three children rode the horses at the shows. Mrs. Holbrook and the children worked long hours at the shows. 6Dr. Holbrook did not ride the horses. However, he performed routine medical care for them, such as giving vaccinations and administering prescription medications. Petitioners would call a veterinarian in cases of emergency, or if there was a problem with a foal. In addition, *397 Dr. Holbrook cleared and maintained the land, built and repaired the fences, worked in the barn, and occasionally took care of the horses. 7Mrs. Holbrook's riding of the horses during the years at issue was limited to "walking" them, after the children rode them, and putting them in their stables. Mrs. Holbrook was involved mainly with the training of the horses and barn maintenance. Petitioners enrolled some of their horses in clinics directed by well-known trainers in 1981, 1983, and 1984. Efforts To Sell the HorsesPetitioners' exhibited their horses in shows and advertised them for sale. Petitioners placed 17 such advertisements in 1984, 15 in 1985, and 10 in 1986 in a weekly publication featuring horses. These advertisements included offers to sell a gelding, *398 filly, ponies, mares, and horse equipment. Petitioners also advertised in local newspapers and in a second horse publication. Petitioners advertised all of their horses for sale at one time or another. Petitioners also contacted show barns and horse dealers who came to the Farm to see the horses. Petitioners took photographs and videos of the horses and mailed them out to potential buyers. Petitioners never refused a purchase offer for any of their horses. Businesslike Operation of the FarmPetitioners retained Thomas Comer (Comer), a certified public accountant, to prepare their 1979 Federal income tax return. After petitioners discussed the Farm with Comer, Comer explained recordkeeping requirements to them. Petitioners kept business records detailing income and expenses 8 and, beginning in 1984, maintained a separate checking account for the Farm. Petitioners and Comer made informal projections of the results of operations. In 1984 and 1985, Comer assisted petitioners in determining the fair market value of their horses. *399 In 1987, petitioners discontinued the Farm. Petitioners sold some of the horses, gave some away, and kept two for the family. The Farm had operating losses from 1979 through 1986 as follows: YearGross IncomeExpenses(Loss)1979-0-$ 2,273$ ( 2,273)1980-0-7,093( 7,093)1981-0-9,396( 9,396)1982$ 1517,127(17,112)198343523,666(23,231)19841,70826,039(24,331)198540024,829(24,429)19864,69020,380(15,690)Petitioners attributed these losses to poor market conditions for the sale of horses. Petitioners also pointed to other uncontrollable factors, such as the death of foals and unsuccessful breeding attempts. OPINION Respondent disallowed petitioners' deductions for their horse breeding, training, and sales activity, having determined that it was not an activity entered into for profit. Section 183 generally limits the amount of expenses that may be deducted with respect to an activity "not engaged in for profit". Sec. 183(a). For this purpose, an activity is "not engaged in for profit" if deductions are not allowable for the taxable year under section 162 or section 212(1) or (2). Sec. 183(c)The test for determining*400 whether a taxpayer conducted an activity for profit is whether he or she entered into, or continued, the activity "with the actual and honest objective of making a profit". Dreicer v. Commissioner, 78 T.C. 642">78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205">702 F.2d 1205 (D.C. Cir. 1983). The taxpayer's expectation of profit need not be reasonable; however, he or she must have a good faith objective of making a profit. Allen v. Commissioner, 72 T.C. 28">72 T.C. 28, 33 (1979); sec. 1.183-2(a), Income Tax Regs.Whether petitioners engaged in their horse operation with the requisite profit objective is to be determined from the facts and circumstances of the case. Golanty v. Commissioner, 72 T.C. 411">72 T.C. 411, 426 (1979), affd. without published opinion 647 F.2d 170">647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(a) and (b), Income Tax Regs. More weight is given to objective facts than to petitioners' statements of their intent. Sec. 1.183-2(a), Income Tax Regs. Petitioners bear the burden of proof. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933).*401 The following factors, which are nonexclusive, aid in determining if an activity is engaged in for profit: (1) The manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation. Sec. 1.183-2(b), Income Tax Regs.No single factor is determinative, Golanty v. Commissioner, supra at 426; sec. 1.183-2(b), Income Tax Regs., and a profit objective does not hinge on the number of factors satisfied, sec. 1.183-2(b), Income Tax Regs. A review of the entire record of this case in the context of these factors persuades us that petitioners engaged in the activity with the requisite profit motive. The following factors favor petitioners: The manner*402 in which petitioners carried on the activity; the expertise of petitioners or their advisers; the time and effort expended by petitioners in carrying on the activity; and the expectation that assets used in the activity may appreciate in value. The following factors are found to be neutral: Petitioners' history of income or loss from the activity and the activity's elements of personal pleasure or recreation. With respect to the manner in which petitioners carried on the activity, one indicium of an activity engaged in for profit is a taxpayer's businesslike conduct of an activity. Sec. 1.183-2(b)(1), Income Tax Regs. This includes the keeping of complete and accurate books and records. Id. Petitioners did so. Petitioners adopted a different breeding technique, artificial insemination, to maintain the Farm's breeding productivity; this is another indication of their profit motive. Sec. 1.183-2(b)(1), Income Tax Regs. Other indications of petitioners' businesslike manner were their attempt to minimize their expenses in an effort to increase profitability, and their advertisements and other sales efforts. With respect to the expertise of petitioners or their advisers, preparation*403 for an activity by extensive study of its practices or by consultation with experts may indicate that a taxpayer has a profit motive where the taxpayer follows such advice. Sec. 1.183-2(b)(2), Income Tax Regs. In this regard, petitioners sought and followed advice from successful horse breeders and trainers. Moreover, Mrs. Holbrook is an expert in the care, training, breeding, and showing of horses. In preparing for the activity, a taxpayer need not make a formal market study, but should undertake a basic investigation of the factors that would affect profit. Underwood v. Commissioner, T.C. Memo. 1989-625; Burger v. Commissioner, T.C. Memo. 1985-523, affd. 809 F.2d 355">809 F.2d 355 (7th Cir. 1987). Based on the facts of this case, we conclude that petitioners made an adequate investigation. While petitioners did not conduct a formal market study, they did consult informally with their C.P.A., successful horse breeders, and trainers, all of which demonstrated their intent to engage in this activity for profit. See Engdahl v. Commissioner, 72 T.C. 659">72 T.C. 659, 668 (1979) (although*404 no formal market study was conducted, petitioners' informal and continuous consultations with their trainer, other breeders, and veterinarians adequate to demonstrate profit motive). Another factor to consider is the time and effort expended by petitioners in carrying on the activity. Sec. 1.183-2(b)(3), Income Tax Regs. Based on the record, petitioners have demonstrated that the time and effort they devoted to the Farm was indicative of a profit motive. Another factor to consider is petitioners' expectation that assets used in the activity may appreciate in value. Sec. 1.183-2(b)(4), Income Tax Regs. Petitioners purchased all their geldings with the expectation that they would increase in value after they were trained and shown. With respect to petitioners' history of losses from the activity, losses continuing beyond the period customarily necessary to make the operation profitable, if not explainable, may indicate that the activity is not engaged in for profit. Sec. 1.183-2(b)(6), Income Tax Regs. All the same, a profit objective may exist despite a history of losses unaccompanied by any gains. Bessenyey v. Commissioner, 45 T.C. 261">45 T.C. 261, 273-274 (1965),*405 affd. 379 F.2d 252">379 F.2d 252 (2d Cir. 1967). Moreover, a series of losses at the beginning or startup stage of an activity does not mean that the activity is not engaged in for profit. Sec. 1.183-2(b)(6), Income Tax Regs. In this regard, we note that the startup phase of an American saddle-bred breeding operation is 5 to 10 years, Engdahl v. Commissioner, supra at 669; Pirnia v. Commissioner, T.C. Memo. 1989-627, and the years at issue fall within this period. This factor does not indicate lack of a profit motive. 9With respect to elements of personal*406 pleasure or recreation, the regulations state that "The presence of personal motives in carrying on an activity may indicate that the activity is not engaged in for profit, especially where there are recreational or personal elements involved". Sec. 1.183-2(b)(9), Income Tax Regs. However, the mere fact that a taxpayer derives personal pleasure from engaging in an activity does not, in and of itself, mean that the activity is not engaged in for profit if other factors show otherwise. Id. In the case at hand, the elements of recreation are not so great as to indicate that the activity was not engaged in for profit. Petitioners were not merely "horsing around"; the Farm demanded many hours of hard physical labor. While the family may have derived some pleasure from the activity, it was not enough to indicate a lack of a profit motive. 10Based on all the facts and circumstances of the case, we hold that petitioners*407 began and operated the Farm with the requisite profit objective during the years at issue. Accordingly, we sustain for each year petitioners' deductions relating to the Farm. Respondent determined additions to tax for negligence under section 6653(a) with respect to the Farm and the conceded automobile expenses, see supra note 3. Negligence under section 6653(a) is defined as lack of due care or failure to do what an ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). In light of our holding that the Farm was engaged in for profit, we need not address whether petitioners are liable for the additions to tax for negligence with respect to the Farm. Finally, we hold that petitioners were not negligent with respect to the additional automobile expenses when we view the whole record. To reflect the foregoing, Decision will be entered under Rule 155. Footnotes1. Petitioners were originally represented by Nicholas J. Harding. Before trial, the Court allowed Mr. Harding to withdraw from the case.↩1. This amount is 50 percent of the interest due on the deficiency.↩2. With respect to the 1981 taxable year, the parties stipulated that respondent failed to issue a notice of deficiency to petitioners within the statutory period of limitations. See sec. 6501(a). Accordingly, the assessment or collection of any tax otherwise due for that year is barred by the statute of limitations, and we conclude there is no deficiency in 1981. Sec. 7459(e). Although petitioners did not raise the expiration of the statutory period of limitations in their petition, the parties expressly or impliedly raised this issue through a stipulation. See Rule 41(b). On brief, respondent conceded that petitioners have no deficiency for the 1981 taxable year.↩3. Respondent's notice of deficiency included her determinations that petitioners may not deduct $ 2,462 and $ 3,137 of the amounts reported as automobile expenses on their 1982 and 1983 Federal income tax returns, respectively, and are liable for the additions to tax for negligence under sec. 6653(a)(1) and (2)↩ with respect to these deductions. Petitioners conceded these additional automobile expense deductions. However, as discussed below, we hold that petitioners are not liable for the additions to tax for negligence that respondent determined with respect to these amounts.4. Petitioners purchased Liseter Mister Fox on the recommendation of one of their advisers. The horse was bought for training and resale. Liseter ponies generally have a good reputation and, by training the pony themselves, petitioners expected a large profit from an anticipated selling price of $ 10,000 to $ 20,000.↩5. Petitioners advertised Ronnie in a weekly horse publication and sent videos to potential buyers. The purchaser of Ronnie contacted Mrs. Holbrook after seeing the advertisement.↩6. Mrs. Holbrook generally started preparing the horses at 3 a.m. for transportation to the show, and the shows lasted until after dark. Following the show, Mrs. Holbrook and the children returned home, where they tended to and stabled the horses that were shown.↩7. Dr. Holbrook cleared the land himself to reduce expenses; petitioners previously employed someone to clear the land for a riding lane, but it was becoming too expensive, so Dr. Holbrook bought a bulldozer and personally continued the work.↩8. Respondent conceded that petitioners substantiated all claimed expenses with respect to their operation of the Farm.↩9. We note that losses due to fortuitous circumstances such as depressed market conditions or disease are not an indication that the activity is not engaged in for profit. Sec. 1.183-2(b)(6), Income Tax Regs.↩ In the instant case, petitioners had difficulty breeding their mares and lost foals. Petitioners also had difficulty selling their horses because of bad market conditions.10. We also note that the stables were not on petitioners' residential property as a "showcase".↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624867/ | MORRIS & BAILEY STEEL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Morris & Bailey Steel Co. v. CommissionerDocket No. 9492.United States Board of Tax Appeals9 B.T.A. 205; 1927 BTA LEXIS 2641; November 21, 1927, Promulgated *2641 Expenditures for capital assets disallowed as deductions. Henry O. Evans, Esq., for the petitioner. Wm. H. Lawder, Esq., for the respondent. TRAMMELL*205 This is a proceeding for the redetermination of deficiencies in income and profits taxes for 1919 and 1920 in the amounts of $508.50 and $15,698.55, respectively. The issues set forth in the assignments of error in the petition are seven in number, which were reduced to four by the abandonment of three issues by the petitioner. The remaining four issues are: The disallowance by the Commissioner as deductions in determining the petitioner's net taxable income of (1) the amount of $1,300 representing an expenditure for a screw down in 1919; (2) an item of $1,050 representing an expenditure for a set of delivery guides for a 10-inch strip mill; (3) an amount of $10,341.71 representing an adjustment of inventory of used rolls in 1920; and (4) an amount of $14,763.72 representing an expenditure for annealing covers in 1920. *206 FINDINGS OF FACT. The petitioner is a Pennsylvania corporation with its principal office in Pittsburgh. Subsequent to the filing of its income and profits-tax*2642 return for 1919 and 1920, the petitioner has been merged with the Oliver Iron & Steel Co. to form the Oliver Iron & Steel Corporation. The petitioner is a manufacturer of cold rolled steel. During 1919 it expended $1,300 for a screw down for a 12-inch mill. This screw down was to take the place of another screw down which the petitioner removed during that year in order to replace with one of a newer design. The old screw down had been in use about 2 1/2 years when the new one was acquired in 1919. Some of the petitioner's mills are still equipped with screw downs similar to the one which was discontinued in 1919. The screw down purchased for $1,300 to replace the old one was still in use at the date of the hearing of this proceeding. In 1919 the petitioner also acquired, at a cost of $1,050, a set of 16-inch delivery guides for a 10-inch strip mill to replace other guides then in use. The new guides were purchased because they embodied a new design working on an improved method which resulted in more profitable operation of the mill. The old delivery guides with a 10-inch face were in use in the mill in 1919 and one of the same style is still in use. The 16-inch delivery*2643 guides which were purchased in 1919 are still in use and the old guides were discontinued and thrown on the scrap heap. The rolls in use in petitioner's steel plant were measured by steel calipers in 1920. The conclusion was reached that approximately 35 per cent of the life or useful diameter of all used rolls throughout the mill had been exhausted. The practice of the petitioner up to 1920 had been not to charge a roll off the books or to charge depreciation in respect thereof until such roll was worn out or broken. This method was changed in 1920 when the petitioner had the rolls calipered or measured and arrived at an estimated average of the amount worn off or exhausted in respect of rolls used in the plant. There were approximately 150 rolls in use at December 31, 1920. Some of these rolls had been used for several years prior to 1920. All of these rolls were "inventoried" as "used rolls." The estimated average of 35 per cent exhaustion took into consideration the wearing down of several years prior on some of the rolls "inventoried" December 31, 1920. The useful diameter of a roll was approximately three-fourths of an inch. The rolls were of two kinds, some cast*2644 iron and some steel. The life of the steel rolls is estimated at about six times the life of the cast iron rolls. The petitioner inventoried its used rolls on the *207 basis of cost or market, whichever was lower, and wrote off the amount of 35 per cent of the inventory price as of December 31, 1920, which inventory price was $29,559.90. The "inventory" at the end of 1920 was the petitioner's first attempt at writing off exhaustion of its used rolls on hand and in use. In the latter part of 1919 or the early part of 1920, the petitioner acquired 14 cast-steel annealing covers. It purchased the cast-steel covers because of its inability at that time to purchase place-steel covers. The cast-steel covers warped and let in oxygen which spoiled the annealing. The use of the cast-steel covers cut down the tonnage produced and added materially to the cost of operation. As soon as it was possible to acquire the plate-steel covers the cast-steel covers were discontinued in use and abandoned. They were removed and abandoned, not because of any exhaustion, wear and tear, but because they could not be profitably used. The covers which were abandoned cost $14,763.72. The residual*2645 value of these covers was nothing. The expense of cutting them up for salvage purposes or scrap would cost more than the amount that could be realized on the sale of same as scrap. They were effectually discarded and permanently abandoned in 1920. OPINION. TRAMMELL: The first question is whether the expenditure of $1,300 for a new screw down is deductible as an ordinary and necessary expense, or whether it is a capital expenditure to be depreciated over a physical life of more than one year. From the evidence we are convinced the the expenditure was for a replacement, that the asset acquired had a life of more than a year and that the expenditure constitutes a capital outlay and is not deductible in computing net taxable income for 1919. The screw down in question was still in use at the date of the hearing of this proceeding. The matter of a deduction on account of the old screw down which was replaced by the new one is not involved in this proceeding. On the question of the purchase of the new 16-inch guides to replace guides which at the time were in use, it appears that the new guides were in use at the date of the hearing of this proceeding and that they had been*2646 used since 1919. There is no evidence that they were not in good condition and will probably last many years longer. It is clear, therefore, that the acquisition of the said guides represents a capital expenditure which is not allowable as a deduction in determining taxable income. There is no question presented here as to any deduction with respect to the guides which were replaced. On the question of the inventory of used rolls, it appears that the petitioner included the same in its inventory on the basis of cost or *208 market, whichever was lower, and that it reduced its inventory by 35 per cent in 1920 on account of depreciation sustained in that year as well as in previous years, no deduction on account of the exhaustion for previous years having been taken or written off until the rolls were worn out or broken. On the rolls which were not used in 1920 no deduction had been taken. While it may be that the actual measuring of the diameter of the rolls would be a fair and reasonable method of determining the actual exhaustion sustained, the deduction on account of exhaustion of assets can not be accumulated and taken in one year with respect to exhaustion which*2647 occurred in prior years. The amount allowable for exhaustion, wear and tear is an annual deduction and is based upon the exhaustion sustained during the taxable year. We do not agree with the petitioner that the rolls should be included in inventory on the basis of cost or market, whichever is lower. Inventories, referred to in the statute, relate to stock in trade or materials or supplies which are used in the manufacturing process and which become a part or ingredient of the manufactured article and do not refer to capital assets such as machinery which is used in manufacturing the article. The 35 per cent reduction of the inventory price of the rolls represents an average wear or exhaustion on all the rolls whether acquired in 1920 or in prior years. There is insufficient evidence in the record to enable the Board to determine the amount of exhaustion suffered during the taxable year 1920 with respect to the rolls in use during that year. We must, therefore, affirm the determination of the Commissioner on this question. With respect to the annealing plates, we think a preponderance of the evidence supports the position of the petitioner that these plates were actually*2648 and permanently abandoned and scrapped during the taxable year 1920. Their depreciated cost was therefore a proper deduction for that year. Judgment will be entered on 15 days' notice, under Rule 50.Considered by MORRIS, MURDOCK, and SIEFKIN. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624868/ | JAMES F. ALLEN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAllen v. CommissionerDocket No. 4774-83.United States Tax CourtT.C. Memo 1985-329; 1985 Tax Ct. Memo LEXIS 305; 50 T.C.M. (CCH) 338; T.C.M. (RIA) 85329; July 3, 1985. Steven Roth, for the respondent. DRENNENMEMORANDUM OPINION DRENNEN, Judge: This case was assigned to Special Trial Judge Helen A. Buckley pursuant to section 7456 of the Code and Rules 180 and 181. 1 The Court*306 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 oral motion to dismiss for failure properly to prosecute. Respondent determined deficiencies in petitioner's Federal income taxes for the year 1980 in the amount of $4,387.80, together with additions to tax under section 6651(a) in the amount of $1,096.95, under section 6653(a) in the amount of $219.39 and under section 6654(a) in the amount of $280.81. The deficiency notice was based upon unreported income in the amount of $21,620. Petitioner timely filed his petition with this Court in which he alleged that he was a resident of El Monte, California. In addition, petitioner made various allegations of a tax-protester nature. Thus, he alleged that he was not required to file an income tax return or pay an income tax for 1980, that he received nothing during that year of known tangible value, that he enjoyed no grant of privilege*307 of franchise and that he did not volunteer to self-assess himself for taxes. Petitioner filed a request for a jury trial which was denied. Respondent moved for leave to file an amendment to his answer which was granted. The amendment to answer alleged that the unreported income of petitioner for the year 1980 was $33,999.46, rather than $21,620 as set forth in the Statement of Income Tax Audit Changes which was a part of the statutory notice of deficiency. The amendment to answer went on to allege that petitioner's income tax deficiency for 1980 was $9,281.76, and the additions to tax under sections 6651(a), 6653(a) and 6654(a) were $2,252.92, $464.09 and $572.43, respectively. Petitioner failed to respond to the call or the recall of the calendar on August 28, 1984. Respondent bore his burden of proving that petitioner received income in 1980 as an employee of Von's Grocery Company in the amount of $33,999.46. The petition filed herein makes it clear that petitioner failed to report this amount, or indeed any other amount, on a tax return for 1980. We hold that petitioner received $33,999.40 in compensation for services in 1980 and that he failed to report that amount or*308 any other amount on a tax return for that year. The Court takes judicial notice that petitioner is one of several hundred persons in the southern California area who have filed petitions and other papers with this Court of a substantially identical nature. 2A notice of deficiency is ordinarily presumed correct, and the taxpayer bears the burden of proving that respondent's determination of his taxable income is erroneous. ; Rule 142(a). As to the increases in deficiency for the year 1980, however, Rule 142(a) places the burden of proof upon respondent. We have held that respondent has borne that burden. Petitioner, by failing to respond to the call and recall of the calendar, has refused to prosecute his case or to offer evidence in regard to it. Rules 123(b) and 149(b) provide: RULE 123.DEFAULT AND DISMISSAL * * * (B) Dismissal: For failure*309 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 and which has not been conceded by his adversary, may be ground for dismissal or for determination of the affected issue against that party. * * * The allegations of petitioner in his petition are so frivolous and groundless as not to warrant any extended discussion. See . We would be doing a disservice to those petitioners who come before this Court with valid controversies were we to expend our time and resources on exhaustive analyses of each meritless allegation of petitioner. In*310 any event, petitioner, by failing to appear to present evidence and by failing otherwise properly to prosecute this matter, has made himself subject to dismissal under Rules 123 and 149. In addition, respondent has requested by oral motion the imposition of damages under section 6673. That section, as in effect for May 1983 when this petition was filed, gives this Court authority to award damages up to $5,000 when proceedings have been instituted or maintained by the taxpayer primarily for delay or where the position in such proceedings is frivolous or groundless. See sections 292(b) and (e)(2), Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 324, 574. This petition is frivolous and groundless. Damages in the amount of $5,000 are awarded to the United States. An appropriate order and decision will be entered.Footnotes1. Section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. Rule references are to the Tax Court Rules of Practice and Procedure.↩2. See, e.g., ; ; ; .↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624869/ | Sheraton Plaza Company, Petitioner, v. Commissioner of Internal Revenue, RespondentSheraton Plaza Co. v. CommissionerDocket No. 89380United States Tax Court39 T.C. 697; 1963 U.S. Tax Ct. LEXIS 206; January 18, 1963, Filed *206 Decision will be entered for the petitioner. Cancellation by petitioner's sole stockholder of debt previously created by unrelated tenant and assumed by petitioner's agreement with its stockholder when petitioner's property was acquired from original debtor, held, on facts, not to result in income taxable to petitioner. Robert J. Richards, Jr., Esq., for the petitioner.Albert R. Doyle, Esq., and John C. Galluzzo, Jr., Esq., for the respondent. Opper, Judge. OPPER*697 Respondent determined a deficiency in income tax for the fiscal year ending April 30, 1954, of $ 37,557.19. The deficiency*207 is based solely upon the determination that petitioner realized income upon the cancellation of indebtedness owed to its sole shareholder. The parties have stipulated some of the facts.FINDINGS OF FACT.The stipulated facts are hereby found accordingly.Petitioner is a corporation organized under the laws of the Commonwealth of Massachusetts on September 11, 1941. It was originally organized under the name of "Copley Plaza Company," which was subsequently changed to "Sheraton Plaza Company." For all taxable years relevant to this proceeding, petitioner filed its Federal income tax returns with the district director of internal revenue, Boston, Massachusetts, on an accrual method of accounting for the fiscal year ending April 30 of each year.From September 11, 1941, to the present, all of the outstanding capital stock of petitioner was owned by the Copley Square Trust (hereinafter called the trust). The trust was organized under the laws of the Commonwealth of Massachusetts as a trust with transferable shares and is taxable as a corporation under the Federal income tax laws. Sheraton Corporation of America (hereinafter called Sheraton), a New Jersey corporation, was a shareholder*208 of the trust during all years relevant to this proceeding, owning the following percentages of the outstanding voting shares of the trust on the dates indicated: September 1, 1941 -- 34 percent; April 30, 1953 -- 91.2 percent; April 30, 1954 -- 92.5 percent; and March 28, 1956 -- 95 percent.For several years prior to and including its taxable year ended April 30, 1954, and for all subsequent taxable years, Sheraton and several of the corporations of which it was majority stockholder filed consolidated income tax returns on an accrual method of accounting. The trust and petitioner were not members of the affiliated group included in Sheraton's consolidated income tax returns through the taxable year ended April 30, 1954. Commencing with the taxable *698 year ended April 30, 1955, and for all subsequent taxable years, petitioner and the trust were members of the affiliated group included in Sheraton's consolidated income tax returns. Through the fiscal year ended April 30, 1954, the trust maintained its books and records and filed its Federal income tax returns on a cash or "modified cash" method of accounting. For the fiscal year ended April 30, 1955, and for subsequent fiscal*209 years, the trust was included in the consolidated income tax returns filed by Sheraton, which were on an accrual basis.During all years relevant to this proceeding, Ernest Henderson was president of Sheraton and of petitioner and was a trustee of the trust and Robert L. Moore was treasurer of Sheraton and of petitioner and was a trustee of the trust.From the date of its organization to the present, petitioner has operated a hotel in the city of Boston, Massachusetts, originally known as the Copley Plaza and now known as the Sheraton Plaza. From 1912 until September 11, 1941, the hotel in question had been operated by Copley Plaza Operating Company (hereinafter called the operating company). Since 1912 and during all years relevant to this proceeding, the land and buildings constituting the hotel were owned by the trust and up to September 1, 1941, were leased to the operating company and, since then, to petitioner.On May 31, 1939, the trust and the operating company, as landlord and tenant, respectively, amended the existing lease of the hotel, in part, as follows:2. For three years and seven months beginning with June 1, 1939, in lieu of the rent and other payments provided*210 in said lease as extended, the rent shall be as provided in clause 4 hereof.* * * *4. In lieu of the rent and other payments provided in said lease as extended, the Lessee [operating company] will pay to the Lessors [the trust] * * * a sum equal to all the Lessee's net profits, if any, from the operation of said Hotel during the preceeding three months * * *; but such payments by the Lessee shall not in any event exceed the amount stipulated in said extended lease for the period involved. In determining the Lessee's net profits, there shall be deducted all taxes paid by the Lessee and a manager's salary as may be agreed upon from time to time by the Lessors and the Lessee, but no executive salary shall be deducted. Notwithstanding the foregoing, the Lessee, in order that it may have on hand sufficient cash for operating expenses, shall not be required to make to the Lessors payments as aforesaid to an amount which will reduce its available cash in bank and on hand below $ 25,000; and the Lessee may retain, to use as aforesaid, $ 25,000 from its cash in bank and on hand on June 1, 1939; but without thereby being released from its (the Lessee's) obligation to account to the Lessor's*211 for the same on January 2, 1943 or on the earlier termination of this agreement. * * ** * * *9. During the three years and seven months beginning June 1, 1939, the Lessee will not pay any dividends on its capital stock, nor any salary or other remuneration to any officer or director of the Lessee except if and while he is manager of said Hotel, or (except as otherwise herein provided) incur debts except *699 rent at any one time in excess of cash in bank and in hand and accounts receivable less reserves as determined by the Lessors' auditors.10. The Lessors hold a chattel mortgage from the Lessee dated June 22, 1932 * * *.11. * * * It is agreed, however, that said mortgage shall secure, in addition to the sums provided for by an unrecorded indenture dated June 22, 1932 between the Lessee and the then trustees of * * * [the trust], the amount by which the rent and other payments due under the lease of said Hotel as extended, are reduced by this agreement, subject to adjustments from time to time by reason of payments received by the Lessors under clause 4 hereof.* * * *14. On December 31, 1942, or upon the termination of this agreement by the Lessors under clause 16, or*212 upon the failure of the Lessee to perform or observe any of its covenants or agreements contained in said lease, * * * the Lessee will, on such termination, expiration or breach, do all reasonable acts necessary or proper to secure to the Lessors the full possession and use of the leased real estate and the mortgaged personal property, if the mortgage has not been foreclosed prior thereto (including similar property acquired since the last preceding mortgage and put in said Hotel), and the business of said Hotel, in such manner as to enable the Lessors to continue without loss or interruption the business of operating said Hotel, and the Lessee will immediately turn over to the Lessors all its cash in Bank and in hand, bills receivable, licenses, permits, guest-registers and all books of account and records pertaining to the business, or copies thereof, and the Lessors may immediately take possession of the same; and the Lessee further covenants that in case of such entry the Lessors may immediately take, for their own use, without payment, the whole or any part of all supplies belonging to the Lessee then in the said Hotel, including fuel, provisions, beverages and all supplies of*213 a perishable nature. * * *15. The Lessors shall as promptly as possible from the property other than mortgaged property which under clause 14 they receive from the Lessee satisfy all current obligations and debts incurred by the Lessee in accordance with clause 9 hereof. They shall then reimburse themselves for any rent due under this agreement and shall pay to the Lessee any balance remaining but in no event more than $ 29,686.86; and thereupon neither party shall have any further claim against the other by reason of said lease, or any modification thereof, or otherwise, and the Lessors will, if the Lessee so requests, discharge any or all then outstanding mortgages of the Lessee held by them.16. The Lessors may terminate this agreement at any time by written notice to that effect * * *.Until August 29, 1941, the stockholders of the trust and the operating company had been unrelated. On that date the trust purchased all of the outstanding shares of capital stock of the operating company for $ 29,686.86. * The balance sheet of the operating company for August 31, 1941, showed:AssetsCash on hand and in banks$ 51,005.41Accounts receivable, less reserve for doubtful accounts45,667.28Due from officer and employees3,264.29Inventories of food, beverages, fuel oil, and supplies41,284.19Prepaid expenses and deferred charges5,966.48Linen, china, glassware, and uniforms28,143.36Fixed asset, front office bookkeeping machine3,007.00Total assets178,338.01LiabilitiesAccounts payable$ 47,298.89Accrued expenses25,310.56Credit balances in accounts receivable87.91Due to employees for locker key deposits, etc13.50Rent due trustees of the Copley Square Trust75,930.29Total liabilities148,641.15CapitalCapital stock$ 75,000.00Deficit45,303.14Total capital* 29,696.86Total liabilities and capital178,338.01*214 *700 On September 11, 1941, the trust and the operating company agreed to terminate the lease and further agreed, in part, as follows:2. The parties hereto agree that the Lessee shall remain in possession of said Copley Plaza Hotel until such time as the Lessee shall transfer all of its assets to a new corporation to be organized for the purpose of taking over the property of the Lessee and that said possession and operation of said property from the period after the termination of said lease shall be for the account of said new corporation.On the same day, the trustees adopted a Plan of Reorganization and Liquidation of the operating company, which provided, in part, as follows:Operating Company owes [the trust] for unpaid rent up to August 31, 1941.* * * *[Petitioner] * * * is a new Massachusetts corporation organized, or to be organized for the purpose of carrying out this plan of reorganization and liquidation.Operating Company will transfer all of its assets*215 to * * * [petitioner] in exchange for the issue to Operating Company of 750 shares of Capital Stock of [petitioner] (being all of the stock of [petitioner] now to be issued) and the assumption by [petitioner] of all liabilities and contract obligations of Operating Company other than the indebtedness of Operating Company to [the trust] for unpaid rent. The furniture and fittings of Copley Plaza Hotel which belong to Operating Company are subject to chattel mortgages to [the trust] to secure the unpaid rent, but there is no liability on Operating Company for the unpaid rent beyond such amount as may be realized from the mortgaged property by foreclosure. The furniture and fittings will be transferred to [petitioner] subject to the lien of said mortgages and without the assumption by [petitioner] of the liability secured by the said mortgages. The transfer contemplated hereby shall be made as of September 1, 1941 and all transactions by Operating Company since that time shall be deemed to have been made for the account of [petitioner].Operating Company will transfer to [the trust] all the stock of [petitioner] thus received as a final distribution in liquidation and will dissolve. *216 Pursuant to the Plan of Reorganization and Liquidation, the operating company assigned and transferred to petitioner (effective *701 as of September 1, 1941) all of its cash, accounts receivable, inventories, merchandise, supplies, licenses, and all furniture, fittings, and equipment, subject to certain chattel mortgages held by the trust on the furniture, fittings, and equipment, solely in exchange for 750 shares of petitioner's capital stock, being all of the capital stock of petitioner issued and outstanding. In addition, petitioner assumed all indebtedness of the operating company exclusive of any indebtedness of the operating company to the trust for unpaid rent.By an agreement dated March 28, 1942, the Plan of Reorganization and Liquidation was amended, in part, as follows:WHEREAS, under agreements between Operating Company and Trustees, Operating Company had not been required to make payments of rent currently payable, and not otherwise postponed, of amounts which would reduce its available cash on hand and in banks below $ 25,000.00, and as a result of such provision Operating Company owed to Trustees on August 31, 1941, on account of such withheld payments an amount*217 of approximately $ 75,000.00 in addition to other amounts of rent which had been postponed and the payment of which was limited by agreement to the amount which should be realized from the foreclosure of the chattel mortgage securing the same; andWHEREAS, it was the intention of the parties that [petitioner] should assume the liability of Operating Company to Trustees for the withheld rental payments amounting to approximately $ 75,000.00 but should not assume the liability of Operating Company for the remainder of the unpaid rent, and the provision of the Plan of Reorganization and Liquidation of [operating company] involves a mutual mistake to that extent:* * * *[Petitioner will assume] all liabilities and contract obligations of Operating Company other than the indebtedness of Operating Company to [the trust] for unpaid rent, except approximately $ 75,000.00 being the amounts withheld from time to time to enable Operating Company to maintain a cash position of $ 25,000.00 at the end of each rental payment period. * * *By this amendment, petitioner assumed a liability amounting to $ 75,930.29, which was subsequently reduced to $ 37,225.36 by cash payments by petitioner *218 and other adjustments.By another agreement also dated March 28, 1942, the trustees of the trust released and discharged all of the chattel mortgages previously given by the operating company to the trust to secure, in part, liabilities for unpaid rent and petitioner assumed and agreed to pay on open account to the trust the sum of $ 35,000, which was the agreed value of the furniture, furnishings, and equipment which had been subject to the chattel mortgages.For the taxable periods commencing January 1, 1933, and ended August 31, 1941, the operating company claimed as deductions for Federal income tax purposes all rent currently payable to the trust. As the trust was on a cash basis for Federal income tax purposes, the amounts owed by the operating company to the trust for unpaid rent for the period commencing January 1, 1933, and ending August 31, *702 1941, were not reported as income on the Federal income tax returns of the trust for such periods.From September 11, 1941, through its fiscal year ended April 30, 1947, petitioner had claimed as deductions for Federal income tax purposes the total amount of rent payable to the trust under the various lease agreements which *219 were in effect during this period. As the trust was on a cash basis during this period, the trust had only reported as taxable the amount of rent actually received.During 1951 the trust and petitioner agreed to the assessment of deficiencies in Federal income taxes relating to their respective taxable years from 1941 to April 30, 1947, based on adjustments of the rental income reported by the trust and the rental deductions claimed by petitioner. Pursuant to the agreement of settlement, the trust was required to treat as constructively received a certain amount of the rent payable by petitioner to the trust from and after January 1, 1942, whether or not paid, and petitioner agreed to deductions for such periods limited to the amounts which the trust was required to report as income. The settlement with the Internal Revenue Service did not involve the obligations of the operating company to the trust assumed by petitioner as of September 1, 1941.As a result of this settlement, the accountants of the trust recommended that the trust account for liabilities owed by petitioner to the trust be segregated so that the amounts which the trust agreed to treat as having been constructively*220 received could be received tax free by the trust in future years. To avoid complication in the future, the accountants suggested that the indebtedness of petitioner to the trust be segregated on petitioner's books, reflecting the amount of accrued rent which the trust had agreed to treat as constructively received, the amount of accrued rent in excess of the amount allowed as a deduction to petitioner pursuant to the agreed settlement, and the amount of $ 72,225.36 which had been assumed by petitioner as of September 1, 1941, at the time it acquired the assets of the operating company. The accountants further suggested that the trustees forgive the amount of accrued rent owed by petitioner which was disallowed as a deduction to petitioner in accordance with the settlement with the Internal Revenue Service.During petitioner's fiscal year ended April 30, 1953, the trustees of the trust forgave indebtedness owed by petitioner in the amount of $ 125,811.95, representing that portion of the amount of accrued and unpaid rent owing by petitioner to the trust for the period from September 1, 1941, through April 30, 1951, which had been disallowed as a deduction to petitioner in accordance*221 with the agreed settlement with the Internal Revenue Service. Appropriate entries were made in petitioner's books of account to restore the amount forgiven to its *703 surplus account. In addition, the liabilities of petitioner to the trust were segregated as the accountants had suggested.For some time prior to October 16, 1953, petitioner's officers had been concerned about the Federal income tax effect of the aggregate amount of $ 72,225.36 owed by petitioner to the trust if the trust and petitioner were included in the Federal consolidated income tax return of Sheraton and its subsidiaries.Upon the advice of their accountants and attorneys, the trustees of the trust canceled and forgave the indebtedness of petitioner to the trust in the aggregate amount of $ 72,225.36, representing the liabilities originally due from the operating company to the trust remaining unpaid as of that date. The cancellation and forgiveness of the indebtedness of petitioner to the trust was recorded on petitioner's books as follows:Debit -- Trustees of Copley Square Trust --Balance at September 1, 1941$ 72,225.36Credit -- Paid-in surplus$ 72,225.36To close out balance*222 in amount of $ 72,225.36 as of September 1, 1941, in accordance with the vote of the Trustees of Copley Square Trust on October 16, 1953.The trust recorded the cancellation and forgiveness of indebtedness on its books as follows:Debits -- Investments, Sheraton Plaza Company$ 72,225.36Credit -- Accounts receivable -- Sheraton PlazaCompany account$ 72,225.36To close out indebtedness in the amount of $ 72,225.36 as of September 1, 1941, in accordance with the vote of the Trustees of Copley Square Trust on October 16, 1953.In his deficiency notice, respondent determined that "the cancellation of indebtedness in the amount of $ 72,225.36 owed by you to your sole stockholder * * * constitutes income taxable to you in that amount."The cancellation of indebtedness in the amount of $ 72,225.36 resulted in no taxable income to petitioner in its fiscal year 1954.OPINION.In dealing with the vexed problem of the receipt of income from cancellation of indebtedness, it is important to consider not only the circumstances under which the debt was forgiven, United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1 (1931); Helvering v. Amer. Chicle Co., 291 U.S. 426 (1934);*223 Helvering v. Amer. Dental Co., 318 U.S. 322">318 U.S. 322 (1943); Commissioner v. Jacobson, 336 U.S. 28">336 U.S. 28 (1949), but also what gave rise to the debt in the first place, so that the entire transaction can be viewed as a whole. See, e.g., Bowers *704 v. Kerbaugh-Empire Co., 271 U.S. 170">271 U.S. 170 (1926); Hirsch v. Commissioner, 115 F. 2d 656 (C.A. 7, 1940), reversing 41 B.T.A. 890">41 B.T.A. 890 (1940); A. L. Killian Co., 44 B.T.A. 169">44 B.T.A. 169 (1941), affd. 128 F. 2d 433 (C.A. 8, 1942); Gehring Publishing Co., 1 T.C. 345">1 T.C. 345 (1942); Astoria Marine Construction Co., 12 T.C. 798 (1949). This case, for example, is not similar to one in which bonds issued for cash at par to third parties are ultimately discharged for a smaller amount, thus benefiting the debtor economically in a pecuniary sense, to the extent of the difference between the cash received or the par value of the bonds assumed and that used to liquidate the debt. See, e.g., United States v. Kirby Lumber Co., supra.*224 Here, petitioner's sole stockholder purchased property and organized petitioner to receive it. 1*225 Apparently as an afterthought, and with no additional consideration, petitioner assumed the obligation to pay its parent an indebtedness due from a stranger for rent which had become due before it was born. 2 It is not as though petitioner had agreed with the previous tenant to assume the obligation; cf. Helvering v. Amer. Chicle Co., supra, or as though petitioner itself had received any benefit from the deductions which gave rise to it. What advantage petitioner or its parent anticipated from this unexplained assumption is entirely mysterious but probably irrelevant. It is this same assumed indebtedness created in connection with the acquisition of petitioner's property that was ultimately canceled and which gives rise to the present claim by respondent that petitioner is thereby in receipt of taxable income.Petitioner's parent could not, of course, write off the debt, since it had never been taken up in its income. And it seems clear, in spite of respondent's insistence to the contrary, that this is not an instance of tax benefit, see, e.g., sec. 22(b)(12), I.R.C. 1939, where the creation of the original debt secured for petitioner the benefit of a current deduction while at the same time eliminating the receipt of income by the parent. But see Commissioner v. Auto Strop Safety Razor Co., 74 F. 2d 226 (C.A. 2, 1934), affirming 28 B.T.A. 621">28 B.T.A. 621 (1933). All such problems were solved in the tax settlement covering the years during which petitioner had been in existence.The debt in question may have created a benefit for the previous tenant of the property by conferring*226 upon it a deduction for the accrual *705 of rent which, in fact, was never paid. We need not pause to consider whether the accruals under such circumstances were proper. See Zimmerman Steel Co., 45 B.T.A. 1041">45 B.T.A. 1041 (1941), revd. 130 F. 2d 1011 (C.A. 8, 1942). The significant factor is that at that time there was no more than an arm's-length relationship between the tenant and petitioner's parent, the landlord, which actually received none of the accrued rent; and we can safely assume, for a similar reason, and since no effort was made to collect the arrearages, that the original debtor was insolvent.3 See Astoria Marine Construction Co., supra.*227 Petitioner suggests that, since the debt was assumed in a transaction in which property was acquired, it partook from its inception of the nature of a capital item as to it. We view the facts as supporting this position. Even had petitioner paid the defaulted rent in lieu of having it forgiven, it could not have taken a deduction therefor. Magruder v. Supplee, 394">316 U.S. 394 (1942). Petitioner received the personal property to be used in operating its business by issuing its stock 4 and assuming certain debts originally represented by chattel mortgages on the personal property. These were released by the parent without eliminating the indebtedness but the record indicates that they were the limit of any value attributable to the chattels. The amount here in question is beyond any such figure.*228 That the portion of the arrangement between petitioner and its parent may have been one in which no gain or loss was recognized is likewise irrelevant. 5 It seems clear that the transfer of the property from the original tenant was a genuine sale, as in Hirsch v. Commissioner, supra, for example, subject to the mortgage, which was evidently the full extent of the value of the property.The debt may have been canceled without donative intent on the part of the parent, see Helvering v. Amer. Dental Co., supra, but that *706 is of no significance in dealing with a contribution to capital by a sole shareholder. Robert H. Scanlon, 42 B.T.A. 997">42 B.T.A. 997 (1940).*229 Had petitioner's parent forgiven the preexisting rental indebtedness of petitioner's insolvent predecessor, which bore every indication of being too high to be tolerable, the situation would have been comparable to that envisaged in both Astoria Marine Construction Co., supra, and Hirsch v. Commissioner, supra, since the property covered by the chattel mortgages, the debtor's only apparent asset, was turned over to the creditor. And this would seem to us to be true notwithstanding that the debtor had currently deducted the rent. Highland Farms Corporation, 42 B.T.A. 1314">42 B.T.A. 1314 (1940). Instead, the parent caused petitioner to assume the indebtedness when acquiring the property and later forgave it.It is hence of little moment whether we view the operation as a readjustment of purchase price, Hirsch v. Commissioner, supra; as one in which the original debtor was insolvent, see Astoria Marine Construction Co., supra; as a transaction in which the entire result was an absence of profit to petitioner, Bowers v. Kerbaugh-Empire Co., supra;*230 or as a capital contribution to petitioner by its parent by means of a gratuitous cancellation of the debt. 6 Even if the petitioner had benefited from the deductions, that would not have prevented the parent's act from being "gratuitous." Commissioner v. Auto Strop Safety Razor Co., supra.Had the obviously worthless old indebtedness never been taken into consideration by petitioner, or had it instead issued additional common stock to its parent, the matter would be free from doubt. It seems to us that the parties have put themselves virtually in this position without in any way adversely affecting the revenue. We regard the deficiency determination in this respect as unwarrantedDecision will be entered for the petitioner*231 . Footnotes*. The discrepancy, if any, is not explained.↩1. From the balance sheet of the old operating company included in our findings, it appears that the trust acquired stock or assets worth some $ 178,000 and subject to liabilities of only about $ 73,000 exclusive of the debt owed to the trust itself -- in other words, a net of over $ 100,000 -- for less than $ 30,000. While in form this was a purchase of stock, but see Estate of James F. Suter, 29 T.C. 244">29 T.C. 244 (1957), the book value of the company's assets is some evidence of the value of the stock. B. F. Edwards, 39 B.T.A. 735">39 B.T.A. 735, 737 (1939); Lillian G. McEwan, 26 B.T.A. 726">26 B.T.A. 726↩ (1932).2. Respondent concurs in this view of the facts: "Thus, at the time of the debt cancellation the petitioner was obligated to the Trust in a total amount of $ 72,256.36, all of which amount related back to the prereorganization rent obligations of the Operating Company to the Trust."↩3. A different interpretation of the facts is possible and we intimate no opinion as to which is correct. If the trust by acquiring property from its debtor at a drastically reduced price (footnote 1, supra) in effect collected the unpaid rent due it and if, representing as it did an income item of unpaid rent, the trust then received income of well over $ 70,000 in 1941, that would still not affect the disposition of our present question. "When the indebtedness was canceled, whether or not it was a contribution to the capital of the debtor depends upon considerations entirely foreign to the question of the payment of income taxes in some previous year." Commissioner v. Auto Strop Safety Razor Co., 74 F. 2d 226, 227↩.4. Regs. 118.Sec. 39.22(a)-15. Acquisition or disposition by a corporation of its own capital stock. * * * The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than, the par or stated value of such stock.See also sec. 118, I.R.C. 1954↩, and S. Rept. No 1622, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess., pp. 18, 190.5. Respondent says, for example: "Since the rent debts were never paid but were claimed as federal income tax deductions, they conferred both tax and economic benefits on the petition and its predecessor, which benefits are attributable to the petitioner whether or not the debts were carried over as part of a 'reorganization'."↩6. "In general, if a shareholder in a corporation which is indebted to him gratuitously forgives the debt, the transaction amounts to a contribution to the capital of the corporation to the extent of the principal of the debt." Sec. 39.22(a)-13, Regs. 118.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624870/ | John Frederick Lewis, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent. Ada Haeseler Lewis, Petitioner, v. Commissioner of Internal Revenue, RespondentLewis v. CommissionerDocket Nos. 107109, 107110United States Tax Court1 T.C. 449; 1943 U.S. Tax Ct. LEXIS 257; January 12, 1943, Promulgated *257 Decisions will be entered under Rule 50. Petitioners are residents of Pennsylvania and are the beneficiaries of an inter vivos trust created in that state. Under the trust the trustees are directed to pay all expenses out of trust income and to distribute the remaining net income to life beneficiaries. In the taxable years carrying charges on unproductive real estate were paid by the trustees out of income. Under Pennsylvania law there is no clear rule that carrying charges on unproductive property are to be paid out of either principal or income. Allocation may be made between the two depending on equitable considerations. Held, that in the absence of a clear rule of local law in Pennsylvania and of any determination by a local court, the terms of the trust govern the amount of the currently distributable income for purposes of section 162(b) of the Revenue Act of 1936. Otto Wolff, Jr., Esq., for the petitioner.Harry L. Brown, Esq., for the respondent. Harron, Judge. HARRON *449 Respondent determined deficiencies in income tax of the petitioners for the years 1936 and 1937, respectively, as follows: John Frederick Lewis, Jr., $ 299.69 and $ 304.72; *258 Ada Haeseler Lewis, $ 83.70 and $ 93.96. The questions in issue are whether income from an inter vivos trust distributable to each petitioner should be reduced by a proportionate amount of the operating losses on certain unproductive real estate comprising part of the original corpus of said trust, upon the ground that such losses are chargeable to trust income rather than principal, and whether petitioners are entitled to deductions for depreciation on the real estate, no depreciation deduction having been taken by the trustee.*450 The returns were filed with the collector for the first district of Pennsylvania.FINDINGS OF FACT.The facts as stipulated are adopted, and only those facts necessary for the consideration of the issues are stated. Petitioners are husband and wife and are residents of Philadelphia, Pennsylvania. Petitioners' books of account were kept on a cash basis and their tax returns for the taxable years were on that basis.Petitioners are the life beneficiarcies of one-third and one-sixth, respectively, of the net income of a trust created by Anne H. R. Baker Lewis on December 23, 1935, known as the Anne H. R Baker Lewis Trust No. 2. There are two*259 other life beneficiaries. Upon the termination of the trust the principal will pass to named persons or to the trustees of the University of Pennsylvania and others. The grantor conveyed to the trustees stocks, bonds, mortgages, and parcels of real estate with the improvements thereon. Included in the real estate so conveyed were 16 farm properties located in Chester County, Pennsylvania, known as the Morstein properties, a property known as the Tammany Pea Shore Fishing Club, and 5 pieces of Philadelphia real estate. During 1936 and 1937 the rental income, taxes, and expenses of each, and depreciation, were as follows:1936RentalPropertiesincomeTaxesExpensesDepreciation1531-1535 Vine Street$ 1,545.84$ 445.48$ 1,431.90$ 179.87414 Arch Street583.65347.73337.50130.001934 Delancey Street1.92142.9665.0060.00208 South 4th Street453.6040.35160.001914 Spruce Street989.3927.25360.00Morstein Properties9.421,027.851,505.00Tammany Pea Shore Fishing Club288.6857.00Total2,140.833,695.691,959.002,394.87Total loss excludingdepreciation3,513.86Total loss includingdepreciation5,908.731937414 Arch Street$ 315.00$ 261.17$ 158.75$ 130.00208 South 4th Street453.60160.001934 Delancy Street104.7657.9660.001914 Spruce Street914.55360.00Morstein Properties1,489.20173.501,505.00Tammany Pea Shore Fishing Club383.2886.80Total315.003,606.56477.012,215.00Total loss excludingdepreciation3,768.57Total loss includingdepreciation5,983.57*260 *451 It is provided in the trust indenture that the trustees are to collect the trust income and to pay the net income to the life beneficiaries "after the deduction of all lawful and proper costs, charges, taxes and expenses incident to the care and management of the trust, then in trust."In 1936 and 1937 the gross income of the trust was $ 9,104.73 and $ 24,510.54. The trust corpus included other real estate besides the real estate involved in this case. In the respective years the trustees reported net income from all of the real estate -- $ 5,323.80 in 1936 and $ 7,879.80 in 1937. In computing the net income from all real estate the trustees subtracted from real estate gross income various amounts for depreciation, repairs, and other expenses. Also, in computing the net income of the trust in each year the trustees deducted $ 8,586.06 and $ 8,495.12 for taxes on real estate. Other deductions left income distributable to beneficiaries in the amounts of $ 508.29 in 1936 and $ 14,974.29 in 1937. The petitioners' share of the distributable income so computed was as follows: John F. Lewis, Jr., $ 162.43 and $ 3,531.89 in 1936 and 1937; and Ada H. Lewis, $ 84.72 and $ 1,765.95*261 in 1936 and 1937. They reported those amounts in their returns in the respective years.The properties in question, listed above, were unproductive properties in the taxable years. The total income from the particular properties was less than the total expenditures, or carrying charges, and, taking depreciation into account, the loss was $ 5,908.73 in 1936 and $ 5,983.57 in 1937.The respondent determined that the income of the trust distributable to beneficiaries should not be reduced by the amount of the losses on the unproductive properties in each year. Under that determination he increased each petitioner's share of the distributable trust income by proportionate amounts of the losses. He increased the share of John F. Lewis, Jr., in the trust income in the amounts of $ 1,969.58 in 1936 and $ 1,994.52 in 1937, and the share of Ada H. Lewis in the amounts of $ 984.79 in 1936 and $ 997.26 in 1937.The beneficiaries of the trust have not questioned the trustees' computation of the distributable trust income. No account has been filed by the trustees with the court having jurisdiction over the trust.The trust assets had an approximate value of $ 766,000 in 1936 and $ 687,000*262 in 1937.OPINION.The question is whether the income of the trust which was retained by the trustees to take care of the carrying *452 charges of certain real estate which was unproductive is the income of the life beneficiaries and taxable to them. The petitioners are two of the life beneficiaries and their income tax liability only is before us. Respondent contends that the rule under Pennsylvania law is that all of the income from unproductive real estate belongs to income beneficiaries of a trust and that it follows that the carrying charges on such property are a charge against principal. Respondent cites , and , as authority for his contention. Petitioners argue that these cases do not support respondent's view and that until the Pennsylvania court having jurisdiction over the trust determines from what source the charges for carrying the unproductive real estate of the trust here involved are to be paid, from principal or income or both, the trustees' treatment should control and the petitioners should not be held liable*263 for tax on the portion of the trust income set aside to cover the charges. Petitioner relies on Levy's Estate.The issue raised by the pleadings does not present a question relating to the propriety of deducting from the gross income of the trust allowances for depreciation on the property in computing the distributable income, and we do not give consideration to such question. Cf. . Rather, the issue is framed so that the depreciation allowances taken by the trustees are treated merely as carrying charges, along with taxes and general expenses. All are put together into the general category of "carrying charges." The question is thus limited by the pleadings and by the stipulation of facts filed. We shall consider, therefore, only the broad question of whether or not carrying charges on unproductive real estate are payable out of trust income, namely, from the income derived from other property in the trust, under Pennsylvania rule, if such exists, or under the terms of the trust.The provisions of section 162 (b) of the Revenue Act of 1936 1 are that in computing the net income of the trust there shall *264 be allowed as a deduction the amount of the income of the trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, but the amount so allowed as a deduction shall be *453 included in computing the net income of the beneficiaries whether distributed to them or not. The question here is, further, whether the amount of the trust income which was to be distributed to the petitioners included the amount of the trust income which the trustees set aside to cover the carrying charges on the unproductive real estate.*265 The trustees are directed by the express terms of the trust to deduct all lawful charges and expenses from gross income in computing the net income to be distributed to the life beneficiaries. The trust makes no reference to any different treatment of expenses on unproductive property. There has been no accounting filed by the trustees in a local court having jurisdiction, there has been no dispute among the beneficiaries and the trustees, and there has not been any determination made by a local court of the matter of which is to bear the burden of carrying the unproductive property, principal or income. Cf. There has been no order of a local court which would govern here the question of the correct amount of the distributable income of the trust. That being so, is there a rule announced by either or both of the two cases cited by respondent which supports respondent's determination?In Nirdlinger's Estate mortgages had been foreclosed and the properties covered by them, having been bought in by the trustees, were held pending sale. The court pointed out that each individual property involved a "salvage operation." *266 The question was who was entitled to the net rents during the time the property was held. Several solutions were proposed, but the court said that the income of the life tenants should be preserved to them, holding that "net rents based upon the return from each individual property, shall be distributed to life tenants." The court also considered whether or not all of the properties should be grouped or whether each property should be considered separately, in computing the amount of the rents payable to the life tenants. The court concluded that the payments of net rents should be based on each individual property. In general net rents from individual property were to be distributed, that is, gross rents, less taxes and carrying charges. Such net rents from productive property were not to be reduced by the carrying charges on unproductive property, according to our understanding of the opinion. Nirdlinger's Estate states the rule that trustees are not to group foreclosed properties in computing distributable income. The problem here is whether or not such rule applies to properties which constitute part of the original corpus as distinguished from properties acquired*267 through foreclosure which are held pending sale.In Levy's Estate the court said that the "precise question of the allocation of carrying charges of unproductive real estate of which a testator died seized" had not heretofore been presented to the court, *454 and that Nirdlinger's Estate "involved the apportionment of carrying charges, where there was a salvage of collateral, held by the estate, in which both the life beneficiary and remaindermen had an interest, the former because interest had not been paid." In Levy's Estate the life beneficiary and remaindermen had interestes in certain real estate. There had been a sale of the real estate and a profit had been realized. The property had been sold for over $ 100,000, the net gain being about $ 5,000, and the question was whether the life beneficiary should be reimbursed out of the proceeds of the sale for taxes on the property which had been paid from income of the estate between the testator's death and the sale. The life beneficiary sought to recover income which the trustees had retained to meet the carrying charges of property which had been unproductive. The court viewed the rule adopted in Nirdlinger's*268 case as limited to the situation there, as it related to salvage of collateral, and said:While it is true that, in times past, no contention was made, or if made was not entertained, that carrying charges of unproductive real estate should be paid out of principal, and it was assumed they were payable out of income, a new day has brought about sound reasons for a departure from this practice, and now we are of opinion that in all cases they should not be charged to and be paid by income, but that whether to be so paid, or to be paid out of principal, or divided between the two, should be determined by considering the equities in each case. The determination of the question is one for the exercise of a sound discretion by the court of first instance and we will review only where there has been a palpable abuse of discretion. The difficulties anticipated in carrying out this program are we think more fanciful than real. The matter can be determined when accounts are filed, embodying the proceeds of the sale of unproductive real estate, or, if greater celerity of disposition is required, the matter can be specially brought before the court.So saying, the court remanded the case*269 to the Orphans' Court to determine whether or not the equities in the situation were such that the life tenant should be reimbursed for taxes paid. A majority of the judges of the Orphans' Court had laid down the general rule that carrying charges of unproductive real estate should be paid out of principal in all cases. The dissenting minority of judges had expressed the view that the matter should be adjudicated, in each instance as it arises, according to the equities as between income recipients and those entitled to principal. The Supreme Court specifically said, "We agree with the latter view."No case has been cited, and we do not find any, in which the Supreme Court of Pennsylvania has given further consideration to this problem. Levy's Estate, decided in 1939, appears to be the latest pronouncement of any rule. That case, therefore, must provide guidance here, and, as we read that opinion, there is no general rule to be applied in all cases, but in each case the matter is to be considered according to the equities as between life beneficiaries and remaindermen. *455 In other words, the Supreme Court of Pennsylvania has indicated that the broad rule stated*270 in the Restatement of the Law of Trusts 2 is not to be applied as a general rule in all cases in that state.There is a close parallel between the status of property of which a testator dies seized and property conveyed by a trustee in an inter vivos trust, and, assuming that the parallel is sound, the trust involved here would come within the view expressed in Levy's Estate. Under that view the trustees of the Lewis Trust No. 2 appear to have a problem which requires their seeking special direction by the court which has jurisdiction of the trust*271 as to how to defray the carrying charges of the unproductive real estate in the trust. The trustees have assumed that the carrying charges on unproductive real estate are payable out of income, but they may be in error. If they are in error, under the equities involved in the particular trust, the amount of the distributable income of this trust is greater than the trustees have determined and paid to the life beneficiaries, including petitioners.Our problem is to determine the correctness of respondent's determination; that is, to determine the correct amount of the distributable income of the trusts. The burden is upon the petitioners to prove that respondent's determination is incorrect. To meet this burden of proof, the petitioners have relied solely upon the terms of the trust instrument. Is that sufficient? The trust indenture makes no mention of the way carrying charges on unproductive property are to be met, nor does it require the trustees to sell the trust assets if a specific rate of income is not earned. The trust indenture does not state that it is the purpose or intent of the grantor that any amount of income or rate of return upon investments is desired. The*272 only provision of the trust which casts light on the grantor's intent in the matter of the investment of the trust estate is as follows:2. The said Trustees, and their successors, shall have full power and authority to invest said trust estate in such securities as they may deem prudent, having regard to the security of the investment, rather than to the rate of income, and without restricting them to so-called legal investments for Trustees; * * * and at any time to convert, dispose of and sell, at either public or private sale, all or any investments, securities, real estate and other property which may at any time comprise the principal of said trust estate, for such prices, and on such terms, as the said Trustees, the survivor of them, and any succeeding Trustee may deem proper, * * **456 Some weight should be given to the grantor's expression that the trustees are to give "regard" to the security of the investment, rather than the rate of income. Reading that direction with the direction that the trustees shall deduct all lawful charges and expenses from gross income before distributing the net income, there has been no violation of the terms of the trust by the trustees. *273 It is our opinion petitioners have met their burden of proof and need go no further than they have in showing the terms of the trust, and that none of the beneficiaries have contested the propriety of the trustees' determination. The rule so far expressed by the Supreme Court of Pennsylvania permits latitude of discretion by the court of first instance. Before the interested persons go to court to request it to exercise its discretion, the trustees must exercise their discretion. It has been held that, ordinarily, the interpretation of a trust by the interested parties should be given great consideration and not be set aside lightly. ; ; . It has been said, also, that taxation is a practical matter. The petitioners have not received trust income in the amounts which the respondent has added to their taxable income in the taxable years, and it may be that they never will, if the court in Pennsylvania having jurisdiction over the trust, when it receives the matter, sustains the*274 trustees in their computation of the amount of the distributable income of the trust. That is a possibility. If the court does not sustain the trustees (if, as, and when it ever has to make a determination relating to the carrying charges on the unproductive real estate), and the trustees reimburse the petitioners for income which they have withheld to cover said carrying charges, then, at such time, the petitioners will be subject to tax upon the income which respondent now attempts to tax them upon. There are equitable considerations in taxation. To tax the petitioners upon income which can not be said to be "distributable income," with finality and certainty as a matter of local law, would be to penalize the petitioners for their reliance upon the correctness of the trustees' acts. Also, to make it a rule for purposes of Federal income tax, that in all cases involving Pennsylvania trusts the carrying charges on unproductive real estate should be paid out of principal, where no such rule has been adopted by Pennsylvania courts, would, of necessity, require either that trustees distribute trust income without reserving amounts for such carrying charges and then recover from *275 the beneficiaries if a court required later, or, that beneficiaries pay a tax on income which they may never receive.Giving due consideration to the equities and the uncertainties in the local law, all being inherent in the situation presented here, we are of the opinion that the terms of the trust instrument are controlling, *457 and that under the terms of the trust the amount of the trust income which was to be distributed in the taxable years to petitioners was the amount which actually was distributed in each year. It is held that respondent erred in determining that an excess amount, representing that which the trustees withheld for the carrying charges, was distributable income under section 162 (b).The deficiencies have been contested in part only. Accordingly, while holding for the petitioners,Decisions will be entered under Rule 50. Footnotes1. SEC. 162. NET INCOME.The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that --* * * *(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year.↩2. Vol. 1, p. 689, par. 233 (m):"Ordinary current expenses as well as extraordinary expenses incurred in connection with unproductive property are payable out of principal, unless it is otherwise provided by the terms of the trust. Thus, taxes and other carrying charges on unproductive land are payable out of principal, even though the trust estate includes other property from which an income is derived, unless it is otherwise provided by the terms of the trust."↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624872/ | John K. Johnsen and Frances Johnsen, Petitioners v. Commissioner of Internal Revenue, RespondentJohnsen v. CommissionerDocket No. 12592-80United States Tax Court84 T.C. 344; 1985 U.S. Tax Ct. LEXIS 114; 84 T.C. No. 24; March 4, 1985; Reversed and Remanded July 11, 1986 March 4, 1985, Filed *114 Petitioners' motion to vacate the decision will be denied. L, a limited partnership, was formed in April 1976 to develop an apartment project. P became a limited partner in July 1976. In our opinion in Johnsen v. Commissioner, 83 T.C. 103 (1984), we held that P was entitled to deduct his distributive share of a construction loan commitment fee, a management and guarantee fee, and a portion of a permanent loan commitment fee incurred by L during 1976. We also held that, under sec. 706(c)(2)(B), I.R.C. 1954, P must adjust his distributive share of such items to reflect the fact that he was not a member of L during its entire 1976 taxable year. However, we did not decide the method to be applied to account for P's varying interest. The Commissioner has the burden of proof with respect to the varying interest issue because he raised the issue through affirmative allegations in the answer. Held:1. Having proven that sec. 706(c)(2)(B) is applicable because P became a partner of L after its formation, the Commissioner's burden of proof extends only to applying a reasonable method of accounting for P's varying interest in the partnership. The*115 Commissioner does not have the burden of proving and applying the method which is most favorable to P.2. The proration method applied by the Commissioner is a reasonable method.3. P has a right to use a more favorable method of accounting for his varying interest in the partnership, but he has the burden of proving the facts necessary for an interim closing of the partnership books as an alternative method; he has failed to carry such burden. Donald W. Geerhart and Donald J. Forman, for the petitioners.Sara M. Coe, for the respondent. Simpson, Judge. SIMPSON*345 SUPPLEMENTAL OPINIONOn July 24, 1984, this Court filed its opinion (83 T.C. 103">83 T.C. 103) determining the issues in this case and withheld entry of its decision for the purpose of permitting the parties to submit computations under Rule 155, Tax Court Rules of Practice and Procedure.1 The parties submitted conflicting computations. *117 On November 21, 1984, we entered our decision, adopting the Commissioner's computation that there was a deficiency of $ 2,698 in the income tax due from the petitioners for the taxable year 1976. The petitioners, John K. and Frances Johnsen, have moved to vacate the decision. We held a hearing on such motion in Washington, D.C., at which representatives for both parties appeared and presented their opposing arguments. Mr. Johnsen will sometimes be referred to as the petitioner.In our prior opinion, we held that under section 212(1) or ( 2) of the Internal Revenue Code of 1954, 2 the petitioner was entitled, as a limited partner in Centre Square III, Ltd. (the limited partnership), to deduct his distributive share of a construction loan commitment fee, a portion of a permanent *346 loan commitment fee, 3 and a $ 50,000 management and guarantee fee incurred by the limited partnership during 1976. Because the limited partnership was*118 formed on April 11, 1976, and the petitioner did not acquire his limited partnership interest until July 19, 1976, we also held that, under section 706(c)(2)(B), the petitioner must adjust his distributive share of the limited partnership's deductible items to reflect his varying interest in the limited partnership. However, we did not decide what method was to be employed in adjusting the petitioner's distributive share.The Commissioner bears the burden of proof with respect to the varying interest (or retroactive allocation of loss) issue because he raised it first in an affirmative allegation in *119 his answer. Rule 142(a). In his post-trial brief, the Commissioner indicated that any reasonable method of allocating the limited partnership's deductions to the portion of the limited partnership's 1976 taxable year during which the petitioner was a partner would suffice. He utilized the proration method in his Rule 155 computation, calculating the petitioner's distributive share on the basis of his having been a limited partner for 165 days of the limited partnership's 263-day 1976 taxable year. 4In their motion to vacate, the petitioners argue that the Commissioner's burden of proof with respect to*120 the varying interest issue extends to proving the method of accounting for Mr. Johnsen's varying interest which is most favorable to them. They maintain that the application of the interim closing of the books method results in no downward adjustment in his distributive share of the limited partnership's *347 deductible items and that, therefore, it is the most favorable method. 5The proration method is the easier method to apply. It involves computing partnership income or loss at the end of the partnership year and allocating the yearend totals ratably over the year. The interim closing of the books method requires a closing of the partnership books as of the date of entry of the new partner*121 and the computation of the various items of partnership income, gain, loss, deduction, and credit as of such date. See Moore v. Commissioner, 70 T.C. 1024">70 T.C. 1024, 1035 (1978); sec. 1.706-1(c)(2)(ii), Income Tax Regs. Thus, in order to effect an interim closing of the books in the present case, it is necessary to determine when the limited partnership, which utilized the accrual method of accounting, incurred the expenses for which a deduction has been allowed by our prior opinion. 6 The petitioners contend that the Commissioner bears the burden of proving when such expenses accrued and that unless the Commissioner can prove that they accrued before Mr. Johnsen became a limited partner, the Commissioner cannot apply the proration method because it does not provide the petitioners with the most favorable result.*122 The regulations under section 706(c)(2)(B) do not set forth methods for determining the distributive share of partners who are subject to the varying interest rule. 7 In Richardson v. *348 , 76 T.C. 512">76 T.C. 512, 526 (1981), affd. 693 F.2d 1189">693 F.2d 1189 (5th Cir. 1982), we stated that partnership income or loss may be allocated between the periods prior to and after the admission of a new partner using any reasonable method, including an interim closing of the books or an allocation of yearend totals of profit and loss ratably over the year. See also Roccaforte v. Commissioner, 77 T.C. 263">77 T.C. 263, 289 (1981), revd. on another issue 708 F.2d 986">708 F.2d 986 (5th Cir. 1983); Marriott v. Commissioner, 73 T.C. 1129">73 T.C. 1129, 1139 (1980); Moore v. Commissioner, 70 T.C. at 1035. If the petitioner elects the interim closing of the books method, he has the additional burden of establishing the date when each partnership item was paid or incurred. Sartin v. United States, 5 Cl. Ct. 172">5 Cl. Ct. 172, 175-176 (1984); Moore v. Commissioner, 70 T.C. at 1036.*123 *124 In the present case, we have already found that the limited partnership taxable year began on April 11, 1976, and that the petitioner did not become a member of such partnership until July 19, 1976. Hence, the Commissioner has already proven that the petitioner is subject to the varying interest provision of section 706(c)(2)(B). There is no basis in law for the petitioners' contention that, having proven that much, the Commissioner must also go on to prove and apply the allocation method most advantageous to the petitioners. Contrary to the petitioners' suggestion at the hearing on this motion, nothing contained in the committee reports accompanying the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1520, supports the imposition of such burden. Both the House and the Senate reports on a clarifying amendment to section 706(c)(2)(B) added by such act state that regulations are to be adopted under section 706(c)(2)(B) which will provide for use of the same allocation methods as are currently applicable to section 706(c)(2)(A) situations. The reports explain:These rules will permit a partnership to choose the easier method of prorating items according to the portion of the *125 year for which a partner was a partner or the more precise method of an interim closing of books (as if the year had closed) which, in some instances, will be more advantageous where most of the deductible expenses were paid or incurred upon or subsequent to the entry of the new partners to the partnership. [S. Rept. 94-938 (1976), *349 1976-3 C.B. (Vol. 3) 49, 136; H. Rept. 94-658 (1975), 1976-3 C.B. (Vol. 2) 695, 816-817.]These reports in no way suggest that if the Commissioner bears the burden of proof on the varying interest issue, he must select the method most favorable to the petitioner. Section 706(c)(2)(B) requires only that a reasonable method be applied, and the proration method selected by the Commissioner is reasonable. Sartin v. United States, 5 Cl. Ct. at 178; Richardson v. Commissioner, 76 T.C. at 526; Marriott v. Commissioner, 73 T.C. at 1139; see sec. 1.706-1(c)(2)(ii), Income Tax Regs. Therefore, we hold that where the Commissioner bears the burden of proof with respect to the applicability of section 706(c)(2)(B), *126 such burden does not extend beyond proving the facts necessary for the application of a reasonable method of allocation. Since the Commissioner here has proven the simple facts needed to apply the proration method, we find that he has met the burden of proof.In cases where the Commissioner has raised the varying interest issue and applied an allocation method (usually proration) in the notice of deficiency, the petitioner has been afforded the opportunity to prove and apply another reasonable method at trial. See Sartin v. United States, supra; Richardson v. Commissioner, supra; Moore v. Commissioner, supra. We believe that the petitioners are entitled to a similar opportunity in this case. The petitioners maintain that all of the limited partnership's deductible expenses accrued sometime after Mr. Johnsen became a partner and, consequently, seek to apply the interim closing of the books method, as it will result, in such circumstances, in no downward adjustment of his distributive share. Upon an examination of the record, we hold that the petitioners have failed to prove that the bulk of the*127 expenses accrued after Mr. Johnsen's entry into the partnership.The expenses in question, construction and permanent loan commitment fees, and a management and guarantee fee, were obligations arising from separate contracts entered into between the limited partnership and Centre Square III (the general partnership). Very generally, the limited partnership was formed to acquire land and to construct and operate an apartment project called Centre Square III. The general partnership provided construction and permanent financing *350 and apartment management services to the limited partnership. See our findings of fact in Johnsen v. Commissioner, 83 T.C. at 104-114, for more details of the arrangement.The construction loan commitment agreement was embodied in a letter issued by the general partnership to the limited partnership on April 15, 1976, as amended by a letter of April 20, 1976. The letter provided that the general partnership would make a construction loan of $ 3,171,200 at an interest rate of 2 1/2 percent over the Chase Manhattan Bank's prime rate. The limited partnership agreed to pay a $ 28,200 "nonrefundable standby commitment *128 fee" due at the time of its acceptance of the commitment. The construction loan commitment was effective until April 30, 1977, but was subsequently extended to August 31, 1977, by agreement dated August 17, 1976. The general partnership charged no additional fee for extending its construction loan commitment. On September 10, 1976, the limited partnership executed a nonrecourse construction loan note.The permanent loan commitment was also contained in a letter, which was issued on April 14, 1976, and amended by a second letter of April 20, 1976. The commitment provided for a 30-year loan of $ 3,171,200 at an annual interest rate of 9 3/4 percent. The limited partnership agreed to pay a "nonrefundable standby commitment fee" of $ 84,600 due at the time of the commitment letter's acceptance (acceptance being required by May 15, 1976). In August 1976, the general partnership extended its permanent loan commitment until August 31, 1977; for the extension, the limited partnership paid a fee of $ 11,280. The limited partnership executed a nonrecourse promissory note and a deed of trust reflecting the terms of the permanent loan commitment in October 1977.The limited partnership *129 amortized the $ 28,200 construction loan commitment fee and the $ 84,600 permanent loan commitment fee over the life of each commitment. According to its accountant's workpapers, the limited partnership treated both commitments as having commenced on April 20, 1976, and using a half-month convention, amortized each commitment over a period beginning on May 1, 1976. Thus, the limited partnership deducted amortization for 8 months in 1976. The $ 11,280 permanent loan commitment extension fee was similarly amortized over the life of the extension. Such fee was *351 treated as having been incurred on August 17, 1976, and applying the half-month convention, was amortized over a period commencing on September 1, 1976. In our prior opinion, we determined that the limited partnership was entitled to deduct in 1976 all of the $ 15,667 claimed on its return as amortization of the construction commitment fee, and $ 20,901 of the $ 50,760 claimed as amortization of the permanent commitment fee and extension fee. 8*130 The limited partnership's $ 50,000 management and guarantee fee deduction, which we determined to be allowable in our earlier opinion, arose under a written management agreement executed by the general and limited partnerships on April 11, 1976. Under the terms of the agreement, the general partnership assumed total responsibility for the leasing, management, and administration of Centre Square III. The general partnership also guaranteed that Centre Square III would operate without cash flow deficits through December 31, 1980. For its services and the guarantee, the general partnership would receive 5 percent of the gross receipts generated by Centre Square III and an additional $ 50,000 each year for 1976 through 1980. During 1976, there were no gross receipts, and the percentage fee yielded no payment. However, the fixed $ 50,000 fee was paid in that year and was primarily intended to compensate the general partnership for management activities. According to its accountant's workpapers, the limited partnership viewed the management fee as having accrued on April 11, 1976, the day on which the management agreement was executed.The petitioners now argue that none of the above*131 expenses were incurred until after Mr. Johnsen became a partner in July 1976, despite the fact that the limited partnership treated all (with the exception of the extension fee) as having been incurred in April 1976 and calculated its amortization deductions from such time. Under the accrual method of accounting, an expense is deductible in the taxable year in which "all the events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy." Sec. 1.461-1(a)(2), Income Tax Regs.; see United States v. Anderson, 269 U.S. 422">269 U.S. 422, 442 (1926). The petitioners do *352 not contest the certainty of the amounts of the expenses in question, but do assert that the fact of the liability was subject to a substantial contingency, the rezoning of the land on which the apartment project was to be built from commercial to residential. 9 This contingency is not express in any of the agreements between the general partnership and the limited partnership. Nevertheless, the petitioners contend that such a condition to the limited partnership's obligation to pay the fees in question is inferable if the management*132 and loan commitment agreements are viewed in the larger context of the apartment project venture. Specifically, they rely upon the general partnership's warranty, contained in the sales agreement under which it agreed to sell the apartment project to the limited partnership, that the project would comply with zoning ordinances. The sales agreement was executed on April 11, 1976, at about the same time as the management and loan commitment agreements, and also referred to such agreements.*133 The petitioners' argument is unpersuasive for a number of reasons. First, none of the agreements between the partnerships, including the sales agreement, was expressly made conditional upon the acquisition of rezoning. Furthermore, there is no evidence that, at the time they executed the agreements, the parties feared that rezoning would not be obtained. At such time, rezoning had already been unanimously approved by the local zoning commission. The parties' confidence that the rezoning would occur is indicated by the construction loan commitment agreement, which provided that the general partnership would be ready to make its first loan advance on May 1, 1976. Only after the execution of the contracts did rezoning become a potential problem. Neighborhood opposition to the project caused the city council to reject the rezoning application, but without prejudice to its resubmission. In September 1976, the city council eventually approved *353 the zoning change. Although the neighborhood opposition delayed the start of construction until September, the petitioners have failed to prove that the eventual outcome of the rezoning application was ever in substantial doubt. *134 The limited partnership itself must not have viewed rezoning as a condition to its liability, since it treated the expenses as incurred in May, and not in September.The petitioners' argument also fails to consider the nature of standby loan commitment fees. Such fees are paid to the lender in return for the lender's present promise to make a loan of a stated amount at a stated interest rate over a stated period. See Neuman & Elfman, "The Tax Treatment of Loan Commitment Fees after Rev. Ruls. 81-160 and 81-161," 60 Taxes 394">60 Taxes 394, 395 (1982); G. Robinson, Federal Income Taxation of Real Estate, pars. 7.02, 8.05[2][b] (1984). The construction and permanent loan commitment fees in the present case were nonrefundable and due upon acceptance of the commitment. The limited partnership's liability to pay the fees became fixed upon acceptance. It is significant that the parties to the commitment agreements executed extensions thereof in August 1976 when the start of construction was delayed by the zoning problem. An additional fee was also charged for the extension of the permanent loan commitment.We can only conclude that the petitioners have failed to prove that the limited partnership's*135 deductible expenses, with the exception of the permanent loan commitment extension fee, 10 accrued after Mr. Johnsen entered the partnership. Consequently, we hold that the petitioners have not proven the facts necessary for application of the interim closing of the books method, and their motion to vacate our decision will be denied.Before we close, we must address one last argument. The petitioners assert that the record suggests, if it does not establish, that the limited partnership did not pay the management and loan commitment fees until September 1976. They maintain that if the limited partnership had utilized the cash method of accounting, Mr. Johnsen would be entitled to an unreduced share of the partnership's losses under the interim closing of the books method. See Richardson v. *354 , 76 T.C. at 527. *136 According to the petitioners, the result should be no different because the limited partnership in the present case used the accrual method, since Mr. Johnsen's funds were used to discharge the limited partnership's obligations.We disagree. In Richardson, the Commissioner contended that new members of a cash method partnership could not be allocated losses based on an interim closing of the books unless the partnership's expenses were incurred as well as paid after their entry. We rejected the Commissioner's contention, observing that the deductibility and timing of a deduction is determined at the partnership level and by the method of accounting utilized by the partnership. 76 T.C. at 527; see W. McKee, W. Nelson & R. Whitmire, Federal Taxation of Partnerships and Partners, par. 9.02[1], at 9-5 to 9-7 (1977). We held that a share of partnership expenses incurred before but paid after the entry of the new partners could be allocated to them because their funds were used to pay the expenses and caused such expenses to become deductible. 76 T.C. at 527. Such is not the case here. The limited partnership utilized the accrual*137 method in calculating its deductions, and since the bulk of the partnership's deductions were incurred and deductible before Mr. Johnsen became a partner, a retroactive allocation of tax losses would result if we pretended that the partnership was on the cash method for purposes of an interim closing of the partnership books.We also observe that Congress has significantly amended section 706(c)(2)(B) since our decision in Richardson. Sec. 72, Tax Reform Act of 1984, Pub. L. 98-369, 98 Stat. 589. Effective for amounts attributable to periods after March 31, 1984, the amendment essentially requires that, for purposes of section 706(c)(2)(B), cash method partnerships must utilize the accrual method with respect to certain expenditures, and that such items must be allocated ratably among old and new partners. Although not applicable to the case before us, the amendment supports our position that an interim closing of the books based on the date of payment rather than accrual would result in the retroactive allocation of losses to Mr. Johnsen.Petitioners' motion to vacate the decision will be denied. Footnotes1. Any reference to a Rule is to the Tax Court Rules of Practice and Procedure.↩2. All statutory references are to the Internal Revenue Code of 1954 as in effect during the year in issue.↩3. The limited partnership claimed a deduction of $ 50,760 for fees charged for a permanent loan commitment and an extension of the permanent loan commitment. We disallowed a portion of the permanent loan commitment fee because such fee was excessive and, therefore, was not an ordinary and necessary expense.↩4. The Commissioner calculated the petitioner's distributive share of the limited partnership's deductible items as follows:↩Partnership loss$ 121,924Petitioner's percentage interest in partnership4.95%Length of partnership's 1976 taxable year (4/11/76 - 12/31/76)263 daysLength of petitioner's membership in 1976 (7/19/76 - 12/31/76)165 days4.95% x 165/263 x $ 121,924 = $ 3,786 (petitioner's share).5. In their Rule 155 computation, the petitioners treated the limited partnership's deductible expenses as having accrued after the petitioner became a partner, and calculated his distributive share of such expenses under an interim closing of the books as follows:4.95% x $ 121,924 = $ 6,035.24 (petitioner's share)↩6. Throughout this opinion, we shall refer to the commitment fees involved herein as deductible expenses, accruable on a single day for tax purposes, because such is the litigating stance of the parties in this case. See Johnsen v. Commissioner, 83 T.C. 103">83 T.C. 103, 121-125 & n. 8 (1984). However, as will be explained more fully in the text, infra, the limited partnership treated the loan commitment fees as capital expenditures and calculated its deductions for such fees by amortizing them over the life of the commitments. We are aware that in other cases, loan commitment fees have been treated as capital expenditures amortizable over the life of the loan. See Williams v. Commissioner, T.C. Memo. 1981-643; Francis v. Commissioner, T.C. Memo. 1977-170; see also Rev. Rul. 81-160, 1 C.B. 312">1981-1 C.B. 312, revoking Rev. Rul. 56-136, 1 C.B. 92">1956-1 C.B. 92↩.7. The regulations under sec. 706(c)(2)(A) do provide rules when there is a sale or liquidation of an entire partnership interest. Sec. 1.706-1(c)(2)(ii), Income Tax Regs., provides that in cases of the sale, exchange, or liquidation of a partner's entire interest in a partnership, the partner may, "in order to avoid an interim closing of the partnership books," estimate his share of the partnership's distributive items "by taking his pro rata part of the amount of such items he would have included in his taxable income had he remained a partner until the end of the partnership taxable year. The proration may be based on the portion of the taxable year that has elapsed prior to the sale, exchange, or liquidation, or may be determined under any other method that is reasonable."The congressional reports accompanying an amendment to sec. 706(c)(2)(B) made by the Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1547, direct that regulations be adopted "to apply the same alternative methods of computing allocations of income and loss to situations falling under section 706(c)(2)(B) as those now applicable to section 706(c)(2)(A)↩ situations (sale or liquidation of an entire interest)." S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, 136. See H. Rept. 94-658 (1975), 1976-3 C.B. (Vol. 2) 695, 816. Such regulations have not yet been adopted.8. See notes 3 & 6, supra↩.9. The petitioners have also contended that, under the terms of the private offering memorandum issued to prospective investors in the limited partnership, all invested funds would be returned if 40 percent of the limited partnership units were not sold prior to closing on the sale of the apartment project to the limited partnership. The 40-percent subscription requirement was said to be a contingency delaying accrual of the expenses at issue until the closing in September 1976. However, at the hearing, the petitioners conceded that the record indicates that such contingency was eliminated by late May, when the 40-percent requirement was met. Therefore, we shall treat this second contingency argument as abandoned and shall not discuss it further.↩10. The permanent loan commitment extension fee accrued after the petitioner became a partner because the extension was not agreed to until August 1976.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624873/ | Gareth Martinis v. Commissioner.Martinis v. CommissionerDocket No. 1672-68.United States Tax CourtT.C. Memo 1969-243; 1969 Tax Ct. Memo LEXIS 51; 28 T.C.M. (CCH) 1265; T.C.M. (RIA) 69243; November 17, 1969, Filed Gareth Martinis, pro se, 3616 Henry Hudson Parkway, Bronx, N. Y. Marwin A. Batt, for the respondent. FORRESTERMemorandum Findings of Fact and Opinion FORRESTER, Judge: Respondent has determined a deficiency in petitioner's 1963 income tax in the amount of $246. The sole issues are whether petitioner is entitled to an exemption for his spouse and whether he is entitled to a dependency exemption for his son during the year in issue. Some of the facts are stipulated and are so found. The stipulation*52 and attached exhibit are incorporated herein by this reference. Petitioner resided in the Bronx, New York City, at the time his petition herein 1266 was filed. His individual income tax return for such year was filed with the district director of internal revenue, Manhattan, New York. Petitioner and his wife, Kathleen, lived together in a rented apartment in the Bronx during parts of the year 1963 and were residing there when their son, Keith, was born on March 14, 1963. Petitioner was employed successively by four construction companies during such year and his total income was $3,233.12 from which $444.33 Federal income taxes were withheld. He does not claim to have had savings, or to have made expenditures other than from his current eanings during such year. Except for relatively short periods of time when Kathleen stayed with her mother, Helen M. Dolan (hereinafter referred to as Helen), she lived with petitioner at their apartment until the first week in September at which time petitioner left home. Kathleen suffered from a heart condition, felt that she could not live alone with her baby and immediately thereafter moved to her mother's house which was also in the Bronx. *53 Keith Martinis, the baby, lived with his mother at all times during the year in issue. Petitioner spent $75 for rent of his family's apartment each month of the year in issue. He gave Kathleen $25 a week for food and all household expenditures for the period January 1 through the first week of September 1963. He paid a hospital bill of $100 incurred for Keith's birth on March 14 and after he had left home in September he sent Kathleen a total of $117 toward Keith's support during the remainder of the year. During 1963 Helen spent at least $720 for Kathleen's support and at least $500 for Keith's support and claimed dependency exemptions for each of them on her individual income tax return. We have allocated petitioner's rent payments, and food and household expenditures payments, between petitioner and Kathleen for the months of January, February and the first half of March. From that time forward through the first week of September we allocated such payments in equalthirds thirds between petitioner, Kathleen and Keith. We have allocated the $100 hospital expense equally between Kathleen and Keith and allocated the $117 support payments for Keith entirely to Keith. As a result, *54 we have concluded that petitioner contributed $608.50 and $458.73, respectively, toward the support of Kathleen and Keith during the year in issue. Petitioner contends that he continued the $75 a month rent payments on their apartment through the end of the year in issue and should be credited with these amounts. He testified, however, that he did not return to the apartment or even telephone after having left in September until early 1964 or late 1963, and did not even know that his wife and son were no longer living there. Coupling this with the circumstance of Kathleen's heart condition, which made her fearful of living alone, we have concluded that no such credit is allowable. Under section 151(b) 1 a taxpayer is entitled to an exemption for his spouse only if such spouse is not the dependent of another taxpayer. A dependent as defined by section 152(a) is an individual (including a daughter) over half of whose support for the year in issue was received from the taxpayer. It follows that petitioner is not entitled to the exemption for Kathleen absent proof that another, in this case Helen, did not furnish over half of Kathleen's support. *55 Petitioner made no attempt to prove what amounts had been so spent by Helen and has thus failed his burden. Helen was called as a witness by respondent and, totaling only the major items from her testimony, we have found that she contributed at least $720 towards Kathleen's support. Under section 152(a) it is petitioner's burden to prove that he contributed over half of Keith's support in order to be able to claim him as a dependency exemption. Again petitioner made no attempt to prove what amounts had been spent for Keith's support by others and has again failed his burden. We note however the major items testified to by Helen totaled over $500 and we have so found. It follows that, Decision will be entered for the respondent. 1267 Footnotes1. All references are to the Internal revenue Code of 1954.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624874/ | LAWRENCE DEMANN AND GLORIA DEMANN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDemann v. CommissionerDocket No. 33150-87United States Tax CourtT.C. Memo 1993-206; 1993 Tax Ct. Memo LEXIS 218; 65 T.C.M. (CCH) 2614; May 17, 1993, Filed *218 For petitioners: Wallace Musoff. For respondent: Jill A. Frisch. WELLSWELLSMEMORANDUM FINDINGS OF FACT AND OPINION WELLS, Judge: Respondent determined the following deficiencies in petitioners' Federal income taxes: YearDeficiency1979$ 78,9941980103,570Unless otherwise indicated, all 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. After concessions, the issues we are asked to decide are: (1) Whether petitioners are entitled to a theft loss deduction for a certain licensing fee paid by petitioner Lawrence DeMann and related expenses; and (2) whether petitioners are entitled to deductions under section 1244 for losses on certain stocks. FINDINGS OF FACT Some of the facts and certain documents have been stipulated for trial pursuant to Rule 91. We incorporate the stipulated facts herein by reference. At the time petitioners filed their petition, they resided in New York, New York. United Laboratories of America, Inc.Petitioner Lawrence DeMann (hereinafter individually referred to as petitioner) was introduced to the principals of *219 United Laboratories of America, Inc. (United Laboratories), which had allegedly developed a process to implant synthetic hair and was allegedly engaged in franchising the process. Petitioner investigated United Laboratories by visiting its office in Ohio, talking with some of its patients being treated there, and watching the process. After his investigation, on September 9, 1977, petitioner entered a franchise agreement with United Laboratories and paid a franchise fee in the amount of $ 50,000 to United Laboratories. The franchise agreement states that the franchisor, United Laboratories, is the owner of all right, title, and interest in the process of implanting synthetic hair. The agreement provides that the franchisor will warrant that it currently has the proper instructions, techniques, and knowledge required to successfully restore hair through the process of implanting synthetic hair. The agreement delineated the franchise territory, training, continuing supervision by the franchisor, and fees. During 1977 and 1978, petitioner attempted to find a location to establish a laboratory, and in 1978 he forwarded a preliminary plan for a location to United Laboratories, which*220 had the right to approve any location selection. By the end of 1978, however, petitioner believed that United Laboratories had failed to fulfill the franchise agreement, and he instructed his attorney to request a refund of his franchise fee. During 1979, having failed to receive a refund of the franchise fee or any response to his request for a refund of the fee, petitioner went to the office of United Laboratories in Ohio. While at the office, petitioner observed a marshal posting a notice that the office was closed. During and after 1979, petitioner was unsuccessful in his attempt to contact the principals of United Laboratories. Petitioner received a statement, dated June 30, 1978, for $ 6,000 from attorney Steven Antler for professional services rendered in connection with United Laboratories which included, but was not limited to, "negotiation, preparation and finalization of all documentation". The record does not reflect how or when the statement was paid. During September 1979, petitioners retained the services of Kenneth Lapine to obtain a refund of their franchise fee. Petitioner Gloria DeMann wrote a letter dated September 20, 1979, to Mr. Lapine regarding United*221 Laboratories, in which she stated that a check for $ 1,000 was enclosed. The check is not part of the record. By letter dated August 7, 1980, petitioners were advised by Mr. Lapine that "there might be some assets [of United Laboratories] left over after the distribution to the customers [who had paid for hair implant treatment]." To take advantage of such a possibility, Mr. Lapine suggested that petitioner obtain a default judgment against the individual principals of United Laboratories. By letter dated January 18, 1982, petitioner was advised by his attorney, Edward Janis, that a hearing on a default judgment against United Laboratories had been scheduled for January 27, 1982. Mr. Janis also advised petitioner that: "In all likelihood, we will probably be unable to collect anything on this judgment." Papaya King Company, Inc.On August 18, 1978, petitioner and Morris Goldberg entered a stockholders agreement with Papaya King, Company, Inc. (Papaya King) an Hawaiian corporation. The record contains a copy of a certificate, dated August 25, 1978, for 2,000 shares of Papaya King stock. The certificate was issued to petitioners. Papaya King was formed to operate retail*222 stores to sell fast food and beverages. Each retail store was to operate through a separate corporation. During 1978, a retail store known as Papaya King of Hawaii was opened. On October 24, 1979, Morris Goldberg and petitioner terminated the stockholders agreement of August 18, 1978, and resigned as officers of Papaya King. The agreement states that such actions were taken to "induce Isoo Oshima to assume control of [Papaya King Company, Inc., and Papaya King of Hawaii]." Petitioner did not receive any payment for his stock when the stockholders agreement was terminated. On December 21, 1979, petitioners transferred, without consideration, their 2,000 shares of Papaya King stock to Morris Goldberg. The record does not reflect the reason for the transfer. The books and records of Papaya King were turned over to an accounting firm in Hawaii which managed the assets of Papaya King after petitioner and Mr. Goldberg terminated the stockholders agreement. The record does not reflect whether petitioners made any attempt to obtain the books and records of Papaya King. Farraday Farms, Inc.On May 19, 1978, petitioners incorporated Farraday Farms, Inc. (Farraday Farms). Farraday*223 Farms issued 50 shares of stock to each of petitioners. Farraday Farms sold health food snacks, such as chopped nuts and raisins, through franchise distributors in the Eastern United States. On December 31, 1980, petitioners sold all their Farraday Farms stock to Benjamin Litman, who was the operations manager of Farraday Farms. The purchase price for the stock was $ 50,000, to be paid by the payment of $ 100 in cash at closing, and the remaining $ 49,900 at the rate of $ 1.00 as each case of Farraday Farms merchandise was packaged. Mr. Litman paid the $ 100 at closing. During January 1981, Mr. Litman informed petitioner that the balance of the purchase price could not be paid. Petitioners agreed to modify their agreement with Mr. Litman to allow the purchase price to be paid after the company had begun to show a profit. The additional $ 49,900, however, was never paid. OPINION The first issue we must decide is whether petitioners are entitled a $ 57,000 theft loss deduction for the license fee which petitioner paid to United Laboratories and related legal expenses. Respondent argues that petitioners are not entitled to such deduction because they have failed to prove that*224 a theft occurred under New York law. To be entitled to their theft loss deduction, petitioners must prove that they sustained a theft during the taxable year. Sec. 165(e). The term "theft" includes, but is not limited to, larceny, embezzlement, and robbery. Sec. 1.165-8(d), Income Tax Regs. Petitioners have the burden of proving that a theft occurred under the laws of the jurisdiction where the alleged theft loss took place. Paine v. Commissioner, 63 T.C. 736">63 T.C. 736, 740 (1975), affd. without published opinion 523 F.2d 1053">523 F.2d 1053 (5th Cir. 1975); Monteleone v. Commissioner, 34 T.C. 688">34 T.C. 688, 692 (1960). Petitioners argue that United Laboratories fraudulently induced petitioner to pay for a franchise which United Laboratories never intended to implement. We take petitioners' argument to mean that United Laboratories committed larceny under the laws of New York. New York law defines larceny as a wrongful taking, obtaining, or withholding of property from its owner with an intent to deprive the owner of such property. N.Y. Penal Law sec. 155.05(1) (McKinney 1988). Larceny includes obtaining property by *225 false pretenses. Id. at sec. 155.05(2)(a). Under New York law, larceny by false pretenses requires the following: (1) An intent to deprive the owner of property; (2) the making of a false representation; (3) knowledge that the representation is false; (4) obtaining the property of another, and (5) inducement of the owner to give up the property in reliance upon the false representation. People v. Chaitin, 462 N.Y.S.2d 61">462 N.Y.S.2d 61, 63 (App. Div. 1983), affd. 460 N.E.2d 1082">460 N.E.2d 1082 (N.Y. 1984). The misrepresentation must relate to a past or present fact, not a statement of future intention. People v. Churchill, 390 N.E.2d 1146">390 N.E.2d 1146, 1149 (N.Y. 1979). In the instant case, petitioners have failed to prove that petitioner relied upon any misrepresentation by United Laboratories when he paid the franchise fee. Petitioner testified that he visited the Ohio office of United Laboratories, talked to patients, and watched the hair implant process being performed. Subsequently, petitioner signed a franchise agreement and paid United Laboratories $ 50,000. Petitioner, however, failed to testify about any specific misrepresentation*226 that United Laboratories made in the process of selling him a franchise. Neither the fact that petitioner found United Laboratories to be closed nor the fact that he was unable to contact the principals of United Laboratories in order to obtain a refund, establishes the existence of a misrepresentation which induced petitioner to pay the franchise fee. Consequently, we are unable to conclude that petitioner was the victim of larceny by false pretenses under New York laws. Accordingly, we hold that petitioners are not entitled to a theft loss deduction for the fees paid to United Laboratories and related legal expenses. The next issue we must decide is whether petitioners are entitled to a deduction under section 1244 for a loss during taxable year 1979 in the amount of $ 100,000 for the worthlessness of their Papaya King stock. Petitioners argue that the stock became worthless in 1979 because petitioner and Mr. Goldberg terminated the Papaya King stockholders agreement on October 24, 1979, without receiving any payment for the stock. Respondent argues that petitioners have failed to prove that the Papaya King stock became totally worthless during 1979. Generally, a taxpayer*227 is entitled to capital losses on stock that becomes worthless during the relevant taxable year. Sec. 165(g). Section 1244(a), however, provides for ordinary losses on "Section 1244" stock, subject to certain restrictions. The provisions of section 1244 apply to losses from section 1244 stock which becomes worthless during the taxable year. Sec. 165(g); sec. 1.1244(a)-1(a), Income Tax Regs. Worthlessness is a question of fact determined by the facts and circumstances. Dustin v. Commissioner, 53 T.C. 491">53 T.C. 491, 501 (1969), affd. 467 F.2d 47">467 F.2d 47 (9th Cir. 1972); Watson v. Commissioner, 38 B.T.A. 1026">38 B.T.A. 1026, 1032 (1938). Petitioners have the burden of proving that the stock became worthless during the taxable year. Dustin v. Commissioner, supra; Watson v. Commissioner, supra.In addition to the foregoing requirements, in order to prove that the stock became worthless during the year, petitioners must prove that the stock had value at the beginning of such year. Dustin v. Commissioner, supra; Anthony P. Miller, Inc. v. Commissioner, 7 T.C. 729">7 T.C. 729, 745 (1946);*228 Rand v. Commissioner, 40 B.T.A. 233">40 B.T.A. 233, 239-240 (1939), affd. 116 F.2d 929">116 F.2d 929 (8th Cir. 1941); Morton v. Commissioner, 38 B.T.A. 1270">38 B.T.A. 1270, 1278 (1938), affd. 112 F.2d 320">112 F.2d 320 (7th Cir. 1940). In the instant case, although petitioners proved that, during taxable year 1979, they terminated the stockholders agreement for Papaya King and that they did not receive any compensation for the stock, they failed to evince any evidence regarding Papaya King's value at the beginning of such year. No corporate books and records were entered into evidence, and petitioners have not indicated that they made any effort to obtain such books and records from their accounting firm in Hawaii. When a party fails to produce evidence which is available to such party, the failure gives rise to the presumption that, if produced, the evidence would be unfavorable. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158">6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). Although the record in the instant case includes a photograph of the Papaya*229 King of Hawaii store and its employees, apparently taken sometime during 1978, petitioner did not testify that Papaya King engaged in any activity or operations at the close of 1978, the year prior to the year in issue. Consequently, on the scant record before us, we are unable to conclude that Papaya King had any value at the beginning of 1979. Dustin v. Commissioner, supra; Anthony P. Miller, Inc. v. Commissioner, supra; Rand v. Commissioner, supra; and Morton v. Commissioner, supra.Accordingly, we hold that petitioners have failed to prove that the Papaya King stock became worthless during 1979. Petitioners, therefore, are not entitled to a deduction under section 1244 for such stock. The final issue we must decide is whether petitioners are entitled to a deduction under section 1244 for a loss during taxable year 1980 in the amount of $ 100,000 for the worthlessness of their Farraday Farms stock. Respondent argues that petitioners have failed to prove that the Farraday Farms stock qualifies as section 1244 stock because they have not*230 shown that the stock was issued pursuant to a written plan as required under section 1.1244(e)-1, Income Tax Regs., as in effect for the years in issue. 1 Petitioners contend that respondent's argument presents a new issue not raised in the notice of deficiency. *231 The notice of deficiency raises specific reasons for the disallowance of petitioners' losses from their Farraday Farms stock. The notice of deficiency states as follows: (g) the deduction of $ 100,000.00 shown on your 1980 return as a loss resulting from worthless Section 1244 stock of Faraday [sic] Farms, Inc. is disallowed because the basis of the stock has not been established. Alternatively, it is further determined that a loss resulting from the worthless Section 1244 stock of Faraday [sic] Farms, Inc. is limited to $ 50,000.00 per Section 1244(b)(2) of the Internal Revenue Code. Accordingly, taxable income is increased $ 100,000.00 in 1980.Where the record reveals that the Commissioner has given the taxpayer adequate notice that the Commissioner intends to raise a new reason or theory for the deficiency determination, we will consider the reason or theory even though it was not set forth in the notice of deficiency. Pagel, Inc. v. Commissioner, 91 T.C. 200">91 T.C. 200, 211 (1988), affd. 905 F.2d 1190">905 F.2d 1190 (8th Cir. 1990); William Bryen Co. v. Commissioner, 89 T.C. 689">89 T.C. 689, 707 (1987). Generally, *232 notice is adequate if the taxpayer is not surprised or prejudiced by the raising of such new reason or theory. Pagel v. Commissioner, supra at 212. At trial, petitioners' counsel clearly indicated that he knew from the time that he entered the case, 16 days prior to the trial, that respondent was going to raise the question of whether the Farraday Farms stock was issued under a written plan. Moreover, at trial, respondent requested that, in the event we found that respondent's argument is a new matter, we permit respondent to amend the answer. Petitioners did not object to allowing respondent to amend the answer to raise the new theory, so long as respondent has the burden of proof on the issue. We conclude that petitioners received adequate notice of respondent's intention to raise the issue of the written plan requirement, and we will grant respondent's motion to amend the answer for the purpose of raising the issue. Respondent argues that the burden of proof should be on petitioner because the issue regarding the requirement of a written plan is not a new matter. Rule 142(a) requires petitioners in this Court to bear the burden of proof, *233 except as to "new matters". A theory not set forth in the notice of deficiency is a new matter when it alters the original deficiency or requires the presentation by petitioner of different evidence. Vetco, Inc. v. Commissioner, 95 T.C. 579">95 T.C. 579, 588 (1990); Achiro v. Commissioner, 77 T.C. 881">77 T.C. 881, 890 (1981); Estate of Falsese v. Commissioner, 58 T.C. 895">58 T.C. 895, 898-899 (1972); McSpadden v. Commissioner, 50 T.C. 478">50 T.C. 478, 493 (1968); Papineau v. Commissioner, 28 T.C. 54">28 T.C. 54, 57 (1957); Tauber v. Commissioner, 24 T.C. 179">24 T.C. 179, 185 (1955). In the instant case, as respondent's argument does not alter the deficiency, we must decide whether respondent's argument would require petitioner to present different evidence. Respondent argues that no new evidence is required to prove that the Farraday Farms stock was issued under a written plan because petitioners would have to show that they satisfied all of the requirements of section 1244(e)-1, Income Tax Regs., as a part of their burden of proving their loss. We disagree. The notice*234 of deficiency specifically states that the loss was disallowed because petitioners had not established their basis in the Farraday Farms stock. No other reason or theory for the disallowance was set forth in the notice of deficiency, although the notice does advance an alternative theory, discussed below, that the loss should be limited to $ 50,000. It is quite obvious to us that the only documentary evidence necessary to corroborate petitioners' basis in the Farraday Farms stock would be a check or some other paper sufficient to persuade us that petitioners actually invested the amount they claimed. The requirement of a written plan as an element of establishing petitioners' entitlement to a section 1244 loss, therefore, is a wholly separate issue, requiring different evidence. Accordingly, we hold that respondent's argument that the stock was not issued under a written plan is a new matter upon which respondent has the burden of proof. Rule 142(a). The record in the instant case contains copies of minutes of Farraday Farms adopting a "PLAN TO OFFER COMMON STOCK FOR SALE PURSUANT TO IRC SEC. 1244". Respondent attempts to cast doubt upon such plan by pointing to certain*235 minor irregularities that are contained in the minutes. Although we are not free of doubt, on the record in the instant case, we hold that respondent has failed to persuade us that the Farraday Farms stock was not issued pursuant to a written plan. As to the primary reason set out in the notice of deficiency for the disallowance of the loss, i.e., that petitioners failed to establish any basis in the Farraday Farms stock, petitioners contend that certain documents and testimony offered at trial satisfy their burden of proof. The first document on which petitioners rely as proof of their investment is an unaudited financial statement of Farraday Farms dated May 31, 1980. The financial statement discloses the existence of capital stock in the amount of $ 100,000. Respondent contends that the financial statement is hearsay and does not fall within the hearsay exception for business records under rule 803(6) of the Federal Rules of Evidence.Fed. R. Evid. 803(6) states: A memorandum, report, record, or data compilation, in any form, of acts, events, conditions, opinions, or diagnoses, made at or near the time by, or from information transmitted by, a person with knowledge, *236 if kept in the course of a regularly conducted business activity, and if it was the regular practice of that business activity to make the memorandum, report, record, or data compilation, all as shown by the testimony of the custodian or other qualified witness, unless the source of information or the method or circumstances of preparation indicate lack of trustworthiness. The term "business" as used in this paragraph includes business, institution, association, profession, occupation, and calling of every kind, whether or not conducted for profit.Fed. R. Evid. 803(6) favors the admission of evidence if such evidence has any probative value. Matter of Ollag Constr. Equipment Corp., 665 F.2d 43">665 F.2d 43, 46 (2d Cir. 1981). Respondent argues that the financial statement does not fall within the hearsay exception because it was not made "at or near the time" of the transaction. The financial statement, however, is dated May 31, 1980, which is sufficiently near in time to the sale of the stock to satisfy us that the "at or near the time" requirement of Fed. R. Evid. 803(6) has been met, especially in light of the corroborating testimony of Mr. Litman discussed*237 infra. Next respondent argues that the financial statement does not fall within the hearsay exception because the financial statement lacks trustworthiness. Respondent's argument is based on the statement of the accounting firm which prepared the financial statement. In the cover letter attached to the financial statement, the accounting firm stated: "Since the scope of our examination did not include independent verification of assets and liabilities, we are unable to express an opinion as to the above statement." In order for business records to be admissible, Fed. R. Evid. 803(6), requires that they have "sufficient indicia of trustworthiness to be considered reliable." Saks International, Inc. v. M/V Export Champion, 817 F.2d 1011">817 F.2d 1011, 1013 (2d Cir. 1987). The decision as to whether a document is trustworthy is within the trial court's discretion. Waddell v. Commissioner, 841 F.2d 264">841 F.2d 264, 267 (9th Cir. 1988), affg. 86 T.C. 848">86 T.C. 848 (1986). At trial, Mr. Litman testified that the financial statement was prepared in the regular course of Farraday Farms business and that he witnessed the financial*238 statement being prepared from the books and records of Farraday Farms. Mr. Litman also testified that he had discussions with the accounting personnel about what Farraday Farms records actually showed. Mr. Litman was the operations manager of Farraday Farms from approximately November 1978 until he purchased Farraday Farms in December 1980. As operations manager, he had control of the books and records of Farraday Farms and was responsible for knowing what had been invested in Farraday Farms. Based upon Mr. Litman's testimony we are satisfied that the financial statement has sufficient indicia of trustworthiness to be considered reliable. Accordingly, we hold that the financial statement is admissible under the business records exception of Fed. R. Evid. 803(6). Petitioner testified that petitioners' basis in the Farraday Farms stock was $ 100,000. The financial statement corroborates petitioner's testimony. Consequently, we hold that petitioners have satisfied their burden of proving that their basis in the Farraday Farms stock was $ 100,000. Respondent alternatively determined that petitioners' deduction for the Farraday Farms stock should be limited to $ 50,000 under section*239 1244(b)(2). Prior to November 6, 1978, the maximum amount allowed as an ordinary loss for a husband and wife filing a joint return was $ 50,000. Sec. 1244(b)(2). Congress amended section 1244(b)(2) to increase such limitation to $ 100,000 for stock issued after November 6, 1978, the date of the amendment's enactment. Revenue Act of 1978, Pub. L. 95-600, secs. 345(b) and (e), 92 Stat. 2844. Subsequently, Congress amended the effective dates of section 345(e) of the Revenue Act of 1978, supra, to allow the $ 100,000 maximum amount to apply to taxable years beginning after December 31, 1978. Technical Corrections Act of 1979, Pub. L. 96-222, sec. 103(a)(9), 94 Stat. 212. Apparently unaware of the amendment contained in the Technical Corrections Act, respondent incorrectly determined that petitioners' deduction is limited under section 1244(b)(2) to $ 50,000. The year in issue in the instant case is 1980. Consequently, under the Technical Corrections Act amendment, petitioners are entitled to a deduction for $ 100,000 for the Farraday Farms stock. 2*240 We have considered all remaining arguments and found them to be without merit. 3To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. Section 1.1244(e)-1, Income Tax Regs., provides: Records to be kept and information to be filed with the return. (a) By the corporation. The plan to issue stock which qualifies under section 1244 must appear upon the records of the corporation. In addition, in order to substantiate an ordinary loss deduction claimed by its shareholders, the corporation should maintain records showing the following: (1) The persons to whom stock was issued pursuant to the plan, the date of issuance to each, and a description of the amount and type of consideration received for each; (2) If the consideration received is property, the basis in the hands of the shareholder and the fair market value of such property when received by the corporation; (3) Which certificates represent stock issued pursuant to the plan; (4) The amount of money and the basis in the hands of the corporation of other property received after June 30, 1958, and before the adoption of the plan for its stock, as a contribution to capital, and as paid-in surplus; (5) The equity capital of the corporation on the date of adoption of the plan; and (6) Information relating to any tax-free stock dividend made with respect to stock issued pursuant to the plan and any reorganization in which stock is transferred by the corporation in exchange for stock issued pursuant to the plan.(b) By the Taxpayer. Any person who claims a deduction for an ordinary loss on stock under section 1244 shall file with his income tax return for the year in which a deduction for the loss is claimed a statement setting forth: (1) The address of the corporation that issued the stock; (2) The manner in which the stock was acquired by such person and the nature and amount of consideration paid; and (3) If the stock was acquired in a nontaxable transaction in exchange for property other than money -- the type of property, its fair market value on the date of transfer to the corporation, and its adjusted basis on such date.In addition, a person who owns section 1244↩ stock in a corporation shall maintain records sufficient to distinguish such stock from any other stock he may own in the corporation.2. Respondent did not argue that petitioners' deduction is limited to $ 50,000 based on the sale price of the Farraday Farms' stock to Mr. Litman. Consequently, we need not address such issue.↩3. Two of these arguments respondent raises for the first time on brief. Respondent argues that petitioners have failed to prove that the Farraday Farms stock became worthless in 1980 and that Farraday Farms did not meet the requirements of a small business corporation under section 1244(c)(2). As stated above we will not consider a new theory not raised in the notice of deficiency unless the Commissioner gives adequate notice of such theory. Pagel Inc. v. Commissioner, 91 T.C. 200">91 T.C. 200, 211 (1988), affd. 905 F.2d 1190">905 F.2d 1190 (8th Cir. 1990); William Bryen Co. v. Commissioner, 89 T.C. 689">89 T.C. 689, 707 (1987). The record is silent as to whether petitioners received notice that respondent intended to raise such issues. Consequently, we will not permit respondent to raise such issues.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624878/ | David E. and Sandra L. Gantner, Petitioners v. Commissioner of Internal Revenue, RespondentGantner v. CommissionerDocket No. 2222-86United States Tax Court91 T.C. 713; 1988 U.S. Tax Ct. LEXIS 125; 91 T.C. No. 47; September 29, 1988September 29, 1988, Filed *125 Decision will be entered under Rule 155. Held, losses on sales of stock options are not subject to disallowance as wash-sales pursuant to sec. 1091, I.R.C. 1954, because options are not "stock or securities" within the meaning of sec. 1091. Held, P is not entitled to deductions and investment credits relating to computers used by his employer, a corporation in which P is a 50-percent shareholder. Held, P is not entitled to deductions for a home office and other expenses. Held, regardless of the date of assessment, P is liable for increased interest pursuant to sec. 6621(c) because a substantial underpayment of taxes attributable to tax-motivated transactions existed after Dec. 31, 1984. Mark Arth, for the petitioners.Genelle Forsberg and Douglas W. Hinds, for the respondent. Wells, Judge. WELLS*714 Respondent determined deficiencies in and additions to petitioners' 1980 and 1981 Federal income taxes as follows:1 Additions to tax YearDeficiencySec. 6651(a)(1)Sec. 6653(a)Sec. 6653(a)(1)Sec. 6653(a)(2)1980$ 63,027.02$ 4,848.79$ 5,241.6019814,433.00$ 248.10(1)*126 Respondent also determined that petitioners are liable for the increased rate of interest pursuant to section 6621(c). 2After settlement by the parties of several issues, the following remain for our decision: (1) Whether a loss on the sale of stock options should be disallowed pursuant to the wash-sale provisions of section 1091; (2) whether deductions and investment credits relating to computer equipment are allowable; (3) whether deductions for an office in petitioners' residence are allowable; (4) whether other business expenses for 1981 are allowable; and (5) whether there was an underpayment of petitioners' 1980 income tax attributable to tax-motivated transactions so that petitioners are liable for the increased rate of interest pursuant to section 6621(c).FINDINGS OF FACTSome of the facts*127 have been stipulated and are so found. The stipulation and attached exhibits are incorporated herein by this reference. Petitioners resided in Bloomington, Minnesota, when they filed their petition.During 1980 and 1981, petitioner David E. Gantner (petitioner) was president and a shareholder of the North Star Driving School, Inc. (North Star). North Star was in the business of selling driving lessons, and it provided students with classroom instruction and behind-the-wheel training. During the years in issue, petitioner also was president of the Driving School Association of the Americas (DSAA), a trade association consisting of approximately 225 dues-paying members, but in effect representing approximately 3,300 driving schools in the United States and *715 Canada. Petitioner's activities in DSAA required only a "token amount" of his time, including attendance at two or three meetings per year of the board of directors. Petitioner also served as a delegate to international driving instruction conventions held in Germany and Austria in 1980 and 1981, respectively.Petitioner and Lee Whited each owned 50 percent of the stock of North Star, and each received compensation*128 from North Star in the amounts of $ 37,874 and $ 38,369 in 1980 and 1981, respectively. Petitioner generally was responsible for the business aspects of North Star such as payroll, other disbursements, and marketing, and Mr. Whited generally was responsible for the operational aspects such as hiring, training, and supervising the driving instructors. The majority of North Star's students were of high school age, so the principal activities of the driving school took place from about 3 p.m. until the early evening hours. Petitioner usually performed his duties for North Star during the afternoon and early evening hours, as well as on weekends. Also, driving instructors sometimes would stop by petitioner's home at night to drop off receipts collected from the students and to pick up contracts that petitioner had brought to them from the North Star office.In addition to his duties with North Star and DSAA, petitioner also devoted a substantial part of the morning and early afternoon hours on weekdays to monitoring the stock market. Those times comported with the hours during which the New York Stock Exchange and the American Stock Exchange were open -- 9 a.m. until 3 p.m., Minnesota*129 time. During 1980, petitioner's stock market transactions consisted of purchases and sales of only call options for stock; he neither acquired nor sold actual shares of stock.Petitioner was not a licensed broker, so he purchased the stock options through the Minneapolis office of the brokerage firm Shearson Loeb Rhoades, Inc. (Shearson). His account statements from Shearson reflect the following activity in 1980:SalesPurchasesJanuary33March42April01May13June44July75August105September68October66November53December32Year total49*716 Petitioner bought 1,330 options in his 42 purchase transactions and sold 1,255 options in his 49 sales transactions. 3 In 1980, petitioner's net sales proceeds from stock options (after commissions) amounted to $ 1,043,978.76, and his total purchases (including commissions) amounted to $ 871,408.49.*130 Due to the high volume of his trading activity, petitioner received a 30-percent discount on commission fees from Shearson. In fact, one of the two Shearson brokers used by petitioner in 1980 described petitioner as "the most active customer I've ever had." Petitioner did not rely on brokers for recommendations to buy or sell options; he depended on the brokers only for execution of the trades and for information, e.g., the most current market prices.The majority of petitioner's 1980 purchases and sales of call options were for stock in Tandy Corp. (Tandy). Included among petitioner's purchases were the following calls for Tandy at $ 100 per share, expiring in January 1981 (JAN 100s): 4Date purchasedNumberCost11/20/8015$ 15,979.3511/20/803538,160.2912/02/805036,260.06On December 3, 1980, petitioner bought 100 JAN 100s at a cost of $ 61,063 and sold 100 JAN 100s for $ 51,490. On his 1980 tax return, petitioner reported a loss of $ 38,909.70 from the sale of the Tandy options. The loss was computed using a cost basis of $ 90,399.70 (total cost of the purchases on November 20 and December 2) and a sales price of $ 51,490.*131 In the notice of deficiency, respondent disallowed that loss for 1980 based upon the wash-sale provisions. Respondent added the amount of the disallowed loss to the basis of the options purchased on December 3, 1980, and allowed *717 petitioner an increased 1981 loss upon the disposition and expiration of the Tandy options in January 1981.In addition to his stock option trades, petitioner purchased and sold commodities futures through a "managed account" administered by Shearson's Chicago office. The managed account gave the broker in Chicago discretionary authority to make trades for the account without any participation by petitioner in the decisions. Petitioner's use of such a discretionary account for his commodity transactions was in direct contrast to his stock option account in which he alone made the decisions to buy or sell.Among petitioner's commodity transactions in 1980 were straddles using gold contracts. Prior to trial, the parties entered into a closing agreement for the disallowance of short-term capital losses claimed on petitioners' 1980 tax return for "gold commodity futures tax straddles transactions" in the amount of $ 253,350. In September 1983, petitioners*132 prepared an amended 1980 tax return reflecting the disallowance of those commodities transactions. The tax liability, as reflected on that amended return, was $ 40,329. As of the date of trial, petitioners had made the following payments to apply against their 1980 Federal tax liability:1980 withholding, net of amounts refunded$ 1,31911/6/8450012/31/8420,00010/17/8543,92910/21/858,19973,947In 1979, 1980, and 1981, petitioner purchased various items of computer equipment and computer software. The computers were used by North Star for payroll, form letters and mailing lists, scheduling students and instructors, and other business purposes. Petitioner, rather than North Star, paid for the computer items because North Star was short of cash at the time. The computers also were used by petitioner to maintain information relating both to DSAA and to petitioner's stock options and commodity futures.All but one of the computers were located in the North Star offices. One computer was kept in a room in petitioner's home and could interface with the computers at the North Star offices via a telephone modem located in the *718 home. The majority of petitioner's*133 use of the computers took place while he was in the North Star office; however, he sometimes used the computers while at his home. During 1979 through 1981, North Star had no rental agreement with petitioner, and North Star made no payments to petitioner for its use of the computer items. There was no written agreement between petitioner and Mr. Whited with respect to the computer items.On their amended 1980 tax return, petitioners claimed deductions and investment credits relating to the computer items as follows:Depreciation$ 9,715.41Expenses for repairs and supplies1,876.41Investment credit for items purchased in 1979and 1980 1,755.00On their 1981 tax return, petitioners claimed deductions and investment credits for computer items as follows:Depreciation$ 6,980.49Expenses for supplies and repairs843.36Investment credit225.61On their 1980 and 1981 tax returns, petitioners claimed additional deductions and credits as follows:19811980Expenses of office in the home$ 285.81$ 285.81Depreciation on a Honeywell security systemin the home 147.04Investment credit on the Honeywell securitysystem 183.87Unreimbursed expenses as DSAA president2,154.711,111.83*134 In the notice of deficiency, respondent disallowed all of petitioners' claimed deductions and credits relating to the computer items, the home office, the Honeywell system, and the DSAA expenses. Petitioners have conceded the nondeductibility of the DSAA expenses claimed for 1980, but they still contest the disallowance of the other items.OPINIONWash SaleThe first issue is whether the loss from petitioner's November and December trades of the Tandy calls should be disallowed for 1980 as a wash-sale pursuant to section *719 1091. Respondent has not suggested that any common law wash-sale doctrine should apply in the instant case. Cf. Shoenberg v. Commissioner, 77 F.2d 446 (8th Cir. 1935), affg. 30 B.T.A. 659">30 B.T.A. 659 (1934); Horne v. Commissioner, 5 T.C. 250 (1945). See also Cottage Savings Association v. Commissioner, 90 T.C. 372">90 T.C. 372, 392-394 (1988). Respondent's position is based solely on the applicability of section 1091 to the facts before us. As in effect in 1980, section 1091(a) provided as follows:SEC. 1091. LOSS FROM WASH SALES OF STOCK OR SECURITIES. *135 (a) Disallowance of Loss Deduction. -- In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by an exchange on which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction for the loss shall be allowed under section 165(c)(2); nor shall such deduction be allowed a corporation under section 165(a) unless it is a dealer in stocks or securities, and the loss is sustained in a transaction made in the ordinary course of its business.We have no doubt that petitioner's Tandy call transactions in November and December fall within the ambit of section 1091 if the Tandy options are "shares of stock or securities." Petitioner purchased 100 calls on November 20 and December 2, he sold 100 identical calls on December 3, and he purchased 100 identical calls on December 3. In short, petitioner's position at the beginning of December*136 3 was identical to his position at the beginning of December 4 -- he owned 100 Tandy JAN 100 calls -- and the repurchase took place within 30 days (actually, the same day) of the disputed loss sale.Petitioners assert, however, that the Tandy options are not "shares of stock or securities" as those terms are used in section 1091. Petitioners also assert that petitioner was in the trade or business of trading options so that the loss is allowable under section 165(c)(1), not section 165(c)(2); therefore, section 1091 does not apply to him. The arguments are disjunctive, so a finding for petitioners on either argument would cause section 1091 to be inapplicable to the loss on the Tandy options.*720 Respondent counters that (1) the options are securities subject to loss disallowance under section 1091; (2) petitioners' assertion that petitioner was in the trade or business of trading options was not timely and should not be considered by the Court; and (3) even if the trade or business issue was raised timely, petitioner's buying and selling of stock options did not rise to such a level that he was either a dealer or trader -- petitioner was merely an investor.Neither Code section*137 1091 nor the regulations thereunder contain a definition of what constitutes a "security" for purposes of section 1091. 5 In addition, the parties have not cited and we are not familiar with any case that decides whether an option is a security for such purposes; the issue before us is one of first impression. Other sections of the Code contain the term "stock or securities," but stock options are not treated uniformly in all those sections. *138 For example, section 1236(c) defines the term "security" to include "any evidence of an interest in or right to subscribe to or purchase" stock in a corporation. On the other hand, "For purposes of section 351, stock rights or stock warrants are not included in the term 'stock or securities.'" Sec. 1.351-1(a)(1), Income Tax Regs. In short, there is no uniform rule under tax law whereby stock options definitively are included in or excluded from categorization as "stock or securities." 6 See A. Kramer, Taxation of Securities, Commodities, and Options, sec. 17.6(a), at 17-10 (1986). We therefore shall focus on the terms of section 1091, itself, to ascertain whether a stock option is a security.By its terms, section 1091(a) requires two events before it can apply. There must be both (1) a sale or other disposition on which a loss was claimed, as well as (2) an acquisition of like property within 30 days of the date of the sale or disposition. The statute speaks in terms of the sale or disposition only of "shares of stock or securities"; however, *721 the reacquisition event is described as occurring if "the taxpayer has acquired * * *, or has entered into a contract or option so to acquire, substantially identical stock or securities." (Emphasis supplied.) *139 Implicit in that statutory language is that a contract or option to acquire stock or securities is not the same as an acquisition of stock or securities. To say that entry into a contract or option to acquire stock or securities is tantamount to the acquisition of stock and securities would be to render superfluous the above-emphasized clause in section 1091(a). Such an interpretation would violate the cardinal rule of statutory construction that "effect shall be given to every clause and part of a statute" ( Ginsberg & Sons v. Popkin, 285 U.S. 204">285 U.S. 204, 208 (1932); Woods v. Commissioner, 91 T.C. 88">91 T.C. 88, 98 (1988); McNutt-Boyce Co. v. Commissioner, 38 T.C. 462">38 T.C. 462, 469 (1962), affd. per curiam 324 F.2d 957">324 F.2d 957 (5th Cir. 1963)), and we decline to read that emphasized clause out of the statute. Thus, insofar as the reacquisition event is concerned, an option to acquire stock or securities surely is not equivalent to stock or securities. Extending that logic to the disposition event, a disposition of an option to acquire stock is not equivalent to a disposition of stock of*140 securities. Such a construction is required in order to maintain the internal consistency of the terms of section 1091, because identical words used in different parts of the same statute must be construed to mean the same thing if no contrary meaning is clearly shown. See Sorenson v. Secretary of Treasury, 475 U.S. 851">475 U.S. 851, 860 (1986); Helvering v. Stockholms Enskilda Bank, 293 U.S. 84">293 U.S. 84, 87 (1934); Gellman v. United States, 235 F.2d 87">235 F.2d 87, 89 (8th Cir. 1956); Estate of Cuddihy v. Commissioner, 32 T.C. 1171">32 T.C. 1171, 1176 (1959). Thus, the plain meaning of section 1091(a) is that an option to acquire stock is not equivalent to "stock or securities" and a loss sustained from a sale or disposition of stock options is not a loss which comes within the plain meaning of section 1091.Even though we have interpreted section 1091(a) on its face to exclude stock options from its ambit, we shall examine the history of section 1091 and its predecessor provisions to determine whether the intent of Congress is contrary to the plain meaning of the words of the statute. *722 See Jaske v. Commissioner, 823 F.2d 174">823 F.2d 174, 176 (7th Cir. 1987),*141 affg. a Memorandum Opinion of this Court; Segel v. Commissioner, 89 T.C. 816">89 T.C. 816, 841 (1987); Huntsberry v. Commissioner, 83 T.C. 742">83 T.C. 742, 747-748 (1984). The tax statutes have contained a provision substantially identical to section 1091 for over 60 years. The Revenue Act of 1924, ch. 234, 43 Stat. 253, 269-270, included the following provision:DEDUCTIONS ALLOWED INDIVIDUALSSEC. 214. (a) That in computing net income there shall be allowed as deductions:* * * *(5) 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 * * *. No deduction shall be allowed under this paragraph for any loss claimed to have been sustained in any sale or other disposition of shares of stock or securities where it appears that within thirty days before or after the date of such sale or other disposition the taxpayer has acquired (otherwise than by bequest or inheritance) or has entered into a contract or option to acquire substantially identical property, and the property so acquired is held by the *142 taxpayer for any period after such sale or other disposition. * * * [Emphasis supplied.]Except for the emphasized clause (which first appeared in the 1924 Act), section 214(a)(5) of the 1924 Act is identical to the first statutory wash-sale provision enacted by Congress -- section 214(a)(5) of the Revenue Act of 1921, ch. 136, 42 Stat. 227, 240. 7 Legislative history to the 1924 Act does not address the addition into law of the emphasized clause, which was the first, and to date remains the only, reference to options in the wash-sale provisions. See H. Rept. 179, 68th Cong., 1st Sess. (1924), 1939-1 C.B. (Part 2) 168, 256; S. Rept. 398, 68th Cong. 1st Sess. (1924), 1939-1 C.B. (Part 2) 266, 282; Conf. Rept. 844, 68th Cong., 1st Sess. (1924), 1939-1 C.B. (Part 2) 300, 305-306. Furthermore, we are not aware of any subsequent legislative history that refers to options in the context of wash sales.*143 The Conference report for the 1921 Act, Conf. Rept. 486, 67th Cong., 1st Sess. (1921), 1939-1 C.B. (Part 2) 206, 214, *723 provides the most expansive explanation available of Congress' intent in enacting the wash-sale provisions:The House bill provided that the taxpayer shall not be allowed any loss sustained in any sale of shares of stock where it appears that at or about the date of such sale the taxpayer has acquired identical property in substantially the same amount as the property sold, and that if such new acquisition is to the extent of part only of the identical property, then the amount of loss deductible shall be in proportion as the total amount of the property sold or disposed of bears to the property acquired. The Senate amendment extends the operation of the rule to cases where the acquisition of new property is within 30 days before or after the date of sale, but excepts from the operation of the rule of the House bill cases where the new property is acquired by bequest or inheritance, and brings within the operation of the rule cases where the new property is substantially identical with the property sold, and provides, in *144 case the new acquisition is to the extent of part only of substantially identical property, in lieu of the proportion provided by the House bill, that only a proportionate part of the loss shall be disallowed. [Emphasis supplied.]At first blush, that Conference explanation leads us to recall the comments of Judge Learned Hand:The words * * * merely dance before my eyes in a meaningless procession * * * [and] leave in my mind only a confused sense of some vitally important, but successfully concealed, purport * * *. [One] cannot help wondering whether to the reader [those passages] have any significance save that the words are strung together with syntactical correctness.See Hand, "Thomas Walter Swan," 57 Yale L.J. 167">57 Yale L.J. 167, 169 (1947). Nevertheless, it is clear from that explanation that Congress, in enacting former section 214(a)(5), certainly did not contemplate the application of that statutory provision to losses on sales of options. The Conference report spoke only in terms of losses from sales of stock, and the House and Senate reports to the 1921 Act described the wash-sale provision as applying only to "losses sustained in the sale of securities." *145 H. Rept. 350, 67th Cong., 1st Sess. (1921), 1939-1 C.B. (Part 2) 168, 177; S. Rept. 275, 67th Cong., 1st Sess. (1921), 1939-1 C.B. (Part 2) 181, 191. In short, the legislative histories accompanying the 1921 and 1924 Acts offer no indication whatsoever that Congress intended the statutory wash-sale provision to disallow losses sustained on the sales of options.*724 Congress' failure to contemplate the application of the statutory wash-sale provision to sales of options likely is attributable to the lack of any significant market for resale of options in the 1920s, because it was not until 1973, when the Chicago Board Options Exchange began to trade in call options, that fungible stock options effectively were able to be bought and resold on public markets in the United States. See L. Loss, Fundamentals of Securities Regulation 252 (1983); H. Johnson, "Is It Better To Go Naked on the Street? A Primer on the Options Market," 55 Notre Dame Law. 7, 10-11 (1979). The fact that there was no ready resale market for stock options in 1921 and 1924 would explain why Congress did not then contemplate stock*146 options being "stock or securities" for purposes of section 1091.Moreover, Congress apparently has been aware of the growth of the options markets, as evidenced by its 1982 amendment of the 1933 and 1934 Securities Acts so as to include put and call options specifically within the definition of a "security" for purposes of those two acts. See note 6, supra. In spite of that apparent awareness, however, Congress has not seen fit to bring losses on options specifically within the ambit of section 1091. In 1982, or at any other time for that matter, Congress could have amended section 1091 just as it amended 15 U.S.C. sections 77b(1) and 78c(a)(10), namely, define the term "security" so as specifically to include put and call options. In short, the facts that (1) there is no legislative history to indicate that Congress ever has intended stock options to be "securities" within the meaning of section 1091, (2) there was no significant market for the resale of options when Congress first passed a statutory wash-sale provision in the 1920s, and (3) Congress has not amended section 1091 so as to include stock options specifically within the purview*147 of that statute, when taken together, lead us to conclude that Congress has never intended for losses on sales of stock options to be subject to disallowance under the statutory wash-sale provision of 1091. That lack of legislative intent, together with our reading of the plain meaning of section 1091, requires a holding that section 1091(a) does not apply *725 to disallow losses sustained on the sales of stock options. 8 We therefore hold for petitioners on this issue. *148 9 On account of such a holding, we need not reach the alternative issue of whether petitioner was engaged in the trade or business of trading options.Computer EquipmentWe next must decide whether, and to what extent, deductions and investment credits are allowed for the computer items. Petitioners have the burden of proof. Rule 142(a). It is evident that the majority of the use of the computers was dedicated to North Star. Furthermore, during the years at issue, there is no question but that North Star was a corporation engaged in substantial business activities whose existence cannot be disregarded. See Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436, 438-439 (1943); Rink v. Commissioner, 51 T.C. 746">51 T.C. 746, 752 (1969).In order to be deductible, business expenses generally must be the expenses of the taxpayer claiming the deduction. Hewett v. Commissioner, 47 T.C. 483">47 T.C. 483, 488 (1967). In that regard, *149 a corporation is treated as a separate entity from its shareholders for tax purposes. Moline Properties v. Commissioner, supra.It is also well established that a shareholder is not entitled to a deduction from his individual income for his payment of corporate expenses. Deputy v. du Pont, 308 U.S. 488">308 U.S. 488, 494 (1940); Rink v. Commissioner, 51 T.C. at 751. Such payments constitute either capital contributions or loans to the corporation and are deductible, if at all, only by the corporation. Deputy v. du Pont, supra;Rink v. Commissioner, supra.*726 Petitioners cite Lockwood v. Commissioner, T.C. Memo. 1970-141, as support for their deduction of the expenses attributable to North Star's use of the computer items. Petitioners, however, misconstrue the facts of Lockwood. In Lockwood, a taxpayer was an officer of Momex, Inc., but not a shareholder in that corporation. That taxpayer's wife, however, was a 25-percent shareholder in Momex, but not an employee thereof. The shareholders and *150 officers of Momex agreed that the officers would pay out of their own pocket, without corporate reimbursement, certain travel and entertainment expenses incurred by them on behalf of Momex. The corporate officer was accompanied by his wife on certain trips for Momex, and the couple claimed deductions for the expenses of those trips. We held that the taxpayers were allowed a deduction for the portion of the expenditures attributable to the husband on the grounds that those were ordinary and necessary expenses of being a Momex officer. We disallowed deductions for the wife's expenses because she was an investor, not an employee of Momex, and she did not show that the expenses were ordinary and necessary expenses of managing or conserving her Momex stock. Lockwood does not support petitioners' position because the taxpayer in Lockwood who was allowed a deduction was not a shareholder in his employer corporation; there was no issue in Lockwood as to whether the allowed expenses might have been capital contributions. Lockwood thus is inapposite to the facts of the instant case.Petitioners cite no other authority to support their deductions of the computer items used*151 by North Star. Petitioners have not suggested how the computer expenses possibly might be deductible expenses related to petitioner's role as an employee of North Star. Cf. Gould v. Commissioner, 64 T.C. 132">64 T.C. 132, 135 (1975). There was no corporate resolution or requirement that petitioner, as an employee, incur those expenses. Indeed, it appears to us that petitioner purchased the computer items in his capacity as a shareholder who desired that the company become more profitable, and the stock therefore more valuable. See Koree v. Commissioner, 40 T.C. 961">40 T.C. 961, 965-966 (1963). 10 Such *727 payments are contributions to the capital of North Star and, if at all deductible, are deductible by North Star, not by petitioners.Petitioner testified that the computers also were used to keep mailing lists for DSAA, as well as to keep track of his options and commodities futures. *152 Petitioners have not offered a log or any other evidence to show what percentage of use of the computers was devoted to North Star and what was devoted to his other activities. We, however, believe petitioner's testimony that he used the computers for activities other than North Star. Therefore, bearing heavily upon petitioners, whose inexactitude is of their own making, we find that they are entitled to a deduction and investment credits for 5 percent of the use of the computers. 11Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540, 544 (2d Cir. 1930); Browne v. Commissioner, 73 T.C. 723">73 T.C. 723, 729 (1980).*153 The parties disagree about the total amount of computer expenses incurred by petitioner during the years at issue. Respondent concedes that petitioner paid for depreciable computer items in the amounts of $ 3,382.95, $ 21,958.95, and $ 2,256.10 in 1979, 1980, and 1981, respectively. On their tax returns, petitioners used a higher cost basis for depreciation of those items; however, since petitioners have offered no evidence to support the higher bases, we deem them to have conceded the amounts in excess of those stipulated by respondent. Petitioners claimed depreciation and investment credit for the items purchased in 1979 as attributable to items first put into service in 1980. Respondent has not questioned the timing of the computer deduction and credit, and we deem him to have conceded that the 1979 and 1980 expenses relate to property placed in service in 1980.Petitioners have not offered evidence to substantiate any of the expenses for computer supplies and repairs claimed for 1980 and 1981. Respondent, however, has stipulated that petitioner incurred expenses for repairs and supplies in 1981 in the amount of $ 843.36 Petitioners therefore are *728 entitled to a deduction*154 for 5 percent of those expenses, but have not shown their entitlement to any such expenses for 1980. Rule 142(a).Last, respondent asserts that petitioner's computer purchases included software in the amounts of $ 397.95 and $ 2,256.10 for 1980 and 1981, respectively. Petitioners have not disputed those assertions, and we find that purchases in those amounts were for software. Rule 142(a). Investment credit is not allowed on computer software, so those amounts must be excluded from the basis of the section 38 property on which investment credit is available. Ronnen v. Commissioner, 90 T.C. 74">90 T.C. 74, 96-100 1988).In summary, we have found that petitioners are entitled to take deductions and credits for computer items to the extent of 5 percent of the following:Depreciable basis -- placed in service1980$ 25,341.9019812,256.10Basis of section 38 property198024,943.95Expenses of supplies and repairs1981843.36Petitioners also claimed investment credit and depreciation for a security system installed in their home in 1981. Their briefs do not address the use or purpose of the system, and they have forwarded no evidence to substantiate*155 any deductions or credits for costs of the system. We therefore deem them to have conceded the deductions and credit relating to the security system. Rule 142(a).Home OfficeNext, petitioners contend that they are entitled to a deduction for use of a room in their home as an office. Petitioners have the burden of proof on this matter. Rule 142(a). Section 280A(a) provides that no deduction shall be allowed with respect to the use of a dwelling unit which is used by a taxpayer as his residence. Section 280A(c)(1) provides exceptions under which a deduction is allowed to the extent a portion of the home is used on a regular basis exclusively as (1) the principal place of business for any trade or business of the taxpayer, 12 or (2) a place of *729 business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of business. In the case of an employee, however, those exceptions apply only if the exclusive use of the portion of the residence is for the convenience of the employer. Sec. 280A(c)(1).*156 Petitioners rely on Heineman v. Commissioner, 82 T.C. 538">82 T.C. 538 (1984), to support the home office deduction. Petitioners apparently overlook the first sentence of the opinion portion of that case, where we stated that "section 280A, relating to the use of a home as an office, is not applicable in this case because [the parties] agreed that the office was not a dwelling unit which was used as a residence within the meaning of section 280A(a)." 84 T.C. at 542. Heineman is thus inapposite to the instant case because there is no doubt that the house in which petitioner's "office" was located was used as petitioners' residence.Petitioners contend that it was necessary for petitioner to have a home office so that he could meet with driving instructors at night, and so that he could perform payroll functions and other duties for North Star. Petitioner maintains that he performed his North Star duties at his home because the North Star office was too noisy and he could not concentrate while there. As asserted in petitioners' brief, "The Petitioner requires solitude when conducting those affairs."Petitioners' brief states that *157 the office in the home was used "exclusively as an office to perform duties required of [petitioner] by North Star." Petitioners' brief 13 does not suggest that the office was used as the principal place of business of petitioner's trading of stock options (assuming arguendo that the options activities were a trade or business), and we take the failure to assert such as a concession that petitioner did not use his home as the focal point of his stock option activities. Indeed, petitioner testified that he would be at the North Star office during most of the time the stock market was open and would keep in contact with the brokers from there. He also testified *730 that in regard to the charting and recordkeeping of his option and commodity transactions, "I would normally do it at the office after the market closed. * * * I didn't really do much at home. I'd read the paper and try to get some information from there." In short, petitioners have based their entitlement to a home office deduction solely on the activities petitioner performed for North Star at home.*158 Petitioners have failed to prove that petitioner's use of an office in his home was "for the convenience of his employer," as required by section 280A(a)(1). North Star provided petitioner with working space at its office. Indeed, petitioner, a 50-percent shareholder and the president of North Star, likely could use as much of the North Star office space as he required; there is no indication that the terms of petitioner's employment with North Star required him to maintain a home office. His meetings with the driving instructors were more for the convenience of those employees than of North Star; the fact that petitioner lived in Bloomington, in the southwest outskirts of the metropolitan area, allowed the instructors in the southwest quadrant to avoid having to drive across town to the North Star offices in St. Paul. Furthermore, there is no indication why petitioner should require an office to meet with the instructors.We understand why petitioner might prefer the quietude of his home to the bustle of the North Star office; however, we think that his use of a home office to perform his other North Star duties was more for his convenience than for that of North Star. Even *159 though the use of petitioner's home office was helpful and possibly appropriate in connection with his employment, Congress specifically intended to negate such a standard of allowability with its enactment of section 280A. H. Rept. 94-658, 1976-3 C.B. (Vol. 2) 695, 853; S. Rept. 94-938, 1976-3 C.B. (Vol. 3) 49, 186-187. 14 In short, we find that petitioners have not shown their entitlement to any home office deductions under section 280A.DSAA ExpensesPetitioners next contend that they are entitled to a deduction in 1981 for unreimbursed expenses related to *731 petitioner's duties as president of DSAA. On their 1981 tax return, petitioners claimed total expenses relating to DSAA of $ 3,418.63 and reimbursement of $ 1,263.92, for a net deduction of $ 2,154.71. The parties have stipulated that petitioner has checks written in 1981 in the total amount of $ 1,992.64. *160 Petitioners' only contentions on this issue are that those checks adequately substantiate the 1981 deduction and that "the revenue agent's demand for unobtainable invoices was beyond the requirements of section 162 and the items were not related to section 274."The only explanation in the record as to the composition of the claimed expenses was the following statement on petitioners' 1981 tax return: "Taxpayer is president of a National Business Association and was required to attend International Convention in Vienna in June 1981." Section 274(d) provides that no deduction shall be allowed for any traveling expense unless the taxpayer substantiates by adequate records or other sufficient evidence the amount of the expenditure, the time and place of the activity, and the business purpose. Section 274 obviously applies to at least some of the 1981 expenses. Petitioners have offered no records or other evidence to substantiate the business purpose of the stipulated checks, and they have not suggested which, if any, of the payments were for activities which are not subject to section 274. We therefore find that petitioners fail to meet their burden to prove their entitlement to any*161 of those claimed expenses. Rule 142(a).Section 6621(c)Section 6621(c) provides for increased interest where there is an underpayment of taxes in excess of $ 1,000 attributable to tax-motivated transactions in any year. Section 6621(c) applies only with respect to interest accruing after December 31, 1984, even though the taxpayer entered into the tax-motivated transactions before the date of the enactment of section 6621(c). Cherin v. Commissioner, 89 T.C. 986">89 T.C. 986, 1000 (1987); Solowiejczyk v. Commissioner, 85 T.C. 552">85 T.C. 552, 556 (1985), affd. per curiam without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986).Respondent has determined increased interest pursuant to section 6621(c) with respect to the portion of petitioners' *732 1980 tax liability attributable to the "gold commodity futures tax straddles transactions" which were the subject of the parties' closing agreement. Petitioners apparently do not dispute that the disallowed losses from the "gold commodity futures tax straddles transactions" are attributable to straddles as contemplated in section 6621(c)(3)(A)(iii); thus, the underpayment*162 attributable to those transactions is attributable to tax-motivated transactions within the meaning of section 6621(c).Petitioners' opposition to the imposition of the increased interest is based on their contention that they gave respondent's revenue agent an amended 1980 tax return reflecting that closing agreement, but that the revenue agent did not file the return. Petitioners reason as follows:Had the return been filed and an amount assessed against the Petitioner all payments could have been made before the effective date of the 1984 amendment to section 6621. Equity demands that the IRS agent's failure to file the amended return or process the item as an agreed adjustment, which resulted in the accruing of interest under section 6621, should excuse the Petitioner from paying a higher rate of interest than that normally charged.Petitioners' arguments do not seem to appreciate the purview of section 6621(c). It does not apply only to interest on assessments after December 31, 1984. Section 6621(c) applies to any interest accruing after that date. Interest on the underpayment attributable to petitioner's 1980 gold straddles accrues from April 15, 1981, the due*163 date for the payment of petitioners' 1980 taxes, until such time as the taxes are paid. Secs. 6072(a), 6151(a), 6601. Thus, any act of the revenue agent in filing or not filing petitioners' amended 1980 return would have had no effect on the accrual of interest. The only act which could stop the accrual of interest on the underpayment attributable to the straddles was petitioners' payment of the taxes by December 31, 1984. See Q and A-11, sec. 301.6621-2T, Temporary Proced. & Admin. Regs., 49 Fed. Reg. 59394 (Dec. 28, 1984).Petitioners made some payments of taxes attributable to their 1980 year before the end of 1984, but they did not make sufficient payments to satisfy the entire liability for the 1980 tax year. In fact, it was not until October 1985 that they made payments sufficient to satisfy the tax *733 liability, without regard to interest and additions to tax, as reflected on the amended 1980 return. Pursuant to Q and A-11 of section 301.6621-2T, Temporary Proced. & Admin. Regs., respondent applied the payments first to reduce the portion of the underpayment not attributable to the straddles. Petitioners have not challenged the validity*164 of those temporary regulations, and we take that as a concession of the validity of the regulations as to them. Thus, since petitioners did not pay the total underpayment attributable to the straddles by December 31, 1984, we find that they are liable for increased interest pursuant to section 6621(c) on the portion of the underpayment attributable to the straddles that remained unpaid after that date. 15To reflect the foregoing,Decision will be entered under Rule 155. Footnotes1. 50 percent of the interest due on $ 4,433↩2. Subsec. (d) of sec. 6621 was redesignated subsec. (c) and amended by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1511(c)(1)(A)-(C), 100 Stat. 2744. We use the reference to sec. 6621 as redesignated and amended.↩3. The parties stipulated that petitioner both bought and sold 1255 options during 1980, but our examination of petitioner's account statements indicates that the stipulation is incorrect in regard to the number of options purchased. See Jasionowski v. Commissioner, 66 T.C. 312">66 T.C. 312, 318↩ (1976).4. A single call represented an option to purchase 100 Tandy shares for $ 100 per share.↩5. Cases have held that commodity futures contracts and certificates of membership in the New York Coffee and Sugar Exchange are not securities for purposes of the predecessor provision to section 1091. See Corn Products Refining Co. v. Commissioner, 16 T.C. 395">16 T.C. 395, 399-400 (1951), affd. 215 F.2d 513">215 F.2d 513 (2d Cir. 1954), affd. on other grounds 350 U.S. 46">350 U.S. 46 (1955); Horne v. Commissioner, 5 T.C. 250">5 T.C. 250↩ (1945).6. This is in contrast to Federal securities law, which defines the term "security" specifically to include any put or call on stock. 15 U.S.C. secs. 77b(1) and 78c(a)(10) (1982). Prior to 1982, those definitions of "security" did not specifically include puts or calls, but did include a "warrant or right to subscribe to or purchase" any security. 15 U.S.C. secs. 77b(1) and 78c(a)(10) (1981)↩. See Act of October 13, 1982, Pub. L. 97-303, 96 Stat. 1409.7. As enacted in 1921, sec. 214(a)(5) also contained a clause limiting its application to sales and dispositions made after the passage of the 1921 Act, but no such clause was included in the 1924 Act.↩8. Such a holding comports with "the rule frequently stated by the Supreme Court that 'taxing acts are not to be extended by implication beyond the clear impact of the language used' and that 'doubts are to be resolved against the government and in favor of the taxpayer.' Helvering v. Stockholms Enskilda Bank, 293 U.S. 84">293 U.S. 84, 93-94 (1934)." Larotonda v. Commissioner, 89 T.C. 287">89 T.C. 287, 292 (1987). See also United States v. Merriam, 263 U.S. 179">263 U.S. 179, 187-188 (1923); Gellman v. United States, 235 F.2d 87">235 F.2d 87, 90 (8th Cir. 1956); Frankel v. United States, 192 F. Supp. 776">192 F. Supp. 776, 777 (D. Minn. 1961), affd. 302 F.2d 666">302 F.2d 666 (8th Cir. 1962); Chicago, St. Paul, Minneapolis & Omaha Ry. Co. v. Kelm, 104 F. Supp. 745">104 F. Supp. 745, 747 (D. Minn. 1952), affd. 206 F.2d 831">206 F.2d 831↩ (8th Cir. 1953).9. As we noted above, respondent has not suggested that any common law wash-sale doctrine should apply to the instant case, and we take that as a concession by respondent that petitioner's loss is allowable if the provisions of sec. 1091↩ do not apply.10. See also Cedrone v. Commissioner, T.C. Memo. 1986-89↩.11. For purposes of this deduction and credit, it is immaterial whether petitioner's trading of options rose to the level of a trade or business. If he were in a trade or business, the computer expenses would be deductible under sec. 162. If he were merely an investor, the expenses would be deductible under sec. 212. Investment credit similarly would be allowable in either event. Secs. 48(a)(1), 168(c)(1).↩12. For certain pre-1980 tax years, this first exception was worded so that a deduction was available for the use of a portion of the home "as the taxpayer's principal place of business." The change in the wording of sec. 280A(c)(1)(A) was made by an Act of December 29, 1981, Pub. L. 97-119, sec. 113, 95 Stat. 1635.↩13. Petitioners' reply brief was devoted solely to arguments regarding the options/wash-sale issue and did not address any other issues.↩14. See Dudley v. Commissioner, T.C. Memo. 1987-607↩.15. Our holdings thus render moot petitioners' motion to amend petition (embodying amendment) and motion to submit testimony to confront testimony previously ordered stricken from record but nevertheless cited in respondent's briefs.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624879/ | William L. Brueck, Sr., and Gwen A. Brueck v. Commissioner.Brueck v. CommissionerDocket No. 4462-62.United States Tax CourtT.C. Memo 1964-204; 1964 Tax Ct. Memo LEXIS 133; 23 T.C.M. (CCH) 1228; T.C.M. (RIA) 64204; July 31, 1964*133 L. J. Benckenstein, Petroleum Bldg., Beaumont, Tex., for the petitioners. Martin J. Nash, for the respondent. SCOTT Memorandum Findings of Fact and Opinion SCOTT, Judge: Respondent determined deficiencies in petitioners' income tax for the calendar years 1959 and 1960 in the amount of $365.36 and $366.51, respectively. The issue for decision is whether petitioners are entitled to deductions in each of the years 1959 and 1960 for the losses sustained in their farming operations. Findings of Fact Some of the facts have been stipulated and are found accordingly. Petitioners, husband and wife residing in Groves, Texas, filed joint Federal income tax returns for each of the years 1959 and 1960 with the district director of internal revenue at Austin, Texas. William L. Brueck, Sr. (hereinafter referred to as petitioner) was employed as an hourly worker in the Cracking Department of the oil refinery of the Gulf Oil Corporation at Port Arthur, Texas during the years here in issue. In 1947 petitioners acquired a farm situated near Woodville in Tyler County, Texas. Although the deed to this farm in describing the tract called for 25 1/2 acres more or less, the*134 tract described actually contains approximately 30 acres. In December 1963 petitioner retired from his employment with Gulf Oil Corporation and petitioners moved to the farm at Woodville, Texas. The farm which petitioners acquired in 1947 is between 60 and 65 miles from Groves, Texas, and is located adjacent to the city limits of Woodville about 1 mile south of the courthouse in that city. During his minority petitioner lived on a 120-acre farm operated by his parents in Amite County, Mississippi. The farm on which petitioner lived as a child was a generalized farm. When petitioner was 13 years old his father died and for several years petitioner assisted his mother and sisters in the operation of the farm while his brothers were away in military service during World War I. During the early 1920's petitioner attended Amite County Agriculture High School, a publicly supported school with curriculum requiring not only book study but field experience in agriculture. In his training at this school petitioner actually worked on the farm owned by the school under the supervision of his instructors. Upon graduation from the Amite County Agriculture High School in 1924, petitioner*135 received a scholarship to the State Agriculture College. Intending to work to obtain the money for clothes and other incidentals in order that he might use his scholarship to attend the State Agriculture College, petitioner, shortly after his graduation from high school, went to Port Arthur, Texas and obtained a job as a common laborer in the oil refinery of the Gulf Oil Corporation in that city. Approximately a year after he had started working in the oil refinery petitioner married his present wife. Petitioner continued working at the Gulf Oil Refinery in Port Arthur, Texas until his retirement in 1963. Petitioners have two children. In 1937 petitioners acquired a small tract of land in Groves, Texas and began farming operations thereon with a truck garden, a cow, some pigs and chickens. Subsequent to 1937 petitioners acquired four additional cows and operated a small dairy business on this farm near Groves. In 1940 petitioner bought a larger farm in Tyler County, Texas, near Woodville, about 6 miles west of where the farm he acquired in 1947 is located. Petitioner operated this farm as a truck farm, raising potatoes, beans, peas, tomatoes, watermelons, and cantaloupes, which*136 he hauled to Port Arthur and Beaumont, Texas to sell on the market. He also raised hogs and cattle and bought and sold cows. In early 1947 petitioner had 17 cows and 1 bull on the farm 6 miles west of Woodville. In September 1946 both of petitioner's children entered college, and in February 1947 petitioner sold his farm 6 miles west of Woodville to obtain money to use to pay the college expenses of his children. He used a portion of the money he obtained from the sale of the farm 6 miles west of Woodville as a down payment on the farm adjacent to the Woodville city limits that he acquired in 1947. When petitioner sold the farm 6 miles west of Woodville, he sold the cattle and other stock on the farm along with it. Petitioner had plans to purchase the farm adjacent to the city limits of Woodville when he sold the other farm. Between the time he acquired the farm in 1947 and 1959, petitioner constructed a small personal residence, several small barns approximately 10 by 20 feet and 12 by 12 feet, sheds, feed troughs, and other farm facilities upon the Woodville farm. Most of these improvements were personally constructed by petitioners during their off or spare workdays. During*137 the year 1958 petitioner purchased a cub tractor and chain saw. No new construction was done at the Woodville farm during the years 1959 and 1960, but during these years petitioners did make some improvements and repairs to buildings previously constructed. In addition to constructing the buildings on the Woodville farm acquired in 1947, petitioners cleared the land, fenced it, cross fenced it, and cleaned out the springs and well, planted grass seed and clover to improve the pasture, put out fruit trees, and started caring for the shrubbery that grew on the place looking toward the possibility of being able to sell some. In 1951 petitioner bought his first cow to put on the Woodville farm and began doing some truck farming, hauling the produce back to Port Arthur and Beaumont to sell. During the first few years of operating the farm at Woodville, petitioner made small profits from the operation but starting in 1957 petitioner sustained losses from this operation, having losses in the years 1957 through 1962 as follows: 1957$1,197.2919581,885.2319592,090.0019602,145.3919611,390.691962966.00During the years 1959 and 1960, approximately 15*138 acres of petitioners' farm had been put into improved pasture and petitioner continued to put more of the acreage into improved pasture thereafter. As of January 1, 1959, petitioner had three cows on his farm and during the year 1959 he sold a cow and a calf for $137. In 1958 petitioner made an agreement with another person to get into a business of breeding Shetland ponies with burros and jacks to raise Shetland mules. Petitioner acquired some burros and jacks which he placed on his farm and the person with whom he had the agreement was to furnish the Shetland pony mares. The agreement did not work out satisfactorily and petitioner bought two mares intending to carry on a business of raising horses on his farm. Petitioner was of the opinion that you could carry horses on the farm along with cows since horses would eat the high grass, and cows, the short grass. Petitioner bought a registered mare which was supposed to have been bred to a registered stallion, but she didn't have a foal. When petitioner concluded that the arrangement for raising Shetland mules was not going to be carried through and that the raising of horses would not be successful, he sold the burros, jacks, and*139 horses he had purchased at the best price he could obtain. Petitioner had bought two saddles at the time he had the horses on his place, and he sold one of these in 1960 and the other in 1961. Before the end of 1959 petitioner had sold one of the mares and two of the burros he bought in that year. The stock on his farm at the beginning of 1960 consisted of one mare, one burro, and five cows. The mare was valued at $100 and the burro at $50, and the five cows at $100 each. During 1960 petitioner sold three cows, the one burro, one of his saddles and some timber. Petitioner as of December 31, 1960, had six cows and one mare in inventory. During the years 1947 through 1958 petitioner made the following capital expenditures: YearExpenditureAmount1947House and barns$ 700.001952Machinery and tools392.331957Weed cutter119.931958Machinery and tools1,004.001958Chain saw100.001958Two saddles75.00At the time of acquiring the farm in 1947 petitioner planned to go into the commercial cattle business on the farm, raising cattle for slaughter. Petitioner was of the opinion that he could make a profit on the farm by keeping a breeding*140 herd, raising calves, selling all of the male calves and all of the heifers except the ones he decided to keep for replacements in his herd. Calves are generally sold at 5 to 7 months old at a weight of 400 to 500 pounds. During the years here involved petitioner sold his calves as milk-fed calves when they were weaned. It is usual to crib feed calves at times but petitioner decided that it was preferable not to crib feed his calves while he was not living on the place. Petitioner had talked to the county agricultural agent about his project. The county agent had told him that people generally considered that improved pasture would carry one cow for every 2 acres. The agent also told petitioner that he should carry 20 head of cattle on his place to make a profit. The agricultural agent also advised petitioner on the amount of fertilizer to put out and the type of grass to plant. Petitioner did not have any registered cattle and did not intend to raise registered cattle because of the amount of veterinarian's services and other expenses required to raise such cattle. Petitioner at times used his neighbor's bull for breeding but also at times acquired his own breeding bull. It was*141 petitioner's practice to buy a bull in the spring of the year, keep it through the breeding season, and sell it in the fall in order to be relieved of the expense of feeding the bull during the winter. In 1959 and at other times thereafter petitioner owned a purebred bull but never a registered bull. During the years 1957 through 1962 petitioner showed total receipts from his farming operation as follows: 1957$276.641958615.301959148.001960264.251961307.991962457.00Petitioner had a small stock pond on the farm which was used as a watering place for cattle. He believed he could make a profit from his cattle operation if he could increase his herd and after his unsuccessful effort with Shetland mule and horse breeding, he began to work towards increasing his herd of cattle. From the time of acquiring the farm in 1947 throughout the years here involved petitioner was operating the farm with an intent to make a profit. Petitioner on his income tax returns for the years 1959 and 1960 deducted the net losses sustained in the operation of his farm. Respondent disallowed the claimed deductions with the following explanation: It is determined*142 that the farm loss * * * was not incurred while in the business of farming, therefore no deduction is allowable. * * * Opinion Petitioner takes the position that since he was operating his farm during the years 1959 and 1960 with an intent and in an effort to make a profit, he was engaged in a trade or business of farming and the losses be sustained in that undertaking are deductible. It is respondent's contention that petitioners purchased the farm to satisfy their personal desires for an outdoor life and also as an investment. It is his position that petitioners were engaged in weekend farming, primarily for recreation and other personal reasons, and that therefore the losses sustained are not deductible since they were not incurred in a trade or business or a transaction entered into for profit. Both parties recognize that the issue here is purely a factual one. Respondent calls attention to the consistent losses over the years 1957 through 1962 and states that this consistent pattern of losses is a factor to be considered as it bears on petitioner's intent, citing Morton v. Commissioner, 174 F. 2d 302 (C.A. 2, 1949), wherein the Court stated: It is true that*143 a record of continual losses over a series of years does not in itself preclude the allowance of such losses as a business expense. [Footnote omitted.] The intent of the taxpayer in making his expenditures is what counts; but the continuing lack of profits is an important factor bearing on the taxpayer's true intention. [Footnote omitted.] * * * Petitioner takes the position that the losses over the 5-year period were occasioned to a large extent by unfortunate circumstances peculiar to those years. Petitioner relies on his direct and positive testimony that from the beginning, his operation of the farm was with an intent to make a profit, the fact that during most of his lifetime he had engaged in farming for a profit usually with success, and the nature of his farm and his operation thereon, to establish that his farming operation was a trade or business. Petitioner relies on a number of cases including Dean Babbitt, 23 T.C. 850">23 T.C. 850, 855, 867, and 868 (1955), and Thomas F. Sheridan, 4 B.T.A. 1299">4 B.T.A. 1299 (1926). Under the facts in the instant case we agree with petitioner. There is no showing whatsoever that petitioners' farm was a hobby or that petitioners*144 used their farm as a place of recreation to overcome petitioner's direct testimony that it was not a hobby and was not used for recreation. Petitioner testified that he sold the farm he had been operating prior to 1947 in order to obtain the money to send his children to college and purchased the farm which he owned in the taxable years here involved intending to pursue farming as a business for profit and did in fact make a profit for several years from this farm. The only scintilla of evidence in the record to the contrary of this positive testimony is whatever inference might be drawn from petitioner's losses during the years 1957 through 1962 and some vague testimony by an internal revenue agent of statements petitioner made to him. Petitioner has explained the efforts he was making to convert his losses into profits. After losses in 1957 and 1958 he attempted to supplement his income by raising Shetland mules and horses. This effort proved unsuccessful and he then began to increase his herd of cattle. These undertakings show that petitioner was in fact attempting to operate his farm at a profit. Petitioner had for approximately 18 years prior to 1957 operated a profitable*145 farm to supplement his hourly wages from his work at the Gulf Oil refinery. His testimony that it was his intention to continue a profitable operation of the farm to supplement his income from wages was straightforward and convincing. In the midfifties he did venture into a concentration on cattle without reliance on the truck farming he had previously carried on. However ill-advised petitioner might have been to drop his truck farming and fruit growing to concentrate his activities on a commercial cattle operation, we are satisfied that he carried on the cattle operation with an intent to make a profit. The evidence also supports petitioner's contention that there did exist a reasonable expectation of his operating the farm at a profit as a cattle farm. Respondent contends that since on the average it takes 2 acres of improved pasture for one cow and since the county agricultural agent told petitioner he should carry 20 cows to make a profit, the evidence does not support petitioner's judgment that he had a reasonable prospect of making a profit from a cattle operation. Petitioner has continued through the years to improve his pasture and increase his cattle. Petitioner could well*146 develop his land to a point where it would support a greater number of cows per acre than the average or could use supplemental feed. Also, petitioner felt he might well show a profit with less than 20 cows, if he got a calf from each cow each year which he generally did. Under the facts here petitioner did have a reasonable prospect of making a profit. See Norton L. Smith, 9 T.C. 1150">9 T.C. 1150 (1947). Respondent in his brief states: * * * It is submitted that the petitioner was motivated primarily by his personal desire for the pastoral life rather than by a pecuniary interest. The wooded areas on the farm afforded him an opportunity to hunt, and the pond afforded him an opportunity to fish. The horses on the farm, in addition to being available to herd the three cows, were available for personal riding purposes. Under cross-examination petitioner stated that he had always enjoyed "outdoor life" and thought such a life a healthy way to live. Otherwise, there is no evidence whatsoever in the record to support this argument of respondent's. The only mention of hunting in the record is petitioner's statement, in response to a question on cross-examination of whether he liked*147 hunting, "Well, I never had time to hunt much in my life." The only reference in the record to fishing is petitioner's response of "Very little", to a question on cross-examination of whether he fished a "little bit." Petitioner was emphatic that he bought the farm at Woodville intending to put it in shape to operate as a commercial cattle venture and that during the 2 years here involved in addition to attempting to build up his herd of cattle, he was trying to operate a horse breeding venture unsuccessfully and also unsuccessfully attempting to start a business of raising Shetland mules. The fact that petitioner enjoyed farm work is no basis for inferring that his farm was not a business operation. Thomas F. Sheridan, supra. Respondent further contends that the losses here involved should be disallowed since petitioner had purchased the Woodville farm as an investment planning either to sell it for subdivision at a profit or to build cabins around his "lake" to rent for weekend recreational purposes. Petitioner emphatically denied that he had such intentions. He also denied that he had made any statements to this effect to the revenue agent who investigated his tax*148 returns. The evidence respondent offered to support his contention was the testimony of the revenue agent who investigated petitioner's tax returns for the years here in issue. This witness stated that he had refreshed his recollection by reviewing certain conference notes included in his work papers underlying his agent's report and from these he testified that petitioner had stated to him that he had been improving his property for several years and intended to sell it at a profit and that later petitioner stated to him that "he had a lake, I believe he called it, which was on his property which he was intending to build some cabins on, and this was to be rented out for fishing or weekend recreation, et cetera." The internal revenue agent obviously had no independent recollection of these conversations. He relied entirely on his notes. It may well be that petitioner made some general statements in talking to the agent of things that he might some day do with this farm. We do not doubt that the revenue agent paraphrased the conclusions he drew from petitioner's statements which he had included in his work papers. We do not believe these statements truly represented petitioner's*149 intention in the years 1959 and 1960 as to his use of his farm. Even if petitioner did have some dreams as to what might be done in the future with his farm, certainly for the years here involved and for years prior thereto, he was engaged in a farming operation with an intention to make a profit. Respondent's final contention is that petitioner purchased the farm for a retirement home and not to operate as a business. Although there is no direct evidence in the record to support respondent's statement that petitioner planned to retire on his farm, the record as a whole gives a fair inference that he did plan to become a fulltime farmer when he retired from his work at the Gulf Oil Corporation. This fact, however, does not show that petitioner was not operating the farm as a business during the years here involved, nor that he did not intend to continue his farming business after he retired from his work at the Gulf Oil Corporation. Dean Babbitt, supra. Under the facts of this case, we hold petitioner is entitled to deduct the losses he sustained in 1959 and 1960 in his farming operation. Since certain adjustments made in the notice of deficiency have not been contested by petitioner. *150 Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624880/ | APPEAL OF JAMES S. MCCANDLESS. 1McCandless v. CommissionerDocket No. 2782.United States Board of Tax Appeals5 B.T.A. 1; 1926 BTA LEXIS 2381; April 23, 1926, Decided *2381 Upon the evidence, held, that the transfer of stock by the taxpayer in 1921 did not constitute a bona fide sale and no deductible loss was sustained on account thereof. The return for 1921, including a deduction on that account, was false and fraudulent and willfully so made. Urban E. Wild, Esq., Arthur S. Hoppe, Esq., E. R. Cameron, C.P.A., and A. R. Bechtold, C.P.A., for the petitioner. A. Calder Mackay, Esq., Ward Loveless, Esq., John D. Foley, Esq., and W. Frank Gibbs, Esq., for the Commissioner. TRAMMELL *1 This is an appeal from the determination of a deficiency in income tax in the amount of $7,363.16 for the year 1921, and an added penalty of $3,681.58 for alleged fraud, or a total deficiency of $11,044.74. FINDINGS OF FACT. 1. The taxpayer is a citizen of the United States and a resident of Honolulu, Territory of Hawaii. 2. The California-Hawaiian Development Co. is a corporation which was organized under the laws of the State of California on or about September 27, 1911. This company, hereinafter called the corporation, was organized by the taxpayer and several associates, among whom was C. G. Bockus, *2382 for the purpose of acquiring from the Sierra Nevada Development Co., an Arizona corporation, certain mining properties located in Placer County, Calif.The corporation was incorporated with a capital stock of 3,000,000 shares having *2 a par value of $1 each. Sometime in 1909 the taxpayer had purchased shares of stock in the Sierra Nevada Development Co. at the price of $7.50 for shares having a par value of $10 each. These shares were exchanged in 1911 for shares of stock in the corporation at the ratio of 1 for 20, thus making the cost to the taxpayer of such shares in the corporation 37 1/2 cents each. Subsequent to the organization of the corporation, the taxpayer bought other shares of stock therein at prices varying from 50 to 10 cents per share. 3. C. G. Bockus was a resident of Honolulu for many years prior to March, 1922, when he left Honolulu for San Francisco, Calif., where he has since continued to reside. He had been one of the organizers and for some time was the secretary of the corporation. He was a licensed dealer in stocks, bonds, and general securities in the Territory of Hawaii. There had been a number of sales of stock of the corporation in 1920*2383 and 1921. Bockus had procured purchasers for some of it and knew of the sales. He was on terms of intimate friendship and association with the taxpayer and had many business dealings with him over a period of 25 years. The taxpayer treated him practically as a member of his family. 4. On or about December 10, 1921, Bockus, after having heard that the taxpayer desired to sell some of his stock through another broker, called at the office of the taxpayer and asked, "Why not let me do it?" stating that he thought he could sell some shares of the stock of the corporation as he had a similar transaction. Bockus stated to the taxpayer that he had already made a similar arrangement with the taxpayer's brother, John A. McCandless, from whom he understood the taxpayer was "undertaking a similar sale through a broker known as Guy H. Buttolph." Bockus offered to purchase some of the taxpayer's shares at 5 cents per share. At that time no agreement was reached between the parties. The taxpayer subsequently made inquiry among stockholders in Honolulu and ascertained from them that, in their opinion, it had a value of about 5 cents per share. Thereafter, on or about December 21, 1921, Bockus*2384 again called upon the taxpayer and at that time he again offered to take shares in the corporation from the taxpayer for 5 cents per share and give his promissory note therefor. During neither of the conversations was mention made by Bockus of any particular number of shares. The taxpayer thereupon delivered to Bockus 159,344 shares of stock of the corporation and took his note on the basis of 5 cents a share. These shares were among those acquired by the taxpayer after the organization of the corporation and were represented by four certificates numbered, respectively, 15, 263, 312, and 395. The certificates were indorsed and delivered by the taxpayer to Bockus and, at the request of Bockus, transferred to him on the books of the corporation and replaced by certificate No. 695, dated December 30, *3 1921, and made out in his name for the 159,344 shares. Certificate No. 695 was thereafter held by Bockus in his possession until he delivered it to the trustee of his estate in bankruptcy, as hereinafter set forth. The taxpayer received from Bockus a promissory note for $7,967.20, dated December 22, 1921, payable on demand. Bockus was in "straightened circumstances." At that*2385 time the taxpayer, on account of his confidential relationship with Bockus, knew in a way his financial condition. On June 30, 1925, the day before it was filed in evidence in this appeal, documentary stamps in the amount of $1,60 were placed on the note and canceled. The taxpayer never made demand on Bockus for payment of the note, nor was any amount ever paid on the note, nor was any interest ever paid thereon. The transaction was entered into and carried out by the taxpayer in the manner set forth, for the purpose of taking a deduction on his income-tax return. The taxpayer stated that one reason he desired to dispose of the stock was that it had been quite a burden to him. Some time in 1922, and prior to the adjudication of Bockus as a bankrupt, but after the transfer to him of the stock, the taxpayer paid an assessment of one-half per cent per share levied upon the shares of stock of the corporation transferred to Bockus. The taxpayer also, on February 11, 1924, paid another assessment which was levied in December, 1923, on the stock transferred to Bockus. Bockus continued to hold certificate No. 695 in his possession until after he was adjudged an involuntary bankrupt*2386 on December 28, 1922. He did not list these 159,344 shares of stock among his assets in the schedule in bankruptcy, nor did he list the promissory note given by him to the taxpayer as a liability. On demand, he delivered the certificate, indorsed in blank by him, to the trustee in bankruptcy about the month of October, 1924. The taxpayer, having knowledge of the bankruptcy proceedings, did not file a claim with the trustee for the amount of the note received by him from Bockus, but stated that he would have been willing to destroy the note if it were not for the question raised by the Commissioner with respect to his tax liability which was coming up. The certificate, from the time of its delivery by Bockus, has been held by said trustee as a part of the assets of the estate in bankruptcy. After the transfer of the stock as above set out, Bockus sold other securities to the taxpayer, and, acting as broker, sold other securities for him. The taxpayer paid Bockus his regular commissions in cash on such deals and paid cash for the securities purchased, and no part of the amount due Bockus was credited on the note. The securities sold to the taxpayer had been bought by Bockus with*2387 his own money. 5. The taxpayer purchased no shares of the stock of the corporation within a year prior to the sale described in the preceding paragraph *4 and has purchased no shares of such stock since that time, either from Bockus or any other person. 6. The certificates of stock acquired by the taxpayer and transferred to Bockus were numbered and issued and cost the amounts set forth in the following schedule: Certificate No.Date of purchase by taxpayer.Number of shares.Cost per share.Total cost of purchase.Cents15Nov. 14, 191150,00040$20,000.00263Aug. 14, 191338,3225019,161.00312Mar. 13, 191432,708103,270.80395Dec. 24, 191438,314103,831.40159,34446,263.20During the period from December 26, 1914, to June 28, 1921, the taxpayer paid assessments amounting to 11 cents per share, or a total of $17,527.84, on the 159,344 shares. The total cost of these shares to the taxpayer was $63,791.04. The cost of certificate No. 15, which was purchased on November 14, 1911, was less than its March 1, 1913, value. 7. The transfer of stock to Bockus referred to in paragraph 4 was*2388 not a sale in good faith, but was resorted to by the taxpayer for the purpose of establishing the appearance of a sale without consummating it in actuality. The taxpayer filed a return for the year 1921 in which a loss was claimed on account of that alleged sale, which claim was false, was known to the taxpayer to be false, and was made with intent to evade tax. OPINION. TRAMMELL: The taxpayer, in his income-tax return for 1921, took as a deduction a loss in the amount of $67,721.20 on account of a sale of 159,344 shares of stock to Bockus. The Commissioner disallowed any loss on that account, upon the ground that there was in fact no sale of the stock referred to. The taxpayer at the hearing conceded that the amount of the loss claimed was erroneous and that, if he was entitled to any loss, the amount thereof was $58,823.84, because the cost of the stock transferred, and which the taxpayer claims that he sold, was less than the cost which he asserted in his return. The Commissioner asserts that the transfer of the stock by the taxpayer to Bockus in 1921 was nothing more than a pretended sale, not an actual bona fide sale, and that the transaction was entered into for*2389 the purpose of evading the payment of tax. The taxpayer admits that the transaction was entered into because he *5 desired to take a loss for the purpose of deducting the same in his return for the year 1921. If the transaction amounted to an actual sale of the stock, the admission by the taxpayer that it was consummated for the purpose of realizing a loss during that taxable year, in order that he might deduct the same in his income-tax return, is perfectly legitimate and sets forth an intention which is legal and which gives rise to no fraud or illegal intent. A taxpayer is not entitled, under the statute, to take a loss merely because stock or securities during a taxable year shrink in value, unless the loss is actually realized by a sale or other disposition of such property. It is perfectly legal and proper for a taxpayer to sell such assets at a price representing their reduced value and thus to sustain a deductible loss which is allowed him by the statute. ; *2390 ; ; . The question now resolves itself into a question of fact, and that is, whether the taxpayer actually sold the stock in question during the taxable year, or whether the transfer of the stock to Bockus was carried out for the purpose of taking a deduction on account of a loss which had not in fact been sustained. In order to determine whether there was an actual sale or merely a pretended one, it is necessary to look at all facts and circumstances in the case and to consider and weigh all the evidence. The taxpayer testified that he sold the stock to Bockus, and Bockus testified that he bought it. The taxpayer and Bockus, however, testified to other facts, and we have the testimony of other witnesses. There were facts and circumstances in connection with and surrounding the transaction which can not be ignored. Facts which are not denied by the taxpayer or Bockus must be taken into consideration and a decision can not be made alone upon categorical statements of the parties. In the light of all*2391 the testimony, we are convinced that the taxpayer did not make a sale to Bockus of the stock in question in 1921, and that the taxpayer's return for that year, in which he claims a deduction on that account, was willfully false and fraudulent. The facts and circumstances which lead us to this conclusion may be briefly stated. Bockus, having learned that the taxpayer desired to dispose of some of his stock and that he was undertaking to sell it through another broker, approached the taxpayer and asked him, "Why not let me do it?" The taxpayer and Bockus were on terms of intimate friendship and were closely associated in business affairs. The taxpayer testified that he treated Bockus as practically belonging to the family. They had many business dealings together. The taxpayer *6 bought securities from Bockus and Bockus acted as the taxpayer's selling agent and sold whatever securities the taxpayer had to sell. During 1920 and 1921 Bockus had sold other stock of the same corporation. Bockus was in a bad financial condition. The taxpayer knew, at least in a general way, of the financial condition of Bockus. He testified that he knew that Bockus was "hard up," although*2392 he did not know of any contemplated bankruptcy proceedings. Bockus himself may not have known that his creditors intended to institute such proceedings. About a year after Bockus received the stock and after he had executed to the taxpayer his promissory note in exchange therefor, Bockus was declared an involuntary bankrupt. He did not list the note of the taxpayer as an indebtedness and did not include the stock as an asset, nor did he list it among his assets when he was notified in 1923 that an assessment had been levied on the stock. If he had overlooked the stock in 1922 when the bankruptcy proceedings were instituted, his mind must have been refreshed when the stock was called to his attention by the assessment thereon. The taxpayer, knowing of the bankruptcy proceedings, did not file a claim against the bankrupt, but testified that he would have been willing to destroy the note, except for the question of tax liability which was coming up. Prior to the adjudication in bankruptcy an assessment of one-half cent per share was levied by the corporation upon the stock transferred to Bockus. This assessment was paid by the taxpayer in order to prevent the stock from being sold*2393 to satisfy the assessment. On February 11, 1924, another assessment which had been levied on the stock held by Bockus was paid by the taxpayer. This was after Bockus had been declared bankrupt. Neither of the assessments have since been paid by Bockus. The taxpayer testified that one of the reasons that he desired to sell the stock was that it was a burden to him; yet he continued after the transaction to bear the burden of paying assessments thereon. After the transfer of the stock to Bockus, and while the taxpayer held Bockus' note payable on demand, Bockus sold other securities to the taxpayer. These securities had been purchased by Bockus with his own funds and the taxpayer paid to Bockus the consideration therefor in cash. Bockus also sold some securities for the taxpayer and the taxpayer paid him his commission in cash. No part of the money due to Bockus as the result of these transactions was credited or applied on the note held by the taxpayer. The note was payable on demand, and, notwithstanding these transactions, the taxpayer did not make demand and has never made demand for any part of the principal or any interest on the note. *7 From all the testimony*2394 in the case, we are of the opinion that the transfer of the stock by the taxpayer to Bockus in 1921 was not an actual bona fide sale, and that the return filed for that year, in which a deduction was claimed on account of such transaction, was willfully false and fraudulent. Order of redetermination will be entered on 30 days' notice, under Rule 50.GRAUPNER, PHILLIPS GRAUPNER and PHILLIPS, dissenting: As the only two members of the Board who heard all of the testimony in this appeal, we feel it incumbent on us to express our opinion that the satisfactory evidence in this appeal does not justify the decision of the Board. It is true that certain incidents disclosed by the record may be considered as raising suspicions, but, on the other hand, these same incidents are susceptible of a different interpretation. From the conclusions formed by us, after hearing all of the testimony and seeing the witnesses on the stand, we do not believe the evidence sufficient to support a finding that the sale from the taxpayer to Bockus was not bona fide, or that the taxpayer was guilty of fraud. The Commissioner relied upon the testimony of two revenue agents for the*2395 purpose of impeaching the testimony of Bockus. We are agreed that it is too evasive and too contradictory to be worthy of belief. As we observed their conduct on the witness stand, we were impressed with the belief that they were overanxious to convict the taxpayer and too willing to make damaging deductions from small incidents. But apparently some weight has been given their testimony in the prevailing opinion, which refers to the testimony of "other witnesses" than McCandless and Bockus. Regarding the sale, the evidence shows beyond a doubt that the stock was assigned and the note was given in December, 1921, that the price was fair, that Bockus took the stock into his possession, had it transferred to his own name, and held the certificate therefor in his own possession and control until he was required to surrender it to the trustee of his estate in bankruptcy. There is no evidence that Bockus held the stock in the capacity of trustee or agent for the taxpayer. On the contrary, we have absolute denials of such relationship from both the parties. There is no evidence to show that the taxpayer exercised or attempted to assert any control over or right to possession of the*2396 stock after its delivery by him to Bockus. The fact that Bockus had frequently acted as broker in the purchase or sale of securities for the taxpayer raises no presumption that in this case he was not operating on his own account. Nor do the incidents to Bockus going into involuntary bankruptcy, without *8 setting forth the stock in question in the schedule filed by him, or of the taxpayer failing to file a claim in bankruptcy on the note held by him, raise any presumption of the relationship of trustee and trustor between them. The individual actions of Bockus should not be permitted to reflect on the actions and attitude of the taxpayer. unless collusion was proven, which it was not. Bockus was declared an involuntary bankrupt on the petition of creditors in Honolulu, while he resided in San Francisco. The schedule was prepared in Honolulu and sent to Bockus, and he signed it as thus prepared. Other assets and liabilities were omitted from the schedule, including Bockus' home in Honolulu and debts due from him secured by mortgage thereon. Many creditors fail to file claims in bankruptcy where the futility of collection is apparent, and there is no reason to distinguish*2397 the taxpayer from other creditors. It must be borne in mind that the taxpayer was traveling about the United States on matters wholly unrelated to his business in Honolulu during all of the period over which the so-called suspicious circumstances were spread, and he was paying little or no attention to his affairs at home. This circumstance might more readily account for his failure to demand payment of the note from Bockus than as assumed evidence of Bockus being agent for the taxpayer. The payment by the taxpayer of the assessment on all of the stock owned by Bockus was not, in our opinion, evidence of other than a generous and over-indulgent attitude on the part of the taxpayer toward the man he considered as a friend. Apparently, these loans were made as a matter of course, without any thought of the status of the stock ownership. The taxpayer loaned money to others, who never had purchased any stock from him, with which to pay these same assessments. It may be that Bockus was unworthy of this friendship, but his conduct, unless in collusion with the taxpayer, should not influence the decision of this appeal. Stress is laid upon the financial condition of Bockus. All*2398 of the evidence in the appeal is to the effect that, in December, 1921, when the transaction took place, Bockus was solvent, although pressed for cash to use in his business. It was not until a year later that bankruptcy proceedings were instituted, and this came about by reason of the failure of a company in which Bockus was financially interested. We believe that from the evidence the transaction between the parties was a sale and that the taxpayer is entitled to the deduction claimed. We further believe that there is no evidence to warrant any finding of fraud. Footnotes1. Publication of this decision was withheld pending the action of the Board on the taxpayer's application for rehearing. - REPORTER. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624818/ | ESTATE OF JOSE M. TARAFA Y ARMAS, DECEASED, FERNANDO J. CANCIO Y ERRO, EXECUTOR AND ANCILLARY EXECUTOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Tarafa y Armas v. CommissionerDocket No. 82656.United States Board of Tax Appeals37 B.T.A. 19; 1938 BTA LEXIS 1096; January 7, 1938, Promulgated *1096 1. Negotiable, unregistered, mortgage bonds of a domestic corporation, property of the community estate of which decedent was a member at the time of his death, physically situated in the Republic of Cuba, are not includable in his gross estate, he being a nonresident alien, who died July 23, 1932, while sojourning in New York. Herman A. Holsten, Executor,35 B.T.A. 568">35 B.T.A. 568, followed. 2. Since the decedent was not engaged in business in the United States at the time of his death, bank deposits in domestic institutions are nt ncludable in his gross estate. Sec. 303(e), Revenue Act, 1926. 3. The amount of capital contributed by the decedent to the conjugal community, under the laws of the Republic of Cuba, at the time of his marriage in 1901, was property situated in that country at the time of his death and may not therefore be included in his gross estate. R. A. Littleton, Esq., for the petitioner. C. A. Gwinn, Esq., for the respondent. BLACK *19 The respondent having determined a deficiency in estate tax of $279,132.45 upon the transfer of property of the decedent allegedly situated in the United States at the time*1097 of his death, the petitioner brings this proceeding for the redetermination thereof, claiming error by reason of the inclusion in the decedent's gross estate of (1) the value of decedent's one-half community interest in a first mortgage bond of the Central Cuba Sugar Co. of the value of $3,304,139.22, which bond was physically situated in the Republic of Cuba at the time of death; (2) one-half of $130,830.01, representing moneys on deposit in banks in the United States doing a banking business here; and (3) the value of his $50,000 capital contribution to the matrimonial partnership created under the laws of the Republic of Cuba. The facts were partially stipulated and there was oral testimony at the hearing, from which we make the following findings of fact. *20 FINDINGS OF FACT. The petitioner is a duly qualified and acting executor under the laws of the Republic of Cuba, and also ancillary executor under and by virtue of the laws of the State of New York, of the estate of Jose M. Tarafa y Armas, deceased, a nonresident alien of the United States, citizen and resident of the Republic of Cuba, domiciled in the city of Habana at the time of his death in New York, New*1098 York, on July 23, 1932. The decedent and his wife, residents and citizens of the Republic of Cuba at the time, were married under its laws in 1901. By virtue of their marriage there was created under said laws then in force, which continued in force at the date of the decedent's death, a conjugal community or partnership, to which the decedent contributed capital of value equal to $50,000, and from that capital, the industry, salaries, or work of the spouses, profits, rents and interest accruing during marriage from community property and from the property which belonged to either one of the spouses, the assets of said community at the time of the decedent's death were derived. The Civil Code of Cuba pertaining to the status of property of a marital partnership at the death of the decedent, which has been agreed upon and stipulated by the parties, need not here be set forth in full, but is nevertheless incorporated herein by reference. The following articles are all that it seems necessary to specifically set forth in these findings: Article 1392. - By virtue of the conjugal community, the earnings or profits indiscriminately obtained by either of the consorts, during the marriage, *1099 shall belong to the husband and the wife, share and share alike, when the marriage is dissolved. * * * Article 1395. - The conjugal community shall be governed by the rules of the contract of partnership in all that does not conflict with the express provisions of this Chapter. Article 1396. - The Following is the separate property of each of the consorts. 1. That brought to the marriage as his or her own. 2. That acquired under a lucrative title by either of them, during the marriage. 3. That acquired by right of redemption or by exchange for other property belonging to only one of the consorts. 4. That bought with money belonging exclusively to the wife or the husband. * * * Article 1401. - To the conjugal community belong: 1. Property acquired by onerous title, during the marriage, at the expense of the community property, whether the acquisition is made for the community or for only one of the consorts. 2. That obtained by the industry, salaries or work of the consorts or of either of them. *21 3. The profits, rents or interests collected or accrued during the marriage, and which come from the community property, or from that which*1100 belongs to either one of the consorts. * * * Article 1407. - All the property of the marriage shall be considered as community property, until it is proven that it belongs exclusively to the husband or to the wife. * * * Article 1412. - The husband is the administrator of the conjugal community, with the exception of what is prescribed in Article 59. * * * Article 1417. - The conjugal community expires on the dissolution of the marriage or when it is declared null. The consort who, on account of his or her bad faith, caused the nullity, shall not share any part of the property of the community. * * * Article 1423. - After the debts, charges and obligations of the community are paid, the capital of the husband shall be liquidated and paid, in so far as the inventoried estate may reach, making the corresponding deductions according to the same rules which are prescribed in Article 1366, in reference to dowry. * * * Article 1426. - The net remainder of the community property shall be divided, share and share alike, between the husband and the wife or their respective heirs. Decedent owned no separate property at the time of his death and his estate passing*1101 at death consisted solely of the $50,000 capital contribution aforesaid and his community interest in the liquidation dividend of his marital partnership upon dissolution thereof by death. The marital partnership at that time owned stocks and bonds aggregating in value $3,577,034.75. This included $3,304,139.22 balance due on a first mortgage, 5 percent bond, negotiable under the laws of Cuba, of the Central Cuba Sugar Co., and $130,830.01 cash on deposit in banking institutions in the United States. These, together with the "decedent's capital contribution" of $50,000, were included by the respondent in the decedent's gross estate. All of said assets were physically located and situated in the United States at the time of his death except (a) the bond of the Central Cuba Sugar Co., the payment of which is secured by a mortgage on properties situated in the Republic of Cuba; and (b) the capital contributed by the decedent to the marital partnership at the time of his marriage in 1901. Said bond, which has never been registered, and mortgage, and the property pledged to secure the payment thereof, were physically located and situated in Cuba at the time of the decedent's death. *1102 The value of the stocks and bonds actually physically present in the United States at the time of decedent's death was $267,666.78, and decedent's interest therein was one-half. *22 The Central Cuba Sugar Co., organized under the laws of the State of New York on May 29, 1911, maintains a statutory agent at 95 Liberty Street, New York, New York, and is qualified to do business and own property in the Republic of Cuba, in accordance with the laws of that country, by recordation of its certificate of incorporation and its bylaws and by registering the corporation at the Mercantile Registry of Habana. It has never owned property situated in the United States. Its minute books are kept in the custody of its said statutory agent, who is also its secretary, but its ordinary and regular business - having to do with the manufacture and sale of sugar and molasses from sugar cane - is conducted and carried on in Cuba, where all of its properties and assets are situated, its business records and accounts ae kept, its principal business office is located, and its executive officers reside. The decedent was not engaged in business, nor did he owe any debts, in the United States at*1103 the time of his death. His deposits were made in United States banking institutions rather than institutions of his country to avoid the unstable tendencies there and to afford greater safety for the money. OPINION. BLACK: Section 301 of the Revenue Act of 1926 imposes a tax upon the value of the "net state", as determined under the provisions of section 303 of that act, of every decedent "whether a resident or nonresident of the United States." Section 302 provides for inclusion in the "gross estate" of the value at the time of the decedent's death of all property "wherever situated" to the extent of the decedent's interest therein at the time of his death. Section 303 prescribes how the net estate of a decedent shall be determined, and by section 303(b) the computation of the net estate of a nonresident starts with only that part of his gross estate which is situated in the United States. While "stock in a domestic corporation owned and held by a nonresident decedent" is "deemed property within the United States" (sec. 303(d)), "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*1104 States at the time of his death" are not so deemed. (Sec. 303(e).) The first numbered issue herein - whether or not the respondent correctly included the value of the decedent's one-half community interest in a first mortgage bond of a private domestic corporation, which bond was physically located in the Republic of Cuba at the time of the decedent's death - has been considered and decided adversely to the respondent in , *23 on review (C.C.A., 2d Cir.). We there held that bonds, even though of domestic corporations and municipalities, to be included in the gross estate of a nonresident alien must be physically located in the United States at the time of his death. On the basis of this decision we sustain petitioner on the first point. The basis for the respondent's inclusion of deposits in United States banks in the decedent's gross estate is that the decedent was engaged in business in the United States and therefore such deposits are not within the ambit of subdivision (e) of section 303, supra. In this connection the proof shows that, while the decedent made many trips to the United States, usually*1105 stopping over for two or three weeks while on his way to Europe, he was not engaged in business here "at the time of his death." Decedent's son, Jose Miguel Tarafa, testified at the hearing that every year, after the busy season in grinding sugar cane was over, his father visited the United States and Europe; that on most of the trips he accompanied his father; that these trips were not business trips, but were made for pleasure and recreation; and that his father carried on no business in the United States and was not in business in the United States at the time of his death. He testified that the bank deposits which his father made with New York banking institutions were made because of unsettled conditions in Cuba and because of the greater safety which United States banking institutions afforded; that his father's death came while he was in the United States upon one of his habitual sojourns on pleasure. Respondent bases his contention that decedent was engaged in business in the United States at the time of his death solely upon the ground that decedent was the sole stockholder of the Central Cuba Sugar Co., which was incorporated under the laws of the State of New York*1106 in 1911. Only in justifiable instances - and we do not consider this one - have the courts and this Board disregarded the separateness of the corporate entity from its stockholders. . Therefore we are not persuaded by respondent's argument that the decedent was engaged in business inthe United States by reason of the fact that his principal interest - Central Cuba Sugar Co. - obtained and enjoyed a domestic charter. The domestication of a corporation does not domesticate its nonresident stockholders to the extent of causing them to be in business inthe United States if they are not otherwise engaged in business in the United States. Furthermore, the suggestion that these funds were deposited in the United States for business purposes therein is refuted by the testimony that they were in the interest of safety and to avoid unstable political tendencies prevalent inCuba since about 1917. These deposits, under the facts *24 and circumstances found, have been expressly excepted by the statute from the decedent's gross estate and the respondent's action in including them was erroneous. See *1107 ; ; affd., . The respondent's argument on the final issue, pertaining to the $50,000 contribution made by the decedent to the marital partnership, is that because, as he says, "all of the decedent's holdings were situated in the United States, it necessarily follows that the decedent's contribution of $50,000 to the marital partnership between himself and his wife necessarily had a situs in the United States for the purpose of the Federal estate tax." If in fact all of the property of the conjugal community had been situated in the United States at the time of decedent's death, we think respondent's contention on this point would be correct. We have held however that the principal asset of the community - a bond of the Central Cuba Sugar Co. on which a balance of $3,304,139.22 was due - was situated in the Republic of Cuba. According to article 1395 of the Civil Code in force in Cuba, "The conjugal community shall be governed by the rules of the contract of partnership * * *." Contracts of partnership are governed by the laws where*1108 entered into and where their businesses are conducted. ; ; ; and . This contract of partnership was entered into in and under the laws of the Republic of Cuba, where the relationship was apparently intended to and did in fact continue until the death of decedent. There is nothing in the record from which it might be even slightly inferred that it was ever intended that the situs of this capital would change or that it in fact did change. It is true that some of the fruits of the community partnership were situated in the United States, and it was stipulated by the parties that "from that capital [the $50,000 contribution], the industry, salaries or work of the spouses, profits, rents and interest accruing during marriage from community property and from the property which belongs to either one of the spouses, the assets of said community at the time of the decedent's death were derived." But certainly it can not be said, with any reasonable force, that because some of the fruits of the contribution are situated in the*1109 United States for tax purposes, the contribution itself became so situated. The contribution having been made at the domicile of the decedent, under the laws of that domicile, which determined its situs and regulated its administration, and there being nothing in the record nor in the laws of Cuba that are before us indicating that such situs changed, we hold, following the situs test now well established, that *25 the respondent's inclusion of this item in the decedent's gross estate was erroneous. ;Respondent has cited us to no authority to sustain his position on this point and we know of none. 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/4624819/ | North Jersey Quarry Co., Petitioner, v. Commissioner of Internal Revenue, RespondentNorth Jersey Quarry Co. v. CommissionerDocket No. 16182United States Tax Court13 T.C. 194; 1949 U.S. Tax Ct. LEXIS 111; August 11, 1949, Promulgated *111 Decision will be entered under Rule 50. 1. In computing equity invested capital for excess profits tax purposes, basis of property received by petitioner in 1930 liquidation of wholly owned subsidiary with which petitioner had filed a consolidated return held determinable under Internal Revenue Code, Supplement C.2. Stock of subsidiary held to have a "cost basis" under Supplement C (Regulations 112, sec. 35.761-3), arrived at in part by valuation of petitioner's stock given in exchange when subsidiary's stock was acquired. Benjamin Harrow, C. P. A., for*112 the petitioner.Francis X. Gallagher, Esq., for the respondent. Opper, Judge. OPPER*194 This proceeding was brought for a redetermination of a deficiency of $ 41,302.26 in excess profits tax for 1942.The sole contested issue is the proper basis, for equity invested capital purposes, of property received in December 1930 by petitioner from a wholly owned subsidiary.The parties filed a stipulation of facts and evidence was adduced at the hearing. Those facts hereinafter appearing which are not from the stipulation are otherwise found from the record.FINDINGS OF FACT.The stipulated facts are hereby found accordingly.Petitioner, a New Jersey corporation organized in May 1904, has its principal office in Morristown, New Jersey. It filed its Federal income and excess profits tax return for 1942 with the collector of internal revenue for the fifth district of New Jersey.On or about May 23, 1895, a corporation known as Morris County Crushed Stone Co. was formed under the laws of the State of New Jersey. It was legally dissolved on or about December 30, 1930.On or about December 30, 1930, a new corporation known as Morris County Crushed Stone Co., hereinafter called*113 the "new company," was formed under the laws of the State of New Jersey. That corporation is still in existence. It is one of the group of subsidiaries of petitioner which it listed in its return for the period in question.*195 Prior to December 29, 1930, petitioner acquired 2,680 shares of stock of the old Morris County Crushed Stone Co. at an aggregate cost of $ 109,000. The following schedule shows the details of petitioner's acquisition of those shares:PaymentsSharesJanuary 4, 1911:Petitioner purchased 100 shares of Morris County CrushedStone Co. stock from F. W. Schmidt. This was paid forby issuing 200 shares of preferred stock of petitionerat $ 200 per share$ 20,000100June 1912:Morris County Crushed Stone Co. declared a dividend payablein stock of petitioner. Petitioner received $ 10,000of its own stock and reduced its investment in theMorris County Crushed Stone Co. by that amount. Deduct10,000December 31, 1916:Morris County Crushed Stone Co. owed petitioner $ 15,000on account of royalties and paid this indebtedness byissuing its stock at par to petitioner15,000150December 1919:Petitioner purchased 250 shares of Morris County CrushedStone Co. stock at $ 200 per share. This was paid asfollows: Cash in the amount of $ 25,283.13,cancellation of indebtedness for royalties, $ 24,716.8750,000250December 1920:Petitioner purchased 150 shares of Morris County CrushedStone Co. stock at $ 200 per share. This was paid asfollows: $ 21,500 in cash and $ 8,500 by cancellationof indebtedness for royalties30,000150April 30, 1922:Petitioner purchased 20 shares of Morris County CrushedStone Co. stock from Margaret Upton at $ 200 per sharefor cash4,00020February 8, 1928:On this date Morris County Crushed Stone Co. issued astock dividend of 3 shares of its stock for each shareheld by its stockholders. Petitioner thus received2,010 shares2,010Total109,0002,680*114 This acquisition constituted 67 per cent of the 4,000 shares of the stock of Morris County Crushed Stone Co. then outstanding. Its stock was all of one class.On December 29, 1930, petitioner acquired all of the then remaining outstanding stock of the old Morris County Crushed Stone Co., consisting of 1,320 shares.In consideration of the acquisition of the 1,320 shares petitioner issued 2,640 shares of petitioner's theretofore unissued stock to the holders of the 1,320 shares of the capital stock of the old Morris County Crushed Stone Co.Stockholders of petitioner immediately prior to the acquisition of the 1,320 shares in the Morris County Crushed Stone Co. were as follows:StockholderShares heldWilliam H. Haelig10F. W. Schmidt, Inc3,460Julia L. Haelig720I. W. Wortman675Lucy Upton277National Iron Bank, trustee (Mrs.E. L. Schmidt)240Eleanor S. Upton234F. W. Schmidt177John H. Schmidt176Louise M. Wortman132C. W. Toye69N. Arrowsmith66L. C. Bonnell44Estate of F. W. Schmidt25Lottie F. Jones25Margaret Hoffman10Sarah J. Voorhees10Nancy R. King10Charles V. Higgins10William H. Spencer10William H. Hosking10Elsie L. Thompson10Total6,400*115 *196 Stockholders of the Morris County Crushed Stone Co. immediately prior to the acquisition of the 1,320 shares by petitioner were as follows:Shares heldNorth Jersey Quarry Co. [petitioner]2,680Estate of F. W. Schmidt620I. W. Wortman600N. Arrowsmith60F. W. Schmidt20John H. Schmidt20Total4,000Stockholders of petitioner after the acquisition of 1,320 shares in the Morris County Crushed Stone Co. were as follows:StockholderShares heldF. W. Schmidt, Inc3,460Julia L. Haelig720I. W. Wortman1,875Lucy Upton277National Iron Bank, trustee (Mrs.E. L. Schmidt)240Eleanor S. Upton234F. W. Schmidt217John H. Schmidt216Louise M. Wortman132C. W. Toye69N. Arrowsmith186L. C. Bonnell44Estate of F. W. Schmidt1,265Lottie F. Jones25Margaret Hoffman10Sarah J. Voorhees10Nancy R. King10William H. Haelig10Charles V. Higgins10Charles C. Spencer10William H. Hosking10Elsie L. Thompson10Total9,040On December 30, 1930, the net assets of the old Morris County Crushed Stone Co. were transferred to petitioner and on December 31, 1930, at a special meeting of the board of directors*116 of the old Morris County Crushed Stone Co., it was resolved that:* * * upon the surrender and delivery to this company by the holders of the 4,000 shares of capital stock of this company now issued and outstanding, the company convey to North Jersey Quarry Co., the actual owner of said 4,000 shares of stock, all of the assets, real and personal, of the company, subject to all of the liabilities of this company, the payment of which said liabilities are [sic] to be assumed by said North Jersey Quarry Co.And it further resolved that "this Morris County Crushed Stone Company thereupon be dissolved."As of the date of acquisition of at least 80 per cent of the stock of the Morris County Crushed Stone Co. by petitioner (December 29, 1930) and as at the date of liquidation (December 30, 1930), the balance sheet of the old Morris County Crushed Stone Co. appeared as follows:AssetsCash$ 215,810.13Accounts receivable43,836.49Bills receivable6,600.00Inventory65,248.47Depreciable assets (net)242,989.96Total574,485.05Liabilities and capitalCapital stock$ 400,000.00Surplus174,485.05Total574,485.05*197 Petitioner's excess*117 profits tax return for 1942 was a consolidated excess profits tax return filed by petitioner as common parent corporation of an affiliated group.The consolidated average invested capital, exclusive of consolidated accumulated earnings and profits as disclosed by the return, was $ 2,428,341.89 and included petitioner's claimed value of the assets acquired from the old Morris County Crushed Stone Co. referred to above at the amount of $ 769,000, which petitioner claims represented the total amount of petitioner's investment in the old Morris County Crushed Stone Co. immediately prior to the transfer.Upon audit of petitioner's excess profits tax return for 1942, respondent determined that petitioner's invested capital should be reduced by a net adjustment of $ 208,205.34, which included a reduction of the assets acquired from the old Morris County Crushed Stone Co. of $ 194,514.95 constituting the difference between $ 769,000, the balance claimed in petitioner's investment account referred to above, and $ 574,485.05, the book value of the net assets of the old Morris County Crushed Stone Co. as above set forth.Between September 3, 1926, and November 2, 1929, there were three changes*118 in petitioner's capital structure. In 1929 the 1,000 shares of preferred stock then outstanding were converted into the same number of shares of common stock. About the same time the stockholders were given the right to subscribe to additional common stock and accordingly subscribed to 1,000 shares. In August 1929, after the two above mentioned increases in the common stock had taken place, the company purchased certain properties for $ 95,000 and issued 400 shares of common stock in payment therefor. The value thus placed on these 400 shares was equivalent to $ 237.50 per share. The difference between the purchase price of $ 95,000 and the total par value of the stock issued of $ 40,000 was credited to capital surplus.There were no changes in the capital structure of the company between November 2, 1929, and December 29, 1930.On March 13, 1931, petitioner filed a consolidated corporation income tax return for the year 1930 for itself and six affiliated companies, among the latter being the old Morris County Crushed Stone Co. which filed the necessary consent to the filing of the consolidated return. In his report dated December 22, 1932, the internal revenue agent eliminated*119 the Morris County Crushed Stone Co. from the consolidation, on the ground that it was not affiliated, and he made a separate report covering its operations.A valuation of $ 293 a share was placed upon petitioner's stock for estate tax purposes on September 3, 1926, on the death of Frederick W. Schmidt.*198 A valuation of $ 331 a share was placed upon petitioner's stock by respondent for estate tax purposes on November 2, 1929, on the death of Margaret Upton.When Morris County Crushed Stone Co. was liquidated, all of its assets were distributed to petitioner. Petitioner retained the plant and plant equipment. The new company was organized, to which rolling stock, including steamshovels, locomotive cranes, and trucks, were sold back at the same figure at which the old company had carried them on their books.The value of petitioner's stock at the time of the transaction in question was $ 200 per share.OPINION.Although asserting that its excess profits credit based on invested capital should be computed under the general provisions of section 718 of the code, rather than the limited terms of section 761, petitioner nevertheless contends that even under the latter section *120 its tax was correctly arrived at and the deficiency is unwarranted. We are compelled to consider both contentions.Section 761 is in terms designed to apply to "an intercorporate liquidation." The effort is reasonably manifest to reach such liquidations only if they were tax-free, 1 but word for word the statutory language applies here. There was "an intercorporate liquidation" because petitioner was in "receipt * * * of property in complete liquidation of another corporation * * * to which * * * a provision of law * * * [was] applicable prescribing the nonrecognition of gain or loss in whole or in part upon such receipt (including a provision of the regulations applicable to a consolidated income * * * tax return * * *)." 2*121 As petitioner points out, no statutory counterpart of section 112 (b) (6) appears in the applicable 1928 Act. But petitioner could and did file with its subsidiary a consolidated return for the period including *199 the transfer, and this it was entitled to do at its option. Revenue Act of 1928, sec. 141; Regulations 75, art. 13 (f). No revenue agent or other administrative officer could deprive the two corporations of that right. Radiant Glass Co. v. Burnet (App. D. C.), 54 Fed. (2d) 718, affirming 16 B. T. A. 610. And once the consolidated return issue is settled, the remainder of the prerequisites of section 761 is supplied by the regulations then in effect denying the recognition of gain or loss in such an "intercompany transaction" 3*122 and by the provisions of section 141 (a), supra, constituting the filing of a consolidated return a consent to their acceptance by the taxpayers. See Charles Ilfeld Co. v. Hernandez, 292 U.S. 62">292 U.S. 62. The applicability of section 761 thus seems to us inescapable. Sec. 718 (d). 4The second phase of the controversy reduces in effect to the meaning of the phrase in section 761 (c) "a basis determined to be a cost basis" and its applicability to the assets acquired by petitioner. 5 The terms "cost basis" and "basis other than cost" are not defined in section 761, which is too extensive to set out here at length. But the legislative scheme appears to be to treat in separate classes the taxpayer's assets acquired through the ownership of shares for which its basis would be represented by what was paid for them, as opposed to other shares for which there would be an inherited, attributed, or substituted basis, typically one computed by reference to that of a transferor. See Maloney "Supplement C," 2 Tax Law Review 231 (Dec. 1946). On that approach there would seem no adequate reason for denying in this instance a "cost basis."*123 The omission in the statute is, moreover, supplied by the regulations. We note first that both subdivisions (1) and (2) of 761 (c) speak in terms of what is "determined" to be the basis. And section 761 (g), entitled "Determinations," provides for "Any determination which is *200 required to be made under this section" to be "made in accordance with regulations * * *."Regulations 112, section 35.761-3, deal with the present issue. They provide:* * * Cost Basis or Basis Other Than Cost. -- (a) Cost Basis. -- In all cases other than those in which the basis of stock is determined to be a basis other than cost under (b) or (c) of this section, the basis of stock shall be determined to be a cost basis.(b) Basis Other Than Cost. -- Stock in any corporation shall be determined to have a basis other than cost if, as a result of the transaction in which such stock was acquired --(1) The basis of such stock is fixed by reference to the basis of other property previously held by the acquiring corporation * * * or(2) The basis of such stock is fixed by reference to its basis in the hands of a preceding owner * * *.(c) Statutory Merger Or Consolidation*124 * * *.The stipulation recites that, as to 2,680 shares of the transferor, petitioner's "aggregate cost" was $ 109,000. These shares clearly fall outside the exceptions described in the foregoing quotation. The remaining shares were acquired in exchange for petitioner's unissued stock. As to these, their cost would be arrived at by reference to petitioner's shares -- Estate of Isadore L. Myers, 1 T. C. 100 -- not either "by reference to the basis of other property previously held" by petitioner nor "by reference to its basis in the hands of a preceding owner." The general rule is consequently applicable that "the basis of stock shall be determined to be a cost basis."We can not, however, subscribe to the valuation placed by petitioner upon its shares for the purpose of arriving at cost. Granting that book values can be employed in the absence of more compelling evidence, B. F. Edwards, 39 B. T. A. 735, the best that can be made of this record is that prior to the transfer petitioner owned two-thirds of the stock of its transferor. All that it acquired by issuing 2,640 shares of its stock was the remaining one-third, *125 having a book value of only about $ 191,500. On the theory that value may, in the absence of better evidence, be gauged by what is received for stock, Estate of Isadore L. Myers, supra, this would put the figure at only $ 72 a share, which under all the circumstances appears to be too low. On the other hand, adding to the pre-transfer book value of petitioner's assets -- $ 1,637,317.28 -- the $ 191,500 of assets received, and dividing by the 9,040 shares then outstanding, results in a value for petitioner's shares of about $ 200. Bearing in mind that prior sales and valuations had been made before the advent of the depression of 1930, of which we may take notice -- Safe Deposit & Trust Co. of Baltimore, Executor, 35 B. T. A. 259, 263; affd. (C. C. A., 4th Cir.), 95 Fed. (2d) 806 -- this seems to us the most appropriate value to place on petitioner's stock, and we have so found.*201 Computations of petitioner's tax liability should be made by use of that figure multiplied by the 2,640 shares as the cost of one-third of the transferor's stock. For that purpose,Decision will be entered*126 under Rule 50. Footnotes1. "SEC. 761. INVESTED CAPITAL ADJUSTMENT AT THE TIME OF TAX-FREE INTERCORPORATE LIQUIDATIONS."↩2. SEC. 761. * * *(a) Definition of Intercorporate Liquidation. -- As used in this section, the term "intercorporate liquidation" means the receipt (whether or not after December 31, 1941) by a corporation (hereinafter called the "transferee") of property in complete liquidation of another corporation (hereinafter called the "transferor") to which (1) the provisions of section 112 (b) (6), or the corresponding provision of a prior revenue law, is applicable or(2) a provision of law is applicable prescribing the non-recognition of gain or loss in whole or in part upon such receipt (including a provision of the regulations applicable to a consolidated income or excess profits tax return but not including section 112 (b) (7), (9), or (10) or a corresponding provision of a prior revenue law), but only if none of such property so received is a stock or a security in a corporation the stock or securities of which are specified in the law applicable to the receipt of such property as stock or securities permitted to be received (or which would be permitted to be received if they were the sole consideration) without the recognition of gain.↩3. Art. 37. [Regulations 75]. Dissolutions -- Recognition of Gain or Loss.(a) During Consolidated Return Period.Gain or loss shall not be recognized upon a distribution during a consolidated return period, by a member of an affiliated group to another member of such group, in cancellation or redemption of all or any portion of its stock; and any such distribution shall be considered an intercompany transaction.↩4. (d) For special rules affecting computation of property paid in for stock in connection with certain exchanges and liquidations, see Supplement C.↩5. SEC. 761. * * ** * * *(c) Rules for the Application of this section. --(1) Stock having cost basis. -- The property received by a transferee in an intercorporate liquidation attributable to a share of stock having in the hands of the transferee a basis determined to be a cost basis, shall be considered to have, for the purposes of subsection (b), an adjusted basis at the time so received determined as follows:* * * *(2) Basis of stock not a cost basis. -- The property received by a transferee in an intercorporate liquidation attributable to a share of stock having in the hands of the transferee a basis determined to be a basis other than a cost basis shall, for the purposes of subsection (b), be considered to have, at the time of its receipt, the basis it would have had had the first sentence of section 113 (a) (15) been applicable.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624820/ | FINCHER MOTORS, INC., PETITIONER, v. COMMISSIONER OR INTERNAL REVENUE, RESPONDENT.Fincher Motors, Inc. v. CommissionerDocket No. 100212.United States Board of Tax Appeals43 B.T.A. 673; 1941 BTA LEXIS 1464; February 19, 1941, Promulgated *1464 On February 28, 1938, petitioner's board of directors approved a bonus of $10,390.47 to H. W. Fincher as president, under a bonus agreement between them. In January 1938, $1,000 had been paid to him as an advance thereon. The unpaid portion was not actually withdrawn until after March 15, 1938. Under the method of accounting employed by Fincher the amount of the bonus involved was not reported by him in his 1937 income tax return. Fincher owned 340 shares of petitioner's class B nonvoting stock and General Motors Holding Corporation owned 160 shares of its class A voting stock, both blocks constituting all of petitioner's outstanding stock and having a par value of $100 per share. The value of the stock was not proved. held, under provisions of section 301 of the Revenue Act of 1937, deduction by petitioner of portion of bonus unpaid on March 15, 1938, not allowable. W. L. Donohue, C.P.A., for the petitioner. F. S. Gettle, Esq., for the respondent. VAN FOSSAN *673 The Commissioner determined a deficiency of $1,373.77 in the petitioner's income tax for the year 1937 and a deficiency of $682.31 in its undistributed profits tax for the*1465 same year. The petitioner alleges that the respondent erred in disallowing as a deduction that part of a bonus payable to the petitioner's president for the year 1937 but not withdrawn by him at March 15, 1938. FINDINGS OF FACT. The facts were stipulated. In so far as they are material to the issue they are as follows: The petitioner is a New York corporation, incorporated under the laws of the State of New York in January 1934, with its principal office in Rochester, New York. In April 1936 the certificate of incorporation was amended by a certificate of increase of capital stock, increase of par value, reduction of number of shares, and reclassification of shares pursuant to section 36 of the Stock Corporation Law. The certificate of incorporation provides that the capital stock of the corporation shall consist of class A stock and class B stock, and that the owners of class A stock, while any such stock is issued and outstanding, shall have the sole and exclusive right of voting on all corporate questions to the exclusion of the owners and holders of class B stock, and it further provides that the owners of class A stock shall have the exclusive right to elect the*1466 board of directors. All of the voting stock, class A, was acquired by investment on January 30, 1934, by the General Motors Holding Corporation, which *674 later became General Motors Corporation, Motors Holding Division, and is hereinafter referred to as the holding division, in accordance with their dealer investment plan. Under this plan the holding division has held the outstanding class A stock from the inception of the corporation. Under the dealer investment plan, H. W. Fincher invested $15,000 in class B stock of the corporation on January 30, 1934. Subsequent thereto, Fincher purchased some of the stock of the holding division under the terms of an option agreement entered into on February 1, 1934, and amended April 23, 1936, between Fincher and the holding division. The option further provided that Fincher was permitted to purchase the outstanding stock owned by the holding division out of dividends and bonus received from the petitioner and that the class A stock so purchased must be converted immediately into class B stock. On December 31, 1937, the holding division owned 160 shares of class A stock, with a total par value of $16,000, representing 100*1467 percent of the voting stock, or 32 percent of the total outstanding stock, and H. W. Fincher owned 340 shares of class B stock with a total par value of $34,000, representing 100 percent of the nonvoting stock, or 68 percent of the total outstanding stock. Between December 31, 1937, and March 15, 1938, the holding division owned all of the voting stock of Fincher Motors, Inc.In accordance with the dealer investment plan, on February 1, 1934, H. W. Fincher was elected the president of Fincher Motors, Inc., and he was elected a member of the board of directors on January 31, 1934. In addition to H. W. Fincher, the board of directors between December 31, 1937, and March 15, 1938, comprised R. W. Scofield and Hugh Courteol, the latter two directors representing the holding division, which owned all of the voting stock of the corporation. On April 23, 1936, H. W. Fincher entered into a bonus agreement with Fincher Motors, Inc., providing for a plan of compensating him as operator in relation to his degree of success in managing the business and affairs of the company. Paragraph 5 of that The amount of bonus due hereunder shall be determined by the Board of The amount of bonus*1468 due hereunder shall the determined by the Board of Directors of the Dealer Company and shall be paid in cash by the Dealer Company on such date as may be fixed by said Board of Directors but in no event shall such date be later than February 28th of the year next following the period for which the same is applicable. A special meeting of the board of directors of Fincher Motors, Inc., was held on January 11, 1938, and it was voted to advance H. W. Fincher, at his request, the sum of $1,000 against the bonus *675 which he had earned for 1937, pending final approval of the bonus. H. W. Fincher was paid $500 of this bonus by check on January 13, 1938, and on January 18, 1938, a check was issued for the balance, $379.77, after the deduction of $120.23 due from him as an account receivable. An examination of the records of the petitioner was made in accordance with the bonus agreement by John W. Stokes, certified public accountant, for the period ended December 31, 1937, and his report dated February 9, 1938, adjusted the amount of the bonus due to Fincher for the year 1937 to $10,390.47, instead of $10,263.37 as estimated by the company and deducted on the income tax return*1469 for the calendar year 1937. The petitioner's books were adjusted to reflect the bonus of $10,390.47. On February 28, 1938, the board of directors voted approval of payment to H. W. Fincher of a bonus for 1937 amounting to $10,390.47, as ascertained by the certified public accountant's report, and such bonus was determined by the board to be due and payable to him and was ordered to be forthwith paid to the said Fincher. All of the bonus was actually withdrawn by the said Fincher in the year 1938, as follows: DateExplanationAmount1938January 13Check No. 937$500.00January 18Check No. 1039379.77January 18Transfer of accounts receivable from H. W. Fincher120.23March 31Check No. 18611,390.47March 24Check No. 18795,000.00April 22Check No. 2254500.00April 30Check No. 23401,500.00May 27Check No. 2664400.00July 18Check No. 3302600.00Total10,390.47There was sufficient cash available to the company to pay the bonus between February 28, and March 15, 1938, as indicated below: DateBalance per bank statementBalance per recordsFebruary 28$14,240.72FiguresMarch 210,315.14n0tMarch 314,297.42availableMarch 413,970.98$13,192March 7$14,834.90$11,180March 1213,382.2010,674March 1417,247.5612,325March 1514,893.0112,541*1470 The check signatories during the period December 31, 1937, to March 15, 1938, were H. W. Fincher, president, Harold H. Henry, treasurer, William Cooke, vice president, and Veronica Frayling, secretary. It was required by the minutes of the petitioner Corporation that checks be signed by two of the signatories and one of the signatories must be the president or vice president. *676 The petitioner keeps its books and reports its income for income tax purposes on the accrual basis. Under the method of accounting employed by H. W. Fincher the amount of the bonus involved in this proceeding was not reported by him in his 1937 income tax return. OPINION. VAN FOSSAN: The Commissioner disallowed the bonus to Fincher in so far as unpaid on March 15, 1938, "as a deduction under the provisions of section 24(c) of the Revenue Act of 1936, as amended by the Revenue Act of 1937." 1 It is clear that all three conditions stated in the statute must coexist, i.e., as to payment, difference of accounting methods, and limitation by section 24(b). 2 Under the rules of the Board petitioner undertook the burden of proving that respondent erred in applying the cited statute. *1471 Admittedly there was no cash payment. Petitioner contends, however, there was constructive payment. We are unable to agree. Constructive payment is a fiction applied only under unusual circumstances not existing here. ; certiorari denied, , affirming ; ; . We believe respondent was correct in holding that the bonus was not paid within the taxable year or within two and one-half months after the close thereof. It is stipulated that Fincher did not report the disallowed, unpaid bonus in his income for the taxable year and petitioner does not challenge the correctness of respondent's action as to the second requisite of the statute. Addressing itself to the third condition found by respondent to exist, petitioner argues that, by reason of the difference between the *677 rights and privileges enjoyed by holders of class A stock and those limited by the provisions of the class B certificates, class A stock*1472 was more valuable than class B stock, although both had the same par value. However, it has made no attempt to ascertain or prove the relative or actual values of the stock. Submission of such proof was part of its burden in the case. The Board can not assume values or speculate with respect thereto. Since the record shows that Fincher owned 68 percent of the total outstanding stock and the petitioner has failed to prove that its value did not exceed the value of the class A stock held by the holding division, we can not say that respondent erred in holding that the situation falls under subsection (3) of section (c). It is axiomatic that the allowance of deductions is a matter of legislative grace. Congress has seen fit to limit that allowance by the enactment of section 301. Respondent determined that petitioner came under the ban raised by this section. The petitioner undertook to prove that this was erroneous. It has failed to do so. We sustain the Commissioner. Decision will be entered for the respondent.Footnotes1. SEC. 301. DISALLOWED DEDUCTIONS. (a) Section 24(a) of the Revenue Act of 1936 is amended to read as follows: * * * "(c) UNPAID EXPENSES AND INTEREST. - In computing net income no deduction shall be allowed in respect of expenses incurred under section 23(a) or interest accrued under section 23(b) - "(1) If not paid within the taxable year or within two and one-half months after the close thereof; and "(2) If, by reason 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)." ↩2. The pertinent part of section 24(b) reads as follows: "(b) Except in the case of distributions in liquidation, between an individual and a corporation more than 50 per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; * * *" [Sec. 24(b)(1)(B).] ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624828/ | Bausch & Lomb, Inc. and Consolidated Subsidiaries, Petitioners v. Commissioner of Internal Revenue, RespondentBausch & Lomb, Inc. v. CommissionerDocket No. 3394-86United States Tax Court92 T.C. 525; 1989 U.S. Tax Ct. LEXIS 38; 92 T.C. No. 33; March 23, 1989. March 23, 1989, Filed *38 Decision will be entered under Rule 155. Petitioner and its subsidiaries engaged in the manufacture, marketing, and sale of soft contact lenses and related products in the United States and abroad. B&L Ireland was organized on Feb. 1, 1980, under the laws of the Republic of Ireland as a third tier, wholly owned subsidiary of petitioner. B&L Ireland was organized for valid business reasons and to take advantage of certain tax and other incentives offered by the Republic of Ireland. Pursuant to an agreement dated Jan. 1, 1981, petitioner granted to B&L Ireland a nonexclusive license to use its patented and unpatented manufacturing technology to manufacture soft contact lenses in Ireland and a nonexclusive license to use certain of its trademarks in the sale of soft contact lenses produced through use of the licensed technology worldwide. In return, B&L Ireland agreed to pay petitioner a royalty equal to 5 percent of sales. In 1981 and 1982, B&L Ireland engaged in the manufacture and sale of soft contact lenses in the Republic of Ireland. All of B&L Ireland's sales were made either to petitioner or certain of petitioner's wholly owned foreign sales affiliates at a price of *39 $ 7.50 per lens. Held, respondent abused his discretion under sec. 482, I.R.C. 1954, when he determined that the $ 7.50 sales price did not constitute an arm's-length consideration for the soft contact lenses sold by B&L Ireland to petitioner. Held, further: The royalty contained in the Jan. 1, 1981, license agreement did not constitute an arm's-length consideration for the use by B&L Ireland of petitioner's intangibles. However, respondent's adjustment to the royalty rate was unreasonable. Sec. 1.482-2(d), Income Tax Regs., applied to determine an arm's-length consideration for use by B&L Ireland of petitioner's intangible property.CONTENTSPageI. Introductory Information529A. Petitioners529B. Bausch & Lomb Ireland, Ltd529C. The Business of B&L and its Subsidiaries530II. Historical Development of the Soft Contact Lens IndustryThrough 1982532A. History of the Contact Lens Industry Prior to theDevelopment of the Soft Contact Lens532B. Development of the Soft Contact Lens and the Spin CastManufacturing Process5331. Discovery and Development of the Soft Contact Lensand the Spin Cast Manufacturing Process5332. Relevant United States and Foreign Patents Obtainedby Dr. Wichterle and Associates535a. Materials Patents535b. Spin Cast Patents535c. Other Process Patents536C. License Agreements Between Czechoslovak Academy ofScience and National Patent Development Corp. andRelated Entities536D. Sublicense Agreements Between NPDC and B&L andCertain Related Litigation5391. Sublicense Agreements Between NPDC and B&L5392. Litigation with Respect to the Wichterle Patents inEurope5403. Litigation Relating to Soft Contact Lens Technology5414. Settlement of Litigation Between NPDC and B&L andthe 1977 Sublicenses543E. B&L's Operations and Activities With Respect to SoftContact Lenses and Spin Cast Technology from 1966Through 19715441. B&L's Development of the Soft Contact Lens and SpinCast Process5442. FDA Activities546F. Development of the Soft Contact Lens Market in theUnited States From 1971 through 1982547G. Development of New Soft Contact Lens Products5481. Thin Soft Contact Lenses5482. Toric Soft Contact Lenses5493. Extended Wear Soft Contact Lenses5494. Rigid Gas Permeable Contact Lenses549H. Development of Manufacturing Technologies5501. The Spin Cast Process5502. Semiautomatic and Automatic Lathing Process5503. The Cast Molding Process5514. The Vertical Spin Cast Process553I. Research and Development Activities of B&L's SoflensDivision554J. Sales and Marketing Activities of B&L's Soflens Division555K. Development of the International Soft Contact Lens Market556III. Historical Development of the Irish Operations of B&LIreland557A. Background of Decision to Establish Foreign ManufacturingFacility557B. Investigation of and Decision to Establish an OverseasManufacturing Facility559C. Negotiations and Agreement Among Petitioners, B&LIreland, and the Industrial Development Authority ofthe Republic of Ireland560D. Manufacturing Intangibles Related to Spin Casting andSoft Contact Lens Products5631. Technology in the Public Domain5632. B&L License of Trade Secrets to B&L Ireland563E. Financing of the Irish Operation5641. Section 84 Financing5642. Lease Financing Arrangements564F. Establishment of Manufacturing Operations by B&L Ireland565IV. Operations of B&L Ireland in 1981 and 1982566A. Production Planning and Scheduling566B. Purchases of Raw Materials and Materials Policies567C. B&L Ireland's Manufacture of Soft Contact Lenses Usingthe Spin Cast Manufacturing Process5671. The Dry Process5682. The Hydration Process5693. The Lens Inspection and Packaging Processes5694. Quality Assurance Procedures570D. B&L Ireland's Engineering Functions571E. B&L Ireland's Sales of Soft Contact Lenses573F. Pricing Policy With Respect to Intercompany Sales AfterEstablishment of B&L Ireland574G. Royalties Paid by B&L Ireland to B&L in 1981 and 1982574V. Sales of Soft Contact Lenses by Other Manufacturers During1981 and 1982574A. American Sterilizer Co. (Lombart)575B. National Patent Development Corp. (American Hydron)5751. Sales Under Trademarks of NPDC and its Affiliates5772. Private Label Sales by NPDC and its Affiliates578C. American Optical Corp578D. Hydrocurve (Soft Lenses, Inc.)579E. Other Manufacturers580VI. Respondent's Proposed Adjustments580Opinion IntroductionA. Determination of Arm's-Length Prices Between Petitionerand B&L Ireland for Soft Contact Lenses584B. Determination of Arm's-Length Royalty Payable by B&LIreland for use of B&L's Intangibles594*40 Dennis I. Meyer, C. David Swenson, John W. Polk, and A. Duane Webber, for the petitioners.Joseph R. Goeke, James E. Kagy, and Helen M. Lokey, for the respondent. Korner, Judge. KORNER*528 Respondent determined deficiencies in petitioners' consolidated corporate Federal income tax in the amounts and for the years as follows:TYEDeficiencyDec. 30, 1979$ 5,797,857Dec. 28, 1980514,141Dec. 27, 19812,714,394The determination of petitioners' 1979, 1980, and 1981 United States consolidated taxable income requires a determination as to petitioners' United States consolidated taxable income for the year 1982 due to net operating loss and foreign tax credit carrybacks.Among other adjustments made by respondent in his statutory notice, respondent determined that income should be reallocated in the amounts of $ 2,778,000 and $ 19,793,750 for the years 1981 and 1982, respectively, from Bausch & Lomb Ireland, Ltd. to Bausch & Lomb Inc. pursuant to section 482. 1 Respondent also made correlative adjustments to the income of Bausch & Lomb Inc. of $ 418,669 and $ 1,368,000 for the years 1981 and 1982 to eliminate the royalties paid to petitioners*41 by Bausch & Lomb Ireland, Ltd. and deducted on its returns. Thus, respondent made *529 net section 482 adjustments of $ 2,359,331 for 1981 and $ 18,425,750 for 1982.After concessions, the issues for determination are: (1) Whether respondent's allocations of gross income from Bausch & Lomb Ireland, Ltd., to Bausch & Lomb Inc. were arbitrary, capricious, or unreasonable; and (2) whether an allocation under section 482 is required to clearly reflect petitioners' income.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulations and exhibits attached thereto are incorporated herein by this reference.I. Introductory informationA. PetitionersPetitioner Bausch & Lomb Inc. is a New York corporation with principal corporate offices at Rochester, New York, at the time its*42 petition herein was filed. Unless otherwise indicated, as used herein, the term "B&L" shall refer to Bausch & Lomb Inc., as a separate and legal entity. B&L is the parent company of a group of corporations which filed consolidated Federal income tax returns for its tax years ending in 1979, 1980, 1981, and 1982. Unless otherwise indicated, as used herein, the term "petitioners" shall include B&L, as well as its subsidiaries which were included in the above-described consolidated Federal income tax returns. The term "B&L and its subsidiaries" shall refer to B&L and those of its subsidiaries and affiliates which are consolidated for financial reporting purposes, including foreign subsidiaries.During the years 1979, 1980, 1981, and 1982, petitioners kept their books and records and filed their Federal income tax returns on the basis of an accrual method of accounting, and on the basis of a 52-53 week taxable year.B. Bausch & Lomb Ireland, Ltd.Bausch & Lomb Ireland, Ltd. (B&L Ireland), is a corporation organized and existing under the laws of the Republic of Ireland, with its principal place of business at Waterford, *530 Ireland, during each of the taxable years at *43 issue herein. B&L Ireland was incorporated on February 1, 1980. During the years 1980, 1981, and 1982, B&L Ireland maintained its books and records on the accrual method of accounting, and on the basis of a 52-53 week taxable year.During each of the taxable years at issue herein, B&L Ireland was a wholly owned subsidiary of Bausch & Lomb Waterford, Ltd. (B&L Waterford). B&L Waterford was incorporated under the laws of the Republic of Ireland on February 1, 1980, as a wholly owned subsidiary of Applied Research Laboratories S.A. (Switzerland) (ARL). ARL was incorporated under the laws of Switzerland on August 19, 1967, and was a wholly owned subsidiary of B&L during each of the taxable years at issue herein.B&L Ireland was organized by B&L for valid business reasons and to take advantage of tax benefits and other inducements offered by the Republic of Ireland to companies establishing manufacturing facilities within the Republic.C. The Business of B&L and its SubsidiariesB&L is the outgrowth of a partnership established by J.J. Bausch and Henry Lomb in the 1850's in Rochester, New York. The business operated as a partnership until March 20, 1908, when B&L was incorporated. *44 Since inception, B&L had been involved in the manufacture and sale of a wide variety of scientific and ophthalmic instruments and products.B&L first entered the contact lens business on a national level in May 1971, when B&L began to manufacture and sell "soft" contact lenses throughout the United States on a commercial basis. B&L produced soft contact lenses at its Rochester facility using both the "spin cast" and "lathing" manufacturing processes. During late 1971 and throughout 1972, B&L and its subsidiaries began to market soft contact lenses in various foreign countries in the Western Hemisphere, Europe, and the Pacific Basin region.In 1971, B&L established the Soflens Division to conduct its soft contact lens business. Prior to January 1, 1982, petitioners' business with respect to soft contact lenses and products related to soft contact lenses, such as accessories, *531 solutions, and other related products were managed by the Soflens Division. On January 1, 1982, the Soflens Division was split into two divisions, the Soflens Professional Products Division which subsequently managed petitioners' soft contact lens business; and the Personal Products Division which*45 subsequently managed petitioners' business with respect to accessories, solutions, and other products related to soft contact lenses.Within the vision care segment of petitioners' business in 1979 and 1980 there were three product areas, (i) contact lens products, consisting of soft contact lenses, accessories, solutions, and insurance, (ii) consumer products, consisting of sunglasses, binoculars, telescopes, and riflescopes, and (iii) ophthalmic products, consisting of eyeglass frames and lenses, and prescription services. In November 1981, B&L discontinued its ophthalmic business, and began to sell all of the assets of such business. Thus, after November 1981 and throughout 1982, the vision care segment of petitioners' business included only contact lens products and consumer products.During the years 1979 through 1982, B&L and approximately 23 of its foreign subsidiaries sold soft contact lenses in approximately 64 countries.During the years 1981 and 1982, B&L Ireland was engaged in the manufacture and sale of soft contact lenses which were manufactured at its manufacturing facility in Waterford, Ireland, using the spin cast process.At the end of 1980, 1981, and 1982, B&L*46 and its worldwide subsidiaries employed approximately 11,800, 10,200, and 7,700 individuals, respectively. The reduction in 1982 in the number of employees of B&L and its subsidiaries was attributable largely to the discontinuation and disposition of B&L's ophthalmic business.The (i) worldwide consolidated net sales and (ii) the worldwide consolidated contact lens and related products net sales (including solutions, accessories, and other products related to contact lenses) of B&L and its subsidiaries for the years 1979 through 1982 were as follows (000s omitted): *532 Worldwide consolidated contactWorldwide consolidatedlenses and related productsYearnet salesnet sales1979$ 503,031$ 139,7401980582,681176,4031981533,300201,6001982509,736205,600II. Historical development of the soft contact lens industry through 1982A. History of the Contact Lens Industry Prior to the Development of the Soft Contact LensIn 1938, a new material known as polymethyl methacrylate (PMMA) was developed. PMMA is a hard, plastic material which is easily shaped into thin dimensions. PMMA's relative safety, lightness, and workability *47 made it a suitable material from which to fashion contact lenses. The first contact lenses had been developed in the late nineteenth century. These contact lenses were made of glass and were extremely uncomfortable. Thus, glass lenses had never gained general acceptance. By 1951, a United States patent with respect to a PMMA contact lens had been issued.Throughout the 1950's and 1960's, virtually all contact lenses manufactured and sold in the United States and throughout the world were hard (as opposed to "soft"), plastic contact lenses made of PMMA. Although PMMA lenses were a significant improvement over lenses made of glass, PMMA lenses are hard, nonpermeable by air, and do not absorb water. Therefore, such lenses can cause significant discomfort to users if worn for an extended period of time.Through the early 1970's, PMMA hard lenses were produced by hundreds of small, independent laboratories, which served local ophthalmologists, optometrists, and opticians (the "3-0s" or "optical practitioners" or "practitioners") on a custom order basis. These laboratories generally had only a few employees and produced PMMA lenses utilizing a manual lathing process. To produce a*48 contact lens using the manual lathing method, a manufacturer first produces or purchases a plastic lens "button," which consists of a thin, circular piece of raw plastic. The plastic lens button is *533 placed on a lathe machine. The machine operator manually guides a cutting device which cuts away excess material on one side of the button to form the base curve of the contact lens. The lens button is then removed from the lathe machine, turned over, and the process is repeated to form the front curve of the contact lens. The lens is then edged, polished, inspected, checked for power, and packaged for storage or shipment.There are few variations in the manual lathing method, which is labor rather than capital intensive. The critical aspect of contact lens manufacturing using the lathing method is the quality control and attention to detail necessary to perform each and every step accurately so that the final product conforms to the specifications of the manufacturer and performs as expected by the practitioner.B. Development of the Soft Contact Lens and the Spin Cast Manufacturing Process1. Discovery and Development of the Soft Contact Lens and the Spin Cast*49 Manufacturing ProcessDuring the late 1940's and early 1950's, Dr. Otto Wichterle and Dr. Drahoslav Lim, Czechoslovakian chemists associated with the Czechslovakian Academy of Science (CAS), began working to formulate new hydrophilic (water absorbing) materials. By 1954, Dr. Wichterle and his associates had developed a hydrophilic gel (hydrogel) that was synthesized by copolymerization of 2-hydroxyethyl methacrylate (HEMA) with ethylene dimethacrylate, a basic liquid HEMA monomer. A monomer is a chemical compound which is capable of undergoing polymerization. Such hydrophilic material in its hardened or "polymerized" state is commonly referred to as a "polymer."In 1955 and 1956, Dr. Wichterle and his associates incorporated the basic HEMA monomer into a contact lens for the first time. A contact lens that is manufactured using a HEMA-based material is referred to herein as a "HEMA lens," a "soft HEMA lens," or a "soft contact lens."HEMA lenses, unlike contact lenses made of PMMA, can absorb water and as a result become soft and flexible, permitting many individuals to wear contact lenses without significant discomfort. "Soft" contact lenses are also generally *534 more*50 comfortable to wear due to differences in thickness, weight, and diameter.Various clinical tests performed in Prague established that contact lenses produced from the HEMA material could be worn successfully by human patients.The first lenses produced by Dr. Wichterle were formed by polymerizing the HEMA compound in a crude, stationary mold. In late 1961, Dr. Wichterle first manufactured soft contact lenses using a spinning open mold mounted on a crude spin cast machine which Dr. Wichterle had fabricated in the kitchen of his home. The spin cast process uses centrifugal force to produce a contact lens. The shape and power of a soft contact lens manufactured using the spin cast process is determined by the shape and size of the mold, the quantity and density of the monomer mixture injected into the mold, and the speed of the rotation of the spindle that holds the mold. Dr. Wichterle and his associates continued to produce soft contact lenses using the "spin cast method" during 1962 through 1965. They continued to improve upon the original spin cast process of producing soft contact lenses throughout this period.In 1963, Dr. Wichterle developed a process by which the gel from*51 which the soft HEMA contact lenses were made was transformed into a hard state, and the material was lathed, machined, ground, and polished in a fashion similar to the PMMA used to make hard contact lenses. Such material was referred to as "Xerogel."During or prior to 1966, Dr. Wichterle and his associates prepared a three volume text entitled "Soflens Production Line Documentation." This text details the steps necessary in the manufacture of the HEMA monomer mixture used in the manufacture of a soft contact lens, as well as the procedure for manufacturing the soft contact lens itself using the spin cast process.During the late 1970's and early 1980's, the soft HEMA lens became the predominant type of contact lens sold in the United States. Prior to 1971, the hard (PMMA) contact lens was the only contact lens available in the United States. The percentage of sales of contact lens which were soft (HEMA) contact lenses and hard (PMMA) contact lenses in the United States for the years 1978 through 1982 were *535 approximately as follows:YearPMMAHEMAOther197851%49%19793954619802764819812170919821575102. Relevant United States*52 and Foreign Patents Obtained by Dr. Wichterle and Associatesa. Materials PatentsOn March 28, 1961, the U.S. Patent Office (Patent Office), issued to Dr. Wichterle and Dr. Lim, a patent with respect to a "process for producing shaped articles from three-dimensional hydrophilic high polymers" (Material Patent I). The 17-year term of Material Patent I expired on March 28, 1978.On November 30, 1965, the Patent Office, issued to Dr. Wichterle and Dr. Lim a patent with respect to "cross-linked hydrophilic polymers and articles made therefrom (Material Patent II). The 17-year term of Material Patent II expired on November 30, 1982. On June 20, 1972, the Patent Office issued to Dr. Wichterle and Dr. Lim a reissued patent which was a reissue of Material Patent II.b. Spin Cast PatentsOn October 29, 1968, the Patent Office issued to Dr. Wichterle and CAS a patent with respect to a "method for centrifugal casting a contact lens" (Spin Cast Patent I). The 17-year term of Spin Cast Patent I expired on October 29, 1985.On May 2, 1972, the Patent Office issued to Dr. Wichterle and CAS a patent with respect to a "method of centrifugally casting thin edged corneal contact lenses" essentially*53 consisting of soft hydrogels of organic polymers (Spin Cast Patent II). Dr. Wichterle and CAS disclaimed the portion of the 17-year term of Spin Cast Patent II which extended beyond October 29, 1985.On February 17, 1970, the Patent Office issued to Dr. Wichterle and CAS a patent with respect to a "method of manufacturing soft and flexible contact lenses" (Xerogel Spin Cast Patent). Dr. Wichterle and CAS disclaimed the *536 portion of the 17-year term of Xerogel Spin Cast Patent which extended beyond January 2, 1985.c. Other Process PatentsOn January 2, 1968, the Patent Office issued to Dr. Wichterle and CAS a patent with respect to "reshaping a xerogel by mechanical removal and swelling to form a hydrogel contact lens" (lathing patent). The term of the lathing patent expired on January 2, 1985.On July 2, 1974, the Patent Office issued to Dr. Wichterle and CAS a patent with respect to a "contact lens blank or replica made from anhydrous, sparingly cross-linked hydrophilic copolymers" (replica patent). The term of the Replica Patent will expire on July 2, 1989.Material Patent I and Material Patent II are referred to collectively herein as the "material patents." The material*54 patents, Spin Cast Patent I, and Spin Cast Patent II, the Xerogel Spin Cast Patent, the lathing Patent, and the replica Patent, and all United States and foreign patents related thereto as the context requires, are referred to collectively herein as the "Wichterle Patents."In addition, Dr. Wichterle and CAS filed patent applications and obtained patents in numerous foreign countries with respect to the technology and inventions covered by the Wichterle patents. However, neither Dr. Wichterle nor CAS obtained any patents in the Republic of Ireland with respect to the soft contact lens, the spin cast process, or any other technology embodied in the Wichterle patents. Nor did any representative or agent of CAS or Dr. Wichterle obtain or attempt to obtain at any time approval from the FDA to market a soft HEMA lens in the United States.C. License Agreements Between Czechoslovak Academy of Science and National Patent Development Corp. and Related EntitiesDuring and prior to the years at issue, National Patent Development Corp. (NPDC) was a publicly owned firm that was unrelated to B&L or its subsidiaries.On or about March 12, 1965, CAS, represented by Polytechna, a Czechoslovakian*55 firm, and Flexible Contact Lens Corp., represented by National Patent Development Corp., entered into a license agreement pursuant to which *537 CAS granted to Flexible an exclusive license (CAS License Agreement) to manufacture and sell the soft HEMA contact lens developed by Dr. Wichterle (Wichterle lens) in the Western Hemisphere. 2*57 CAS also agreed to provide Flexible with 25,000 first class quality sample Wichterle lenses. The license agreement was for an initial term of no less than 10 years with annual renewals at the option of the parties thereafter. Pursuant to this agreement, Flexible was obligated to pay to CAS an initial fee of $ 75,000 and a royalty of $ 2.50 per lens sold during the 1st year of the agreement. During the 2nd through 6th years of the agreement, Flexible agreed to pay CAS a royalty of $ 2 per lens for the first 100,000 lenses sold each year; a royalty of $ 1.50 per lens for the next 150,000 lenses sold; and a royalty of $ 1 per lens for every lens in excess of 250,000 sold each year. After the 6th year of the agreement, the royalty would be $ 1 per lens sold. The agreement also provided that the royalty payable in the 2nd through 6th years of*56 the agreement be no less than $ 100,000 per year. On or about May 6, 1965, the parties adopted two amendments to this agreement one of which extended the territory covered by the agreement to include South Africa in exchange for an addition of $ 5,000 to the initial $ 75,000 fee described above. The exclusive license granted by CAS to Flexible pursuant to the CAS License Agreement covered the Wichterle Patents, all related patents subsequently issued in the United States or other countries in North America, South America, and Central America, and any other know-how, formulas, or technical information which related to the technology or inventions covered by the Wichterle Patents and all related patents. 3 A sublicense of the CAS License Agreement was subsequently granted to NPDC by Flexible.*538 On or about May 25, 1966, NPDC and CAS, represented by Polytechna, entered into a license agreement pursuant to which CAS granted to NPDC a 15-year exclusive license to manufacture and sell the Wichterle lens in Israel. In consideration for the exclusive license, NPDC agreed to pay CAS an initial fee of $ 1,750 and a royalty of $ 2 for each Wichterle lens sold by NPDC in Israel.On or about May 20, 1968, the parties to the CAS License Agreement adopted an amendment to the agreement to modify the royalty provisions contained therein (1968 Amendment). Pursuant to the 1968 Amendment, in 1969 NPDC was required to pay royalties to CAS in the amount of 6 percent of the net selling price of each soft contact lens sold in the United States and Canada with a reduction in the rate to 5 percent of the net selling price after the*58 minimum royalty was reached (not to be less than $ 1 per lens). 4 Additionally, NPDC was required to pay CAS a royalty in the amount of 5 percent of the net selling price of each soft contact lens sold in countries under the agreement other than the United States and Canada. "Net selling price" was defined as the net proceeds per Wichterle lens sold to the first independent buyer that was not a subsidiary or affiliate of NPDC the licensor. Unless otherwise indicated, this definition of net selling price or "net sales" applies to all subsequently discussed licensing agreements.On June 26, 1967, CAS and NPDC entered into a license agreement pursuant to which CAS granted to NPDC an exclusive license to manufacture and sell the Wichterle lens in six specified countries in the Far East (Far East License Agreement). Pursuant to such agreement, NPDC was required to pay to CAS*59 an initial fee of $ 35,000 and royalties in the amount of 5 percent of net sales in the specified territories. A sublicense was subsequently granted to Hydron International by NPDC.On or about October 16, 1970, CAS and Hydron Europe entered into an agreement pursuant to which CAS granted to Hydron Europe an exclusive license for a minimum term of 15 years to manufacture, use, and sell the Wichterle soft contact lens throughout Europe (European License Agreement). *539 Pursuant to such agreement, Hydron Europe was required to pay to CAS an initial fee of $ 25,000 and royalties in the amount of 5 percent of net sales in the specified territories. The agreement also contained provision for minimum royalties of between $ 25,000 and $ 50,000 per year.On February 15, 1972, Hydron Europe, Optics Bermuda, Ltd., NPDC, and Smith & Nephew Associated Cos. Ltd., entered into a license agreement pursuant to which Hydron Europe granted to Optics an exclusive license to manufacture, use, and sell the Wichterle lens in the United Kingdom and in certain specified European countries. After a period of 2 1/2 years the license became nonexclusive. Pursuant to such agreement, Optics was required*60 to pay to CAS on behalf of Hydron Europe royalties in the amount of 5 percent of net sales in the specified territories.D. Sublicense Agreements Between NPDC and B&L and Certain Related Litigation1. Sublicense Agreements Between NPDC and B&LOn or about October 6, 1966, NPDC and B&L entered into an agreement pursuant to which NPDC granted to B&L, inter alia, an exclusive sublicense to manufacture, use, sell, and distribute the Wichterle lens in the Western Hemisphere and to use the Wichterle patents and any related patents then or subsequently issued to CAS in such territories and all of the related technical know-how which CAS licensed to Flexible, and which Flexible licensed to NPDC (NPDC Sublicense Agreement). NPDC also agreed to endeavor to acquire monomer mixture for B&L under certain terms and conditions. On or about August 16, 1971, the parties to the NPDC Sublicense Agreement and Flexible adopted an amendment to the NPDC sublicense agreement, which, inter alia, extended the exclusive sublicense to include Israel and South Africa.Pursuant to the NPDC Sublicense Agreement, B&L agreed to pay to NPDC a royalty with respect to domestic sales in an amount equal to 50 *61 percent of the difference between (a) B&L's sales of soft contact lenses in the United States and (b) the sum of (i) 35 percent of such sales, (ii) all direct and indirect expenditures incurred by B&L in connection with *540 the development, engineering, and manufacture of the soft contact lens, the spin cast machine, and related products, (iii) all other direct costs and expenses incurred by B&L in connection with soft contact lenses sold in the United States, (iv) all amounts paid to CAS, and (v) all previously unrecouped amounts referred to above. With respect to foreign sales, B&L agreed to pay to NPDC a royalty in an amount equal to (i) 10 percent of its sales to purchasers outside the United States plus (ii) $ 1 per each lens sold to purchasers outside the United States. B&L also agreed to purchase from NPDC the two automatic spin cast lens manufacturing machines which NPDC had agreed to purchase from KOVO on the same terms that NPDC had agreed to.On August 16, 1971, NPDC, Hydron Pacific, and B&L entered into a sublicense agreement pursuant to which Hydron and NPDC granted to B&L, inter alia, an exclusive sublicense to make, use, sell, and distribute the Wichterle lens*62 in Japan, Okinawa, South Korea, the Philippines, Taiwan, and Hong Kong (Pacific Sublicense Agreement). The Pacific Sublicense Agreement covered any patents issued in such countries which related to the technology or inventions covered by the Wichterle patents.2. Litigation with Respect to the Wichterle Patents in EuropeIn May 1969, B&L and NPDC agreed that NPDC would assist B&L in obtaining a license from CAS to manufacture and sell soft contact lenses in various European countries. Notwithstanding this agreement, NPDC obtained a license with respect to Europe before B&L could negotiate such a license with CAS. Thereafter, in 1972, B&L began selling soft contact lenses in Europe without a license under the Wichterle patents in Europe.On November 8, 1972, NPDC and Hydron Europe filed a patent infringement action against B&L and Bausch & Lomb Optical Co. Ltd., a subsidiary of B&L, in the High Court of Justice, Chancery Division, London, England, seeking to enjoin B&L from selling soft contact lenses covered by the Wichterle patents. On December 26, 1972, CAS, along with NPDC and Hydron Europe, commenced a *541 similar patent infringement action against B&L France S.A. in*63 a French court.On December 4, 1972, B&L filed an action against NPDC and Hydron Europe in New York State Supreme Court alleging that NPDC and Hydron Europe were constructive trustees holding, for the benefit of B&L, a license from CAS with respect to the Wichterle patents in Europe, and seeking all profits derived by such parties in Europe.On February 14, 1973, NPDC, Hydron Europe, and B&L entered into an agreement pursuant to which they agreed to discontinue the above described actions. Pursuant to this settlement agreement, Optics, Hydron Europe, Hydron-Lens B.V., and Contact Lens Insurance Ltd., granted to B&L a nonexclusive, nonassignable, and nontransferable sublicense for the manufacture, use, and sale of the Wichterle lens in the United Kingdom and 18 specified European countries in exchange for royalties in the amount of 6 percent of net sales in England and France and 5 percent of net sales in the other specified territories (European Sublicense Agreement). The European Sublicense Agreement covered all patents issued in Europe which related to the technology or inventions covered by the Wichterle patents.Also on February 14, 1973, NPDC, Hydron Pacific, and Hydron Australia, *64 granted to B&L a nonexclusive sublicense to manufacture, use, and sell the Wichterle lens in Australia, New Zealand, and Singapore in exchange for royalties in the amount of 5 percent of net sales in the specified territories (Australian Sublicense Agreement). The Australian Sublicense Agreement covered all patents issued in Australia, New Zealand, and Singapore which related to the technology or inventions covered by the Wichterle patents.3. Litigation Relating to Soft Contact Lens TechnologyFrom 1967 through 1972, B&L paid no amounts to NPDC pursuant to the NPDC Sublicense Agreement in excess of the amounts due to CAS because the revenues received by B&L in such years with respect to sales of soft contact lenses, in the aggregate, did not exceed the costs and expenses incurred by B&L, as computed by B&L, with *542 respect to soft contact lenses in such years, in the aggregate.On October 30, 1972, NPDC filed a suit in the Supreme Court of the State of New York against B&L (accounting action). NPDC alleged inter alia, that B&L had violated the terms of the NPDC Sublicense Agreement and requested an accounting under the terms of such agreement. NPDC alleged that B&L owed*65 it at least $ 3 million pursuant to the NPDC Sublicense Agreement. 5On April 19, 1974, B&L filed a suit against Hydron Pacific, NPDC, and Hydron Europe, in the Supreme Court of the State of New York, in which B&L alleged, inter alia, that Hydron Pacific and NPDC breached the Pacific Sublicense Agreement and that Hydron Europe interfered with the performance of such agreement.On August 23, 1974, CAS, NPDC, Flexible, and B&L filed a suit against Automated Optics, Inc. in the U.S. District Court for the District of Colorado in which the plaintiffs alleged that Automated Optics was infringing upon*66 certain patents held by CAS (Automated Optics litigation), including the materials patents and the lathing patent. Such litigation did not involve the spin cast process.On September 25, 1975, Hydron Pacific filed a suit against B&L in the Supreme Court of the State of New York, in which Hydron Pacific alleged, inter alia, that B&L did not have an exclusive license under certain Japanese patents held by CAS in Japan.In December 1975, Milton Roy Co. and Milroy-Automated, Inc. filed a declaratory judgment action against B&L, NPDC, Flexible, Flexible Contact Lens (Nevada), Inc., and CAS in the U.S. District Court for the District of Delaware in which the plaintiffs sought a declaratory judgment that plaintiffs were not infringing upon certain patents held by CAS (Milton Roy litigation), including the materials patents and the lathing patent.*543 On January 16, 1976, NPDC et al. filed an action against B&L and Mr. Daniel Schuman, chief executive officer of B&L, in the U.S. District Court for the Southern District of New York, in which NPDC sought antitrust damages and patent infringement damages against B&L. Each of the defendants in such action denied the allegations raised *67 by NPDC.In January and February 1976, B&L filed cross-claims against NPDC, Flexible, and CAS in the Automated Optics litigation and the Milton Roy litigation, claiming that certain patents held by CAS, including the materials patents, the spin cast patents, the lathing patent, and the replica patent were not valid patents and were obtained by fraud. B&L also amended its answer in the accounting action to claim as a defense that the subject patents were invalid and unenforceable.4. Settlement of Litigation Between NPDC and B&L and the 1977 SublicensesOn January 7, 1977, NPDC, Flexible-Nevada, and B&L entered into a settlement agreement pursuant to which the parties settled the litigation among them (Settlement Agreement). Flexible-Nevada was a successor in interest to Flexible.Pursuant to the Settlement Agreement, B&L paid to NPDC $ 11,500,000 in settlement of the litigation between B&L and NPDC. B&L paid another $ 2 million in exchange for a new sublicense agreement pursuant to which Flexible-Nevada granted to B&L a fully paid, nonexclusive sublicense (1977 Flexible License Agreement), under all of the Wichterle patents in the Western Hemisphere, the Republic of South Africa*68 and Israel, to manufacture, use, and sell soft contact lenses, to practice all processes relative to such lenses, and to make and have made the material from which such lenses are made. B&L paid an additional $ 500,000 to NPDC in exchange for a new sublicense agreement pursuant to which NPDC granted to B&L and its subsidiaries a fully paid, nonexclusive sublicense (1977 NPDC License Agreement) under all of the Wichterle patents in other countries of the world, including the territories previously covered by the Pacific Sublicense Agreement, the Australian Sublicense *544 Agreement, and the European Sublicense Agreement. The NPDC Sublicense Agreement, the Pacific Sublicense Agreement, the European Sublicense Agreement, and the Australian Sublicense Agreement were canceled by the parties thereto and the five pending actions between the parties to the Settlement Agreement were dismissed, and releases pertaining thereto were granted. The 1977 NPDC License Agreement and the 1977 Flexible License Agreement are referred to collectively herein as the "1977 NPDC Sublicenses." B&L relinquished the exclusive right to manufacture and sell soft contact lenses in the United States under*69 the Wichterle patents, and NPDC thereafter was free to manufacture and sell soft contact lenses in the United States under such patents and was free to enter into license agreements with other companies with respect to the manufacture and sale in the United States of the soft contact lens. 6*70 E. B&L's Operations and Activities With Respect to Soft Contact Lenses and Spin Cast Technology from 1966 Through 19711. B&L's Development of the Soft Contact Lens and Spin Cast ProcessB&L acquired the first of the two Wichterle spin cast machines it had agreed to acquire from NPDC in late 1966. Four Czechoslovakian technicians and various other professionals traveled to Rochester to assist B&L employees in the installation and operation of this machine. Dr. Wichterle himself visited Rochester in January 1968, to discuss various aspects of soft contact lenses and the spin cast *545 technology. In addition to the spin cast machine itself, B&L received from Dr. Wichterle and CAS copies of the three Wichterle Soflens Production Line Documentation Manuals which included technical information, drawings, and tables relating to soft contact lenses and the Wichterle spin cast machine. B&L also received from NPDC a book entitled "Documentation of Hydrophilic Contact Lenses" in January 1967. This book, which was prepared by Drs. Wichterle and Lim, contained various technical information concerning soft contact lenses.In April 1967, four employees of B&L travelled to Prague, *71 Czechoslovakia, to obtain additional information with respect to the soft contact lens project.The second spin cast machine B&L had agreed to acquire was purchased in 1967 and moved to Rochester early in 1968. B&L retained the right to reject both spin cast machines if they were unable to attain an actual yield of good lenses of at least 20 percent of the lenses produced. Although B&L was unable to obtain these yields initially, the machines were kept and from 1966 until 1972, B&L employees under the direction of William Coombs worked to refine the spin cast technology and increase yields to an acceptable level. By 1971, approximately 24 B&L employees were involved in the soft contact lens project either full or part-time. By the early 1970's, B&L had adapted the machines to use ultraviolet (UV) light rather than heat to polymerize the monomer mixture. At some point in the late 1960's, B&L began using plastic (polyvinylchloride or PVC) molds rather than glass molds. Dr. Wichterle had contemplated that polymerization with UV light and plastic molds could be used in the spin cast process although neither was incorporated by him in the design of the spin cast machine. B&L conducted*72 other development activities during the years 1967 through 1971 with respect to the spin cast machines including:(i) Engineering the spindles which held the various molds and associated drive equipment such that the molds in the spindles would spin true;(ii) Engineering the spindles and drive equipment to allow constant and accurate speed control;*546 (iii) Engineering a system to control precisely the injection of liquid monomer mixture into the spinning mold; and(iv) Reducing the time from injection of liquid monomer until the partial curing of the monomer mixture.By 1971, B&L was able to obtain yields of about 50 percent on the spin cast machines. By 1981, yields were averaging 70-80 percent and in some cases as high as 90 percent of lenses produced.During the years 1967 through 1971, as in all subsequent years through 1982, B&L produced the liquid monomer mixture used in the manufacture of soft contact lenses by a purification and mixing process. B&L used basically the same monomer mixture originally employed by Dr. Wichterle. The only change in the monomer mixture itself was a change in the catalyst required to cause polymerization which was necessitated by the *73 change in the polymerization method from heat to UV light.From 1966 through and including 1970, B&L incurred total costs with respect to its soft contact lens project of approximately $ 3,609,071, which are summarized as follows:Research and process development$ 1,435,282Manufacturing costs380,361Other direct charges444,842Consulting and professional services104,996Royalties400,000Interest509,892Equipment333,6983,609,0712. FDA ActivitiesIn 1967, B&L voluntarily contacted the FDA to discuss B&L's plans to market a soft contact lens in the United States. The FDA advised B&L that the soft contact lens would be treated as a "medical device" rather than as a new "drug" and therefore would not require FDA approval prior to use and sale in the United States. However, on December 12, 1968, the FDA advised B&L that soft contact lenses were being considered a "new drug" by the FDA rather than a "device," and that FDA approval was therefore required prior to the marketing of such product in the United States. The FDA regulations required that an investigatory new drug application (IND) be filed prior to the performance of any clinical studies on humans to*74 evaluate *547 the product's quality and safety. B&L had already begun performance of clinical studies in 1967 and was permitted to continue ongoing clinical studies pending the filing of an IND. Prior to December 12, 1968, no contact lenses had ever been subjected to the IND and new drug application (NDA) approval process.On April 8, 1969, B&L filed with the FDA an IND with respect to the soft contact lens. On September 26, 1969, B&L filed with the FDA an NDA with respect to the soft contact lens. Such NDA included, inter alia, a report and exhibits including, among other items, clinical investigation reports, new drug experience reports, an index to articles relative to soft contact lenses, and manufacturing procedures.In February 1970, B&L withdrew its NDA and filed a new NDA in July 1970. During 1970 and early 1971, B&L sent several reports to the FDA relative to clinical studies concerning soft contact lenses. On March 18, 1971, the FDA approved B&L's NDA with respect to soft contact lenses, and B&L thereafter was permitted to market soft contact lenses in the United States. The FDA approval of an NDA with respect to B&L's soft contact lens, the first soft contact*75 lens for which approval was requested from the FDA, took approximately 1 year and 11 months from the date of the original FDA filing.Beginning with the FDA's approval, B&L maintained a master file at its offices in Rochester. Through 1982, such master file consisted of approximately 100 volumes pertaining to applications, reports, letters, correspondence, and other documents relative to the FDA regulatory requirements with respect to soft contact lenses, saline solutions, sterilizers, export approvals, marketing packages, carrying cases, advertisements, manufacturing, and other matters.F. Development of the Soft Contact Lens Market in the United States From 1971 through 1982In May 1971, B&L first marketed soft contact lenses in the United States by introducing the product in a series of regional seminars across the country. By the end of 1971, soft contact lenses were generally available throughout the United States.*548 Beginning in 1973, other companies obtained FDA approval with respect to soft contact lenses and entered the United States soft contact lens market. Some companies developed new materials which were different from the Wichterle soft contact lens *76 material licensed to B&L, while other companies used materials which were potentially subject to infringement actions under the Wichterle materials patents.Competition in the soft contact lens market in the United States increased significantly from 1977 through 1982 as the market for soft contact lenses grew rapidly. Set forth below is a schedule which lists the percentage market share of each of the major competitors in the United States market for soft contact lenses from 1978 through 1982.Firm19781979198019811982Bausch & Lomb50.6%47.9%52.8%48.3%41.5%Hydrocurve12.2 14.3 11.2 9.8 13.0 (Revlon, BarnesHind)American Hydron2.5 4.7 6.9 8.5 American Optical15.7 18.5 13.1 10.7 7.0 Ciba Vision0.1 1.7 UCO Optics5.3 7.7 6.5 7.9 6.6 Cooper Vision0.4 1.8 3.4 6.4 Wesley-Jessen6.0 3.8 3.1 2.5 4.6 Lombart2.5 3.6 4.1 2.8 Vistakon1.1 1.1 0.5 1.4 1.3 Syntex0.8 2.2 Other8.9 1.1 2.7 3.8 4.3 G. Development of New Soft Contact Lens Products1. Thin Soft Contact LensesBy the late 1970's and early 1980's, most competitors in the United States*77 soft contact lens industry had a "thin" soft contact lens on the market. Thin soft contact lenses are more comfortable than the "thicker" soft contact lenses available in the mid-1970's. These lenses were produced by B&L using the same basic spin cast technology as used to produce standard soft contact lenses. However, this lens required the development and use of new molds and new spin parameters such as spin speed, amount of monomer, *549 and time to polymerize. B&L introduced its thin soft lens in late 1977.2. Toric Soft Contact LensesIn 1978, Hydrocurve became the first company in the soft contact lens industry to market a "toric" soft contact lens in the United States. Toric lenses are designed to correct astigmatism, that is, an irregularly shaped cornea. B&L was unable to develop a marketable toric soft contact lens through 1979. Therefore, B&L acquired the assets of Milton Roy Co. (Milton Roy) in 1979 in order to gain access to that company's toric lens production technologies. After the acquisition and through December 31, 1982, B&L continued to use Milton Roy's Sarasota facility for manufacture of toric soft contact lenses using a lathing method.3. Extended*78 Wear Soft Contact LensesExtended wear soft contact lenses are soft contact lenses which can be worn for periods of several days or more. At least two competitors in the United States soft contact lens market introduced extended wear soft contact lenses for cosmetic use in the United States market early in 1981. B&L's research and development program had not developed an extended wear soft contact lens which was marketable as of the end of 1982. B&L, therefore, entered into a licensing agreement with American Hospital Supply Corp., which had developed an extended wear soft contact lens that was marketed in the United States for aphakic and therapeutic purposes. B&L sold such lenses under the name "CW-79."4. Rigid Gas Permeable Contact LensesIn 1978, Danker Laboratories became the first company to develop a marketable "rigid gas permeable" contact lens for the United States market. Rigid gas permeable lenses are hard lenses which are produced from a material which permits oxygen to pass through the lens to the eye. Several other competitors of B&L introduced gas permeable lenses soon after the first introduction of such lenses in 1978. B&L began research and development activities*79 with respect to a rigid gas permeable contact lens in the 1970's. However, B&L's efforts to develop a rigid gas permeable lens were *550 unsuccessful. Subsequent to 1982, B&L acquired the assets of a company which had developed a gas permeable contact lens.H. Development of Manufacturing Technologies1. The Spin Cast ProcessFrom 1967 through the first half of 1971, B&L manufactured soft contact lenses in Rochester using the two Wichterle spin cast machines acquired from NPDC via KOVO. In late 1971, B&L fabricated an additional spin cast machine based on the two Wichterle spin cast machines and the spin cast technology licensed from NPDC. This new machine was also used in Rochester in the production of soft contact lenses and incorporated the modifications made to the technology by B&L in the late 1960's. At some point in the early 1970's, B&L made the decision to commit to the spin cast technology. It thus discontinued operations at its Canadian facility, which had been manufacturing soft contact lenses using a lathing process since the 1970's, prior to 1981.By 1981, B&L was able to produce soft contact lenses for a cost of $ 1.50 per unit with a standard cost *80 of $ 1.54 per unit. Standard cost is a cost accounting concept and is an estimate of the cost at which a unit can be produced under normal circumstances.2. Semiautomatic and Automatic Lathing ProcessVirtually all of B&L's competitors in the United States soft contact lens market through 1977 used the manual lathing method to manufacture soft contact lenses. During the period 1977 through 1980, various manufacturers sought to automate various functions performed manually as part of the lathing process. Elimination of manual functions both reduced the per-unit costs of producing soft contact lenses using the lathing method, and improved the accuracy with which a lens of a designated specification could be reproduced. Petitioners' contact lens industry expert, Dr. Irving J. Arons, estimated that lenses can be produced using the lathing method for a unit cost varying between $ 3.50 and $ 10 per lens. During 1981 and 1982, *551 NPDC was able to produce lathed lenses for $ 6.18 and $ 6.46 per unit, respectively.3. The Cast Molding ProcessIn the mid-1970's, the original cast molding process was developed by Thomas Sheperd, an employee of International Lens Corp. (ILC). In the*81 cast molding process, soft contact lenses are formed by polymerizing a monomer mixture in the cavity between two stationery molds. Mr. Sheperd obtained various patents in the United States with respect to the cast molding process which he assigned to ILC. American Optical also developed a cast molding process for which it obtained certain patents in the late 1970's.On February 18, 1977, ILC and NPDC entered into an agreement pursuant to which ILC granted to NPDC a license to make, use, and sell soft contact lenses using ILC's patents, trade secrets, technical information, formulas, manufacturing know-how, research and development information, and similar information pertaining to the ILC cast molding process (1977 ILC Agreement). The license was exclusive in North America, Japan, Okinawa, Australia, New Zealand, and the U.S.S.R., and nonexclusive throughout the remaining countries of the world. In exchange for this license, NPDC agreed to pay ILC royalties equal to the lesser of 5 percent of net sales or 50 cents per lens. In 1979, an amendment to the agreement reduced the royalty to the lesser of 4 percent of net sales or 50 cents per lens.On December 6, 1979, NPDC and CooperVision*82 entered into an agreement pursuant to which NPDC granted a coexclusive license to CooperVision (1979 CooperVision Agreement) to manufacture extended wear soft contact lenses using the ILC cast molding process in the various countries in which NPDC had exclusive rights to the cast molding process pursuant to the 1977 ILC agreement. The license included all information to which NPDC was entitled pursuant to the 1977 ILC agreement, as well as any additional information pertaining to the cast molding process which was developed by NPDC. In exchange for the license, CooperVision agreed to pay NPDC a royalty of $ 1 per extended wear lens manufactured using the ILC cast molding process, with a 50-percent reduction in the royalty *552 if patent protection was lost. In addition, CooperVision agreed to pay NPDC an initial license fee of $ 2 million, $ 1 million of which was payable immediately, and $ 1 million of which was payable at the rate of $ 4 per lens sold for the first 250,000 lenses sold by CooperVision. The agreement was amended on March 20, 1981, to include daily wear soft contact lenses produced using the ILC cast molding process. Pursuant to this amendment, CooperVision*83 agreed to pay to NPDC for each daily wear soft contact lens manufactured and sold using the ILC cast molding process a royalty of 25 cents above the royalty per lens paid by NPDC to ILC, not to exceed a total of 75 cents per lens. In addition, CooperVision agreed to pay NPDC an additional lump sum license fee of $ 700,000. A second amendment agreed to on April 10, 1981, altered the royalty provision of the initial agreement with respect to extended wear soft contact lenses to bring it into conformity with the royalty provisions for daily wear lenses which were adopted in the March 20, 1981, amendment. NPDC was in a difficult financial position in 1979 at the time the 1979 CooperVision Agreement was being negotiated. Thus the up-front payments due NPDC under the agreement were particularly attractive to it.On August 5, 1981, CooperVision agreed to make a one-time, lum-sum payment of $ 500,000 for access to NPDC's FDA masterfile with respect to standard daily wear soft contact lenses and for NPDC's agreement not to file suit against CooperVision under the Wichterle materials patents and Wichterle replica patent with respect to the sales of soft contact lenses in the United States*84 and other countries. 7By the early 1980's, several companies were using a cast molding process to manufacture soft contact lenses in the United States including NPDC, CooperVision, and American Optical. NPDC and its affiliates obtained FDA approval to market soft contact lenses manufactured using the cast molding process in 1980. In 1981 and 1982, NPDC and its *553 affiliates manufactured approximately 394,882 and 509,612 soft contact lenses, respectively, using the cast molding process. NPDC's per unit manufacturing costs for lenses produced using the cast*85 molding process were $ 4.19 and $ 4.02 in 1981 and 1982, respectively. NPDC's standard cost of manufacturing soft contact lenses using the cast molding process was $ 3.33 in 1981.4. The Vertical Spin Cast ProcessBy the late 1970's, Dr. Wichterle had developed a new spin cast machine which embodied all of the concepts of the initial spin cast design, except that the molds containing the liquid monomer mixture were spun while stacked in a tube rather than spun individually on spindles situated on a rotating table. This advance on the initial spin cast design is hereinafter referred to as the "vertical spin cast process."On July 6, 1981, CAS, represented by Polytechna, and NPDC entered into an agreement pursuant to which CAS granted to NPDC an exclusive license to make, use, and sell soft contact lenses using the Wichterle vertical spin cast method in the Western Hemisphere, Western Europe, and certain Pacific Rim countries. The license included all patented and unpatented technical, engineering, and manufacturing information relating to the vertical spin cast method as well as any additional information subsequently developed by CAS. The agreement also contemplated the purchase*86 of at least one Wichterle vertical spin cast machine by NPDC from CAS, and that CAS would make technicians available to NPDC on a fee basis to provide start up assistance in connection with NPDC's commencement of contact lens production using the vertical spin cast method. In exchange for the license, NPDC agreed to pay to CAS royalties equal to 5 percent of the net selling price of all soft contact lenses manufactured using the Wichterle vertical spin cast process. The agreement also provided for an escalating minimum royalty payment and a reduction in the royalty rate to 2 1/2 percent should CAS begin using the process itself in any one of the licensed territories.NPDC considered the vertical spin cast process to be a "quantum jump" in the state of the art of spin cast technology. Between 1981 and September 1984, NPDC spent *554 approximately $ 300,000 for purchase and modification of vertical spin cast machines. During this period, NPDC personnel worked to master the process, and conducted clinical tests on lenses produced using the vertical spin cast method. FDA approval for the sale in the United States of soft contact lenses produced using the vertical spin cast process*87 was obtained in September 1984.Through 1982, B&L's competitors in the United States used the manual lathing process, the cast molding process, or various automated and semiautomated lathing processes to produce soft contact lenses. Through 1982, no firm other than B&L manufactured soft contact lenses in the United States using the spin cast process. B&L's effective monopoly over use of the spin cast method allowed it to produce soft contact lenses for a cost significantly below that attainable by any of its competitors during this period. No company used the vertical spin cast process to produce soft contact lenses for sale prior to 1984.Contact lenses within the same diopter or power range are generally considered fungible. Thus the consumer is generally indifferent as to whether a lens is manufactured using the spin cast, lathing, or some other process. However, soft contact lenses manufactured using the spin cast process do enjoy an advantage as to reproductibility. Thus it is more likely to get an exact reproduction of a lost or damaged lens through use of the spin cast process than with some other manufacturing process.I. Research and Development Activities of B&L's*88 Soflens DivisionPrior to 1982, the B&L Soflens Division research and development function investigated the performance of various soft contact lens designs on the eyes of human subjects. The function also investigated new contact lens materials and performed assessments of potential soft contact lenses and associated products. In 1978, 1979, and 1980, the major research and development projects in the Soflens Division were "Project W," "hard gas permeable lenses," "toric soft contact lenses," "accessories research," and "solutions research." Project W was a project to develop an extended wear lens using a new lens material. As stated previously, *555 this development effort proved unsuccessful and B&L licensed the extended wear technology of American Hospital Supply Corp. in 1983.On September 3, 1974, the Patent Office issued to Richard J. Wrue, an employee of B&L, a patent with respect to an "Apparatus for and method of edging a nonrigid lens," and on July 29, 1975, the Patent Office issued to Mr. Wrue a patent with respect to a "method of edging a nonrigid lens." The patents were assigned to B&L when granted. The technology to which those patents relate was used by *89 B&L and B&L Ireland in the commercial manufacture of soft contact lenses in the years 1981 and 1982. B&L and B&L Ireland consider such technology to be part of the technology covered by the license agreement between B&L Ireland and B&L, dated January 1, 1981.J. Sales and Marketing Activities of B&L's Soflens DivisionIn the mid-1970's, B&L had field marketing sales personnel who contacted practitioners and chain store representatives in the United States to market soft contact lenses and related products. At the end of 1982, B&L had approximately 185 field sales employees.Additionally, B&L had approximately 120 employees engaged in marketing sales support who were employed within the United States.In 1981 and 1982, among the duties of the Soflens Division marketing personnel were the preparation and organization of sales programs, brochures, advertising copy, and exhibits at trade shows; sales forecasting and interface with research and development personnel relative to new products. Marketing personnel of certain of B&L's competitors performed similar functions on behalf of their respective employers.B&L had a system for the receipt and resolution of complaints concerning*90 soft contact lens products and related products from 1978 through 1982. The employees engaged in this activity were employed in Rochester.B&L associated the Bausch & Lomb trademark with its soft contact lens products in the United States. B&L also associated the Soflens trademark with such products in the United States.*556 B&L and its subsidiaries claimed common law or other unregistered copyrights with respect to promotional materials relative to soft contact lenses and related products. However, B&L and its subsidiaries did not, as a matter of general practice, register such copyrights in the United States or foreign countries.K. Development of the International Soft Contact Lens MarketB&L began to sell soft contact lenses in Canada late in 1971 and in various other foreign markets late in 1972. However, B&L was not the first company to sell soft contact lenses outside the United States.In 1971, NPDC, Hydron Europe, and Smith & Nephew Associated Co., Ltd., formed a new company, Hydron Lens Ltd., to manufacture and sell soft contact lenses in all European countries except France.In 1972, NPDC and its affiliates began manufacturing and selling soft contact lenses*91 throughout Europe. Shortly thereafter, NPDC and its affiliates began selling soft contact lenses in Japan and manufacturing and selling soft contact lenses in Australia. According to NPDC's 1975 Annual Report and Securities and Exchange Commission 10K Report, NPDC had, inter alia, the following market shares in 1975:Australia75 percentUnited Kingdom50 percentSpain80 percentThus, when subsidiaries of B&L entered a foreign soft contact lens market, such subsidiaries generally had competitors. By 1977, most foreign affiliates of B&L were established as competitors in the respective foreign soft contact lens markets. B&L's foreign affiliates typically were the third or fourth largest competitor in their respective markets.Each foreign affiliate of B&L which sold soft contact lenses maintained its own marketing, sales, and distribution departments which performed certain marketing, sales, and distribution activities with respect to its sales of soft contact lenses.*557 In 1977 and 1978, B&L sold standard soft contact lenses to its foreign affiliates at a transfer price of $ 6.70 per lens. By 1979, B&L was also selling to its foreign affiliates its thin soft*92 contact lenses, which practitioners sold to customers at a price higher than the standard soft contact lenses. Rather than maintaining separate transfer prices for standard soft contact lenses and thin soft contact lenses, B&L established in 1979 a single uniform transfer price of $ 7.50 with respect to all sales of soft contact lenses to foreign affiliates. This price remained in effect until 1983, when the intercompany transfer price was reduced to $ 6.50.III. Historical development of the Irish operations of B&L IrelandA. Background of Decision to Establish Foreign Manufacturing FacilityPrior to 1980, B&L and its subsidiaries had no manufacturing facilities, other than the Rochester Facility, which had the ability to produce soft contact lenses using the spin cast process. Therefore, all soft contact lenses produced using the spin cast process and sold to B&L's foreign marketing subsidiaries were manufactured in Rochester.B&L's long range forecasts prepared in 1978 and 1979 with respect to the foreign markets predicted that the demand for soft contact lenses in such markets would increase in 1980 and future years, particularly in Europe. B&L expanded its manufacturing*93 and distribution capacity at the Rochester Facility to in part meet this expected increase in demand. The expansion of manufacturing capacity was accomplished in part by increasing the number of spindles on certain of its spin cast machines from 16 to 24 spindles.Additional long range forecasts conducted in 1980 predicted approximately 20-percent per year growth in both the domestic and international market for soft contact lenses from 1981 through 1985. B&L also contemplated in 1980 that its share of the United States contact lens market would increase as a result of its various marketing strategies in the late 1970's and early 1980's.*558 B&L's 5-year strategic plan in 1980 projected the following demand for contact lenses in the United States and international markets:Gross demandNet demandsoft contactsoft contactYearlens unitslens units198114,200,0009,230.000198216,800,00010,920,000198319,100,00012,415,000198419,400,00012,610,000198520,700,00013,455,000The "gross" demand refers to the number of lens-in-mold units needed in order to net a sufficient number of saleable units to meet the projected market demand for soft*94 contact lenses. For planning purposes, B&L utilized a 35-percent yield loss factor. In 1980, after addition of the 24 spindle spin cast machines and other increases in capacity, the Rochester facility had a maximum gross manufacturing capacity of approximately 17 million units. However, as a matter of corporate policy, B&L assumed operation of the Rochester facility at 65 percent of capacity in order to maintain a safety margin of 35 percent of full capacity so that B&L could move quickly to meet any unexpected surge in demand and to have a margin of safety for peak demands, production problems, shutdowns, and other manufacturing difficulties. Thus, for planning purposes, B&L considered the Rochester facility as capable of producing just over 7 million saleable units. The Soflens Division management determined that it would require substantial additional manufacturing capacity in order to meet demand through the early and mid-1980's.A factor in situating the additional capacity was B&L's concern that concentration of virtually all its soft lens manufacturing capability at one location overly exposed it to risks that natural or man-made disasters or labor problems could shut *95 down the Rochester facility and virtually eliminate petitioners' ability to supply soft contact lenses to the United States and foreign markets. Thus a decision was reached that any additional manufacturing capacity established should be located at a site other than the Rochester facility. A European location for the new manufacturing operation had the additional attraction of *559 providing a closer source of supply for B&L affiliates in Europe, where particularly strong increases in soft contact lens demand were predicted.Another significant factor in the decision to site additional capacity overseas rather than expanding the Rochester facility or establishing a manufacturing facility elsewhere in the United States was based on regulatory considerations. Most foreign countries did not have as strict regulatory environments as that imposed in the United States by the FDA. A location outside the United States would permit the manufacture of lenses made of new materials for foreign markets prior to the obtaining of FDA approval for sale of these products within the United States. Upon receiving FDA approval, these new lenses could immediately be introduced into the United*96 States without manufacturing start up delays.B. Investigation of and Decision to Establish an Overseas Manufacturing FacilityDuring 1978 and 1979, B&L investigated generally the possibility of locating a contact lens manufacturing facility at several possible locations both within and outside the United States. On June 10, 1978, a planning team (Overseas Task Force) was established for the purpose of determining the factors to be considered in B&L's 5-year plan with respect to an overseas manufacturing facility. On October 19, 1978, several members of the Overseas Task Force met in Rochester with Mr. Olaf O'Duill, a representative of the Industrial Development Authority of the Republic of Ireland (IDA) to discuss the various financial and other incentives available to corporations doing business in Ireland. The IDA is responsible for promoting industrial development in the Republic of Ireland. The IDA's principle objective is to encourage Irish industrialists and foreign industrialists to establish operations in Ireland.On November 3, 1978, the Overseas Task Force issued a report (Stage I report) in which it stated that it envisioned that the proposed overseas manufacturing*97 facility would produce HEMA soft contact lenses for the foreign market and new products for the total international market. It also contemplated that the overseas facility would be FDA *560 approved so that overseas production could be shipped to the United States to sustain the domestic market for a short time should production at the Rochester facility be interrupted.The second stage of the analysis of an overseas manufacturing facility, which commenced on or about October 19, 1978, was originally intended to compare the financial considerations relevant to a manufacturing facility located in variuos locations, but was ultimately limited to an evaluation with respect to the Republic of Ireland. Ireland was chosen as a site for further investigation based on the IDA's program of investment incentives and Ireland's membership in the European Economic Community.On March 26, 1979, the Overseas Task Force issued a report (Stage II report) which reviewed the various capital and training grants provided by the IDA, financial incentives, Irish tax incentives, and location savings available to an Irish business operation. On October 18, 1979, the Soflens Division submitted to the*98 B&L board of directors a proposal for Soflens manufacturing facility in Ireland which proposed certain capital expenditures for the establishment of a new manufacturing facility in Waterford, Ireland. The project was authorized by the B&L board of directors in October 1979. On October 15, 1980, a Special Expenditure Application with respect to the Irish lens facility was submitted to B&L management. It contained formal cost and profitability projections and served as a financial justification to B&L management of the proposed capital expenditures.C. Negotiations and Agreement Among Petitioners, B&L Ireland, and the Industrial Development Authority of the Republic of IrelandOn or about July 24, 1979, B&L submitted to the IDA a general project outline for an Irish manufacturing facility. On August 1, 1979, the IDA provided indications of grant support with respect to facilities located in the following Irish cities: Dublin, Cork, Mullingar, Tullamore, and Waterford. B&L selected Waterford, Ireland, because the IDA and the Irish government offered (i) the highest capital grant of 45 percent of the total investment for facilities in *561 Waterford, (ii) low-cost lease*99 financing on 35 percent of the total investment, (iii) training grants to cover the cost of training employees of the operation, (iv) low-cost "section 84" financing available through Irish banks, (v) a partially completed "advance" building in Waterford, and (vi) a tax holiday on all export profits through 1990.In early 1980, B&L submitted to the IDA an Industrial Proposal for the establishment of manufacturing operations in Ireland (IDA Proposal). The IDA Proposal anticipated that B&L Ireland would manufacture approximately 1,500,000 and 3 million gross HEMA contact lenses in 1981 and 1982, respectively, and would have sales of approximately 800,000 and 1,800,000 HEMA contact lenses in 1981 and 1982, respectively. It was contemplated that all of these lenses would be sold to foreign affiliates of B&L. No sales to B&L itself were then contemplated. The IDA Proposal indicates that after an initial start up phase, the Waterford facility would have a maximum production capacity for HEMA soft contact lenses of 5 million gross lenses, or a net yield of 3,250,000 saleable lenses after giving effect to a yield loss factor of approximately 35 percent.The IDA Proposal was presented *100 as a four-phase project to be implemented over a 7-year period. Phase One contemplated the establishment of a facility for manufacture of B&L's First Fit System of Soflens Contact Lenses. The series of lenses incorporated in the First Fit System included both thin and standard thickness lenses which would satisfy the requirements of over 90 percent of potential contact lens users.The Second Phase of the project contemplated establishment of manufacturing facilities for a second-generation lens B&L intended to develop as a replacement for the Soflens lens.Phase Three was expansion of the Phase Two manufacturing facility to meet projected worldwide demand (including in the United States market) as the second-generation lens gained wider acceptance.The fourth and final phase was the planned renovation of the Phase One facility to accommodate manufacture of the second-generation lens. B&L anticipated that by this stage *562 the second-generation lens would be widely accepted and demand for the Soflens lens would deteriorate as that lens became obsolete. Through 1982, however, only the first phase of the project had been implemented.On or about February 10, 1981, B&L, B&L Ireland, *101 and the IDA entered into an agreement pursuant to which the IDA agreed to provide certain grants and other benefits to B&L Ireland (IDA Agreement). Pursuant to the IDA Agreement, B&L Ireland received from the IDA in 1981 and 1982 capital grants in the amount of approximately 45 percent of its initial investment in the Waterford facility and the equipment installed therein. Also pursuant to the IDA Agreement, B&L Ireland agreed not to enter into any royalty commitments, except that B&L Ireland could pay royalties to B&L or any subsidiaries in an amount not to exceed 5 percent of B&L Ireland's annual net sales. In the preamble to the IDA Agreement, B&L represented that to the best of its belief, there would be available to B&L Ireland the raw materials, business and technical personnel, knowledge and facilities required for the proper establishment of operations. In 1981 and 1982, B&L Ireland received training grants with respect to the training of B&L Ireland employees. Such grants generally covered training costs, including, inter alia, compensation and expenses for instructors, transportation, and salaries for trainees.The IDA Agreement required B&L Ireland to fulfill certain*102 obligations as a condition to the capital grants and other incentives provided by the IDA. In particular, B&L Ireland was obligated to operate its manufacturing facility within the specific parameters outlined in the IDA Proposal. Additionally, B&L Ireland was required to commence production at the Waterford facility by December 31, 1981, and continue operating thereafter. The contingent liability undertaken by B&L Ireland for repayment of grants was reduced by one-tenth on each anniversary of the grant payment provided B&L Ireland's obligations under the IDA Agreement were being satisfied. The IDA Agreement was severable such that a failure to proceed as to any of the late phases of the project would have no effect as to earlier phases.*563 D. Manufacturing Intangibles Related to Spin Casting and Soft Contact Lens Products1. Technology in the Public DomainThrough 1982, no patents had ever been issued under the laws of the Republic of Ireland to Dr. Wichterle, CAS, NPDC or any of its subsidiaries, or B&L or any of its subsidiaries with respect to the soft contact lens, the HEMA soft contact lens material, the spin cast process, the lathing process, or any other related*103 manufacturing processes. Therefore any individual or entity had the legal right to manufacture, use, and sell soft contact lenses in Ireland using the technology represented by the Wichterle materials patents and the Wichterle spin cast patents without infringing on any patent rights. As noted above, the Wichterle materials patents expired on November 30, 1982, and Wichterle Spin Cast Patent I, Wichterle Spin Cast Patent II, and the Wichterle Xerogel Spin Cast Patent expired on January 2, 1985.2. B&L License of Trade Secrets to B&L IrelandOn or about January 1, 1981, B&L entered into an agreement with B&L Ireland pursuant to which B&L granted to B&L Ireland a nonexclusive license to use certain manufacturing intangibles in the manufacture of soft contact lenses and certain other rights (B&L Ireland License Agreement).Pursuant to the B&L Ireland License Agreement, B&L granted to B&L Ireland a nonexclusive license to make use of all B&L owned Irish patents and all other technical information and know-how possessed by B&L which relates to contact lenses, the materials used in the production thereof, and the methods and apparatus used in contact lens manufacture to manufacture or*104 use contact lenses in Ireland, and to sell contact lenses anywhere in the world. B&L Ireland also became entitled to any improvements resulting from B&L's ongoing research and development in the manufacture of contact lenses. The agreement also included a nonexclusive license for B&L Ireland to sell contact lenses anywhere in the world using the names Bausch & Lomb and Soflens and any other B&L trademarks registered in Ireland by B&L in connection with the *564 marketing of contact lenses. The agreement also granted B&L Ireland the right to use Bausch & Lomb in the company's name. B&L Ireland was prohibited to sublicense any of the rights it acquired in the license agreement. In exchange for these rights, B&L Ireland agreed to pay B&L a royalty equal to 5 percent of net contact lens sales. The agreement also stipulated that it was terminable at any time by either party on the giving of written notice.E. Financing of the Irish Operation1. Section 84 FinancingSection 84 of the Irish Corporation Tax Act of 1976 provides that under certain circumstances, Irish banks may receive loan interest tax free. This induces Irish banks to provide favorable interest rates to*105 Irish companies. B&L Waterford, the parent of B&L Ireland, was able to secure section 84 financing and to loan such funds to B&L Ireland. B&L Waterford was important to the above structure, since a non-Irish company could not receive section 84 financing and because a loan directly from an Irish bank to B&L Ireland would not have qualified for purposes of determining the amount of the matching IDA capital grant to be received by B&L Ireland. On or about March 9, 1981, B&L Waterford and Allied Irish Banks Ltd. (Allied) entered into a loan agreement that qualified under section 84, pursuant to which B&L Waterford borrowed from Allied $ 4,200,000, and concurrently loaned the money to B&L Ireland. On January 16, 1981, B&L Ireland and Allied entered into another loan agreement pursuant to which Allied agreed to make available to B&L Ireland, as required, up to $ 7 million.2. Lease Financing ArrangementsLeasing arrangements at favorable terms were made available through certain Irish tax incentives to banks for the financing of machinery and equipment. The total amount of machinery and equipment which could be financed through such leasing arrangements, however, was limited to the*106 lesser of 35 percent of total machinery and equipment costs or 20 percent of total fixed assets costs. Rather than purchasing all of the equipment required to *565 operate a contact lens manufacturing facility in Ireland, B&L Ireland leased certain equipment from Allied. On March 30, 1981, B&L Ireland and Allied entered into a Master Lease Agreement, and leased from Allied certain equipment used in the manufacture and processing of soft contact lenses at the Waterford facility.F. Establishment of Manufacturing Operations by B&L IrelandIn 1980, B&L informally agreed to acquire from the IDA a partially complete building located in the IDA Industrial Estate in Waterford, Ireland. Bruce Dornan of B&L was assigned as an employee of B&L Ireland to supervise completion of the building and start-up of operations at the Waterford facility.B&L Ireland purchased four spin cast machines from B&L in 1980, and an additional four spin cast machines in 1981. Each of the spin cast machines was installed at the Waterford facility, by employees of B&L Ireland's engineering department. B&L Ireland paid to B&L $ 60,024, plus packaging, handling, shipping, and insurance costs for each*107 spin cast machine. Once the machines were installed in the Waterford facility, it was necessary to perform quality assurance and other preoperation tests to ensure that all aspects of the spin cast machine were operating properly, and to identify any operational or quality problems with each particular machine. Initial testing of the machines was conducted in Rochester. After installation in Waterford, additional testing was conducted by employees of B&L Ireland's quality assurance and engineering departments in accordance with test "protocols" adopted from B&L protocols.B&L Ireland also purchased edging machines from B&L at a price of $ 10,235.51, plus packaging, handling, shipping, and insurance. Other items of equipment were also purchased from B&L. In each case, equipment sold to B&L Ireland which B&L purchased from independent vendors was priced at the full vendor price. Equipment fabricated by B&L or purchased from independent vendors and modified by B&L was priced in accordance with internal B&L memoranda which took into account direct costs, *566 overhead, and a profit factor. B&L Ireland also purchased certain parts and items of equipment directly from independent*108 vendors in Ireland during each of the taxable years at issue.B&L Ireland's purchase from B&L of various items of capital equipment permitted B&L Ireland to commence operations at a date much earlier than the date on which operations would have commenced if B&L Ireland had purchased such capital equipment from unrelated third parties. Manufacturing activities were begun in March 1981, although significant sales were not made until after FDA approval of the facility had been obtained in September 1981.IV. Operations of B&L Ireland in 1981 and 1982A. Production Planning and SchedulingIn 1981, B&L Ireland manufactured and sold five series of soft contact lenses, including the minus U3, minus U4, minus B3, minus B4, and minus F series lenses. 8 The lens series selected for production during this start-up phase were generally those series which were easiest to manufacture. During 1982, as B&L Ireland's manufacturing proficiency increased, B&L Ireland expanded the range of soft contact lenses which it manufactured and sold. In 1982, B&L Ireland manufactured and sold more than 10 series of daily wear soft contact lenses, although there were other daily wear soft contact lenses*109 manufactured at the Rochester facility which were not manufactured by B&L Ireland.In 1981 and 1982, employees of B&L Ireland prepared production schedules based primarily on the forecasted international demand for specific lens series, which were prepared by Soflens Division. The international marketing personnel generated the demand forecasts from sales and inventory information gathered from the various foreign subsidiaries of B&L. The international demand forecast was forwarded to the materials management manager of B&L *567 Ireland. The quantity of lenses to be produced by B&L Ireland was determined by the estimated capacity of the Waterford facility for the particular year. The*110 mix of lenses to be produced, i.e., the quantity of lenses within each series of lenses to be produced by B&L Ireland, was determined by forecasted demand.B. Purchases of Raw Materials and Materials PoliciesB&L Ireland made efforts to locate local supplies of various raw materials including vials, rubber stoppers, labels, and styrofoam trays used for shipping. However, B&L Ireland continued to purchase substantial quantities of vials, caps, and stoppers from B&L because, inter alia, B&L could obtain volume discounts on the purchase of these items from independent vendors.B&L Ireland purchased the liquid monomer mixture used in soft contact lens production from B&L. Since the Rochester facility was already equipped for the production of the monomer mix, there was no need for B&L Ireland to establish a separate laboratory of its own for production of the such monomer mix. B&L Ireland also purchased the plastic molds used in the manufacture of contact lenses from B&L.In 1980, 1981, and 1982, the customs duties on goods sold by B&L to B&L Ireland were paid by B&L Ireland.Orders for raw materials were communicated to vendors, including B&L, by purchase order. Raw materials*111 used by B&L Ireland in the manufacture of contact lenses were stored in the warehouse, manufacturing, and mold storage rooms. Components were quarantined and, where appropriate, inspected, sampled, and tested prior to acceptance. Storage and inspection procedures generally similar to those performed by B&L Ireland were also performed by B&L at the Rochester facility.C. B&L Ireland's Manufacture of Soft Contact Lenses Using the Spin Cast Manufacturing ProcessIn 1981 and 1982, B&L Ireland manufactured contact lenses of a particular Stock Keeping Unit (SKU) within a particular lens series in a batch or "lot" of approximately 400 to 900 lenses (Lot). The manufacture of a Lot of a *568 particular SKU within a lens series at the Waterford facility was initiated by a Lens Manufacturing Order (M.O.).B&L Ireland materials management personnel recorded the necessary information for the manufacture of the specific series and SKU selected, including the mold radius, cycle time, spin speed, and monomer volume on the M.O. These specifications were originally determined by B&L when each SKU was introduced. B&L and B&L Ireland considered such information to be part of the technological*112 information and know-how covered under the B&L Ireland License Agreement.In 1980, 1981, and 1982, the manufacturing processes and related functions at the Rochester facility were generally similar to those processes and functions of B&L Ireland. Both involved a "dry process" and a "wet process." The spin cast processes, the various lathing processes, and the cast molding processes all involved both a "dry" process and a "wet" process.1. The Dry ProcessThe first step in the "dry process," involves the formation of a contact lens "blank." The monomer mix is loaded onto the spin cast machine. Based on information recorded on the M.O., the machine operator adjusts the spin speed of the machine and the volume of monomer mix to be injected into the mold so as to produce the desired SKU and series of lens. The spin cast machine injects the appropriate amount of monomer mix into the mold cavity, and as the mold begins to spin the centrifugal force spreads the liquid monomer mix and conforms such material to the mold to form a spherical shape. As the mold continues to spin, the polymerization process begins to solidify the monomer mix in the mold into the shape of a contact lens. After*113 polymerization is complete, the lenses attached to the molds leave the spin cast machine and are collected for edging. An operator places each mold-lens unit into an edging machine which automatically edges the lens with a diamond tool. The edging machine then carries the edged mold-lens unit on a rotating table to another portion of the machine which buffs the edges of the mold-lens unit to remove any residue on the unit. After inspection, a manufacturing operator *569 places edged and buffed mold-lens units into hydration trays, thus completing the last step in the "dry process." The edging process utilized by B&L Ireland was the subject of a United States process patent owned by B&L. Such processes, functions, and procedures were performed in a generally similar manner by employees of B&L at the Rochester facility. B&L Ireland and B&L considered such processes, functions, and procedures to be part of the technical information and know-how covered under the B&L Ireland License Agreement.2. The Hydration ProcessDuring the second stage of the manufacturing process, known as the "hydration stage" or "wet process," the lens absorbs a considerable amount of water, thus allowing*114 the lens to soften and become pliable. Mold-lens units are collected in a hydration tray which is placed in a hot water hydration unit for a specified period of time until the lenses become loose in the molds. Manufacturing operators then remove the lenses from the molds and dip the lenses in distilled water.3. The Lens Inspection and Packaging ProcessesAfter the lenses in a Lot have been cleaned and rinsed, they are inspected with a comparator to determine whether the cosmetic specifications are satisfied. Lenses with nicks, tears, blotches, or any other defect are rejected and are not processed further. If any new or unusual defects arise, the inspector reports such defects to quality assurance. The cosmetic inspector places each acceptable lens into a saline-filled vial, and places a stopper in the mouth of the vial.A sample of lenses which have passed cosmetic inspection are then placed into a vertometer to determine their optical power. If, as a statistical matter, the Lot cannot be assigned a single power, each lens in the Lot will be inspected to determine its power. After a complete Lot has been cosmetically inspected, placed in vials, and measured for power, quality*115 assurance performs an audit on the Lot for cosmetic defects, power reading, and dimensions. Quality assurance delivers accepted lots to another area for crimping of the cap over the stopper in the vial.*570 In 1982, B&L Ireland acquired from an unrelated party an automated vial cleaning machine, which performs the vial cleaning task. Such machine was not employed by B&L at the Rochester facility.After the vials containing inspected lenses are capped, crimped, and washed, they are sterilized. Sterilized, inspected lots are then delivered to the labeling area where each vial is labeled. The label must set forth, inter alia, the power, lot number, and expiration date applicable to the lens contained in the vial. Late in 1981, B&L Ireland began using an automatic labeling machine to label certain of its sterilized and inspected lots of lenses. The 1981 President's Report indicates that the expiration date labeling, one aspect of the labeling process, on certain lenses sold by B&L Ireland to B&L was done at the Rochester facility.Once the labeling is completed all labeled vials are routed to final inspection. There the Lot is checked against the M.O. and each vial is inspected. *116 Approved lenses are then transferred to quarantine. Upon verification by quality assurance testing of sterility of the lenses in the Lot, such lenses are released to materials management and placed in inventory.4. Quality Assurance ProceduresB&L Ireland manufacturing department personnel performed extensive testing at each stage of the manufacturing process to assure the quality of the finished products. The quality assurance department performed a function which was quite different from this quality control function performed in the manufacturing department. The quality assurance department had the responsibility of assuring that the products manufactured and sold were quality products which satisfied the good manufacturing practice standards established by the FDA. Accordingly, the quality assurance department was required to maintain independence from the manufacturing and other departments. Thus, the B&L Ireland assurance manager reported to the Soflens Division as well as within B&L Ireland.The primary responsibilities of the quality assurance manager included, inter alia, the following:*571 (i) Implementing quality assurance policies and procedures for inspecting*117 raw materials, packaging materials, in-process, and finished product to assure that all products generated conformed to standards and specifications.(ii) Monitoring, auditing, and supervising facilities and manufacturing operations for conformance with established procedures and requirements of the FDA and other governmental regulatory agencies.(iii) Maintaining required records and documents, including, inter alia, formulae, quality assurance test results, inspections, archive samples, product disposition, regulatory inspections, standards, and specifications.(iv) Coordinating regulatory agencies' inspection of B&L Ireland's manufacturing operations with assistance, as needed, from the B&L regulatory affairs department at the Rochester facility.The quality assurance department was also charged with the responsibility of preparing, maintaining, and revising the device master record. The device master record is the governing document for the manufacture of soft contact lenses, and was prepared to outline the good manufacturing practice standards mandated by the FDA in the manufacture of soft contact lenses. The device master record describes the basic facilities, operations, *118 procedures, and controls used in manufacturing and packaging of soft contact lenses and discusses the quality assurance functions. The device master record also serves as a document which references all applicable and approved specifications, procedures, and forms used in the manufacture of soft contact lenses. B&L Ireland's device master record was prepared in 1981 by employees of B&L Ireland. Since prior to 1981, a device master record was maintained by B&L at the Rochester facility relating to soft contact lenses. B&L Ireland's quality assurance department was also responsible for maintaining the standard operating procedures for all other functions performed by the various departments of B&L Ireland.D. B&L Ireland's Engineering FunctionsIn 1981 and 1982, B&L Ireland's engineering department had, inter alia, the following responsibilities: (i) Maintenance *572 of the Waterford facility and necessary modifications thereto; (ii) engineering with respect to the manufacturing and other processes; and (iii) preventative and corrective maintenance with respect to all equipment used in the manufacturing and other processes of B&L Ireland. B&L Ireland engineers were involved*119 in the correction of problems encountered in the construction of the Waterford facility, including a faulty water system, ventilation problems, and leaking walls. As a result of continuing problems with the water system, a complete new water system was designed and installed at the Waterford facility of B&L Ireland, including a stainless tank and pipework, a pump arrangement, and a filter arrangement. B&L Ireland's engineering department was also charged with the responsibility for performing the test procedures with respect to equipment housed in the Waterford facility.In 1981, B&L Ireland began investigating the acquisition from an unrelated supplier of an automatic machine which would automatically clean vials, fill each vial with a saline solution, and insert into each vial a rubber stopper. Subsequently, B&L Ireland acquired an automated machine which cleaned and sterilized each vial, transported each cleaned and sterilized vial along a conveyor to be filled with a saline solution, and placed on each vial a rubber stopper. Employees of B&L Ireland installed the automatic machine at the Waterford facility.In 1982, B&L Ireland performed certain process engineering activities*120 with respect to the spin cast process and the production of soft contact lenses. For instance, in June 1982, B&L Ireland employees installed and began testing a lift-pin height detector system for the edging machines. The lift-pin height detector system was designed to provide early warning of unedged lenses due to improper lift-pin operation.In October 1982, B&L Ireland fitted a conveyor onto an automatic labeling machine previously in use in the manufacturing process. Such conveyor permitted the post-labeling inspection to be performed in-line with the labeling.In November 1982, B&L Ireland adopted a method of installing and removing tray-closure pins, which reduced the incidence of folded lenses in the thin series of lenses.*573 In December 1982, B&L Ireland commenced an evaluation of the finger cleaning of lenses to determine the effect of finger cleaning on the quality of the final product. After performing statistical analysis of the results of such tests, B&L Ireland determined in 1983 that the cosmetic finger cleaning process was not necessary to ensure a quality product.In late 1982, B&L Ireland adopted a procedure for presampling suspect defective lots prior*121 to the wet process. Such sampling permitted B&L Ireland to halt processing of defective lots prior to incurring additional processing expenses with respect to such defective lots.E. B&L Ireland's Sales of Soft Contact LensesIn 1980, 1981, and 1982, B&L produced approximately 8,135,400, 7,135,600, and 5,196,000 daily wear soft contact lenses, respectively. B&L sold approximately 4,148,000, 5,354,000, and 5,264,000 daily wear soft contact lenses in 1980, 1981, and 1982, respectively, in the United States. The average realized price (ARP) for sales of daily wear soft contact lenses to unrelated parties in the United States was $ 16.74 and $ 15.25 in 1981 and 1982, respectively. B&L's foreign subsidiaries sold approximately 1,474,000 and 1,803,000 daily wear soft contact lenses in 1981 and 1982 at ARP's of $ 22.03 and $ 18.41, respectively.In 1981 and 1982, B&L Ireland produced approximately 1,338,000 and 3,958,000 daily wear soft contact lenses, respectively. In 1981 and 1982, B&L Ireland sold daily wear soft contact lenses in the following amounts and sales volumes:Soft contact lensSoft contact lensunits sold bytotal sales byYearB&L IrelandB&L Ireland19811,116,000$ 8,373,00019823,694,00027,370,000*122 Of B&L Ireland's total sales, 680,106 units (61 percent) and 2,056,435 units (56 percent) in 1981 and 1982, respectively, were sold to B&L for resale in the United States market. However, there was no contractual obligation which required B&L or any of its affiliates to purchase any lenses produced by B&L Ireland.*574 F. Pricing Policy With Respect to Intercompany Sales After Establishment of B&L IrelandIn 1981 and 1982, B&L Ireland sold daily wear soft contact lenses in Ireland to B&L and foreign affiliates of B&L for $ 7.50 per lens. The purchaser paid freight, duties, freight insurance, and packing charges and customs duties with respect to soft contact lenses sold by B&L Ireland. Duty and freight charges for B&L Ireland lenses shipped to B&L were $ 0.62 per lens in 1982. Such policies applied to sales of soft contact lenses by B&L to foreign affiliates of B&L during such years as well. B&L began using an intercompany transfer price of $ 7.50 per lens in 1979. The intercompany transfer price was subsequently reduced to $ 6.50 per lens in 1983 to reflect reduced market prices as a result of increased competition.B&L Ireland did not have a formal procedure for*123 collecting overdue accounts. Since B&L Ireland sold soft contact lenses only to B&L and foreign affiliates of B&L, it had little need for such a procedure. Nor did B&L Ireland have a marketing department or engage in any media advertising outside of Ireland in 1981 or 1982.G. Royalties Paid by B&L Ireland to B&L in 1981 and 1982In 1981 and 1982, B&L Ireland paid royalties to B&L in the amounts of $ 418,669 and $ 1,368,000, respectively, with respect to B&L Ireland's sales of soft contact lenses manufactured at the Waterford facility. Such amounts equaled 5 percent of B&L Ireland's sales of contact lenses in each year.V. Sales of Soft Contact Lenses by Other Manufacturers During 1981 and 1982During the years 1981 and 1982, B&L functioned as the distributor in the United States of the contact lenses which it purchased from B&L Ireland during those years. All manufacturing, processing, packaging, and other activities necessary to prepare the lenses for sale to optical practitioners and chains in the United States were performed in Ireland by B&L Ireland. 9 B&L had a general policy of *575 selling only to practitioners and chains rather than other distributors.*124 During the years 1981 and 1982, the soft contact lens market in the United States was highly competitive. Although B&L remained dominant, it shared the market with eight to ten other major participants (i.e., market share in excess of 1 percent). The daily wear standard and thin lenses produced by B&L and B&L Ireland were generally fungible and interchangeable with the standard and thin soft contact lenses produced by their competitors. B&L lenses were perceived to be superior by some in the industry due to the better reproductibility of lenses manufactured using the spin cast process. A brief description of representative sales made by independent manufacturers to competing distributors follows.A. American Sterilizer Co. (Lombart)During 1981 and 1982, American Sterilizer Co. (also known as Lombart) manufactured contact lenses in the United States for sale to optical practitioners, optical chains, and distributors. The Lombart lens was made from a HEMA-based material known as Deltafilcon through use of a lathing method. Lombart sold standard and thin soft contact lenses to optical practitioners under the trademarks "AMSOF" and "AMSOF THIN," respectively. These lenses*125 generally sold at discounts of approximately 20 percent off list prices of $ 16 and $ 18, respectively. Lombart sold lenses to distributors for resale using the trade names Deltacon and Deltacon XT and on a private label basis, i.e., bearing the distributor's private label instead of a Lombart trade name. During the years 1980, 1981, and 1982, Lombart entered into a number of distribution contracts for the sale of Deltacon or private label lenses to various unrelated distributors. These agreements and their basic terms were as follows:Distributor of softDate ofMinimum annualPrice percontact lensesagreementNo. of lenseslens1. X-Cel Contact Lens, Inc.June 198030,000$ 8.00 2. Sakura Contact LensAugust 198018,0008.75 3. Aire-Con LaboratoriesSeptember 198030,0008.00-9.004. Art Optical ContactNovember 198030,0008.00-9.00Lens, Inc.5. Carolina Contact Lens, Inc.November 198030,0008.00-9.006. Bailey-Smith Corp.December 198050,0007.50-8.45 7. Winchester OpticalDecember 198030,0008.00-9.00 8. Art Optical ContactJanuary 198112,0009.75-10.00Lens, Inc.9. Global Optics, Inc.February 198150,0007.50-8.45 10. X-Cel Contact Lens, Inc.August 198140,0007.50-8.45 11. ICN PharmaceuticalDecember 198125,0007.50-8.45 Holland B.V.12. Breger-Mueller Welt Corp.May 198240,0008.50 13. Global Optics, Inc.May 198240,0008.50 14. X-Cel Contact Lens, Inc.May 198230,0008.95 15. Winchester OpticalMay 198220,0009.95 16. Soderberg Contact Lens, Inc.August 198212,50010.45 Total lenses487,500*126 *576 Agreements 1. and 2. were for the purchase of standard thickness lenses only. In Agreements 3. through 11., the lower price is for standard thickness lenses while the higher price is for thin lenses. Agreements 12. through 16. had a single price for both standard and thin lenses. All of the agreements allowed the distributor to use the Deltacon and Deltacon XT names but not the AMSOF or AMSOF THIN trade marks, except for Agreements 11. and 12. which are private label agreements. Agreements 13. through 16. specify that the prices are subject to change in the event Lombart began paying royalties to NPDC. Many of the agreements also provided that the sales price would be adjusted pursuant to a sales-volume schedule should the actual number of lenses purchased during the term of the agreement be below the specified minimum. 10*127 B. National Patent Development Corp. (American Hydron)During 1981 and 1982, NPDC manufactured both standard and thin daily wear contact lenses in the United States for sale to optical practitioners, chains, and unrelated distributors. *577 The lenses were made of a HEMA-based material using both the lathing process and the cast molding process. NPDC marketed its standard and thin daily wear soft contact lenses under the trademarks "MINI Lens" and "ZERO 6," respectively. NPDC also entered into private label agreements whereby its soft contact lenses were sold without the NPDC trademarks. Distributors who purchased lenses under private label agreements sold lenses under their own name.1. Sales Under Trademarks of NPDC and its AffiliatesOn or about April 13, 1979, NPDC entered into a Distribution Agreement with Mid-South Soft Contact Lens, Inc. (Mid-South). Pursuant to the agreement, Mid-South agreed to purchase soft contact lenses from NPDC in 1980 pursuant to the following volume/price schedule:No. of lensesPurchase pricepurchasedper lens8,625$ 1717,2501625,8751534,50014During 1980, 1981, and 1982, Southern Optical Co. (Southern) *128 was a manufacturer and distributor of eyeglasses, contact lenses, and opthalmic instruments. Southern manufactured hard and rigid gas permeable contact lenses, but not soft contact lenses. During 1981 and 1982, Southern purchased soft contact lenses from NPDC and various other manufacturers for resale to optical practitioners and chains under the manufacturer's name. Southern sold between 50,000 and 60,000 soft contact lenses per year during this period in a six- or seven-State area in the mid-Atlantic and Southeastern United States.During 1981 and 1982, Southern purchased between 20,000 and 30,000 soft contact lenses from NPDC pursuant to a distribution agreement. This agreement entitled Southern to purchase NPDC soft contact lenses at a discount of upto 40 percent off the NPDC list price. 11 The list price of *578 lenses sold by NPDC were approximately $ 25 to $ 27 per lens. Thus the agreement entitled Southern to purchase these lenses for approximately $ 15 to $ 16 per lens. Southern resold these lenses to optical practitioners for approximately $ 25 per lens.*129 In 1981, NPDC offered to sell its standard and thin daily wear soft contact lenses to its distributors at a flat $ 15 per lens.2. Private Label Sales by NPDC and its AffiliatesDuring 1981 and 1982, Omega Optical Co. (Omega) was a manufacturer and wholesaler of eyeglasses and hard contact lenses. On January 1, 1981, Omega entered into a private label agreement with NPDC whereby Omega agreed to purchase, for resale under its "Omega Soft" trade name, a minimum of 25,000 soft contact lenses per year at prices ranging from $ 12 to $ 16 per lens based upon the following monthly lens volume schedule:Monthly lens volumeStandardThin0-999$ 15$ 161,000-1,99914152,000-2,99913143,000 and above1213The agreement offered rebates of $ 1 per lens if annual lens volume under the agreement exceeded 50,000 lenses, and $ 2 per lens if annual volume exceeded 75,000 lenses. This agreement constituted Omega's first experience in the soft contact lens market and was the first private label agreement it had ever entered into.C. American Optical Corp.During 1980, 1981, and 1982, American Optical manufactured and sold standard and thin soft contact*130 lenses under the "AO Soft" and "AO Thin" trade names, respectively. These lenses were composed of a HEMA-based material and were manufactured using both a lathing and a cast molding process.During 1981 and 1982, American Optical offered its AO Soft and AO Thin soft contact lenses for sale to distributors for $ 16 per lens. In 1982, American Optical offered discounts ranging from 5 to 15 percent of the $ 16 price to *579 distributors whose 1982 volume exceeded 1981 volume by 15 percent or more. During 1981 and 1982, Bailey-Smith and Mid-South were among the distributors who purchased American Optical lenses. During 1982, Bailey-Smith resold these lenses to optical practitioners at a price of $ 21.60 per lens. Mid-South resold American Optical lenses for $ 21 per lens.D. Hydrocurve (Soft Lenses, Inc.)Between 1980 and 1982, Hydrocurve (and its predecessor Soft Lenses, Inc.) sold and manufactured, inter alia, 45- and 55-percent water content soft contact lenses under the Hydrocurve II trademark. Hydrocurve II lenses were composed of a HEMA-based material and were manufactured using a lathing process.During 1980, Hydrocurve sold its Hydrocurve II lenses to distributors*131 at the following prices:45-percent55-percentwater contentwater contentWith replacement policy$ 24.25Without replacement policy17.00$ 20Bailey-Smith entered into a Distributorship Agreement with Hydrocurve with respect to Hydrocurve II lenses in 1980. Bailey-Smith purchased Hydrocurve II (45-percent water content) and Hydrocurve II (55-percent water content) soft contact lenses from Hydrocurve for $ 17 and $ 20, respectively. These lenses were then resold to optical practitioners in the United States market for $ 21.95 and $ 29.50, respectively.During the years 1980 though 1982, Hydrocurve was Southern's largest supplier of contact lenses, selling approximately 30,000 Hydrocurve lenses during this period. Southern paid approximately $ 17 to $ 17.50 for Hydrocurve lenses which it resold to optical practitioners for approximately $ 23 per lens. Lenses purchased by Southern from Hydrocurve came with a product warranty, but did not include a performance warranty. 12*132 *580 E. Other ManufacturersSouthern purchased soft contact lenses from various other manufacturers in addition to NPDC and Hydrocurve both pursuant to distributor agreements and otherwise. In determining which manufacturer from whom to purchase lenses, Southern looked for a good, marketable product and a relationship with the manufacturer which allowed Southern to maintain a reasonable profit margin of between 25 and 40 percent.Southern Optical purchased B&L soft contact lenses although a formal distribution relationship between the two companies did not exist. Southern Optical generally purchased the most popular B&L daily wear lenses for prices in the $ 14 to $ 15 range. These lenses were resold to optical practitioners for approximately $ 20 per lens. Due to the lack of a formal distribution agreement with B&L, Southern Optical purchased far fewer lenses from B&L than it did from manufacturers with which it had such a relationship. At trial, Thomas Sloan, president of Southern testified he would have "enjoyed" being able to purchase B&L soft contact lenses at the $ 7.50 price at which such lenses were offered to B&L by B&L Ireland.The lowest price at which Southern*133 was able to purchase soft contact lenses from a manufacturer was $ 11.17 per lens which it paid Alcon for its "Tre soft" lens.VI. Respondent's Proposed AdjustmentsOn or about December 30, 1985, respondent timely issued a statutory notice of deficiency to petitioners relative to petitioners' 1979, 1980, and 1981 taxable years. In paragraph (ii) in respondent's statutory notice, respondent increased B&L's 1981 and 1982 United States consolidated taxable income in the amounts of $ 2,778,000 and $ 19,793,750, respectively, by allocating such amounts of income in those years from B&L Ireland to B&L. Respondent explained in the notice of deficiency that the allocation was made under section 482 in order to reflect an arm's-length consideration for the use of B&L's intangible assets by B&L Ireland. The allocation was calculated to give B&L Ireland a net profit before taxes on its manufacturing *581 activities of 20 percent of sales. In paragraph (jj) of the statutory notice, respondent made a correlative adjustment to petitioners' income by eliminating royalty income of $ 418,669 and $ 1,368,000 shown on petitioners' 1981 and 1982 returns, respectively, as having been received*134 from B&L Ireland.In respondent's answer to petitioners' petition, he alleged that an allocation under section 482 was also necessary to clearly reflect income and to prevent the evasion of taxes which allegedly resulted because of the lack of arm's-length pricing between B&L and B&L Ireland.OPINIONIntroductionSection 482 authorizes respondent to allocate income between controlled enterprises if he determines that such an allocation is necessary to prevent evasion of taxes or clearly to reflect the true income of the controlled enterprises. 13 The purpose of section 482 is to prevent the artificial shifting of the true net incomes of controlled taxpayers by placing controlled taxpayers on a parity with uncontrolled, unrelated taxpayers. Commissioner v. First Security Bank, 405 U.S. 394">405 U.S. 394, 400 (1972); see W. Braun Co. v. Commissioner, 396 F.2d 264">396 F.2d 264, 266 (2d Cir. 1968), revg. and remanding T.C. Memo. 1967-66; sec. 1.482-1(b)(1), Income Tax Regs.*135 Respondent's authority to make allocations under section 482 is broad. Edwards v. Commissioner, 67 T.C. 224">67 T.C. 224, 230 (1976); PPG Industries v. Commissioner, 55 T.C. 928">55 T.C. 928, 990-991*582 (1970). Respondent's section 482 determination must be sustained absent a showing that he has abused his discretion. Paccar Inc. v. Commissioner, 85 T.C. 754">85 T.C. 754, 787 (1985), affd. 849 F.2d 393">849 F.2d 393 (9th Cir. 1988). The taxpayer thus bears the heavier than normal burden of proving that respondent's section 482 allocations are arbitrary, capricious, or unreasonable in order for us to redetermine the deficiency. Your Host, Inc. v. Commissioner, 489 F.2d 957">489 F.2d 957 (2d Cir. 1973); G.D. Searle & Co. v. Commissioner, 88 T.C. 252">88 T.C. 252, 359 (1987). Whether respondent has exceeded his discretion is a question of fact. American Terrazzo Strip Co. v. Commissioner, 56 T.C. 961">56 T.C. 961, 971 (1971). In reviewing the reasonableness of respondent's allocation under section 482, we focus on the reasonableness of the result, not*136 the details of the methodology employed. Eli Lilly & Co. v. United States, 178 Ct. Cl. 666">178 Ct. Cl. 666, 676, 372 F.2d 990">372 F.2d 990, 997 (1967).For purposes of section 482, the terms "tax avoidance" and "tax evasion" are interchangeable. Asiatic Petroleum Co. v. Commissioner, 79 F.2d 234">79 F.2d 234, 236 (2d Cir. 1935). Respondent's determinations have been upheld where the challenged transactions were arranged solely to avoid taxes and without a valid business purpose. Asiatic Petroleum Co. v. Commissioner, supra.Even in the absence of tax avoidance motives, respondent may make allocations under section 482 in order to clearly reflect the respective incomes of members of the controlled group. Central Cuba Sugar Co. v. Commissioner, 198 F.2d 214">198 F.2d 214, 215-216 (2d Cir. 1952), revg. and remanding on this issue 16 T.C. 882">16 T.C. 882 (1951). Thus establishment of a business purpose for a transaction does not necessarily insulate the taxpayer from a section 482 allocation. Eli Lilly & Co. v. United States, 372 F.2d at 998-999.*137 We have found as fact that petitioners had sound business reasons for the establishment of B&L Ireland. Petitioners had reason to believe that manufacturing capacity at its Rochester facility was inadequate to meet expected increases in soft contact lens demand. Petitioner determined that it was prudent to establish additional manufacturing capacity overseas in order to minimize regulatory delays, establish an alternative supply source to the Rochester facility, and to have a facility capable of more *583 efficiently servicing the increasingly important European markets. Ireland was determined to be the location at which these objectives could be realized most cost effectively due to the incentives offered by the Republic of Ireland to induce the location of manufacturing facilities within the Republic. Since a non-Irish company could not receive section 84 financing, there were sound business reasons for incorporating an Irish manufacturing facility rather than merely operating the facility as a division of B&L. Although it is possible that B&L could have established the Irish facility in a manner which resulted in a greater United States tax, it is axiomatic that a taxpayer*138 is not obligated to arrange his affairs in a manner which maximizes his tax burden. Seminole Flavor Co. v. Commissioner, 4 T.C. 1215">4 T.C. 1215, 1235 (1945). 14 Thus respondent's determination must stand or fall based on the "clear reflection of income" prong of section 482.As a preliminary matter, we must first address respondent's contention that it is inappropriate to analyze the transfer price and royalty rate used by B&L separately, on the theory that B&L and B&L Ireland would have constructed their relationship in a different manner had they been conducting their affairs at arm's length. Respondent argues that B&L would never have agreed to license its spin cast technology which allowed it to produce soft contact lenses for approximately $ 1.50 per lens and then purchase lenses from the licensee for $ 7.50 per lens. Respondent argues that B&L would have been unwilling to pay an independent*139 third party much more than its costs would have been had it chosen to produce the contact lenses itself. He is indifferent as to whether the royalty is increased or the transfer price is decreased as long as the result is that B&L Ireland receives only its costs of production and a reasonable mark up. In essence, respondent argues that B&L Ireland was little more than a contract manufacturer the sale of whose total production was assured and who thus was not entitled to the return normally associated with an enterprise which bears the risk as to the volume of its product it will be able to sell and at what price.*584 Respondent's argument would have some merit had we found that B&L was required to purchase B&L Ireland's production of soft contact lenses. In such a case, B&L Ireland would indeed have been a contract manufacturer in substance despite the fact that ostensibly the license agreement and product purchases were not interdependent. However, we have found as fact that no such purchase requirement existed. All of the documents generated by B&L in evaluating the feasibility of the Irish lens facility indicate that it was intended to serve the foreign markets with *140 limited possible importation of Irish lenses into the United States in the event of production problems at the Rochester facility. That B&L would import substantial quantities of Irish lenses into the United States should worldwide demand not meet expectations was not guaranteed. Nor did B&L Ireland have a guarantee that the transfer price it received for its lenses would remain at $ 7.50 per lens. In actuality, the transfer price was reduced to $ 6.50 in 1983 due to market pressures. The most that can be said is that B&L Ireland had certain expectations as to the volume and price of lenses it could anticipate selling to B&L or its affiliates. However, such expectations are no different than those which any supplier has with regard to the business of a major customer and do not constitute a guarantee which effectively insulated B&L Ireland from market risks. In a case where the license of intangibles and sale of the product manufactured to the licensor were interdependent, then the separate royalty rate and transfer price would be unimportant as long as the net result is satisfactory. The same cannot be said in this instance where both the volume and price of sales to the licensor*141 are subject to variation. The transfer price and the royalty rate each has independent significance and will thus be examined separately.A. Determination of Arm's-Length Prices Between Petitioner and B&L Ireland for Soft Contact LensesSection 1.482-2(e)(1)(i), Income Tax Regs., provides that when one controlled entity sells tangible property to another controlled entity at "other than an arms's-length price," respondent has the authority to make appropriate *585 allocations between the seller and the buyer to reflect an arm's-length price for such sale. An arm's-length price is that price that an unrelated party would have paid under the same circumstances for the property involved in the controlled sale. Sec. 1.482-2(e)(1)(i), Income Tax Regs.The same interests that controlled B&L unquestionably also had control over B&L Ireland. The basic prerequisite to respondent's allocation of income pursuant to section 482 is thus satisfied. We therefore turn to an examination of the $ 7.50 price per lens charged by B&L Ireland to petitioners during the years in question to determine whether it is a price at which such lenses would have been sold between unrelated parties*142 dealing at arm's length.The regulations set forth three specific methods for determining an arm's-length price for the sale of tangible property: the comparable-uncontrolled-price method, the resale-price method, and the cost-plus method. Sec. 1.482-2(e)(1)(ii), Income Tax Regs. The regulations further specify that use of the comparable-uncontrolled-price method is mandatory if comparable, uncontrolled sales of the tangible property in question exist. The resale-price method must be utilized if no comparable, uncontrolled prices exist and if the standards for its application are met. If all of the requirements for application of the resale-price method are not present, then either that method or the cost-plus method may be utilized depending upon which method is more feasible and is more likely to result in a more accurate estimate of an arm's-length price. Sec. 1.482-2(e)(1)(ii), Income Tax Regs. When none of the three methods specified above can be reasonably applied under the facts and circumstances of a particular case, the regulations authorize use of any other appropriate method of pricing. Sec. 1.482-2(e)(1)(iii), Income Tax Regs. The regulations offer no guidance *143 in developing or applying such a "fourth" method. But see DuPont v. United States, 221 Ct. Cl. 333">221 Ct. Cl. 333, 608 F.2d 445">608 F.2d 445, 454-456 (1979).Under the comparable-uncontrolled-price method, the arm's-length price of a controlled sale is equal to the price paid in comparable uncontrolled sales. Sec. 1.482-2(e)(2)(i), Income Tax Regs. Uncontrolled sales for purposes of application of the comparable-uncontrolled-price method include: *586 (i) Sales made by the taxpayer to an unrelated party, (ii) purchases made by the taxpayer from unrelated parties, and (iii) sales made between two unrelated parties. Sec. 1.482-2(e)(2)(ii), Income Tax Regs. Controlled and uncontrolled sales are deemed comparable if the physical property and circumstances involved in the uncontrolled sales are identical to the physical property and circumstances involved in the controlled sales, or if such properties and circumstances are so heavily identical that they either have no effect on price, or can be measured and eliminated by making a reasonable number of adjustments to the price of uncontrolled sales. Some of the differences which may affect the price of property*144 are differences in quality, terms of sale, intangible property associated with the sale, time of sale and the level of the market, and geographic market in which the sale takes place. Sec. 1.482-2(e)(2)(ii), Income Tax Regs.The resale-price method arrives at an arm's-length price by measuring the value of the distribution function where a controlled taxpayer buys goods from a related supplier and sells them to unrelated buyers. Use of the resale-price method is inappropriate if the buyer/reseller has added more than an insubstantial amount to the value of the property by physically altering the product before resale or by the use of intangible property. Sec. 1.482-2(e)(3)(ii), Income Tax Regs. An arm's-length price is determined by subtracting an appropriate markup from the resale price at which the property purchased in the controlled sale is resold in an uncontrolled sale. An appropriate markup is the gross profit (expressed as a percentage of sales) that would be earned by the buyer/reseller on the sale of property that is both purchased and resold in uncontrolled transactions "most similar" to the resale of property purchased in the controlled sale. In determining the appropriate*145 markup, adjustments must be made for differences between the uncontrolled purchase and resale and the controlled purchase and uncontrolled resale if those differences have a definite and reasonably ascertainable effect on price. The regulations identify the following factors as important in evaluating the similarity of resales: (1) The types of property sold; (2) the functions performed by the reseller with respect to the *587 property (i.e., packaging, labeling, maintenance of inventory, minor assembly, advertising, selling at wholesale or retail, billing, maintenance of accounts receivable, and servicing); (3) the effect on price of any intangible property used by the seller; and (4) the geographic market in which the seller operates. Sec. 1.482-2(e)(3)(vi), Income Tax Regs.The cost-plus method is primarily applicable to sales of goods to which the controlled seller has added substantial value. Sec. 1.482-2(e)(4), Income Tax Regs. An arm's-length price is derived by adding an appropriate gross profit percentage to the controlled seller's cost of production. The cost of production is computed in accordance with sound accounting practices consistently applied. The appropriate*146 gross profit percentage is equal to the gross profit percentage (expressed as a percentage of cost) earned on uncontrolled sales of property most similar to the uncontrolled sales in issue. Similarity for this purpose is determined in the same manner as under the resale-price method. Adjustments are required for differences between comparable uncontrolled sales and the controlled sale if those differences have a definite and reasonably ascertainable effect on price. If similar sales are not available, the prevailing gross profit percentages in the particular industry may be appropriate. Sec. 1.482-2(e)(4)(iv), Income Tax Regs.Petitioners contend that they have presented ample evidence of comparable, uncontrolled sales of soft contact lenses which establish that the $ 7.50 per lens price charged by B&L Ireland to B&L was at or below the price which would have been charged by uncontrolled manufacturers to distributors for similar lenses. 15 Specifically, petitioners point to sales to distributors by Lombart, American Hydron, American Optical, and Hydrocurve of soft contact lenses during 1980 through 1982. No sale cited by petitioner took place for a price less than the $ 7.50*147 charged by B&L Ireland. Alternatively, petitioners argue that application of the resale-price method to the facts of this case lends further support to the arm's-length nature of the $ 7.50 transfer price.*588 Respondent contends that neither the comparable-uncontrolled-price or resale-price methods are applicable herein. He argues that the sales by manufacturers to distributors cited by petitioners on the one hand, and the sales by B&L Ireland to B&L on the other, are not sufficiently similar to function as comparables. He also urges that dissimilarities between B&L and the distributors cited by petitioners render inappropriate reference to the markup percentages of these distributors in application of the resale-price method.Specifically, respondent*148 urges that the disparities in the volumes of lenses sold by B&L Ireland to B&L and those purchased by independent distributors from manufacturers indicate that these distributors and B&L operated at different levels of the market. He hypothesizes that any distributor who purchased lenses in the quantities purchased by B&L from B&L Ireland would have demanded and received significant volume discounts in purchase price.The second distinction respondent finds significant is that whereas B&L was an integrated manufacturer and distributor of soft contact lenses with a worldwide sales and marketing force and a substantial research and development function, the distributors cited by petitioners performed only distribution functions. Respondent hypothesizes that at arm's length B&L would not be willing to pay as much for soft contact lenses as other distributors since, unlike non-integrated distributors, it needed the profit from soft contact lens sales to support these additional functions.Finally, respondent urges that it is inconceivable that at arm's length B&L, which possessed the technology and present ability to manufacture contact lenses at a cost far below that achievable by *149 any of its competitors, would go into the open market and pay $ 7.50 per lens for a product it could produce itself for approximately $ 1.50 even though other distributors without this capability would consider the $ 7.50 a market price.Although he never explicitly says so, respondent contends that the cost-plus method is the only proper method for determination of the price B&L would have paid for B&L Ireland soft contact lenses at arm's length. Based on the testimony of his economic expert, Dr. David Bradford, *589 respondent determined that an arm's-length price would be "in the neighborhood" of $ 2.25 to $ 3 per lens. Dr. Bradford based his conclusion on his finding that B&L produced 7.1 million lenses in 1981 at a cost of $ 1.50 per lens. He studied the gross profit margins of several soft contact lens manufacturers, most notably NPDC, Danlex Corp., and the Amsco/Lombart division of the American Sterilization Co. and found that these companies employed gross markups ranging from 22 to 141 percent. Applying this gross markup to B&L's production costs, Dr. Bradford determined that an arm's-length price would be $ 1.82 to $ 3.62. He further posited that the quantities *150 purchased by B&L and the fact that the hypothetical manufacturer would not have to support sales or research and development functions dictated a figure at the lower end of this range. He thus determined a 50-100 percent markup was most likely, resulting in a lens price of between $ 2.25 and $ 3.We have found as fact that B&L functioned as a distributor with respect to lenses it purchased from B&L Ireland. We fail to see the significance of the fact that B&L engaged in other functions in addition to distribution with respect to soft contact lenses. We have also found that daily wear soft contact lenses of any manufacturer are generally considered a fungible commodity. Therefore, the third party purchase agreements identified by petitioner qualify as comparable-uncontrolled-sales for purposes of application of the comparable uncontrolled price method. However, these sales differ from those of B&L Ireland to B&L in that the buyers, unlike B&L, were not required to pay an additional $ 0.62 of duty and freight charges on their purchases. We therefore must reduce the sales prices identified by petitioner by $ 0.62 in order to make those transactions comparable to the sales at issue. *151 After giving effect to the above adjustment, we find that use of the comparable-uncontrolled-price method of determining an arm's-length price is mandatory. The third-party transactions identified by petitioner provide ample evidence that the $ 7.50 per-lens price charged by B&L Ireland is equal or below prices which would be charged for similar lenses in uncontrolled transactions.*590 Only the Lombart agreements which contain separate prices for standard and thin lenses suggest a market price below the $ 7.50 plus freight and duty charged by B&L Ireland. However, we place more weight on the Lombart agreements which, similar to B&L Ireland pricing, charge a single price for either standard or thin lenses. The $ 8.50 charged by Lombart, less the $ 0.62 adjustment described above exceeds the $ 7.50 charged by B&L. 16*152 We place particular reliance on the Second Circuit's opinion in U.S. Steel Corp. v. Commissioner, 617 F.2d 942">617 F.2d 942 (2d Cir. 1980), revg. T.C. Memo. 1977-190. We are constrained to follow Second Circuit precedent since that circuit is where an appeal of this decision would lie. See Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971).U.S. Steel Corp. involved the prices charged the taxpayer by its wholly owned subsidiary, Navios, for transporting iron ore from Venezuela to the United States. Although U.S. Steel was by far Navios' largest customer, Navios also transported significant amounts of ore from Venezuela to the United States for unrelated parties at the same price it charged U.S. Steel. This Court refused to accept these uncontrolled sales as comparables for purposes of applying the comparable-uncontrolled-price method because the unrelated parties with whom Navios did business, unlike U.S. Steel, did not have a continuing relationship with Navios for the transportation of over 10 million tons of ore per year. U.S. Steel Corp. v. Commissioner, T.C. Memo. 1977-190,*153 revd. 617 F.2d 942">617 F.2d 942 (2nd Cir. 1980). In other words, at arm's length Navios would have charged a lower price to U.S. Steel than to other customers in order to retain U.S. Steel as a high volume, long-term customer. The Second Circuit reversed on the ground that Navios' transactions with uncontrolled parties were sufficiently comparable to permit application of the comparable-uncontrolled-price method stating:*591 We think it is clear that if a taxpayer can show that the price he paid or was charged for a service is "the amount which was charged or would have been charged for the same or similar services in independent transactions with or between unrelated parties" it has earned the right, under the Regulations, to be free from section 482 reallocation despite other evidence tending to show that its activities have resulted in a shifting of tax liability among controlled corporations. Where, as in this case, the taxpayer offers evidence that the same amount was actually charged for the same service in transactions with independent buyers, the question resolves itself into an evaluation of whether or not the circumstances of the sales to independent*154 buyers are "similar" enough to sales to the controlling corporation under the circumstances "considering all relevant facts." * * * [U.S. Steel Corp. v. Commissioner, 617 F.2d at 947.]The Second Circuit rejected this Court's position that the standard against which the rate paid by U.S. Steel should be measured is what a reasonable charge would be for a continuing relationship involving the transportation of more than 10 million tons of iron ore per year stating:To say that [the independent importer] was buying a service from Navios with one set of expectations about duration and risk, and Steel another, may be to recognize economic reality; but it is also to engraft a crippling degree of economic sophistication onto a broadly drawn statute which -- if "comparable" is taken to mean "identical," as Judge Quealy would read it -- would allow the taxpayer no safe harbor from the Commissioner's virtually unrestricted discretion to allocate. [U.S. Steel Corp. v. Commissioner, 617 F.2d at 951.]We find that the purchases of contact lenses by B&L from B&L Ireland present an analogous situation. To posit that B&L, the world's*155 largest marketer of soft contact lenses, would be able to secure a more favorable price from an independent manufacturer who hoped to establish a long-term relationship with a high volume customer may be to recognize economic reality, but to do so would cripple a taxpayer's ability to rely on the comparable-uncontrolled-price method in establishing transfer pricing by introducing to it a degree of economic sophistication which appears reasonable in theory, but which defies quantification in practice.Although U.S. Steel dealt with the performance of services, we see no reason why its rationale should not also apply to other aspects of section 482, including the sale of tangible property. Nor do we find significant the fact that *592 the comparables in U.S. Steel were transactions by the taxpayer with unrelated purchasers, whereas the comparables here do not involve petitioner. The regulations identify both situations as potentially giving rise to comparable uncontrolled prices. See sec. 1.482-2(e)(2)(ii), Income Tax Regs.Respondent's argument that the disparities in the volumes of lenses purchased by B&L from B&L Ireland on the one hand and the purchases petitioner*156 claims are comparable on the other, render the two incomparable is unpersuasive. Although many of the manufacturers cited by petitioners offered volume discounts to large volume purchasers, there is no evidence of any manufacturer's offering discounts for annual purchases in excess of 75,000 units. It is unrealistic to presume, as does respondent, that comparable discounts would be given for purchases above this level. Manufacturers presumably give volume discounts since high volumes allow them to spread their fixed manufacturing costs over more units and thus allow them to attain lower unit costs of production. At some point, however, the economies of scale achievable through increased production will begin to diminish and a manufacturer's unit production costs will approach an irreducible minimum.The market price for any product will be equal to the price at which the least efficient producer whose production is necessary to satisfy demand is willing to sell. During 1981 and 1982, the lathing methods were still the predominant production technologies employed in the soft contact lens industry. American Hydron, an affiliate of NPDC and a strong competitor in the contact lens*157 market, was able to produce 466,348 and 762,379 soft contact lenses using the lathing method in 1981 and 1982, for $ 6.18 and $ 6.46 per unit, respectively. It is questionable whether any of B&L Ireland's competitors, save B&L, could profitably have sold soft contact lenses during the period in issue for less than the $ 7.50 charged by B&L Ireland. The fact that B&L Ireland could, through its possession of superior production technology, undercut the market and sell at a lower price is irrelevant. Petitioners have shown that the $ 7.50 they paid for lenses was a "market price" and have thus "earned the *593 right to be free from a section 482 reallocation." U.S. Steel Corp. v. Commissioner, supra at 947.Finally, respondent argues that B&L could have produced the contact lenses purchased from B&L Ireland itself at lesser cost. However, B&L did not produce the lenses itself. The mere power to determine who in a controlled group will earn income cannot justify a section 482 allocation of the income from the entity who actually earned the income. Bush Hog Manufacturing Co. v. Commissioner, 42 T.C. 713">42 T.C. 713, 725 (1964);*158 Polak's Frutal Works, Inc. v. Commissioner, 21 T.C. 953">21 T.C. 953, 976 (1954). B&L Ireland was the entity which actually produced the contact lenses. Respondent is limited to determining how the sales to B&L by B&L Ireland would have been priced had the parties been unrelated and negotiating at arm's length. We have determined that the $ 7.50 charged was a market price. We thus conclude that respondent abused his discretion and acted arbitrarily and unreasonably in reallocating income between B&L and B&L Ireland based on use of a transfer price for contact lenses other than the $ 7.50 per lens actually used. When conditions for use of the comparable-uncontrolled-price method are present, use of that method to determine an arm's-length price is mandated. Sec. 1.482-2(e)(1)(ii), Income Tax Regs. Therefore, we need not consider petitioner's alternative position -- that application of the resale-price method supports the arm's-length nature of the $ 7.50 transfer price. We note, however, that application of such method lends further support to the arm's-length nature of B&L Ireland's $ 7.50 sales price. Uncontrolled purchases and resales by American Optical, *159 Southern, Bailey-Smith, and Mid-South indicate gross profit percentages of between 22 and 40 percent were common among soft contact lens distributors. This is confirmed by the testimony of Thomas Sloan, president of Southern, who testified that he tried to purchase lenses from manufacturers at prices which allowed Southern to maintain a reasonable profit margin of between 25 and 40 percent. Applying a 40-percent gross margin to B&L's average realized price of $ 16.74 and $ 15.25 for domestic sales in 1981 and 1982, respectively, indicates a lens cost of $ 10.04 and $ 9.15, respectively -- well above the *594 $ 7.50 received by B&L Ireland for its lenses and also above the $ 8.12 cost to B&L when freight and duty are added.B. Determination of Arm's-Length Royalty Payable by B&L Ireland for Use of B&L's IntangiblesWe next address the adequacy of the royalty charged by B&L to B&L Ireland for use of its patent rights, technology, and trademarks as they relate to the production and sale of soft contact lenses. The license agreement entered into by B&L and B&L Ireland, effective January 1, 1981, requires B&L Ireland to pay to B&L 5 percent of the net sales proceeds from *160 the sale of any products manufactured by B&L Ireland using any of B&L's patent rights or technology, or marketed under B&L's trademarks. None of the experts were of the opinion that the license agreement as written constitutes arm's-length consideration to B&L for license of its intangibles. Petitioners maintain that 5 percent is the proper royalty percentage, but now contend that the 5 percent should be applied to the average realized price (ARP) of B&L and its subsidiaries from the sale of B&L Ireland contact lenses to third parties (contended to be $ 16.74 in 1981 and $ 15.25 in 1982 for domestic sales, and $ 22.43 in 1981 and $ 18.10 in 1982 for foreign sales).Section 1.482-2(d), Income Tax Regs., provides a framework for determining an arm's-length consideration for the transfer, sale, assignment, or loan of intangible property or an interest therein between related entities. "Arm's-length consideration" is specifically defined as "the amount that would have been paid by an unrelated party for the same intangible property under the same circumstances." Sec. 1.482-2(d)(2)(ii), Income Tax Regs. The best evidence of such arm's-length consideration is the amount actually paid*161 by unrelated parties for the same or similar intangible property under the same or similar circumstances. In the absence of sufficiently similar transactions involving an unrelated party, section 1.482-2(d)(2)(iii), Income Tax Regs., lists the following factors as relevant in determining the amount of an arm's-length consideration:(a) The prevailing rates in the same industry or for similar property,(b) The offers of competing transferors or the bids of competing transferees,*595 (c) The terms of the transfer, including limitations on the geographic area covered and the exclusive or nonexclusive character of any rights granted,(d) The uniqueness of the property and the period for which it is likely to remain unique,(e) The degree and duration of protection afforded to the property under the laws of the relevant countries,(f) Value of services rendered by the transferor to the transferee in connection with the transfer within the meaning of paragraph (b)(8) of this section,(g) Prospective profits to be realized or costs to be saved by the transferee through its use or subsequent transfer of the property,(h) The capital investment and starting up expenses required of the*162 transferee,(i) The next subdivision is (j),(j) The availability of substitutes for the property transferred,(k) The arm's-length rates and prices paid by unrelated parties where the property is resold or sublicensed to such parties,(l) The costs incurred by the transferor in developing the property, and(m) Any other fact or circumstance which unrelated parties would have been likely to consider in determining the amount of an arm's-length consideration for the property.Petitioners primarily rely on the expert testimony of Professor Irving H. Plotkin as support for their position that a royalty of 5 percent of ARP constitutes an arm's-length consideration to B&L for the license of its intangibles. Professor Plotkin's report relies upon and is supplemented by the expert report of petitioner's contact lens industry expert, Dr. Irving J. Arons, and pro forma financial statements of B&L and B&L Ireland prepared for 1981 and 1982 by the public accounting firm of Price Waterhouse.Professor Plotkin concurs with Dr. Arons' conclusion that a royalty rate of 5 percent of ARP was the standard licensing rate for licensing technology in the contact lens industry during the relevant years. *163 Petitioners place great reliance on Dr. Arons' identification of the Vertical Spin Cast License Agreement between CAS and NPDC, and the 1979 CooperVision Agreement pursuant to which NPDC granted CooperVision a coexclusive license to use the ILC Cast Molding Process of soft contact lens production as comparable uncontrolled transactions which support a royalty of 5 percent of net sales as an appropriate royalty rate for the intangibles licensed to B&L Ireland. Professor *596 Plotkin also conducted a rate of return analysis in which he calculated B&L Ireland's rate of return on investment for production of contact lenses, and B&L's rate of return on the marketing and sale of Irish produced lenses. Using the pro forma financial data compiled by Price Waterhouse, Professor Plotkin determined that B&L Ireland earned a rate of return of 106 percent in 1982 compared to 66 percent for B&L with respect to their respective activities involving Irish lenses. He concluded that such a profit split accurately reflected the relative risks borne by each entity and further supported a royalty rate of 5 percent of ARP.Respondent primarily relies on the expert reports of Dr. David Bradford*164 and Dr. Clark Chandler to support his position that a royalty rate of between 27 and 33 percent of ARP would be necessary to adequately compensate B&L for the use of its intangibles by B&L Ireland.Dr. Bradford first determined that B&L could have produced the lenses produced for it by B&L Ireland itself for $ 1.50 per lens. He then determined that an independent manufacturer would require a markup of between 50-100 percent to profitably produce lenses using the spin cast technology. He thus determined that B&L would have paid a maximum of $ 2.25 to $ 3 for lenses from an independent manufacturer using its spin cast technology. 17 He then determined the appropriate royalty by subtracting this maximum lens price from the $ 7.50 actually paid by B&L to arrive at a royalty of between $ 4.50 and $ 5.25 per lens.Dr. Chandler's approach was to identify each of the discrete intangibles which he alleged B&L Ireland gained access to through the B&L License Agreement, and*165 based on transactions involving similar intangibles and other criteria, determine what an independent contact lens manufacturer would be willing to pay, expressed as a percentage of ARP, 18 for use of such an intangible. The results of his analysis are as follows:LowHighIntangibleestimateestimateLens design and materials4%8%FDA and other regulatory approval1 1 Spin casting and relatedmanufacturing processes1922Trademarks and other marketing intangibles35Allocation of R.D. & E. costs42740*597 Dr. Chandler determined that the maximum royalties arrived at by his estimates were obviously unrealistic given the $ 7.50 per lens transfer price utilized in 1981 and 1982, he therefore reduced his high end royalty rate to 33 percent of ARP.We have closely examined the expert's reports and the clarifying testimony given at trial by each expert as to his respective report. We are not bound*166 by the opinion of any expert when the opinion is contrary to our own judgment. We may embrace or reject expert testimony, whichever in our judgment is most appropriate. Helvering v. National Grocery Co., 304 U.S. 282">304 U.S. 282, 295 (1938); Silverman v. Commissioner, 538 F.2d 927">538 F.2d 927, 933 (2d Cir. 1976), affg. a Memorandum Opinion of this Court. We are not restricted to choosing the opinion of one expert over another, but may extract relevant findings from each in drawing our own conclusions. Chiu v. Commissioner, 84 T.C. 722">84 T.C. 722, 734 (1985).For the reasons stated below, we do not completely embrace the approach or results arrived at by any of the experts. We think, however, that petitioners have adequately demonstrated the unreasonableness of the royalty espoused by respondent. However, we are not required to approve or disapprove of respondent's allocation in toto. G.D. Searle v. Commissioner, 88 T.C. at 367; Ach v. Commissioner, 42 T.C. 114">42 T.C. 114, 126-127 (1964); Nat Harrison Associates Inc. v. Commissioner, 42 T.C. 601">42 T.C. 601, 617 (1964).*167 We think the record also establishes that B&L would have received greater consideration for the license of its intangibles had B&L and B&L Ireland been independent and the royalty arrived at through arm's-length bargaining. We therefore draw upon elements of the expert reports and record as a whole to determine the royalty the parties would have negotiated under these circumstances.*598 We first must determine whether the record contains a sufficiently similar transaction to the B&L License Agreement involving an unrelated party. The royalty paid by an unrelated party for the same intangible property under the same circumstances should be the best indication of an arm's-length consideration. Ciba-Ceigy Corp. v. Commissioner, 85 T.C. at 223; sec. 1.482-2(d)(2)(ii), Income Tax Regs.We cannot agree with petitioners' position that either the 1979 CooperVision Agreement or the Vertical Spin Cast License Agreement involve "the same or similar intangible property" as the transfer at issue in this case. See sec. 1.482-2(d)(2)(ii), Income Tax Regs. Both the cast molding process and the vertical spin cast process were relatively new technologies which*168 had not yet proven susceptible to large volume commercial exploitation as of January 1, 1981, the date of the B&L Ireland License Agreement. There is no indication in the record as to the extent ILC, the original developer of the technology, or American Optical were able to commercially exploit the technology during the late 1970s. FDA approval to market soft contact lenses manufactured using the cast molding process was not obtained by NPDC until 1980 despite having received the license to such technology in February 1977. Significant use of the process by NPDC in production of soft contact lenses did not commence until 1981. Thus there is no evidence that any company was using the cast molding process successfully on a commercial basis at the time B&L and B&L Ireland entered into their license agreement on January 1, 1981.Similarly, NPDC did not obtain FDA approval to market soft contact lenses manufactured using the vertical spin cast process it licensed in July 1981 until September 1984. Although the license agreement recites that CAS was engaged in commercial production of contact lenses using the vertical spin cast technology, there is no evidence in the record as to the*169 extent of CAS's commercial operations, the yields they were experiencing using the process, or the costs of production experienced by CAS.In contrast, at the time the B&L Ireland License Agreement was entered into, the spin cast technology used by B&L had been successfully used to produce soft contact *599 lenses on a commercial basis since 1971. Only B&L had been able to successfully mass produce soft contact lenses in the United States using the spin cast process. The spin cast process was the most efficient production process then in use. B&L's effective monopoly in use of the spin cast process in the United States enabled it to enjoy significant savings in production costs over those incurred by any of its competitors.We thus conclude that the intangible property encompassed in B&L's spin cast technology was superior to that existing on January 1, 1981, with respect to either the cast molding process or the vertical spin cast process. Neither of these technologies had successfully been shown to be commercially feasible over an extended period of time as had the B&L spin casting technology. Each then would have been viewed as significantly riskier technology for a potential*170 licensee to invest in at that time than the proven spin cast technology of B&L. This risk is heightened if the licensee is, as was B&L Ireland, a start up company with no prior experience in the soft contact lens industry. In contrast, CooperVision and NPDC both had experience in the industry at the time they entered their respective license agreements. Both therefore would be expected to be less reticent in committing to the development of unproven yet potentially productive technologies. In contrast, a start-up company with no experience in the field would be expected to opt for a proven technology. Under the circumstances, we would not think that either the cast molding process or vertical spin cast process would be considered an appropriate technology for an independent manufacturer in the position of B&L Ireland.We also note that terms of the 1979 CooperVision Agreement may have been influenced by the precarious financial position in which NPDC found itself at the time of the agreement. The agreement was structured so that NPDC received a $ 1 million license fee up front with an additional $ 1 million payable at the rate of $ 4 per lens sold for the first 250,000 lenses*171 sold by CooperVision. This royalty structure was designed to give NPDC a quick infusion of much needed cash, and also had the effect of creating more risk for the licensee than would a more traditional licensing *600 arrangement in which royalties are payable uniformly as the licensee makes sales of products produced with the licensed technology. A licensee would demand a lower overall royalty rate than he would be willing to pay under normal circumstances to compensate him for assumption of this additional risk. In the instant case, there is no evidence in the record that B&L had similar urgent cash needs which would place it in such a weakened bargaining position visa vis a potential licensee.Finally, we note that CAS, the licensor in the Vertical Spin Cast License Agreement, was not in a position to exploit its technology in the United States. The Czechoslovakian organization had no sales or marketing function in place in the United States and was generally unfamiliar with the market dynamics of capitalist societies. It therefore needed to form an alliance with someone who had the capability itself to fully exploit its spin cast technology. In contrast, B&L had both*172 the technology and a network of affiliated sales corporations able to market the products produced with this technology. Thus B&L would have found itself in a much stronger bargaining position in a hypothetical negotiation with B&L Ireland than would have CAS in its negotiations with NPDC.We thus conclude that the intangible property embodied in the 1979 CooperVision Agreement and the Vertical Spin Cast Licensing Agreement differed from that embodied in the B&L Ireland License Agreement. Additionally, the circumstances under which the former two agreements were negotiated differed significantly from the circumstances of B&L and B&L Ireland at the time they entered their license agreement. See sec. 1.482-2(d)(2)(ii), Income Tax Regs. We thus refuse to rely on either agreement as evidence of an arm's-length consideration for the intangibles licensed by B&L to B&L Ireland.Having found that the record does not contain a sufficiently similar transaction involving an unrelated party, we must attempt to construct an arm's-length royalty. In doing so, we look to the relevant factors identified by section 1.482-2(d)(2)(iii), Income Tax Regs., for guidance.Section 1.482-2(d)(2)(iii)(g)*173 and (h), Income Tax Regs., provides that we may consider the "prospective profits to *601 be realized * * * by the transferee through its use * * * of the property" and "the capital investment and starting up expenses required of the transferee." The best indication of the prospective profits to be anticipated through use of the spin cast technology by an Irish manufacturing facility and the capital investment required to generate these profits are the projections actually prepared by B&L for the purpose of determining the feasibility of such a facility, as well as the actual proposals submitted to the IDA. Unlike both respondent and petitioners' experts, we find little relevance in B&L Ireland's actual results of operations during 1981 and 1982. Such information would not have been available in 1980 to a potential licensee negotiating a license agreement which was entered on January 1, 1981. The arm's-length nature of an agreement is determined by reference only to facts in existence at the time of the agreement. R.T. French Co. v. Commissioner, 60 T.C. 836">60 T.C. 836, 852 (1973). Rather, we place heavy reliance on the Special Expenditure Application*174 (SEA) dated October 15, 1980, the various documents prepared by B&L to determine the feasibility of the proposed Irish lens manufacturing facility, and the actual proposal submitted to the IDA. These documents all contain various projections of earnings to be generated by the Irish lens manufacturing facility. These projections were intended to serve as financial justification to B&L management and the IDA of the capital investment to be made in development of the facility.The capital cost of developing the Irish lens manufacturing facility was estimated in the SEA to be $ 9,570,000, including $ 2,718,000 of leased capital assets. Acquisition of nonleased capital assets would occur during 1980 and 1981 and would be financed as follows:19801981TotalB&L Ireland capital stock$ 213,000$ 213,000B&L intercompany loan19 5,489,000($ 1,933,000)3,556,000IDA grant3,083,000 3,083,0005,702,0001,150,000 6,852,000*175 *602 The leased assets could be obtained under favorable lease terms since the lessor was entitled to IDA grants of 45 percent of their $ 2,718,000 cost ($ 1,223,000). In addition to the capital costs described above, the SEA projections also indicated that $ 1,511,000 of section 84 financing would be obtained in 1980 to provide working capital and to finance start-up costs. The SEA therefore projects a B&L Ireland investment of $ 8,363,000 capital assets and working capital in order to generate the earnings projected through operation of the proposed Irish lens manufacturing facility. 20 We thus focus our inquiry on the earnings an independent entrepreneur would have required as an inducement to risk this level of assets to a lens manufacturing venture using the B&L spin cast technology.The best indication in the record of the earnings such a hypothetical investor would hope to generate are the 10-year earnings and cash-flow*176 projections contained in the October 15, 1980, Special Expenditure Application. This document was generated closest in time to the license agreement and would thus appear to be the most up-to-date information available prior to the date of the license. However, we feel that a prudent investor would have adjusted these projections in several important respects before using them as a basis for determining the price at which he would be willing to enter into a royalty arrangement with B&L for use of its intangibles.First, the earnings projection assumes that the Irish facility would be operating at or near full capacity by 1983 and that it would be able to sell almost all of its production from that year through 1989. We think this is an unreasonable assumption with respect to years 1986 through 1989. B&L's 1980 strategic plan projected substantial increases in international demand for soft contact lenses in years 1981 through 1985. Thus the increasing projected sales by the Irish facility through 1985 appear reasonable. However, there is no support for the assumption that the Irish plant would have been able to operate at full capacity in years 1986 through 1989. To the contrary, *177 the Stage II financial *603 evaluation of the proposed Irish manufacturing facility prepared by the overseas task force indicated that the members of the task force anticipated an erosion in the demand for both standard and thin lens sales as prolonged wear lenses made of new materials became available. Although the license agreement entitles B&L Ireland to share in any technological or product advancements made by B&L, the fact that the agreement is terminable by either party at will makes this provision of limited value. We believe a prudent investor would have factored into his investment analysis the assumption that the reduced demand for HEMA daily wear soft lenses would have precluded sale of the facility's full production capacity during the later years of its useful life. Using our best judgment, we believe an assumption of steady erosion in demand to 80 percent of capacity in 1986, 60 percent in 1987, 40 percent in 1988, and 20 percent in 1989 is reasonable and would have been utilized by an independent investor. We will thus adjust the SEA projections accordingly.Second, the SEA projections assume that the unit selling price for lenses produced at the Irish facility*178 would be $ 7.50 throughout each of the years of projected operation. Such an assumption ignores the probability that lower cost competitors would enter the market and that new contact lens products would be developed which both would exert downward pressure on the price the Irish facility could be expected to receive for its HEMA, daily wear soft lenses. This probability was recognized in the Irish lens facility financial statements prepared January 24, 1980, for presentation to the IDA which presume a reduction in the $ 7.50 per unit sales price to $ 6.50 in 1983, with $ 0.50 reductions in each year thereafter. We find such an assumption reasonable and will adjust the later-generated SEA data accordingly.Incorporating these adjustments into the SEA projections, we arrive at the following projected earnings from operation of the lens facility before reduction for payment of any royalty for use of B&L's intangibles. It is the division of these projected earnings between the licensor and licensee of the intangibles which the parties to the license agreement would seek to accomplish through setting of the royalty rate. *604 Schedule AB&L IrelandEarnings Projections -- Pre-Technology Royalty(000s omitted)19801981198219831984Units sold1,000 2,100 3,100 3,200$ /unit7.50 7.50 6.50 6.00Sales7,500 15,750 20,150 19,200Cost of sales 21*180 Standard cost2,570 5,397 7,967 8,224Start up/variance531 1,406 2,222 1,888 Total cost of sales531 3,976 7,619 9,855 8,224Gross profit(531)3,524 8,131 10,295 10,976Operating expenses 22700 970 1,716 2,176 2,176Operating earnings(1,231)2,554 6,415 8,119 8,800(pre-royalty)Other income/expenseAmortization of grants308 308 308 308Interest expense(105)(342)(153)(21)Total other income/expense(105)(34)155 287 308Net earnings(pre-royalty)(1,336)2,520 6,570 8,406 9,108*179 Schedule AB&L IrelandEarnings Projections -- Pre-Technology Royalty(000s omitted)19851986198719881989Units sold3,2252,5801,9351,290645 $ /unit5.505.004.504.003.50 Sales17,73812,9008,7085,1602,258 Cost of sales 21Standard cost5,8694,9924,1153,2372,360 Start up/varianceTotal cost of sales5,8694,9924,1153,2372,360 Gross profit11,8697,9084,5931,923(102)Operating expenses 222,1761,7411,306870435 Operating earnings9,6936,1673,2871,053(537)(pre-royalty)Other income/expenseAmortization of grants308308308308308 Interest expenseTotal other income/expense308308308308308 Net earnings(pre-royalty)10,0016,4753,5951,361(229)*605 Despite petitioner's concession in this regard, we do not think that independent parties negotiating at arm's length would arrive at a royalty based on ARP. The purpose of the license agreement is to divide the income earned through exploitation of the licensed intangibles between the licensor and licensee. In this case, the income earned through exploitation of the licensed intangibles is the price B&L Ireland received from the sale of products produced using the licensed technology. The fact that the purchaser of the product also happens to be the licensor of the technology used to produce the product is irrelevant as long as the purchaser pays a market price. Therefore the price realized by B&L on its resale of lenses to nonaffiliates is of no consequence. We think an arm's-length royalty would be based on the price which the licensee is able to realize through sale of products produced using the licensed technology. *181 Basing the royalty rate on this amount has the effect of varying the amount of royalty payable based on the amount of income the licensee is able to generate through use of the license and thus more accurately effectuates the parties' purpose in entering into the agreement. We will thus construct a royalty rate which is a percentage of the price B&L Ireland could expect to earn from lens sales.In dollar terms, the lowest estimate by either Dr. Chandler or Dr. Bradford of the amount of royalty which would constitute an arm's-length consideration in 1981 or 1982 for the intangibles licensed by B&L to B&L Ireland is $ 4.33 per lens sold. 23 This translates to a royalty rate of just under 58 percent of the $ 7.50 price at which B&L Ireland sold lenses to B&L during those years. The unreasonableness of respondent's contention that a royalty of such magnitude constitutes an arm's-length consideration for use of B&L's intangibles is amply apparent when deducted from the previously constructed results of operations which a prudent investor in B&L Ireland's position could reasonably have expected to realize from use of the licensed intangibles: *606 Schedule BB&L IrelandOperating Earnings Projection57% Technology Royalty(000s omitted)19801981198219831984Operating earnings(1,231)2,554 6,415 8,119 8,800 (Pre-royalty)(From Schedule A)Royalty(57% of transfer price)(4,275)(8,978)(11,485)(12,064)Adjusted earnings(1,231)(1,721)(2,563)(3,336)(3,264)*182 Schedule BB&L IrelandOperating Earnings Projection57% Technology Royalty(000s omitted)19851986198719881989Operating earnings9,693 6,167 3,287 1,053 (537)(Pre-royalty)(From Schedule A)Royalty(57% of transfer price)(10,111)(7,353)(4,964)(2,941)(1,287)Adjusted earnings(418)(1,186)(1,677)(1,888)(1,824)*607 Obviously, no independent party would enter into an agreement for the license of intangibles under circumstances in which the royalty charged would preclude any reasonable expectation of earning a profit through use of the intangibles. We therefore find respondent's section 482 allocation with respect to the royalty to be arbitrary, capricious, and unreasonable.Our rejection of the royalty rate advocated by respondent does not, however, require that we accept that proposed by petitioners. G.D. Searle v. Commissioner, 88 T.C. at 367.*183 Both Dr. Arons and Dr. Plotkin testified that in their opinion a royalty of 5 percent of the transfer price charged for the contact lenses sold by B&L Ireland was inadequate as arm's-length consideration. On brief, petitioners recalculated the royalty due from B&L Ireland based on 5 percent of the average realized price (ARP) of Irish-produced lenses, arriving at royalties of $ 1,072,522 and $ 3,050,028 for 1981 and 1982, respectively. 24 This translates to a royalty of $ 0.9611 and $ 0.8257 per lens in 1981 and 1982, respectively. As stated previously, we do not consider ARP to be an appropriate base on which to calculate the royalty due. The fact that the royalty per unit payable in 1981 and 1982 declined despite the fact that B&L Ireland earned the same $ 7.50 per lens in each year is further evidence that a royalty based on ARP is inappropriate. Expressed as a percentage of the $ 7.50 transfer price received by B&L Ireland, the royalty conceded by petitioners is 12.81 and 11.01 percent in 1981 and 1982, respectively. Using the same analysis as was applied to respondent's royalty, we *608 find that even a royalty of 15 percent of the price received from the sale of*184 products produced using the licensed intangibles is too low to constitute an appropriate arm's-length consideration in this case for use of the licensed intangibles. At a royalty of 15 percent of sales price, an investor in the position of B&L Ireland at the time the license agreement was being negotiated could have anticipated the following earnings through exploitation of the licensed intangibles:As demonstrated by Schedule C, an investor in the Irish lens facility could expect an internal rate of return on investment of*185 approximately 35 percent and could expect earnings from the first 3 years of operations to cover his initial $ 8,363,000 investment in the project. Over the life of the project, B&L would recover 37 percent of the operating earnings through the 15 percent royalty (16,405 / 44,320). We consider such a result overly generous to B&L Ireland in light of the moderate level of risk to which it was exposed and the substantial discounts to projected earnings we have already incorporated into the forecasts.In his expert report and at trial, Dr. Plotkin testified that as a rule of thumb a royalty rate generally divides net profits before royalties 25 to 75 percent between the licensor and licensee, respectively. See also Ciba-Ceigy Corp. v. Commissioner, 85 T.C. 172">85 T.C. 172, 229 (1985). Even accepting this generalization, we think the B&L Ireland license agreement was unique and would have been an exception to the general rule had it been negotiated at arm's length. In the normal licensing situation, each party possesses something unique which is necessary for exploitation of a particular project. For example, one party may possess the production technology and*186 the other possesses the capital and marketing expertise. A license agreement is negotiated since neither party possesses all of the attributes needed to exploit the product on its own. Here in contrast, B&L possessed both the production technology and the marketing network necessary to produce and sell soft contact lenses. B&L Ireland merely had the capital, a nonproprietory asset which theoretically could have been supplied by any number of entities. Thus, B&L Ireland would have found itself in a weaker bargaining position vis a vis B&L *609 Schedule CB&L IrelandOperating Earnings Projection15% Royalty(000s omitted)19801981198219831984Operating earnings(1,231)2,554 6,415 8,119 8,800 Pre-royalty(From Schedule A)Royalty -- 15% oftransfer price(1,125)(2,362)(3,023)(2,880)Operating earnings(1,231)1,429 4,053 5,096 5,920 Net present value ofearnings discounted at35 percent 25(1,231)1,058 2,224 2,071 1,782 Schedule CB&L IrelandOperating Earnings Projection15% Royalty(000s omitted)19851986198719881989TotalOperating earnings9,693 6,167 3,287 1,053 (537)44,320 Pre-royalty(From Schedule A)Royalty -- 15% oftransfer price(2,661)(1,935)(1,306)(774)(339)(16,405)Operating earnings7,032 4,232 1,981 279 (876)27,915 Net present value ofearnings discounted at35 percent 251,568 699 242 25 (59)8,379 *187 *610 Schedule DB&L IrelandOperating Earnings Projection20% Royalty(000s omitted)19801981198219831984Operating earnings(1,231)2,554 6,415 8,119 8,800 Pre-royalty(From Schedule A)Royalty -- 20%of transfer price(1,500)(3,150)(4,030)(3,840)Operating earnings(1,231)1,054 3,265 4,089 4,960 Net present value ofearnings discounted at27 percent(1,231)830 2,024 1,996 1,907 *188 Schedule DB&L IrelandOperating Earnings Projection20% Royalty(000s omitted)19851986198719881989TotalOperating earnings9,693 6,167 3,287 1,053 (537)44,320Pre-royalty(From Schedule A)Royalty -- 20%of transfer price(3,548)(2,580)(1,742)(1,032)(452)21,874Operating earnings6,145 3,587 1,545 21 (989)22,446Net present value ofearnings discounted at27 percent1,860 855 290 3 (115)8,419*611 and would have had to cede more of the profits from plant operations to B&L than the customary 25 percent. Using our best judgment, we find that at arm's length B&L Ireland would have been willing to invest in the lens production facility even if required to share approximately 50 percent of the profits therefrom with B&L as consideration for use of its intangibles. As illustrated in Schedule D, this equates to a royalty rate of 20 percent of net sales.As Schedule D indicates, at a royalty rate of 20 percent of net sales an investor in the Irish lens facility could expect to generate sufficient net earnings to cover his $ 8,363,000 investment by early in his 4th year of operations. *189 Over the course of the project, he could expect to generate an internal rate of return on this investment of approximately 27 percent. We can assume that the 12-percent rate used to discount future cash-flows in the SEA projections constituted petitioner's estimate of the acceptable rate of return on a relatively riskless venture. The additional 15 percentage points earned by the investor can thus be viewed as compensation for assuming the risks involved in the venture. Considering the proven, low-cost production technology to which B&L Ireland gained access via the licensing agreement, and its access to worldwide markets through its relationship with B&L, we consider the risks assumed by B&L Ireland to be moderate in comparison to those of other manufacturing ventures and the 15-percent premium to be wholly adequate to compensate B&L Ireland for assumption of these risks.We thus hold that a royalty of 20 percent of B&L Ireland's sales price for soft contact lenses constitutes arm's-length consideration for use of B&L's intangibles. At arm's length B&L would thus have received royalties of $ 1,674,000 and $ 5,541,000 from B&L Ireland in 1981 and 1982, respectively. 26*190 To give effect to the foregoing,Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect in the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure except as otherwise noted.↩2. During the 1960's, 1970's, and early 1980's, the following corporations were either wholly or partially owned subsidiaries of National Patent Development Corp.; Hydron Europe, Inc. (Hydron Europe), Hydron International, Ltd. (Hydron International), Hydron Pacific, Ltd. (Hydron Pacific), Flexible Contact Lens Corp. (Flexible), Flexible Contact Lens (Nevada), Inc. (Flexible-Nevada), Hydron Australia, Ltd. (Hydron Australia), and NPD Optics, Inc. (NPD Optics). NPD Optics had a division known as American Hydron. Hereinafter NPDC together with its subsidiaries as the context requires are referred to as NPDC.↩3. On or about Dec. 18, 1965, NPDC and KOVO, a Czechoslovakian corporation, entered into an agreement pursuant to which NPDC agreed to purchase from KOVO two production spin cast machines based on the technology set forth in certain of the Wichterle patents for $ 150,000.↩4. The amendment also increased the minimum royalty payable during the 5th and 6th years of the agreement from $ 100,000 to $ 200,000 per year.↩5. On Nov. 6, 1973, NPDC filed an amended complaint in the Accounting Action raising additional allegations and requesting the payment of royalties under the NPDC Sublicense Agreement. Such first amended complaint asserted a claim for damages in the amount of $ 10 million.A second amended complaint filed in the Accounting Action raised additional allegations and asserted a claim for damages in the amount of $ 23 million.↩6. In light of the settlement of its litigation with B&L, NPDC considered it desirable to adjust its contractual relationship with CAS. Therefore, on or about Jan. 1, 1977, NPDC, Flexible-Nevada, and CAS, represented by Polytechna, entered into an agreement pursuant to which the parties terminated and canceled the CAS License Agreement, the Far East License Agreement, and the European License Agreement in exchange for a total payment of $ 3,500,000 from Flexible-Nevada to CAS.Also on or about Jan. 1, 1977, CAS, represented by Polytechna, and Flexible-Nevada entered into an Assignment Agreement pursuant to which CAS assigned to Flexible all of its rights with respect to the Wichterle patents in exchange for a payment of $ 500,000 (CAS Assignment Agreement).The Automated Optics Litigation was settled in 1977. Pursuant to the settlement of that litigation, Automated Optics paid NPDC and its affiliates a royalty of 5 percent of sales for a license to maintain, use, and sell soft contact lenses under the Wichterle Materials, Lathing, and Replica Patents.↩7. On or about Nov. 2, 1981, CooperVision acquired ILC and thus became the owner of the ILC cast molding patents and all ILC's other technology and know-how related to the cast molding process. As a result, NPDC and CooperVision entered into an agreement on Jan. 6, 1982, pursuant to which the 1979 CooperVision Agreement was generally terminated. Thereafter, NPDC became a licensee of CooperVision with respect to the ILC cast molding process and patents.↩8. The letter in a lens series manufactured by B&L designates the thickness of the particular lens, while the number refers to the lens diameter. The "minus" designation indicates the lens is for the correction of myopic (nearsighted) patients, while a "plus" designation indicates correction of hyperopic (farsighted) patients.↩9. We discount the significance of any expiration date labeling of a limited number of B&L Ireland lenses which may have been done by B&L in Rochester during 1981.↩10. The distribution agreements which charged a single price per lens whether standard thickness or thin, contained the following price-volume schedule:↩Price per lensAnnual volume$ 10.9510,000-14,999 10.4515,000-19,999 9.9520,000-24,999 9.4525,000-29,999 8.9530,000-39,999 8.5040,000 and over11. The distribution agreement provided for a four-level pricing structure, with greater discounts based on greater volumes. Since Southern purchased in excess of 15,000 lenses from NPDC each year it was entitled to the highest discount available.↩12. Product warranties, which relate to the quality and parameters of the lens were offered by most competitors in the soft contact lens business. The suitability of a particular lens for a particular customer is warranted under a performance warranty. Performance warranties were not standard in the business, although Southern sometimes purchased and resold lenses with a performance royalty.↩13. Sec. 482, as in effect for the years in issue, provides as follows: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 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.Sec. 1231(e)(1) of the Tax Reform Act of 1986 amended sec. 482↩ to provide that "in the case of any transfer (or license) of intangible property * * *, income with respect to such transfer or license shall be commensurate with the income attributable to the intangible." However, this amendment is effective only with respect to taxable years beginning after Dec. 31, 1986, and only with respect to transfers of intangibles that occurred after November 16, 1985, or licenses granted after such date. Tax Reform Act of 1986, Pub. L. 99-514, sec. 1231(g)(2)(A) (1986) 100 Stat. 2085, 2563.14. See also Johnson Bronze Co. v. Commissioner, T.C. Memo. 1965-281↩.15. Proof that B&L Ireland's $ 7.50 price was less than an arm's-length price would be beneficial to petitioners inasmuch as respondent argues that the price charged by B&L Ireland was too high, thus allowing petitioners to shift too much income to B&L Ireland.↩16. Even the Lombart agreements, which charge $ 7.50 for standard lenses and $ 8.45 for thin lenses, do not support a finding that a uniform price of $ 7.50 is other than a market price. The average of these two prices is $ 7.98. When reduced by the $ 0.62 adjustment described above, this equals $ 7.36. Although this amount is lower than the $ 7.50 charged by B&L Ireland, the variance is so small (less than 2 percent) as to be insignificant and cannot support a finding that B&L Ireland's price was excessive, especially when examined in light of the other agreements identified by petitioner.↩17. $ 1.50 x 150% = $ 2.25$ 1.50 x 200% = $ 3.00↩18. Dr. Chandler used figures for ARP of $ 17.88 in 1981 and $ 16.06 in 1982.↩19. Of this amount, $ 1,933,000 of the initial B&L loan was to be interim financing to cover the expected 3-month lag between acquisition of assets and disbursement of grant funds by the IDA.↩20. ↩Capital assets$ 6,852,000Working capital1,511,0008,363,00021. The Jan. 24, 1980, Irish Lens Facility Financial Statements indicate that the variable manufacturing costs of producing HEMA soft contact lenses was projected at $ 1.36 per lens with the remaining manufacturing costs fixed. Absent any evidence to the contrary, we employ the same assumptions in adjusting the manufacturing costs of 1986 through 1980 for the hypothesized lower levels of production. Thus, $ 1,483 of the manufacturing costs in 1986 through 1989 are fixed and variable costs of sales are calculated at $ 1.36 per unit.↩22. Operating expenses in the years 1986 through 1989 are reduced from the figures appearing in the SEA earnings statement in the same proportion as are unit sales.↩23. $ 16.06 ARP in 1982 per Dr. Chandler times his low end estimate of the royalty rate of 27 percent.↩24. Computed as follows:↩1981Per lensRoyaltyRoyaltyResellerUnitsARPrateamountB&L680,106x$ 17.15x.05=$ 583,191Foreign affiliates436,345x22.43x.05=489,3611,116,4511,072,5521982Per lensRoyaltyRoyaltyResellerUnitsARPrateamountB&L2,056,435x$ 15.25x.05=$ 1,568,032Foreign affiliates1,637,565x18.10x.05=1,481,9963,694,0003,050,02825. The internal rate of return on the project is derived by discounting the project's future earnings by the discount factor which results in the net present value of future earnings equaling the amount of investment. See generally, Anthony & Reece, Management Accounting 635-636 (5 ed. 1975). In this case, the net present value of future earnings approximated B&L Ireland's $ 8,363,000 investment when discounted at 35 percent. Normally discounted cash-flows, rather than earnings, are used in calculation of a project's internal rate of return. However, in situations such as this where, due to common control, there is no risk that earnings will not be ultimately realized in cash and the timing of such realization is within the discretion of the controlling party, we feel that use of earnings for measurement of the project's profitability is more appropriate.↩26. 1981: 1,116,000 units x $ 7.50 x 20% = $ 1,674,0001982: 3,694,000 units x $ 7.50 x 20% = $ 5,541,000↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624829/ | Estate of Hermann Becker, Deceased, H. E. Becker, Theodor E. Becker and August Haenel, Trustees of Said Estate v. Commissioner.Estate of Becker v. CommissionerDocket No. 110598.United States Tax Court1943 Tax Ct. Memo LEXIS 229; 2 T.C.M. (CCH) 341; T.C.M. (RIA) 43311; June 28, 1943*229 J. A. Rauhut, Esq., 824 Littlefield Bldg., Austin, Tex., for the petitioner. Stanley B. Anderson, Esq., for the respondent. ARNOLD Memorandum Findings of Fact and Opinion Petitioner is a trust estate created by the will of Hermann Becker, H. E. Becker, Theodor E. Becker and August Haenel, all residents of Austin, Texas, are surviving trustees. Fiduciary income tax returns (for estates and trusts), Form 1041, were filed with the collector of internal revenue for the first district of Texas. The taxes in controversy are income and excess profits taxes for the calendar years 1937, 1938 and 1939, in the aggregate sum of $26,621.31, as follows: ExcessYearIncome TaxProfits Tax1937$ 5,133.93$ 5,843.6419383,039.715,197.8519392,976.264,429.92$11,149.90$15,471.41 Several adjustments resulting in part of the asserted income tax deficiencies have been conceded by petitioner and will be taken care of under Rule 50. It was stipulated at the hearing that by reason of petitioner's filing of capital stock tax returns and payment of the tax thereon under protest, there is no excess profits tax liability. The statutory notice of deficiency, dated January *230 19, 1942, holds that the Estate of Hermann Becker is an association taxable as a corporation and the major portion of the deficiency results from computation of the tax liability for the years involved in accordance with this holding. Findings of Fact Hermann Becker, died on October 22, 1933, and his will was probated in Travis County, Texas, on November 20, 1933. H. E. Becker, Theodor E. Becker, Paul A. Wilde and August Haenel were appointed independent executors and qualified on November 28, 1933. The last debt of the estate existing at testator's death was paid off on March 17, 1937. Pursuant to the will, the executors then automatically became trustees of the trust estate created under the will. Paul A. Wilde died in 1939. With minor omissions, the will of Hermann Becker is as follows: 1. It is my purpose in making this will to devise, bequeath and dispose of all of my separate property and all property constituting the community estate of my wife and myself, and to include in this disposition the interest of my wife in our marital community estate. The bequests herein made to and for the benefit of my wife are made upon condition that she accept them in lieu and satisfaction*231 of her marital community interest in any property owned by my wife and me. This disposition of our community property is made with the full and free concurrence of my wife, she and I having fully discussed and agreed upon it. 2. I give, devise and bequeath to my wife. Pauline Becker, our present home located at the Corner of San Jacinto and East Fourth Streets in the City of Austin, together with all the furniture and furnishings therein, she to have the right to use, occupy and enjoy and to dispose of the same as she sees fit. 3. I hereby give, will and bequeath to my said wife, Pauline Becker, the sum of Three Hundred ($300.00) Dollars per month during her life, which sum shall be paid to her out of this estate by my executors or trustees at the end of each month during her life. As I have stated above, this bequest to my wife is made in lieu of any marital community interest which my wife has or might otherwise claim in any of our community property. 4. All of the remainder of my estate I give. devise and bequeath in equal parts to my four (4) children, namely: Hermann E. Becker, Theodor E. Becker, Hermine Wilde (wife of Paul A. Wilde) and Bertha Haenel (wife of August Haenel), *232 and to their descendants, but I will and direct that they shall receive and take the title and possession thereof only at the time and upon the conditions hereinafter set forth. 5. I hereby designate and appoint my sons. Hermann E. Becker and Theodor E. Becker, and my sons-in-law, Paul A. Wilde and August Haenel, all of Travis County, Texas, or such of them as shall survive me, the sole executors of my last will and testament; and I will and direct that no bond or security shall be required of any of them as executor, and that letters testamentary shall be issued to them without any bond when this will is probated; and I further will and direct that no action shall be had in the County Court, or in any court of probate, in relation to the settlement of my estate, or with reference to this will, other than the probating and recording of this will and the return of an inventory, appraisement and list of claims of my estate. 6. I hereby give and grant to my said executors the power and authority to manage, control and dispose of all of the property of this estate (including herein, as above stated, any and all interest of my wife in our community property) and to sell, convey and exchange*233 same as and when all of my said executors shall think proper, but it is my will that neither the lumber business nor any of the real estate belonging to this estate shall be disposed of or conveyed except upon the unanimous consent of all of my executors then living, which consent shall be evidenced by their signatures to the deeds of other instruments of conveyances. 7. My said executors are authorized and directed to pay all debts owing by this estate at the time of my death, and their action in passing upon the validity of any claims against this estate shall be final and binding upon the beneficiaries of this estate. 8. After my executors have paid all debts owing by this estate at the time of my death they shall cease to be executors of this estate and shall immediately become trustees of this estate under this will and shall thenceforth act as such trustees under the provisions of this will hereinafter stated. As such trustees, they shall not be required to give any bond or security, and shall act free of control of any court. 9. My said trustees shall have, and I do hereby give, will, devise and bequeath to them, all of the property constituting this estate as hereinabove*234 described wheresoever said property may be situated. It is my will that said trustees shall keep, hold, manage, control and use said property, and shall have the power and right to sell and convey the same in the same manner that the full owner thereof might do, with the exception that none of said property shall be sold or conveyed except upon the consent and signature of all of the trustees to the instrument conveying same. 10. When in the judgment of those of my executors or trustees who are engaged in conducting and managing, or are employed in the lumber business owned by this estate, it shall be necessary to borrow money for and upon the credit of this estate, it is my will that they have and I do hereby give and grant unto them the power and authority to borrow upon the credit of this estate such sums of money as they may need, but it is my will that this power be used only when necessary and that the loans be made for no longer time than is necessary under the existing conditions. 11. My said trustees shall have and are hereby given the further power to collect all sums owing to this estate, to compromise all claims, to give receipts and releases, to sell, transfer and assign*235 notes and liens, to make contracts, and to invest and reinvest all funds belonging to or received for this estate. They shall exercise their judgment in determining the terms and conditions upon which property shall be acquired or sold and disposed of, and shall generally, upon unanimous consent of all of them, have the unqualified right to use, manage, control and dispose of all of the property constituting this estate in the same manner that the full owner thereof could use, control and dispose of same. 12. My said trustees are further authorized to improve any of said property, to construct and erect such houses and improvements as they may think proper, and to make such changes in said property as they shall think advisable. 13. It is my will and I do hereby direct that my said executors or trustees shall retain possession and control of all of this estate, whether same continue to be the identical property existing at the time of my death or the proceeds of the sale of such property or property acquired by purchase or exchange or the rents and revenues of this estate, using and managing the same in the manner hereinabove stipulated for a period of at least three (3) months *236 after the death of my wife. At the expiration of said three (3) months, my said four (4) children, or such of them as shall then be living and the descendants of any of my children that may have died, may if they so desire, require this estate to be partitioned and receive their full parts thereof in fee, or they may, if they so desire, continue said estate as an entire property under the management and control of the trustees herein named for such period of time as they may see fit. 14. It is my will, and I do hereby direct, that during the time my estate is held, managed and controlled by my said executors or said trustees my said son, Hermann E. Becker shall be the manager of the lumber business, and as such manager, shall have general supervision and control over the conduct and affairs of said business. 15. It is further by will, and I do hereby direct, that so long as my estate shall be held by my executors or trustees my said sons. Herman [Hermann] E. Becker and Theodor E. Becker, and my son-in-law, Paul A. Wilde, shall have the right to continue to work for and be employed by this estate in the same capacities in which they are employed at the time of my death, except that, *237 as above directed, by said son, Hermann E. Becker, shall be manager of the lumber business; and I will and direct that when by son. Theodor E. Becker becomes 25 years of age, he shall receive the same salary which is then paid to my son, Hermann E. Becker and my son-in-law, Paul A. Wilde, and shall thereafter receive the same salary which they receive. 16. It is my will and I do hereby direct that the salary to be paid to and received by my sons and son-in-law shall be left to the best judgment of my executors and trustees. 17. It is my will and I do hereby direct that my said executors and trustees shall have the right to pay to my devisees as dividends as much as one-fourth (1/4) of the net profits, rents and revenues form this estate during each year, but that not more than one-fourth (1/4) thereof shall be paid as dividends and that the remaining three-fourths (3/4) shall be kept and used by the executors or trustees as a part of this estate until its final partition. 18. I further will and direct that my executors or trustees shall at least once during each year make a full and accurate statement of the condition of this estate and give a true copy thereof to each person having*238 a beneficial interest in this estate. 19. It is my will and I do hereby direct that my said trustees may in the exercise of their discretion sell any portion or all of the property constituting my estate and may reinvest the proceeds from such property in other property or in such other business as they may decide upon, and that they may, in their discretion, retain the proceeds of such sale or sales, and loan, invest and reinvest the moneys so received, it being my will and desire to give to my said trustees the right and power to decide whether they shall continue to conduct my lumber business or sell or discontinue same, and to decide upon the sale or retention of any other property belonging to this estate, and to decide in what business this estate shall engage, and how its moneys shall be invested and its business conducted. 20. When this estate is partitioned such partition shall be made by my trustees and their action in partitioning it shall be binding and conclusive upon all of my devisees. Said partition shall allot to each of my four (4) children in severalty one-fourth (1/4) part in value of all of the property then constituting this estate; provided, however, that *239 if any of my said four (4) children have died prior to the time of such partition not survived by any child or children, then the portion of this estate which under the provisions of this will would have been allotted to such child or children then deceased shall be allotted in equal portions to my surviving child or children; and in the event any of my said four children shall have died prior to such partition leaving a child or children surviving him or her, then such surviving child or children of my deceased child shall be allotted jointly such interests as their deceased parent would have been entitled to if he or she had lived to the time of such partition. 21. It is my will and I do hereby direct that neither my said executors or trustees shall receive any fees, commissions or compensation for acting as executors or trustees. 22. It is further my will that if any of the persons named herein as executors or trustees dies or does not qualify, that the others herein named shall be and constitute the sole executors and trustees of this estate. All property of the estate was community property of testator and his wife Pauline Becker. On December 26, 1933, the widow duly elected*240 to accept under the will the gift thereby made to her of the home, furniture, furnishings, and $300 per month payable out of the estate for the remainder of her life, in lieu of her community interest. The payments of $300 per month have been made regularly. Pauline Becker was 76 years old at the time of the hearing. The testator's four children, namely H. E. Becker, Thedor E. Becker, Hermine Wilde (wife of Paul A. Wilde) and Bertha Haenel (wife of August Haenel), who are to share equally in the estate when distributed, were alive at the time of the hearing. At testator's death, all but Theodor were married and he married subsequently. There were eleven grandchildren at the time and five were born subsequently. The sixteen grandchildren, two of whom are married, were alive at the time of the hearing. Under the will distributions of estate income may not exceed 25 per cent thereof. During 1937, 1938 and 1939, the amounts of $10,859.72, $9,765.40, and $8,175.88, respectively, were distributed, the testator's four children each receiving, during the respective years, $2,714.93, $2,441.35, and $2,043.97. The undistributed income was required to be kept and used as a part of the estate*241 until its partition. The residual estate consisted of unimproved farm and ranch property, part of which was oil bearing, yielding royalties; unimproved land and lots in or near Austin, Texas, in part of which the community owned full title and in part an undivided interest acquired by testator through a partnership, Assman & Becker; improved residential and business property in Austin, held for rental purposes; a retail lumber business, the Becker Lumber Co., situated on improved lots owned by the marital community, which testator had operated as sole proprietor for about 20 years; accounts and notes receivable; and some stocks and bonds. The residual estate was taken over by the executors and has been managed and controlled by them as executors and trustees under the will. Substantially all of the property which comprised the original estate is still on hand. The executors-trustees have sold some of the unimproved real estate which was not yielding revenue and have improved other unimproved property owned by testator at his death, or subsequently purchased. They also sold some property which came into their hands in the course of liquidating debts owing to the testator, and some*242 property which testator had acquired before his death in the same manner, also some houses which the executors and trustees were forced to take back. Surplus funds derived from the lumber business and other sources have been used to purchase realty and to improve nonproductive realty. No improved, income-producing realty has been sold. The policy of the executors-trustees has been to retain income-producing real estate, to reduce the lumber business, to invest surplus funds in order to produce income therefrom, and to put the property of the estate in such form that it might be divided in kind when the time for partition arrived. The Assman-Becker partnership arose from the purchase by Herman Becker and one Assman of outlying land around Austin, Texas. One tract was laid out in lots before Becker's death. No attempt has been made to continue the partnership, as Assman's widow and the Becker estate desired to liquidate the holdings. The lots have been sold and the Becker estate's pro rata share turned over to it. The executors-trustees have continued to operate the Becker Lumber Co. along substantially the same lines as testator had done. They have not attempted to expand the business*243 and have added no new lines. Some money has been transferred out of the business for the improvement of nonproductive property. There are approximately 30 employees, consisting of sawmill operators, delivery drivers, office force, a collector, and an inside salesman. The executors-trustees would have disposed of the business if they could, but they have not had an opportunity for sale. A separate set of books has been kept for the lumber business, as testator did before his death. H. E. Becker, Theodor Becker and Paul A. Wilde, were employed by testator in his lumber business, receiving salaries. Wilde was manager. After testator's death, and until Wilde's death, these three continued to work in connection with the business, H. E. Becker having been substituted for Wilde as manager under the will. During the taxable years, the income derived from the lumber business decreased rapidly, whereas that from other sources shows a steady increase. Rents and royalties constitute a large part of the income of the estate. Some of the rent is collected by agents and some by the estate itself, depending upon who obtained the tenant. Some of the lands had been leased for oil and gas by testator*244 and the executors-trustees merely collected the royalties produced therefrom. No new royalties have been acquired and none have been sold. The beneficiaries, as such, have and exercise no voice in the management of the estate. There are no certificates or shares to evidence the beneficial interests, the will being the only evidence of interest therein. No beneficiary has attempted to transfer an interest in the estate. The estate has no office, by-laws, seal, or formal meetings of the trustees. There is an informal understanding among the beneficiaries that the estate will be partitioned in kind at the time permitted by the will, which is three months after the death of their mother. Opinion ARNOLD, Judge: The principal question in this proceeding is whether the Estate of Herman Becker is an association, taxable as a corporation as determined by respondent, or as a trust as claimed by petitioner. If an association taxable as a corporation then the issue is raised whether, in computing surtax on undistributed profits for 1937, it is entitled to a credit under section 26(c) of the Revenue Act of 1936, by reason of the fact that distributions of estate income are limited under the*245 will to 25 per cent thereof. Income of corporations and income of trusts are taxable at different rates. Section 2797(a)(3) of the Internal Revenue Code and the corresponding provisions of the Revenue Acts of 1938 and 1936, define the term "corporation" as including "associations." Section 19.3797-3 of Treasury Regulations 103, provides, as follows: Sec. 19.3797-3. Association distinguished from trust. - The term "trust," as used in the Internal Revenue Code, refers to an ordinary trust, namely, one created by will or by declaration of the trustees or the grantor, the trustees of which take title to the property for the purpose of protecting or conserving it as customarily required under the ordinary rules applied in chancery and probate courts. The beneficiaries of such a trust generally do no more than accept the benefits thereof and are not the voluntary planners or creators or the trust arrangement. Even though the beneficiaries do create such a trust, it is ordinarily done to conserve the trust property without undertaking any activity not strictly necessary to the attainment of that object. As distinguished from the ordinary trust described in the preceding paragraph there*246 is an arrangement whereby the legal title to the property is conveyed to trustees (or a trustee) who, under a declaration or agreement of trust, hold and manage the property with a view to income or profit for the benefit of beneficiaries. Such an arrangement is designed (whether expressly or otherwise) to afford a medium whereby an income or profit-seeking activity may be carried on through a substitute for an organization such as a voluntary association or a jointstock company or a corporation, thus obtaining the advantages of those forms of organization without their disadvantages. The nature and purpose of a cooperative undertaking will differentiate it from an ordinary trust. The purpose will not be considered narrower than that which is formally set forth in the instrument under which the activities of the trust are conducted. The regulation then discusses other characteristic features of associations particularly emphasizing the business purpose involved. This is summarized in the last sentence of section 19.3797-3, as follows: * * * The distinction is that between the activity or purpose for which an ordinary strict trust of the traditional type would be created, and the*247 activity or purpose for which a corporation for profit might have been formed. The corresponding articles of Regulations 101 and 94 contain similar language. The leading case in regard to trusts which may be classified as associations, taxable as corporations, is Morrissey v. Commissioner, 296 U.S. 344">296 U.S. 344 (1935), which held, briefly, that the prerequisites of such classification are (1) associates, (2) business purpose, and (3) a combination of characteristics resulting in a closer resemblance to a corporation than to an ordinary trust. See also A. A. Lewis & Co. v. Commissioner, 301 U.S. 385">301 U.S. 385 (1937); Swanson v. Commissioner, 296 U.S. 362">296 U.S. 362 (1935); Helvering v. Combs, 296 U.S. 365">296 U.S. 365 (1935); and Helvering v. Coleman-Gilbert Associates, 296 U.S. 369">296 U.S. 369 (1935). The trust estate before us was created as part of a testamentary plan whereby the decedent, Herman Becker, provided by will for the conservation of his estate during the lifetime of his widow, in order that she might be supported therefrom, and for distribution of the estate among*248 his four children or their descendants, per stirpes, three months after the widow's death. The beneficiaries did not, "as mere cestuis que trustent, plan a common effort or enter into a combination for the conduct of a business enterprise." The object of the trust was "to hold and conserve particular property, with incidental powers, as in the traditional type of trusts," and not "to provide a medium for the conduct of a business and sharing its gains." Morrissey v. Commissioner, supra, at 357. The fact that testator's estate consisted in part of a going business, formerly operated by him as a sole proprietorship, which the executors and later the trustees continued to operate, does not supply the business purpose called for by the Morrissey case. The facts show that the continued operation of the business was entirely consistent with the duty of the fiduciaries to conserve the estate. There was a definite plan to reduce the business and to convert its proceeds into income-producing realty, so that the estate might be divided in kind when the time for partition arrived. The business would have been sold had an advantageous opportunity arisen. *249 The powers granted to the fiduciaries under the will, and the manner in which the estate operated, do not show any features which cause this trust to resemble a corporation and which distinguish it from an ordinary trust. The Morrissey case is clearly distinguishable on the facts, and in principle that case would require that petitioner herein be classed as an ordinary trust and not as an association. None of the cases relied on by respondent involve an ancestral or testamentary trust as here. We have not been cited to any other case which would require a contrary result. In view of the above, we hold that the Estate of Hermann Becker is an ordinary trust and not an association taxable as a corporation. As a result of this holding, it is not necessary to consider the issue raised in the alternative. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624830/ | APPEAL OF SCHINDLER, INC.Schindler, Inc. v. CommissionerDocket No. 5856.United States Board of Tax Appeals4 B.T.A. 319; 1926 BTA LEXIS 2312; July 22, 1926, Decided *2312 On the evidence, held, that the taxpayer was not a personal service corporation. David L. Ullman, Esq., for the petitioner. J. Arthur Adams, Esq., for the Commissioner. *319 Before GRAUPNER 1 and TRAMMELL. This is an appeal from the determination of a deficiency in income and profits taxes for 1920 and 1921, in amounts of $1,461.73 and $141.08, respectively. The deficiencies arise from the denial by the *320 Commissioner of personal service corporation classification to the taxpayer. FINDINGS OF FACT. The taxpayer is a New York corporation with its principal office in the City of New York. Its name prior to 1920 was Schindler National Detective Agency, which name was subsequently changed to Schindler, Inc. It was incorporated in 1912, taking over the business previously operated by Raymond C. Schindler, who became its president and continued as such until after expiration of the period involved in this appeal. Associated with him in the conduct of the business were his father, John F. Schindler, and his brother, Walter S. Schindler. The authorized*2313 capital stock of the company was $30,000, consisting of 300 shares of the par value of $100 each. Of this amount, on January 1, 1920, 140 shares were outstanding as follows: SharesRaymond C. Schindler, president72John F. Schindler10Walter S. Schindler35Raymond Schindler, trustee for Raymond Schindler, jr5James R. Gooding11William M. Adams2Nellie Schindler5Of the above outstanding shares, 25 were issued for the good will of the business formerly conducted by Raymond C. Schindler, which was taken over by the corporation, and 25 shares were issued to the said Raymond C. Schindler pursuant to a resolution of the corporation on November 148 1916, for services performed for the corporation. The other 90 shares represented cash capital of the corporation. The only change in the stock holdings during the years 1920 and 1921 was the transfer by John F. Schindler of 9 shares held by him to his wife. During the taxable years in question, Raymond C. Schindler and John F. Schindler devoted their entire time to the active conduct of the taxpayer's business. William M. Adams was bookkeeper of the corporation and devoted his entire time to*2314 the active conduct of its affairs. Nellie Schindler was the wife of Raymond C. Schindler and she, as well as Raymond Schindler, jr., his son, and Gooding were not actively connected with the conduct of the business. The business of the taxpayer was that of conducting investigations for a selected list of clients, among whom were included many of the leading law firms of New York City. Some of the services rendered consisted in frustrating attempts at blackmail, in tracing lost persons, in secretly obtaining information for clients, and similar work, necessitating a great amount of skill and discretion. The *321 success of the business depended upon the confidence of the clients in the personal ability and integrity of the members of the Schindler family who actively carried on or supervised the operations intrusted to the corporation. On some occasions the taxpayer assisted the district attorney, and at times carried on investigations for foreign governments. During the years in question the taxpayer did no advertising and no canvassing. Its clients were obtained entirely through personal contacts established by the Schindler family and by the recommendation of other*2315 clients. During the entire period the taxpayer was engaged in business, there was no service performed which was not personally planned and supervised, if not actually done, by either the father or his sons. In some cases the actual investigation was performed by them. In other cases the investigation was carried on in part by operatives employed by them under their supervision. Only one operative was constantly on the pay roll. Other operatives were employed on a per diem basis, at rates of six to fifteen dollars a day and expenses. These operatives performed the task of "shadowing," that is, of keeping the person as to whose movements information was desired under close observation. The average number of operatives employed by the taxpayer was about six or seven, though at times it ran as high as twenty. The assets and liabilities of the taxpayer for the years 1920 and 1921 were as follows: Jan. 1, 1920.Dec. 31, 1920.Dec. 31, 1921.ASSETSCash$1,286.64$1,964.50$1,320.27Accounts receivable19,346.5829,713.0523,096.26Loans receivable2,322.813,670.893,403.92Liberty Loan bonds1,600.001,642.801,642.80Driggs stock440.00Furniture and fixtures2,156.682,415.912,259.62Stationery773.37246.76Equipment385.16292.92Deferred charges1,824.151,913.292,498.93Total28,922.0242,093.8135,200.58LIABILITIESNotes payable1,350.008,900.004,400.00Accounts payable2,026.306,244.725,059.68Reserve for bad debts1,416.951,800.002,000.00Capital14,000.0014,000.0014,000.00Surplus10,128.7711,149.099,740.90Total28,922.0242,093.8135,200.58*2316 During the year 1920, the gross income of the taxpayer was $188,141.83, and during 1921, $167,898.43. The expenses and salaries of operatives in 1920 were $127,414.26, and in 1921 $114,268.81. These figures include traveling expenses in this country and Europe, maintenance of operatives in the field, and their salaries and bonuses. *322 None of the operatives were stockholders. During 1920 the taxpayer paid out $5,375.80, as commissions, to two persons who were employed to canvass lawyers and others for business, and for 1921, for the same purpose, the taxpayer paid out $6,361 as commissions on business brought in. During the years involved in this appeal, Walter S. Schindler, who owned 35 shares of stock, was in bad health and traveled to some extent. He visited in Atlanta, Ga., and secured a position there. The taxpayer continued to pay him his salary and expense money. The greater part of the work was done for clients of long standing. To these clients the taxpayer did not send any statement of amounts expended or services rendered until the work was completed. Large sums of money were expended for traveling expenses and, in order to meet these current expenses, *2317 the taxpayer made short-time loans from the bank, some of which were only for a period of a few days. On December 15, 1919, the directors of the taxpayer passed the following resolution: In consideration of the increased value of services of the officers of the corporation, we hereby authorize the increase of salaries as follows: R. C. Schindler from $6,000.00 to $9,000.00 and expense allowance of $250.00 per month; J. F. Schindler from $1,800.00 to $4,000.00, with expense allowance of $75.00 per month; W. S. Schindler from $2,400.00 to $5,000.00 with expense allowance of $100.00 per month. This increase to take effect as of January 1, 1919. The total compensation provided for each officer by the above resolution was handled uniformly on the books as one salary account, and was checked out as such. Both the father and the two sons were very active socially; belonged to a number of clubs, and entertained extensively. This activity was for the purpose of establishing personal contacts by rason of which clients for the taxpayer might be obtained. Judgment for the Commissioner.Footnotes1. This decision was prepared during Mr. Graupner's term of office. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624832/ | FOSTORIA MILLING & GRAIN CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Fostoria Milling & Grain Co. v. CommissionerDocket No. 17191.United States Board of Tax Appeals11 B.T.A. 1401; 1928 BTA LEXIS 3631; May 15, 1928, Promulgated *3631 TRANSFEREE - LIABILITY - SECTION 280, REVENUE ACT OF 1926. - A taxpayer sustained losses in 1921 and 1922 rendering it insolvent. In 1923 it conveyed all of its assets to petitioner, a new corporation organized by certain of its stockholders, together with other parties not previously identified with it, the consideration of the sale being the assumption by petitioner of certain specified debts of the taxpayer and being all of its then known liabilities. In 1924 respondent determined a deficiency for the year 1920, later assessed same against the taxpayer, and in 1926 proposed assessment of same against petitioner under section 280 of the Revenue Act of 1926. On the facts, held, that petitioner is not liable at law or in equity as transferee of the assets in question, such transfer having been made in good faith without intent to hinder or defraud creditors of the transferor and for a good and sufficient consideration, the debts assumed and paid by petitioner being in excess of the value of the property received. Charles A. Guernsey, Esq., for the petitioner. Henry Ravenel, Esq., for the respondent. TRUSSELL *1401 This proceeding results*3632 from the action of respondent in notifying the petitioner as follows: As provided in section 280 of the Revenue Act of 1926, there is proposed for assessment against you the amount of $959.92 constituting your liability as transferee of the assets of The Fostoria Milling Company, Sandusky Street, Fostoria, Ohio, for an unpaid income and profits tax in the amount of $959.92, assessed against the Fostoria Milling Company for the year 1920, as per attached statement. Petitioner alleges that respondent erred in determining that petitioner as transferee of the assets of the Fostoria Milling Co., or otherwise, is liable for the payment of said taxes or of any part thereof. *1402 FINDINGS OF FACT. Petitioner is an Ohio corporation with its principal office at Fostoria, Ohio. Another corporation, the Fostoria Milling Co., hereinafter referred to as the Milling Co., was incorporated in Ohio on November 30, 1915, under the name of The Fostoria Farmers' Exchange Co., with an authorized capital of $20,000, divided into 200 shares of common stock of a par value of $100 each. The name of this corporation was subsequently changed to The Fostoria Milling Co. and the authorized*3633 capital was increased to 1,000 shares of common stock of a par value of $100 each. The business of the milling company was the milling of wheat and the buying and selling at wholesale of grain, flour, feed and fertilizer. Approximately 90 per cent of the outstanding capital stock was held by farmers, and the stockholdings of any one individual were small. The mill was small and was located at Fostoria, Ohio, where was also located a large mill belonging to a competitor. Operations, especially the provisions for the declaration of dividends, were conducted so as to attract the patronage of the farmer stockholders and render the enterprise cooperative. The milling company was fairly successful until about 1919 or 1920, when market conditions became unsettled. Heavy losses were suffered in 1921 and 1922, due in part to speculation in the grain markets and in part to the failure of a commission company which was indebted to the milling company. The milling company had borrowed $72,000 from several banks. The debt was secured by the deposit of collateral in the form of the entire issue, $72,000, par value, of bonds of the milling company, which bonds were secured by a first mortgage*3634 on all of its property. Thirty thousand dollars of the $72,000 indebtedness was further secured by the endorsements of directors on the notes of the milling company. The milling company, in 1922, in addition to the $72,000 was indebted to five directors for $3,500 and to two directors for $2,000 borrowed money and for certain taxes then assessed, due and payable. Efforts were made to borrow more money but without success. Similarly, endeavors to dispose of the property of the milling company met with failure. In the latter part of 1922, J. E. Babbitt of Cleveland, Ohio, a mill representative and commission flour salesman who was interested in preserving an outlet for the sale of his commodities in Fostoria, tendered a written offer to purchase all of the assets of the milling company agreeing in consideration therefor to assume, pay off and discharge all taxes then a lien on the property or then levied and assessed, and the indebtedness of $72,000, $3,500 and $2,000, together with all interest due thereon. A stockholders' meeting was held on November 28, 1922, at which meeting 811 shares of capital stock were represented and acceptance of the Babbitt *1403 proposal was*3635 authorized by a vote of 677 for and 134 against the motion. Babbitt did not have the means to own and operate the property and his offer was with intention to organize a new corporation and effect the purchase through same. Petitioner was incorporated on December 19, 1922, by five individuals - Emerine, Twining, Newson, Slosser and Mickey, all of whom were stockholders of the milling company. The authorized capital of petitioner was 1,500 shares of preferred stock, par value $100 per share, and 2,500 shares of common stock without par value. Five hundred dollars in cash was paid in by the incorporators for common stock on a basis of $5 per share. The first officers of petitioner were J. L. Newson, president, also president of the milling company, Oscar Slosser, secretary and treasurer, also secretary of the milling company, and J. W. Mickey, vice president, also a stockholder of the milling company. Under date of January 12, 1923, Babbitt offered to petitioner in writing, to sell to petitioner all of the property of the milling company in consideration of the assumption by petitioner of all of the liabilities of the milling company listed in Babbitt's agreement with the*3636 milling company, and in addition, $500 in cash and 900 shares of non-par common capital stock of petitioner. Acceptance of the proposal was authorized by the stockholders of petitioner. Under date of January 12, 1923, title to all of its property subject to the mortgage for $72,000 passed from the milling company direct to petitioner by warranty deed, and by bill of sale. Under the same date Babbitt transferred to Oscar Slosser the right to receive the $500 cash and 800 shares of the 900 shares of common stock due Babbitt in consideration of the purchase of the property by petitioner. The 800 shares were issued to Slosser and he subsequently disposed of them in part in the payment of bonuses to stockholders of petitioner. As an extra inducement stockholders of the milling company were offered bonuses of common stock in addition to the bonus offered subscribers for preferred stock, in order to interest as many of them as possible in petitioner. The 100 shares remaining of the 900 shares were issued to Babbitt and are held by him. At the time of the transfer, 361 individuals were stockholders in the milling company. The preferred stock of petitioner was offered to the public*3637 at par with a bonus of common stock. Sales of the preferred stock for cash amounted to $69,000. The 85 individuals who constituted all of the holders of the capital stock of petitioner at the close of 1923 included 80 individuals who also had owned capital stock of the milling company. There were outstanding after *1404 the transfer of the property, 952 shares of common stock of petitioner, including 392 shares owned by the 80 individuals who also had been owners of stock in the milling company. These 392 shares were acquired from Slosser as a bonus. The charter of the milling company eventually was revoked under the laws of Ohio due to the nonpayment of state fees. Upon the transfer of the assets of the milling company to petitioner the latter paid off the indebtedness of that company secured by mortgage amounting to $72,000 and interest on same in the amount of $4,542.40 and also the two notes for $3,500 and $2,000 together with the interest due thereon, and the taxes agreed by the contract of purchase to be assumed. These payments were made partly out of cash paid in for petitioner's preferred stock and partly out of the proceeds of the sale of the mill for $30,000. *3638 The assets of the milling company transferred to petitioner had a fair market value at the time of the sale and transfer not in excess of $75,000. For the year 1920 the milling company made an income and profits-tax return, reporting income of $12,981.53 and paid a tax in the sum of $1,321.21. Under date of April 25, 1924, respondent notified the milling company of an additional income and profits-tax liability for the year 1920, amounting to $959.92, and the deficiency was subsequently assessed against the milling company. OPINION. TRUSSELL: The petitioner herein, the Fostoria Milling & Grain Co., on January 12, 1924, purchased from the Fostoria Milling Co., all of its assets. This appeal is from a proposed assessment by the respondent, under section 280 of the Revenue Act of 1926, of the alleged liability on its part, as the transferee, for unpaid income and profits tax due from the transferor for the calendar year 1920, a deficiency in such taxes having been determined and asserted by respondent against the transferor 14 months subsequent to the sale of its assets to petitioner. There is accordingly no question involved of a statutory lien on a transferred property*3639 for the taxes in question. The only question presented by the appeal is whether, under the facts proven, the petitioner is liable at law or in equity as transferee of the assets of the Fostoria Milling Co. for unpaid income and profits taxes of that company for the calendar year 1920. Petitioner does not question the determination of tax either in principle or amount as made by respondent against the taxpayer, but insists that it is a purchaser in good faith, for value, of the assets of the taxpayer, and as such has no liability at law or in equity for the latter's unpaid *1405 debts and accordingly there can be no assessment against it under section 280 of the Revenue Act of 1926. The section in question provides: SEC. 280. (a) The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, collected, and paid in the same manner and subject to the same provisions and limitations as in the case of a deficiency in a tax imposed by this title (including the provisions in case of delinquency in payment after notice and demand, the provisions authorizing distraint and proceedings in court for collection, and the provisions prohibiting*3640 claims and suits for refunds): (1) The liability, at law or in equity, or a transferee of property of a taxpayer, in respect of the tax (including interest, additional amounts, and additions to the tax provided by law) imposed upon the taxpayer by this title or by any prior income, excess-profits, or war-profits tax Act. By this section it will be noted that no new liability is created on the part of the transferee but merely a method of enforcement of such liability as is already his at law or in equity by reason of the circumstances under which he acquired the property of the taxpayer or by reason of any prior lien attaching to the property at the time of its acquirement. Respondent insists that petitioner is no more than a reorganization and continuation of the taxpayer under a slightly altered name. In support of this he calls attention to the fact that of the 85 stockholders of the present corporation 80 were stockholders in the old corporation; that it is carrying on the same business and with the same physical assets. He further insists that even though it were not a continuation or successor of the old corporation it is still liable in equity under the trust-fund*3641 theory that the assets of a corporation are impressed with a trust in favor of creditors and if sold and transferred can be followed by a creditor whose claim is not satisfied. Petitioner insists that it is not a reorganization of the taxpayer corporation but an entirely new, separate and distinct corporation, organized by 80 of the 361 stockholders of the taxpayer. It admits that it was organized for the purpose of purchasing the assets of the taxpayer and carrying on the business, but insists that its capital represents no interest of a stockholder in the former company but is new capital paid in by these certain stockholders of the former company as individuals and these amounts paid in do not represent assets of the old company distributed to stockholders, as there was no such distribution, as all stockholders in the old company lost their entire investment therein. It further insists that it purchased the assets of the old company for full value. The record shows to our satisfaction that the Fostoria Milling Co., with a capitalization of $100,000, sustained in 1921 and 1922 losses in two ventures in very large amounts and found itself near the close *1406 of the*3642 latter year insolvent, and unable to borrow funds to continue business. Its indebtedness to local banks amounted to $72,000 against which it had deposited collateral consisting of a similar amount of its bonds, secured by a first mortgage upon its property. Of this indebtedness $30,000 was additionally secured by personal endorsements of its directors. It was further indebted to several of its directors for $5,500 borrowed to pay current bills and in addition had various items of indebtedness such as unpaid salaries and taxes. The banks were pressing for payment and the business was at a standstill. Faced with this situation it can easily be seen that to avoid foreclosure and forced sale there were two courses open, either a reorganization by the stockholders or a voluntary sale of the property at a figure sufficient to meet existing indebtedness or at least one in excess of the sum which the property would likely bring at a forced sale. Efforts were made by the officers of the taxpayer to find a purchaser for the property. It was thought that the fair market price of the property was between $70,000 and $75,000 but no purchaser could be found at that figure and no offers were*3643 made for the property. It is testified by the former officers of the Fostoria Milling Co. that strenuous efforts to find a purchaser at a figure sufficient to pay the known indebtedness were made and this testimony can be readily believed when we consider that these men were individuals bound by indorsement on $30,000 of this indebtedness and were faced with a condition presenting a probability of loss not only of their total investment in the corporation but a much larger amount in addition. The failure to find a purchaser willing to pay $70,000 for the property indicated that a forced sale under foreclosure would be at a very much lower figure and one much below the amount of known indebtedness and less than the bonded indebtedness. The condition faced by the company and its directors was discussed by the latter with a Mr. Babbitt, a flour mill agent of Cleveland, Ohio, from whom for some years the company had made regular purchases of flour. Babbitt was not a stockholder of the company and had no interest in the matter other than to keep a good customer from whose account he had profited. This party conceived a plan of organizing a new company composed of the directors*3644 of the old company, who were faced with a large individual loss on their endorsements of the old company's paper, and such of its stockholders as could be induced to take stock together with what new parties they could interest, this company to purchase all of the assets of the old business for a consideration consisting of the assumption of the known indebtedness amounting to approximately $80,000. *1407 In carrying out this arrangement, Babbitt, in his own name, made an offer to the Fostoria Milling Co. agreeing to assume and pay this indebtedness for a conveyance of all of its assets. This was accepted by the directors and submitted to and approved by the stockholders by a vote of 677 shares for and 134 against the proposal. A new corporation, the petitioner herein, was then organized and the assets of the Fostoria Milling Co. were conveyed direct to it by direction of Babbitt, under an agreement made by it with the latter to accept them for a consideration consisting of the liability of Babbitt to pay indebtedness of the old company under his agreement with it, and also the payment to Babbitt of $500 cash and 900 shares of no par value common stock of the new company. *3645 The new company was organized with an authorized capital stock of 1,500 shares preferred, of a par value of $100 each, and 2,500 shares of no par value common stock. Eighty out of a total of 361 of the stockholders of the old company and five individuals who had no interest in that company subscribed for $69,000 preferred stock of the new company, paying par for it. The business of the old company was of a cooperative nature, serving a farming community, the farmers in that section having been its organizers and stockholders. It afforded a market for the grain produced in a comparatively small surrounding territory. That company was largely dependent on this business, the control of which was made possible by the personal interest of these producers in the business. For the same reason a new company organized to take over the business, to be successful, had to be local in character and number among its stockholders as many as possible of those with whom its daily business would be carried on. Unless it secured the personal interest of a considerable number of the local producers of grain its chance of successful operation would be doubtful in view of the fact that it had*3646 as a competitor in the same city one of the largest mills in the State. It thus became necessary to the new company to secure as stockholders as many of these local farmers as possible and those recognizing the necessity to the local farmer of maintaining a mill under their control were in large measure already stockholders of the old company. Petitioner insists that there is no improper significance attached to the fact that of the 85 stockholders of the new company 80 had been stockholders in the old, but that this is due to the fact that the stock membership of the old company represented those to whose interest it was to maintain a local and cooperative business of this character and consequently they were necessarily the ones who wished to invest in the new company and whom the new company desired most to interest, and this desire on the part of each was *1408 wholly aside from the fact that they had been stockholders in the old company. The conditions testified to indicate strongly to us that the stock membership of the old company was composed of those parties whose individual interest was necessary to the successful operation of any new company which might be*3647 organized to carry on the business and consequently we can not consider the fact that 80 of the 85 stockholders in the new company were stockholders in the old as indicating that the former was a continuation or successor of the latter. The test of that is not identity of stock ownership in the two companies but whether or not some interest of the stockholders in the old is preserved to them in the new. It can not, in our opinion, be said that petitioner was a reorganization of the old company. There was no merger nor consolidation. American Railway Express v. Commonwealth,190 Ky. 636">190 Ky. 636, 228 S.W. 433">228 S.W. 433; Little Rock Chamber of Commerce v. Reliable Furniture Co.,138 Ark. 403">138 Ark. 403, 211 S.W. 371">211 S.W. 371. The organization of petitioner was distinct and separate. All of the issued preferred stock of petitioner was sold at par for cash or its equivalent, and the fact that persons interested in petitioner were also interested in the former company would not of itself render petitioner liable for its debts. *3648 Anderson v. War Eagle Consol. Min. Co., 8 Idaho, 789, 72 Pac. 671; Racine Eng. & Mch. Co. v. Confectioners Mch. Co.,234 Fed. 876. Respondent calls attention to the fact that stockholders of the old company were given a bonus in common stock on preferred stock sold them in the new in excess of the bonus given purchasers who had not been stockholders in the old. We can not see that this alters the case as none of the stockholders in the old company were given any stock in the new, either common or preferred, because of such interest. In the organization of the latter no interest was given the stockholders of the old company as such. Such common stock as was given them by way of bonus was because of their new investment, and if of any value it was value represented by the new capital invested and not by the assets of the old company. In view of the record we can not but view petitioner as a new and independent corporation and accordingly must consider whether the purchase of those assets by it was under such conditions as would impress those assets with a trust in favor of creditors whose claims were not satisfied. We can not find the*3649 slightest evidence in the record of bad faith on the part of the taxpayer or petitioner in connection with this transaction. There is no indication in this sale of assets of an intent to defraud or defeat the claims of creditors. The contrary is clearly shown by the fact that the sale provided specifically for the payment of every indebtedness then known to the taxpayer and that all of these debts were paid by the purchaser on taking the property. *1409 Petitioner insists also that it paid the full value of the property and this assertion is supported by the record. The best evidence of the value of the property is the fact that with $72,000 of indebtedness the banks refused to make further loans and even required the personal endorsements of the directors on $30,000 of this amount although secured by a first mortgage on all the property of the taxpayer. At the hearing several of the former officers of the milling company testified to the efforts made to find a purchaser. They estimated the market value of the property to be between $70,000 and $75,000 and told of unsuccessful attempts made to find a purchaser at or between those figures. *3650 This testimony as to value is uncontradicted. We can not but conclude that a fair market value for the property was not in excess of $75,000 and the consideration actually paid by the purchaser under this sale was the equivalent of an amount in excess of $80,000 in the assumption and subsequent payment of debts, as the satisfaction of an antecedent debt is a consideration of the value of the debt satisfied. Wareheim v. Bayliss (Md.), 131 Atl. 27. Atkinson v. Western Development Syndicate,170 Cal. 503">170 Cal. 503; 150 Pac. 360; Justice v. Catlettsburg Timber Co.,168 Ky. 665">168 Ky. 665; 182 S.W. 831">182 S.W. 831. It is quite apparent that the consideration paid by petitioner was if anything in excess of the actual market value of the property and the payment of such a consideration was due in large measure to the fact that the directors of the taxpayer were thereby escaping a personal liability incurred through their indorsement of its paper. It can scarcely be thought that there was a lack of consideration for the sale when many of the stockholders assenting to it were thereby deprived of any chance of benefiting, as they were*3651 not interested in the purchasing corporation in any way, and when we consider the fact that this was a cooperative, neighborhood corporation and these stockholders were its customers, in daily contact with it, and in position to personally know its actual condition and fair value. Had the consideration been inadequate these stockholders would have suffered to that extent and we can not conceive of their approving the sale under those conditions with the knowledge which they must have possessed. The question then to be determined is whether in a case of the purchase of all the assets of a corporation by another in good faith and for a consideration equivalent to their value, such assets are taken impressed with a trust in favor of creditors whose claims are not provided for. In the case of Wood v. Dummer, 3 Mason, 308; 30 Fed. Cases 435, Justice Story originated the doctrine that the capital assets of a *1410 corporation constituted a trust fund so far as corporate creditors were concerned and should be in equity so considered. This opinion was the authority for decisions by the courts in many cases in following years holding transfers by corporations*3652 of all of their assets void as against creditors. It finally became recognized, however, that the trust-fund theory as a distinct theory of legal responsibility in cases of sales of corporate assets was unsound as too broad, as there were many cases which must on their facts be excepted from its application, and consideration of these exceptions shows that these cases to which the rule could be applied were upon facts which would invalidate such sales, as to creditors, under the general rules applying to fraudulent conveyances by individuals. The trust fund theory does not exist in England. It is purely an American doctrine. The fact is that the trust fund theory has beclouded rather than clarified the subject. For instance, on account of this theory some of the courts have fallen into error and hold that when a corporation is insolvent it cannot prefer one creditor as against another. The trust fund theory may well be superseded by the fact that the capital stock of a corporation is like the capital of a business man, and that just as he cannot, as against his creditors, give it away or forgive the debts of those who owe him, so the corporation cannot, as against its creditors, *3653 release subscriptions, give away its assets to stockholders by way of dividends, or buy its own stock with funds, which, upon insolvency, belong to its creditors instead of the stockholders. (Cook on Corporations, section 9.) An examination of the decisions in cases where the transfer of the capital assets of corporations has been questioned by corporate creditors shows that these fall into three general classes, the first of these being those cases in which the assets of a corporation are sold for an equivalent consideration which, however, under an agreement is paid the stockholders, leaving the corporation without assets to satisfy its creditors. The courts have uniformly held the purchasing corporation liable to creditors of the selling corporation, to the extent of the value of the property received, the sale being in fraud of creditors and the purchaser being a party to such fraud through his knowledge that the result of the transaction must necessarily leave such creditors with no assets from which to satisfy their claims. *3654 United States v. Capps Mfg. Co., 15 Fed.(2d) 528; Grennell v. Detroit Gas Co.,112 Mich. 70">112 Mich. 70, 70 N.W. 413">70 N.W. 413; McWilliams v. Excelsior Coal Co.,298 Fed. 884; Swing v. American Glucose Co.,123 Ill. App. 156">123 Ill.App. 156; Chicago M. & St. P. Ry. v. Third National Bank,134 U.S. 276">134 U.S. 276; Vance v. McNabb Coal & Coke Co.,92 Tenn. 47">92 Tenn. 47, 20 S.W. 424">20 S.W. 424; Berry v. Railroad Co., 52 Kans. 724; 36 Pac. 724; Jennings, Neff & Co. v. Crystal Ice Co.,128 Tenn. 231">128 Tenn. 231, 159 S.W. 1088">159 S.W. 1088, 47 L.R.A. (N.S.) 1058. This rule has even been extended to cases where the consideration paid was stock of the purchasing corporation delivered to the seller, the court refusing to confine the creditors to the satisfaction of their claims out of the asset represented *1411 by this stock, on the ground that such a sale converted the assets from something which could easily be reached and impounded to one which could be easily transferred to defeat creditors and in many cases would necessitate their going into foreign jurisdiction to assert their claims. See *3655 Hibernia Ins. Co. v. St. Louis & New Orleans Transportation Co.,13 Fed. 516. The second general class of cases is that involving sales of all assets of a corporation in effecting a consolidation, merger or reorganization in which the rights and interests of the stockholders in an old corporation are represented in the new. In these cases the courts hold the new corporation liable to creditors of the old upon the ground that by the arrangement effected the interests of stockholders are sought to be maintained as against the creditors, which would constitute a fraud upon the latter, whose rights are superior, and in view of this fact an implied agreement on the part of the new corporation to assume the indebtedness of the old will be presumed. Cashman v. Brownlee,128 Ind. 266">128 Ind. 266, 27 N.E. 560">27 N.E. 560; Berthold v. Holladay-Klotz Land & Lumber Co.,91 Mo.App. 233; Langhorne v. Richmond R. Co.,91 Va. 369">91 Va. 369, 22 S.E. 159">22 S.E. 159; United States Capsule Co. v. Isaacs,23 Ind. App. 533">23 Ind.App. 533, 55 N.E. 832">55 N.E. 832; *3656 Shadford v. Railroad Co.,130 Mich. 300">130 Mich. 300, 89 N.W. 960">89 N.W. 960; Couse v. Columbia Powder Mfg. Co. (N.J.), 33 Atl. 297; Tacoma Ledger Co. v. Western Home Building Association,37 Wash. 467">37 Wash. 467, 79 Pac. 992; Central Railroad v. Paul,93 Fed. 878; Austin v. Tecumseh National Bank,49 Nebr. 413, 68 N.W. 628">68 N.W. 628; Blanc v. Paymaster Mining Co.,95 Cal. 524">95 Cal. 524, 30 Pac. 765; Blair v. Railroad,24 Fed. 148; McVicher v. American Opera Co.,40 Fed. 861; Wolff v. Shreveport Gas Co.,138 La. 743">138 La. 743, L.R.A. 1916D 1138, 70 So. 789">70 So. 789; Luedecke v. Des Moines Cabinet Co.,140 Iowa 223">140 Ia. 223, 32 L.R.A. (N.S.) 616, 118 N.W. 456">118 N.W. 456; Okmulgee Window Glass Co. v. Frick,260 Fed. 159. The authorities in cases falling within the general class above referred to, in most cases, hold that there is a liability at law on the part of the new corporation on the ground that an agreement to assume the debts of the old corporation is implied from the circumstances of the transaction, but some authorities hold the*3657 creditor limited to the relief equity will give in voiding the transfer on the ground of fraud or fixing a lien on the transferred property in his favor. Armour v. E. Bement's Sons,123 Fed. 56. The third general class of cases includes those in which a corporation by one transaction disposes of all of its assets for a sufficient consideration other than stock of the purchasing corporation, received by it individually and in which its stockholders do not participate by division, or where that consideration is an agreement by the purchaser to assume and pay certain specified indebtedness. *1412 The general rule in respect to such sales, whereby the corporation disposes of all of its property and practically ceases to do business, leaving unpaid obligations, is that it will be carefully scrutinized and a strict accountability for any bad faith discovered will be applied against the purchasing company, but where nothing appears tending to show that the sale was made upon inadequate consideration, or was characterized by bad faith, the purchaser takes the property without liability for payment of the vendor's unsecured debts. *3658 In re Locust Building Co.299 Fed. 756; Hannegan v. Denver S.F.R. Co.,43 Colo. 122">43 Col. 122, 16 L.R.A., (N.S.) 874, 95 Pac. 343; Byrne Hammer Dry Goods Co. v. Willis-Dunn Co.,23 S.D. 221, 29 L.R.A. (N.S.) 589, 121 N.W. 620">121 N.W. 620; Valley Bank v. Malcolm,23 Ariz. 395">23 Ariz. 395, 204 Pac. 207; Hawkins v. Central Ry. Co.,119 Ga. 159">119 Ga. 159, 46 S.E. 82">46 S.E. 82; Vicksburg and Y. City Tel. Co. v. Citizens Tel. Co.,49 Miss. 341">49 Miss. 341, 30 So. 725">30 So. 725; Anderson v. War Eagle Consol. Mining Co., 8 Idaho, 789, 72 Pac. 671; Chattanooga R. & C. Ry. Co. v. Evans,66 Fed. 809; Taenzer & Co. v. Chicago, Rock Island & Pacific Ry.,170 Fed. 240; Equitable Trust Co. v. United Box Board & Paper Co.,220 Fed. 714; Drovers & Merchants National Bank v. Third National Bank,260 Fed. 9; Amer. Ry. Express Co. v. Commonwealth,190 Ky 636, 228 S.W. 433">228 S.W. 433. In the last cited case the court said: It is equally well settled that when a sale is a bona fide transaction, and the selling corporation*3659 receives money to pay its debts, or property that may be subjected for the payment of its debts and liabilities, equal to a payment of a fair value of the property conveyed by it, the purchasing corporation will not, in the absence of a contract obligation or active fraud of some substantial character, be held responsible for the debts or liabilities of the selling corporation. Even in those cases in which there was constructive fraud on the creditors by the corporation in the sale of the assets for less than their value, it is held that the purchaser, in the absence of active fraud on his part, will be called upon to answer to creditors of the seller only to the extent of that portion of the property received over and above the value of the consideration paid by him. Malcolm Savings Bank v. Mehlin (Ia.), 205 N.W. 788">205 N.W. 788; Tillman v. Heller,78 Tex. 597">78 Tex. 597; 14 S.W. 700">14 S.W. 700; 11 L.R.A. (N.S.) 628; Love v. Bracamonte (Ariz.), 240 Pac. 351; Overstreet v. Citizens Bank,12 Okla. 383">12 Okla. 383; *3660 72 Pac. 379. See also Hibernia Ins. Co. v. St. Louis Transportation Co., supra.The cases cited by respondent in his brief holding transfers of assets void as against creditors are all cases falling within the first or second general class mentioned above. In Railroad v. Howard,7 Wall. 392">7 Wall. 392; Northern Pacific Ry. Co. v. Boyd,228 U.S. 482">228 U.S. 482; Georgia Railway v. Paul,93 Fed. 878; Ex parte Savings Bank of Rock Hill,73 S.C. 393">73 S.C. 393, 5 L.R.A. (N.S.) 520; and Jackson v. Knights and Ladies of the Orient, 101 Kans. 383; 167 Pac. 1046, all *1413 cited by respondent, the transfers of assets were transfers in which the consideration paid was enjoyed in part by the stockholders of the selling corporation, either in a division of a cash consideration or in stock of the purchasing corporation, and were properly held to be fraudulent as preferring the rights of stockholders to those of creditors. The case of *3661 Hibernia Ins. Co. v. St. Louis & New Orleans Transportation Co., supra, we have already commented on above. It is not in point with the case before us. In that case a corporation faced with a dangerous lawsuit and chance of a large liability organized a new corporation to which it conveyed all of its assets for stock in that company. The court held that the consideration being stock of the new company, the parties in interest being the same and the consideration paid being much less than the value of the assets conveyed, the new corporation would be considered as assuming the obligations of the old and creditors would not be confined to enforcing their claims against the stock held by the selling corporation. In that case the purpose of the sale was to defraud creditors in placing the assets of the selling corporation beyond their reach. The record in this appeal shows clearly that the disposition of assets of the taxpayer was under conditions which bring it within the third class mentioned. It is not liable at law or in equity for the indebtedness of the Fostoria Milling Co. for unpaid income and profits tax for the year 1920 asserted and assessed against*3662 that company subsequent to the acquiring of the assets in question by petitioner and which indebtedness was unknown to the taxpayer and petitioner at the time of the transaction in question. Reviewed by the Board. Judgment will be entered for the petitioner. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624833/ | Stern & Stern Textiles, Inc., Successor in Interest to Huguet Fabrics Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentStern & Stern Textiles, Inc. v. CommissionerDocket Nos. 31362, 33978, 33979, 53104United States Tax Court26 T.C. 1000; 1956 U.S. Tax Ct. LEXIS 96; September 11, 1956, Filed *96 Decision will be entered for the respondent. Taxpayer now seeks excess profits tax relief under section 722 (b) of the 1939 Code for the taxable years ended September 30, 1942, 1943, 1944, 1945, and 1946. A prior decision of this Court, Huguet Fabrics Corporation, 19 T. C. 535, denied relief to the same taxpayer for the year ended September 30, 1941, on the ground of insufficiency of evidence. The issues and the collateral facts are the same in both cases. Held, the prior decision was a decision on the merits and the doctrine of collateral estoppel prevents the taxpayer from seeking relief in these proceedings. Richard L. Shook, Esq., for the petitioner.Emil Sebetic, Esq., for the respondent. Mulroney, Judge. MULRONEY *1000 OPINION.Petitioner corporation is successor in interest*97 to Huguet Fabrics Corporation, the petitioner in Docket No. 7292, *1001 Huguet Fabrics Corporation, 19 T. C. 535. That case involved petitioner's claims for relief from excess profits taxes for its fiscal year ending September 30, 1941. The petitions filed in the four cases now before the Court allege error in the respondent's disallowance of applications for relief under section 722 (b) (1), (2), (3) (A), (3) (B), (4), and ( 5), Internal Revenue Code of 1939, for the taxable years ending September 30, 1942, 1943, 1944, 1945, and 1946. The four cases were consolidated.One of the issues raised by respondent's answer in each of the four cases was whether petitioner was barred from a hearing on the merits under the doctrine of collateral estoppel by virtue of this Court's determination in the previous case in 19 T.C. 535">19 T. C. 535. We granted respondent's motion for severance of this latter issue and the collateral estoppel issue was submitted and is the only issue to be decided at this time. At the hearing certain facts were stipulated into the record and the entire record and proceedings in Docket No. 7292 were introduced by *98 respondent, together with the Form 991 claims for the years here involved. Petitioner's evidence was designed to show that there was a mistake in the stipulation of facts in prior Docket No. 7292.The doctrine of collateral estoppel, or, as it is sometimes called, estoppel by judgment, is that a decision on the merits in one suit precludes further litigation between the same parties of issues which were presented, litigated, and decided when the controlling facts and applicable legal rules remained unchanged. Fairmont Aluminum Co., 22 T. C. 1377, and cases there cited. It is applicable to tax cases, and we have held a prior determination denying relief under portions of section 722 for one year precludes consideration of claims for relief under identical portions of section 722 for later years. Jacob's Fork Pocahontas Coal Co., 24 T. C. 60; George Kemp Real Estate Co., 17 T. C. 755, affd. 205 F.2d 236">205 F. 2d 236, certiorari denied 346 U.S. 876">346 U.S. 876. Three things must be present before the principles of collateral estoppel are applicable. First, there*99 must be identity of the parties, second, there must be identity of the issues, and third, the controlling facts and applicable legal rules must remain unchanged.Here it was stipulated that the parties in both proceedings are identical. Petitioner makes no argument that there is not substantial identity of issues. We have examined the entire record in both proceedings and compared the Form 991 claims and pleadings in the prior case and in the instant cases and we find the identical matters and issues decided in the prior proceeding were also raised in the instant cases. Petitioner did not allege, and does not argue, that any change has occurred in the applicable legal principles. In Jacob's Fork Pocahontas Coal Co., supra, we pointed out there has been no change in the legal rules applicable in section 722 cases.*1002 Petitioner on brief narrowed his defense to the estoppel by judgment plea to the "controlling facts" requirement. His argument is that the facts of the prior case and those of the present case are different. And this is so, petitioner argues, "due to a mutual mistake of fact made by the respondent and the petitioner in a stipulation*100 in the prior trial." Petitioner adds another argument to the effect that the collateral estoppel plea should be denied for it will result in injustice to the taxpayer.The facts found in our prior case in 19 T. C. 535 can be incorporated here by reference but we feel it would be helpful to give a short summary by way of background for the discussion of the issues now before us.Petitioner, a silk manufacturing company, sought relief from excess profits tax for its fiscal year ending September 30, 1941, under the provisions of section 722 (b) of the 1939 Internal Revenue Code. Respondent denied relief and in Docket No. 7292 petitioner sought to prove the denial was error on the general ground that its average base period net income is an inadequate standard of normal earnings. Its main reliance was on the allegation that it changed the character of its business during its base period by going into a new and different market with a new and different product. In Docket No. 7292 we found as a fact that petitioner commenced the manufacture and sale of fabrics manufactured from nylon in the last quarter of its last fiscal year of its base period ended September*101 30, 1940. We there held this was a change from its silk and combination silk and rayon manufacturing business but the differences in the products were insufficient to satisfy the requirements of the statute. That is, the evidence of some differences which its nylon fabric possessed which distinguished it from silk or combination of silk and rayon fabrics was insufficient to establish a change in the character of taxpayer's business when it started manufacturing nylon fabric.Our Opinion in Docket No. 7292 next takes up the "further argument" advanced by petitioner that it went into a new business. This argument was that all of the nylon fabrics were in fact sold to the manufacturers of ladies' brassieres and girdles, whereas prior to the time the petitioner manufactured and sold nylon fabrics all of its sales of all of its fabrics were made through jobbers. We examined and discussed the evidence relied on to establish this point saying:Relevant evidence with respect to this point is contained in (1) several pages of a somewhat general and incomplete stipulation and (2) a very general statement of an interested witness, a person who was the general manager, vice president and*102 a director of the petitioner during the taxable periods involved. * * *We quoted much of the testimony of the witness referred to above and then summarized it stating it was "to the effect that during the *1003 base period petitioner sold all its nylon fabrics directly to the manufacturers of ladies' brassieres and girdles." We pointed out the witness's testimony did not identify such sales and we quoted another portion of his testimony that was confusing and cast some doubt on the accuracy of his statement that all base period sales of nylon were made to the undergarment industry.We next looked at the stipulation which showed that in the month of September 1940 the sales to 5 jobbers (including sales to Wm. Cohen Fabrics, $ 8,579.25) totaled $ 81,719.84, and the total sales that month were $ 90,939.50, of which $ 10,346.45 were sales of nylon. This allowed the inference that at least $ 1,126.79 nylon sales were made to jobbers in September 1939, none of whom were manufacturers of undergarments.Here is where petitioner centers his argument in the instant cases. His evidence is designed to show that the portion of the stipulation showing sales to jobber Wm. Cohen Fabrics *103 of $ 8,579.25 in September 1940 was wrong; that in fact there were no sales to Wm. Cohen Fabrics in September 1940 at all; that this was a mutual mistake of fact in the stipulation, and the true fact is the sales to jobbers in the month of September 1940 were $ 73,140.59. Petitioner's argument is that in Docket No. 7292 our "decision turned upon this finding" that $ 1,126.79 nylon sales were made to jobbers showing no clear-cut change in selling policy by the petitioner such as to warrant the application of section 722. From this he argues the facts in the instant cases are different from the facts in the prior case and thus one of the essential elements for the application of collateral estoppel is not present.We need not go into the question of whether petitioner's evidence establishes no sales were made to Wm. Cohen Fabrics in September 1940. We can assume it does. The controlling facts were the ultimate facts or the events and results that occurred during the base period, not the evidence by which petitioner sought to establish what occurred. The allegations of fact in the instant cases were substantially identical to the allegations in the former case.In the prior*104 case the petitioner introduced certain evidence designed to produce a conviction in the mind as to the existence of the ultimate facts which would warrant section 722 relief. We held that evidence insufficient. The fact that petitioner could now produce more or different evidence which would tend to prove the same ultimate facts it sought to prove in the first case does not entitle it to relitigate the issue. Petitioner fails to distinguish between evidence and the ultimate facts to be found from the evidence introduced. The stipulation of facts was not different from the other evidence. It was merely an admission of certain evidentiary facts relieving the party of the inconvenience of making other proof. As an admission it is considered and weighed like other evidence and it is considered in the light of *1004 other evidence in arriving at the ultimate determination. Even if one or more of the evidentiary facts introduced are erroneous, the ultimate determination stands as a bar to relitigation. If this were not so there would be no end to litigation. In Fairmont Aluminum Co., supra, we said at page 1381:Perhaps, on a different record, *105 a different result might follow, but it is the essence of the doctrine of collateral estoppel that only one opportunity be given, in the normal course, to litigate an issue. * * *Petitioner is in the same situation as it would be if its bookkeeper had testified as to the sales to jobbers and he was defending against the bar of the judgment on the ground his testimony as to the sales to 1 jobber during 1 month was wrong.Petitioner had the burden of proof and the prior adjudication is based upon his failure to discharge that burden. We said in our Opinion: "insufficient evidence was introduced to establish the existence during the base period of a qualifying change within the requirements of section 722 of the Code [19 T. C. 535, 547]." It cannot be said, as petitioner now argues, our decision in the prior case "turned" on this bit of evidence which petitioner now says is wrong. The petitioner in the prior case was endeavoring to show it changed the character of its business by the stipulation and the testimony of the witness to the general effect that after it started manufacturing nylon it sold nylon fabric direct to manufacturers instead of through *106 jobbers. We held both testimony and stipulation insufficient to establish that fact and in passing we also pointed out certain portions of the stipulation even warranted an inference it did not wholly change its method of doing business. But the Opinion was not based and did not "turn" on the correctness of such inferences. It was grounded solely on the insufficiency of the evidence. We drew other inferences from other portions of the stipulation which indicated nylon sales might well have been made to jobbers in the base period and we pointed out there was a complete lack of any evidence showing nylon sales to specifically named manufacturers of brassieres and girdles until after the base period. Finally we pointed out that even if nylon sales were made to manufacturers, and, as the witness stated, the jobbers' percentages were eliminated, the petitioner failed to show the benefit of such elimination of any such commission was not passed on to the manufacturers of girdles and brassieres in the form of reduced selling prices. It is abundantly clear our Opinion in the former case was on the merits and it turned on the insufficiency of the evidence. In Fairmont Aluminum Co., supra,*107 we said at page 1381:There is a burden of proof on some party in every case, and even though the adjudication may be rested upon a failure to discharge that burden it is nonetheless an adjudication on the merits. * * **1005 As a decision on the merits the estoppel of the judgment on the fact issue presented is complete.Little need be said with respect to petitioner's other point that estoppel by judgment should not be applied because it will result in injustice. Petitioner's argument stems from language in Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, where it is stated: "where two cases involve income taxes in different taxable years, collateral estoppel must be used with its limitations carefully in mind so as to avoid injustice."The opinion in the Sunnen case merely holds the doctrine of collateral estoppel should be confined to cases "where the matter raised in the second suit is identical in all respects with that decided in the first proceeding and where the controlling facts and applicable legal rules remain unchanged."We have held the stated requirements are present here and when that is so, the Sunnen case holds, "the prior *108 judgment will be conclusive as to the same legal issues which appear, assuming no intervening doctrinal change."The application of the doctrine of collateral estoppel in tax cases is of as much benefit to taxpayers generally as to respondent. It is grounded upon the principle that relitigation of identical issues "tends to defeat the ends of justice." Fairmont Aluminum Co., supra. Of interest is Arthur Curtiss James, 31 B. T. A. 712, wherein the taxpayer was asserting the doctrine of collateral estoppel and the Commissioner contended the prior decision was based on an erroneous fact (accumulated earnings and profits figure) contained in the stipulation, and therefore the doctrine of collateral estoppel did not apply. We held for the taxpayer saying the prior decision "conclusively established" the fact.Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624834/ | APPEAL OF CONRAD & CO., INC.Conrad & Co. v. CommissionerDocket No. 3941.United States Board of Tax Appeals3 B.T.A. 692; 1926 BTA LEXIS 2575; February 13, 1926, Decided Submitted October 27, 1925. *2575 In the reorganization of a business, a partnership paid in to a corporation on November 1, 1917, all of its tangible assets for all the capital stock of the corporation, and all of its intangible assets upon an agreement by the corporation to assume its liabilities and to pay its debts. For the net assets of the partnership the partners received all the shares of capital stock of the corporation. Held, that section 331 of the Revenue Act of 1918 prevents the corporation from valuing the net assets at a greater amount in computing invested capital than the partnership could have valued them in computing invested capital if they had not been so transferred. Hugh Satterlee, Esq., for the taxpayer. Ward Loveless, Esq., for the Commissioner. SMITH *692 Before JAMES, SMITH, and TRUSSELL. This is an appeal from the determination of a deficiency in income and profits tax for a four-month fiscal period ended February 28, 1918, of $3,794.91. The question in issue is whether section 331 of the Revenue Act of 1918 is applicable to the facts as disclosed by the record in this appeal. FINDINGS OF FACT. The taxpayer is a Massachusetts corporation, *2576 with its principal office in Boston. It was incorporated on or about November 1, 1917, with an authorized capital stock of $500,000 par value. It established a fiscal year ending February 28, and has made its Federal income-tax returns on the accrual basis for such accounting period. On or about November 1, 1917, the taxpayer entered into a contract with Sidney S. Conrad and Bertram B. Conrad, partners, doing business under the firm name of Conrad & Co., a copy of which is as follows: MEMORANDUM OF AGREEMENT entered into this first day of November, 1917, by and between Sidney S. Conrad, of Boston, in the County of Suffolk, and Bertram B. Conrad, of Brookline, in the County of Norfolk, both in the Commonwealth of Massachusetts, co-partners under the firm name of Conrad & Company, parties of the first part, and Conrad & Co., Inc., a corporation organized under the laws of the said Commonwealth of Massachusetts, party of the second part, WITNESSETH that WHEREAS the said partnership has heretofore carried on the business at 25 Winter Street in the City of Boston, and is the owner of the assets connected therewith, and the said corporation desires to purchase the said business*2577 and to issue its capital stock in payment therefor: Now, THEREFORE, it is hereby agreed by and between the parties hereto as follows: *693 First: The said Sidney S. Conrad and Bertram B. Conrad, co-partners as aforesaid, hereby assign, transfer and set over unto the said Conrad & Co., Inc., its successors and assigns, the cash accounts and notes receivable, stock of merchandise, furniture, fixtures, equipment, and all other tangible assets of whatever kind and description belonging to the said business, to have and to hold the same unto the said corporation, its successors and assigns, to their own use forever; and further covenant with the said corporation that the said property as aforesaid is of the fair value of the amount of not less than Four hundred ninety-nine thousand seven hundred ($499,700) dollars, and is free from all encumbrances, and that the said co-partners have full right to convey the same, and will each of them make, execute and deliver any further writings or instruments which may be necessary or convenient to vest a perfect title to the said property in the said corporation and to secure to the said corporation full benefit and enjoyment of the said*2578 property. And the said corporation hereby agrees to issue shares of its capital stock of the par value of one hundred dollars each at par to the said co-partners or to such persons as they may designate as payment for the foregoing property, said shares to be issued to an amount equal at their aggregate par value to the value of said property transferred as aforesaid, as of November 1, 1917, as the same may appear according to an inventory of said property to be taken forthwith. Second: The said Sidney S. Conrad and Bertram B. Conrad, co-partners as aforesaid, further agree with the said corporation to sublet to the said corporation the premises 25 Winter Street in the City of Boston, Massachusetts, at which the business of the said Conrad & Company has heretofore been carried on, for the term of the two leases thereof from Charles E. Cotting et al, one dated November 5, 1908, for a term ending October 31, 1920, and the other dated March 19, 1917, for the term beginning November 1, 1920, and ending October 31, 1935, for the rent in the amount reserved in the said leases, the said sub-leases to contain the same terms and provisions set forth in the copies thereof hereto annexed. *2579 Third: The said Sidney S. Conrad and Bertram B. Conrad, co-partners as aforesaid, further convey, assign, transfer and set over unto the said corporation the good will of the said partnership, the trade mark "Lady Dainty" and other trade marks owned by said partnership, and all intangible property belonging to the said partnership not included in the paragraph designated First: and the right to use the name Conrad & Company as a part of the corporate name, and in payment therefor the said corporation agrees to and with said Sidney S. Conrad and Bertram B. Conrad and each of them to assume and pay all the bills payable and other outstanding liabilities of said partnership, including the liability of the said partnership for taxes due now or hereafter to the United States, Commonwealth of Massachusetts, and the City of Boston, and to save the said Sidney S. Conrad and Bertram B. Conrad and each of them forever harmless therefrom. In pursuance of the terms of the above contract, the partnership of Conrad & Co. transferred and conveyed to the taxpayer corporation on or about November 1, 1917, (1) its cash, cash items, merchandise, supplies, and other tangible property, which*2580 cost and had a current cash value of $562,265.20, in exchange for the taxpayer's entire capital stock of $500,000 par value; and (2) certain trademarks and other intangible property, in consideration of the taxpayer's *694 agreement to assume the liabilities and pay the debts of said partnership, which amounted to $147,446.87. In its income and profits-tax return for the four-month period ended February 28, 1918, the taxpayer claimed the amount of $562,265.20 as its invested capital. The Commissioner allowed this amount as the taxpayer's invested capital for the purpose of determining its tax liability under the provisions of the Revenue Act of 1917, but excluded from the claimed invested capital $147,446.87 in determining its tax liability under the provisions of the Revenue Act of 1918. DECISION. The deficiency determined by the Commissioner is approved. OPINION. SMITH: The taxpayer was incorporated on or about November 1, 1917, with an authorized capital stock of $500,000, all of which was issued to the members of a predecessor partnership in exchange for assets. The partnership had tangible assets of a current cash value of $562,265.20 and liabilities of*2581 $147,446.87, or net book assets of $414,815.33. It also had certain intangible assets the cash value of which has not been alleged or proven. The tangible assets were paid in to the taxpayer corporation in exchange for its $500,000 capital stock; the intangible assets were paid in at the same time and under the same contract of sale, and, in payment therefor, the taxpayer agreed to assume all the outstanding liabilities of the partnership, of an admitted amount of $147,446.87. In its income-tax return for the four-month fiscal period ended February 28, 1918, the taxpayer claimed invested capital of $562,262.20 for the purpose of computing its tax liability under both the Revenue Acts of 1917 and 1918. The Commissioner has excluded from this amount $147,446.87 in determining the excess-profits tax liability under the Revenue Act of 1918, such action being predicated upon the Commissioner's interpretation of section 331 of such Act. The taxpayer alleges error upon this point. Section 331 of the Revenue Act of 1918 reads as follows: In the case of the reorganization, consolidation, or change of ownership of a trade or business, or change of ownership of property, after March 3, 1917, if*2582 an interest or control in such trade or business or property of 50 per centum or more remains in the same persons, or any of them, then no asset transferred or received from the previous owner shall, for the purpose of determining invested capital, be allowed a greater value than would have been allowed under this title in computing the invested capital of such previous owner if *695 such asset had not been so transferred or received: Provided, That if such previous owner was not a corporation, then the value of any asset so transferred or received shall be taken at its cost of acquisition (at the date when acquired by such previous owner) with proper allowance for depreciation, impairment, betterment or development, but no addition to the original cost shall be made for any charge or expenditure deducted as expense or otherwise on or after March 1, 1913, in computing the net income of such previous owner for purposes of taxation. The contention of the taxpayer is that the contract of November 1, 1917, under which the assets of the partnership were paid in to the taxpayer corporation, is a severable or divisible contract; that the tangible assets of a current cash value*2583 of $562,262.20 were paid in to the corporation in exchange for its $500,000 capital stock; that the intangible assets of the partnership were purchased for cash and that the paid-in capital of the corporation (tangibles in the amount of $562,262.20), was not affected by the transaction resulting in the acquisition of the intangibles; that section 331 of the Revenue Act of 1918 applies to and limits the determination of invested capital where assets are paid in for shares of stock, and that, in the instant case, since the good will was not paid in for shares of stock, section 331 has no application. We think it is not material to determine whether the contract of November 1, 1917, is an entire contract or a severable contract. The ruling of the Board would have to be the same in either case. The facts are that the partnership had assets of a net value of $414,815.33. It could not value those assets at any greater amount if it were computing its own invested capital. We think that section 331 is a complete bar to any greater value in the computation of the corporate invested capital. In *2584 , we stated with respect to the interpretation of this provision of the 1918 law: It is clear from the sections of the statute quoted above that two purposes are designed to be accomplished, among others, namely, that the taxpayer shall not include in invested capital any borrowed capital, and that, for the purpose of determining invested capital, a taxpayer which is the result of a reorganization after March 3, 1917, shall not be virtue of such reorganization obtain any advantage by comparison with the invested capital which would be allowed to a predecessor had no such reorganization taken place. The situation is the same when a business carried on by a partnership is incorporated after March 3, 1917, and an interest or control in the property of 50 per cent or more remains in the same individuals. In the instant appeal a 100 per cent interest in the property transferred to the corporation remained in the same individuals. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624838/ | DAVID L. HAMMOND AND LILLIAN C. HAMMOND, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentHammond v. CommissionerDocket No. 568-84.United States Tax CourtT.C. Memo 1985-252; 1985 Tax Ct. Memo LEXIS 381; 49 T.C.M. (CCH) 1562; T.C.M. (RIA) 85252; May 28, 1985. B. Roland Freasier, Jr. and Gary S. Cook, for the petitioners. John A. Guarnieri, for the respondent. DAWSONMEMORANDUM OPINION DAWSON, Chief Judge: Respondent determined a deficiency of $128 in petitioners' Federal income tax for the year 1981. The issue for decision is whether petitioner-husband can exclude from income under section 191, 1 or include in income and deduct under section 162, 2 the cash meal reimbursements he received from his employer. *382 This case was submitted fully stipulated. The stipulation of facts and joint exhibits are incorporated herein by this reference. The pertinent facts are set forth below. Petitioners filed a timely joint Federal income tax return for 1981 with the Internal Revenue Service Center in Memphis, Tennessee. At the time the petition was filed in this case, petitioners were husband and wife and resided in Roanoke, Virginia. They were divorced after filing their petition. David L. Hammond (petitioner) was employed during the calendar year 1981 as a state police trooper with the Virginia Department of State Police. During that year he requested and received $342 from his employer as reimbursement of the cost for meals he consumed while on duty. As a state trooper, petitioner was required to be available at all times during his shift to answer emergency calls. For that reason he could not return home to eat his meals unless his home was located inside his area of patrol. Pursuant to the meal reimbursement program of his employer, petitioner submitted monthly expense vouchers for actual expenses he incurred for midshift meals while on duty. He was then reimbursed for these expenses*383 by his employer. This reimbursement was subject to certain limitations. Petitioner was not reimbursed for meals he prepared at home. In addition, he was required to eat only at establishments within his area of patrol that did not serve alcoholic beverages or provide any lewd form of entertainment that would detract from the proper image of a state police officer. However, petitioner was not required to participate in his employer's meal reimbursement program and was allowed to bring his meals from home and eat them in his patrol car if he wished. None of the reimbursements provided to petitioner were for meal expenses incurred while away from home overnight, and none of the meals were provided to petitioner on the premises of his employer or at meal stations owned and operated by the state of Virginia. Petitioner contends that the cash meal reimbursements he received are excludable from income under section 119. He argues that the facts of this case are distinguishable from those in Commissioner v. Kowalski,434 U.S. 77">434 U.S. 77 (1977). Petitioner asserts that Kowalski involved an advance meal allowance program whereby the state troopers therein received a cash*384 advance for meals regardless of the amount they actually spent. He argues that, by contrast, the payments he received are reimbursements for amounts actually expended, and not additional compensation. If the reimbursement is held to be includable in income, petitioner contends alternatively that the meal expenses are deductible as ordinary and necessary expenses incurred by him in his trade or business as a state trooper. To the contrary, respondent contends that the meal reimbursements are not excludable from petitioner's gross income under section 119 because the meals were not furnished in kind on the business premises of his employer. Respondent argues that Commissioner v. Kowalski,supra, supports his contention that section 119 does not act to exclude either cash meal allowances or reimbursements from gross income. We agree with respondent. Section 119 permits a taxpayer to exclude from his gross income the value of meals furnished by his employer, if they are furnished on the employer's premises and for the convenience of the employer.Here petitioner's employer did not furnish him any meals but merely reimbursed him for his meal expense. Despite*385 petitioner's attempt to distinguish Commissioner v. Kowalski,supra, the Supreme Court held in that case that section 119 allowed exclusions for meals furnished by an employer but not for cash reimbursements for meals. In Kowalski, the Supreme Court discussed the legislative history of section 119 and why that section applies only to meals or lodging furnished in kind. See S. Rept. No. 1622, 83d Cong., 2d Sess., 190 (1954); U.S. Code Cong. & Admin. New 1954, p. 4825; section 1.119-1(e), Income Tax Regs. We need not elaborate further on this issue. Suffice it to say that we view the Kowalski, decision as controlling. 3We reject petitioner's alternative argument that the cash meal reimbursements are deductible as business expenses under section 162. Such expenses are only deductible when the employee is away from home overnight. United States v. Correll,389 U.S. 299">389 U.S. 299 (1967). Decision will be entered for respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954 as amended and in effect during the taxable year at issue. ↩2. In his reply brief respondent contends that this issue was not raised in petitioner's pleadings and therefore constitutes new matter. We need not address this issue because it has no effect upon our ultimate resolution of this case.↩3. We note that section 199(b)(3), added to the Internal Revenue Code by Pub. L. 95-427, 92 Stat. 996, and relating to certain fixed charges for meals, does not mandate a different result.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624851/ | Carol F. Hall and Isabel M. Hall, Petitioners, v. Commissioner of Internal Revenue, RespondentHall v. CommissionerDocket 29345United States Tax Court19 T.C. 445; 1952 U.S. Tax Ct. LEXIS 22; December 11, 1952, Promulgated 1952 U.S. Tax Ct. LEXIS 22">*22 Decision will be entered under Rule 50. Petitioner is a partner in an old and well established accounting firm. The partnership agreement provided that upon the death, retirement or withdrawal of a partner his interest in the firm assets and business should be transferred to the continuing partners, that the partnership should not thereby be dissolved, and there should be paid to him or to his estate in settlement of all claims against the continuing partners and the assets, the amount of his capital contribution, the balance of his current account and his proportionate share of profits for the current year. He was also to receive an additional amount to be determined by the administrative partners, which, in case of death or retirement at age 65, was to be equal to not less than his share of three years' earnings, past or future, and was to be paid over a 6-year period out of distributable profits. In 1947 these additional payments were made to retired partners and the estate of a deceased partner. Held: These payments were distributions of income to the retired partners and estate and are deductible by the continuing partners in determining the distributable income taxable1952 U.S. Tax Ct. LEXIS 22">*23 to them. George E. Cleary, Esq., and George Stinson, Esq., for the petitioners.Paul M. Stewart, Jr., Esq., for the respondent. Tietjens, Judge. TIETJENS19 T.C. 445">*445 Respondent determined a deficiency in income tax for the calendar year 1947 in the amount of $ 2,906.29. Petitioners, 1952 U.S. Tax Ct. LEXIS 22">*24 husband and wife, filed a joint return for 1947 with the collector of internal revenue, Customhouse, New York, New York. Petitioner Carol F. Hall is a member of the partnership of Touche, Niven & Co., public accountants and auditors. The partnership's return of income, filed for its fiscal year ended September 30, 1947, reported an amount as ordinary income 19 T.C. 445">*446 distributed to two retired partners and to the estate of a deceased partner. Respondent determined that such payments were made for the purchase of capital assets, the interests of the retiring or deceased partners, and were not expenditures deductible in determining the distributable income of the partnership. Respondent allocated to petitioner Carol F. Hall his pro rata share (7/116) of the amount so paid. The sole issue is whether these payments represent part of the purchase price of partners' interests, or on the other hand distributions of income to the retired partners and the estate of the deceased partner, and therefore deductible in determining the partnership's distributable profits. The deficiency involves other adjustments not in controversy. Certain corrections in the determination are stipulated 1952 U.S. Tax Ct. LEXIS 22">*25 and will be given effect in a computation under Rule 50.This proceeding was consolidated for hearing, but not for opinion, with those of Charles R. Whitworth, et al, Docket No. 28723, and Francis J. Clowes, Docket No. 29262. Whitworth and Clowes were members of the partnership of Touche, Niven & Co., who retired prior to 1947. Respondent determined deficiencies in those cases holding that the payments here in controversy represented distributions of partnership income taxable as ordinary income to the retired partners. Whitworth and Clowes have filed briefs supporting their contentions that the payments were part of the consideration for the purchase of their partnership interests and are taxable to them as capital gains. A joint stipulation of facts with exhibits was filed and testimony introduced which is for consideration in all three proceedings.FINDINGS OF FACT.The stipulated facts are found accordingly and the exhibits attached are incorporated herein by reference.Petitioner Carol F. Hall was in 1947 and has been since 1936 a member of the partnership of Touche, Niven & Co., public accountants and auditors, hereinafter referred to as the firm. The firm kept its1952 U.S. Tax Ct. LEXIS 22">*26 books and filed its partnership returns of income on the basis of fiscal years ended September 30. The firm was originally founded in 1900 by George A. Touch, of London, England, who later changed his name to Touche, and John B. Niven of New York, New York. The firm later established offices in other cities of the United States and Canada with resident partners or resident managers. A partnership agreement signed in 1922 named six members as senior partners, George A. Touche and Andrew W. Tait, of London; John B. Niven, Charles R. Whitworth, Henry E. Mendes, and Francis J. Clowes, in the United States. Other members were admitted to the partnership in later years. Whitworth entered the employ of the firm in 1913 and became a partner in 1919, at which time he made a capital contribution 19 T.C. 445">*447 of $ 12,500. He remained a member of the firm until May 1, 1942. Clowes entered the employ of the firm in 1915 and became a partner in 1919. He made a capital contribution of $ 26,000. He ceased to be a partner as of September 30, 1946, having theretofore attained the age of 65 years. Victor H. Stempf became a member of the firm about 1922. He made a capital contribution of $ 22,000. 1952 U.S. Tax Ct. LEXIS 22">*27 He died on April 18, 1946, while still a partner.A new partnership agreement was signed in 1936, naming seventeen partners, including Carol F. Hall. Five of these were designated administrative partners -- Niven, Whitworth, Mendes, Clowes, and Victor H. Stempf.The partnership agreement of 1936 provided, inter alia:ARTICLE IVFirm NameSection 1. The firm name of Touche, Niven & Co. shall belong to and may be used by the partnership and shall not be sold or disposed of so long as the partnership shall continue in existence.Upon the dissolution of the partnership or the termination thereof as provided in Article I hereof, the firm name shall become the property of the then surviving Administrative partners and may be disposed of in such manner and upon such terms as a majority in interest of the Administrative partners shall determine.Section 2. In the event of the death, retirement, or withdrawal of any of the partners during the term of the partnership, the deceased, retiring or withdrawing partner shall have no interest in the firm name and shall have no right to receive any payment therefor.ARTICLE VManagement and ControlSection 1. The business and affairs of the 1952 U.S. Tax Ct. LEXIS 22">*28 partnership shall be managed and controlled by the Administrative partners and all matters involving the general policy of the firm and its administration shall be decided by the Administrative partners. Except as in this Agreement otherwise specifically provided, in the event of any difference of opinion among the Administrative partners any matter or question shall be decided by a majority in interest of the Administrative partners.* * * *ARTICLE VIIStated CapitalSection 1. The stated capital of the partnership on the taking effect of this Agreement shall consist of the number of units of a stated value of $ 2500 each set forth in the attached Participation Schedule No. 1. The participations of the individual partners in the stated capital shall be in the same ratios as their participations in the distributable profits, and the stated capital at the time of 19 T.C. 445">*448 taking effect of this Agreement shall be contributed by the partners in such ratios and to the amount of their respective participations therein, as set forth in the attached Participation Schedule No. 1 showing the ratio, number of units and amount of the participation of each partner.* * * *Section 3. In the1952 U.S. Tax Ct. LEXIS 22">*29 event of the death, retirement or withdrawal of any of the partners as hereinafter provided, there shall be repaid to such retiring or withdrawing partner or the legal representative of such deceased partner, in the manner provided in Section 1 (c) of Article XI hereof, an amount equal to his paid-up participation in the stated capital at the date of his death, retirement or withdrawal. By decision of a majority in interest of the Administrative partners, the stated capital and the number of units therein may be decreased by the amount of such repayment, or the stated capital and the number of units therein may be readjusted to the former aggregate amount and number or to such other amount, number or stated value, as the Administrative partners may determine, by proportionate contributions from the remaining partners. If the stated capital is decreased by the repayment as aforesaid, the participations of the remaining partners in the remaining stated capital shall remain at the same number of units and the same amounts as before.* * * *ARTICLE XDeath, Retirement or WithdrawalSection 1. The death, retirement or withdrawal of any partner shall not dissolve the partnership between1952 U.S. Tax Ct. LEXIS 22">*30 the other partners.Section 2. Any partner may retire from the partnership at any time after the first day of October, 1936 upon giving six (6) calendar months prior notice in writing of his intention so to do and his retirement shall be effective as at the date specified in such notice, notwithstanding that such date does not coincide with the end of a fiscal year. Such notice shall be deemed to be sufficient if sent by registered mail addressed to the firm at its principal office in New York City not less than six (6) calendar months prior to the date when such retirement is to become effective.* * * *Section 6. Upon the death, retirement or withdrawal of any of the partners during the term of partnership the interest of the deceased, retiring or withdrawing partner in the firm assets and business shall be and become vested in and transferred to the surviving or continuing partners in the proportion of their participations in the stated capital and distributable profits and the retiring or withdrawing partner or the legal representative of the deceased partner shall have no interest in or claim against the firm assets and business or the firm name except the right to receive 1952 U.S. Tax Ct. LEXIS 22">*31 the payments hereinafter provided for in Article XI hereof.* * * *ARTICLE XVIILiquidationSection 1. In the event that the partnership shall be dissolved or terminated by the Administrative partners as in Article I provided, the surviving Administrative 19 T.C. 445">*449 partners shall become the sole and exclusive owners of the firm name, books, records and files of the partnership and shall be entitled to continue the business without liquidation or to liquidate the business or to dispose of the business as a majority in interest of the Administrative partners may determine without accountability to any of the other partners except for the payment to such partners of the amounts due them under the provisions of Section 1 of Article XI hereof. The partnership shall not be deemed to be dissolved or terminated by the death, retirement, or withdrawal of one or more of the partners.Article XI of the agreement was amended by certain Amendatory Agreements in 1940 and 1943. As so amended it provided:ARTICLE XIPayments to Deceased, Retiring or Withdrawing PartnerSection 1. If any partner shall die, retire or withdraw for any reason whatsoever during the term of the partnership there shall1952 U.S. Tax Ct. LEXIS 22">*32 be payable to such retiring or withdrawing partner or to the personal representative of such deceased partner the following payments, which shall be computed and paid in the following manner and at the following times: (a) An amount equal to the sum of (a) any loan by the partner to the firm, (b) any balance standing to his credit in his current account after crediting or debiting such account with all items not theretofore taken into the account but applicable thereto from the close of the preceding fiscal year to the date of his death, retirement or withdrawal, and (c) any other indebtedness due from the firm to him other than the sums due under paragraphs (b) and (c) hereof. Such balance shall be payable immediately.(b) Such proportion of the distributable profits, as defined in Article II hereof, to which he would have been entitled for the then current fiscal year as the period from the beginning of such year to the date of death, retirement or withdrawal shall be to the whole of the then current fiscal year. Such sum shall be credited directly to the partner or his estate and shall be payable thereafter at such time or times and in such amounts during the ensuing fiscal1952 U.S. Tax Ct. LEXIS 22">*33 year as a majority in interest of the Administrative partners may determine.(c) An amount equal to his paid-up participation in the stated capital, as set forth in the Participation Schedule in effect at the date of his death, retirement or withdrawal. Said sum shall be paid in six (6) equal semi-annual instalments, the first of which shall be payable at the expiration of six (6) months from the date of death, retirement or withdrawal, and the unpaid balance thereof shall bear interest at the rate of 5% from the date of death, retirement or withdrawal. The continuing or surviving partners shall have the privilege at any time and from time to time of accelerating the payment of the whole or any part or parts thereof prior to the due date at any time without notice or bonus.The surviving or continuing partners shall have the right to offset against the payments to be made under paragraphs (a), (b) and (c) hereof any claims which the partnership may have against such deceased, retiring or withdrawing partner arising out of the partnership or this Agreement.Section 2. If any partner shall retire pursuant to Section 2 of Article X hereof after attaining the age of sixty-five years1952 U.S. Tax Ct. LEXIS 22">*34 or shall die at any age, there shall 19 T.C. 445">*450 be payable, in addition to the amounts hereinbefore provided in paragraphs (a), (b) and (c) of Section 1 of this Article XI, to such retiring partner, or to the personal representatives of such deceased partner, out of distributable profits, such amount as may be determined by the decision of a majority in interest of the Administrative partners but in no event less than the smaller of the following: (a) an amount equal to three (3) times the annual average of the sum of the salary plus the distributable profits of the partnership which such deceased or retiring partner received or was entitled to receive in respect of the business of the partnership carried on during the ten (10) fiscal years of the partnership next preceding the fiscal year in which such partner died or retired; or(b) an amount equal to the sum of the salary plus the distributable profits of the partnership to which such deceased or retiring partner would have been entitled, if he had not died or retired and if his ratio in the profits of the partnership had not been altered, in respect of the business of the partnership carried on during the three (3) succeeding1952 U.S. Tax Ct. LEXIS 22">*35 fiscal years of the partnership, including the fiscal year in which such partner died or retired, but for the purposes of this subdivision (b) the distributable profits shall be determined after deducting current salaries and current interest on capital of any additional partners as well as those of the surviving or continuing partners.The amount so determined to be payable shall be payable, without interest, in six (6) equal annual instalments, the first of which shall become payable at the expiration of one (1) year from the date of death or retirement or at such earlier date as a majority in interest of the Administrative partners may determine, but, unless the distributable profits then available shall not be sufficient, no annual instalment payment during each of the first three (3) years after such death or retirement shall be less than fifty per cent (50%) of the annual salary of such deceased or retired partner at the date of his death or retirement, or less than five thousand dollars ($ 5,000) per annum.The payment under this Section 2 is intended as a distribution of income to the retiring partner or the estate of a deceased partner for a limited period subsequent to1952 U.S. Tax Ct. LEXIS 22">*36 his retirement or death.* * * *The provisions for the payment to be made under this Section 2 of this Article XI are limited to the cases specifically provided for hereunder and do not apply to any partner who retires or withdraws at any other age or for any other cause.Section 3. Notwithstanding any of the provisions of this Article XI, by decision of a majority in interest of the Administrative partners, there may be paid such sum of money in such instalments as they shall deem advisable to any partner retiring before he attains the age of sixty-five (65) years or to any other partner who may withdraw for any other reason.Section 4. The amounts payable under this Article XI to a retiring or withdrawing partner and to the personal representative of a deceased partner shall be paid by the continuing or surviving partners and accepted by the retiring or withdrawing partner and by the personal representative of a deceased partner in full, final and complete settlement and satisfaction of all the claims of such retiring, withdrawing or deceased partner, as a partner, against the partnership, the surviving or continuing partners, and the assets of the partnership.19 T.C. 445">*451 Under1952 U.S. Tax Ct. LEXIS 22">*37 date of October 27, 1939, Whitworth wrote the firm as follows:I have hitherto expressed the view that I should like to retire from the firm when I reach the age of sixty, which will occur on October 12, 1943. I have been giving further consideration to the matter and am convinced not only that I should retire from the firm on September 30, 1943 but that, in the meantime, I should be relieved of all administrative duties. I feel that the orderly administration of the business and affairs of the firm makes it desirable that I give notice at this time, in a formal manner, of my intention to retire and of my desire for a less active status in the meantime, so that my partners may plan for the future of the firm and act accordingly. Furthermore, in view of the fact that the partnership agreement makes specific provisions for voluntary retirement of a partner only "after attaining the age of sixty-five years" it would also be helpful to me to make definite arrangements with the firm at this time for my retirement and interim status so that I can plan my affairs accordingly.I understand that it is agreeable to the firm that upon my retirement on September 30, 1943, the provisions of1952 U.S. Tax Ct. LEXIS 22">*38 Section 2 of Article XI of the partnership agreement shall be applicable notwithstanding the fact that I shall not have then attained the age of sixty-five years; that in the meantime, except that my aggregate participation in the profits of the firm, including salary, shall not exceed an average for the four years of $ 20,000.00 per annum, my present salary and interest in the distributable profits shall continue unchanged, but that my status shall be no longer that of an administrative partner.Accordingly I hereby give notice of my intention to retire from the firm on September 30, 1943 and agree that my retirement shall be effective as of that date, with the understanding that this letter shall be deemed to be sufficient notice under the provisions of Section 2 of Article X, and that the provisions of Section 2 of Article XI shall be applicable to my retirement and that I shall at that time surrender all of my interest in the firm and the firm name and assets, subject only to my right to receive the payments provided for in said Section 2 of Article XI, as well as the payments provided for in Section 1 of Article XI. It is also understood that upon my request you will accelerate1952 U.S. Tax Ct. LEXIS 22">*39 the payments provided under Section 2 of Article XI so that the said payments shall be made in five instead of six years. It is, of course, understood that in case of my death prior to September 30, 1943, my estate shall not be a partner in the firm and the provisions of Sections 1 and 2 of Article XI with respect to payments upon the death of a partner shall immediately be applicable.From October 1, 1939 until my retirement I shall have a less active status as set forth above but nevertheless I shall retain my interest in the firm and shall be entitled to vote as a member of the firm in accordance with my interest in the distributable profits in connection with firm matters and until my actual retirement my present salary and participation in the distributable profits shall continue subject to the limitation set forth above.If this is agreeable to you will you kindly note your acceptance on the duplicate hereof, and this letter and your acceptance shall constitute an agreement between the firm and myself effective as of the date of your acceptance.The firm noted acceptance of the terms of this letter. Whitworth was relieved of his duties as an administrative partner.19 T.C. 445">*452 1952 U.S. Tax Ct. LEXIS 22">*40 On April 30, 1942, Whitworth retired from the partnership to accept a commission as Assistant Supervisor of Cost Estimate for the Signal Corps, United States Army, in the Chicago District. He was then 59 years of age.After some interim correspondence the firm wrote Whitworth under date of November 27, 1942:Although all arrangements as to your retirement from the firm as of May 1, 1942 have been heretofore informally agreed upon, it seems to us advisable to incorporate our agreement in a letter signed by the firm and approved by you.This will confirm your retirement as a partner in the firm of Touche, Niven & Co. as of May 1, 1942. Notwithstanding your retirement, the financial arrangements agreed upon in our agreement of October 27, 1939 shall remain unchanged and accordingly you shall be entitled to receive the following payments: 1. For the fiscal years ending September 30, 1942 and September 30, 1943 you shall receive an amount equal to your salary and interest in the distributable profits of the firm under the partnership agreement the same as though you had remained a member of the firm, except that (a) as provided in our agreement of October 27, 1939, your aggregate 1952 U.S. Tax Ct. LEXIS 22">*41 participation in the profits of the firm, including salary, shall not exceed an average for the four years ending September 30, 1943 of $ 20,000 per annum but (b) any deficiency below $ 20,000 per annum in any of said four years shall be made good to the extent of any excess over $ 20,000 available from any prior or subsequent year of said four year period, the intention being that the average for the four year period shall be determined on a cumulative basis.2. Notwithstanding the fact that you have not and will not have attained the age of sixty-five years on September 30, 1943, you shall be entitled to receive the retirement payments provided for in Section 2 of Article XI of the Partnership Agreement which shall be computed and be payable as if you had retired on September 30, 1943 except that, upon your request, we will accelerate the payments provided under Section 2 of Article XI so that the said payments shall be made in five instead of six years.3. You shall be entitled to receive the payments provided for in Section 1 of Article XI of the Partnership Agreement but, notwithstanding your retirement as of May 1, 1942, said payments shall be determined and be payable as if 1952 U.S. Tax Ct. LEXIS 22">*42 you had retired on September 30, 1943.4. It is understood that in case of your death prior to September 30, 1943 the provisions of Sections 1 and 2 of Article XI with respect to payments upon the death of a partner shall be applicable immediately.It is also understood that as of May 1, 1942 you have surrendered all of your interest in the firm and the firm name and assets subject only to your right to receive the payments above provided for.We should appreciate it if you would note your approval on the enclosed duplicate hereof and this letter and your approval shall constitute an agreement between the firm and yourself.Whitworth noted his approval of this arrangement.After April 30, 1942, Whitworth performed no services for the firm.The firm paid Whitworth $ 20,405.17 during its fiscal year ended in 1942 and $ 20,000 during its fiscal year ended in 1943. Such amounts were reported as partners' distributable income in the firm's income tax information returns. In the firm's participation schedule effective 19 T.C. 445">*453 October 1, 1941, Whitworth's annual salary was shown as $ 15,000 and his share of profits as 5/105. In the participation schedules effective October 1, 1942, 1952 U.S. Tax Ct. LEXIS 22">*43 and thereafter, Whitworth was not included as a participant in the salaries and profits. In each of the firm's fiscal years ended in 1944, 1945, 1946, 1947, and 1948, the firm paid Whitworth $ 12,000.In addition to such payments the firm paid Whitworth the credit balance of $ 12,500 in his capital account, and $ 3,978.36 as his share of the cash surrender value of a policy on the life of John B. Niven. The premiums paid had been charged to Whitworth and other partners proportionately. These two payments were not deducted by the firm in computing distributable income nor were they reported as distributions of income to Whitworth.Under date of November 21, 1945, Clowes gave notice to the firm of his intention to withdraw and retire as of September 30, 1946. Under date of July 10, 1946, Clowes wrote the firm:Under our partnership agreement, there becomes payable to me following my retirement as of September 30, 1946, in addition to my share of distributable profits for the year ending September 30, 1946, and my partnership capital and interest thereon (both of which are or will be matters of record), the additional retirement payments provided for under Section 2 of Article XI, 1952 U.S. Tax Ct. LEXIS 22">*44 of the partnership agreement.It is stipulated, first, in Section 2 that the measure of the additional retirement payments shall be (see page 14 of the agreement): "Such amount as may be determined by the decision of a majority in interest of the Administrative partners".It is further provided, however, that the minimum thus determinable under the discretion vested in the administrative partners shall not be less than the smaller of: (a) three times the retiring partner's annual average partnership income for the past ten years (paragraph numbered (a) of Section 2 of Article XI., as amended as of October 1, 1943; see page 43 of the partnership agreement); or(b) the partnership income the retiring partner would have received if he had continued as a partner during the three years succeeding retirement (paragraph numbered (b) of Section 2 of Article XI.; see pages 14-15 of the partnership agreement.)I now claim the right to have my additional retirement payments under Section 2 of Article XI, determined under (a) above, at three times my annual average partnership income for the ten fiscal years ending September 30, 1946, without reference to alternative (b) based on the1952 U.S. Tax Ct. LEXIS 22">*45 three years subsequent to September 30, 1946; and I call on the administrative partners to discharge the duty imposed on them under the above quoted provision of Section 2 of Article XI., by determining the amount of my retirement payments immediately following my retirement on that basis and not to cause me to wait for three years for final determination.Will you please acknowledge this letter indicating whether this proposal is agreed to.19 T.C. 445">*454 Under date of November 8, 1946, Niven wrote Clowes as follows:With reference to our recent correspondence relating to the waiving of the so-called "catch clause" in the partnership agreement, in so far as it relates to any limitation upon the amount of your retiring allowances, the matter was given careful consideration by the administrative partners last Monday, having before them your final letter of September 27th, as well as Mr. Pell's letter to you of August 28th.We were all along, of course, fully alive to the fact that the administrative partners had a discretion in the matter and that they could waive the clause (subdivision (b) of Section 2 of Article XI) if they should see fit. At the same time Mr. Pell seems to have the1952 U.S. Tax Ct. LEXIS 22">*46 same opinion as we had, namely, that it was purely a matter for their discretion and that there was no legal obligation upon the administrative partners to act as suggested.The administrative partners, however, not as a legal obligation but entirely as an act of grace, decided, after considering all the circumstances, that they would waive the terms of subdivision (b) and the amount of your retirement allowance will accordingly be regarded as a fixed amount, namely, $ 21,224.85 per annum to be paid for a period of six years, an aggregate of $ 127,349.10, subject of course to the further terms recited in your letter of September 27th.During the fiscal year ended in 1947 the firm paid Clowes a total of $ 25,887.20, which consisted of $ 162.50 interest, $ 4,500 as compensation for services rendered after September 30, 1946, and $ 21,224.70 pursuant to the agreement with the administrative partners. In November 1946 the firm paid Clowes the balance of $ 26,000 in his capital account and the amount of his share in the profits for the fiscal year ended September 30, 1946. The payment of $ 26,000 was not deducted by the firm in determining distributable income nor was it reported as 1952 U.S. Tax Ct. LEXIS 22">*47 a distribution of income to Clowes.Clowes was relieved of his duties as an administrative partner in November 1944 at his own request. Neither Clowes nor Whitworth made any agreement or promise not to compete with the firm after retirement.The firm paid to the estate of Victor H. Stempf the balance of $ 22,000 in Stempf's capital account, the credit balance of $ 125 in his current account and $ 7,581.31 for the period April 18, 1946, to September 30, 1946. The payment of $ 22,000 was not deducted by the firm in computing distributable income, nor was it reported as a distribution of income. During the fiscal year ended in 1947 the firm paid the estate $ 950.77 in interest on capital and $ 15,443.41 pursuant to the contract. This was computed as follows: The annual average of the salary and profits to which Stempf was entitled during the ten years ended September 30, 1946, was $ 33,694.72. One-half of this, or $ 16,847.36, was the amount payable to the estate annually for 6 years. Eleven-twelfths of this, or $ 15,443.41 was paid by the firm. The balance was paid by the successor partnership described below.19 T.C. 445">*455 As of September 1, 1947, the firm was dissolved and the partners, 1952 U.S. Tax Ct. LEXIS 22">*48 with others, formed a new partnership under the name of Touche, Niven, Bailey & Smart. The partnership agreement thereof provided that the Stempf estate was to be entitled to 5 1/2 per cent of the profits from September 1, 1947, to April 19, 1952, but not to exceed $ 16,847.36 for each fiscal year. It further provided for payment to Clowes of $ 21,224.85 per year for 5 years from October 1, 1947. This partnership distributed $ 1,403.95 to the Stempf estate for one month of the fiscal year ended in 1947.In 1947 the firm had 19 active partners, employed a staff of about 200 accountants and maintained offices in New York, Chicago, St. Louis, Minneapolis, Los Angeles, Detroit, and Cleveland.In the partnership return of income for the fiscal years ended in 1944, 1945, and 1946 the payments to Whitworth were treated as distributions of income and not as payments for acquisition of his interest in the firm. In the return for 1947 the amounts paid Whitworth, Clowes, and the Stempf estate were reported as ordinary income distributed to partners with the notation that Whitworth and Clowes were retired and that the amounts shown indicated their credits for the year.The firm possessed 1952 U.S. Tax Ct. LEXIS 22">*49 working papers concerning its clients' organizational history and background which were of value to the firm in that this information would not have to be obtained again if further accounting work was done for those clients.The capital contributed by the partners was a factor in producing income as it enabled the firm to carry payrolls of work in progress until the fees could be collected.The firm accounted for its income on a cash basis and did not take into account bills rendered but unpaid nor work in progress. Records were kept of work in progress at salary cost and of unpaid bills with a reserve for uncollectible accounts. The amounts thereof at the close of the fiscal years ended in 1940 to 1946 were:UncollectedSalary costYearfee, billsof work inrenderedprogress1940$ 34,355$ 85,449194152,52785,270194261,98668,916194368,08995,360194467,75768,654194588,76994,266194681,486119,911As of April 30, 1942, when Whitworth withdrew to accept employment with the United States Army, these amounts were, respectively, $ 72,195.74 and $ 263,600.19. By September 30, 1942, such fees had 19 T.C. 445">*456 been collected or written off1952 U.S. Tax Ct. LEXIS 22">*50 and such work in progress had been liquidated.During the fiscal years ended in 1940 to 1946 the firm had from 16 to 20 partners. The following shows the partnership income before partners' salaries, interest and retirement payments, the amount of partners' salaries for each of those fiscal years, and the partners' equity, according to the firm's statement of financial condition at the end of the fiscal year:PartnershipPartners'Partners'Fiscal year ended in --incomesalariesequity1940$ 288,944$ 217,000$ 245,5811941357,717207,000317,3241942503,583209,038431,6251943553,712204,500579,8231944610,439213,500598,2481945597,298206,000616,9161946720,608244,083597,142OPINION.The partnership of Touche, Niven & Company paid certain amounts during its fiscal year ended September 30, 1947, to Whitworth, Clowes, and the estate of Victor E. Stempf. The sole issue is whether $ 48,668.26 of these amounts was paid as part of the purchase price of the interests of these former partners, or as a distribution of profits, as income, to the retired partners and the estate.If the payments in controversy were paid as part of the1952 U.S. Tax Ct. LEXIS 22">*51 purchase price of the interests of the former partners, they would not be deductible in computing the distributable income of the partnership taxable to the continuing partners, of whom Carol F. Hall is one, and, accordingly, in the hands of the retired partners, Whitworth and Clowes, the payments would be properly treated as capital gains. This is the position taken by the respondent in this proceeding, and by the retired partners in their related proceedings. On the other hand, if the payments represented distributions of firm income to the retired partners and the estate of the deceased partner, they would not be includible in the profits taxable to the continuing partners and would be taxable as ordinary income to the retired partners. This is the position of these petitioners and is also the position taken by respondent in the related cases of Whitworth and Clowes.The payments in controversy were part of a total of $ 228,433.26 which the administrative partners had agreed to pay Whitworth, Clowes, and the estate of Stempf under the partnership agreement of 1936, which was in effect at the times Whitworth and Clowes retired and Stempf died. This agreement provided that the1952 U.S. Tax Ct. LEXIS 22">*52 death or retirement of a partner should not dissolve the partnership between the 19 T.C. 445">*457 remaining partners and required the continuing partners to make certain payments to the retired partners or estates of deceased partners. The continuing partners were required by Article XI, section 1, to repay any loan made the firm by the former partner, as well as his current account balance and his share of the past distributable profits. His paid-up participation in the stated capital was to be repaid in installments with interest. Article XI, section 2, provided that in case of the death of a partner, or his retirement at age 65 there was to be paid, in addition, an amount to be fixed by the administrative partners, which amount was to be measured by the former partner's share in earnings in past years or the share he would have had in the next 3 years' profits had he continued as a partner; it was to be paid out of distributable profits in installments over a period of 6 years; and the agreement stated the payment "is intended as a distribution of income to the retiring partner or the estate of a deceased partner for a limited period subsequent to his retirement or death." In section1952 U.S. Tax Ct. LEXIS 22">*53 3 of Article XI, authority was given the administrative partners to pay such sum as they might deem advisable in the case of any partner retiring before reaching age 65, or withdrawing for any other reason.The solution of the question depends upon the intent of the parties and that is to be derived from the 1936 partnership agreement. Despite contrary arguments, we think the payments here involved were made pursuant to section 2 of Article XI of that agreement and, accordingly, are controlled by that section. Whitworth argues that section 2 applies only in cases of death or retirement at age 65 and therefore cannot be applicable in his case, since he retired at age 59, but his correspondence with the firm effecting the agreement under which the payments were made to him contradicts this assertion. He wrote the firm giving notice of his intention to retire on September 30, 1943, stating that he agreed that his retirementshall be effective as of that date, with the understanding that * * * the provisions of Section 2 of Article XI shall be applicable to my retirement, [Emphasis added.]The firm's letter of November 27, 1942, to Whitworth statedyou shall be entitled to1952 U.S. Tax Ct. LEXIS 22">*54 receive the retirement payments provided for in Section 2 of Article XI of the Partnership Agreement [Emphasis added.]Clowes also argues that the payments made to him were not pursuant to section 2 of Article XI. His point is that since the administrative partners agreed to compute his payments upon the basis of the past earnings without applying the alternative limitation of the earnings of the subsequent 3 years, the arrangement was not made under section 2, but was made under section 3, giving the administrative partners general authority to make discretionary payments in the case of other retirements. The letters effecting the agreement with 19 T.C. 445">*458 Clowes do no bear out his contention. He claimed the right "to have my additional retirement payments under Section 2 of Article XI determined" without reference to alternative (b), the limitation based on subsequent earnings. The administrative partners decided "that they would waive the terms of subdivision (b)," of section 2. The context of the correspondence clearly shows the intention of the administrative partners and of these retiring partners, that their retirement payments should be fixed pursuant to section 2, 1952 U.S. Tax Ct. LEXIS 22">*55 as modified in certain particulars at their own requests. The payments to the Stempf estate were also measured by the prior earnings alone without limitation by reference to subsequent earnings. These payments were likewise made pursuant to section 2, rather than section 3.The payments, being made pursuant to section 2, are subject to certain other provisions of that section. They were to be made "out of distributable profits" and they were "intended as a distribution of income to the retiring partner or the estate of a deceased partner for a limited period subsequent to his retirement or death." Also, it was provided that no annual installment in the first 3 years should be less than 50 per cent of the partner's annual salary at death or retirement or less than $ 5,000, "unless the distributable profits shall not be sufficient." Thus the payments were keyed to the existence of profits, and the intent appears that a partner who retired, or the estate of a partner who died, was to continue for a time to participate in the profits on the same basis and in approximately 50 per cent of the amount as before the event. We find no language in the written agreement which would justify1952 U.S. Tax Ct. LEXIS 22">*56 a conclusion that the retiring partners intended to "sell" their interest in the partnership to the continuing partners, or vice versa, that the continuing partners intended to "buy" the retiring partners' interests.The case of Charles F. Coates, 7 T.C. 125, is here apposite. There are factual differences, but we do not think them significant. Respondent has acquiesced in that case, 1946-2 C. B. 2. Coates was a continuing partner in an accounting firm which provided in the partnership contract that the death of a partner should not operate to dissolve the co-partnership, that the estate should continue as a member for 5 years with no direct voice in management, that the estate should participate in the net earnings in stated proportions and not be liable for losses, that the deceased partner's "capital interest" should be settled as soon as possible, and that at the end of 5 years and the completion of the payments the interest of the deceased parties should terminate. No partner had contributed any capital and capital was not important in that personal service organization. The "capital interest" consisted of (1) the1952 U.S. Tax Ct. LEXIS 22">*57 pool of undrawn earnings (the amount withdrawn having been limited to 85 per cent of each partner's share 19 T.C. 445">*459 for the previous year) and (2) the value of the work then in process. We noted that since the agreement provided for the return of any remaining interest in the firm's assets it was difficult to find evidence of an intent to sell the interest of the deceased partner, that the parties placed no value upon the good will and partnership name and that ordinarily no substantial value attaches to good will of such a personal service partnership. We said further:In addition to the provisions for the return of the "capital interests" to the estates are the provisions with which we are here concerned for participation by the estate of a deceased partner in the earnings of the partnership for five years after the partner's death. These payments have no relation to the other type of payments provided for the liquidation of the capital account. They provide simply that the estate of any deceased partner shall participate to the extent there provided in the net earnings of the partnership for a period of five years. The evidence establishes that this provision was intended 1952 U.S. Tax Ct. LEXIS 22">*58 by the parties not to be the consideration paid by the surviving partners for the capital interest of a deceased partner upon the dissolution and liquidation of the partnership, but was intended to be a present consideration given by each partner upon the formation of the partnership. It was intended to be in the nature of a mutual insurance plan, the disadvantage of which each partner was willing to accept in consideration of a similar commitment for his benefit on the part of all other partners, and, in part, as further compensation for the past services of the deceased partner payable after his death.These payments were not made in liquidation of any capital interest of the deceased partner in the firm's assets. The only payments of this nature required upon the death of a partner were the payments on account of past earnings and work in process, here designated as the "capital account." In addition to these payments, the estate of a deceased partner was entitled to the payment of a share of post death earnings, not in consideration of a sale of partnership assets on liquidation, but in consideration of mutual promises contained in the original partnership agreement having no1952 U.S. Tax Ct. LEXIS 22">*59 relationship to such a sale. These payments arose out of and depended upon the contract and their character must be determined by its terms. The estate acquired, upon the death of the partner, a vested contractual right to a share of the earnings, as earnings, and this right was fortified by a power lodged in the trustee to require a liquidation of the business if its rights were not fully respected by the surviving partners. When and as the income was earned, it became immediately subject to the preexisting rights of the estates to their share of it. The amounts so distributable to the estates were not distributable to any surviving partner, with the result that here, as in Richard P. Hallowell, 2nd, supra, the disputed amount attributed by the respondent to each surviving partner may not be regarded as "his distributive share, whether distributed or not, of the net income of the partnership."The case of Richard P. Hallowell, 2nd, 39 B. T. A. 50, referred to in the above quotation, is also in point. There, the agreement provided that the interest of the estate of a deceased partner should be deemed a loan and that1952 U.S. Tax Ct. LEXIS 22">*60 the estate should have the same interest in profits the deceased partner would have had if living, until the termination of a period agreed upon. Since settlement of the capital interest 19 T.C. 445">*460 was to be accomplished under other provisions of the agreement, we concluded that the estate shared in profits as a matter of right under the contract. See also Sidney Hess, 12 T.C. 773, and cf. Estate of Boyd C. Taylor, 17 T.C. 627.Clowes and Whitworth, and respondent in this proceeding, rely upon certain cases to the effect that where the partners agree that a deceased partner's interest shall be acquired by the surviving partners by payments of firm profits to his estate, there is a sale of the interest and the profits so paid are taxable to the survivors and represent the purchase price of a capital asset. See Hill v. Commissioner (C. A. 1, 1930), 38 F.2d 165, affirming 14 B. T. A. 572; Pope v. Commissioner (C. A. 1, 1930), 39 F.2d 420, affirming 14 B. T. A. 584; W. Frank Carter, 36 B. T. A. 60 (1937),1952 U.S. Tax Ct. LEXIS 22">*61 and Estate of Bavier C. Miller, 38 B. T. A. 487 (1938). In these cited cases the deceased partners had made a capital investment in the partnership which was not repaid to their estates, but was transferred to the surviving partners in consideration of the payments involved. In the present case the capital investments of the deceased or retiring partners were returned to them in full pursuant to section 1 (c) of Article XI. Payment of the distributable profits for the current year of retirement or death was also provided for in section 1 (b) of Article XI. The payments provided for in section 2 or 3 of that Article were additional and distinct. Since they could not be a return of capital they could be only distributions of income. We think these cases are distinguishable on their facts. No sale or purchase of partnership interests was here intended. See Bull v. United States, 295 U.S. 247">295 U.S. 247 (1935).Clowes and Whitworth contend that the partnership had good will of a considerable value and working papers which were an asset in their business, that the interest of the retiring partners in these items was the subject1952 U.S. Tax Ct. LEXIS 22">*62 of a sale in the transfer of their interests to the continuing partners and that the payments in controversy were intended as the purchase price of these assets. This argument is not borne out by the agreement. Article IV provides that a deceased, retiring, or withdrawing partner shall have no interest in the firm name and no right to receive any payment therefor. As to the good will, in the first place it is inextricably associated with the firm name and not transferable otherwise, and in the second place the good will of a personal service organization such as this, is rarely a vendible article. Charles F. Coates, supra.As for any good will attaching to Whitworth or Clowes individually and separate from firm good will, these retiring partners made no agreement not to compete with the firm and hence must be deemed not to have relinquished or transferred it, if indeed it could be transferable. The firm in its financial calculations at no time placed any value upon the firm name, good will, or working 19 T.C. 445">*461 papers. Nor do we find anything in the agreement disclosing any intention to value good will as such or to make any payments in consideration1952 U.S. Tax Ct. LEXIS 22">*63 of the sale thereof to the surviving partners.We think that the partners in entering into the 1936 agreement, intended that a retired partner, or the estate of a deceased partner, should share in the profits of the firm, as profits, for a limited period after the event, that the provision was in the nature of a mutual insurance plan in which each partner assumed its possible burdens in consideration of the assumption of a like obligation by his partners to him, and that the payments here in controversy were properly deducted by the continuing partners in determining the distributable partnership income taxable to them.Because of conceded adjustments,Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624852/ | James J. Donohue, Petitioner, v. Commissioner of Internal Revenue, RespondentDonohue v. CommissionerDocket No. 74002United States Tax Court39 T.C. 91; 1962 U.S. Tax Ct. LEXIS 53; October 12, 1962, Filed 1962 U.S. Tax Ct. LEXIS 53">*53 Decision will be entered under Rule 50. During 1954 the petitioner owned and conducted a combination hotel, liquor store, and beer and liquor tavern business. The respondent determined that for the year the petitioner had gross receipts from the business in an amount in excess of that shown by the books maintained for the business and reported in petitioner's income tax return and determined a deficiency accordingly. In a subsequent year the petitioner discovered that the accountant, whom he had employed to handle all financial matters relating to the business and maintain the books with respect thereto, had embezzled gross receipts of the business and had appropriated to his own use merchandise charged as an expense of the business. Held, respondent's determination is sustained. Sydney M. Eisenberg, Esq., and Andrew F. Slaby, Esq., for the petitioner.William J. Wise, Esq., for the respondent. Withey, Judge. WITHEY39 T.C. 91">*91 FINDINGS OF FACT AND OPINION.A deficiency in the income tax of petitioner has been determined by respondent for the taxable year 1954 in the amount of $ 3,282.54. The issue presented is whether the respondent has erred in adding to petitioner's gross income the amount of $ 8,392.23 as unreported gross receipts from petitioner's operation of a business.Such facts as have been stipulated are found as stipulated.Petitioner James J. Donohue filed a joint Federal income tax return for the taxable year 1954 with the district director of internal revenue at Milwaukee, Wisconsin. During that year one of his several business activities was a combination hotel, beer and liquor tavern, and liquor store, known as the Towne House, in Port Washington, Wisconsin. His income tax return correctly reflects the1962 U.S. Tax Ct. LEXIS 53">*55 books and records kept in conjunction with the operation of the Towne House. There is no dispute between the parties as to the adequacy of the form of such books to reflect such operation. However, respondent and petitioner both agree in substance that the books and records of the Towne House do not reflect additional gross receipts which were, in 1954, embezzled by the accountant employed by petitioner to take and maintain complete control over the financial matters of the business.39 T.C. 91">*92 We find as a fact that such is the case.Respondent, in the statement attached to his deficiency notice, has added the amount first above mentioned to petitioner's gross income for the taxable year 1954. We think he was conservative in computing additional unreported gross income at that figure. The petitioner in his pleadings has alleged that the accountant embezzled the amount of an average of $ 100 to $ 150 from Towne House receipts each week during 1954. In his opening statement and his brief, he contends such embezzlement took place. In his testimony he has shown conclusively that in addition to $ 100 to $ 150 per week embezzlement the accountant, during 1954, charged certain purchases1962 U.S. Tax Ct. LEXIS 53">*56 for his own use in undisclosed amounts to the Towne House account; that since petitioner's discovery of the embezzlement in a year subsequent to 1954, the accountant has made restitution in at least the amount of $ 700. We find these facts to be true.Respondent has computed the total gross income from operation of the Towne House by the use of the mark-up method. We note that the amount of additional gross income thus arrived at, $ 8,392.23, is strikingly similar to the amount of the embezzlement figured at $ 150 for 52 weeks during 1954, or $ 7,800. The record shows and we find that additional undisclosed amounts were embezzled by way of charges unlawfully made to the Towne House account by the accountant. When the two defalcations are coupled it appears respondent's use of the mark-up method was remarkably apt and accurate. We find that petitioner had additional unreported income for 1954 in the amount of at least $ 8,392.23.It appears that petitioner mistakenly believes that because of the embezzlement of his unreported income, having never individually and physically received the same in the taxable year at issue, he is not liable for income tax thereon. He cites no authority1962 U.S. Tax Ct. LEXIS 53">*57 for his position and we know of none. To be sure, he would be entitled to a loss deduction with respect to an embezzled amount but only in the year of his discovery thereof. See section 165 (e), I.R.C. 1954. However, section 61 of the 1954 Code provides that gross income means "all income from whatever source derived, including (but not limited to) * * * Gross income derived from business."We have found as a fact that petitioner derived $ 8,392.23 additional and unreported gross income from the operation of the Towne House business. Because petitioner in effect agrees that this amount was received as gross income, it is unnecessary for us to discuss or rule upon respondent's method of arriving at that figure.Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4653928/ | IN THE SUPREME COURT OF PENNSYLVANIA
WESTERN DISTRICT
COMMONWEALTH OF PENNSYLVANIA, : No. 264 WAL 2020
:
Respondent :
: Petition for Allowance of Appeal
: from the Order of the Superior Court
v. :
:
:
MARTHA FENCHAK BELL, :
:
Petitioner :
ORDER
PER CURIAM
AND NOW, this 20th day of January, 2021, the Petition for Allowance of Appeal is
DENIED. | 01-04-2023 | 01-22-2021 |
https://www.courtlistener.com/api/rest/v3/opinions/4624888/ | ARTURO P. ALCALEN AND WILHELMINA B. ALCALEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentAlcalen v. CommissionerDocket No. 3599-82.United States Tax CourtT.C. Memo 1984-334; 1984 Tax Ct. Memo LEXIS 342; 48 T.C.M. (CCH) 406; T.C.M. (RIA) 840334; June 28, 1984. Arturo P. Alcalen, pro se. Hugh M. Spall, for the respondent. PARKERMEMORANDUM FINDINGS OF FACT AND OPINION PARKER, Judge: Respondent determined a deficiency of $1,115.20 in petitioners' 1978 Federal income tax. After concessions, discussed below, the issues for our decision are (1) whether various travel expenses incurred by petitioners are deductible, and (2) the amount of petitioners' allowable deduction for local transportation. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts*345 and exhibits attached thereto are incorporated herein by this reference. At the time they filed their petition in this case, Arturo P. Alcalen (Sgt. Alcalen) was stationed at Fort Lewis, Washington, and his wife, Wilhelmina B. Alcalen (Mrs. Alcalen), resided in San Francisco, California. Petitioners filed a joint Federal income tax return (Form 1040) for 1978. At the beginning of 1978, Sgt. Alcalen was an enlisted man in the United States Army, stationed in San Francisco. Sgt. Alcalen was awaiting orders that he believed would transfer him to Turkey, where his wife could not accompany him. In April 1978, Sgt. Alcalen took leave and flew to Italy with Mrs. Alcalen. Petitioners' trip to Italy had several purposes. First, Sgt. Alcalen wanted to spend time with Mrs. Alcalen to soothe her feelings about his pending transfer to Turkey. Petitioners also wanted to investigate contacts in Italy regarding their possible entry into the business of importing and exporting various internationally traded commodities. Petitioners did not meet any business contacts in Italy and instead spent their time vacationing in Rome, Florence, Naples, and Venice. Sgt. Alcalen was transferred to*346 Germany instead of Turkey. Mrs. Alcalen did not accompany him, because his remaining enlistment period was too brief for his wife and child to be permitted to travel at Government expense. Also Mrs. Alcalen was employed in San Francisco and her salary constituted a significant part of the family's total income. While in Germany, Sgt. Alcalen took leave, flew to California to visit Mrs. Alcalen, picked up his California tax returns, and returned to Germany. While Sgt. Alcalen was back in California on this trip, petitioners continued to investigate a possible business venture in international trading. At some point in the late spring or early summer of 1978, petitioners sent $10,000 to their agent in the Philippines to subscribe to the stock of a corporation that was intended to engage in international trading. In 1979, petitioners discovered that the stock had not been issued.Sgt. Alcalen still hopes the Philippine venture will prove to be a viable investment. While he was stationed in Germany, Sgt. Alcalen was authorized by his commanding officer to use his privately owned vehicle on Army business if Government transportation was not available. Sgt. Alcalen used his own vehicle*347 only when Government transportation was not available. Sgt. Alcalen was not reimbursed for his costs in using his own automobile in those instances. On their 1978 joint return, petitioners claimed the following deductions, all of which respondent disallowed: ItemAmountAir fare, meals, and lodging$2,139.29Car expenses--standard mileage rate2,707.35Car towing173.25Car insurance and depreciation1,686.32Space rental/telephone share/longdistance calls980.00Home maintenance and repair cost57.01Bond for mortgage requirement276.00Fire insurance, mortgage requirement108.00Subsistence payment to Sgt. Alcalen'smother in Philippines1,320.00Utility taxes (water, electric, telephone)79.19The first two items were listed on Form 2106 (Employee Business Expenses) and deducted as adjustments to gross income and the remaining items were listed as itemized deductions on Schedule A and deducted from adjusted gross income. The air fare, meals, and lodging are allocable 50 percent to petitioners' trip to Italy and 50 percent to Sgt. Alcalen's trip from Germany to California. Petitioners computed their automobile expense deduction under*348 the standard mileage rate claiming 77 percent business use. The car towing expense also reflects 77 percent of the total cost. Of this 77 percent business use, one-half is allocable to Sgt. Alcalen's use of his car on Army business and the remaining one-half is allocable to sgt. Alcalen's investigation of the possibility of entering the import-export business. Respondent now concedes that the portion of petitioners' automobile expense allocable to Sgt. Alcalen's use of his car on Army business is deductible. Respondent also concedes that petitioners have verified the amounts for cary towing, Insurance, and depreciation. Petitioners concede that they are not entitled to automobile expense deductions for both their actual costs (and depreciation) and the amount computed under the standard mileage rate, as claimed on their return. Petitioners also concede that the $1,320 they paid to Sgt. Alcalen's mother is not deductible. OPINION Deductions are a matter of legislative grace, and taxpayers must prove their entitlement to them. Deputy v. du Pont,308 U.S. 488">308 U.S. 488 (1940); New Colonial Ice Co. v. Helvering,292 U.S. 435">292 U.S. 435 (1934). Petitioners presented*349 no evidence regarding their claimed itemized deductions for "space rental/telephone share/long distance calls," "home maintenance and repair cost," "bond for mortgage requirement," "fire insurance, mortgage requirement," and "utility taxes." These items facially appear to be nondeductible personal expenditures. Sec. 262. 1 In any event petitioners have either conceded these items or have failed to carry their burden of proof. Accordingly, we sustain respondent's disallowance of these deductions. Rule 149(b); Rule 142(a). To the extent that petitioners' claimed travel and transportation expenses are allocable to their investigation of the import-export business, no deduction is allowable under either section 162 or section 212. At the time petitioners incurred those expenses, they were not engaged in that trade or business nor were they owners of, nor had any interest in, any income-producing asset. See Contini v. Commissioner,76 T.C. 447">76 T.C. 447, 451-452 (1981);*350 Frank v. Commissioner,20 T.C. 511">20 T.C. 511, 514 (1953). Petitioners' expenses, if not nondeductible personal expenses, were part of the capital cost of petitioners' investment in the Philippine trading company. No loss under section 165 is allowable; there was no closed transaction during the taxable year, nor was petitioners' investment worthless as of the end of 1978. Sec. 165(c)(2); sec. 165(g); sec. 1.165-1(b), Income Tax Regs.The balance of petitioners' travel expenses relate to Sgt. Alcalen's trip to Italy with Mrs. Alcalen and his trip from Germany to California to see her. These trips may well have smoothed out whatever marital difficulties, if any, they were having because of Sgt. Alcalen's transfer overseas. We have carefully reviewed the various Army personnel regulations and similar materials that petitioners submitted. In so doing, we had the benefit of the testimony of Major Patrick P. Brown, an expert in military law on the staff of the Judge Advocate General, United States Army. We accept the fact that the Army exercises greater control over its soldiers' personal lives than does a civilian employer over its employees' personal lives. Nonetheless, *351 we do not believe that the minor marital difficulties to which Sgt. Alcalen testified, or even the divorce he may have feared, would bar his reenlistment or otherwise subject him to military discipline. Similarly, although Sgt. Alcalen might have forfeited his entitlement to leave had he not taken it, we do not believe that he could be disciplined or barred from reenlisting by refusing to accept leave. 2 The record does not indicate that Sgt. Alcalen was ordered or required to take leave, and the leave he actually took for the trips to Italy and from Germany may well have been leave granted at his own request. The fact that Sgt. Alcalen was still subject to certain Army regulations while on leave does not convert the expenses incurred during his leave into employee business expenses. Such expenses are inherently personal and nondeductible. Sec. 262. *352 Finally, respondent now concedes that the portion of the automobile expense deduction allocable to Sgt. Alcalen's use of his car on Army business is allowable. Although respondent concedes that petitioners have substantiated the portion of their actual expenses they claimed, 3 the amount calculated under the standard mileage rate is higher. Consequently, petitioners are entitled to an automobile expense deduction of $1,353.68. Petitioners have conceded that they are not entitled to deduct their insurance and depreciation in addition to the standard mileage rate deduction. However, under the standard rate method, petitioners are also entitled to deduct certain additional amounts actually incurred, such as parking and tolls. See Rev. Proc. 74-23, 2 C.B. 476">1974-2 C.B. 476. We believe that petitioners' towing costs, which respondent has conceded were substantiated, also fall within this category. The amount petitioners claimed represents their total costs, limited to the same percentage (77 percent) of business use they used in computing their mileage. Since one-half of the mileage was allowable as allocable*353 for business use, we believe that $86.62, one-half of the towing charges, is similarly deductible as part of the employee business expenses to be taken as an adjustment to income above the line. We commend Sgt. Alcalen for his obvious loyalty to the Army and his considerable talents devoted to its service. We also commend Sgt. Alcalen for his capable presentation of his case. Although Congress has enacted certain provisions of the Internal Revenue Code in recognition of the contributions of our Nation's military personnel, see secs. 72(n), 112, 113, 122, 217(g), 692, 1034(h), 2201, and 7508, absent such special legislation, we must apply the tax laws equally to soldiers and civilians. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable year in question, and all references to "Rules" are to the Tax Court Rules of Practice and Procedure.↩2. This case is plainly distinguishable from Stratton v. Commissioner,448 F. 2d 1030 (9th Cir. 1971), revg. 52 T.C. 378">52 T.C. 378 (1969), and Hitchcock v. Commissioner,578 F. 2d 972 (4th Cir. 1978), revg. 66 T.C. 950">66 T.C. 950 (1976). Both Stratton and Hitchcock↩ involved Foreign Service officers stationed overseas who were required by law and State Department regulations to take home leave. Although Sgt. Alcalen argued in general terms that the Army "required" him to go on leave, we are persuaded by Major Brown's testimony that Sgt. Alcalen could not be required to do so. Also the factual record simply does not show that Sgt. Alcalen was "ordered" or "required" to take the leave involved in the present case.3. Petitioners claimed no deduction for gasoline, oil, or repairs.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4653929/ | IN THE SUPREME COURT OF PENNSYLVANIA
MIDDLE DISTRICT
ETHAN CLEMENS, : No. 14 MAP 2020
:
Appellant :
: Appeal from the Order of the
v. : Commonwealth Court at No. 59 MD 2018
: dated February 7, 2020.
PENNSYLVANIA STATE POLICE AND :
LIEUTENANT COLONEL LISA CHRISTIE :
(INDIVIDUALLY AND IN HER CAPACITY :
AS LIEUTENANT COLONEL OF THE :
PENNSYLVANIA STATE POLICE), :
:
Appellees :
ORDER
PER CURIAM: DECIDED: January 20, 2021
AND NOW, this 20th day of January, 2021, the Order of the Commonwealth
Court is AFFIRMED. | 01-04-2023 | 01-22-2021 |
https://www.courtlistener.com/api/rest/v3/opinions/4624889/ | Carl Hensley and Eloise G. Hensley, Petitioners, v. Commissioner of Internal Revenue, RespondentHensley v. CommissionerDocket No. 60275United States Tax Court31 T.C. 341; 1958 U.S. Tax Ct. LEXIS 37; November 12, 1958, Filed *37 Decision will be entered for the respondent. T was member of a partnership that constructed an apartment house for a corporation under an F. H. A. commitment. The partnership originally owned most of the stock in the corporation and during the tax year (1952) owned about two-thirds of the stock. After completion of construction T assigned his partnership interest in the stock to his partner in consideration of payment of certain partnership obligations. Held, T's partnership interest in the stock was a capital asset and his loss upon disposition was subject to statutory limitations upon capital losses. Sec. 117 (a) (1) and (d) (2), I. R. C. 1939. Ernest G. Pharr, Esq., for the petitioners.Allen T. Akin, Esq., and Harold D. Rogers, Esq., for the respondent. Raum, Judge. RAUM*341 The respondent determined that the petitioners are liable for a deficiency in income tax and additions to tax as follows:Additions to tax (I. R. C. 1939)DeficiencyYearin taxSec. 294(d)(1)(A)Sec. 294(d)(2)1952$ 11,510.94$ 1,285.70$ 791.20The Commissioner's determination of deficiency made the following adjustment, among others, to petitioners' net income for 1952:Unallowable deduction:(a) Loss on forfeiture of interest upon withdrawal from partnership $ 36,670.89That adjustment, which is the only one presently in controversy, was explained as follows:(a) It has been determined that the loss sustained from disposition of capital stock in Canyon View Apartments, Inc., in 1952 was a long-term capital loss, deductible to the extent provided in Section 117 (d) (2) of the Internal Revenue *342 Code of 1939, and was not a loss on forfeiture of a partnership interest as reported*39 in your return. Therefore, the amount claimed, $ 36,670.89, has been disallowed as a loss on forfeiture of interest. * * *The petitioners do not contest the additions to tax determined by the Commissioner if they should not prevail in their challenge to the basic adjustment.FINDINGS OF FACT.The parties have filed a written stipulation of facts, and have also entered into certain oral stipulations at the hearing. All such stipulations are incorporated herein by reference.Petitioners, husband and wife, are residents of Lubbock, Texas. They filed a joint income tax return for the year 1952 with the director of internal revenue at Dallas, Texas. Carl Hensley will hereinafter be referred to as the petitioner or as Hensley.In September 1950 petitioner and E. D. Lindsey formed an equal partnership known as the H & L Construction Company. At the time it was formed petitioner had been engaged in the construction business for 20 or 25 years. Lindsey had never engaged in that business and was taken into the partnership because of the financial stability and backing he was expected to furnish. Petitioner did not invest any of "his own money" in the partnership which "was capitalized*40 entirely on borrowed money."In October 1950 petitioner and Lindsey, as partners, organized and incorporated Canyon View Apartments, Inc. It was their intention to build an apartment house in Lubbock, Texas, costing about $ 1,000,000, that would be financed by a mortgage loan insured by the Federal Housing Administration. The corporation was organized because F. H. A. regulations required that the property be owned by a corporation. The plan was to have the apartment house constructed by the partnership with interim bank financing, after an F. H. A. commitment had been obtained, and upon completion, to transfer the property to the corporation which would use the F. H. A.-insured loan to pay the partnership which in turn would pay off the interim financing loans.In order to form the corporation, the partnership borrowed $ 150,000 from the Citizens National Bank of Lubbock, Texas. That amount was used by the partnership to purchase 150,000 of the 156,228 issued shares of the corporation's $ 1-par-value common stock.Shortly after formation of the corporation the partnership entered into a contract with it to build the apartment house for the corporation.During the course of construction*41 the partnership borrowed additional amounts from the bank in the aggregate of about $ 850,000.Lindsey's mother was surety on all of the foregoing bank loans that *343 were made to the partnership. The bank insisted that she endorse the notes executed by the parties, and she did so.Upon completion of construction and after applying the proceeds of the F. H. A.-insured loan against the foregoing partnership bank loans, there still remained a note of the partnership (with Lindsey's mother as surety) to the Citizens National Bank of Lubbock, Texas, with an unpaid balance of $ 34,682.02.The property was transferred to the corporation by the partnership prior to August 26, 1952. The partnership received rental income during its fiscal year ending June 30, 1952, in the amount of $ 27,736.95.On August 26, 1952, the partnership owned stock of the corporation, having a book value or cost to the partnership of $ 104,332.09. That stock was shown on its balance sheet as an "investment." Also, on August 26, 1952, the partnership owned depreciable assets having a book value of $ 1,012.55 and accounts receivable of $ 649.21.On August 26, 1952, petitioner executed a written assignment*42 of his partnership interest in the stock to Lindsey, in consideration of the payment by Lindsey and his mother of the partnership's $ 34,682.02 indebtedness. That instrument reads as follows:Whereas, the said Mrs. J. D. Lindsey and E. D. Lindsey have heretofore signed a note to the Citizens National Bank, of Lubbock, Texas, in the sum of $ 34,682.02, and,Whereas, the said note above referred to has been paid by said Mrs. J. D. Lindsey and E. D. Lindsey, who now own and hold same;Now, Therefore, in consideration of the payment by the said Mrs. J. D. Lindsey and E. D. Lindsey of said note, the said Carl Hensley does hereby sell, transfer and deliver to the said E. D. Lindsey all of the shares of stock owned by him in that certain corporation, to-wit: CANYON VIEW APARTMENTS, INC., of Lubbock, Texas. This instrument is intended as a full and complete transfer and delivery of all right, title and interest in and to said shares of stock shown upon the records of said corporation, as being owned and held by the said Carl Hensley, and the said Carl Hensley does hereby authorize the transfer upon the books of said corporation all of the said shares of stock to the said E. D. Lindsey. *43 In consideration of the sale, transfer and delivery of the above described shares of stock, the said Mrs. J. D. Lindsey and E. D. Lindsey do hereby release the said Carl Hensley from any further liability upon said note originally made, executed and delivered by the H. & L. Construction Company, to the Citizens National Bank, of Lubbock, Texas, including all accrued interest thereon; and the said Carl Hensley does hereby release any and all claim to any interest in said corporation or its properties.The petitioner sustained a loss in the amount of $ 34,825.04 in 1952 upon the disposition of his partnership interest in the Canyon View stock.In the joint income tax return of petitioners for the calendar year 1952, they reported income from the partnership in the amount of $ 44,451.97 and claimed as a deduction for "Loss on Forfeiture of *344 Interest Upon Withdrawal From Partnership -- H & L Construction Company" the amount of $ 36,670.89.In the notice of deficiency the respondent disallowed the claimed loss of $ 36,670.89, and determined that the petitioner sustained a loss of $ 34,825.04 and that this loss was a long-term capital loss deductible to the extent provided in section*44 117 (d) (2) of the Internal Revenue Code of 1939.OPINION.We encountered considerable difficulty in this case by reason of the lack of clarity as to the precise nature of petitioners' claim and the vagueness of the evidence. Our repeated efforts, in the interests of justice, to obtain clarification at the trial, were only partly successful.At the outset, it must be remembered that petitioners' returns claimed a deduction in the amount of $ 36,670.89 as "Loss on Forfeiture of Interest Upon Withdrawal From Partnership -- H & L Construction Company." But the evidence nowhere could support any finding that Hensley forfeited an interest in or withdrew from the partnership. Indeed the evidence shows that the partnership owned certain depreciable assets as well as accounts receivable in addition to the Canyon View stock, and that the transaction relied upon as generating the deductible loss was merely an assignment by Hensley of his partnership interest in the Canyon View stock in consideration of the payment of the partnership's obligation to the bank. There was no "forfeiture" nor is there any evidence that he withdrew from the partnership. Any deduction based upon "forfeiture" must*45 be disapproved upon this record.However, the Government does recognize that Hensley sustained a loss in the amount of $ 34,825.04 upon disposition of his partnership interest in the stock. That amount appears to have been computed as follows: The cost of the stock to the partnership was $ 104,332.09, of which $ 52,166.05 represented Hensley's one-half. From his supposed basis of $ 52,166.05 there was subtracted his one-half of the bank indebtedness ($ 34,682.02) paid off, namely, $ 17,341.01, representing in substance the "sales price" of his interest, thus leaving a net loss of $ 34,825.04. An oral stipulation made at the trial fixes the amount of the claimed loss at that amount.Section 117 (a) (1) of the Internal Revenue Code of 1939 defines "capital assets" as "property held by the taxpayer (whether or not connected with his trade or business)" with certain exceptions, one of which is "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." The Commissioner's position is that Hensley's partnership interest in the *345 Canyon View stock was a capital asset within section 117 (a) (1) and that the loss sustained*46 upon the sale is deductible only in accordance with the limitations set forth in section 117 (d) (2) with respect to such assets. Petitioners, on the other hand, contend that the loss was not a capital loss, and that it is deductible in full as an ordinary loss or as an ordinary and necessary expense incurred in carrying on his trade or business.Reading the statute literally, Hensley's partnership interest in the Canyon View stock certainly falls within the statutory definition of capital assets, and does not qualify for any of the exceptions spelled out in the various subparagraphs of section 117 (a) (1). Petitioners do not argue that any of those subparagraphs other than (A) is applicable, 1 and they concede on brief that the only clause in (A) upon which they rely is the one relating to "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business."*47 The quoted language plainly does not appear to cover Hensley's partnership interest in the Canyon View stock. That interest was not held by him primarily for sale to customers in the ordinary course of his trade or business, and the attempt to bring it within the exclusionary clause of (A) would stretch the statutory language beyond the breaking point.Petitioners undertake to support their position by referring to three cases: Gilbert v. Commissioner, 56 F. 2d 361 (C. A. 1); Harry Dunitz, 7 T. C. 672, affirmed 167 F. 2d 223 (C. A. 6); and Edwards v. Hogg, 214 F. 2d 640 (C. A. 5). In these cases the courts held that bonds or shares of stock were not capital assets, the sale of which gave rise to capital gain or capital loss, because they constituted property held primarily for sale by the taxpayers in the ordinary course of their trade or business. They involved instances where stock received by a partnership in lieu of cash for services rendered in the construction of an apartment house was held by it for resale (Gilbert v. Commissioner); where*48 the purchase and sale of mortgage bonds was regarded as an essential part of the business of taxpayers (Harry Dunitz); and where a partnership engaged in the wholesale whisky business was required to purchase stock in order to acquire whisky for sale to its customers (Edwards v. Hogg).The facts of the instant proceeding are sharply distinguishable from those in the foregoing cases. Hensley did not sustain a loss *346 from the sale of stock of Canyon View. That stock was owned by the partnership which purchased it and carried it on its balance sheet as an investment. The stock was a capital asset of the partnership even though it was purchased with the object of obtaining the job of constructing the apartment project and deriving profit therefrom. Exposition Souvenir Corporation v. Commissioner, 163 F. 2d 283 (C. A. 2). Hensley's partnership interest in the stock was also a capital asset as defined in section 117 (a) (1), inasmuch as it was property held by him and did not fall within the classes of property specifically excluded. Cf. Commissioner v. Shapiro, 125 F. 2d 532 (C. A. 6); Commissioner v. Smith, 173 F. 2d 470*49 (C. A. 5), certiorari denied, 338 U.S. 818">338 U.S. 818. Petitioners have not proved that it was not held by Hensley for more than 6 months. In the circumstances we hold that the respondent did not err in his determination that the loss sustained upon the sale of the partnership interest was a long-term capital loss as defined in section 117 (a) (5) of the Internal Revenue Code of 1939 which was deductible only to the extent provided in section 117 (d) (2).Petitioners' further claim to a deduction as an ordinary and necessary business expense is not amplified or discussed by them, and we are unable to see how section 23 (a), which deals with such deductions, could govern here. Section 23 (a) contemplates deduction for expenditures, and the record is utterly devoid of proof that petitioner made an expenditure in 1952 that would form the basis for the applicability of these provisions. There is no merit to the contention.Decision will be entered for the respondent. Footnotes1. SEC. 117. CAPITAL GAINS AND LOSSES.(a) Definitions. -- As used in this chapter -- (1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include -- (A) 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 taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624890/ | Frank H. Ayres & Son v. Commissioner.Frank H. Ayres & Son v. CommissionerDocket No. 37033.United States Tax CourtT.C. Memo 1954-172; 1954 Tax Ct. Memo LEXIS 76; 13 T.C.M. (CCH) 952; T.C.M. (RIA) 54278; October 12, 1954, Filed *76 Held: That petitioner did not accumulate its surplus or profits beyond the reasonable needs of its business, and, accordingly, is not liable for additional surtax under section 102, I.R.C.Raymond R. Hails, Esq., 412 West Sixth Street, Los Angeles, Calif., and M. B. Hunt, Esq., for the petitioner. Clayton J. Burrell, Esq., for the respondent. *77 BRUCE Memorandum Findings of Fact and Opinion BRUCE, Judge: The respondent determined deficiencies in income tax of the petitioner, as follows: Fiscal Year EndedDeficiencyJune 30, 1948$11,277.07June 30, 19491,227.81June 30, 195017,556.68The question for decision is whether the petitioner was formed or availed of during any of the taxable years ended June 30, 1948, June 30, 1949, and June 30, 1950, for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting earnings or profits to accumulate instead of being divided or distributed within the meaning of section 102 of the Internal Revenue Code of 1939. Findings of Fact Some of the facts have been stipulated and they are found accordingly. Other facts are found from the evidence. The petitioner is a California corporation with its principal office in Los Angeles, California. It kept its books and filed its income tax returns on the basis of the fiscal year ended June 30 and upon the cash method of accounting. The returns for the period here involved were filed with the collector of internal revenue for the sixth district of California. *78 Petitioner was formed to carry on a real estate business on April 22, 1946, with an authorized capital of $100,000, represented by 10,000 shares of common stock, par value $10 per share. At the time of its organization 666 shares were purchased at par by Donald B. Ayres, and 334 shares were purchased at par by Frank H. Ayres. During the period from April 22, 1946 to June 30, 1950, no additional shares were issued, and there was no transfer of the original issue of 1,000 shares. The following schedule shows for each year in question the taxable net income reported, the dividends declared or paid, the accumulated surplus, and the salaries paid to the two stockholders, who received for their services as officers one-half of the net income before taxes in the same ratio as their stock holdings. Taxable YearNet IncomeSalariesSurplusDividendJune 30, 1948$61,592.69$61,870.89$ 95,179.00NoneJune 30, 194927,870.0027,870.0099,643.77NoneJune 30, 195070,844.3770,844.37163,486.25NoneAfter petitioner's organization, the board of directors consisted of two stockholders, Frank H. Ayres and his son, Donald B. Ayres, and the counsel*79 for the corporation. Following the death of Frank H. Ayres in December 1950, he was replaced on the board by the son-in-law of Donald B. Ayres. Prior to April 22, 1946, the business had been carried on from 1904 to 1927 by Frank H. Ayres, as an individual, and from 1927 to approximately June 1, 1946, by Frank H. Ayres & Son, a co-partnership, in which Donald B. Ayres owned a two-thirds interest and Frank H. Ayres a one-third interest. Petitioner's business was of a nature that the services rendered and activities undertaken had to be geared to the eexigencies of the real estate market; however, a major part of the business consisted in acting as agent for landowners in the development of their vacant lots into subdivided property. As a subdivider, petitioner had to expend considerable sums of money for advertising and selling expenses before getting any return on its projects. The normal cycle for developing a parcel of land into subdivision property consumes a period of two to three years. It takes at least one year from the time the project is begun to complete the engineering and clearance of the plans with the various government agencies concerned to a point where the actual*80 physical work of subdividing can begin. Another year or two is then consumed in making the physical improvement and doing the actual selling of lots before any substantial return of invested capital occurs. The factors leading up to the formation of petitioner were essentially twofold. (1) Just prior to April 1946 the principal activity of the partnership, Frank H. Ayres & Son, consisted of acting as exclusive agent for landowners in the subdivision development of certain vacant land, known as Kentwood and Westchester, and the sale of the subdivided property. Kentwood consisted of 940 acres and the partnership had a contract to act as exclusive agent for the development and sale of 400 of those acres; but, beyond that contract it had no assurance of being allowed to develop or sell any more land in that area. (2) In April 1946 the end of the 400 acre project was in sight. No new engagements to act as exclusive agent for development and sale of subdivision properties of other landowners had been secured, and the prospect of getting such engagements was dim. This situation arose out of a government policy, developed during the war, which allowed builders to borrow 90 or 95 per cent*81 of the cost of land and buildings. With this method of financing more and more builders were able to buy directly from the landowners, subdivide the land, build homes and completely eliminate the use of subdividers such as petitioner. The partnership management realized that if the company was to continue developing property it would have to purchase the land itself. The intrusion of the builder into the subdivision business made it difficult for non-building subdividers to purchase undeveloped land which was of such a nature and so priced as to permit profitable development. The prospect that the purchase of land as a partnership would increase the possibility of large personal liability plus the realization that Frank H. Ayres was advancing in years and the consequent desire to see the business continued led the partners to form petitioner. Tax counsel had been consulted as to the probable effect tax-wise of incorporation on the partners, but he had been unable to determine in advance what the effect would be. Between 1946 and 1948 petitioner's business grew from a small corporation with about $14,000 in assets to a concern of $114,000 in assets on June 30, 1948. In 1948 Frank*82 H. Ayres and Donald B. Ayres determined that at least a fund of $100,000 per year was needed to handle the normal working capital needs of petitioner. Land and improvement prices had increased since 1946, expenses, exclusive of commissions paid to salesmen and officers' salaries, averaged from $4,400 to $5,100 per month for the next three fiscal years and there was the frequent need for large sums of immediately available cash to meet potential real estate deals. The amounts of the net working capital (adjusted) for the three fiscal years under review were as follows: Fiscal year endedJune 30June 30June 30194819491950Total current assets$84,939.01$107,295.23$133,274.06Total current liabilities9,173.224,451.4212,566.76Net working capital$75,765.79$102,843.81$120,707.30Federal income tax payable23,405.237,001.8926,920.86Net working capital (adjusted)$52,360.56$ 95,841.92$ 93,786.44Near the close of each of the three years in question the board of directors considered the advisability of paying a dividend. In each case it was decided that the payment of dividends would be unwise and contrary to sound*83 business policy. At the May 24, 1948 board of directors' meeting the directors considered the fact that petitioner had made an offer in April 1948 to the Palos Verdes Corporation to purchase 33 acres at Abalone Cove for the price of $50,000. Petitioner's management estimated that should the offer be accepted $75,000 would be required to make the subdivision improvements. Subsequent to this directors' meeting the offer was rejected and the Palos Verdes Corporation subdivided the property itself at a cost of $92,645.38. Between May 24, 1948 and the next board meeting on May 4, 1949, petitioner's average monthly income had fallen below that of the previous year. The average monthly income for the 1948 and 1949 fiscal years was as follows: TotalTotalMonthCommissionsMonthCommissions19471948July$ 11,275.50July$ 24,833.12August36,789.91August6,991.54September39,512.50September14,906.30October12,518.14October15,059.00November30,380.07November20,293.70December25,368.12December30,917.9719481949January$35,671.86January$15,038.40February25,377.00February6,041.71March62,689.00March28,066.84April12,847.00April13,839.43May38,146.75May8,731.77June8,827.25June13,934.82Journal EntryDec. 1948 Extra10,560.00Total$339,403.10Total$209,214.60*84 During the same period petitioner had completed its activities as exclusive agent for landowners in the Kentwood and Westchester areas with respect to the 400 acres for which it had a written contract. The principal source of income at that time was from subdividing the Kentwood and Westchester properties for which it had no contract. There was no assurance that petitioner would be allowed to continue as agent for the landowners, except a verbal agreement that it would be allowed to complete the particular tract it might be operating on at any given time should the owner dispose of the remaining property by means other than through the agency of petitioner. At this time the Hughes Aircraft Co. was trying to buy up all unsubdivided Kentwood and Westchester acreage and petitioner's management was fearful that these attempts would be successful. Petitioner continually sought to purchase property to subdivide in the period from May 4, 1949 to June 16, 1950, the date of the next board meeting. It succeeded in purchasing a 47 per cent interest in a 75 acre tract of land in La Crescenta, California. At the June board meeting it was pointed out that it was the intent of the management to*85 join with the owner of the remaining 53 per cent of the property and subdivide it at a cost of $100,000 to petitioner. The net working capital at the date of the meeting was $96,150. Petitioner made no loans to its shareholders or their relatives and did not invest in any assets not connected with its business. At no time during the period in issue were the earnings or profits of petitioner permitted to accumulate beyond the reasonable needs of its business. Petitioner was not formed, and at no time during the period under review was it availed of for the purpose of preventing the imposition of surtax on its shareholders by permitting earnings or profits to accumulate instead of being divided or distributed. Opinion The respondent contends that petitioner was formed and availed of during the taxable years ended June 30, 1948, June 30, 1949, and June 30, 1950, for the purpose of preventing the imposition of surtaxes upon its shareholders through the medium of permitting earnings or profits to accumulate instead of being divided or distributed. He has accordingly determined a deficiency as provided by section 102(a), 1 Internal Revenue Code of 1939. *86 Under section 102(c), if petitioner's earnings or profits were permitted to "accumulate beyond the reasonable needs of the business," that fact is determinative of the purpose, to prevent the imposition of the surtax upon the shareholders, unless the petitioner proves to the contrary by a clear preponderance of the evidence. See Eastern Ry. & Lumber Co., 12 T.C. 869">12 T.C. 869; Whitney Chain & Mfg. Co., 3 T.C. 1109">3 T.C. 1109, affd. 149 Fed. (2d) 936. What are the reasonable or unreasonable needs of a business is a question of fact. Trico Products Corp. v. McGowan, 67 Fed. Supp. 311, affd. 169 Fed. (2d) 343, certiorari denied 335 U.S. 899">335 U.S. 899, rehearing denied 335 U.S. 913">335 U.S. 913; Dill Mfg. Co. 39 B.T.A. 1023">39 B.T.A. 1023. There is no set standard of measurement. Prominent factors in one case may become minor in another. Universal Steel Co., 5 T.C. 627">5 T.C. 627. "Whether or not earnings have been retained for the purpose of evading taxes on the stockholders is a question of intent, and each case must of necessity be decided upon facts and circumstances in that case. There is no rule of thumb or yardstick by which*87 this question of intent can be decided. The court must look at the matter from the viewpoint of the officers of the corporation, and place himself in the position they occupied at the time, take into consideration all of the facts and circumstances then existing and say what the officers intended at the time, * * *" Gazette Publishing Co. v. Self, 103 Fed. Supp. 779, 782. We think petitioner has met its burden of proof. Upon the evidence received at the hearing, we have found as ultimate facts that during the taxable years in question petitioner did not permit its earnings or profits to accumulate beyond the reasonable needs of its business. Petitioner was an operating company, engaged in a highly competitive and fluctuating business. Its officers and directors were men experienced in real estate business. As a result of the growth of petitioner's business and the rising price level its management decided in 1948 that at least $100,000 per year would be required to meet the normal working capital requirements of fixed monthly expenses and large sums of immediately available cash for potential real estate deals. In addition to the general needs for working capital*88 there was the realization that petitioner's income from activities as exclusive agent for the subdividing landowners in the Kentwood and Westchester areas might be cut off in the near future. The operation on the 400 acre portion for which petitioner had a contract, ended during the 1949 fiscal year. After completion of the 400 acre tract the termination of petitioner's activities in and the income from the Kentwood and Westchester projects were at all times at the will of the landowners. Since commissions from the Kentwood and Westchester projects represented the major portion of petitioner's income, provision for a source of replacing those commissions in the event of termination represented a very urgent need, even during the fiscal year ended June 30, 1948. Especially is this true since income from any new project would not be realized for at least one year and possibly as much as three years after commencement. This necessitated the anticipating from one to three years in advance the need for property to sell. Otherwise petitioner would be faced with a period in which it was developing property but had none to sell. The record shows that the possibility of replacing the Kentwood*89 and Westchester projects with similar ones was not bright. With the advent of the builders into the subdividing business, non-building subdividers such as petitioner were being bypassed. To stay in the subdividing business petitioner was forced to purchase land on its own account and then subdivide it, necessitating a larger investment than previously required. At the board of directors' meeting for each of the years under review the possibility of paying dividends was considered. The considerations which led the directors to determine that the payment of a dividend would be contrary to sound business policy were set out in the record in detail. At the 1948 meeting the directors considered the outstanding offer to the Palos Verdes Corporation for the purchase of 33 acres of land for $50,000. Those in charge had estimated that $75,000 would be needed for the cost of improvements should the offer be accepted. (After the offer was rejected the actual cost to the Palos Verdes Corporation was $92,645.38). Facing a potential expenditure of $125,000 the board concluded that dividends should not be paid. At that time the net working capital could not have differed materially from the $52,350.56*90 of net working capital as of June 30, 1948. In 1949 the directors reviewed a year that had shown a marked reduction in monthly income over the previous year and the attempt of Hughes Aircraft Co. to purchase all unsubdivided Kentwood and Westchester property. At that time petitioner had no written contract for development in that area. It was operating under a verbal agreement as to each small parcel it developed. Prior to the 1950 meeting petitioner had purchased a 47 per cent interest in a tract of land in La Crescenta, California, and was expecting to spend $100,000 in its development. At the date of the meeting the net working capital was $96,150, a sum hardly sufficient to pay dividends, normal expenses, and the La Crescenta improvement costs. Respondent urges that there must be an immediate need for the accumulation, citing Eastern Ry. & Lumber Co., supra; Trico Products Corp. v. McGowan, supra; McCutchin Drilling Co. v. Commissioner, 143 Fed. (2d) 480; KOMA, Inc. v. Commissioner, 189 Fed. (2d) 390. A review of these cases leads to the conclusion that "immediate need" is a label used in cases where there was an unreasonable*91 accumulation of earnings either because the need or plan of the corporation was so vague, tentative or indefinite that it did not justify the accumulation or that for some reason the contemplated expenditures could not be made during the period under review or in the ascertainable future. In the instant case the intention of petitioner was not to purchase land at some indefinite future date. Cf. World Publishing Co. v. United States, 169 Fed. (2d) 186, 189. It had a definite plan to replace the eventual loss (by completion or termination of the agency) of the Kentwood and Westchester projects, as evidenced by the Palos Verdes offer, the continuing search for profitable land during 1949 and 1950, and the purchase of the La Crescenta tract. The fact that at all times during the years in question petitioner remained as exclusive agent for the Kentwood and Westchester landowners is of no consequence. It was necessary that it find new property to develop while it was completing existing projects because of the time lag between investment and return. It is true that the intrusion of the builders into the subdividing business made undeveloped property scarce but some profitable*92 property was always available. Cf. Universal Steel Co., supra. Respondent also contends that since the Ayers were sole owners of the corporation the business would have been as well protected against unexpected demands for capital by distribution of its earnings to them as by the accumulation of its profits. This is completely fallacious. Respondent does not consider that the earnings if distributed would be diminished by an income tax on dividends and that there is no assurance that the net amount distributed would be retained by the shareholder, as it could voluntarily be expended or be reached by his personal creditors. The adoption of respondent's position would mean that no closely held corporation could ever accumulate any earnings, however reasonable the need. Having found that the accumulation was not unreasonable, it follows that petitioner was not formed or availed of for the prohibited purpose. 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 102↩ net income in excess of $100,000. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624891/ | Gene P. Green and Louise Green, Petitioners v. Commissioner of Internal Revenue, RespondentGreen v. CommissionerDocket No. 1785-73United States Tax Court66 T.C. 538; 1976 U.S. Tax Ct. LEXIS 85; June 22, 1976, Filed *85 Decision will be entered under Rule 155. Petitioner was a member of a partnership, known as the Raven Club, which conducted a casino-type gambling operation, including dice tables, a roulette wheel, blackjack tables, and slot machines, in Biloxi, Miss., during the taxable years involved. The partnership maintained a daily record showing its net wins or net losses, operational expenses and disbursements, and the balance of the partnership bankroll for each day. The originals of these records, together with receipts for expenditures, were delivered monthly to an experienced accountant and former IRS agent, who maintained a journal and general ledger and prepared the tax returns for the partnership. The respondent accepted the daily net wins shown by the partnership records as evidence of its gross income, but disallowed as deductions the amounts shown by the partnership records as net losses. Held, the records maintained by the partnership are substantially accurate both as to net wins and net losses, and clearly reflect petitioner's distributive share of partnership income under sec. 165(d), I.R.C. 1954. Larry L. Lenoir, for the petitioners.Frank Simmons, for the respondent. Bruce, Judge. BRUCE *539 Respondent determined the following deficiencies in Federal income taxes and additions to tax against the*87 petitioners:Addition to taxYearDeficiencysec. 6653(b) 11964$ 2,078.35$ 1,039.1819659,997.544,998.7719663,738.381,869.19Two issues are presented for determination: (1) Whether petitioners had unreported income from a partnership engaged in gambling operations, and, if the first question is answered in the affirmative, (2) whether petitioners' failure to report such income was due to fraud.FINDINGS OF FACTSome of the facts have been stipulated and the stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.Petitioners are husband and wife. During the relevant portion of taxable year 1964 petitioners were residents of Long Beach, Miss. During the taxable years 1965 and 1966 petitioners resided in Mississippi City, Miss. At the time of the filing of their petition herein, petitioners were residents of Gulfport, Miss. *88 Petitioners filed their Federal income tax returns for the years 1964 and 1965 with the District Director of Internal Revenue, Jackson, Miss., and their 1966 return was filed with the Internal Revenue Service Center, Chamblee, Ga. The amounts here in dispute relate to the activities of Gene P. Green, and his wife, Louise, is a party to this litigation only because she filed joint returns with her husband. When used hereafter, "petitioner" will refer to Gene P. Green.Prior to moving to Mississippi in May or June of 1964, petitioner and his family resided in Hot Springs, Ark. Petitioner was there employed in a gambling casino where he served as a *540 dealer and "boxman" at dice tables. Petitioner's duties did not include any record or bookkeeping functions.During late May or June of 1964, petitioner and his family moved to Long Beach, Miss., where petitioner and four other individuals -- Richard K. Head, Jack N. S. Denis, Sam F. Uchello, and Herschal D. Dyer (hereafter Head, Denis, Uchello, and Dyer) formed a partnership for the purpose of operating the Raven Club (hereafter the Raven Club or club). Petitioner, Denis, Uchello, and Dyer each contributed $ 2,000 to the partnership, *89 and each one also contributed an additional $ 500 for Head, who furnished the lease and paid renovation costs on the building in Biloxi which housed the Raven Club. The partners agreed to share profits equally and the three active partners, petitioner, Denis, and Uchello were to be paid salaries of $ 100 a week. The partnership, and successor partnerships which operated the Raven Club, employed the cash receipts and disbursements method of accounting. The partnerships did not maintain a bank account.The Raven Club began operation on July 18, 1964, and continued in existence until June 30, 1966. The club provided free food and beverages to customers and offered a variety of gaming activities including two dice tables, one roulette wheel, three blackjack tables, and slot machines.On January 22, 1965, Dyer withdrew from the partnership and the four original partners formed a new partnership which was similar in all respects to the former partnership. During the period from May 1965 through October 1965, the partnership conducted similar gambling operations at another Biloxi establishment, the Sa When Club. The Raven Club and the Sa When operations were treated as one combined*90 partnership business. On March 5, 1966, Head withdrew from the partnership, and petitioner, Uchello, and Denis formed a new partnership to conduct the Raven Club business.Customers were required to use chips in making wagers. No cash was allowed on the gambling tables. Patrons could purchase chips from a "boxman" stationed at each table. When a customer concluded his play for the evening, a "boxman" would exchange any remaining chips for cash. There was no central cashier's cage and the "boxmen" did not record the amounts received for chips nor the amount paid to redeem chips.*541 The cash in the several boxes constituted the gambling bankroll or "kitty." All gambling payouts, amounts paid to redeem chips, as well as all business expenses, e.g., rent, utilities, and food, were paid in cash from the "kitty." Petitioner normally carried the "kitty" on his person. However, if the "kitty" became extremely large, other partners would share the responsibility of carrying the currency.Petitioner was primarily responsible for maintaining partnership records although he had no previous experience or training as a bookkeeper. At the end of each gambling day petitioner and at *91 least one other partner would count the money in the boxes. If, after taking into account all expense disbursements, the amount exceeded the count on the preceding day, the partners would record a "win" and the amount thereof. Conversely, if the amount in the "kitty" was less than the amount present on the preceding day, the difference was recorded as a "lose." The difference represented the net gain or loss for that day without regard to each separate gain or loss from a particular gaming activity. The partnership maintained a daily record of the beginning bankroll, gain or loss from gambling, and operational expenses incurred. This record was maintained by petitioner in calendar notebooks for each year of operation. An example of entries from the 1964 notebook are set forth herein:Thursday, Oct. 1$ 25,051Win27125,322Pay out15325,169Friday, Oct. 225,169Lose6025,109Pay out4525,064Saturday, Oct. 3Closed -- Storme [sic]25,064Net pay roll$ 584Employ tax WH6164524,419*542 These entries indicate that prior to beginning play on October 1, 1964, the partnership bankroll*92 was $ 25,051. The partnership had a net gain of $ 271 as a result of play that evening, and paid $ 153 in expenses. Similarly, the partnership lost $ 60 as a result of operations on Friday, October 2, 1964, and paid $ 45 in expenses. The club was closed on Saturday, October 3, however the weekly payroll and employee tax withholding are reflected.The partnership records thus reflected daily net gains and losses from gambling and the total amount of cash paid for necessary expenses and salaries. This record and all cash receipts for expense items were delivered monthly to William G. Murphy, Jr., an experienced public accountant, who maintained a journal and general ledger for the partnership. With the cash receipts for all expense disbursements, Murphy was able to identify and account for all expense payments noted in the daily record. For example, the credit entries to "cash" and debit entries to various expense accounts for October 1 and 2, 1964 (see the daily record illustration above), indicate the following expense disbursements:BuildingOct.CashRepairLinenLiquor1 Grover Graham Jr. & Co.$ 146.26$ 146.26Mobile Linen1.66$ 1.66Sandwiches4.75$ 152.672 Gulf Coast Lumber Co.3.15$ 3.15Wilkes Printing Co.17.50Coca Cola Bottling10.00Coca Cola9.45Sandwiches5.0045.10*93 Oct.CokeFoodGeneral1 Grover Graham Jr. & Co.Mobile LinenSandwiches$ 4.75$ 152.672 Gulf Coast Lumber Co.Wilkes Printing Co.$ 17.50 (office supplies)Coca Cola Bottling10.00 (coke box)Coca Cola$ 9.45Sandwiches$ 5.00The partnership daily records, supplemented by cash receipts evidencing payouts, were the sources from which Murphy compiled formal partnership books. Additionally, Murphy prepared Federal employment tax and partnership information returns.Petitioner also kept a personal record of all partnership gains and losses in a separate notebook. This personal record was maintained in the event the partnership records, which were kept in a desk at the club, were destroyed or stolen. The figures in both notebooks correspond except that the partnership records were generally more detailed.Petitioner was a partner in each of the three partnerships which operated the Raven Club. A total of five partnership *543 information returns, Forms 1065, were filed during the 24 months the Raven Club was in operation. Partnership gross income was computed by netting all daily win and loss figures during the taxable period. *94 The net result was reported on line 1 of the partnership returns as "Gross receipts" and also on line 12 as "Total income." Deductible business expenses were subtracted from this figure to arrive at distributable income.The records of the Raven Club indicate the following wins and losses during the 3 calendar years of operation:Calendar year 1964Number of days on which wins are reported104Number of days on which losses are reported58Total days of operation162Total amount of wins$ 97,926.00Total amount of losses44,506.00Net income from gambling53,420.00Calendar year 1965Number of days on which wins are reported216Number of days on which losses are reported127Total days of operation343Total amount of wins260,993.00Total amount of losses121,233.00Net income from gambling139,760.00Calendar year 1966Number of days on which wins are reported90Number of days on which losses are reported61Total days of operation151Total net wins90,687.10Total net losses62,691.00Net income from gambling27,996.10Respondent disallowed all*95 daily loss figures and correspondingly increased partnership income by the same amount.The parties have stipulated that no method, other than disallowance of the net daily gambling losses, was used in determining petitioners' gross income.*544 ULTIMATE FINDINGS OF FACTThe Raven Club incurred deductible gambling losses during the taxable years in the following amounts:1964$ 40,055.401965109,109.70196656,421.90OPINIONRespondent contends that the records maintained by the Raven Club partnerships do not satisfy the requirements of section 6001, and the regulations thereunder, since they do not contain information as to gross receipts and total gambling disbursements. Respondent also contends that the records are inadequate to determine the character of income and deductions under section 702(b). Further, respondent claims that the records fail to prove the total amount of gambling losses and, therefore, a deduction under section 165(d) is not allowable. Finally, the Government contends that since the records fail to "clearly reflect income," it has authority by virtue of section 446(b) to disallow all daily net losses and accordingly to increase petitioner's*96 distributive share of partnership income.The deficiency determination by respondent is presumptively correct, Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933); Wickwire v. Reinecke, 275 U.S. 101">275 U.S. 101, 105 (1927), and petitioner bears the burden of proving otherwise. Rule 142, Tax Court Rules of Practice and Procedure. The disallowance of daily net gambling losses is not an arbitrary, erroneous, or unreasonable method of reconstructing income under certain circumstances. Stein v. Commissioner, 322 F.2d 78">322 F.2d 78 (5th Cir. 1963), affg. a Memorandum Opinion of this Court; Plisco v. United States, 306 F.2d 784">306 F.2d 784 (D.C. Cir. 1962). Disallowance of such losses is based on the theory that the total amount of wins can be accepted as an admission against interest while the amount of total losses is merely a self-serving declaration which must be proven by verifiable data. Respondent did not consider using another method of reconstructing income but, according to the testimony of the revenue agent, relied on "case law" in disallowing all losses.Respondent urges that Stein v. Commissioner, supra,*97 is controlling since this Court is obligated to follow decisional law "squarely in point" by the Court of Appeals to which an appeal in *545 the instant case would lie. Jack E. Golsen, 54 T.C. 742">54 T.C. 742, 757 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940 (1972). Such reliance is misplaced since we find little similarity between Stein and the case at bar.The taxpayer in Stein was a professional gambler most of whose gambling activities included poker, dice, gin rummy, and betting on sports events. He did not engage in bookmaking or operate a gambling establishment. He purportedly counted his bankroll prior to engaging in a gambling activity, but made no record of this amount. At the conclusion of his play he recounted his bankroll to determine whether he had a gain or loss. The difference between what he remembered his beginning bankroll to have been and his ending balance was noted on a scrap of paper, such as a cocktail napkin, match cover, soap wrapper, etc., with the date and a "W" or "L" indicating a win or loss. These scraps of paper were allegedly retained*98 in a drawer at the taxpayer's home and the daily win and loss figures were transcribed in a notebook at the end of each year. The taxpayer computed his income for the taxable year by netting all wins and losses recorded in the notebook. At trial the taxpayer relied on the summarized records contained in his notebook to prove gambling gains and losses. These records were found on the whole to be unreliable and the truthfulness of taxpayer's testimony was questionable. Under these circumstances, where there was no corroborating evidence, the disallowance of daily net loss amounts was upheld. Further, the Cohan rule, Cohan v. Commissioner39 F.2d 540">39 F.2d 540 (2d Cir. 1930), was held inapplicable since there was insufficient evidence upon which a valid approximation of deductible losses could be determined.Similarly, in Plisco v. United States, supra, daily net losses were disallowed a bookmaking partnership. The partners destroyed all verifying records, particularly the betting slips and "20-line sheets," and relied only on books summarizing their daily gambling profits and losses.While we agree generally with the *99 decisions in Stein and Plisco, we do not regard those cases as authority for respondent to summarily disallow all losses simply because the taxpayer is a gambler who has netted his wins and losses. The question of the amount of losses sustained by a gambling partnership is essentially one of fact to be determined from the entire record, H. T. Rainwater, 23 T.C. 450">23 T.C. 450 (1954), and, obviously, the facts in *546 each case differ. In our opinion petitioner has met his burden of proving that substantial losses did occur and we are convinced that his records essentially reflect the amount of losses sustained. The present case involves different types of gambling activities and is clearly distinguishable from Stein and Plisco. 2 We hold that petitioner is entitled to his share of partnership losses as set forth in our ultimate findings of fact. We base our determination on the following considerations.*100 First, petitioner produced original records of the partnership which reported wins, losses, expenses, payroll disbursements, distributions to partners, and a running balance of the partnership bankroll. These records were made at the end of each day's activities and constitute a clear, systematic, and consistent record of the partnership activities throughout the period in which the Raven Club was open. These records were also consistent with the personal records kept by petitioner. The daily computations of "win" or "lose" were made with at least two partners present and apparently were relied on by the absentee partners in determining their division of the profits.The present case differs from those cases where original records were not submitted in evidence usually because they had been deliberately destroyed. E.g., Plisco v. United States, supra;Anthony Delsanter, 28 T.C. 845">28 T.C. 845 (1957); Jack Showell, 23 T.C. 495 (1954), revd. 238 F.2d 149">238 F.2d 149 (9th Cir. 1956); T.C. Memo. 1957-22, on remand revd. 254 F.2d 461">254 F.2d 461 (9th Cir. 1958); *101 T.C. Memo. 1960-7 on second remand affd. 286 F.2d 245">286 F.2d 245 (9th Cir. 1961); H. T. Rainwater, 23 T.C. 450 (1954). We are not faced with the problem of accepting transcriptions from original records to secondary books. It is recognized that original records do not necessarily assure an accurate account of business transactions, since parties sometimes intentionally or negligently fail to keep complete records. However, original entries may merit consideration.The very nature of a casino operation makes it difficult to maintain extensive verifying records in contrast with bookmaking operations on horseracing or sporting events which require written records of each wager in order for the bookmaker and the bettor to have proof of their wager. Also, wagers are oftentimes placed well in advance of the race or event and the *547 bettor may not collect his winnings until several days after the event. The instant case does not involve bookmaking but casino style gambling where, from a practical standpoint, it is impossible to record each separate roll of the dice or spin of the wheel. Casino operators*102 are not excused from keeping adequate records and they assume a risk in not maintaining books sufficient to verify figures on a tax return. But what constitutes sufficient records depends, in each case, on the nature and complexity of the business. In the present case, we find the records sufficient to show wins and losses and we believe they are substantially accurate.A qualified public accountant employed by the partners to maintain formal books and records and to prepare their tax returns testified that, in his opinion, the method of reporting used complied with general accounting principles. The regular disclosure of the daily records to an accountant and the maintenance of a journal and general ledger by the accountant which appear to be unusually complete and accurate for a gambling operation of the kind involved herein have in large measure dispelled any notion of connivance or deceit on the part of the petitioner in reporting his gambling losses. Respondent's agents testified that petitioner had been cooperative and forthright throughout their investigation, and from our observation of the petitioner as he testified at the trial, we are satisfied that his testimony concerning*103 his business affairs was substantially trustworthy and credible.We think it is an obvious fact that a gambling operation such as that conducted by the Raven Club could not have been carried on without incurring some losses. Respondent, in effect, has recognized that the partnership incurred a certain amount of losses to the extent that for each "win" day an unknown amount of losses was subtracted from an unknown amount of wins. It is unrealistic to assume that the operation did not have some days on which losses in excess of wins were incurred. On the basis of all the facts shown in the present case, we see no reason for not accepting the reliability of the partnership records on the "loss" days as well as the "win" days. Cf. John Federika, a Memorandum Opinion of this Court (14 T.C.M. (CCH) 653">14 T.C.M. 653, 657-3, P.H. Memo. T.C. par. 55,172 (1955)), affd. per curiam 237 F.2d 916">237 F.2d 916 (6th Cir. 1956), cert. denied 352 U.S. 1025">352 U.S. 1025 (1957), rehearing denied 353 U.S. 931">353 U.S. 931 (1957); Herman Drews, 25 T.C. 1354">25 T.C. 1354 1354 *548 (1956); Jack Showell, supra.*104 3One of the troublesome aspects of this and similar cases is that respondent has not seen fit to indicate what records would be deemed sufficient to prove losses under section 165(d). The regulations under section 6001 certainly do not specify an ironclad formula, particularly for professional gamblers. Apparently it is respondent's position that petitioner's fault was in not maintaining a record of gross receipts and gambling payoffs. A tabulation of the amounts paid for chips less the amount paid to redeem chips would have served to verify the net win or loss figures recorded by petitioners since, under either approach, the same mathematical result would*105 obtain. But failure to account for gross receipts and gambling disbursements does not warrant total disregard of the daily net loss figures where, as here, it is shown that those amounts were obtained from orderly records and, when subtracted from the amounts reported as net wins, are sufficient to calculate gross income and net income. We believe these records are substantially accurate and that the difference between wins and losses constitutes gross income. Cf. James P. McKenna, 1 B.T.A. 326 (1925); Winkler v. United States, 230 F.2d 766 (1st Cir. 1956).Section 165(d) permits the deduction of gambling losses to the extent of gambling gains. Under the facts of this case, we think the method of reporting employed by petitioner results in an accurate computation under that provision. Since there is no dispute as to the character of income, it is unnecessary to consider respondent's contentions under section 702(b).Although we believe petitioner's computations are substantially accurate, we deem it appropriate to make a minor adjustment under the Cohan rule. 4 This is due to two factors. First, petitioner and*106 his partners could have segregated the slot machine operation from the gaming activities and provided exact data as to winnings from the slot machines. Secondly, although there is no evidence of any irregularities or misappropriations on the part of those handling the "boxes," we think a record of the amount of cash and chips given each boxman at the beginning of play, the amount of cash paid out in redemption of chips, and the *549 amount of cash and chips in possession of each boxman at the end of play would have furnished more control and perhaps a more reliable record of gains and losses. Absent any defalcations, the result should be the same. For these reasons, and using our best judgment, we have found the partnership had deductible gambling losses as reported in our ultimate findings of fact.We turn now to the second issue on which respondent bears the burden of proving fraud by clear and convincing evidence. Carter v. Campbell, 264 F.2d 930">264 F.2d 930, 936 (5th Cir. 1959).*107 "The fraud meant is actual, intentional wrongdoing, and the intent required is the specific purpose to evade a tax believed to be owing. Mere negligence does not establish either." Mitchell v. Commissioner, 118 F.2d 308">118 F.2d 308, 310 (5th Cir. 1941).In attempting to meet this burden respondent has sought to link several events which, he claims, prove fraud on the part of petitioner. First, respondent offered testimony of two revenue agents and a special agent which, taken together, indicated that Denis was issued an "inadequate records notice" in 1962 while operating a gambling establishment in Biloxi known as the Key Club. Secondly, the testimony further indicated that Uchello was formerly a partner in a Biloxi gambling establishment known as the Gay Paree. During an audit of the Gay Paree in 1963, a revenue agent testified that he orally advised Uchello that the records were inadequate; however, the agent also testified that Uchello had terminated his interest in the Gay Paree partnership prior to the audit. Both clubs employed a netting system like, or similar to, the one used by petitioner in determining gaming profts. Since petitioner's partners, *108 Uchello and Denis, had knowledge that more detailed records were required, and since the reporting system used by petitioner was discussed with and approved by all partners, respondent contends that these and surrounding facts create a strong inference that the three active partners willfully and knowingly maintained books and records designed to conceal essential information as to receipts, disbursements, and actual income.While "direct proof of fraud is seldom possible," Leon Papineau, 28 T.C. 54">28 T.C. 54, 57-58 (1957), we believe the link which respondent has attempted to establish is far too weak and tenuous to constitute clear and convincing evidence for three reasons. First, petitioner denied having knowledge of the notices issued to Denis and Uchello, and we believe his testimony. Secondly, the *550 notice issued to Denis is itself inadequate for us to conclude that he was informed that a netting of wins and losses was improper. The notice states:Taxpayer failed to keep records of names and addresses of individuals from whom he accepted wagers and to whom he made payments.Although the taxpayer is apparently not operating at all at the present*109 time, the possibility exists that he may be able to go back into business at some future date.Read literally, the notice says nothing about netting income and losses nor does it require the reporting of gross receipts and gambling disbursements. Thirdly, in view of these circumstances, we refuse to impute knowledge from Denis and Uchello to petitioner where we are unconvinced that Denis and Uchello had knowledge of what system respondent considered adequate, or inadequate, in reporting gains and losses from gambling. "It [fraud] is never imputed or presumed and the courts should not sustain findings of fraud upon circumstances which at the most create only suspicion." Davis v. Commissioner, 184 F.2d 86">184 F.2d 86, 87 (10th Cir. 1950); Olinger v. Commissioner, 234 F.2d 823">234 F.2d 823 (5th Cir. 1956).Finally, respondent is left with one argument on the issue of fraud. Even assuming the Raven Club operation violated Mississippi and Federal law, we think that fact standing alone is insufficient to prove fraud in the filing of tax returns. We therefore hold petitioner not liable for the civil fraud penalty under section 6653(b).In order *110 to give effect to our determination,Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Compare Golden Nuggett, Inc., T.C.Memo. 1969-149; Aaron Greenfeld, T.C.Memo. 1966-83↩.3. Compare Golden Nugget, Inc., T.C. Memo. 1969-149; Anthony F. Gallagher, T.C. Memo. 1968-27; Harry Bennett, T.C. Memo. 1968-71; B. H. Bickers, T.C. Memo. 1960-83; Clarence E. Baldwin, T.C. Memo. 1955-200↩.4. Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540↩ (2d Cir. 1930). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624892/ | FEDERAL HOME LOAN MORTGAGE CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentFed. Home Loan Mortg. Corp. v. Comm'rNo. 3941-99; No. 15626-99 United States Tax Court121 T.C. 129; 2003 U.S. Tax Ct. LEXIS 27; 121 T.C. No. 8; September 4, 2003, Filed Petitioner's adjusted basis for purposes of amortizing intangible assets was found to be the higher of regular adjusted cost basis or fair market value as of January 1, 1985. P was chartered by an act of Congress in 1970 and was originally exempt from Federal income taxation. Pursuant to the Deficit Reduction Act of 1984 (DEFRA), Pub. L. 98-369, sec. 177, 98 Stat. 709, P became subject to Federal income taxation, effective Jan. 1, 1985. For its taxable years 1985 through 1990, P claims entitlement to amortize intangibles using a fair market value basis as of Jan. 1, 1985. P's claim that it is entitled to use fair market value as its adjusted basis for amortization is based on the provisions of DEFRA that specifically apply only to P. R determined that P's adjusted basis for amortizing any intangibles is the regular adjusted cost basis of those assets as of Jan. 1, 1985. Held: Under sec. 167(g), I.R.C.*28 , the basis for amortization of property is the adjusted basis provided in sec. 1011, I.R.C., for the purpose of determining gain on the sale or other disposition of property. The adjusted basis provided in sec. 1011, I.R.C., is generally based on cost. However, DEFRA sec. 177(d)(2)(A)(ii) modifies the application of sec. 1011, I.R.C., by providing specific rules for determining the adjusted basis of property held by P on Jan. 1, 1985. Under DEFRA sec. 177(d)(2)(A)(ii), the adjusted basis of any asset held by P on Jan. 1, 1985 (with the exception of tangible depreciable property) shall, for purposes of determining any gain, be equal to the higher of the regular adjusted cost basis as provided in sec. 1011, I.R.C., or the fair market value of such asset as of Jan. 1, 1985. P's adjusted basis as of Jan. 1, 1985, for purposes of amortization, is the higher of the regular adjusted cost basis or fair market value on Jan. 1, 1985. Robert A. Rudnick, Stephen J. Marzen, James F. Warren, and Neil H. Koslowe, for petitioner.Gary D. Kallevang, for respondent. Ruwe, *29 Robert P. RUWE*130 OPINIONRUWE, Judge : Respondent determined deficiencies in petitioner's Federal income taxes in docket No. 3941-99 for 1985 and 1986, as follows:YearDeficiency1985$ 36,623,695198640,111,127 Petitioner claims overpayments of $ 9,604,085 for 1985 and $ 12,418,469 for 1986.Respondent determined deficiencies in petitioner's Federal income taxes in docket No. 15626-99 for 1987, 1988, 1989, and 1990, as follows:YearDeficiency1987$ 26,200,358198813,827,654 19896,225,404 199023,466,338 Petitioner claims overpayments of $ 57,775,538 for 1987, $ 28,434,990 for 1988, $ 32,577,346 for 1989, and $ 19,504,333 for 1990.Petitioner claims entitlement to amortize (all or a portion of) its asserted tax basis in certain alleged intangibles held on January 1, 1985. 1 Petitioner's asserted tax basis in each of these alleged intangibles represents petitioner's determination of the respective fair market values of those intangibles as of January 1, 1985. Petitioner and respondent filed cross-motions for partial summary judgment under*30 Rule 1212 regarding the appropriate basis for amortizing intangible assets that petitioner claims to have held on January 1, *131 1985, the date it first became subject to Federal income taxation.In this opinion, we decide*31 whether, for purposes of computing a deduction for amortization, the adjusted basis of any amortizable intangible assets that petitioner held on January 1, 1985, is the regular adjusted cost basis provided in section 1011 or the higher of the regular adjusted cost basis or fair market value of such assets on January 1, 1985, as provided in the Deficit Reduction Act of 1984 (DEFRA), Pub. L. 98-369, sec. 177, 98 Stat. 709">98 Stat. 709. BackgroundSome of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time of filing the petition, petitioner's principal office was located in McLean, Virginia. At all relevant times, petitioner was a corporation managed by a board of directors.Petitioner was chartered by Congress on July 24, 1970, by the Emergency Home Financing Act of 1970, Pub. L. 91-351, title III (Federal Home Loan Mortgage Corporation Act), 84 Stat. 451. Petitioner was originally exempt from Federal income taxation. However, Congress repealed petitioner's Federal income tax exemption status in DEFRA section 177. Pursuant to this Act, petitioner became*32 subject to Federal income taxation, effective January 1, 1985.The question we must decide in this opinion involves a determination of petitioner's basis for amortizing intangibles that it allegedly held on January 1, 1985. Section 167(g), which forms the basis for amortization deductions, provides that "The basis on which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the adjusted basis provided in section 1011 for the purpose of determining the gain on the sale or other disposition of such property." (Emphasis added.) Section 1011 generally provides for an adjusted cost basis for purposes of determining gain or loss (regular adjusted cost basis). From the arguments presented by the parties, it appears that petitioner would have relatively little or no adjusted basis in its alleged intangibles if the regular adjusted cost basis provisions of section 1011 applied. *132 As a part of the legislation pursuant to which petitioner became subject to Federal income taxation, Congress enacted "special basis rules designed to ensure that, to the extent possible, pre-1985 appreciation or decline in the value of * * * [petitioner's] *33 assets will not be taken into account for tax purposes." H. Conf. Rept. 98-861, at 1038 (1984), 1984-3 C. B. (Vol. 2) 1, 292. The special basis rules, which are contained in DEFRA section 177(d)(2), 98 Stat. 711, provide a dual-basis rule for purposes of determining any loss and any gain regarding assets held by petitioner on January 1, 1985. DEFRA section 177(d)(2)(A) provides:(2) Adjusted basis of assets. -- (A) In general. -- Except as otherwise provided in subparagraph (B), the adjusted basis of any asset of the Federal Home Loan Mortgage Corporation held on January 1, 1985, shall -- (i) for purposes of determining any loss, be equal to the lesser of the adjusted basis of such asset or the fair market value of such asset as of such date, and (ii) for purposes of determining any gain, be equal to the higher of the adjusted basis of such asset or the fair market value of such asset as of *34 such date. [Emphasis added.]Petitioner claims that it is entitled to amortize intangibles that it held on January 1, 1985, using a fair market value basis under DEFRA section 177(d)(2)(A)(ii). Petitioner claims the following fair market values for its alleged intangibles:IntangiblesFair Market ValueInformation systems$ 27,214,000Favorable leasehold9,459,349 Seller/servicer list6,215,000 Favorable financing456,021,853Customer relations600,000,000Petitioner claims entitlement to the following amortization deductions for its 1985-90 taxable years:ClaimedIntangible198519861987Information system$ 5,981,964$ 5,981,964$ 5,981,952Favorableleaseholds513,120513,120380,625Seller/servicelist1,123,5721,123,5721,123,572Favorablefinancing50,219,11648,702,45747,017,000Customerrelations60,000,00060,000,00060,000,000Total Claim117,837,720 1116,321,113114,503,149ClaimedIntangible198819891990Information system$ 5,931,920$ 3,336,160$ 40 Favorableleaseholds368,580 368,446 367,164Seller/servicelist711,072 711,072 711,072Favorablefinancing45,835,55640,680,42038,028,084Customerrelations60,000,00060,000,00060,000,000Total Claim112,847,128105,096,09899,106,360*35 *133 DiscussionSummary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. FPL Group, Inc. v. Commissioner, 116 T.C. 73">116 T.C. 73, 74 (2001). Either party may move for summary judgment upon all or any part of the legal issues in controversy. Rule 121(a); FPL Group, Inc. v. Commissioner, supra at 74. A decision will be rendered on a motion for partial summary judgment if the pleadings, answers to interrogatories, depositions, admissions, and other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law. Rule 121(b); Elec. Arts, Inc. v. Commissioner, 118 T.C. 226">118 T.C. 226, 238 (2002). The moving party has the burden of proving that no genuine issue of material fact exists*36 and that party is entitled to judgment as a matter of law. Rauenhorst v. Commissioner, 119 T.C. 157">119 T.C. 157, 162 (2002).The parties in the instant cases filed cross-motions for partial summary judgment on the question of whether petitioner's claimed intangibles are amortizable using their fair market value on January 1, 1985, as adjusted basis. The parties agree that there are no genuine issues of material fact relating to this legal question. Respondent assumes for purposes of this issue that at least some of petitioner's claimed intangibles are amortizable for tax purposes.Arguments of the PartiesPetitioner claims that the special basis rules of DEFRA section 177(d)(2) provide the adjusted basis for purposes of amortizing any intangibles that it held as of January 1, 1985. Petitioner contends that this result is required by the interaction of section 167(g) and DEFRA section 177(d)(2)(A). Thus, petitioner claims that it is entitled to amortize its alleged intangibles at their fair market value.*134 Respondent argues that DEFRA section 177(d)(2) does not provide rules for determining the adjusted basis for amortization of petitioner's intangibles but, instead, *37 provides special basis rules solely for purposes of determining gain and loss from the sale or other disposition of property that petitioner held on January 1, 1985. He argues that petitioner's adjusted basis for purposes of amortizing any intangibles that it might have held on that date is determined under the regular adjusted cost basis rules of the Code without reference to the special basis rules of DEFRA section 177(d)(2). Respondent contends that petitioner would have relatively little or no adjusted cost basis.AnalysisIn interpreting a statute, we start as always with the language of the statute itself. Consumer Prod. Safety Commn. v. GTE Sylvania, Inc., 447 U.S. 102">447 U.S. 102, 108, 64 L. Ed. 2d 766">64 L. Ed. 2d 766, 100 S. Ct. 2051">100 S. Ct. 2051 (1980). We look to the legislative history primarily to learn the purpose of the statute and to resolve any ambiguity in the words contained in the text. Wells Fargo & Co. v. Commissioner, 120 T.C. 69">120 T.C. 69, 89 (2003); Allen v. Commissioner, 118 T.C. 1">118 T.C. 1, 7 (2002). If the language of the statute is plain, clear, and unambiguous, we generally apply it according to its terms. *38 United States v. Ron Pair Enters., Inc., 489 U.S. 235">489 U.S. 235, 241, 103 L. Ed. 2d 290">103 L. Ed. 2d 290, 109 S. Ct. 1026">109 S. Ct. 1026 (1989); Burke v. Commissioner, 105 T.C. 41">105 T.C. 41, 59 (1995). If the statute is ambiguous or silent, we may look to the statute's legislative history to determine congressional intent. Burlington N.R.R. v. Oklahoma Tax Commn., 481 U.S. 454">481 U.S. 454, 461, 95 L. Ed. 2d 404">95 L. Ed. 2d 404, 107 S. Ct. 1855">107 S. Ct. 1855 (1987); Ewing v. Commissioner, 118 T.C. 494">118 T.C. 494, 503 (2002).DEFRA section 177(d)(2)(A) does not specifically state that the adjusted basis for purposes of determining gain provided therein is also to be used for purposes of amortizing petitioner's intangibles held on January 1, 1985. The legislative history likewise does not contain a specific expression of congressional intent with respect to the amortization of intangibles. The conference report states simply: The Senate amendment includes special basis rules designed to ensure that, to the extent possible, pre-1985 appreciation or decline in the value of Freddie Mac assets will not be taken into account for tax purposes. Under these rules, for purposes of determining*39 gain, the basis of any asset held on January 1, 1985, is to be the higher of (1) the regular adjusted basis of the asset in the hands of Freddie Mac, or (2) the fair market value *135 of the asset on January 1, 1985. For purposes of determining loss, the basis of any asset held on January 1, 1985, is to be the lower of these two figures. Where the amount realized on the disposition of an asset is greater than the lower of these figures, but less than the higher figure, no gain or loss is to be recognized by Freddie Mac on the disposition. [H. Conf. Rept. 98-861, supra at 1038, 1984-3 C.B. (Vol. 2) at 292.]DEFRA section 177(d)(2) provides a specific adjusted basis for purposes of determining any gain on the sale or other disposition of petitioner's property: DEFRA section 177(d)(2)(A)(ii) provides that the adjusted basis of any asset held by petitioner on January 1, 1985, shall, for purposes of determining any gain, be equal to the higher of the regular adjusted cost basis of such asset or the fair market value of such asset as of such date. The Code has historically used the adjusted basis for*40 determining gain as the reference point for determining the basis for the depreciation or amortization of property. Indeed, section 167(g)3 specifies that the basis for determining gain is the basis to be used for depreciation or amortization. 4Section 167(g) provides that "The basis on which exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the adjusted basis provided in section 1011 for the purpose of determining the gain on the sale or other disposition of such property." See also sec. 1.167(g)-1, Income Tax Regs. Section 167(g)*41 refers specifically to the adjusted basis for determining gain provided in section 1011. Section 1011(a) provides: SEC. 1011(a). General Rule. -- The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis (determined under section 1012 or other applicable sections of this subchapter and subchapters C (relating to corporate distributions and adjustments), K (relating to partners and partnerships), and P (relating to capital gains and losses)), adjusted as provided in section 1016.As a general matter, section 1011 requires the use of the cost basis determined under section 1012, 5 adjusted as provided*136 in section 10166 (i.e., the regular adjusted cost basis), for purposes of determining gain or loss. Section 1011 does not specify any alternative basis rules besides those contained in other sections of subchapters C, K, O, and P of the Code, which are not applicable to the instant cases.*42 DEFRA section 177(d)(2), which has not been codified, is not specifically referenced in section 1011. Nevertheless, DEFRA section 177(d)(2)(A) specifically provides the rules for determining adjusted basis in property held on January 1, 1985, when determining petitioner's gain on the sale or other disposition of such property. Thus, as to petitioner, the specific basis rules contained in DEFRA section 177(d)(2)(A) replace the regular adjusted cost basis rules contained in sections 1011 through 1023 of the Code. Since section 167(g) requires that the adjusted basis for determining gain be used as the adjusted basis for amortizing intangibles, it is logical*43 to conclude that petitioner must use the specific adjusted basis determined under DEFRA section 177(d)(2)(A)(ii) to amortize any intangibles it might have held on January 1, 1985.Respondent argues that section 167(g) refers to section 1011 and that section 1011 does not refer to the specific adjusted basis rule of DEFRA section 177(d)(2)(A)(ii). However, we point out that DEFRA section 177(d)(2)(A)(ii) is a special transition rule, which is applicable only to property held by petitioner as of January 1, 1985, and which replaces section 1011 for purposes of determining gain. Under these circumstances, we are not inclined to read too much into the absence of a specific reference to DEFRA section 177(d)(2)(A)(ii) in section 1011 or in the enumerated subchapters cited in section 1011. Further, the regulation interpreting section 1011(a) provides: The adjusted basis for determining the gain or loss from the sale or other disposition of property is the cost or other basis prescribed in section 1012 or other applicable provisions of subtitle A of the Code, adjusted to the extent provided in sections 1016, 1017, and 1018 or as otherwise specifically*44 provided for under applicable provisions of internal revenue laws. [Sec. 1.1011-1, Income Tax Regs.; emphasis added.]*137 The parties advance differing interpretations of the "internal revenue laws" language in section 1.1011-1, Income Tax Regs. Petitioner argues that this language should be read to incorporate any internal revenue law which specifically provides the adjusted basis for determining gain or loss from the sale or other disposition of property. Respondent contends that "It is apparent" from the text of section 1011 "that alternatives to the cost basis of section 1012 are confined to 'this subchapter' (subchapter O) or elsewhere in the Code, namely, subchapters C, K and P." He argues that section 1011 does not refer to an adjusted basis specified in other "internal revenue laws", and the language in section 1.1011-1, Income Tax Regs., "does not provide for alternatives to section 1012 itself; it provides for some mechanism of basis adjustments as an alternative to sections 1016, 1017 and 1018." 7*45 We read section 1.1011-1, Income Tax Regs., to incorporate rules for determining adjusted basis in property which are "specifically provided for under applicable provisions of internal revenue laws." We do not read the regulation to mean that the section and subchapters enumerated in section 1011 are the exclusive means of determining adjusted basis in property. 8 This interpretation is more consistent with the application of the regular adjusted basis rules and any special adjusted basis rules, including DEFRA section 177(d)(2).Even if the "internal revenue laws" language in the regulation refers only toadjustments to initial cost*46 or other basis, we fail to see how this forecloses any reference to DEFRA section 177(d)(2). In our view, DEFRA section 177(d)(2) is in effect an adjustment to cost basis. 9Section 1.1011-1, Income Tax Regs.,*138 reflects such an interpretation. A reasonable interpretation of adjusted basis under section 1011 incorporates any internal revenue laws which provide for a specific adjusted basis for purposes of determining gain or loss. DEFRA section 177(d)(2)(A) is an internal revenue law, which specifically provides the adjusted basis for purposes of determining any gain from the sale or other disposition of property held by petitioner on January 1, 1985. Section 167(g) requires the use of this adjusted basis for purposes of amortizing petitioner's alleged intangibles.*47 It also appears that Congress contemplated this result under section 167(g) when it provided an exception in DEFRA section 177 for purposes of determining petitioner's adjusted basis in tangible depreciable property. That exception is contained in DEFRA section 177(d)(2)(B) and provides: (B) Special Rule for Tangible Depreciable Property. -- In the case of any tangible property which -- (i) is of a character subject to the allowance for depreciation provided by section 167 of the Internal Revenue Code of 1954, and (ii) is held by the Federal Home Loan Mortgage Corporation on January 1, 1985, the adjusted basis of such property shall be equal to the lesser of the basis of such property or the fair market value of such property as of such date.The conference report accompanying this legislation states with respect to this exception: The conference agreement follows the rules of the Senate amendment regarding the basis of Freddie Mac assets held by the corporation on January 1, 1985. However, the conference*48 agreement provides an exception to these general rules in the case of tangible depreciable property held by Freddie Mac on January 1, 1985. For such property, the adjusted basis, for purposes of both gain or loss, is to be equal to the lesser of (1) the regular adjusted basis of the property in the hands of Freddie Mac, or (2) the fair market value of the property as of January 1, 1985. This rule is primarily intended to prevent Freddie Mac from claiming deductions based on pre-1985 depreciation of tangible property (e.g., buildings or office equipment) held by the corporation as of the date of taxability. [H. Conf. Rept. 98-861, supra at 1039-1040, 1984-3 C.B. (Vol. 2) at 293-294.]*139 In enacting this exception, Congress contemplated and explicitly separated tangible depreciable property from other property, including intangibles, that petitioner held on January 1, 1985. Congress recognized that DEFRA section 177(d)(2)(A)(ii) would otherwise have provided the adjusted basis for the depreciation (or amortization) of all property under section 167(g). *49 Since the special rule of DEFRA section 177(d)(2)(B) applies only to tangible depreciable property, it follows that DEFRA section 177(d)(2)(A)(ii) provides the adjusted basis for the amortization of all assets other than tangible depreciable property. It also follows that any amortizable intangibles that petitioner held on January 1, 1985, are to be amortized using the basis rule provided in DEFRA section 177(d)(2)(A)(ii).Respondent contends that Congress did not provide a special exception similar to the exception contained in DEFRA section 177(d)(2)(B) for intangibles, because Congress was not aware that petitioner held any of the alleged intangibles at the time of the enactment of DEFRA. He points out that, since its inception, petitioner has been required by statute to provide its financial statements to Congress, and petitioner has not reported any of the alleged intangibles as assets on its books or on any financial statement. He speculates that while Congress would have been aware of petitioner's tangible depreciable properties from a review of the financial statements, and this might explain why Congress explicitly provided basis rules for depreciation of those properties*50 in DEFRA section 177(d)(2)(B), Congress would not have been aware of any intangibles since none were apparently listed on the financial statements. We do not know whether Congress reviewed, or relied upon, petitioner's financial statements in devising the special basis rules under DEFRA section 177(d)(2), or whether Congress was aware or not aware of petitioner's claimed intangibles. We do know that for purposes of determining adjusted basis, Congress separated tangible depreciable property from other property that petitioner held on January 1, 1985. We cannot assume that Congress inadvertently failed to include a special exception for intangibles simply because no intangibles appeared as assets on petitioner's financial statements. That being said, we are left with a special exception to DEFRA section 177(d)(2)(A), which refers only to tangible depreciable property and which by*140 implication indicates that the adjusted basis of intangible property is determined under DEFRA section 177(d)(2)(A).Respondent argues that we should not infer "an amortization scheme for petitioner's intangibles" on the basis of congressional silence. However, given the statutory framework for*51 determining adjusted basis, the interplay of DEFRA section 177(d)(2)(A) and section 1011 of the Code, and the reference in section 167(g) to the basis for determining gain as the basis to be used for amortization, we cannot agree that we are inferring petitioner's basis for amortization by reason of congressional silence.Respondent argues that petitioner's interpretation of DEFRA section 177(d)(2) is inconsistent with fundamental tenets of depreciation in that: (1) Petitioner is claiming amortization using a fair market value basis as of the date it became taxable; and (2) permitting petitioner to amortize its intangibles using a fair market value basis allows petitioner to receive a "double recovery" of costs that it expensed on its books before becoming a taxable entity. But, Congress's selection of the special basis rule contained in DEFRA section 177(d)(2)(A)(ii) is not the first time that Congress selected a higher of fair market value or regular adjusted cost basis for determining adjusted basis. Petitioner's situation is analogous to the determination of the adjusted basis of property held at the time of the enactment of the Federal income tax on March 1, 1913. The basis rules*52 which finally developed for property held on, and acquired before, that date are contained in section 1053, 10 which provides:SEC. 1053. PROPERTY ACQUIRED BEFORE MARCH 1, 1913. In the case of property acquired before March 1, 1913, if the basis otherwise determined under this subtitle, adjusted (for the period before March 1, 1913) as provided in section*53 1016, is less than the fair market value of the property as of March 1, 1913, then the basis for determining gain shall be such fair market value. * * *[11]*141 Since section 167(g)12 requires the same basis used for determining gain to be used as the basis for amortization,*54 it follows that the amortization of an intangible asset held on March 1, 1913, will be based on the fair market value of the asset as of that date if that value is higher than the adjusted cost basis in the intangible asset. Seesec. 1.1053-1(a), Income Tax Regs.*55 We fail to see why these same principles are not analogous to petitioner's situation. Congress provided a special adjusted basis for purposes of determining any gain on petitioner's property held as of January 1, 1985. Certainly, Congress was aware of the rules that developed from the enactment of the Federal income tax on March 1, 1913, recognized the potential of a similar application with respect to tangible depreciable property, and provided a special exception for such property but did not provide a special exception for intangible property. This contradicts respondent's suggestion that Congress could not have intended the use of a fair market value basis with respect to petitioner's alleged intangibles.Respondent suggests that petitioner's situation is more analogous to provisions that pertain to the adjusted basis of assets belonging to previously exempt organizations. Respondent points to the repeals of tax exemption for the Blue Cross and Blue Shield organizations in the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1012(b), 100 Stat. 2391">100 Stat. 2391, and for the Teachers Insurance Annuity Association and College Retirement Equities Fund in the Taxpayer Relief Act of 1997, Pub. L. 105-34, sec. 1042, 111 Stat. 939">111 Stat. 939*56 . Unlike DEFRA section 177(d)(2), both of those enactments provided a fair*142 market value basis for purposes of determining both gain and loss. Also, unlike our situation, Congress expressed its intent in the conference reports accompanying those enactments that the fair market value basis was not to be used for purposes of determining depreciation or for other purposes. See H. Conf. Rept. 99-841 (Vol. II), at II-349 to II-350 (1986), 1986-3 C.B. (Vol. 4) 1, 349-350; H. Conf. Rept. 105-220, at 566-567 (1997), 1997-4 C.B. (Vol. 2) 1457, 2036-2037. We cannot discern what considerations went into enacting different basis rules in these enactments or the statements in the conference reports. However, those rules are confined to the particular taxable entities involved.Respondent also argues that Congress did not intend to provide a basis for the amortization of petitioner's intangible assets different from the regular adjusted cost basis determined under sections 1011, 1012, and 1016, because Congress explicitly reaffirmed the application of the regular adjusted basis rules in DEFRA section 177(d)(5). DEFRA section 177(d)(5) provides: "For purposes of*57 this subsection, the adjusted basis of any asset shall be determined under part II of subchapter O of the Internal Revenue Code of 1954." Accepting respondent's position with respect to DEFRA section 177(d)(5) would seemingly nullify the specific adjusted basis rules provided in DEFRA section 177(d)(2)(A) and (B). We do not read this provision as respondent does. Instead, as we explain in greater detail below, we read DEFRA section 177(d)(5) to provide the rules for purposes of determining petitioner's regular adjusted cost basis in its assets as of January 1, 1985. This regular adjusted cost basis is then used in various parts of DEFRA section 177(d)(2) as a comparison to the fair market value of petitioner's assets for purposes of determining which of these two amounts should be used as petitioner's adjusted basis.Section 1016(a)(3) generally deals with amortization sustained in periods where a taxpayer was not subject to tax. Section 1016(a)(3) provides that proper adjustment in respect of property shall in all cases be made: *143 (3) in respect of any period -- (A) before March 1, 1913, (B) since February 28, 1913, during*58 which such property was held by a person or an organization not subject to income taxation under this chapter or prior income tax laws, * * * * * * * for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent sustained; 13Respondent speculates that since section 1016(a)(3) provides a mechanism to account for amortization that may have occurred when petitioner was not subject to Federal income taxation, then: there would have been no reason for Congress to include some specially tailored provision in * * * [DEFRA] section 177 to account for any depreciation in petitioner's assets that may have occurred before 1985, or after 1985; unless, of course, Congress chose to deviate from the statutory scheme already in place in the Code. * * * Congress did not so chose [sic] with respect to intangible assets, only tangible assets.We disagree with respondent's interpretation of the interplay of DEFRA section 177(d)(2) and section 1016(a)(3).*59 For purposes of determining any gain on the sale or other disposition of property (other than tangible depreciable property), DEFRA section 177(d)(2)(A)(ii) first requires a comparison between petitioner's adjusted cost basis under the general rules and the fair market value of the property as of January 1, 1985. DEFRA section 177(d)(2)(A)(ii) mandates that for purposes of determining any gain, petitioner's adjusted basis is the higher of the two. In order to make such *144 a comparison, petitioner's adjusted cost basis under the regular rules must first be determined. It is clear that this adjusted cost basis is determined under the regular adjusted basis rules of the Code (i.e., sections 1011-1023), which include section 1016(a)(3). Indeed, DEFRA section 177(d)(5) provides that "For purposes of this subsection, the adjusted basis of any asset shall be determined under part II of subchapter O of the Internal Revenue Code of 1954." 14 It follows that, for purposes of the DEFRA section 177(d)(2)(A)(ii) comparison, the regular adjusted cost basis of any property held by petitioner would include a section 1016(a)(3) adjustment where appropriate to account for pre-1985 amortization*60 sustained in petitioner's intangibles. It also follows that the regular adjusted cost basis rules of the Code would apply for purposes of amortization allowed (or allowable) for years after 1984. Seesec. 1016(a)(2). It does not follow that section 1016(a)(3) requires a pre-1985 adjustment where the higher fair market value basis is prescribed under DEFRA section 177(d)(2)(A)(ii). 15Seesec. 1053 (providing a similar rule for March 1, 1913 property); 16 Even Realty Co. v. Commissioner, 1 B.T.A. 355">1 B.T.A. 355 (1925); Atterbury v. Commissioner, 1 B.T.A. 169">1 B.T.A. 169 (1924).*61 *62 *145 Respondent argues that petitioner's claimed amortization of its alleged intangibles at their fair market values as of January 1, 1985, is "precisely contrary to the stated intent of the dual basis rule. This rule was explicitly intended to avoid taking pre- 1985 appreciation into account for tax purposes; by amortizing FMVs, petitioner would take such pre-1985 appreciation into account." We disagree. Taking amortization deductions using a fair market value basis does not, in our view, thwart the congressional purpose stated in the legislative history. Indeed, as petitioner suggests, recovering pre-1985 appreciation through amortization assures that pre-1985 appreciation will not be taxed in much the same way as a recovery of basis does when it is used as an offset to gain in the sale or other disposition of the property. 17*63 Respondent also focuses on the magnitude of the amortization deductions that petitioner claims for 1985 through 1990. Those deductions range from approximately $ 99 million in 1990 to $ 117.8 million in 1985. Respondent claims that allowing deductions of this size would be inconsistent with Congress's repeal of petitioner's tax exempt status, since it virtually eliminates petitioner's tax liabilities for the years following January 1, 1985. 18 Respondent relies upon certain revenue estimates contained in Staff of Joint Comm. on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 555 (J. Comm. Print 1984), as follows: "This provision is estimated to increase fiscal year budget receipts by $ 67 million in 1985, $ 109 million in 1986, $ 142 million in 1987, $ 185 million in 1988, and $ 240 million in 1989." Respondent speculates that given the size of the amortization deductions, petitioner's tax liabilities for 1985-90 would fall substantially short of the revenue estimates.*64 First, we fail to see how the revenue estimates and the comparative reductions in petitioner's tax liabilities are particularly relevant to the question before us, which*146 involves the interpretation of a particular statute, as well as its interplay with the regular adjusted basis rules in the Code. Second, it would be inappropriate to speculate on the factors that were considered in making such "estimates". 19See Fort Howard Corp. v. Commissioner, 103 T.C. 345">103 T.C. 345, 364 (1994)(revenue estimates have little relevance in interpreting a statute).Respondent also claims that "with respect to the dual basis rule provided in * * * [DEFRA] section 177(d)(2)(A), it is not possible to know which basis rule applies until such time that the asset is disposed of and*65 the sales price is known." He contends that the basis to be used for purposes of determining any gain "depends entirely on the amount of the sale as well as the fact of the sale", since "Until petitioner's Intangibles are sold or disposed of, and the sales proceeds are known, it will not be known whether there will be any 'gain' at all for purposes of * * * [DEFRA] section 177(d)(2)(A)(ii)."Petitioner's basis for amortization is not dependent upon whether the particular property is sold or disposed of or upon the amount realized in that transaction. Indeed, if respondent's argument is correct, the same logic would apply in all cases where Congress has provided a dual-basis rule for determining gain or loss. Section 167(g) requires the basis for depreciation or amortization be the same basis as the basis for determining gain. Since petitioner's adjusted cost basis and fair market value in its assets are ascertainable as of January 1, 1985, and since DEFRA section 177(d)(2)(A)(ii) provides that the adjusted basis for determining gain is the higher of those two amounts, petitioner's adjusted basis for amortization of its intangibles is determinable as of that date. Any subsequent*66 sale or disposition of those intangibles has no bearing on this comparison.*147 We hold that petitioner's adjusted basis for purposes of amortizing intangible assets under section 167(g) is the higher of regular adjusted cost basis or fair market value as of January 1, 1985. 20An appropriate order will be issued. Footnotes1. Respondent disputes whether the claimed intangibles are assets that are amortizable for tax purposes. One of the claimed intangibles involves certain below-market financing which petitioner claims to have held on Jan. 1, 1985. In their cross-motions for partial summary judgment, the parties also ask us to determine whether the claimed intangible for below-market financing is amortizable. We do not decide that issue in this Opinion.↩2. All Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for the taxable years in issue.↩1. The parties stipulate this table; the actual total of the claimed amortization deductions for 1985 is $ 117,837,772.↩3. Sec. 167(g) currently appears in the Code as sec. 167(c)↩.4. Sec. 167(g) provides rules relating to the basis for the depreciation of tangible property and the amortization of intangible property. Seesecs. 1.167(a)-3,1.167(g)-1↩, Income Tax Regs.5. Sec. 1012 provides:SEC. 1012. BASIS OF PROPERTY -- COST. The basis of property shall be the cost of such property, except as otherwise provided in this subchapter and subchapters C (relating to corporate distributions and adjustments), K (relating to partners and partnerships), and P (relating to capital gains and losses). * * *↩6. Sec. 1016 provides adjustments to basis; e.g., for expenditures, receipts, losses, or other items, properly chargeable to capital account and for exhaustion, wear and tear, obsolescence, amortization, and depletion to the extent of the amount allowed (but not less than the amount allowable) as deductions in computing taxable income. Sec. 1016(a)(1) and (2)↩.7. Respondent also argues: Even if Treas. Reg. section 1.1011-1 can be read, as petitioner apparently wants to read it, so as to permit some other "internal revenue act" to supplant the cost basis of section 1012 (or the others permitted by section 1011), such alternative "internal revenue act" would then be outside of section 1011. * * * We do not construe respondent's argument to suggest that sec. 1.1011-1, Income Tax Regs., may be an invalid interpretation of sec. 1011↩.8. We point out that the Deficit Reduction Act of 1984(DEFRA), Pub. L. 98-369, sec. 177(d)(2), 98 Stat. 711">98 Stat. 711 , was enacted after sec. 1011 was added to the Code and amended in the Tax Reform Act of 1969, Pub. L. 91-172, sec. 201(f), 83 Stat. 564">83 Stat. 564. Sec. 1.1011- 1, Income Tax Regs., was promulgated on Nov. 6, 1957, and has not been changed. DEFRA sec. 177(d)(2)↩ has not been codified.9. Respondent claims that "The plain language of the dual basis rule provides for no such alternatives to section 1016, 1017 or 1018 for the purpose of making basis adjustments. Thus, nothing in * * * [DEFRA] section 177(d) triggers the 'as otherwise specifically provided' clause of the regulation for any purpose." However, DEFRA sec. 177(d)(2)↩ refers to an "adjusted basis" and not an unadjusted basis. An adjusted basis presupposes that the appropriate adjustments have either been made or incorporated.10. The rule now contained in sec. 1053 has undergone a number of changes since the original enactment of the Federal income tax in 1913. Although taxpayers were originally required to use a fair market value basis for determining any gain from the sale or other disposition of property, see Revenue Act of 1916, ch. 463, sec. 2(c), 39 Stat. 758">39 Stat. 758, Congress eventually settled on a dual-basis rule for determining gain or loss with the basis for determining any gain as the higher of the regular adjusted cost basis or fair market value of the property as of Mar. 1, 1913. See Revenue Act of 1934, ch. 277, sec. 113(a)(14), 48 Stat. 706">48 Stat. 706↩.11. The regulations indicate that sec. 1053 and related Code sections provide a dual-basis rule similar to DEFRA sec. 177(d)(2) with respect to property held as of Mar. 1, 1913. The basis for determining gain is the cost or other basis, adjusted as provided in sec. 1016 and other applicable provisions of ch. 1 of the Code, or its fair market value as of Mar. 1, 1913, whichever is greater. Sec. 1.1053-1(a), Income Tax Regs. The basis for determining loss is the basis determined in accordance with pt. II (sec. 1011 and following), subch. O, ch. 1 of the Code, or other applicable provisions of ch. 1 of the Code, without reference to the fair market value as of Mar. 1, 1913. Sec. 1.1053-1(b), Income Tax Regs↩.12. Sec. 167(g) followed a similar historical path as sec. 1053 in its inclusion in the Code. The rules stated in sec. 167(g) were enacted as sec. 114(a) of the Revenue Act of 1934, ch. 277, 48 Stat. 710">48 Stat. 710. As its basis for including those rules, Congress stated that "Since in some cases the basis for determining gain differs from the basis for determining loss, it is necessary to specify definitely which of these bases is to be used for depreciation * * * purposes." H. Rept. 704, 73d Cong., 2d Sess., at 29 (1934), 1939-1 C.B. (Part 2) 554, 575; S. Rept. 558, 73d Cong., 2d Sess., at 36 (1934), 1939-1 C.B. (Part 2) 586, 613. It is clear that Congress, in enacting this rule, made a conscious choice that in the circumstance of a dual-basis rule, the basis for depreciation (or amortization) is the basis used for determining gain on the sale or other disposition of property. It is clear that Congress envisioned the type of situation, such as sec. 1053 and DEFRA sec. 177(d)(2)↩, wherein specific legislation provides different bases for purposes of determining gain or loss.13. Sec. 1.1016-4, Income Tax Regs., provides: (a) Adjustments to basis must be made for exhaustion, wear and tear, obsolescence, amortization, and depletion to the extent actually sustained in respect of: (1) Any period before March 1, 1913, (2) Any period since February 28, 1913, during which the property was held by a person or organization not subject to income taxation under chapter 1 of the Code or prior income tax laws, * * * * * * * (b) The amount of the adjustments described in paragraph (a) of this section actually sustained is that amount charged off on the books of the taxpayer where such amount is considered by the Commissioner to be reasonable. Otherwise the amount actually sustained will be the amount that would have been allowable as a deduction: (1) During the period described in paragraph (a)(1) or (2) of this section, had the taxpayer been subject to income tax during those periods, * * * * * * * * * *In the case of a taxpayer subject to the adjustment required by subparagraph (1) or (2) of this paragraph, depreciation shall be determined by using the straight line method. ↩14. Part II of subch. O of the Code is entitled "Basis Rules of General Application" and consists of secs. 1011 through 1024 (renumbered as secs. 1011 through 1023↩).15. See also Staff of Joint Comm. on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 551 (J. Comm. Print 1984), which states: "For purposes of determining gain, the basis of any asset held on January 1, 1985, is to be the higher of (1) the regular adjusted basis of the asset in the hands of Freddie Mac (as determined under Code secs. 1011-1023) or (2) the fair market value of the asset on January 1, 1985." Of course, the General Explanation is not prepared by members of Congress, and it is not a part of the legislative history. See Allen v. Commissioner, 118 T.C. 1">118 T.C. 1, 14-15 (2002). However, the statements in the General Explanation are consistent with our reading of DEFRA sec. 177(d) and the legislative history, and it is therefore entitled to respect. See Intl. Multifoods Corp. v. Commissioner, 108 T.C. 579">108 T.C. 579, 588↩ (1997).16. Sec. 1.1053-1(c), Example, Income Tax Regs., provides: Example. (i) On March 1, 1908, a taxpayer purchased for $ 100,000, property having a useful life of 50 years. Assuming that there were no capital improvements to the property, the depreciation sustained on the property before March 1, 1913, was $ 10,000 (5 years @ $ 2,000), so that the original cost adjusted, as of March 1, 1913, for depreciation sustained prior to that date is $ 90,000. On that date the property had a fair market value of $ 94,500 with a remaining life of 45 years. (ii) For the purpose of determining gain from the sale or other disposition of the property on March 1, 1954, the basis of the property is the fair market value of $ 94,500 as of March 1, 1913, adjusted for depreciation allowed or allowable after February 28, 1913, computed on $ 94,500. Thus, the substituted basis, $ 94,500, is reduced by the depreciation adjustment from March 1, 1913, to February 28, 1954, in the aggregate of $ 86,100 (41 years @ $ 2,100), leaving an adjusted basis for determining gain of $ 8,400 ($ 94,500 less $ 86,100).↩17. We recognize that Congress provided a different rule with respect to tangible depreciable property. Congress did not express any similar concern with respect to any intangible property that petitioner might have held on Jan. 1, 1985. Congress could have provided a similar rule for intangible property, but did not.↩18. Respondent contends that allowing deductions of this size would have allowed petitioner to maintain its competitive advantage against its chief competitor, the Federal National Mortgage Association (Fannie Mae), a consequence which Congress sought to avoid. See Staff of Joint Comm. on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 550 (J. Comm. Print 1984).↩19. We point out that we have not yet decided, in these proceedings, the appropriate amount of any deductions to which petitioner is entitled, and, indeed, whether its alleged intangibles are subject to amortization for tax purposes.↩20. We express no opinion at this time whether petitioner actually held the claimed intangible assets on Jan. 1, 1985, their value on that date, or whether such putative assets are amortizable.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624893/ | Jack Dempsey's Punch Bowl, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentJack Dempsey's Punch Bowl, Inc. v. CommissionerDocket No. 15153United States Tax Court11 T.C. 1030; 1948 U.S. Tax Ct. LEXIS 10; December 15, 1948, Promulgated *10 Decision will be entered under Rule 50. Upon the facts, held, respondent improperly disallowed part of the compensation which petitioner paid to one of its officers during the taxable year 1942. T. Newman Lawler, Esq., for the petitioner.Thomas R. Wickersham, Esq., for the respondent. Hill, Judge. HILL *1030 Respondent determined a deficiency in petitioner's excess profits tax for the year ended December 31, 1942, in the amount of $ 12,732.82. Certain adjustments made by respondent are not contested. The only question presented is whether respondent erred in disallowing in part the compensation paid to one of petitioner's officers during 1942.The tax return for the year involved was filed with the collector of internal revenue for the third district of New York, at New York City.FINDINGS OF FACT.The facts as stipulated are so found.Petitioner is a corporation, organized under the laws of the State of New York on December 28, 1937. It was formed pursuant to an agreement dated November 16, 1937, among William Harrison Dempsey, known as Jack Dempsey, Jacob Amron, and Louis I. Brooks. Its purpose in organizing was to conduct a general restaurant and bar*11 business. The pertinent parts of the agreement are as follows:First: The parties agree to form a corporation under the laws of the State of New York with an authorized capital stock of three hundred (300) shares, no par value, all of which will be of one class, and for which the parties agree to subscribe in the following proportion:Amron and Brooks agree to subscribe for two hundred (200) shares, the proportion in which each is to hold said 200 shares to be agreed upon by Amron and Brooks.Dempsey agrees to subscribe for one hundred (100) shares.* * * *Fifth: It is understood and agreed that the total cost of remodeling said bar and grill, including decorations and furniture, including the cost of the *1031 decorator selected by Dempsey, shall not exceed Seventy-five Thousand Dollars ($ 75,000) without the mutual consent of all three parties.* * * *Seventh: Amron and Brooks agree to loan to the corporation an amount of money necessary to remodel, equip, decorate, furnish and complete the bar and grill, said loans to bear interest at the rate of four per cent (4%) and to be returned to Amron and Brooks out of the first profits of the corporation as hereinafter defined. *12 * * * *Fourteenth: Making due allowance for the four per cent (4%) interest to be allowed to Amron and Brooks for each repayment, until one-half of the cost with interest has been recouped by Amron and Brooks, no one of the parties shall draw any salary or other compensation out of said venture.Fifteenth: As soon as one-half of the cost has been repaid to Amron and Brooks, the parties agree that the corporation shall pay the following amounts as compensation, to wit:(a) To Dempsey an amount equal to two per cent (2%) of the gross monthly cash receipts of said bar and grill, said sums to be paid monthly on or before the tenth day of the month immediately following the month for which the amount is due.(b) To Amron and Brooks, the sum of One Thousand Dollars ($ 1,000) per month, to be divided between Amron and Brooks in such percentage as they agree upon mutually.Sixteenth: After the entire cost of said bar and grill has been repaid to Amron and Brooks, then Dempsey's compensation shall be increased to three per cent (3%) payable in the same manner.* * * *Nineteenth: Amron and Brooks agree to secure from the 850 Corporation, and all three parties agree to secure from Jack Dempsey's*13 Corner, Inc., and Dempsey personally agrees to approve such consents, the right to use Jack Dempsey's name in connection with the bar and grill contemplated in this agreement for the full period of this agreement.Twentieth: Dempsey hereby grants to the corporation the right to use his name in connection with the bar and grill contemplated herein for the full term of the lease and any renewals. It is the intention of the parties that the right to use Jack Dempsey's name in connection with this bar and grill is a personal right granted to the corporation to be formed for the venture and to the individuals named in this agreement, to wit: Amron and Brooks and in the event Amron and Brooks dispose of their interest in the corporation, either by sale or are divested of interest by operation of law, then Dempsey shall have the right to terminate the right to use his name, unless the sale or disposition is with his consent.Dempsey's grant of the right to use his name is made with the consent of the 850 Corporation, and shall not be construed by either party in derogation of any rights which 850 Corporation, Jack Dempsey's Corner, Inc., Amron or Brooks may have in and to the use of Jack*14 Dempsey's name, pursuant to preexisting agreements.* * * *Twenty-second: In the event Jack Dempsey's Corner, Inc. shall cease to operate the restaurant and bar at 850 Eighth Avenue, New York City, and as a result of such cessation of operation Dempsey's compensation from that source shall *1032 be cut off, then it is agreed that Dempsey's minimum compensation, to be computed at the rate of three per cent (3%) of the gross receipts, shall be a guaranteed monthly minimum of Fifteen Hundred Dollars ($ 1,500). Any additional amounts paid to Dempsey to make up his guarantee shall be charged against the business of the corporation as an operating expense and before any dividends are declared.* * * *Twenty-fourth: Amron and Brooks agree to follow Dempsey's directions regarding the manner of service, food, liquors and any other suggestions which he may have regarding the manner of operation of said bar and grill.Twenty-fifth: The parties agree that under no consideration will Dempsey be liable for any of the obligations or debts of said bar and grill, or for the construction or equipment of same, or for any other obligation that may be incurred in connection with the venture.(a) *15 It is understood and agreed by the parties that after the bar and grill is fully completed that no capital expenditures in excess of $ 5,000 per annum shall be made in any year of the first two years of actual operation without the consent of all three of the parties unless such expenditures are requested as the result of any governmental order.* * * *Twenty-seventh: Dempsey agrees to devote as much time and attention as he possibly can and be present at the bar whenever possible, except when he is engaged in other business matters in this city or elsewhere, it being the intention of the parties that whenever he is in the City of New York that he shall personally appear at the bar and grill and supervise the business of operating the same, it being further understood that his failure to appear at any given time at the bar and grill shall not be construed as a breach on Dempsey's part.All parties recognize the fact that Dempsey's presence will materially increase the revenue of said bar, and that he will, as far as he is able without interfering with his other commitments, be present at the bar and supervise its operation.* * * *By resolution passed at the meeting of petitioner's*16 incorporators held on December 29, 1937, the following shares were issued as consideration for the assignment by Dempsey, Amron, and Brooks to petitioner of a lease on premises known as the Trans-Lux Theatre, located at 1695 Broadway, New York, New York:Jack Dempsey100 sharesJacob Amron170 sharesLouis I. Brooks30 sharesDuring 1938 petitioner found that it needed additional capital. Dempsey advanced petitioner $ 23,000, for which Amron transferred to him 70 shares of the 170 shares of stock of petitioner which he owned at that time. In 1942 Dempsey transferred 35 of these shares to his manager, Max Waxman. On May 21, 1942, the stockholders of petitioner were as follows:Jack Dempsey135 sharesJacob Amron100 sharesMax Waxman35 sharesLouis I. Brooks30 shares*1033 Petitioner's officers from 1938 through 1942 were as follows:1937-19401940-19411942-1943PresidentJack DempseyJack DempseyJack DempseyVice presidentHerman AmronJacob AmronJacob AmronTreasurerJacob AmronJacob AmronJacob AmronSecretaryLouis I. BrooksLouis I. BrooksLouis I. BrooksAsst. secretaryJoseph DempseyAsst. treasurerMax Waxman.Amron, petitioner's*17 vice president and treasurer, was general manager of the restaurant and bar. His actions were subject to Dempsey's veto. Amron, before his association with petitioner corporation, had many years of experience in the restaurant and bar business.Brooks, petitioner's secretary, was in charge of construction, changes, and any repairs which had to be made to petitioner's properties.Dempsey, petitioner's president, served as its host. He signed autographs, talked with customers, and as many times as possible put in his appearance in the bar and restaurant.Petitioner's gross receipts and profit or loss from 1938 through 1942 were as follows:YearGross receiptsProfit or (loss)1938$ 270,170.66($ 258.91)1939396,038.7030,948.97 1940423,535.6427,943.82 1941516,116.2236,557.82 1942819,673.78110,328.38 The compensation paid to petitioner's officers from 1938 through 1942 was as follows:19381939194019411942Jack Dempsey, president$ 12,858.96$ 18,198.71$ 36,724.72Jacob Amron, treasurer9,000.009,000.0018,999.99Louis I. Brooks, secretary$ 3,0003,000.003,000.0010,400.00Joseph Dempsey, asst.3,579.17treasurerTotal3,00024,858.9630,198.7169,703.88*18 Of the total of $ 36,724.72 paid to Dempsey during the year 1942, $ 24,724.72 is 3 per cent of the gross sales for 1942 plus certain other items of income, such as coatroom concessions, but less certain items of sales and certain rebates and allowances to various customers. The difference between the above amount and a straight 3 per cent of gross sales is $ 128.66. The remaining $ 12,000 is money voted to Dempsey by the board of directors during the taxable year 1942.Beginning in June 1942, Amron and Brooks commenced activities for an increase in their compensation. Both Dempsey and his manager *1034 felt that if their compensation was raised, Dempsey's also should be increased. A special meeting of petitioner's board of directors was held on September 11, 1942, for the purpose of acting upon the salary question. The board was composed of Dempsey, Arthur F. Driscoll, Dempsey's attorney, Benjamin Shapiro, Amron's attorney, and Amron and Brooks. There was much disagreement among the members of the board as to what amount each of the officers should receive. It was finally determined by the directors that the payments then being made to petitioner's officers were inadequate*19 and that the matter of compensation should be referred to a resolutions committee composed of Driscoll, Shapiro, Benjamin Blattner, accountant for petitioner, and Amron. The committee then drew up a recommendation and the directors at this same meeting determined, among other things, (1) that the compensation of Brooks be increased by the sum of $ 4,400 for the calendar year 1942, (2) that the compensation of Amron for the same period be increased by $ 10,000, and (3) the compensation of Dempsey be increased during that year in the amount of $ 12,000. The committee on resolutions reported in part as follows: 1. In the opinion of this Committee the compensation paid to the officers of this Corporation should be increased.2. The compensation to Mr. Dempsey for the use of his name in connection with the said enterprise should be increased by the sum of $ 12,000 for the calendar year 1942.During 1942 Dempsey, in addition to the compensation of $ 36,724.72 paid to him by petitioner, also received a dividend from it in the amount of $ 13,500.Dempsey from time to time has received from $ 750 to $ 10,000 a night for refereeing prize fights. He received $ 25,000 for the use of*20 his name in connection with McKesson & Robbins' whiskey. His customary fees for radio appearances are from $ 1,500 to $ 2,000 a night.From 1938 until June 11, 1942, when he accepted a commission in the Coast Guard, Dempsey's usual hours at petitioner's restaurant were during the lunch period for several hours and from about 6:30 p. m. until, on most occasions, 1 a. m. to 2 a. m. After accepting the commission in the Coast Guard on June 11, 1942, Dempsey no longer appeared at petitioner's restaurant during the lunch period.During 1942 Dempsey was in New York approximately 300 days. He visited petitioner's restaurant on two-thirds of those days.During the war years the United States Coast Guard became a part of the United States Navy. In 1942 the Bureau of Naval Personnel Manual, part H, chapter 1, H-1707, provided in part as follows:Orders to Officers and Men to Active Duty in Time of War* * * *(3) When so placed on active duty, it is expected that officers and men will devote their whole time to naval duties and shall not engage in private employment, *1035 except in such cases as may be specifically authorized by the Bureau of Naval Personnel.Before Dempsey entered*21 the United States Coast Guard he discussed with his prospective superior officers the fact that he was under obligation to appear at petitioner's restaurant and bar. They told him that he could do so on his off-duty hours. His superior officers accompanied him to the restaurant and bar on several occasions during their off-duty hours.In his notice of deficiency, under explanation of adjustments, respondent stated as follows:(a) It is held that the sum of $ 24,724.72 represents reasonable compensation for services actually rendered by Jack Dempsey during the year 1942 and the amount paid in excess of that sum, $ 12,000.00, is disallowed as a deduction.A reasonable payment to Jack Dempsey during 1942 for the use of his name and for his services is in the amount of $ 36,724.72.OPINION.Respondent contends that $ 12,000 of the $ 36,724.72 paid by petitioner to Dempsey in 1942 was excessive and on that account not deductible by it for tax purposes. Petitioner, on the other hand, argues that the total amount given to Dempsey in 1942 constitutes a reasonable payment for the use of his name and for his services. We agree with petitioner that the payment in question is deductible as*22 an ordinary and necessary business expense under section 23 (a) (1) (A) of the Internal Revenue Code.As petitioner has pointed out, Dempsey's compensation from petitioner during the year involved, although it was designated as salary, was both for the right to use his name and for the services he performed in putting in his appearance at the restaurant. There can be no question that petitioner would not have enjoyed anywhere near the success it did without the use of his name and his services. The evidence shows that the people who came to New York in 1942, as well as in previous years, sought out petitioner's restaurant in the hope of seeing Jack Dempsey. Harry S. Gerstein, who has been associated with many of Broadway's famous restaurants and night clubs as executive secretary of the Allied Restaurant & Entertainment Industry of New York since 1938, testified as follows:A. I would like to say from my estimation that Dempsey's is a unique type of operation in so far as Dempsey himself is the drawing card there. Without Dempsey it would be an ordinary restaurant.On cross-examination he further testified as follows:* * * After the war started in December of 1941 we had in New*23 York City an influx of uniformed and nonuniformed people gathered here, and the hue and cry up and down Broadway was Dempsey's, Dempsey's, Dempsey's.As a matter of fact, a lot of the restaurant people complained Dempsey was doing all the business in the early part of the war, 1942.*1036 The payments made to Dempsey by petitioner during 1942 were not disproportionate to compensation he has received from other sources for the use of his name and for his services. He has received from $ 750 to $ 10,000 a night for refereeing prize fights. He received $ 25,000 for the use of his name in connection with McKesson & Robbins' whiskey. He has been paid from $ 1,500 to $ 2,000 for radio appearances. These facts, we believe, lend strong support to petitioner's contention that the $ 36,724.72 which it paid to Dempsey during 1942 for the use of his name and for his services was reasonable.There can be no doubt that the payment was agreed upon in an arm's length transaction. The facts show that there was a sharp disagreement among the board members as to what the compensation of Amron, Brooks, and Dempsey should be. The question of payments was finally referred to a special resolutions*24 committee for action. Out of this committee came, among other things, the recommendation that payments made to Dempsey should be increased by $ 12,000 in 1942, which recommendation was approved by the board of directors. The above, together with the fact that petitioner in 1942 declared a dividend of $ 100 for each share of stock, is compelling evidence that the payment in question was not a guised distribution of profit.Respondent points out that Dempsey did not receive permission from the proper authorities in the Navy Department to appear in petitioner's restaurant after receiving his commission from the United States Coast Guard. From this fact he states "a serious question of public policy is presented as to whether the payments should be recognized for tax purposes even if otherwise allowable." He cited no authority for this statement and we have been unable to find any valid reason to support respondent's suggestion. The facts show that Dempsey's appearances at petitioner's restaurant had the approval of his immediate superior officers; indeed, they accompanied him there on several occasions. Respondent, however, says this is not enough, that he should have had the approval*25 of the chief of the Bureau of Naval Personnel. We believe the effect of respondent's argument is an attempt to have this tribunal enforce naval regulations, which function, of course, is not vested in this Court.In view of all the circumstances of this case, we conclude that the entire amount paid to Dempsey during 1942 as compensation was reasonable in amount for services actually rendered and that such compensation, together with the amounts paid for the use of his name, constituted ordinary and necessary business expenses, and are deductible for tax purposes. It follows that respondent erred in his determination.Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624894/ | FRANK TAVANO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentTavano v. CommissionerDocket No. 14570-88United States Tax CourtT.C. Memo 1991-237; 1991 Tax Ct. Memo LEXIS 266; 61 T.C.M. (CCH) 2743; T.C.M. (RIA) 91237; May 29, 1991, Filed *266 An appropriate order will be issued and decision will be entered under Rule 155. Frank Tavano, pro se. Monica Miller, for the respondent. PARR, Judge.PARRMEMORANDUM OPINION Respondent determined deficiencies and additions to petitioner's individual Federal income taxes as follows: Additions to taxunder sectionsTaxable year endingDeficiency6653(a)(1) 16653(a)(2)6661December 31, 1985$ 9,100$ 455.00*$ 2,275.00December 31, 1986$ 6,869$ 343.45*$ 1,717.25Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the taxable years in issue. All Rule references*267 are to the Tax Court Rules of Practice and Procedure. After concessions by both parties the issues remaining for decision are: (1) Whether the notice of deficiency is arbitrary and excessive thereby shifting the burden of going forward to respondent on all issues; (2) Whether petitioner is entitled to deduct the following in 1985: a) home computer expenses of $ 5,469, b) charitable contribution of $ 2,500, c) moving expenses of $ 25,530, 2d) capital losses of $ 16,250, and e) casualty loss of $ 5,810;(3) Whether petitioner is entitled to deduct the following in 1986: a) charitable contribution of $ 1,500, b) miscellaneous expenses of $ 2,572, c) rental expenses of $ 16,141 and depreciation of $ 8,000, and d) capital losses of $ 806;(4) Whether petitioner failed to include interest ($ 10), wages ($ 155), and worker's compensation ($ 350), in his 1986 income; (5) Whether petitioner is liable for the additions to tax for negligence under section 6653(a) and substantial understatement under section 6661(a) for both years in issue; and (6) Whether petitioner's motion for protective order to prevent disclosure of Tax Court records, pleadings, motions, or *268 any other documents regarding petitioner's case to third parties should be granted. Some of the facts are stipulated and found accordingly. The stipulations of facts and accompanying exhibits are incorporated herein. Petitioner resided in Windermere, Florida, at the time he filed his petition for redetermination in this Court. During 1984 and 1985 petitioner resided in Rancho Palos Verde, California, and was employed by Hughes Aircraft. In or around May 1985 petitioner accepted employment with Lockheed Electronics Company and moved to Florida. He worked for Lockheed until November 1986. Petitioner holds a degree in electrical engineering. Petitioner timely filed his individual Federal income tax returns for 1985 and 1986 with the Internal Revenue Service Center in Atlanta, Georgia. For convenience, *269 we combine our findings of fact and opinion for each issue/subissue. Burden of ProofPetitioner alleges the notice of deficiency is arbitrary and excessive and, therefore, respondent bears the burden of going foward with the evidence on all issues. We do not agree. It is well settled that, except where otherwise provided in the Internal Revenue Code or the Tax Court Rules of Practice and Procedure, respondent's determinations generally are presumed correct, and the burden of proof and the burden of going forward with the evidence ordinarily rests with petitioner. Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 78 L. Ed. 212">78 L. Ed. 212, 54 S. Ct. 8">54 S. Ct. 8 (1933). When, however, respondent's determinations are shown to be arbitrary and excessive (e.g., without "factual foundation" or "rational basis"), the presumption evaporates and the burden of going forward with the evidence shifts to respondent. Helvering v. Taylor, 293 U.S. 507">293 U.S. 507, 79 L. Ed. 623">79 L. Ed. 623, 55 S. Ct. 287">55 S. Ct. 287 (1935); Berkery v. Commissioner, 91 T.C. 179">91 T.C. 179, 186 (1988), affd. 872 F.2d 411">872 F.2d 411 (3d Cir. 1989); Dellacroce v. Commissioner, 83 T.C. 269">83 T.C. 269, 280 (1984). Petitioner has not advanced any argument or presented any evidence*270 sufficient to show that respondent's determination is arbitrary or excessive, or that any exceptions to the general rule apply in this case. See Berkery v. Commissioner, 91 T.C. at 186, and the cases cited therein. Accordingly, petitioner bears the burden of going forward with the evidence, as well as the burden of proof, on all issues for decision. Rule 142(a). DeductionsComputer expensesIn or around February 1985, while an employee of Hughes, petitioner purchased a computer. Hughes did not reimburse petitioner for this expense. Petitioner deducted $ 5,469 3 on his 1985 return as an ordinary and necessary business expense. Respondent disallowed the deduction in full. Petitioner alleges he is entitled to deduct the costs he incurred in acquiring his computer*271 because (1) it was essential to the performance of his duty as a professional engineer and employee of Hughes, and (2) it was required by his employer. Respondent contends that petitioner's expenses of purchasing his home computer, even though used in connection with the business of Hughes, were personal in nature, not ordinary or necessary to petitioner's trade or business of being an employee of Hughes; i.e., it was not placed in his home for the convenience of his employer or as a condition of his employment so he could properly perform his duties as an employee. We agree with respondent. Section 162(a) allows a taxpayer to deduct all ordinary and necessary expenses paid or incurred during the taxable year in carrying on his trade or business. Petitioner is in the trade or business of being an employee. See Lucas v. Commissioner, 79 T.C. 1">79 T.C. 1, 6 (1982); Primuth v. Commissioner, 54 T.C. 374">54 T.C. 374, 377 (1970). Accordingly, he may deduct all ordinary and necessary expenses incurred in carrying on that trade or business. He may not, however, deduct personal expenses. In a letter from Theryl W. Bell (Mr. Bell), a Manufacturing Project Manager of*272 Hughes, to respondent dated September 26, 1989, Mr. Bell stated that petitioner was not required as a necessary condition of his employment to purchase his own computer and/or use it in his home. 4We are convinced that petitioner voluntarily undertook to purchase a computer, place it in his home, and use it for his convenience rather than the convenience of Hughes. Accordingly, we find petitioner is not entitled to deduct any portion of the*273 computer's cost, even if he could substantiate the cost, because it represents a nondeductible personal expense. Sec. 262(a); Heineman v. Commissioner, 82 T.C. 538">82 T.C. 538, 542 (1984). Charitable contributionsPetitioner alleges he made charitable contributions to the Worldwide Church of God ($ 2,500 in 1985 and $ 1,500 in 1986), Smithsonian Institution, the First Baptist Church of Orlando (between $ 500 and $ 1,000), and public broadcasting television and radio during 1985 and 1986. Respondent contends petitioner's testimony is not credible on this subject especially in light of the testimony of John Wilson, the co-worker Officer for the Worldwide Church of God. Although we are not convinced petitioner made the amount of contributions claimed either on his return or alleged above, we find he made some contributions during the years in issue. Thus, petitioner is entitled to claim $ 500 in 1985 and $ 500 in 1986 in charitable contributions. See secs. 170(a) and (i). Moving expensesIn May 1985 Atlas Van Lines, Inc. (Atlas) loaded and moved 4,420 pounds of petitioner's personal belongings, including his car, from his home in California to his new*274 home in Orlando, Florida. Lockheed would have paid Atlas to move up to 12,000 pounds of household goods excluding household pets, coins, jewelry, plants, and other articles of peculiarly inherent or extraordinary value. Petitioner deducted $ 35,310.39 in moving expenses on his 1985 Federal income tax return. Respondent disallowed the entire deduction. Before trial the parties agreed that petitioner is entitled to deduct at least $ 3,846.98 in 1985. Additionally, respondent allowed petitioner a $ 123.14 deduction in 1986. Petitioner claims that Lockheed paid for or reimbursed a total of $ 9,097 5 during 1985 and included same in his income for 1985, and that he incurred $ 25,530 6 of expenses over and above that amount. He also claims he did not have any moving expenses in 1986. We do not agree. *275 On June 3, 1985, petitioner submitted his travel/relocation expense report to Lockheed claiming reimbursement for $ 1,154.25. Petitioner was reimbursed. Additionally, Lockheed paid Atlas $ 2,692.73 on July 12, 1985, and $ 123.14 in or around July 1986 for moving and storing petitioner's household effects. The $ 3,846.98 and $ 123.14 was included in petitioner's nonwage income for 1985 and 1986, respectively. The $ 5,000 bonus, however, is not a "moving expense," paid by Lockheed and deductible by petitioner. It is additional income to petitioner which, without evidence to the contrary, we find was included in his W-2 Form for 1985. Additionally, we find that the $ 25,530 figure is comprised of at least $ 12,640 worth of nondeductible personal or capital costs. 7 Sec. 262. Accordingly, we must decide whether any portion of the $ 12,890 remaining is deductible. Petitioner's evidence on his claim is confusing. Petitioner claims he expended an additional $ 10,184 8 to move other household goods and personal items by jet, truck, Federal Express, UPS, taxi, limo, and personal courier; $ 875 on an unexpired lease; $ 1,100 for househunting trips; and at least $ 731 for attorney*276 fees, escrow fees, loan origination fees, and points. We agree that Lockheed would not pay to move "prohibited items" such as coins, plants, chemicals, mice, and fish. 9*277 Accordingly, petitioner is entitled to deduct the expenses attributable to those items. We find petitioner incurred moving expenses 10 of $ 500. However, due to the lack of third-party documentation, we are not persuaded petitioner is entitled to deduct any additional amounts. Capital lossesPetitioner reported on his 1986 Schedule D that he purchased silver (coins or bullion) on April 12, 1982, for $ 5,211 and sold it on February 5, 1986, for $ 953. He claimed a $ 2,129 capital loss deduction on his 1986 return. Respondent contends petitioner neither purchased the silver in April 1982 from Crystal Coin, Inc., nor sold it in 1986. Additionally, and for the first time at trial, petitioner claimed he purchased 28 South African Krugerrands and 10 ounces of Engelhard silver bars on January 21, 1980, from Crystal Coin, Inc., in Wakefield, Massachusetts, for $ 23,492 and $ 5,340, respectively. Furthermore, he alleges he sold these items on February 12, 1985, to Ken Edwards (Mr. Edwards) of CNI (California Numismatics, Inc.) in Redondo Beach, California, for $ 11,732 and $ 850.80, respectively, and, therefore, he is entitled to a $ 3,000 capital loss in 1985. Respondent contends petitioner did not purchase the coins or silver bars and, therefore, could*278 not have sold them. This issue was tried by the mutual consent of the parties. Rule 41(b). Based on the credible testimony of Ms. Jo Anne Burque of Crystal Coin, Inc., and Mr. Edwards, we agree with respondent. Casualty lossThis issue was tried by the mutual consent of the parties. Rule 41(b). 11Petitioner claims that Atlas' subcontracting carrier damaged his household goods and automobile when it moved him from California to Florida. Additionally, he alleges that he attempted to file a claim against the subcontractor but was told he could not do so because "he signed off on those items." This is the only evidence petitioner presented*279 to substantiate his claimed loss. We find it insufficient to prove that a loss actually occurred or the amount thereof. Accordingly, we sustain respondent on this issue. MiscellaneousPetitioner claimed a $ 3,021 deduction for miscellaneous expenses on his 1986 return, including $ 1,150 for computer software and an estimated $ 1,100 on travel, hotel, and meals attending the 1986 Monolithic Circuits Symposium in Baltimore, Maryland. Respondent concedes petitioner is entitled to deduct $ 449, but contends the balance is not allowable. We agree with respondent. Petitioner failed to prove that the acquisition of the computer software was in any manner related to his employment with Lockheed. Accordingly, he is not entitled to deduct the $ 1,150. Additionally, petitioner failed to provide any documentation substantiating that he actually attended the symposium. Moreover, even if he had proved he attended the symposium he, nevertheless, failed to satisfy the strict substantiation requirements under section 274(d). Thus, we are without any means to allocate the expenses between the meeting and the section 274(d) expenses. Accordingly, we find petitioner is not entitled *280 to any deduction. Rental and depreciationPetitioner claimed deductions in 1986 for rental expenses and depreciation on two properties, Breezy Palms ($ 5,274) and Lake Drive ($ 18,867). 12We find the Breezy Palms property is and at all times was petitioner's personal residence. Accordingly, all costs, except the mortgage interest 13 attributable to it, are either personal or capital and therefore nondeductible. Secs. 262, 263. *281 Petitioner alleges he purchased the Lake Drive property on June 7, 1985, for $ 63,118, lived there until February or March of 1986, and leased it thereafter for at least two 7-month terms for approximately $ 450 per month. Petitioner included $ 4,590 in rental income on his 1986 Schedule E. Additionally, petitioner provided the names of the three tenants to whom he rented the property, although he failed to produce any other documentary evidence substantiating his rental activity. We find petitioner rented the Lake Drive property during 1986 and conclude he incurred some expenses in 1986. Accordingly, we allow petitioner to deduct the advertising, cleaning and maintenance, and insurance expenses as reported on his return. All other claimed deductions are disallowed, except the mortgage interest respondent allowed as a deduction on petitioner's Schedule A. Additional incomeIncomePetitioner concedes he failed to include $ 10 of interest in his income for 1986. However, he alleges that (1) the $ 350 in unemployment compensation is not taxable income according to IRS Publication 17, 14 and (2) he did not have an additional $ 155 in wages. *282 (1) Unemployment compensationSection 85 provides as follows: (a) In General. -- If the sum for the taxable year of the adjusted gross income of the taxpayer (determined without regard to this section, section 86, and section 221) and the unemployment compensation exceeds the base amount, gross income for the taxable year includes unemployment compensation in an amount equal to the lesser of -- (1) one-half of the amount of the excess of such sum over the base amount, or (2) the amount of the unemployment compensation.Petitioner's base amount is $ 12,000. See sec. 85(b)(1). In accordance with this section, the $ 350 is fully includable in petitioner's income for the year. Accordingly, we sustain respondent's determination on this issue. (2) Additional taxable incomePetitioner's W-2 Form for 1986 indicates he received $ 39,613.54 in "wages, tips, other compensation, and paid social security on $ 39,458.96 in wages. Petitioner reported the latter amount as his total income from wages, tips, and other compensation. Petitioner's only explanation is that "if [the $ 155] were for wage income, the petitioner would have been taxed FICA on this amount." *283 Petitioner fails to understand that although the $ 155 is not "wages," it may be "other compensation." Without additional evidence to the contrary, we find the W-2 Form introduced at trial correctly reflects petitioner's income for that year. Accordingly, we find for respondent on this amount. Additions to taxNegligenceThe next issue for decision is whether petitioner is liable for the additions to tax for negligence under section 6653(a)(1) and (a)(2) (section 6653(a)(1)(A) and (B) for 1986). Petitioner bears the burden of proving that the underpayment was not due to negligence or intentional disregard of the rules or regulations. Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791-792 (1972); Rule 142(a). Respondent contends that petitioner is liable for the section 6653(a) additions because, among other things, he (1) deducted personal expenses and other expenses knowing they were not authorized by the Internal Revenue Code; (2) deducted charitable contributions without adequately substantiating the donee or the amount; and (3) failed to maintain adequate books and records to substantiate his claimed deductions. Negligence is defined as a failure to *284 exercise the due care that a reasonable and ordinarily prudent person would exercise under the circumstances. Marcello v. Commissioner, 380 F.2d 499">380 F.2d 499, 506 (5th Cir. 1967), affg. in part and remanding in part 43 T.C. 168">43 T.C. 168 (1964); Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). See Antonides v. Commissioner, 91 T.C. 686">91 T.C. 686, 699 (1988), affd. 893 F.2d 656">893 F.2d 656 (4th Cir. 1990). We agree that petitioner failed to exercise due care by claiming deductions in excess of what he could adequately substantiate or reconstruct, as required by section 6001 and the regulations promulgated thereunder. Although petitioner's lack of actual records is understandable if the metal box stolen from his home in 1988 contained his tax records, he, nevertheless, failed to obtain documents from third parties to adequately reconstruct his expenses. We also agree petitioner deducted expenses he must have realized, in light of his education and business experience, were personal. Accordingly, we find petitioner liable for the addition to tax under section 6653(a)(1) and (a)(2) (section 6653(a)(1)(A) and (B) for 1986) on the entire*285 redetermined deficiency. Substantial understatementThe next issue for decision is whether petitioner is liable for the addition to tax under section 6661(a) for substantial understatement of income tax with respect to the taxable years in issue. Petitioner bears the burden of proof on this issue. Rule 142(a). An understatement is substantial if it exceeds the greater of $ 5,000 or 10 percent of the amount required to be shown on the return. The amount of the understatement is reduced for section 6661 purposes by the portion of the understatement which is attributable to the taxpayer's treatment of an item for which there was "substantial authority," or if the relevant facts affecting the item's tax treatment are "adequately disclosed" on the return or in a statement attached thereto. Sec. 6661(b)(2)(B)(i) and (ii). In his notice of deficiency, respondent determined that, due to the adjustments made to petitioner's Federal income tax returns for 1985 and 1986, he was liable for the 25-percent 15 addition to tax pursuant to section 6661(a). Petitioner neither offered "substantial authority" for his understatement, nor did he "adequately disclose" any facts affecting*286 the tax treatment of the items in issue. Accordingly, he is liable for the addition to tax under section 6661. Protective OrderOn October 12, 1989, petitioner moved under Rule 103 for a protective order as follows: 1. A protective order to prevent any disclosure of Tax Court records, pleadings, motions, or any other documents regarding the Petitioner's case to third parties. 2. A protective order to prevent the Respondent from disclosing any information to third party contacts regarding the above-styled case. From its disclosure of information to date, the Respondent has caused irreparable damage to the petitioner's business, and may have interfered with other civil litigations in County Court.The granting of the order *287 would prohibit the unauthorized transfer of confidential information received from petitioner to any third party without permission from either the Court or petitioner. See sec. 7461. As a general rule, common law, statutory law, and the U.S. Constitution support the proposition that official records of all courts, including this Court, shall be open and available to the public for inspection and copying. Nixon v. Warner Communications, Inc., 435 U.S. 589">435 U.S. 589, 597, 55 L. Ed. 2d 570">55 L. Ed. 2d 570, 98 S. Ct. 1306">98 S. Ct. 1306 (1978); In re Coordinated Pretrial Proceedings in Petroleum Products Antitrust, 101 F.R.D. 34">101 F.R.D. 34, 38 (C.D. Cal. 1984); sec. 7461. The right to inspect and copy judicial records is not, however, absolute. Willie Nelson Music Co. v. Commissioner, 85 T.C. 914">85 T.C. 914, 918 (1985). This Court, in its discretion, may seal the record or portions thereof where justice so requires and the party seeking such relief demonstrates good cause. American Telephone & Telegraph Co., v. Grady, 594 F.2d 594">594 F.2d 594, 596 (7th Cir. 1979); Rule 103(a). See Belo Broadcasting Corp. v. Clark, 654 F.2d 423">654 F.2d 423, 430-434 (5th Cir. 1981). To determine whether the sealing*288 of any documents is appropriate we must weigh the public's interest in access to the documents against the interest of the party seeking the protective order, i.e., petitioner. Nixon v. Warner Communications, Inc., 435 U.S. at 602; Willie Nelson Music Co. v. Commissioner, 85 T.C. at 919. Petitioner must produce "appropriate testimony and factual data" to support claims of harm that would occur as a consequence of disclosure. Estate of Yaeger v. Commissioner, 92 T.C. 180">92 T.C. 180 at 189, citing Wyatt v. Kaplan, 686 F.2d 276">686 F.2d 276, 283 (5th Cir. 1982); United States v United Fruit Co., 410 F.2d 553">410 F.2d 553, 557 n.11 (5th Cir. 1969). He may not rely on conclusory or unsupported statements to establish good cause. Willie Nelson Music Co. v. Commissioner, 85 T.C. at 920; Estate of Yeager, supra, citing In re Coordinated Pretrial Proceedings in Petroleum Products Antitrust, 101 F.R.D. 34">101 F.R.D. 34, 44 (C.D. Cal. 1984). Moreover, merely asserting annoyance and embarrassment is wholly insufficient to demonstrate good cause. See Willie Nelson Music Co. v. Commissioner, 85 T.C. at 925.*289 Good cause has been demonstrated and records sealed where patents, trade secrets, or confidential information are involved or where an individual's business reputation will be hurt. See Willie Nelson Music Co. v. Commissioner, 85 T.C. at 921. A showing that the information would harm an individual's personal reputation is generally not sufficient to overcome the strong common law presumption in favor of access to court records. Willie Nelson Music Co. v. Commissioner, supra.Petitioner stated that he has a civil lawsuit pending with his former employer (Lockheed) and does not want Lockheed to know the facts of this case. The trial involving Lockheed was to be held in November 1989. Petitioner advances no other facts to support his motion. Without more, we find petitioner has not demonstrated any harm (financial or otherwise) that his business has suffered or will suffer if his motion is denied. Accordingly, we deny his motion for a protective order in this case. To reflect the foregoing, An appropriate order will be issued and decision*290 will be entered under Rule 155. Footnotes1. For taxable year 1986 the addition to tax for negligence is section 6653(a)(1)(A) and (B), rather than 6653(a)(1) and (2). Any reference to section 6653(a) for the 1985 and 1986 tax years refers to section 6653(a)(1) and (2) and section 6653(a)(1)(A) and (B), respectively.↩*. 50 percent of the interest payable on the entire deficiency.↩2. The $ 25,530 is calculated as follows: $ 35,310 (the amount claimed) minus $ 3,970 (the total amount respondent allows) and $ 5,810 (the amount petitioner claims is a casualty loss incurred during the move).↩3. He reconstructed the following in the interrogatories: ↩19851986 Software$ 153$ 1,150Computer3,800-Printer492-Graphics Card188-Monitor595-Cables148-Other93$ 5,469$ 1,1504. The September 26, 1989, letter stated that (1) "Use of a home computer in order to perform the duties of his [Mr. Tavano's] employment was not required by the Company;" (2) "Mr. Tavano was not required by the Microwave Products Division to have a home computer in 1984 and 1985;" (3) "The Company typically discourages employees from taking Company documents to and from the work site, due to security and proprietary information related issues;" and (4) petitioner had access to three computers, which included a main frame and two desk tops, while employed with Hughes Aircraft.↩5. The $ 9,097 is comprised of $ 4,097 in moving costs and a $ 5,000 "Employee Incentive Bonus."↩6. This figure was arrived at by subtracting the total amounts allowed as a deduction, i.e., $ 3,970 rounded, from the amount petitioner estimates he is now entitled to, $ 29,500, i.e., the average of $ 29,000 and $ 30,000. He testified that he amended his 1985 return reducing the moving expenses from $ 35,310 to between $ 29,000 and $ 30,000.↩7. The $ 12,640 is made up of the following: (1) $ 11,725 of expenses incurred for the purchase price of petitioner's new home in Florida which includes the downpayment; (2) $ 70 for car tags; (3) $ 25 for driver's license; and (4) $ 820 to refit carpets and draperies at his new home.↩8. $ 13,000 minus ($ 2,693 plus $ 123 rounded).↩9. Petitioner stated that Lockheed would not pay to move approximately 60 to 75 percent of his possessions, including his gold and silver coins and bullion, 2 grand pianos, grandfather clock collection, firearms, 29 pyraponic growth chambers with 29 plants, chemicals, 47 lab mice, ham radio antennas, satellite dish antenna, 2 radio telescope interferometers, and an aquarium with various fish.↩10. Petitioner provided respondent with the names of at least 4 separate companies he used to move these items.↩11. Petitioner claims he initially and incorrectly included the loss deduction as a moving expense, and upon discovering his mistake, filed an amended return reducing his moving expenses by the loss amount and claiming a casualty loss deduction. Respondent has no record of receiving the amended return, and petitioner was not able to present a copy of the return at trial.↩12. Petitioner deducted the following amounts on the Lake Drive property on his 1986 Schedule E: ↩Advertising$ 38Auto and travel3,811Cleaning and maintenance285Commissions179Insurance225Legal and other professional fees899Mortgage interest paid to financial institutions6,480Repairs124Taxes548Utilities28Wages and salaries120Garbage130$ 12,867Depreciation6,000$ 18,86713. Respondent allowed petitioner to deduct mortgage interest (of $ 1,587) on the Breezy Palms and Lake Drive properties on his Schedule A.↩14. IRS Publication 17 provides as follows: Amount to Include In Income. You must report the total unemployment compensation you received during the year on line 20a, Form 1040, * * *. However, you include in your gross income on line 20b, Form 1040, * * * the lesser of: 1) Your total unemployment compensation, or 2) One-half of the amount by which the sum of your adjusted gross income (figured as explained later) plus your total unemployment compensation is more than the base amount that applies to you. For purposes of determining taxable unemployment compensation, figure your adjusted gross income without: 1) Any amount of unemployment compensation, 2) Any taxable social security * * *, and 3) Any deduction for a married couple when both work.↩15. The Omnibus Reconciliation Act of 1986, Pub. L. 99-509, sec. 8002(a), 100 Stat. 1874, 1951, increased the section 6661(a)↩ addition to tax to 25 percent of the underpayment attributable to a substantial understatement for additions to tax assessed after October 21, 1986. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624896/ | Jelindo A. Tiberti and Marietta Tiberti v. Commissioner.Tiberti v. CommissionerDocket No. 89138.United States Tax CourtT.C. Memo 1962-174; 1962 Tax Ct. Memo LEXIS 133; 21 T.C.M. (CCH) 961; T.C.M. (RIA) 62174; July 25, 1962*133 Petitioner J. A. Tiberti owned and operated as a sole proprietorship a general construction business. He and his wife created four trusts for their minor children, to each of which one-fifth of the assets of the business was contributed. A partnership was created, with Tiberti as the managing partner and two contrustees as partners representing the four trusts. All of the business assets were contributed to this partnership. Held, the transfers in trust were bona fide and each of the trusts owned a one-fifth capital interest in a bona fide partnership in which capital was a material income-producing factor. The distributable shares of partnership income were properly includible in the gross income of the trusts. Mark Townsend, Esq., for the petitioners. Walter S. Weiss, Esq., for the respondent. BRUCE Memorandum Findings of Fact and Opinion BRUCE, Judge: Respondent determined deficiencies in income taxes for the years and in the amounts which follow: YearDeficiency1955$46,705.91195616,474.15195775,491.32The sole question for our determination is whether trusts created by petitioners for their minor children owned capital interests in a bona fide partnership in which capital was *134 a material income-producing factor so that distributable shares of partnership income were properly includible in the gross income of each of four trusts. Findings of Fact The parties have stipulated certain facts. The stipulated facts, together with the exhibits, are incorporated herein by this reference. The petitioners are Jelindo A. Tiberti and Marietta Tiberti, husband and wife. Their residence was Las Vegas, Nevada, and they filed a joint income tax return with the district director of internal revenue at Reno for each of the years here involved. (For convenience, Jelindo A. Tiberti will sometimes hereinafter be referred to as petitioner or as Tiberti.) Petitioner, who is a registered engineer in the State of Nevada, formed the J. A. Tiberti Construction Company in 1950 and operated it as a sole proprietorship through 1954. (The sole proprietorship and the partnership are hereinafter sometimes referred to as the company.) The company engaged in the heavy construction business. Before establishing his own business Tiberti had worked as an employee or associate in other general contracting firms. Tiberti, whose parents were born in Italy, comes from a family of nine children. While *135 they were still in high school, petitioner and his brothers were taken into the family business by their father, who operated a gas station under the name Tiberti & Sons. In 1954 petitioner had four children: John Tito, Laura Lisa, Mary Andrea, and Renaldo Milan, whose ages as of January 1, 1955, were 9, 7, 5, and 3, respectively. Over a period of time, Tiberti and his wife discussed taking the four children into petitioner's business. Both the partnership and corporate forms of doing business were considered; but, upon the advice of his attorney, Tiberti ultimately decided to utilize the former. In late 1954, at a meeting of petitioner, his attorney, E. W. Cragin, and Don R. Beagle, it was agreed that a trust would be created for the benefit of each of petitioner's four children. The res of each trust was to consist of a one-fifth interest in the assets and liabilities of Tiberti's construction business. It was planned that each of the four trusts and the petitioner would exchange an undivided interest in the assets and liabilities for a one-fifth interest in a partnership which would thereafter operate the business. Cragin and Beagle consented to serve as cotrustees for each of *136 the four trusts and to form a partnership to take effect on January 1, 1955. Petitioner's attorney was requested to prepare the formal documents evidencing these agreements. Four trust instruments, identical save for the designated beneficiary, were executed in the spring of 1955. They provided as follows: TRUST AGREEMENT TRUST AGREEMENT made January 1, 1955, among J. A. Tiberti and Marietta Tiberti, residing in Las Vegas, Nevada, as Grantors and Don R. Beagle and E. W. Cragin, as Trustees. 1. GRANT. The Grantors hereby irrevocably assign to the Trustees in trust an undivided one fifth interest in certain assets subject to certain liabilities as more fully described in a schedule annexed hereto as Schedule A and made a part hereof, all of which property is hereinafter termed the trust property; and the Grantors direct that the trust property be contributed to a partnership organized this day in accordance with the copy of a partnership agreement attached hereto, and that the Trustees continue their interest in that partnership until the termination of this trust or of their interest in that partnership in accordance with the terms of the partnership agreement; and that the Trustees *137 shall not be accountable for any diminution of the trust property by reason of their compliance with these directions. 2. BENEFICIARY. The trust property shall be held as a trust fund for the benefit of the Grantors' * * * [son or daughter designated by name], hereinafter called the beneficiary. 3. DISCRETIONARY PAYMENTS. The income of the trust shall be accumulated; provided, however, that the Trustees may, in their absolute discretion pay to or apply for the beneficiary so much of the current or accumulated income or the corpus of the trust as they shall determine. The Trustees are further authorized, when in their sole absolute discretion they may deem it advisable, to make such payments of income or corpus directly to the beneficiary, or to any person with whom the beneficiary shall reside, or to any person, partnership, or corporation furnishing services, goods or facilities to the beneficiary at the request of the Trustees or otherwise. 4. RETENTION OF BUSINESS EARNINGS. (a) Notwithstanding the right to beneficial enjoyment of trust property generally accorded to an income beneficiary of a trust under the general principles of the law of trusts, or the purport of any other *138 rules affecting, inter alia, the administration of trusts, or the rights of beneficiaries of trusts, or the duties of trustees, so long as the assets of the trust are at any time invested in any business or businesses, whether sole proprietorship, partnership, or corporation and it is decided from time to time by the managers, working partners, or proprietors of any such business (whether or not such managers, working partners, or proprietors include or consist of any of the trustees of this trust) that it is in the best interests of the business to retain earnings for working capital needs, or for legitimate business purposes connected with the protection or expansion of the earning capacity of the business, then and in that event, the earnings shall not be required to be distributed to the trust until such time as it is decided by the managers, working partners, or proprietors of the business that the retention of any such earnings is no longer necessary or helpful to the business. The decisions as to the retention of earnings in any business shall be in the absolute discretion of the managers, working partners, or proprietors thereof and shall be binding on all parties in interest *139 hereunder; and the trustees shall abide by any such decision so long as they deem it in the best interest of the trust, as a proprietor of such business, to do so. In the event any conflict arises between the duties imposed by law upon the Trustees in their capacities as Trustees, and the duties imposed by law or otherwise upon the Trustees in their capacities as Managers of the business, the latter shall control. The Trustees shall not be held accountable in any way for decisions or actions taken in good faith in furtherance of the Grantors' intentions as expressed in or implied by this paragraph; nor shall any of the Trustees be held responsible to the beneficiaries or to any persons beneficially interested in the trust for any loss in income or to the corpus thereof unless the same shall occur through his own gross neglect or wilful malfeasance. (b) For the purposes of the Trustees' exercise of their discretionary power of distributing trust income under paragraph 3 hereof, the earnings of any business which have been retained pursuant to the terms of sub-paragraph (a) of this paragraph shall not be deemed to be income of the trust until such time as the earnings of the business *140 are released to the Trustees. 5. TERMINATION OF TRUST. The trust shall terminate upon the death of John Tito Tiberti, and the principal and any undistributed and accumulated income shall be paid over absolutely to his issue per stirpes, or, if there be none, to Renaldo Milan Tiberti, Mary Andrea Tiberti, and Laura Lisa Tiberti, son and daughters of the Grantors herein, as joint tenants, and to the survivors of them. 6. ADDITIONAL GRANTS. The Grantors reserve the right to themselves or to any person at any time by deed or will to add to the principal of the trust herein created and any property so added shall be held, administered, and distributed as part of such trust. 7. POWERS OF FIDUCIARIES. In the administration of the trust, the Trustees shall have the following powers: (a) They may retain the trust property received hereunder and any additional property which may be received by them in their adsolute [absolute] discretion even though such property is not income producing property and may invest and reinvest the trust in such real or personal property of any kind or description as they in their absolute discretion may deem proper, although the same may not be of the character *141 permitted for the investment of trust funds by the laws of the State of Nevada or of any state in which such property may be situate, and not with standing that the same may constitute leaseholds, royalty interests, patents, interest in mines, oil and gas wells, timber lands or other wasing [washing] assets, or business interests as more fully described in sub-paragraph (j) of this paragraph. (b) With regard to any real, or other property at any time constituting a part of the trust, they may whenever they deem it in the best of interest of the trust: 1. Make, renew, or modify leases on any such property upon such terms as they may determine, irrespective of the provisions of any statute or of the termination of any trust: 2. Mortgage any such property on such conditions as they may determine, and extend, modify, or consolidate any such mortgages; 3. Make repairs and improvements at any time deemed necessary and proper on any such property; 4. Sell any such property or any interest therein, or exchange the same for other property, on such terms as they may determine, and execute and deliver any deed or deeds (with or without warranty,) receipts, releases, contracts, or other instruments *142 necessary in connection therewith. (c) They may vote, personally or by proxy, all securities belonging to the trust, or may consent to the reorganization, consolidation, merger, liquidation, readjustment of or other change in any corporation, company, partnership, or association, or to the sale or lease of the property thereof or any part thereof; and may do any act or exercise any power with reference thereto that may be legally exercised by any person owning similar property in his own right, including the exercise of options, deposit, or exchange of securities, entrance into voting trusts, and the making of agreements or subscriptions. Any securities or other property belonging to the trust may be registered in the Trustees' own names without qualification or description, or in their names as Trustees, or in the name of the trust, or in the name of any nominee, or may be kept in bearer form. (d) They may enforce, by suit or otherwise, compromise, settle, arbitrate, or defend any debt, claim, lien, or demand in favor of or against the trust. (e) They may incur and pay the ordinary and necessary expenses of administration, including (but not by way of limitation) reasonable attorney's *143 fees, accountants' fees, investment counsel fees, and the like. (f) They may borrow money for any purposes of the trust upon bond or promissory note, and secure the repayment thereof by mortgaging or pledging or otherwise encumbering any part or all of the property of the trust, and, with respect to the purchase or other acquisition of any property, as part of the consideration given thereof, assume a liability of the transfer or acquire such property subject to a liability. (g) They may lend money to any person or persons upon such terms, and in such ways, and with such security as they may deem advisable and for the best interest of the trust. (h) They may determine in their discretion the allocation of receipts between corpus and income except that all capital gains and extraordinary and stock dividends shall be corpus. (i) With regard to any necessary and proper debts, assessments, charges and other expenses in connection with the administration of the trust, they may: (1) Pay out of any money belonging to the trust, any such expenses; (2) Determine the apportionment of such expenses between corpus and income; (3) Determine whether to make any provision for depreciation in respect *144 of any tangible property. If the expenses of any period apportioned to income exceed the income for such period, or the undistributed income for any prior period, they may charge such excess proportionately against the earliest net income of the trust thereafter realized. (j) Except as limited by the provisions of paragraph 1 above they may engage in business or businesses with the property of the trust as sole proprietor, or as a general or limited partner or as a minority or majority stockholder of a closed corporation, with all the power customarily exercised by an individual so engaged in business, and may hold an undivided interest in any property as tenant in common or tenant in partnership and in connection therewith they shall have the power to enter into agreements with co-owners, partners, or co-stockholders, and into modifications of any such agreements. (k) They may make any division or distribution of corpus or income required under the terms of this instrument in kind or in money, or partly in kind and partly in money. (l) They may freely act under all or any of the powers by this instrument given to them notwithstanding that they may also be acting individually, or *145 as Trustees of other trusts, or as agents for other persons or corporations interested in the same matters, or as stockholders, directors, or otherwise. The powers herein granted to the Trustees shall be deemed to be supplementary to and not exclusive of the general powers of Trustees pursuant to law, and shall include all powers necessary to carry the same into effect. 8. IRREVOCABILITY. The trust shall be irrevocable and shall not be amendable except for the purpose of clarification by the Grantors; and the Grantors hereby expressly acknowledge that they shall have no right or power, whether alone or in conjunction with others, and in whatever capacity, to alter, amend (except for purposes of clarification), revoke, or terminate the trust, or any of the terms of this instrument, in whole or in part, or to designate the persons who shall possess or enjoy the trust property, or the income therefrom. By this instrument the Grantors intend to and do hereby relinquish absolutely and forever all possession or enjoyment of, or right to the income from, the trust property, whether directly, indirectly, or constructively, and every interest of any nature, present or future in the trust *146 property. 9. CONSTRUCTION. It is intended that, insofar as permitted under the rules of private international law, the construction of this instrument, the validity of the interest created hereby, and the administration of the trust property will be governed by the laws of the State of Nevada. 10. DESIGNATION OF FIDUCIARIES. The Trustees shall be Don R. Beagle and E. W. Cragin, or the survivor of them. In case of the death, resignation, or inability of any Trustee, the District Judge of Department N. 1 of the Eight Judicial Court, District Court of the State of Nevada in and for the County of Clark, shall appoint a successor Co-Trustee. None of the Trustees shall be required to furnish bond for the performance of the duties of Trustee. The expression "Trustee" as used in this instrument shall mean and include the persons named as such herein and any substitute or successor Trustee named in accordance with the provisions of this paragraph. 11. ACCOUNTING. Notwithstanding the provision of any statute to the contrary, the Trustees shall not be required to render a formal accounting of the trust in any court. They shall annually prepare a true statement of the corpus and of the income *147 and expenditures of the trust and shall furnish the beneficiary with a copy of the same. Such annual accounts of the Trustees shall be binding upon the beneficiary of the trust and upon any other person or persons beneficially interested therein unless within thirty days after receiving such annual account the beneficiary or such other person shall submit a disapproval in writing to the Trustees. 12. TRUSTEES' COMPENSATION. The Trustees shall be entitled to receive for their joint compensation 1% of the gross income of said trust estate during each fiscal year, and in no case less than $25.00 each, per annum, and upon the termination of said trust, otherwise than by resignation or death of the trustees, a sum equal to 1% of the corpus of the trust estate at the date of such termination, which several payments shall be in full payment for all services rendered by the Trustees. IN WITNESS WHEREOF, the parties hereto have signed and sealed this agreement. /s/ J. A. Tiberti J. A. Tiberti, as Grantor /s/ Marietta Tiberti Marietta Tiberti, as Grantor /s/ Don R. Beagle Don R. Beagle, as Trustee /s/ E. W. Cragin E. W. Cragin, as Trustee Also executed in the spring of 1955 was a partnership *148 agreement which provided as follows: PARTNERSHIP AGREEMENT AGREEMENT made January 1, 1955, among Jelindo A. Tiberti, being hereinafter sometimes referred to as the individual party, and Don R. Beagle, and E. W. Cragin, as Trustees of the John Tito Tiberti Trust, Renaldo Milan Tiberti Trust, Mary Andrea Tiberti Trust, and of the Laura Lisa Tiberti Trust, hereinafter sometimes referred to as the fiduciary parties. Whereas the fiduciary parties are the trustees of four trusts the corpus of each trust consisting of an undivided interest in certain assets subject to certain liabilities referred to in Schedule A annexed hereto, and Whereas the individual party owns the entire remaining undivided interest in the assets subject to liabilities referred to in Schedule A, and Whereas the individual party desires to form a partnership with the fiduciary parties to engage in the general building contracting business, it is therefore agreed: 1. FORMATION OF PARTNERSHIP. The parties hereby form a partnership under the firm name of J. A. Tiberti Construction Company in which the individual and fiduciary parties are partners, to engage in the business of general building construction, rental of equipment, *149 selling of fence and other legitimate enterprises. 2. TERM. The partnership shall begin business January 1, 1955, and shall continue until December 31, 1955, and thereafter from year to year until terminated as hereinafter provided. 3. PRINCIPAL OFFICE. The principal place of business of the partnership shall be located at Las Vegas, Nevada. Such other offices shall be maintained as the partners may, from time to time, find necessary or desirable. 4. ORIGINAL CAPITAL. The original capital of the partnership shall consist of certain assets, subject to liabilities, as are now fully described in the schedule to be annexed hereto as Schedule A, and to form a part hereof at values set forth therein, in which the partners own undivided interest in the same proportions as set forth in paragraph 5. 5. CAPITAL ACCOUNTS AND PROFITS. The initial capital accounts of each partner shall equal the proportion of the original capital of the partnership set forth opposite his/her name below, and all net profits and net losses of the partnership shall be divided in the same proportions, to wit: J. A. Tibertione-fifthDon R. Beagle and E. W.Cragin, Trustees of theJohn Tito Tiberti Trustone-fifthDon R. Beagle and E. W.Cragin Trustees of theRenaldo Milan Tiberti Trustone-fifthDon R. Beagle and E. W.Cragin Trustees of theMary Andrea Tiberti Trustone-fifthDon R. Beagle and E. W.Cragin Trustees of theLaura Lisa Tiberti Trustone-fifth*150 6. WORKING PARTNER. J. A. Tiberti shall be the working partner and shall draw an annual salary in the amount of $15,000.00. This salary shall be treated as an expense in determining the net profits or net losses of the partnership. 7. MANAGEMENT. The partners shall have equal rights in the management and conduct of the partnership business. 8. WITHDRAWAL OF PROFITS. At the end of each accounting year of the partnership and at such other times during the year as the partners shall mutually determine, the partners shall have the right to withdraw their shares of partnership net profits for the year. All withdrawals of profits shall be made in the ratio of the partners' capital accounts as set forth in paragraph 5. It is agreed, however, that profits will not be withdrawn when to do so would be contrary to the best interest of the partnership business in the opinion of the working partner. 9. BOOKS. The books of the partnership shall be maintained at the principal office and shall be kept on such accounting basis as the partners may determine from time to time.10. TERMINATION OF TRUST. The termination of one of the trusts participating as a partner in this partnership shall not terminate *151 or dissolve the partnership but the interest of the trust in the partnership shall abate by reason of such termination; and the trust shall be deemed to have withdrawn from the partnership as of the end of the month in which such termination occurs pursuant to the provisions of paragraph 11 hereof, except that the 90 day notice and waiting period provided in such paragraph shall not apply. The partnership shall continue to carry on the business therefore conducted by it and the fractional interests of the remaining partners in the partnership net profits and net losses shall be adjusted proportionately. 11. WITHDRAWAL. Any partner shall have the right to withdraw from the partnership at any time upon giving 90 days' notice in writing to the other partners. In such event the partnership shall be dissolved and liquidated of notice in writing of the election to dissolve is given to the other partners within such period by partners who in the aggregate would be entitled to one-half or more of the partnership net profits if the partnership were to continue after the withdrawal of such partner. If there shall be no election to dissolve, the withdrawing partner shall receive from the partnership *152 the value of his or its capital account as of the end of the month in which the 90 day period elapses. The value of capital accounts shall be taken from the partnership books of account, without allowance for good will, trade names, patents, or other intangible assets, except for costs, incurred by the partnership in the acquisition of such intangible assets as are reflected on the partnership books of account, and for the purpose of this paragraph the books of account shall be conclusive on all parties. 12. DEATH OF PARTNER. (A) On the death of a partner the partnership shall not be terminated or dissolved not-withstanding any provision of law to the contrary, and the interest of the decedent in the partnership shall not abate by reason of his death. The partnership shall continue to carry on the business theretofore conducted by it and the decedent's estate shall continue to share in the partnership profits and losses equally with the surviving partners. The estate of the decedent shall have no right by reason of the death of the decedent to demand any part of the current earnings other than by way of drawing account, or any part of the decedent's capital account except as provided *153 in sub-paragraph (b). (b) In case of the death of a partner the surviving partners shall have the right to redeem the interest of the estate of the decedent at any time at the value provided in paragraph 11, and the estate of the decedent may withdraw from the partnership at any time on the terms provided in paragraph 11. 13. PAYMENT FOR PARTNERSHIP INTEREST. In the event of the redemption of a partner's interest in the partnership pursuant to paragraph 10, 11, or 12, the redemption price shall be paid in cash without interest in four semiannual installments commencing on a date 90 days after the date hereinabove fixed for the valuation of the capital account of the withdrawing or deceased partner. 14. TERMINATION. Except as hereinabove otherwise provided, the partnership shall continue from year to year; provided, however, that the partnership may be dissolved and terminated at the end of any accounting year at the election of partners who, in the aggregate, are entitled to at least 51% of the partnership profits, or at any other time upon the mutual consent of all the partners. 15. BENEFIT. This agreement shall be binding upon and inure to the benefit of the partners and their legal *154 representatives, successors, and assigns. IN WITNESS WHEREOF, the parties hereto have signed and sealed this agreement. /s/ J. A. Tiberti / J. A. Tiberti /s/ Don R. Beagle / Don R. Beagle As Trustee of the John Tito Tiberti Trust, Renaldo Milan Tiberti Trust, Mary Andrea Tiberti Trust, Laura Lisa Tiberti Trust. /s/ E. W. Cragin / E. W. Cragin As Trustee of the John Tito Tiberti Trust, Renaldo Milan Tiberti Trust, Mary Andrea Tiberti Trust, Laura Lisa Tiberti Trust. The following schedule was attached to each of the trust instruments and to the partnership agreement: ASSETSCurrent AssetsCash in bank$56,928.47Loans receivable3,445.38Work in process - net9,076.02Total Current Assets$ 69,449.87Other AssetsPartnership interest - Nevada Perlite Co.5,000.00Land Fifth Street2,053.55Common stock - Waale, Camplan & Tiberti3,480.00Total Other Assets10,533.55Reserves forNetFixed AssetsCostDepreciationValueLand$ 7,512.20$ 7,512.20Buildings48,930.72$ 3,919.5845,011.14Equipment and trucks7,843.874,909.562,934.31Office furniture and fixtures1,524.45661.35863.10Automobile2,100.001,050.001,050.00Totals$67,911.24$10,540.4957,370.75Total Assets$137,354.17LIABILITIES AND CAPITALCurrent LiabilitiesFederal withholding taxes$ 1,253.00Social Security taxes96.58Bank overdraft - payroll1,661.40Total Current Liabilities$ 3,010.98Other LiabilitiesDue Partner, J. A. Tiberti29,343.19 *CapitalJ. A. Tiberti$21,000.00Don R. Beagle & E. W. Cragin, Trustees for John Tito Tiberti21,000.00Don R. Beagle & E. W. Cragin, Trustees for Renaldo MilanTiberti21,000.00Don R. Beagle & E. W. Cragin, Trustees for Mary Andrea Tiberti21,000.00Don R. Beagle & E. W. Cragin, Trustees for Laura Lisa Tiberti21,000.00Total Capital$105,000.00Total Liabilities and Capital$137,354.17*155 Balance sheets submitted to the Royal Indemnity Company, sometimes hereinafter referred to as Royal, which company provided bonding for J. A. Tiberti Construction Company, reflected net worths of the sole proprietorship as follows: 6/30/514/1/519/1/522/1/531/1/547/31/54$81,641$101,074$160,628$185,407$203,745$247,181 These balance sheets were prepared on a percentage-of-completion basis. They reflect accrued items and estimated and contingent assets, which items and assets are not normally reflected as assets on the books of a business reporting income either on the cash receipts and disbursements basis or on the completed-contract basis. Such balance sheets normally reflect personal assets as well as business assets, listed for credit purposes at their estimated fair market value. Prior to 1953 the construction company used a cash receipts and disbursements method of reporting income. Beginning with the year 1953 the company changed to the completed-contract method. The statement of assets and liabilities supplied to Royal for sole proprietorship as of December 30, 1954, indicated total assets of $358,091.14 and total current liabilities *156 of $76,955, resulting in a net worth of $281,136.14. The statement of assets and liabilities supplied to Royal as of April 1, 1955, indicated total assets of $421,126.63 and total current liabilities of $126,829.97, resulting in a net worth of $294,296.66. Financial statements were filed with Royal for the periods ending December 31, 1955, December 31, 1956, June 30, 1957, December 31, 1958, June 30, 1959, December 31, 1959, and December 31, 1960. Upon formation of the partnership, Tiberti and his wife retained personal assets consisting of the family residence, personal life insurance, and a small homestead property. They conveyed undivided interests in the remaining assets and liabilities of the business to the extent of four-fifths thereof to the trusts. Legal title to the company's office building was not formally conveyed to the partnership. Upon sale of that property in 1957, however, the proceeds were received by the partnership; the gain was reflected on the partnership return and the individual returns of the partners; and the gain was credited equally to the capital account of each of the partners. Upon purchase in 1957 of the property which became the site of the company's *157 new office building, title was taken in the name of the partnership. Gift tax returns reporting the gift to each of the four trusts of a one-fifth interest in the assets and liabilities of the sole proprietorship were filed on behalf of the petitioners. The gift tax returns reflected the amounts shown in the schedule attached to both the trust instruments and the partnership agreement as set out hereinbefore. E. W. Cragin, one of the original cotrustees of the trusts, had a number of business interests in Las Vegas, including a partnership interest in an insurance brokerage firm. Cragin was familiar with the construction business in general through his experience as agent for bonding companies. His firm represented the bonding company which provided bid and performance bonds for the partnership and prior thereto for the sole proprietorship here involved. Through bond placement, his firm realized commissions from the partnership, but this business was not substantial in comparison to the over-all business of the firm. Cragin had a personal net worth of between $400,000 and $600,000. He was a former mayor of Las Vegas; was highly respected in the community; and was not a person who *158 would be amenable to the will of others. Don R. Beagle was appointed as the other contrustee for each of the trusts. He was initially employed by petitioner in December 1952 when the business was conducted in proprietorship form, and has continued to be employed by the partnership up to the present time. Beagle's duties upon his initial employment were primarily clerical in nature. He advanced rapidly in the business and in a few years was handling some of the most important operations in the business. Upon becoming trustee he was given more responsibility in the operation of the business. After his appointment as trustee the signature cards at the bank were changed and Beagle was authorized to sign checks on the partnership account. Since that time he has signed most of the checks. He was also authorized to sign, and has signed, bids, bonds, contracts, and other documents pertinent to the business. Beagle is familiar with all facets of the business and has participated in estimation work, bid preparation and submission, preparation of subcontracts and contracts, and has supervised the bookkeeping and office work. Beagle's salary, while working for the taxpayer, was as follows: YearSalary1953$ 4,000 - $4,20019544,08919554,35019567,55019577,875195811,500195910,707196012,180Upon *159 the death of E. W. Cragin in 1959, Abe P. Miller, in conformance with the trust agreements, was appointed successor contrustee by the district judge of Department No. 1 of the Eighth Judicial Court, District Court of the State of Nevada, in and for the County of Clark. Miller was one of three persons considered as successor trustee. He was independent of the petitioner. Petitioner originally considered appointment of a corporate trustee, but decided against such appointment because he considered a corporate trustee cold, impersonal, and cumbersome in the type of business carried on by the partnership. Beagle was selected as cotrustee because of his understanding of the business and because he was young, energetic, and honest. Cragin was selected because of his business experience and judgment. The trustees were consulted on business matters apart from routine or day-to-day matters and participated in all the major policy decisions affecting the business. The trustees were regularly advised of the financial condition of the business and received copies of annual financial statements. They participated in discussions of the jobs currently under construction by the company, future contract *160 opportunities, progress and capital requirements of the company. They also participated in decisions determining matters such as the salary and bonus of the managing partner, whether earnings should be retained for the needs of the business or distributed to the partners, and whether the company should expand its business operations. A separate capital account was set up on the partnership books for each of the trusts. The books maintained by the J. A. Tiberti Construction Company showed capital accounts, distributive shares of earnings, the drawings and the balances in the accounts for each of the trusts and for the petitioner. While separate ledger sheets were maintained for each of the trusts reflecting distributions and balances, a separate set of books for the trusts was not maintained until cash distributions were made to the trusts in 1960. After such cash distributions a separate set of books was maintained for the trusts. Partnership returns were filed annually on behalf of the partnership and fiduciary returns reflecting partnership income were filed annually on behalf of each of the trusts. A certificate of doing business under the fictitious name of J. A. *161 Tiberti Construction Company was executed and notarized on January 3, 1955, and filed with the Clerk of Clark County, Nevada, on April 25, 1955. The certificate set forth the names of the petitioner, the cotrustees, and the trusts as the persons composing the firm doing business under that name. Annual financial statements for the company were filed with the National Bank of Nevada and such statements set forth that the business was being conducted in the form of a partnership with the trusts and trustees as partners. Annual financial statements setting forth the partnership arrangement also were filed with the bonding company. Royal required Cragin and Beagle, in their capacity as trustees, to sign indemnity agreements with the bonding company. Notice of the formation of the partnership and the identity of the partners was given to Dun & Bradstreet, which published reports reflecting this information and the change in form of doing business from sole proprietorship to partnership. On construction jobs which the company performed for the Corps of Engineers the company was required to submit copies of the partnership agreement and the trust agreements to the Corps of Engineers. Bids *162 submitted to the Atomic Energy Commission by the company set forth the existence of the partnership and the identity of the partners. The State Contractor's Board, which issues licenses to contractors, was notified of the formation of the partnership, as was the county school district. On two occasions, creditors have brought suit against the company on disputed matters, and the complaints filed therein have set forth the existence of the partnership. The existence of the partnership was made known to the public and to persons doing business with the company. The major portion of the construction work performed by the company has been under contract with agencies of Federal, state, city, and county governments. On all such work of a public nature, and on most private contracts performed by the company, it is necessary to furnish bid and performance bonds in order to bid or be awarded such contracts. In the general contracting business in which the partnership was engaged, the bonding capacity of the company determines the volume of work that can be performed and the specific construction jobs which can be bid by the company. One of the most important factors considered in determining *163 the bonding capacity of the company is the liquid capital position which it maintains. A rule of thumb used by bonding companies is that a contractor must maintain capital in readily negotiable form equal to at least 10 percent of the contractor's total work on hand. On both public and private contract work performed by the company, the governmental agency or owner retains 10 percent of payments due under the contract until the work has been completely performed and accepted. The partnership performs the concrete, carpentry, and millwork portions of construction contracts, and subcontracts between 60 percent and 70 percent of the work, a normal percentage in the industry. While the subcontracts provide that the company may retain 10 percent of amounts due subcontractors until completion and acceptance of the job, it is necessary in many cases for the company to pay its subcontractors currently without retention despite the fact that amounts due the company as prime contractor are subject to retention. It is necessary for the company to pay monthly for materials used on the jobs and to meet weekly payrolls of its own labor force engaged on the portions of the prime contracts performed *164 by the company and not subcontracted. In addition, the construction business is such that the maintenance of liquid capital reserves to meet emergency conditions is essential. Capital is a vital factor in producing income in the business in which the company was engaged. In the early period of the partnership the company's capital position and bonding capacity were limited so that the company was unable to bond and bid large-scale contracts submitted for competitive bidding. By virtue of retaining earnings in the business the company has increased its capital position and bonding capacity so as to enable it to bond, bid, and perform similar large-scale contracts. Due to retention of earnings the company has increased its liquid capital position so that its bonding capacity has increased over the period 1955 to 1961 from approximately $1,000,000 in 1955 to approximately $6,000,000 in 1961, making possible a proportionate increase in the volume of work which can be performed by the company. In 1958 the company was able to secure a bond and therefore able to bid on the contract for the Clark County Courthouse with a contract price exceeding $3,000,000. The company did not have the capital *165 to bid a job of that magnitude in 1955, 1956, or 1957. Annual distributions of earnings to the partners would have limited the volume of work which it could perform; might have prevented the company from entering into or performing large construction contracts; and could have prevented the company from withstanding emergency situations that arose in the course of its operations. Tiberti indicated to a representative of the bonding company that withdrawals by the trusts would not be substantial. During the years 1955 to 1960 Tiberti received the following salaries: YearSalary1955$15,000195615,000195725,000195815,000195930,000196030,000 The decisions as to basic salary of the managing partner, and whether or not business warranted additional salary or bonuses, were made by all of the partners and were based upon services performed by the petitioner and the volume and profits of the business. The payment of a base amount of salary with additional amounts, if any, dependent upon volume and profits is a normal method of compensating managers in the industry. The amounts allocated to petitioner as salary were comparable to compensation paid for the performance of similar services in that *166 area in the industry. The following withdrawals were made by Tiberti from the J. A. Tiberti Construction Company: 19551956195719581959$ 3,000.00$ 1,105.15$ 5,801.08$14,716.77$14,807.3519,882.682,250.0012,430.0810,000.002,500.002,250.006,953.662,500.002,250.002,646.458,795.842,000.006,477.7325,946.825,451.25$36,678.52$47,730.95$18,231.16$34,316.88$14,807.35 Salary and capital distributions were credited to Tiberti's account at the end of each year. The partnership was indebted to petitioner at the end of 1955 in the amount of $7,664.67. Petitioner was indebted to the partnership at the end of 1956 and 1957 in the respective amounts of $18,719.49 and $34,981.18. These latter amounts were reflected on the books and partnership returns as receivables due from the petitioner. At all times the liability of petitioner to the partnership was substantially less than the balance of his capital account. This liability was reduced in each of the years 1958, 1959, and 1960. Petitioner borrowed from the partnership to purchase land and construct a residence to replace the small tract house in which the family lived at that time. Prior to such withdrawals petitioner consulted the trustee partners, *167 who agreed that the family needs required a new residence and to the borrowing of such amounts from the partnership rather than from the bank. No interest was paid by Tiberti on the loans. Distributions from capital accounts were made equally to each of the partners, and the balance in each partner's capital account was equal at the end of each partnership year. During the years in issue distributions were made to the trusts for the purpose of paying income taxes. In 1960 a $5,000 cash distribution was made to each of the four trusts. These amounts were deposited in savings accounts for the trusts, and the passbooks are in the possession of the trustee. Trust assets were never used for the support of petitioners' children. Cash distributions were not made to the trusts in other years because of the capital requirements of the business. Opinion Petitioners created four trusts for their minor children. Under trust agreements dated January 1, 1955, each of the trusts received a one-fifth interest in the assets of Tiberti's construction business, theretofore operated as a sole proprietorship. The remaining one-fifth interest was retained by Tiberti. All of the assets were contributed to *168 a partnership which thereafter operated the business. The sole question for our determination is whether trusts created by petitioners for their minor children owned capital interests in a bona fide partnership in which capital was a material income-producing factor so that distributable shares of partnership income were properly includible in the gross income of each of four trusts. Section 704(e)(1) and ( 2), Internal Revenue Code of 1954, provides as follows: SEC. 704. PARTNER'S DISTRIBUTIVE SHARE. * * *(e) Family Partnerships. - (1) Recognition of Interest Created by Purchase or Gift. - A person shall be recognized as a partner for purposes of this subtitle if he owns a capital interest in a partnership in which capital is a material income-producing factor, whether or not such interest was derived by purchase or gift from any other person. (2) Distributive Share of Donee Includible in Gross Income. - In the case of any partnership interest created by gift, the distributive share of the donee under the partnership agreement shall be includible in his gross income, except to the extent that such share is determined without allowance of reasonable compensation for services rendered *169 to the partnership by the donor, and except to the extent that the portion of such share attributable to donated capital is proportionately greater than the share of the donor attributable to the donor's capital. The distributive share of a partner in the earnings of the partnership shall not be diminished because of absence due to military service. Paragraphs (1) and (2) of section 704(e) were enacted as a part of the Revenue Act of 1951. Section 340(a), Revenue Act of 1951, amended section 3797(a)(2), Internal Revenue Code of 1939, by adding thereto the following sentence: A person shall be recognized as a partner for income tax purposes if he owns a capital interest in a partnership in which capital is a material income-producing factor, whether or not such interest was derived by purchase or gift from any other person. Section 340(b), Revenue Act of 1951, amended supplement F of chapter 1 by adding at the end thereof a new section, in part, as follows: SEC. 191. FAMILY PARTNERSHIPS. In the case of any partnership interest created by gift, the distributive share of the donee under the partnership agreement shall be includible in his gross income, * * *. This legislation was enacted *170 to make it clear that "where there is a real transfer of ownership, a gift of a family partnership interest is to be respected for tax purposes without regard to the motives which actuated the transfer." 1 Accordingly, our inquiry is directed to the question whether there was in the instant case a completed gift of income-producing property effective to shift to the donees the tax incidence of the income thereafter derived from the property. Cf. Blair v. Commissioner, 300 U.S. 5">300 U.S. 5. As the regulations indicate, where there is a family relationship close scrutiny must be given the facts of the case to make sure that dominion and control of the partnership interests actually are fixed in the transferees. 2*171 We have examined carefully the trust and partnership agreements, the actions of the trustees here involved, the representations made to people with whom the purported partnership did business, and the purported partnership's record of earnings accumulation and distribution. The trust and partnership instruments are set out in full in the findings of fact. Under the agreements, Tiberti, as the managing partner, retained wide powers to operate the business, including discretion to retain profits. The trust instruments provide that the managing partner's decisions regarding the retention of earnings are to be respected only "so long as * * * [the trustees] deem it in the best interest of the trust, * * *" but contain the further provision that "In the event any conflict arises between the duties imposed by law upon the Trustees in their capacities as Trustees, and the duties imposed by law or otherwise upon the Trustees in their capacities as Managers of the business, the latter shall control." Of themselves, however, these and other provisions giving Tiberti extensive authority are not conclusive, for partnership affairs frequently are conducted by a managing partner who has such authority. Theodore D. Stern, 15 T.C. 521">15 T.C. 521. Very similar provisions were employed in Henry S. Reddig, 30 T.C. 1382">30 T.C. 1382, relied *172 upon by respondent, wherein this Court held the partnership was not to be recognized for income tax purposes. There are significant differences between Reddig and the instant controversy, however. For example, while a withdrawing partner in either case would receive only the book value of his capital account without allowance for intangibles unless there were a termination of the partnership, the trustees could force termination of the partnership in the instant case, whereas the grantors alone had sufficient control to do so in Reddig. In Reddig, moreover, withdrawals of funds by the grantors exceeded their capital accounts. Tiberti never withdrew amounts in excess of his capital account. Any withdrawals by him in excess of salary and regular partnership distributions were treated as amounts due the partnership and were repaid by Tiberti year by year in whole or in part. While Tiberti controlled the day-to-day management of the business, it appears from all of the facts that the trustees actively pursued their fiduciary obligations and took part in the making of significant decisions with respect to the partnership. A contrary conclusion was reached in Reddig. Don R. Beagle had *173 been employed by Tiberti for about two or three years when he became a trustee. He continued in the employ of the partnership. Undoubtedly he was responsible to Tiberti for his job, his promotions, and his salary. Nevertheless, he was familiar with the business; his actions as trustee reflected his best judgment asserted in a constructive fashion; and we do not find that he was subject to Tiberti's will. E. W. Cragin was the other contrustee until his death. His successor was appointed by a Nevada District Court. Cragin was a man of substantial means and business experience. Although he received commissions from Tiberti and the partnership as the result of his acting as agent for a bonding company, he was not, in fact, amenable to petitioner's control. We are satisfied that the trustees acted with independent judgment in their participation in the business. They are not to be regarded as mere tools of the petitioner. Thus, unlike Reddig, the power in the trustees to make payments to persons with whom the beneficiaries reside does not destroy the bona fides of the gifts or partnership arrangement. 3Respondent's suggestion that continued *174 investment of all of the trust assets in the construction business is evidence that the trustees were subject to control by Tiberti is without merit. While the business had an element of risk, it was profitable. The trustees watched it carefully, successfully advising Tiberti against certain projects they considered unwise. Similarly, their agreement to the retention of earnings by the partnership was based not on subjection to Tiberti's will but on the fact that retained earnings were essential to the growth of the business. All of the evidence detailed in our findings of fact indicates that the existence of the partnership was widely known and that third parties took cognizance of the partnership in their dealings with it. Even if petitioners' primary purpose in creating the trusts and forming the partnership was to reduce their taxes - a finding which we do not make - that purpose would not, in the face of a bona fide gift, make the entire income of the partnership taxable to them. 4*175 To be recognized as partners, the trusts must own a capital interest in a partnership in which capital is a material income-producing factor. 5 Respondent argues that capital was not a material income-producing factor in the business and that the success of the business is attributable almost entirely to the efforts of Tiberti. Tiberti. Tiberti did play the principal role in operating the company. Perhaps his efforts were indispensable to its continued success. Nevertheless, as the Regulations indicate, "the determination as to whether capital is a material income-producing factor must be made by reference to all the facts of each case." 6The record amply demonstrates that this company was engaged primarily in bidding and operating as a general contractor on local, county, state, and Federal projects. In order to bid on such contracts, a construction company must have both "bid" and "performance" bonds. Its ability to bid on a contract is directly dependent upon the size of the bond which it is able to obtain. In order to *176 increase its bonding capacity, and thereby be able to bid on larger jobs, the company retained earnings. By virtue of retained earnings, the bonding capacity increased over the period 1955 to 1961 from about $1,000,000 in 1955 to approximately $6,000,000 in 1961. A rule of thumb used by bonding companies is that a contractor must maintain capital in readily negotiable form equal to at least 10 percent of the contractor's total work on hand. Moreover, it appears that a general contractor often has 10 percent of the amounts due it retained by the party letting the contract, whereas the general contractor often must make payments, without any comparable retention, to subcontractors who have a weaker capital position; and, almost inevitably, a contractor must be in a position to survive emergency situations and to make weekly payments for labor and supplies, regardless of payments received. For all of these reasons, we think it is abundantly clear that capital was a material income-producing factor in this business. Cf. Walberg v. Smyth, 142 F. Supp. 293">142 F. Supp. 293 (N.D. Cal., 1956). Respondent argues that even if the gifts were complete and capital was a material income-producing factor, the amount *177 of the gifts is limited by the values set out in the balance sheet attached to the trust and partnership agreements and disclosed in the gift tax return filed by petitioners. We cannot agree. The trust instruments provide for assignment to each child of a one-fifth interest in the business assets, and we are convinced that petitioners' intention was to convey a one-fifth interest in the entire business to each trust. Values assigned the assets on the gift tax return are not material herein. Nor do we find any reason to adjust the amounts includible in the incomes of the trusts by reason of salaries paid to Tiberti. Section 704(e)(2) provides that "the distributive share of the donee under the partnership agreement shall be includible in his gross income, except to the extent that such share is determined without allowance of reasonable compensation for services rendered to the partnership by the donor, * * *." The partnership agreement provided that Tiberti was to receive a salary of $15,000 per year. In fact, he received more than that in some years when, on the basis of his services and of the profits of the business, all of the partners deemed a greater amount appropriate. Tiberti's *178 salary was comparable to salaries paid persons in similar positions in other companies in the same business in the Las Vegas area. We find that the trusts created by petitioners for their minor children owned capital interests in a bona fide partnership in which capital was a material income-producing factor, and hold that the distributable shares of partnership income were properly includible in the gross incomes of the trusts. Jack Smith, 32 T.C. 1261">32 T.C. 1261; Thomas H. Brodhead, 18 T.C. 726">18 T.C. 726, affd. 210 F. 2d 652 (C.A. 9, 1954). Decision will be entered for the petitioners. Footnotes*. Amount held back for Tiberti's 1954 tax liability.↩1. H. Rept. 586, 82d Cong., 1st Sess., pp. 32, 33-34 (1951), 2 C.B. 357">1951-2 C.B. 357↩, 380-381.2. Sec. 1.704-1(e)(1)(iii), Income Tax Regs.Section 1.704(e)(1)(i) through (iv) set out the applicable regulations with respect to recognition of the donee as a partner, requirement of capital transfer to the donee, and the necessity that capital be a material income-producing factor.3. See section 1.704-1(e)(2)(vii), Income Tax Regs.↩4. See footnote 2. In fact, it does not appear that tax considerations motivated the transactions. Tiberti was one of nine children and had been taken into his father's business as a boy. He testified that he wished to make a similar arrangement for his own children.5. Section 704(e)(1), Internal Revenue Code of 1954↩. 6. Section 1.704-1(e)(1)(iv), Income Tax Regs.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624897/ | W. H. B. Simpson and Katherine M. Simpson, Petitioners, v. Commissioner of Internal Revenue, RespondentSimpson v. CommissionerDocket Nos. 1245-63, 2169-63United States Tax Court43 T.C. 900; 1965 U.S. Tax Ct. LEXIS 108; March 30, 1965, Filed March 30, 1965, Filed *108 Decisions will be entered under Rule 50. Petitioner transferred the assets of two retail dry goods businesses and stock and securities having a fair market value considerably in excess of petitioner's basis therein to a newly formed corporation solely in exchange for stock of the corporation which petitioner controlled immediately after the exchange. As a part of the consideration for the exchange the corporation assumed liabilities, of petitioner's, or received property subject to petitioner's liabilities totaling in amount slightly less than petitioner's basis in the properties transferred in exchange. Held: Petitioner's principal purpose with respect to the assumption by the corporation of the liabilities, and with respect to the acquisition by the corporation of properties subject to liabilities, was not to avoid income tax on the exchange and was a bona fide business purpose. Section 357(b), I.R.C. 1954, is not applicable and no gain or loss is to be recognized to petitioner on the transactions under section 351, I.R.C. 1954. Joseph E. McAndrews and Thomas A. Frazier, Jr., for the petitioners.Winfield A. Gartner, for the respondent. Drennen, Judge. DRENNEN*900 In these consolidated proceedings respondent determined deficiencies in petitioners' income tax for the taxable years 1958 and 1959 in the respective amounts of $ 233,532.55 and $ 231,899.97.The only issue for decision is whether petitioners realized long-term capital gain in the amount of $ 908,697.95 1 upon the transfer*112 of stocks, securities, and other property to Collins-Crain Co. (hereafter referred to as Collins-Crain) upon its incorporation in a transaction by which Collins-Crain issued 498 of its 500 shares of outstanding stock to petitioner W. H. B. Simpson and assumed liabilities to which the stocks, *901 securities, and other property were subject at the time of the transfer.Because of uncertainties as to when the transfers took place, respondent determined that petitioner W. H. B. Simpson realized a gain on the transaction in both the years 1958 and 1959, but concedes that the gain should be taxed in one year or the other but not both.FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Petitioners are husband and wife, residing in Greenville, S.C. They filed joint Federal income *113 tax returns for the taxable years 1958 and 1959 with the district director of internal revenue, Columbia, S.C. Hereafter, W. H. B. Simpson will be referred to as petitioner.Petitioner is a successful retailer with a substantial interest in the outstanding stock of 29 corporations comprising the Belk-Simpson department store chain which operates a number of department stores, principally in the Southeast. During the periods in issue, petitioner was an executive officer in, and received salaries, dividends, and director's fees in substantial amounts from, these corporations.At an early age petitioner became associated with W. H. Belk, Sr., the founder and owner of the Belk chain of department stores throughout the South. In 1929 petitioner was given the opportunity to purchase a Belk store which had been losing money, by assuming its indebtedness. Petitioner did so, and moved the store to Greenville, S.C., where he operated it under the name "Greenville Bargain House." The store was successful in Greenville under petitioner's management, and petitioner was given the further opportunity to open additional Belk stores and accept a minority stock interest in the corporations which*114 operated the stores. These stores became the Belk-Simpson chain.In 1932 petitioner incorporated the Greenville Bargain House, becoming the owner of over 80 percent of the stock of the corporation. W. H. Belk, Sr., later bought some of the stock of Greenville Bargain House, but petitioner remained the majority stockholder and controlled the policies of the corporation. Greenville Bargain House continued to be successful, and petitioner followed a policy of investing surplus funds of the corporation in stocks and securities (hereafter referred to collectively as securities). He considered that it was good business to have the funds of Greenville Bargain House invested in the stock of mills and other suppliers because it could buy merchandise from these suppliers at bargain prices which would not have been available to the corporation without owning stock in the suppliers. He also believed that it was important for the corporation to own marketable securities that could be used by the corporation as collateral to obtain bank loans when the corporation needed working capital or funds for expansion, without the personal endorsements of its stockholders. *902 He found that the*115 appreciation in value of the securities, plus dividends and interest received from them, generally exceeded interest charges on loans which were secured by the securities. Petitioner also considered that it was good business for Greenville Bargain House to purchase stock of banks with which it dealt in borrowing money.Petitioner also felt that it was advisable for the Belk-Simpson stores, in which he held a minority interest, to purchase securities with excess funds. W. H. Belk, Sr., concurred in petitioner's views and, during the lifetime of W. H. Belk, Sr., this policy of investing funds in the stocks of banks, suppliers, and other corporations was followed by the Belk-Simpson corporations.During 1954 Greenville Bargain House purchased five branch stores at a cost of over $ 730,000. Despite the fact that the corporation then owned securities having a total cost of over $ 600,000 and a market value in excess of that amount, these branch store purchases were financed with borrowed funds, the securities owned by the corporation being used as collateral for the loans.As of December 31, 1954, Greenville Bargain House was merged into and with the Belk-Simpson Co. of Greenville, *116 S.C. (hereafter referred to as Belk-Simpson, Greenville), and petitioner became a substantial, although minority, stockholder in the surviving corporation. At this time much of the net worth of Greenville Bargain House was reflected in the securities owned by it, and their market value made the merger attractive to the Belk interests.From the time he first began in business petitioner made it a practice to invest his own funds in securities, not only of the Belk-Simpson corporations but also of local corporations with which he was familiar, as well as publicly held corporations. He often purchased securities with borrowed funds, and he borrowed money from various banks throughout North Carolina, South Carolina, Georgia, and Florida to finance his purchases. Also, he often used securities which he owned as collateral for loans, the proceeds of which he used for loans to Belk-Simpson corporations for working capital. Petitioner was quite successful in his choice of investments.In February 1952, petitioner's longtime associate, W. H. Belk, Sr., died. His interests in the Belk-Simpson corporations were inherited by his surviving widow and his six children, one of whom was W. H. *117 Belk, Jr., who became president of most of the Belk corporations. Personality and policy differences arose among the Belk children and Belk, Jr., was gradually removed from the presidency of many of the Belk corporations. Petitioner, realizing that he was not a controlling stockholder in any of the Belk-Simpson corporations, became somewhat apprehensive about his own position in these companies and *903 particularly about the influence he could exert on management policies of the corporations.By 1956 serious differences among the directors of Belk-Simpson, Greenville, developed, particularly in regard to financial matters. Petitioner urged that the corporation continue to follow the policy of borrowing funds to meet corporate needs, using the stocks and securities owned by it as collateral for the loans. However, a majority of the directors disagreed and at a meeting on May 7, 1956, adopted a resolution empowering and directing the officers of Belk-Simpson, Greenville, "to sell, for fair market value, all of the stocks and securities or real estate owned by this corporation, which are not related to the principal business of the corporation, namely the mercantile business, *118 said sale and liquidation to be accomplished in an orderly manner so as not to sacrifice said securities or depress the market price." At this meeting of the board, the directors voted on three motions; petitioner's vote was in the minority on each.Petitioner did not comply literally with this action of the directors and at the annual meeting of the stockholders of Belk-Simpson, Greenville, in 1957, petitioner pointed out that had he complied literally with such resolutions adopted in the past by the directors, the financial stability of the corporation would have been endangered and a loss of $ 100,000 would have been sustained on the sale of one particular block of stock. But despite this statement, the disagreement over the financial policies of the company persisted and the corporate bylaws were amended to reserve to the stockholders control of the purchase and sale of stocks and securities by the corporation.Petitioner, finding himself in disagreement with the majority of the directors of the Belk-Simpson corporations, decided to enter a business which would be independent of the Belk interests. He had a substantial net worth at the time, with his principal assets being stocks*119 and securities, and this net worth made feasible his investment in a business without the necessity of seeking financing from the Belk interests. Petitioner felt he should enter the retail dry goods business since he was experienced in this business, and he anticipated that he could make a success of a business which he independently controlled, as he had the Greenville Bargain House prior to its merger, when he relinquished control.Petitioner was well aware that most of the dividends he received from his stocks were includable in his gross income, subject to tax at high rates as ordinary income. He also knew that dividends received by a corporation were includable in its income only to the extent of 15 percent because of the dividends-received credit available to a corporation, and he was aware of corporate income tax rates.*904 In 1957 petitioner consulted a lawyer in Greenville, S.C., named Dobson, who specialized in tax matters, about forming a corporation which petitioner would control to enter the retail dry goods business. Petitioner knew that Dobson was well acquainted and thought he might know of a business which petitioner might acquire. Petitioner also discussed*120 with Dobson the feasibility of transferring some of the securities he owned to such a corporation to be used as working capital and for possible future expansion.Dobson considered the income tax effects of petitioner's transfer of stocks and securities to a corporation which would be controlled by petitioner immediately after the transfer. Dobson concluded that petitioner could transfer properties, including securities, to a new corporation in exchange for its stock in a transaction that would qualify as a tax-free exchange under section 351, I.R.C. 1954, 2 and he also concluded that there were several tax advantages to be gained by petitioner's transferring securities to the new corporation. He also realized that if the corporation received a large amount of dividend income it might be subjected to the accumulated earnings tax under section 531 unless its earnings were distributed, and that it might qualify as a personal holding company under section 542 unless its gross income from other sources was substantial. He concluded that the latter problem would be solved if the corporation's income from the mercantile business was sufficient. With reference to the first problem, *121 Dobson concluded that if it could be arranged for the corporation to have liabilities, from the date of incorporation, which would be discharged out of its net earnings, it would be insulated from the accumulated earnings tax for a while. Inasmuch as a large part of the securities owned by petitioner at the time were pledged as collateral for bank loans to petitioner and as security for petitioner's margin accounts with stockbrokers, Dobson felt that a transfer of these securities to the corporation, with the corporation assuming the indebtedness, would be a solution to this problem.But Dobson's proposed solution raised another problem: If petitioner transferred his stocks and securities in the newly formed corporation in exchange for stock and assumption of the liabilities, care would have to be taken that the liabilities assumed did not exceed petitioner's basis in the assets transferred to the corporation, since Dobson*122 was aware that any excess of such liabilities over petitioner's basis would give rise to recognition of gain to petitioner by virtue of the provisions of section 357(c). Dobson gave no consideration to the provisions of section 357(b).Dobson's consideration of the problems extended over a period of time. He requested that petitioner give him a net worth statement *905 and a list of petitioner's securities which he could study prior to advising petitioner what securities should be transferred to the new corporation. Petitioner told him that he did not want to transfer worthless or low-yield stocks to the corporation because that would defeat his purpose of providing the new corporation with income-producing stocks that could be used to produce working capital and finance future expansion.Petitioner retained a firm of certified public accountants to prepare his Federal income tax returns and he requested this firm to prepare a net worth statement for him together with a list of his securities and their bases and fair market values. This information was given to Dobson in early 1958. At no time did petitioner discuss with his accountants any methods for the minimization of*123 income taxes, and he did not consult with them as to the formation of a controlled corporation.The net worth statement prepared by petitioner's accountant as of November 30, 1957, reflected petitioner's net worth as follows:AssetsCurrent assets:Cash in hands [sic]$ 55,976.67Loans receivable (payable on demand)41,859.68Marketable securities -- predominantly thoselisted on stock exchange -- valued atmarket value2,260,077.89Marketable securities held by stockholderson margin accounts521,667.75Stock in various Belk-Simpson stores (bookvalue at Dec. 31, 1956)1,378,040.20Total current assets$ 4,257,622.19Real estate94,445.00Automobiles20,000.00Total assets4,372,067.19Liabilities and Net WorthCurrent liabilities:Due to stockbrokers (secured bysecurities above)$ 289,780.24Due to various banks -- payable on demand(secured by stocks)1,234,780.02Due to relatives and Belk-Simpson stores(payable on demand)253,349.67Estimated income taxes50,000.00Total liabilities$ 1,827,909.93Net worth2,544,157.264,372,067.19Note: Contingent liabilities on which there*124 is a liability as endorser of various notes amount to approximately $ 1,500,000.*906 Petitioner's net worth, except for about $ 30,000-$ 40,000 which he inherited, had been built up from his earnings, dividends, and gains on investments.Of the approximately $ 2,780,000 in market value of marketable securities owned by petitioner, approximately $ 520,000 in value were held by stockbrokers in margin accounts securing liabilities of approximately $ 290,000. All or most of the remainder of these securities were pledged as collateral to secure petitioner's bank loans totaling approximately $ 1,235,000.On or about this time petitioner and Dobson began looking for a retail dry goods business which petitioner could purchase. After looking at several businesses, which were not suitable for one reason or another, they contacted Roy E. Collins, Jr., who, together with his mother and father, owned the stock of Bailes-Collins Co., a corporation operating a department store in Greer, S.C. Collins, Sr., was also a stockholder with Hugh T. Crain in Bailes-Collins & Crain Co., a corporation operating a department store in Inman, S.C.Dobson and petitioner began negotiations with Collins, *125 Jr., and with Crain for the purchase of the stock of the two corporations with the idea that petitioner's newly formed corporation would operate the two department stores, with Collins, Jr., and Crain as the managers thereof. By an agreement dated October 21, 1958, petitioner agreed to purchase the stock of Bailes-Collins Co. and of Bailes-Collins & Crain Co., at a cost reflecting book value of the stock, with certain adjustments. Petitioner agreed to liquidate the corporations after purchase and to transfer the assets of the corporations to a new corporation to be known as Collins-Crain Co. to be formed by petitioner. Collins-Crain was to operate the two department stores and to employ Collins and Crain as managers at stipulated salaries, plus percentage bonuses. Collins-Crain was to operate the stores "promptly after January 1, 1959." Dobson was made a party to the agreement and agreed to act as petitioner's agent in purchasing the stock and liquidating the corporations. Collins was particularly anxious to become associated in business with petitioner because he considered sufficient working capital to be important to a department store business and he knew that petitioner's*126 net worth would permit him to supply necessary capital for the business. Petitioner was glad to obtain the services of Collins because he considered that Collins was young, aggressive, and able.Dobson was to act as petitioner's agent in the transactions and as petitioner's nominee in holding the stock of the new corporation because petitioner did not want it known that he was entering into a business which might be competitive with stores owned by the Belk interests.*907 Collins-Crain Co. was incorporated under the laws of South Carolina on October 29, 1958, with an authorized capital stock of $ 100,000 represented by 1,000 shares of $ 100 par value stock. Except for one qualifying share, the stock of Collins-Crain was initially issued in the name of Dobson.On November 19, 1958, petitioner transferred to Collins-Crain securities pledged to the Citizens & Southern National Bank of Greenville to secure a liability of petitioner to that bank having a balance then due of $ 330,069.74. Petitioner's total basis in these securities was $ 330,804.90, but the total fair market value thereof on the date of transfer was $ 911,769.11. Other securities owned by petitioner and pledged*127 to secure this loan were not transferred to Collins-Crain and were also removed as collateral for the loan. Collins-Crain assumed payment of the liability to the bank. The loan policy of this bank at this time was to loan up to 60 percent of the fair market value of listed securities and up to 50 percent of the fair market value of unlisted securities. This indebtedness, originally in the amount of $ 336,000 was evidenced by a demand note executed by petitioner bearing interest at 4 1/2 percent, and had been incurred by petitioner in December 1957. The proceeds of the loan had been used by petitioner to repay loans and interest to banks, brokers, and others, to loan money to a Belk-Simpson store and others, and to purchase securities and pay other obligations of petitioner.As of November 26, 1958, petitioner was indebted to the South Carolina National Bank on two loans, one in the amount of $ 220,000 and the other in the amount of $ 80,000, both of which were secured by securities owned by petitioner and pledged as collateral for the loans. The $ 220,000 was the balance due on a loan of $ 230,000 made by the bank to petitioner on August 18, 1955, evidenced by a demand note executed*128 by petitioner bearing interest at the rate of 3 3/4 percent, the proceeds of which were used primarily to repay loans and interest to banks, Belk corporations, and others, and to purchase securities and make payments on his margin accounts.On November 26, 1958, petitioner transferred to Collins-Crain securities pledged to the South Carolina National Bank as collateral for the loan in the amount of $ 220,000 in which petitioner had a basis of $ 220,168.28 but which had a fair market value as of that date of $ 422,092.23, and Collins-Crain assumed payment of petitioner's liability to the bank in the amount of $ 220,000. The securities transferred remained pledged as collateral for the indebtedness, but other securities which had been pledged to secure this loan and the $ 80,000 loan were not transferred to Collins-Crain, and the corporation did not assume the $ 80,000 liability to the bank. In determining just which securities were to be transferred it was necessary for petitioner, with *908 the advice of Dobson, to rearrange the collateral securing the two loans. The securities which were removed as collateral for the $ 220,000 debt were pledged as additional collateral for*129 the $ 80,000 debt, and were also hypothecated by petitioner as collateral for the $ 220,000 debt.In December 1958, petitioner maintained three accounts with Thomson & McKimon, stockbrokers; a margin account, a special subscription account, and an investment account. On December 19, 1958, as the result of certain transfers among the several accounts, the total indebtedness due from petitioner on the margin account and the special subscription account was $ 197,512.18, against which were pledged various securities owned by petitioner, having a basis in petitioner's hands of $ 198,553.47 and a fair market value on that date of $ 383,933.74. On December 19, 1958, petitioner transferred those securities to Collins-Crain subject to the liability and Collins-Crain assumed payment of the indebtedness in the amount of $ 197,512.18. As of December 31, 1958, as the result of the various debits and credits to and between the various accounts and as a result of the transfer, petitioner's margin and subscription accounts had zero balances, any excess in these accounts over the margin requirements having been transferred to petitioner's investment account.As a result of the three transfers *130 last above mentioned, Collins-Crain received from petitioner securities having a total fair market value on the dates of transfer of $ 1,717,795.08 but which had an aggregate basis in petitioner's hands of $ 749,526.65, and assumed liabilities for which these securities were pledged as collateral in the aggregate amount of $ 747,581.92.In November 1958, the total cost basis and fair market value of petitioner's securities, including those subject to liabilities and those free of liabilities, were such that petitioner could have sold securities (other than stock of Belk and Belk-Simpson corporations, and other than Seaboard Airline RR. Co. stock in which petitioner had large unrealized gains) for $ 866,540.34; realized a capital loss for tax purposes in the amount of $ 1,665.55; paid off all liabilities to which his securities were subject; and still have transferred to Collins-Crain securities having a fair market value of $ 1,195,988.10, free of all liabilities.On January 1, 1959, Dobson, as agent for petitioner, purchased the stock of Bailes-Collins Co. for a total of $ 136,049.67, payable $ 27,209.94 upon execution of the agreement with the balance payable in four yearly installments*131 represented by notes in the amounts of $ 27,209.93, $ 27,209.93, $ 27,209.93, and $ 27,209.94, due January 1, 1960, 1961, 1962, and 1963, respectively.Also on January 1, 1959, Dobson, as agent for petitioner, purchased the stock of Bailes-Collins & Crain Co. for $ 114,426.95, payable $ 22,885.39 upon execution of the contract with the balance payable *909 in four yearly installments represented by notes, each in the amount of $ 22,885.39, due January 1, 1960, 1961, 1962, and 1963.Thereupon, as of January 1, 1959, the two corporations were liquidated. Thereafter the assets and liabilities of the two corporations, except as hereinafter noted, were transferred by petitioner to Collins-Crain.The total purchase price of the stock of the two corporations was $ 250,476.62. The two downpayments, totaling $ 50,095.33, were satisfied by petitioner from assets received by him upon the liquidation of the two corporations, being a note receivable due from the seller-stockholder in the amount of $ 28,750 which was canceled, an account receivable in the amount of $ 600 which was assigned to the seller-stockholder, and cash on hand in the purchased corporations in the amount of $ 20,745.33. *132 The balance of the purchase price, in the amount of $ 200,381.29, was paid as follows: Notes dated January 1, 1959, in the face amount of $ 50,095.33, bearing interest at 5 percent, due January 1, 1963, were executed by petitioner and Dobson and issued to the sellers; notes in the aggregate amounts of $ 150,285.98, also dated January 1, 1959, and due January 1, 1960, through January 1, 1963, with interest at 5 percent, were executed by Collins-Crain and issued to the sellers. This liability of $ 150,285.98 3 was carried as a liability on the books of Collins-Crain.On January 1, 1959, Bailes-Collins Co. and Bailes-Collins & Crain Co. had total cash on hand in the amount of $ 101,315.66. Of this total, the amount of $ 20,745.33 was disbursed to selling stockholders as noted above; the amount of $ 31,421.07 was used to discharge certain liabilities of the acquired corporations; the amount of *133 $ 39,000 was transferred to Collins-Crain; and the amount of $ 10,149.26 was retained by Dobson and subsequently disposed of by order of a local court. All other assets of the acquired corporations were transferred to Collins-Crain and used in operation of the two department stores.The basis of the total assets of the acquired corporations transferred to Collins-Crain was $ 211,211.34, computed as follows: 4Petitioner's basis of stock purchased$ 250,476.62Liabilities assumed on liquidation:Amount retained by Dobson to cover liabilities10,436.57Accrued payroll taxes393.48261,306.67Less: Cash and assets not transferred50,095.33211,211.34*910 At the conclusion*134 of all of the above transfers, petitioner had transferred to Collins-Crain assets (including the securities and the assets of the two liquidated corporations) having an aggregate basis in his hands of $ 960,737.99 (from above figures); and Collins-Crain had assumed liabilities totaling $ 908,697.95 ($ 747,581.92 due to the banks and the broker, $ 150,285.98 due on the notes to the former owners of the two corporations, and $ 10,830.05 due on the liabilities of the two stores).Journal entries were made to record the foregoing transfers of stocks, cash, and assets to Collins-Crain. The stocks and other assets were shown on the books of Collins-Crain at their bases to petitioner. Liabilities assumed, including the notes to the sellers of stock of the two acquired corporations, were recorded. The excess of basis of property, plus cash, over liabilities was credited to capital stock and to capital surplus.On January 1, 1959, 450 shares of stock of Collins-Crain were issued to Dobson, and all but 1 of the shares previously issued to Dobson were canceled. The remaining two outstanding shares were transferred to Roy E. Collins, Jr., and Hugh T. Crain.On January 7, 1959, 249 shares *135 of stock of the Collins-Crain Co. were issued to Dobson, trustee for Katherine McArver Simpson and Mary Elizabeth Simpson, and on the same date, 249 shares of the stock of the Collins-Crain Co. were issued to Dobson, trustee for Katherine McArver Simpson and Lucy B. Simpson. On the same date the 450 shares previously issued to Dobson were canceled. As of January 7, 1959, there were 500 shares of stock of Collins-Crain Co. outstanding, each of which was stated to have a par value of $ 100; and 498 of such shares were issued in the name of Dobson, trustee, and 1 share each was held by Roy E. Collins, Jr., and Hugh T. Crain.At some date shortly before October 1960 petitioner discovered for the first time that Dobson had caused 498 shares of Collins-Crain stock to be issued in his name as trustee. On October 28, 1960, petitioner filed complaints in the County Court, Greenville County, S.C., against Dobson individually and as trustee, seeking to have the alleged trusts declared null and void. An officer of the County Court conducted a hearing in the matter, at which time both Dobson and petitioner, who did not object to Dobson's testimony on the grounds of privileged communication *136 of client-attorney relationship, testified extensively as to petitioner's motives, including those relating to Federal tax minimization, for forming Collins-Crain. In May 1961 the County Court held the purported trusts null and void ab initio. Petitioner became president of Collins-Crain upon termination of the litigation.Following petitioner's litigation with Dobson, the Belk heirs discovered petitioner's interest in Collins-Crain, which was operating the *911 stores in Greer and Inman. They considered petitioner's interest to be in conflict with that of the Belk-Simpson chain, and the Belk children demanded that he either divest himself of an interest in competing stores or resign as an officer and director of the Belk-Simpson stores. He finally acceded to their demands and, on February 13, 1962, he entered into an agreement with five of the Belk children in which he agreed that, so long as he remained a director or officer in any of the Belk corporations, he would not participate (as a stockholder, director, officer, or otherwise) in the ownership or operation of any mercantile store, wholesale or retail, without the prior written consent of a majority of the Belk *137 children. He also agreed to dispose of any interest in such a competing mercantile store by July 1, 1962.Pursuant to the agreement, petitioner caused Collins-Crain to sell the Greer store to Collins and the Inman store to Crain.Petitioner obtained the consent of the Belk heirs to have Collins-Crain purchase a wholesale candy and notions business.Petitioner resigned as an officer and director of the Belk and Belk-Simpson corporations in about May 1963.From 1959 to the date of trial, Collins-Crain has been actively engaged in business, first the operation of the Greer and Inman stores and later the wholesale candy and notions business. Collins is presently a stockholder and officer in the corporation and, from 1959 to the present, petitioner and Collins have actively investigated department stores in West Virginia, Tennessee, North Carolina, South Carolina, New York, and Michigan which the corporation might purchase. However, none of the businesses investigated were purchased by Collins-Crain. Petitioner did open a department store in Murphy, N.C., but this store was owned and operated by a separate corporation of which petitioner individually owned a major portion of the outstanding*138 stock. While Collins-Crain did not own any of the stock of the Murphy corporation, the store opened by that corporation was largely financed with loans from Collins-Crain. Both Collins and petitioner are hopeful that the business of the corporation can be expanded.The name of Collins-Crain was changed to Simpson Enterprises, Inc., on December 17, 1962.The corporation reported net income as follows for the taxable years (ended September 30) 1959-63:Taxable yearNet income 11959$ 25,662.54 196066,455.72 196129,314.37 1962(92,590.24)1963(36,155.94)*912 Collins-Crain owned securities as follows at September 30, 1959-63:SecuritiesAt yearend(at cost)1959$ 690,789.351960734,129.211961741,513.461962789,568.311963904,353.91Collins-Crain had liabilities (other than accounts payable and accrued expenses) as follows at September 30, 1959-63:At yearendLiabilities1959$ 777,274.091960677,511.791961690,910.391962645,877.931963668,178.20Prior to December 31, 1960, Collins-Crain had paid $ 125,069.74 on the indebtedness to the Citizens & Southern National*139 Bank and had discharged the $ 220,000 liability with the South Carolina National Bank, but the corporation, before December 31, 1960, had incurred new bank loans in the total amount of $ 225,000.ULTIMATE FINDINGSPetitioner's principal purpose with respect to the assumption of petitioner's liabilities by Collins-Crain and with respect to the acquisition by Collins-Crain of property from petitioner subject to liabilities, in the transactions involved, was not a purpose to avoid income tax on the exchange, and was a bona fide business purpose.OPINIONBeginning in November 1958 and concluding with the transactions on January 1, 1959, petitioner, by four successive transfers, transferred assets of two department stores and cash, which he had acquired on liquidation of the two corporations which operated the department stores, and securities, which he had owned individually, to Collins-Crain, a newly organized corporation. He received upon the exchanges 498 out of 500 shares of the issued and outstanding stock of Collins-Crain, 5 and the parties agree that the transactions *913 fall within the purview of section 351, 6 which provides that no gain is to be recognized upon the *140 transfer of property solely in exchange for stock, if the transferor is in control of the corporation immediately after the exchange.*141 While petitioner admittedly did not actually receive any "money or other property" on the exchange, Collins-Crain did assume certain liabilities of petitioner upon the exchange and acquired property of petitioner subject to other liabilities. Respondent has determined that these liabilities must be considered as money received by petitioner on the exchange and that petitioner's gain on the exchange is to be recognized to the extent thereof. Respondent's determination and his contention herein are based upon the provisions of section 3577 which provides rules which qualify the effect of section 351.*142 *914 In summary, section 357 provides the general rule that, upon an exchange governed by section 351, the assumption by the transferee-corporation of the transferor-stockholder's liabilities or the acquisition by the transferee-corporation of property subject to liabilities, shall not constitute "money or other property" -- that is, boot -- received by the transferor-stockholder on the exchange. Thus, generally, the incorporating stockholder, such as petitioner in the instant case, will not be deemed to have realized any recognizable gain on the exchange if he transfers appreciated property subject to liabilities to a controlled corporation, and if he receives nothing upon the exchange but stock of the corporation.Subsections 357 (b) and (c), however, provide exceptions to this general rule. Subsection (c) provides that in the case of an exchange to which section 351 applies if the sum of the liabilities assumed by the transferee, plus the liabilities to which the transferred property is subject, exceed the total adjusted basis of the property transferred, then such excess shall be considered as a gain realized and recognized on the exchange. Here it is clear that the transactions*143 were so arranged that the liabilities assumed and to which the transferred properties were subject were less than the transferor's basis in the properties transferred in the exchange, so subsection (c) is not applicable.But section 357(b)(1) provides that the corporation's assumption of the transferor's liabilities, or the acquisition by the corporation of property subject to liabilities, shall, for purposes of section 351, be considered as money received by the transferor-stockholder on the exchange, if it appears that the principal purpose of the "taxpayer" (the transferor), with respect to the assumption or acquisition by the corporation, was a purpose to avoid Federal income tax on the exchange, or if not such purpose, was not a bona fide business purpose. In determining the principal purpose of the taxpayer in such a situation, we are directed by the statutory provision to consider the nature of the liabilities and the circumstances in the light of which the arrangement for the assumption or acquisition was made. Furthermore, subsection (b)(2) provides that, in a situation such as the present one in which petitioner has the burden of proving that such assumption or acquisition*144 is not to be treated as money received by him, petitioner must sustain his burden by the clear preponderance of the evidence.We have previously had occasion to review the legislative purpose for the enactment of section 357, the predecessor provision of which in the 1939 Code was section 112(k). See F. W. Drybrough, 42 T.C. 1029">42 T.C. 1029 (1964), on appeal (C.A. 6, Mar. 9, 1965); Arthur L. Kniffen, 39 T.C. 553 (1962); Estate of John G. Stoll, 38 T.C. 223 (1962); Jack L. Easson, 33 T.C. 963 (1960), modified 294 F. 2d 653 (C.A. 9, 1961). *915 Of course, the statutory provisions pertaining to the present controversy -- both section 357 and section 351 -- are to be applied in the light of the legislative purpose which they are designed to serve. Griffiths v. Commissioner, 355">308 U.S. 355 (1939). But in view of our previous discussions of the legislative history of these provisions we need review it only briefly here.Section 357 was originally enacted to dispel problems arising from the decision of the Supreme*145 Court in United States v. Hendler, 303 U.S. 564">303 U.S. 564 (1938), rehearing denied 304 U.S. 588">304 U.S. 588 (1938), which suggested that, upon a tax-free exchange, the assumption by the transferee of the transferor's liabilities would constitute "money or other property" to the transferor with the result that, to the extent of such "money or other property," the transferor's gain upon the exchange would be recognized and subjected to tax. Congress intended to nullify the effects of the Hendler decision with respect to bona fide transactions and consequently enacted the predecessor of section 357 to permit nonrecognition of gain in bona fide transactions of this kind even though the transferee-corporation assumed liabilities of the transferor. Section 357 (and its predecessor, sec. 112(k), 1939 Code) provided primarily that the assumption of liabilities by the transferor in a section 351 exchange would not be considered as money or other property and would not make section 351 inapplicable to the transaction. However, it was realized that taxpayers might take advantage of this provision to gain unintended tax benefits, so exceptions were*146 written into these sections to provide that if the principal purpose of having the transferee-corporation assume the liabilities on the exchange was to avoid tax, or was not a bona fide business purpose, the liabilities assumed would be considered as money received or "boot" under sections 112(c), I.R.C. 1939, and 351(b).It requires a careful analysis of the entire statutory scheme to understand just how section 357(c) operates in this context, but such an analysis indicates that it was designed to make certain that the excess of the liabilities assumed over the transferor's basis will be gain recognized on the exchange regardless of the transferor's purpose in having the liabilities assumed. See example illustrating the application of section 357(c) in S. Rept. No. 1622, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d sess., p. 270 (1954); see also N. F. Testor, 40 T.C. 273">40 T.C. 273 (1963), affd. 327 F. 2d 788 (C.A. 7, 1964). However, we are not concerned with section 357(c), because it does not apply here and both parties agree that section 357(b) provides the critical test.All of these provisions appear to be directed to *147 the transaction in which property is exchanged for stock, and to be limited in application to determining the recognition or nonrecognition of gain, and the amounts thereof, resulting from such transactions alone. They are *916 not concerned with the tax effects of activities of the transferor-stockholder prior to engaging in the transaction, nor with those of the transferee-corporation after the transaction is completed, except to the extent they might shed some light on the purpose of the taxpayer in entering into the transaction. Compare F. W. Drybrough, supra, and Jack L. Easson, supra.Section 351 provides that no gain shall be recognized if property is transferred to a corporation solely in exchange for stock and immediately after the exchange the transferor is in control of the corporation. Section 357(a) provides that if the transferee assumes liabilities in such a transaction, such assumption shall not be treated as money received and shall not prevent the exchange from qualifying under section 351. Section 357(b) refers to the principal purpose of the taxpayer with respect to the assumption of*148 the liabilities in such a transaction, and to a purpose to avoid tax on the exchange. And section 357(c) relates to the excess of liabilities assumed over the basis of property transferred pursuant to such an exchange.We recognize that section 357(b) directs that in determining the purpose of the taxpayer we must take into consideration "the nature of the liability and the circumstances in the light of which the arrangement for the assumption or acquisition was made." But we believe the indictment of this section is limited to transactions of this nature arranged primarily so that the assumption of the transferee's liability in the transaction itself results in tax avoidance for the transferor, or has no bona fide business purpose. We do not believe it was intended to require recognition of gain on bona fide transactions designed to rearrange one's business affairs in such a manner as to minimize taxes in the future, consistent with existing provisions of the law.Applying the somewhat general language of section 357(b) to the facts in this case in the light of the principles stated above, in our opinion petitioner has carried his burden of proving by the clear preponderance*149 of the evidence that his principal purpose in having Collins-Crain assume the liabilities it assumed in this transaction or series of transactions was not a purpose to avoid tax on the exchange and was for a bona fide business purpose.Turning first to the alleged tax avoidance purpose, we do not see how petitioner can be said to have avoided any tax on the exchange except by the nonrecognition of gain on the conversion of assets held individually into corporate ownership, which is one of the very purposes of section 351. Petitioner did not borrow money against the assets transferred in excess of his basis therein immediately before the transfer, as was the situation condemned in F. W. Drybrough, supra, but accepted by the Court of Appeals in Easson v. Commissioner, 294 F. 2d 553 (C.A. 9, 1961). But even if he had done so, *917 he did not have the corporation assume liabilities in excess of his basis in the assets transferred. It would appear that his economic position was the same immediately after the transaction as it was immediately before the transaction. Presumably he could have withdrawn from his collateral*150 and margin accounts for his own use prior to the transaction the same securities and cash he withdrew prior to the transfer to Collins-Crain. The appreciation in value of the securities transferred would be reflected in the value of petitioner's stock in Collins-Crain after the transfer but would also be subject to the same amount of liabilities they were subject to prior to the transfer. The only tax advantage gained by petitioner would result from having the corporation pay off the liabilities with income, possibly from the securities, which, because of dividends-received credit and the corporate tax rate, had been taxed at a lower rate than it would have been had the securities remained in petitioner's hands. But this is apt to be true as a result of any transaction in which any high-bracket taxpayer incorporates his business assets. As was pointed out in Arthur L. Kniffen, supra, in using the term "liability" in sections 351 and 357, Congress was concerned with the assumption by the transferee of an existing liability of the transferor, not with the manner in which it might subsequently be discharged. It is clear that as the corporation *151 paid off the liabilities the value of petitioner's stock in Collins-Crain would be increased and petitioner's gain would be recognized upon disposition of that stock. But under the law the gain on that stock will be deferred until it is disposed of, and under section 351 recognition of the gain resulting from the appreciation in value of the securities transferred will also be postponed until the Collins-Crain stock is disposed of. We find no permanent escape from taxation of any of this gain. We do not believe the fact alone that the income which will be used to pay off the liabilities to which the securities were subjected will be taxed at a lower rate falls within the tax-avoidance purpose contemplated in section 357(b).Unlike in the Drybrough case, and in W. H. Weaver, 32 T.C. 411 (1959), affirmed sub nom. Bryan v. Commissioner, 238">281 F. 2d 238 (C.A. 4, 1960), petitioner did not incur the liabilities to which the transferred securities were subject immediately prior to the transfer and solely in anticipation thereof. The evidence indicates that the liabilities transferred were incurred by petitioner prior *152 to 1958 and that Dobson did not crystallize his plan or begin analyzing petitioner's assets and liabilities until sometime in February 1958. Furthermore, petitioner and Dobson both testified that Dobson did not advise petitioner to borrow money against the securities to be transferred; he simply decided, with petitioner's acquiescence, which securities were to be transferred. And unlike the $ 400,000 liability in Estate of John *918 , the assets subject to the liabilities assumed were also transferred to the corporation. Nor was petitioner's borrowing against his securities to buy additional securities and to refinance loans at all unusual for petitioner. The evidence indicates that this had been his practice with respect to both his personal assets and corporate assets over which he had control throughout his business experience.Respondent argues that Dobson's admitted efforts to avoid the effect of section 357(c) by having the liabilities assumed total slightly less than petitioner's basis in the property transferred, and to so arrange the corporate affairs as to avoid the pitfalls of the accumulated earnings tax and personal*153 holding company status, is proof that petitioner's principal purpose in having the corporation assume the liabilities was to avoid tax. As previously noted we find no tax avoidance in limiting the liabilities assumed to petitioner's basis in the property transferred -- in fact to not so limit them would be grounds for argument that tax avoidance was a purpose. And in our opinion the arrangement of the corporation's affairs in such a manner as to avoid possible penalty taxes in the future is not a tax-avoidance purpose contemplated by section 357(b). If there was a bona fide business purpose for the transaction, it would be ridiculous not to so arrange it that the corporation would not subsequently run afoul of the provisions of sections 531 and 541, which the penalty taxes imposed thereby were designed to prevent. In fact, it appears from the evidence that one of the principal reasons Dobson suggested having the corporation assume the liabilities was to avoid the accumulated earnings tax on the corporation rather than just to have the corporation pay petitioner's liabilities. The evidence indicates that petitioner could have sold a sufficient number of his securities prior*154 to the transaction to pay off the liabilities and, because of the market value of such securities in relation to petitioner's basis in such securities, to have realized a tax loss rather than a gain.We are also of the opinion that petitioner has carried his burden of proving that there was a bona fide business purpose in having the corporation assume the liabilities in this transaction.So far as petitioner personally was concerned, it had been his abiding conviction, and one which abetted his split with the Belk heirs and gave rise to the formation of Collins-Crain, that it was vitally important for a dry goods business to own stock of its suppliers and of banks with which it did business, and other marketable securities. He believed that this made possible obtaining supplies and financing at a lower cost, and that the appreciation in value of, and the income received from, such securities would provide the necessary reserves both to weather bad times and for expansion. He also believed that *919 it was better where possible to borrow money against such securities rather than sell them to obtain necessary funds. He had applied this philosophy quite successfully for a number*155 of years. When the Belk heirs disagreed with this philosophy, it was not unnatural that petitioner should look around for a business which he could buy and control himself. He had been quite successful in such a venture before and felt he could do it again, if he was free to run the business as he felt best. We cannot agree with respondent's suggestion that petitioner acquired Bailes-Collins and Bailes-Collins & Crain just to avoid personal holding company status for Collins-Crain. We think he seriously intended to go into the dry goods business on his own and would still be in it had not the Belks insisted that he get out or sever his connection with the Belk chain. There is no reason to believe that Collins and Crain would have sold their successful businesses to petitioner had they thought it would be a temporary arrangement designed primarily to enhance petitioner's tax position. The fact is that Collins-Crain is still in business, but in a line of business different than the Belk business. It is understandable that petitioner's troubles with Dobson and his subsequent troubles with the Belk heirs severely hampered whatever plans he may have had for expansion of the Collins-Crain*156 business.Having decided to go into the retail dry goods business on his own, it is not strange that petitioner wanted to operate it in corporate form. In addition to the obvious advantages of operating a risky business in corporate form, he also wanted to avoid letting the Belks know that he was involved in a competing business. It was in accordance with his established practice to provide the corporation with adequate capital for expansion and other purposes. Most of his liquid assets consisted of marketable securities and, inasmuch as he intended to have the corporation acquire securities in any event, there was an adequate business reason for him to transfer some of his better securities to the corporation to provide its working capital. If this was to be done, there was certainly good reason on petitioner's part to require the corporation to assume the liabilities which the securities were pledged to secure. He relied in part on the income from these securities to pay the liabilities and it would seriously impair his own position to transfer these high-yield securities to the corporation without having it assume the liabilities.So far as the corporation was concerned, there*157 was a bona fide business purpose for it to assume the liabilities. It was receiving securities having a market value of about $ 1,715,000, and a high yield, in exchange for the assumption of liabilities totaling about $ 750,000. The indicated income from the securities was in excess of the interest due on the liabilities, and the excess in value of the securities could *920 be used as working capital if necessary. As said by the Court of Appeals in Bryan v. Commissioner, 281 F. 2d 238, 242 (C.A. 4, 1960):The transfer of the properties to corporations, subject to a debt not exceeding his cost, may well have had a business purpose, but it is his purpose in arranging for the assumption by the corporations of the excess indebtedness which is critical under § 112(k).We do not think there can be any question about the business purpose in having Collins-Crain assume the liabilities of the two liquidated corporations in exchange for their operating assets.We are not naive enough to acknowledge that tax minimization did not play an important role in dictating the manner in which these transactions were arranged, but we think the record clearly*158 supports petitioner's argument that the tax avoidance was not his principal purpose in having the corporation assume the liabilities and that there was a bona fide business purpose in having it do so.Inasmuch as we have found that section 357(b) does not apply to these transactions, we conclude that section 351(a) does apply and no gain is to be recognized to petitioners on the transactions involved.To reflect concessions on other issues,Decisions will be entered under Rule 50. Footnotes1. Respondent originally determined that petitioners' gain to be recognized upon the exchange was in the amount of $ 940,119.52. The above amount reflects respondent's concession in the stipulation of facts.↩2. All section references are to the Internal Revenue Code of 1954 unless otherwise indicated.↩3. Total amount of notes as finally executed differ in an immaterial amount from that called for in the purchase agreement.↩4. Apparently, upon liquidation of the corporations, petitioner assumed their unpaid liabilities. Collins-Crain in turn assumed them. The amount retained by Dobson was to cover contingent liabilities and there is some doubt that this amount should be added to basis. In view of our holding, the point is immaterial.↩1. After dividends-received credit.↩5. The parties agree that the shares of Collins-Crain, issued on Jan. 7, 1959, to Dobson as trustee are to be deemed to have been issued to petitioner.↩6. SEC. 351. TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.(a) General Rule. -- 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 (as defined in section 368(c)) of the corporation. For purposes of this section, stock or securities issued for services shall not be considered as issued in return for property.(b) Receipt of Property. -- If subsection (a) would apply to an exchange but for the fact that there is received, in addition to the stock or securities permitted to be received under subsection (a), other property or money then -- (1) gain (if any) to such recipient shall be recognized, but not in excess of -- (A) the amount of money received, plus(B) the fair market value of such other property received; * * *↩7. SEC. 357. ASSUMPTION OF LIABILITY.(a) General Rule. -- Except as provided in subsections (b) and (c), if -- (1) the taxpayer receives property which would be permitted to be received under section 351, 361, 371, or 374 without the recognition of gain if it were the sole consideration, and(2) as part of the consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property subject to a liability,then such assumption or acquisition shall not be treated as money or other property, and shall not prevent the exchange from being within the provisions of section 351, 361, 371, or 374, as the case may be.(b) Tax Avoidance Purpose. -- (1) In general. -- If, taking into consideration the nature of the liability and the circumstances in the light of which the arrangement for the assumption or acquisition was made, it appears that the principal purpose of the taxpayer with respect to the assumption or acquisition described in subsection (a) -- (A) was a purpose to avoid Federal income tax on the exchange, or(B) if not such purpose, was not a bona fide business purpose,then such assumption or acquisition (in the total amount of the liability assumed or acquired pursuant to such exchange) shall, for purposes of section 351, 361, 371, or 374 (as the case may be), be considered as money received by the taxpayer on the exchange.(2) Burden of proof. -- In any suit or proceeding where the burden is on the taxpayer to prove such assumption or acquisition is not to be treated as money received by the taxpayer, such burden shall not be considered as sustained unless the taxpayer sustains such burden by the clear preponderance of the evidence.(c) Liabilities in Excess of Basis. -- (1) In general. -- In the case of an exchange -- (A) to which section 351 applies, or(B) to which section 361 applies by reason of a plan of reorganization within the meaning of section 368(a)(1)(D),if the sum of the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceeds the total of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be.(2) Exceptions. -- Paragraph (1) shall not apply to any exchange to which -- (A) subsection (b)(1) of this section applies, or(B) section 371 or 374↩ applies. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624898/ | Sefer A. Markley v. Commissioner. Wilma L. Markley v. Commissioner.Markley v. CommissionerDocket Nos. 10172 and 10173.United States Tax Court1948 Tax Ct. Memo LEXIS 216; 7 T.C.M. (CCH) 198; T.C.M. (RIA) 48056; April 14, 1948*216 Partnership. - Held, that petitioners, husband and wife, were partners doing business under the firm name of M & M Truck Company. Income. - Held, that the business of M & M Truck Company did not have additional unreported income from certain bank deposits as determined by respondent. Depreciation. - Useful life of motor tractors and tank trailers used in the business determined. Harry S. Silverstein, Esq., 922 Equitable Bldg., Denver 2, Colo., and William H. Goldberg, C.P.A., 520 University Bldg., Denver 2, Colo., for the petitioners. Frank M. Cavanaugh, Esq., for the respondent. TYSON Memorandum Findings of Fact and Opinion TYSON, Judge: These consolidated proceedings involve income tax deficiencies determined by respondent against each petitioner, respectively, and also overpayments claimed by each petitioner, for the years and in the amounts, as follows: Sefer A. MarkleyWilma L. MarkleyYearDeficencyOverpaymentDeficiencyOverpayment1939$ 697.24$ 311.21NoneNone194024,122.023,624.37$10,833.94None19411,703.752,801.531,675.66$186.91Totals$26,523.01$6,737.11$12,509.60$186.91*217 The issues presented are whether respondent erred in determining (1) that petitioners, husband and wife, were not partners operating a trucking business under the firm name of M & M Truck Company during each of the years 1939, 1940, and 1941; (2) that an estimated portion of certain bank deposits constituted unreported income of that business in the amounts of $5,498.25 for 1939, $15,422.99 for 1940, and $14,488.36 for 1941; and (3) that depreciation should be computed on the basis of a useful life of four years for tractors and five years for trailers used in that business for each of the years 1939, 1940, and 1941 instead of a claimed useful life of three and four years, respectively. The petitioners have abandoned allegations of error as to respondent's disallowance of certain claimed bad debt deductions for 1940 and 1941. The deficiencies determined against Wilma L. Markley were asserted by respondent "to protect the Government's interest" in the event the claim for recognition of the partnership should prevail in this litigation. The proceedings were submitted upon testimony, documentary evidence, and a stipulation of certain facts, together with exhibits attached to the*218 stipulation. The stipulated facts are included herein by reference as part of our findings of fact. Findings of Fact Petitioners are husband and wife, residing at East 59th Avenue and Highway No. 6 in Adams County, just outside the City of Denver, Colorado. Individual income tax returns of Sefer A. Markley for the years 1939, 1940, and 1941 and separate individual income tax returns of Wilma L. Markley for the years 1940 and 1941 were each made on the accrual basis and filed with the collector for the district of Colorado. No partnership returns were filed under the firm name of M & M Truck Company for the years involved herein or any prior years. The petitioners, respectively, and the respondent through the successive execution of written waivers extended the time for assessment up to January 1, 1946, for each of the years involved herein, and the deficiency notice to each petitioner was mailed on November 29, 1945. Claims for refunds, in undisclosed amounts, were filed by Sefer A. Markley on March 15, 1943 and April 14, 1943 and by Wilma L. Markley on January 31, 1944. Each petitioner made partial payments of income taxes shown to be due on their respective tax returns when*219 those returns were filed, and the amounts and dates of such payments were as follows: Sefer A. MarkleyWilma L. MarkleyTaxable YearAmountDate PaidAmountDate Paid1939$ 77.81March 15, 1940None19402,494.53March 14, 1941$ 76.83March 14, 19411941703.89April 14, 1942132.94March 13, 1942 The petitions herein were filed on February 18, 1946. The petitioners were married in 1923 when Sefer was 19 and Wilma 18 years of age. During parts of 1923 and 1924, Wilma worked an saved all her earnings while living with her parents and apart from her husband; and, thereafter, she had separate earnings, from doing work outside the home, which she saved. Prior to 1934 Sefer owned and operated a garage and service station at Weldona, Colorado, and in that business Wilma sold gasoline and kept the books. From time to time they discussed entering into a joint business enterprise of purchasing a tractor and tank trailer and transporting pertroleum products. In 1934 the petitioners jointly negotiated the purchase of a Dodge tractor and a Fruehauf trailer from Blauer-Markley Motor Company, in which concern Sefer's brother, Fred Markley, *220 had an interest, and Wilma made the down payment consisting of $650 of her own separate money, earned through her employment outside the family circle, plus $150 borrowed from her father. Sefer made a payment of $856 from his own funds for the purchase of a tank which was mounted on the trailer. That first piece of equipment was registered in Sefer's name. At that time the mutual understanding of Sefer and Wilma was that the latter was not making a loan of her $650 but that each was contributing to a joint venture or partnership on the basis of a 55 per cent interest in Sefer and a 45 per cent interest in Wilma. Sefer's brother, Fred Markley, who sold them the tractor and trailer, also understood at that time that Sefer and Wilma were starting a partnership business. Sefer and Wilma immediately started their trucking business in 1934 under the firm name of M & M Truck Company, which name was painted on their equipment and used on their letterheads. During the first year of operations, they could not afford to hire any drivers so Wilma accompanied Sefer as a relief driver and they took turns driving and sleeping on the long hauls. At first and for only a short time they transported*221 crude oil from a well near Casper, Wyoming, to a refinery at Adams City, near Denver, and then they transported gasoline from McPherson, Kansas, to Denver, a haul which required from 24 to 36 hours of continuous driving. They withdrew from the business only such funds as were necessary for living expenses, including a hired girl to look after their home. After the first year of operations and out of profits realized therefrom, they repaid the $150 loan from Wilma's father, made the down payment on an additional piece of equipment, and hired extra drivers. During all the years from 1934 and including the taxable years involved no new capital was contributed directly by either Sefer or Wilma from any source outside their business, and they continued the practice of withdrawing only such profits as were required for their living expenses and used the other profits from the business to expand it by acquiring business property and additional units of equipment, each unit consisting of a tractor and tank trailer. In some instances they jointly signed notes for the balance of the purchase price due on new equipment, while at other times Sefer alone signed the notes. Part of their equipment*222 was registered in Wilma's name and part in Sefer's name. Title to their Casper, Wyoming, terminal was taken in Wilma's name. Their home and business office was first located at Fort Morgan, Colorado, but in 1936, at which time they owned eight units of equipment, they moved to Denver and purchased a home in their joint names. They used the basement of the house as a business office until the office was moved to another small frame building in 1940. Title to their present terminal and office building, in or near Denver, erected in 1942, was taken in and is in Wilma's name. From 1934 on, and including the years in question, Sefer and Wilma were held out to and known by various parties, with whom they did business, as partners, operating under the firm name of M & M Truck Company, and many of such parties dealt directly with Wilma about as often as they did with Sefer on various business matters including the purchase of equipment and repair parts, financial matters, and in giving orders for transportation service. Throughout the years from 1934 to and including the taxable years in question the petitioners had no written partnership agreement. Also, during that period Wilma's name*223 did not appear on the intrastate and interstate common carrier certificates under which the business was operated, which certificates are more particularly described in the next succeeding paragraph. However, during that period the petitioners had a definite understanding that they were partners, with Sefer having a 55 per cent interest and Wilma having a 45 per cent interest in the business of M & M Truck Company; and, during that period, each of them rendered vital services in the operation and continued growth of the business and jointly acted in a managerial capacity. In 1942 and because it was anticipated that Sefer might be drafted into the war service, Wilma instituted suit in the District Court in and for the City and County of Denver and State of Colorado, against Sefer for a declaratory judgment as to her partnership interest in the M & M Truck Company, and after a hearing the Court entered its decree on November 24, 1942, that Wilma had a 45 per cent interest in that business and had had such an interest from its inception. During the first year or so of operations no interestate common carrier certificate was required, at least to the knowledge of the Markleys. Thereafter*224 they were advised to obtain such a certificate from the Interstate Commerce Commission. Application was made and a certificate was issued, under the so-called "grandfather rights," in the name of Sefer A. Markley, doing business as M & M Truck Company. That certificate was applied for in Sefer's name alone more as a matter of convenience than for any other reason and without any intention of thereby signifying that he was actually the sole proprietor of M & M Truck Company. At that time and during subsequent years, both petitioners regarded the common carrier certificates as merely permits to operate vehicles for transporting petroleum products over certain routes and not as a legally binding designation of the owners of the business. Shortly prior to 1938, at a time when petitioners did not have sufficient equipment to meet the demands of their intereste transportation service, Sefer requested an intrastate carrier, H. M. Melton, to operate a piece of the latter's equipment on the Markleys interstate route and under the Markleys' certificate, but it was not a joint operation and each retained the freight revenues collected from the operation of their separate vehicles. Subsequently*225 the Markleys had an opportunity to transport petroleum products to Salt Lake City but did not have sufficient equipment so Sefer Markley and Melton split the costs in obtaining an interstate certificate in about December 1938 in the name of H. M. Melton and S. A. Markley, copartners, doing business as Melton and Markley, which was transferred in February 1939 to Melton and Markley, Inc. Under those certificates the Markleys and H. M. Melton, respectively, operated their separate equipment and collected their separate revenues from such operations until the Interstate Commerce Commission advised them they could not operate in that manner. Thereupon by agreement of the parties Markley's original interstate certificate was transferred to Melton and the certificate in the name of Melton and Markley, Inc., was transferred by order of the Commission, dated May 2, 1939, to S. A. Markley, doing business as M & M Truck Company. The Markleys continued operating under that latter certificate until the Commission issued an order in July 1943 transferring it from S. A. Markley, doing business as M & M Truck Company, to S. A. Markley and Wilma L. Markley, a partnership, doing business as M & M Truck*226 Company, based on a request by Sefer for such transfer originally made in June 1941. H. M. Melton was never in business with the Markleys as a partner and no corporation was ever organized under the name of Melton and Markley, Inc. From 1934 until the latter part of 1938 Wilma in addition to managing the office, kept all the books and records of M & M Truck Company by her own method of accounting, which consisted mainly of entries of income and expenses and records on their equipment. In the fall of 1938 Sefer and Wilma employed an accountant to open a more complete set of books and advised him at the time that they were partners. The books were set up under the name of M & M Truck Company on the accrual basis to reflect revenues from the freight bills but did not show any partnership capital accounts for Sefer and Wilma, respectively. Wilma Markley continued to keep the books for the business from the fall of 1938 until November 1939 when Sefer and Wilma employed L. C. Boswell as their office assistant in matters pertaining to accounting. Boswell was advised at that time that Sefer and Wilma were partners and during the period of his employment by them until May 1941, he took*227 instructions from both of them as joint managers of the business. The growth of the business required better accounting records and, as of the first of 1940, Boswell installed a new accounting system to comply with the Interstate Commerce Commission Regulations under the Carriers' Act. The new books, under the name of M & M Truck Company, were set up on the accrual basis from the then existing records with some necessary adjustments and they reflected the capital accounts of Sefer and Wilma as partners in the business. The freight revenue, which was the only source of income, was entered on the books from the freight bills and reflected in accounts receivable. A main set of books was set up to reflect the revenues and expenses of the interstate business, which at that time consisted of transporting petroleum products for the Standard Oil Company, and a subsidiary set of books was opened to reflect separately the intrastate business carried on with two or three pieces of equipment and which phase of the M & M Truck Company's business was handled almost exclusively by Wilma. Early in 1940 Fred Hansen of the Interstate Commerce Commission inspected the books and records of M & M Truck*228 Company and stated that since the carrier certificate was then in the name of S. A. Markley, doing business as M & M Truck Company, the books of account should reflect a sole proprietorship so as to be in conformity therewith, and he further suggested that an application be filed for a transfer of the certificate to Sefer and Wilma as copartners. Application for such a transfer was not made until June 1941 and no change was made in the books of account; however, the necessary reports filed with the Interstate Commerce Commission from time to time up to 1943 continued to reflect a sole proprietorship business in conformity with the carrier certificate during that period of time. Prior to and during the years in question a bank account was maintained at the First National Bank at Fort Morgan, Colorado, and used as the regular and main business account of the M & M Truck Company. That account was maintained in the name of S. A. Markley, subject to the signature of either S. A. Markley or Wilma L. Markley, until October 9, 1939, when it was changed to the name of M & M Truck Company, subject to the same signatures. After the Markleys moved to Denver in 1936 they made deposits in the*229 Fort Morgan account by mail. On August 27, 1938 another and subsidiary bank account was opened in the Central Savings Bank and Trust Company of Denver (hereinafter referred to as Central Savings) in the name and subject to the signature of S. A. Markley and on September 7, 1939 it was changed to a joint account subject to the signature of either S. A. or Wilma L. Markley, but on September 23, 1941 it was made subject only to the signature of S. A. Markley. The Central Savings account was opened for the purpose of keeping the intrastate business separate from the interstate business, but it was also regularly used as an "exchange account" or a "clearing house account," that is to say, for depositing cash collections on the interstate business and writing checks thereon for deposit by mail in the Fort Morgan account. A reconciliation of both bank accounts was made each month. Also, the Central Savings account was used in carrying out a business policy maintained for the convenience of customers, which consisted of M & M Truck Company making payment to consignors on behalf of the consignees for the price of gasoline, plus tax, when a tank trailer was filled at the "oil dock" of the consignor, *230 and then upon delivery collecting from the consignee the price of the gas and tax thereon plus the freight charge; and that practice accounted for withdrawals from and deposits in the Central Savings account in large amounts compared with the freight revenue derived from such haulage. The Markleys derived no income from that practice other than the regular freight revenue. In March 1941 the M & M Truck Company's frame office building was destroyed by a fire which also destroyed its books of account and canceled checks for earlier years and partially destroyed other records but not those on its motor equipment. Thereafter and with respect to the years here involved, a revenue agent made an examination of the M & M Truck Company in 1942 at which time no partnership question was involved so far as his examination was concerned. The agent conceived the idea that the Central Savings bank account probably reflected items of income which had not been reported, and since the M & M Truck Company's records prior to March 1941 were not complete, he made an analysis of the bank records of that account for the years 1939, 1940, and 1941, but he made no examination of the Fort Morgan bank account. *231 As stipulated by the parties, the Central Savings account reflected the following total deposits and withdrawals. BalanceWithdrawalsYearJan. 1Depositsby Check1939$ 994.68$47,458.09$46,959.8419401,492.9360,924.0861,587.061941829.9618,729.6818,485.3319421,074.31 The agent treated all deposits as items of income from the business although he had no knowledge of the source thereof. By considering deductible items appearing on the tax returns and information from other sources not identifiable at the time of the hearing and also by mere estimate, the agent arrived at the amounts of the withdrawals which he considered as representing allowable business expenses. He also estimated nondeductible personal expenses. A summary of his analysis, as stipulated by the parties, is as follows: 193919401941Withdrawals$46,959.84$61,587.06$18,485.33Less items deemed not deductible5,000.0016,085.9714,244.01Deductible items$41,959.84$45,501.09$ 4,241.32Deposits47,458.0960,924.0818,729.68Taxable income$ 5,498.25$15,422.99$14,488.36 Those amounts designated as taxable income*232 were determined to constitute additional unreported taxable income for each of those years, respectively, in the determination of the asserted deficiencies. For each of the years 1939, 1940, and 1941 the books of the account of the M & M Truck Company were kept on the accrual basis and its income from freight charges, which was its only source of income, was accrued from the freight bills, irrespective of the time of the collection thereof, and the petitioners' tax returns were made on the accrual basis and in accord with its books of account. The total deposits in the Central Savings account did not represent income from the business for large amounts thereof in each of those years but represented merely repayments of the amounts advanced by the Markleys on behalf of customers for the f.o.b. price of gasoline, plus tax, being transported for such customers and amounts other than those representing such repayments constituted cash deposits for transfer by check to the Fort Morgan bank account. The amounts of $5,498.25 for 1939, $15,422.99 for 1940, and $14,488.36 for 1941 of deposits in the Cetral Savings bank account did not constitute unreported income of M & M Truck Company for*233 each of those years. In the course of his examination for the years in question the revenue agent considered that the M & M Truck Company equipment was being depreciated too repaidly although he did not consider the actual mileage of such equipment, and he adjusted the claimed rate of depreciation based on a useful life of three years on tractors and four years on trailers to a rate based on four and five years, respectively, which was used in the determination of the deficiencies involved herein. In the years prior to and during the years in question, actual experience showed that the average useful life, from the standpoint of profitable operation, in the business of the M & M Truck Company was three years for tractors and our years for trailers and for that reason the company has endeavored to follow the practice of selling or trading in its equipment within those periods. The average mileage for each piece of the company's equipment was 150,000 miles in 1939, 168,000 miles in 1940, and 150,000 miles in 1941 over routes so rough that they were used for experimental runs in testing the durability of similar equipment. Another factor in the useful life of such equipment, in the*234 nature of obsolescence, was that in each year new tractors were being made with greater motive power and new trailers were being made with greater load capacity without increasing the weight of the trailer, and competition required the use of equipment providing the greatest load capacity per trip on long hauls. Another factor in the life of tank trailers used in the business of the M & M Truck Company was that after four years of usage, if not before, the metal in the tanks tended to crystallize resulting in cracks and leaks and while they might have some remaining usefulness for short hauls or some other purpose, they were unprofitable to operate on long hauls. During 1939 the M & M Truck Company sold none of its equipment; during 1940 it sold one tractor and two trailers; and during 1941 it sold seven tractors and six trailers and also one body tank. As to such equipment sold during 1940 and 1941 the averages for the cost, the sales price, the depreciation claimed, the profit realized after adjustment for its claimed rate of depreciation, and the period of years owned were as follows: AverageAverageAverageAverageAverageDepreciationProfit AfterYearsEquipmentCostSales PriceClaimedDepreciationOwned8 tractors$3,467.10$1,393.75$2,525.16$451.811.758 trailers andbody tank3,028.741,894.901,219.5085.661.25*235 During the years 1942 to 1944, inclusive, the M & M Truck Company sold 15 tractors, 9 trailers, and a body tank. As to such equipment, the averages for the cost, the sales price, the depreciation claimed, the profit realized after adjustment for its claimed rate of depreciation, and the period of years owned, were as follows: AverageAverageAverageAverageAverageDepreciationProfit AfterYearsEquipmentCostSales PriceClaimedDepreciationOwned15 tractors$3,375.60$2,173.33$3,148.20$1,945.933.569 trailers andbody tank2,963.872,775.002,488.022,299.153.35 During those war years the resale price was abnormally high for used equipment of that type, irrespective of its age or mechanical condition, and furthermore on eight tractors and trailers the sale price included certain of the M & M Truck Company's contracts for hauling petroleum products. The petitioners sold much of their equipment because of the high prices offered and because of the difficulty in obtaining drivers. On April 30, 1944, the M & M Truck Company had on hand 9 tractors and 13 trailers which had been acquired between August 10, 1939 and December 31, 1941 and*236 had been in use for an average of 3.75 years and four years, respectively. They were kept on hand as extra or spare equipment and were not regularly used. The average useful life of the tractors and trailers used in the business of the M & M Truck Company was three years for tractors and four years for trailers. In March 1940 the office assistant Boswell advised petitioners to file a 1939 partnership return for M & M Truck Company, but they took the advice of other accountants not to do so because the reports to the Interstate Commerce Commission showed a sole proprietorship in Sefer A. Markley in conformity with the carrier certificate. Accordingly, Sefer A. Markley's individual original income tax return for 1939 reported, on the accrual basis, the income of the trucking business operated under the name of the M & M Truck Company. His original tax returns for 1940 and 1941 followed a similar pattern for reporting income, except that for those two years Wilma L. Markley also filed individual returns, on the accrual basis, on which she reported that portion of the M & M Truck Company's income which was derived from the interstate business and deducted depreciation on the two or*237 three trucks used in that phase of the business, and she also reported a salary of $3,600 from the company for each of those two years although she did not withdraw more than two-thirds thereof. The fact that Wilma reported the income from the intrastate phase of the business was not intended to reflect the extent of her actual interest in the whole business of the M & M Truck Company. Sefer A. Markley filed certain amended returns and claimed that for each of the years 1939, 1940, and 1941 the income from the trucking business conducted under the name of M & M Truck Company should have been reported on the basis of a partnership in which the interests were 45 per cent in his wife, Wilma, and 55 per cent in himself. In determining the deficiencies asserted against Sefer A. Markley, the respondent denied the existence of the claimed husband and wife partnership and made certain other adjustments, including the disputed amounts determined by respondent to represent unreported income reflected in the deposits in the Central Savings bank account and also the disputed allowances by respondent for deductible depreciation which also embraces certain adjustments by him, as set forth in the*238 stipulation, as to the gain or loss on tractors and trailers sold in 1940 and 1941. In determining the deficiencies asserted against Wilma L. Markley, respondent increased her reported net income to equal 45 per cent of the income of the M & M Truck Company as determined by him. Opinion These consolidated proceedings present three issues, all of which are questions of fact. The first issue is whether, during the taxable years, a valid partnership existed between the petitioners for income tax purposes. There is no question as to Sefer A. Markley having a real interest in the business conducted under the firm name of M & M Truck Company; in fact, the respondent contends that it was his sole proprietorship. The ultimate question presented is, whether under the facts, the wife, Wilma L. Markley, was a real partner in that business within the tests announced in ; and ). In applying those tests we are presented with the subsidiary questions of whether the wife invested capital originating with her, of whether she substantially contributed to the control and*239 management of the business, of whether she otherwise performed vital additional services, or of whether she did all those things. In our opinion, the enumerated subsidiary questions and consequently the ultimate question must all be answered in the affirmative. Here we have a fairly large trucking business which over a period of years has grown from a very small beginning in 1934, consisting of an original capital investment of $856 contributed by Sefer on his own behalf and $650 contributed by Wilma on her behalf out of funds originating from her separate earnings outside the family circle, plus $150 borrowed from Wilma's father, which capital was used for the down payment on one tractor and tank trailer to start the business enterprise. The growth of the business has been due to the mutual efforts of Sefer and Wilma in both management of and services rendered in the business, together with their consistent practice of plowing back into the business the profits which their combined efforts produced. It is conclusively shown that throughout the years Wilma's participation in the management of the business was substantial and her services rendered in the regular daily operation of*240 the business were vital and also clearly in addition to Sefer's services. From the beginning in 1934 up through the years in question the petitioners had no written agreement or articles of partnership. However the record definitely establishes that, at the time they each contributed their separate funds for the purchase of their first unit of equipment in 1934, they mutually understood and agreed that each was contributing to a joint venture or partnership on the basis of a 55 per cent interest in Sefer and 45 per cent interest in Wilma. That understanding continued throughout the years in question and pursuant thereto title to certain business real property was held in Wilma's name; part of their equipment was registered in Wilma's name and part in Sefer's name; in some instances they jointly signed notes for the balance due on new equipment; the main business bank account at Fort Morgan was subject to withdrawals by both of them; the other bank account maintained at Central Savings in Denver from 1938 on was a joint account during the period from September 1939 to September 1941; and they were known to and dealt with as partners operating under the firm name of M & M Truck Company*241 by many parties with whom they did business. In our opinion the acts and conduct of Sefer and Wilma, pursuant to their mutual understanding as to their business relationship, establish a partnership between them as that term was defined in the Tower case, supra, to wit: " "A partnership is generally said to be created when persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, profession, or business and when there is community of interest in the profits and losses"; and we conclude that the validity of such partnership should be recognized for income tax purposes on the basis of a 55 per cent interest in Sefer and a 45 per cent interest in Wilma. In our opinion the evidence supporting the above conclusion outweights conflicting evidence of facts as hereinafter mentioned in this paragraph and relied upon by respondent in his determination and his contention here of a sole proprietorship in Sefer A. Markley. It is a fact that the books of account of the M & M Truck Company did not reflect partnership capital accounts until so set up as of the first of 1940 by a regularly employed office assistant and accountant, but prior thereto the books*242 and records were maintained, from 1934 to the fall of 1938, by Wilma according to her own methods of recording income, expenses, and equipment owned, and from the fall of 1938 until the fall of 1939 the books were maintained by Wilma according to an accrual system installed by an accountant, and, further, the systems of accounting employed prior to 1940 were not intended by petitioners to signify the existence of a sole proprietorship. Neither book entries nor the lack thereof are controlling as to the actual ownership of a partnership interest, . The fact that the common carrier certificates under which the M & M Truck Company operated did not contain the name of Wilma L. Markley and the fact that the company's various reports to the Interstate Commerce Commission indicated that Sefer A. Markley was the sole proprietor of the business are of little, if any, purport. See , where the husband filed with the county clerk "Certificate of Persons Conducting Business Under An Assumed Name" in which he stated that he was conducting the business as the sole owner; ,*243 in which the husband had filed with the proper official a certificate of doing business as an individual and had not changed the certificate after his wife was taken into the partnership and in which case the husband, after his wife was taken into the partnership, filed employer's tax returns as owner of the business; and , where an excise tax return under the Social Security Act was signed by the husband and the "form of organization" was checked therein as "individual". Petitioners herein regarded the common carrier certificates as merely permits to operate motor vehicles, for transporting petroleum products over certain routes and not as legally binding designations of the owners of the business, and the facts as to the manner of their actual operations throughout the many years bear them out in that regard. Furthermore the practice of indicating in the reports on the business to the Interstate Commerce Commission that Sefer A. Markley was the sole proprietor was followed so that the name in which the reports were filed would be in conformity with the certificates. The fact that no partnership returns were filed for the M & M Truck*244 Company for the years in question was due to the advice of accountants. The fact that a declaratory judgment was entered in November 1942 does not indicate that the partnership was not formed until that time; and furthermore such declaratory judgment is not controlling in the matter of this Court's determination as to the recognition of a family partnership for income tax purposes. , certiorari denied ); and . The respondent erred in failing to recognize the existence of a valid partnership between Sefer A. and Wilma L. Markley during the years in question on the basis of a 55 per cent and 45 per cent interest, respectively, and the taxes in controversy in both docket Nos. 10172 and 10173 will be recomputed on that basis under Rule 50. The second issue is whether certain portions of deposits in the Central Savings bank account in amounts as estimated by respondent for each of the years in question constituted additional unreported income of the M & M Truck Company. The facts herein show conclusively that the respondent's determination*245 is grossly erroneous in that his estimate of so-called unreported income is based on total deposits in the Central Savings account which deposits included large amounts constituting redeposits of funds theretofore withdrawn in connection with an accommodation service rendered to customers without profit. In addition to overcoming the prima facie correctness of respondent's determination, the facts further establish that for each of the years in question the books of account of the M & M Truck Company were kept on the accrual basis, that the only source of income was freight revenue which was accrued as income from the freight bills for services rendered and irrespective of subsequent cash collections on such bills, and that the tax returns were made on the accrual basis and in accordance with the books of account. Since the accounts were kept and the income reported on the accrual basis in accordance with the books, the amount of cash deposits in bank is not a proper criterion for determining income. The respondent erred in his determination that the business of the M & M Truck Company had additional unreported income in the amounts of $5,498.25 for 1939, $15,422.99 for 1940, and*246 $14,488.36 for 1941. The third issue involves the question of the useful life of the tractors and trailers used in the business of the M & M Truck Company during 1939, 1940, and 1941, and we have found as a fact that such useful life is three years for tractors and four years for trailers, That finding is clearly borne out by the testimony as to the actual usage of the equipment in the M & M Truck Company's business and also by the figures set out in the findings relative to its disposition of equipment during 1940 and 1941, two of the three tax years here in question. The figures set out in the findings relative to the company's disposition of equipment in subsequent years during which war conditions and abnormally high prices obtained, do not in our opinion affect our determination of the normal useful life of the equipment in the taxable years before us during which normal conditions obtained. The parties have stipulated all other factors necessary for computing the correct allowance for depreciation for each of the years in question and also for computing gain or loss on equipment sold during 1940 and 1941. The respondent erred in his determination of allowable depreciation. *247 Decision in each proceeding will be entered pursuant to Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624899/ | THOMAS FITZERALD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. PETER G. TEN EYCK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.FITZERALD v. COMMISSIONERDocket Nos. 62075, 68197.United States Board of Tax Appeals29 B.T.A. 1113; 1934 BTA LEXIS 1420; February 16, 1934, Promulgated *1420 It appearing that the Albany Port District Commission was established by the State of New York to serve the broad purpose of developing an integral link in a transportation project of national significance and was given powers and duties which in their nature were such as can be exercised only by an arm of the government, including the fixing of rates and the determination of deficits which are made up by taxation, the making of orders binding on municipal corporations, corporations and individuals for the violation of which orders penalties are provided and other comparable powers: Held, that the Commission is performing an essential governmental function and the salaries of its members are exempt from Federal tax. John C. Watson, Esq., and Laurence Graves, Esq., for the petitioners. Frank A. Surine, Esq., for the respondent. VAN FOSSAN *1113 OPINION. VAN FOSSAN: These proceedings were brought to redetermine deficiencies of $311.85 for 1929 as to Fitzgerald and of $471.89 for 1930 as to Ten Eyck. The sole issue is whether or not the salaries of the petitioners, as members of the Albany Port District Commission, are exempt from*1421 Federal income tax by reason of its having been received for services in connection with the exercise of an essential governmental function. On March 25, 1925, the Legislature of the State of New York created a public corporation having perpetual existence, known as the Albany Port District (hereinafter called the District). The act establishing the District provided that the District: * * * shall embrace the city of Albany and the lands belonging to the city of Albany, within the town of Bethlehem; the city of Rensselaer; and all lands and water, in the Hudson River contiguous thereto, subject to the right, title and interest of the state in and to the lands under the waters of the Hudson River. The said act also established the Albany Port District Commission (hereinafter called the Commission) to administer the affairs of the District. The Commission is a body corporate and consists of five members, four residents of Albany and one a resident of Rensselaer. *1114 The members are appointed by the Governor of New York upon nomination of the mayor of the city in which the proposed member resides. The governor may reject the nomination made by the mayor. Vacancies*1422 in office are filled in the same manner. The term of office is three years and the annual salary is $5,000. Members are required to take the constitutional oath of office. They may be removed by the governor for inefficiency, neglect of duty or misconduct in office. The Commission is granted the "power and authority over the survey, development, control and operations of Port facilities" in the District and "the co-ordination of the same with existing or future agencies of transportation, with a view to the increase and efficiency of all such facilities and the furtherance of commerce and industries in the district * * *." The Commission was required to make an annual report of its proceedings and deliver a copy thereof to the state superintendent of public works, the state engineer and surveyor, the mayor and common council of each city in the District, the resident United States Army engineer, the Chief of Engineers of the United States Army and the Secretary of Commerce of the United States. An appropriation of $5,000 was made to cover the expenses in connection with the appointment and functioning of the Commission. The powers and duties of the Commission constituted*1423 by the said act, as amended April 5, 1929, are in part as follows: Sec. 5. Such port commission also shall (1) Have power to confer with the governing bodies of each of the municipalities within the port district and dock, port, harbor, channel and improvement commission and any other body or official having to do with port and harbor facilities within and without the district and hold public hearings as to such facilities. (2) Have power to confer with the railroad, steamship, warehouse and other officials in the district with reference to the development of transportation facilities in such district and the coordination of the same. (3) Confer with the proper state officials as to means and measures for stimulating the use of the barge canal. (4) Formulate and adopt a financial, building and operation program, which shall be submitted to the mayor of each city, in the district, who shall be entitled to be heard thereon before formal adoption, notice of such hearing to be given in writing at least twenty days before the day of such hearing. (5) Have power to adopt a comprehensive plan, and to change or revise the same, for the development of port facilities in such*1424 district, which plan may provide separately for the work of initial development, and shall include an estimate of the total cost of all the work and/or of the work include in such initial development, and to apportion the cost thereof, as provided in section eight, and not oftener than once in three years to revise such apportionment to accord with any changes theretofore made in the comprehensive plan, as required by said section eight; and as part of such comprehensive plan, or pursuant thereto, to determine upon the location, type, size and construction of requisite port facilities, subject, however, to the approval of the secretary of *1115 war and chief of engineers, United States army, where federal statute or regulation requires it. (6) Have power to acquire, lease, erect, construct, make, equip and maintain port facilities within or outside the district, either on land owned by the district or upon land set aside for its uses and control, as provided in section thirteen, and for any such purpose to acquire and improve real property, including easements therein, lands under water and riparian rights, by agreement or by condemnation, and to sell, rent, exchange or dispose*1425 of any property, real or personal, as may seem advisable. (7) Have power to contract with any municipality in the district for the construction by the municipality of one or more docks, wharves, terminals or warehouses, to belong to the municipality and be maintained by it, whereby a part of the cost of construction shall be borne by the district, in cases where the commission, after a public hearing, determines that such work is of common benefit to the municipalities, inhabitants and property in the district. (8) Have power to execute contracts within the provisions and limitations of this act and to issue and sell bonds or other obligations of the port district to the amount authorized pursuant to section ten and in such additional amount, not exceeding fifteen per centum of the amount so authorized, as may be required for work included in any revision or amendment of the comprehensive plan, pending a re-apportionment of the total cost as above provided. (9) Have power to fix rates, charges and wharfage for the use of all port facilities, or to rent the same or grant the use thereof for limited periods, and collect rates, rents, charges and wharfage for such facilities*1426 owned or controlled by the district. (10) Operate and maintain all port facilities owned or controlled by it, including a general terminal railroad connecting with any railroad within said district, use the revenues therefrom for the upkeep thereof and the expenses of the commission and the residue, if any, on hand at the end of any fiscal year, for further construction and port development, or in reduction of taxation. (11) Have power to regulate and supervise the construction and operation of all port facilities, by whomsoever constructed, installed or owned. (12) Expend moneys, if any, appropriated by the state for the purposes of this act on account of benefits accruing thereunder to the state or its property. (13) Have power to create and maintain a traffic bureau. (14) Have power to employ such clerical, engineering, legal or other professional assistants as it may deem necessary for the purposes of this act, fix their compensation and at pleasure discharge any of them. (15) Have power to do all things necessary to make the deeper Hudson project useful and productive. The term "facilities," "port facilities," "terminals," and "terminal work" as used in this*1427 act, shall include, among other things, wharves, docks, piers, terminals, railroad tracks on terminals, cold storage and refrigerating plants, warehouses, elevators, and such property real or personal as may be acquired or used in connection therewith, personal service, freight handling machinery and such equipment as is used in the handling of freight and the establishment and operation of a port, and the appurtenances thereto and work of deepening parts of the Hudson river adjacent to the terminal, exclusive of the channel, within the port district. SEC. 6. The commission may make, and cause to be served upon any municipal or other corporation, or individual, within the district, any reasonable order which it may determine to be necessary for the proper development, *1116 maintenance and use of the port, relating to the construction, equipment, repair, maintenance, use and rental of any dock, wharf, slip, terminal or warehouse owned or leased by such corporation or individual within the district. With a copy of the order shall be served a notice specifying a day, not less than ten days after such service, when such corporation may appear before the commission, present*1428 written objections to the making of the order and be heard on such objections. If no such objections be filed within the time stated, or if the order be sustained as the result of such hearing, either in its original or a modified form, such order shall be final, subject only to review by a court of competent jurisdiction; but no order staying or suspending an order of the commission shall be made by any court otherwise than upon notice and after a hearing; and if the order of the commission is suspended, the order suspending the same shall contain a specific finding based upon evidence submitted to the court and identified by reference thereto that great and irreparable damage would otherwise result to the petitioner and specifying the nature of the damage. When an order of the commission shall become final, including the termination of any court proceeding sustaining the order, or of the time for beginning such a proceeding if none be brought, if the corporation or individual shall fail to obey it, or if any municipal or other corporation or individual shall violate a lawful rule of the commission, the commission may commence and maintain an action or proceeding in the name of*1429 the Albany port district, in an appropriate court having jurisdiction, for the purpose of having such disobedience to an order or violation of a rule prevented or obedience enforced, either by mandamus or injunction. Such an action or proceeding may be brought in the supreme court, which shall have jurisdiction to grant mandamus or injunction or any other relief appropriate to the case. The commission also, by rule, may prescribe a civil penalty of not more than fifty dollars for disobedience to an order or violation of a rule for any distinct act of such disobedience or violation, or, in the case of a continuing disobedience or violation, a penalty of not more than fifty dollars for each day that it continues. Any such penalty may be sued for and recovered by the commission in any court of competent jurisdiction, and the moneys recovered shall be used in carrying out the provisions of this act. Two or more such penalties incurred by the same corporation or person may be sued for in one action. Sec. 7. The commission, and any member thereof when directed by the commission, may make any investigation which the commission may deem necessary to enable it effectually to carry out*1430 the provisions of this act, and for that purpose the commission, or such member, may take and hear proofs and testimony and compel the attendance of witnesses and the production of books, papers, records and documents, including public records. The commission and its authorized agents may enter upon any lands as in its judgment may be necessary for the purpose of making surveys and examinations to accomplish any purpose authorized by this act, the district being liable for actual damage done. The petitioners were appointed members of the Commission previous to the taxable years and still hold those offices. They took the oath of office and each received the salary of $5,000 per year. Ten Eyck is chairman of the Commission and devotes practically all his time to the performance of his duties as such member and chairman. Fitzgerald was secretary of the Commission and devoted less time to his duties. The Commission has performed its duties in accordance *1117 with the statutes creating it and has complied with the conditions therein imposed. Albany is the junction point of the Hudson River, the New York Barge Canal, the Oswego Canal, the Cayuga Canal and the Champlain*1431 Canal. It is 143 miles inland from New York Harbor. Within a 250-mile radius of the city the population is equal to one third of the population of the United States. The western terminus of the New York Barge Canal is at Buffalo. The Barge Canal and the Great Lakes afford a continuous waterway of 1,500 miles, serving more people than any other inland waterway in the world. The Sixty-eighth Congress of the United States appropriated $11,200,000 for the construction of a channel in the Hudson River from New York City to Albany, having a width of 300 feet and a depth of 27 feet at mean low water. Between $8,000,000 and $9,000,000 of that sum was used for the purpose. The State of New York expended approximately $175,000,000 in the construction and improvement of the Barge Canal, formerly the Erie Canal. Prior to the appropriation by Congress the Chief of Engineers, under date of June 2, 1924, recommended that local interests provide dumping ground for dredged material, "organize an agency to design, construct and operate suitable terminals and to promote the actual transfer of freight between ship and rail at such terminals" and "before any Federal funds are expended on channel*1432 improvement, make provision satisfactory to the Chief of Engineers and the Secretary of War for the construction of terminals * * * supporting warehouses * * * a grain elevator * * * and a publicly controlled belt-line railroad * * *." He also stated that credit should be given to the State of New York for its great expenditure in construction of the Barge Canal and for that reason that the locality be relieved from contributing to the cost of the improvement. During 1930 and prior thereto the Commission was engaged in the construction of the Port of Albany. The following provision contained in chapter 523 of the Law of 1927, amending the original act creating the District, governs the payment of the Commission's expenses: Annually, in the month of June, the commission shall file with the clerk and with the treasurer of each city in the district, a statement of the amount to be raised upon the territory within such city and paid to the commission, for the estimated expenditures of the commission under this act during such fiscal year, including construction cost, expenses other than for construction, and installments of the district debt, if any, and interest, to fall due in*1433 such year. The statement shall specify when the amount should be paid to the commission which shall, so for as practicable, be after the collection of taxes next to be levied in or for such municipality. The clerk of each city shall cause such statement to be presented to the legislative governing body, and board of *1118 estimate, if any, of the city at its next meeting, and such board or body shall cause the amount chargeable to the several parcels of real estate in the city to be levied upon such real estate in the city by the first annual municipal tax levy next occurring, in proportion to the valuation of the taxable real property for city taxes. The amounts chargeable under this section, when collected, shall be paid to the treasurer of the commission. In anticipation of the levy and collection of taxes under this section, the commission may issue and sell certificates of indebtedness of the district, payable for moneys so to be collected by tax in such cities. In determining the total amount to be raised for any fiscal year under this section the commission shall deduct from its estimate of total expenditures the probable amount of net revenues, if any, from its*1434 port facilities, and the amount of any appropriations by the legislature to be available in such year. Each year the Commission submits to the cities of Albany and Rensselaer its estimate of the deficit anticipated in the operation of the port. The salaries of the commissioners are included therein. The amount of the estimate is apportioned between the cities and each includes its respective share in its budget, issues a check therefor to the Commission in a lump sum and levies a general tax assessment against its property owners to cover the amount. The Commission maintains its offices at Albany and has an information office in New York City. Its employees are compelled to contribute to the retirement fund of the State of New York. The commissioners may do so. The Commission makes such contribution in a lump sum for the benefit of its employees. The Commission has paid for the construction of its port facilities by issuing bonds and certificates of indebtedness. Its bonded indebtedness is $6,036,000 and its outstanding certificates of indebtedness amount approximately to $900,000. Generally speaking, the Commission's duties are administrative, financial, operative, *1435 engineering, and negotiating. The Commission holds hearings on the apportionment of the annual deficit between the cities of Albany and Rensselaer. It arranges for bond issues to provide funds for its constructive work. It formulates plans for the building and expansion of the port. It negotiates with shippers using the port facilities, with municipal, state and Federal officials and with the officers of railroad and steamship lines. The District is the connecting link between the deeper Hudson project and the Barge Canal. It is the transfer point for export cargoes carried on the Barge Canal from inland shipping points and for import cargoes received by water from the Pacific coast, West Indies, Europe and other points. The Commission owns the land comprising the port. It consists of 201 acres on the west, or Albany, side of the Hudson River and 110 acres on the east, or Rensselaer, side thereof. Some of the acreage was contributed by the two cities and some was purchased by the *1119 Commission. The facilities and equipment of the port consist of docks aggregating 4,400 feet in length, a belt-line railroad, two transit sheds containing 156,000 feet of floor space, *1436 a warehouse 600 feet long, and 180 feet wide, a grain elevator with a capacity of over 13,000,000 bushels of grain - the largest single unit grain elevator in the world - a feed mill, a lumber terminal, and other necessary port and dock equipment such as conveyors, loading devices, turning basin, car-float ferry, stevedoring and fire protection equipment, and water supply. It leases its feed mill to cooperative farm organizations. It also leases land to three stevedoring companies and to the Molasses Products Corporation. These concerns have erected buildings and installed extensive equipment on the properties. The Commission has adopted certain rules and regulations governing its operations and makes certain fixed charges for the use of its various facilities and equipment. Each year since its creation the Commission has incurred a large deficit. In 1930 the deficit was placed in the budget estimate at $50,000; in 1931, at $65,000; and in 1932, at $228,442.50. Much has been said and written concerning the exemption from Federal taxation of officers and employees of states and political subdivisions thereof. In the cases before us the status of the petitioners as officers*1437 or employees of the state is not challenged. Therefore, we may disregard that phase of the question and confine our discussion to the character of the powers, duties, and activities of the District. The fundamental rule governing the determination of the Federal taxation is set forth in , in the following language: The cases unite in exemption from Federal taxation the means and instrumentalities employed in carrying on the governmental operations of the State. The exercise of such rights as the establishment of a judiciary, the employment of officers to administer and execute the laws and similar governmental functions can not be taxed by the Federal Government. ; ; . * * * The true distinction is between the attempted taxation of those operations of the States essential to the execution of its governmental functions, and which the State can only do itself, and those activities which are of a private character. The former, the United States*1438 may not interfere with by taxing the agencies of the States in carrying out its purposes; the latter, although regulated by the State, and exercising delegated authority, such as the right of eminent domain, are not removed from the field of legitimate Federal taxation. We must, therefore, scrutinize carefully the underlying purpose of the creation of the District as reflected by the statutes authorizing it *1120 and also examine the historical background antedating the state and national legislation. For many years the Erie Canal, running roughly east and west across the State of New York, had been in use as a public waterway. Prior to 1925 the State of New York had expended over $175,000,000 in deepening, strengthening, improving and reequipping the canal and had changed its name to "Barge Canal." The state authorities opened negotiations with the Federal authorities for deepening and widening the channel of the Hudson River from Albany to New York City to accommodate sea-going vessels, to the end that a continuous waterway might be established from New York Harbor to the Great Lakes. Three other canals had their terminals at Albany, thus materially enlarging the territory*1439 to be served from the Hudson River. The negotiations resulted ultimately in an appropriation of $11,200,000 by Congress for the construction of a channel in the Hudson River 300 feet wide and 27 feet deep at mean low water, but before the appropriation was granted the Chief of Engineers of the United States Army recommended that the state authorities should provide terminals, warehouses, a grain elevator, a belt-line railway, etc., satisfactory to himself and the Secretary of War. He also made the following statement: * * * The capital district, from the point of view of transportation economies, is a unit whose needs and potentialities transcend those of any individual community contained in it. The Nation's interest lies not in extending deep water to any community as such, but rather in providing a port within the district adequate to serve its hinterland. A suitable site is available at Albany, below the Albany-Greenbush Bridge. We have noted that on March 25, 1925, the Legislature of the State of New York established the District and designated the Commission to administer its affairs. By the language of the act the commissioners were constituted state officers. The*1440 Commission was granted general power and authority over the survey, development, control and operation of the port facilities. The adoption and alteration of its plan of procedure, however, were subject to the approval of the Secretary of War and of the Chief of Engineers of the United States Army. The legislature appropriated from state funds sums deemed necessary to defray the initial expenses. The Commission was also given power to enforce its orders, to make investigations and to proceed in the courts. The annual reports of the Commission were required to be filed with state and national officials. The power was given to and duty imposed upon the Commission to confer with municipal, state and Federal authorities in all matters relating to the development and operation of the port and to its utilization as a thoroughfare for intrastate, interstate, national and international commerce. *1121 As we view the facts, the establishment of the Port of Albany was inspired and impelled by national need. The purpose and use of the port went far beyond the limits of local or sectional requirements. In its inception the project of connecting the Great Lakes with New York Harbor*1441 by water was national in its scope. The intent of those advocating it was to build a great system of communication and transportation to aid in the growth of the nation and its economic problem of distribution. It is equally obvious that the District was not created primarily for the purpose of revenue. The successful launching of such a national undertaking compelled the support of the local cities. There was no thought of profit to them. In fact, there appears to be an increasing yearly deficit arising from the operation of the port. The service charges are fixed at a rate low enough to induce shipments by water. If and when the port shall become self-supporting and shall have reimbursed the cities of Albany and Rensselaer for monies advanced by them, it is reasonable to assume that the rent, wharfage and other charges will be adjusted to maintain that selfsupporting basis, but not to produce gain. The primary purpose of the port is to serve the public and not to make money. Looking more closely to the principal functions of the Commission, we find that they conform to those operations which the Supreme Court, in *1442 , classifies as essentially governmental in that the state alone can perform them. The appropriation of $11,200,000 by the Federal Government for the construction of the Hudson River channel was conditioned solely upon the creation of the District and the Commission by the legislative action of the State of New York. The agency so created was an instrumentality of the state. It was a corporate body with perpetual existence. Its members were appointed and conducted themselves as other state officers. It was empowered and directed to confer, treat and cooperate with the Federal Government in order to enable the port to render a maximum service to the public. No private corporation or agency could thus have represented the State of New York. We are convinced from the facts that the main object of the District and hence, the primary function of the Commission is to provide for the use and benefit of the general public an inland waterway extending from New York Harbor to the Great Lakes; that this vast project has been completed successfully through the joint efforts of the State of New York and the Federal Government; that the*1443 Port of Albany is an integral part of that system; that the service charges made by the Commission are necessary but only incidental to the operation of the port; and that, therefore, the compensation *1122 paid to the petitioners as commissioners is exempt from Federal taxation. The case of , in which the status of the Delaware River Bridge Joing Commission (of Pennsylvania and New Jersey) and the Port of New York Authority (of New York) was under consideration is basically in point. In that case we stated that "the power of the states to establish public agencies for harbor improvements, for drainage and reclamation purposes, to aid navigation and to provide facilities for commerce is not open to question," our holding being that the agencies named were exercising governmental functions. The Delaware River Bridge Joint Commission was established in Pennsylvania and New Jersey for the purpose of constructing a highway bridge across the Delaware River between Philadelphia, Pennsylvania, and Camden, New Jersey. The Port of New York Authority was created by a compact between the States of New York and New Jersey, consented*1444 to by the Congress of the United States. That compact recited that "It is confidently believed that a better co-ordination of the terminal, transportation, and other facilities of commerce in, about and through the Port of New York, will result in great economies, benefiting the nation, as well as the States of New York and New Jersey * * *," and pledged the two States to "* * * faithful cooperation in the future planning and development of the Port of New York, holding in high trust for the benefit of the nation the special blessings and natural advantages thereof." The Port Authority constructed the Arthur Kill Bridges, the Hudson River Bridge and the Kill van Kull Bridge. In , although we reached a contrary result, in which it is to be noted we have now been reversed by the Circuit Court of Appeals, First Circuit (C.C.H. 1934, No. 9048), we made the following comment respecting the Moisseiff case: * * * In that case, the instrumentalities employed by the States concerned were engaged in providing bridge facilities in furtherance of commerce, and making harbor improvements in aid of navigation, and in so doing did not merely*1445 take over and operate a private corporation, as in the instant proceedings. In the case of the States of New York and New Jersey, the legislatures thereof expressly provided that the Port Authority be regarded as performing a governmental function (see page 526); the same inference is drawn from the legislation creating the Delaware River Bridge Joint Commission. In reversing the Board in the Powers case the Circuit Court of Appeals stressed the fact that the trustees had power to fix rates and to declare deficits which upon their decision were collected by taxation. Functions and powers comparable to those possessed in both the Moisseiff and Powers cases were possessed and exercised by the petitioners. *1123 The facts in the cases at bar show that the primary purpose of the District was the establishment and maintenance of a major link in the ocean-to-lake waterway, a development of national importance; that only the state could do the things required to effect such a result; and that, therefore, the Commission was performing essential governmental functions. The deductions for contributions should be adjusted in accordance with this opinion. Decision*1446 will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624901/ | Susan H. Epp, Petitioner v. Commissioner of Internal Revenue, RespondentEpp v. CommissionerDocket No. 12740-79United States Tax Court78 T.C. 801; 1982 U.S. Tax Ct. LEXIS 99; 78 T.C. No. 55; May 12, 1982, Filed *99 P paid $ 2,000 to the Institute of Individual Religious Studies for information, guidance, and written materials to be used to establish a family estate trust. Subsequently, P established and transferred assets to such a trust. Held, P failed to prove that any part of such payment was an ordinary and necessary expenditure paid for the management, conservation, or maintenance of property held for the production of income or for tax advice. Sec. 212(2) and ( 3), I.R.C. 1954. Donald B. Brown and Barbara J. Rose, for the petitioner.Peter D. Bakutes and Catherine L. Wong, for the respondent. Simpson, Judge. *SIMPSON*801 The Commissioner determined a deficiency of $ 848 in the petitioner's Federal income tax for 1976 and an addition to tax of $ 42.40 under section 6653(a) *101 of the Internal Revenue Code of 1954. 1 By agreement of the parties, the sole issue for decision at this time is whether the petitioner is entitled to deduct under section 212 the expenses of establishing a family estate trust. 2FINDINGS *102 OF FACTSome of the facts have been stipulated, and those facts are so found.The petitioner, Susan H. Epp, resided at 324 Stanley Street, Medford, Oreg., at the time she filed her petition in this case. She timely filed her Federal income tax return for 1976 with the Internal Revenue Service Center, Ogden, Utah.*802 The petitioner is a Canadian citizen, permanently residing in the United States. During 1976, she was a registered nurse, employed in the field of public health. In 1976, she had three sisters, all of whom were Canadian citizens residing in Canada, and in that year, she and her sisters jointly owned two parcels of real property. One of such parcels was located at 324 Stanley Street, Medford, Oreg. The other parcel was located in Beaverton (which is near Portland), Oreg.The petitioner learned from friends of the existence of the Institute of Individual Religious Studies (the institute). Subsequently, she contacted and met with a representative of the institute, John (Jack) O'Keefe. 3 Mr. O'Keefe discussed with the petitioner the formation of a family estate trust and the alternatives to the creation of such a trust. She generally was unaware of Mr. O'Keefe's*103 qualifications, but she knew that he was not an attorney.In December 1976, following her discussion with Mr. O'Keefe, the petitioner paid $ 2,000 to the institute for information, guidance, and written materials to be used to establish a family estate trust. She received a package of forms to be used to create the trust and to transfer assets to the trust, as well as instructions for the completion of such forms. In addition, she received legal advice from attorneys selected by the institute, advice from the institute for preparing her Federal income tax return for the first year the trust was in existence, and bookkeeping advice from the institute. Also, employees of the institute typed the information to be filled in on the printed forms and notarized the signatures on*104 such forms. The petitioner did not know what portion of her payment to the institute was allocable to any particular service, and she did not make any separate payments for legal services in connection with the trust.On December 30, 1976, the petitioner, using the forms and instructions supplied by the institute, created the Susan Epp Trust (the trust). Subsequently, her sisters transferred their interest in the jointly owned real properties to her, and she transferred such properties to the trust.*803 On her 1976 Federal income tax return, the petitioner deducted the $ 2,000 that she paid to the institute as a "cost to conserve and maintain assets IRC 212." On such return, she reported her home address as 324 Stanley Street, Medford, Oreg. In his notice of deficiency, the Commissioner disallowed such deduction in its entirety on the grounds that it was both a nondeductible personal expenditure and a nondeductible capital expenditure.OPINIONThe sole issue for decision is whether the petitioner is entitled to deduct the $ 2,000 that she paid to the institute. She contends that she is entitled to deduct such payment either as a cost of managing and conserving income-producing*105 property under section 212(2) or as tax advice under section 212(3). The Commissioner contends that such payment was a nondeductible personal expenditure. Alternatively, he argues that the petitioner has failed to establish what portion of the payment, if any, was for expenses deductible under section 212(2) or (3). Also, he argues that even if a portion of such payment was for tax advice, a deduction under section 212(3) is limited to "legitimate tax advice and tax planning, not such short cut tax avoidance."The petitioner testified that her purpose for creating the trust was to protect the real properties owned by her and her three sisters. She contends that transferring the title of the real properties to the trust facilitated the management and conservation of such properties, minimized the probate and related tax problems which might result upon the death of one of the joint owners, and protected such properties from any potential liability that might arise as a result of her employment as a registered nurse. Her testimony as to her reasons for creating the trust was vague, evasive, self-serving, and uncorroborated. We are not required to, nor do we, accept such testimony. *106 See Armes v. Commissioner, 448 F.2d 972 (5th Cir. 1971), affg. on this issue a Memorandum Opinion of this Court; Banks v. Commissioner, 322 F.2d 530">322 F.2d 530, 537 (8th Cir. 1963), affg. on this issue a Memorandum Opinion of this Court; Weiss v. Commissioner, 221 F.2d 152">221 F.2d 152, 156 (8th Cir. 1955), affg. a Memorandum Opinion of this Court.*804 Section 212 provides, in part: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 --* * * * (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.The deduction provided by section 212(2) is limited in application; an expenditure is not deductible under such section if it is a personal, living, or family expense which is nondeductible under section 262. Secs. 1.211-1 and 1.212-1, Income Tax Regs.4 Also, no deduction is allowable for an expenditure for the acquisition of property or for property which is not held for the production*107 of income when the expenditure was made. Sec. 1.212-1(g) and (h), Income Tax Regs.; Contini v. Commissioner, 76 T.C. 447">76 T.C. 447, 452 (1981); Frank v. Commissioner, 20 T.C. 511">20 T.C. 511, 514 (1953); Beck v. Commissioner, 15 T.C. 642">15 T.C. 642, 670 (1950), affd. per curiam 194 F.2d 537">194 F.2d 537 (2d Cir. 1952).The property located at 324 Stanley Street apparently was used by the petitioner as her residence since she gave that address as her residence on both her petition in this case and her Federal income tax return for 1976. There is no evidence that such property produced any income. Thus, to the extent the payment to the institute related to such property, it is not deductible. Sec. 1.212-1(h), Income Tax Regs.; Contini v. Commissioner, supra at 453.The only evidence in the record that the Beaverton property was held*108 for the production of income is that the petitioner reported rental income and deductions on her 1976 return from property merely identified as "Portland OR." However, even if the Beaverton property was held for production of income, 5 the petitioner has failed to meet her burden of proving that the payment to the institute in any way related to the management, conservation, or maintenance of such property. Rule 142(a), Tax Court Rules of Practice and Procedure; Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Rather, it is apparent that the petitioner received only generalized instructions on *805 how to transfer her assets to the trust, and preprinted forms for making such transfers. There is no probative evidence that such advice in any way related to the management or conservation of such property. See Contini v. Commissioner, supra at 453; Bagley v. Commissioner, 8 T.C. 130">8 T.C. 130, 135-136 (1947). 6 Moreover, advice on merely how to rearrange title to income-producing property relates to neither the management nor the conservation of such property within the meaning of section 212. See Schultz v. Commissioner, 50 T.C. 688">50 T.C. 688, 699-700 (1968),*109 affd. per curiam 420 F.2d 490">420 F.2d 490 (3d Cir. 1970); Bagley v. Commissioner, supra.Likewise, there is no merit in the petitioner's argument that she should be allowed a deduction under section 212(2) and (3) since the transfer of the real properties in trust served to avoid probate and to minimize any problems that would arise on the death of petitioner or one of her sisters. It is true that estate planning advice to reduce taxes may be deductible under section 212(3) (see Merians v. Commissioner, 60 T.C. 187">60 T.C. 187 (1973); Schultz v. Commissioner, supra), but the petitioner expressly claimed that tax implications did not in any way influence her decision*110 to establish the trust. Thus, according to her testimony, no part of the payment is deductible under section 212(3) for tax advice.We have held that amounts paid for advice with respect to planning one's personal and family affairs, such as establishing trusts for family members or making gifts, are nondeductible personal expenditures within the meaning of section 262. Mathews v. Commissioner, 61 T.C. 12">61 T.C. 12, 27 (1973), revd. on another issue 520 F.2d 323">520 F.2d 323 (5th Cir. 1975); Cobb v. Commissioner, 10 T.C. 380">10 T.C. 380, 383 (1948), affd. 173 F.2d 711">173 F.2d 711 (6th Cir. 1949); Bagley v. Commissioner, supra.7 The deduction contemplated by section 212(2) is for situations where property is held by the taxpayer for the production of income for her. Seidler v. Commissioner, 18 T.C. 256">18 T.C. 256, 260-261 (1952). The petitioner did not show what probate expenses could be saved by the creation of the trust. However, even if the creation of the trust would *806 save some probate expenses, such savings would not benefit the petitioner, but*111 would benefit her estate or her sisters. Hence, the savings of probate expenses through the creation of the trust would not, within the meaning of section 212(2), help to conserve property held for the production of income while she held it.Furthermore, the petitioner's argument that the transfers would serve to insulate her property from any liability arising from her employment as a nurse is not supported by Oregon law. Section 95.060, Oregon Revised Statutes (1981), provides that:Gifts and transfers in trust for transferor. All deeds of gift, all conveyances and all verbal or written transfers or assignments of goods, chattels or things in action made in trust for the person making the same, are void as against the creditors, existing or subsequent, of such person.See Or. Rev. Stat. sec. 114.435 (1981); Johnson v. Commercial Bank, 284 Or. 675">284 Or. 675, 588 P.2d 1096">588 P.2d 1096 (1978);*112 Coston v. Portland Trust Co., 131 Or. 71">131 Or. 71, 278 P. 586">278 P. 586, rehearing in banc 282 P. 442">282 P. 442 (1929); see generally 2 A. Scott, Trusts sec. 156, at 1190-1193 (3d ed. 1967). Thus, even after the transfers to the trust, the interest of the petitioner in the properties may have been subject to the claims of her creditors. Moreover, the deduction under section 212(2) applies to expenditures for the protection or preservation of property itself, such as safeguarding or keeping it up, but not to the expenditures for a taxpayer's retention of ownership in it. United States v. Gilmore, 373 U.S. 39">373 U.S. 39, 44 (1963); Reed v. Commissioner, 55 T.C. 32">55 T.C. 32, 42 (1970). Hence, although an amount paid by the petitioner in settlement of a malpractice action may be deductible by her under section 162(a), expenses incurred by her to transfer title to her property to protect it against such a claim are not deductible under section 212(2). See Wallace v. Commissioner, 56 T.C. 624">56 T.C. 624, 633 (1971); Cobb v. Commissioner, 10 T.C. at 383-385.*113 Finally, even if we were to conclude that part of the $ 2,000 payment to the institute was made for a purpose within the scope of section 212(2) or (3), the record is devoid of any rational basis by which we could allocate a portion of the payment to such purpose. Compare Merians v. Commissioner, supra.The petitioner has the burden of proving what portion, if any, of such payment was paid for deductible items. Rule 142(a), Tax Court Rules of Practice and Procedure; Welch v. *807 .When a petitioner proves that some part of an expenditure was made for deductible purposes and when the record contains sufficient evidence for us to make a reasonable allocation, we will do so. Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (2d Cir. 1930). However, on this record, there is absolutely no basis for making any such allocation. Under such circumstances, a deduction based on the Cohan rule would be "unguided largesse." Williams v. United States, 245 F.2d 559">245 F.2d 559, 560 (5th Cir. 1957); see Gran v. Commissioner, 664 F.2d 199">664 F.2d 199 (8th Cir. 1981),*114 affg. per curiam a Memorandum Opinion of this Court; Contini v. Commissioner, 76 T.C. at 454; Schultz v. Commissioner, 50 T.C. at 500. 8 Therefore, we hold that the petitioner is not entitled to any deduction under section 212 by reason of the payment to the institute. In light of our holding, we need not address the Commissioner's alternative argument that a deduction under section 212(3) is limited to "legitimate tax advice and tax planning."An appropriate order will be issued. Footnotes*. This case was tried before Judge Cynthia Holcomb Hall who subsequently resigned from the Court. By order of the Chief Judge, this case was reassigned to Judge Charles R. Simpson for disposition.↩1. All statutory references are to the Internal Revenue Code of 1954 as in effect during 1976, unless otherwise indicated.↩2. The Commissioner's determination of a deficiency in the petitioner's Federal income tax for 1976 is based on several adjustments, including the disallowance of the deduction claimed by the petitioner for the expenses of establishing a family estate trust. This Court has granted the joint motion of the parties to sever such issue for purposes of trial, briefing, and opinion. The petitioners in several other cases now pending before this Court have agreed to be bound on such issue by our decision in this case. The other adjustments in this case, including the addition to tax under sec. 6653(a)↩, will be the subject of a separate trial, if necessary.3. Apparently, Mr. O'Keefe is the same person referred to in Cole v. Commissioner, T.C. Memo. 1981-48↩. In that case, Mr. O'Keefe promoted similar family estate trusts on behalf of Educational Scientific Publishers.4. See Hoelzer v. Commissioner, T.C. Memo. 1982-6↩.5. In his notice of deficiency, the Commissioner made adjustments which related to property identified as "PortlandOR."↩6. See also Hicks v. Commissioner, T.C. Memo. 1982-200; Hoelzer v. Commissioner, T.C. Memo. 1982-6↩.7. See Deeks v. Commissioner, T.C. Memo. 1981-501; Larson v. Commissioner, T.C. Memo 1981-499">T.C. Memo. 1981-499↩.8. See also Shuman v. Commissioner, T.C. Memo. 1981-264↩, on appeal (7th Cir., Feb. 8, 1982). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624903/ | ROBERT S. FARRELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Farrell v. CommissionerDocket No. 100139.United States Board of Tax Appeals44 B.T.A. 238; 1941 BTA LEXIS 1357; April 23, 1941, Promulgated *1357 In 1927 while petitioner was a director of a corporation dividends were declared and paid under circumstances which were later claimed by bondholders to violate provisions of the Oregon Code. In 1933 petitioner and certain other directors, in consideration of their release from liability under the Oregon Code, guaranteed the bondholders that they would make good any deficiency in interest up to 3 percent on their bonds. Pursuant to the guaranty petitioner in 1936 paid out $4,843.13. Held, petitioner sustained a loss during the taxable year that was not compensated for by insurance or otherwise. Ashley Greene, Esq., for the petitioner. B. M. Coon, Esq., for the respondent. ARNOLD*238 OPINION. ARNOLD: This proceeding involves a deficiency in income tax for 1936 in the sum of $394.53. The issue is whether petitioner is entitled to a deduction of $4,843.13 as (1) interest paid, or (2) as an ordinary and necessary business expense, or (3) as a loss incurred during the taxable year and not compensated for by insurance or otherwise. The parties filed a written stipulation of facts, which are adopted as our findings of fact, and the pertinent*1358 portions thereof are hereinafter summarized. The petitioner resides in Portland, Oregon, and filed his income tax return for the taxable year with the collector of internal revenue at Portland. In computing his income he claimed a deduction for "interest paid" of $4,843.13. The disallowance of this deduction was one of the adjustments made by respondent which resulted in the present deficiency. Petitioner paid out the amount deducted under the following circumstances: In 1927 he was vice president and a director of the Morgan-Bushong Investment Co., an Oregon corporation organized in 1912, which owned and operated an office building in Portland. During 1927 the capital stock of the Morgan-Bushong Investment Co., hereinafter referred to as the company, issued and outstanding, consisted of 3,142 common shares having a par value of $314,200. During 1927 the company paid cash dividends as follows: January$15,710May15,710July62,040July315,000Total408,460*239 At January 1, 1927, the company had a surplus of $83,995.96. In its income tax return it reported taxable income of $49,700.87 and it had nontaxable income of $476.25. During*1359 1927 the company added $315,000 to its surplus account as "appreciation by appraisal", which resulted from an appraisal of its assets on or about April 18, 1927. The appraisal showed the replacement cost in 1927 of a building constructed in 1913 to be approximately $1,035,000 which gave a value of $765,900 for the building in 1927, allowing 2 percent depreciation for 13 years. Prior to June 4, 1927, the company's outstanding bond issue had been reduced to $53,000, and negotiations were entered into on or about that date relative to placing a new bond issue on the property in the aggregate principal amount of not to exceed $500,000. Proceeds of the bond issue were to be used to retire existing bonds and for other corporate purposes including payment of current liabilities, expenses of securing the loan and issuing the bonds, and the declaring of a dividend estimated to equal $120 to $125 per share. At a directors' meeting held on July 29, 1927, it was determined that the company's books reflected no good will value in its assets, that the earnings of the company had been satisfactory and its dividends had not been large, and that the appraisal and other estimates of value of*1360 the building showed that the property was worth in excess of its book value. After a thorough discussion the secretary was authorized and instructed to set up on the books an account to be known as "good will and appraisement of building', in the amount of $315,000, and a corresponding credit to an account to be known as "surplus by appraisement." The petitioner and Charles A. Shea and Grant Phegley attended this meeting of the board of directors. Thereafter bonds were issued and dividends paid in July 1927, in accordance with the authorization of the stockholders and directors of the company. During 1928 to 1930, inclusive, the company operated at a profit and paid the interest on its outstanding bonds. In 1931 the company sustained a large loss and defaulted on interest payments. The arrears increased during 1932 and 1933 and the bondholders threatened action against the directors on account of the dividends paid in July 1927. The Oregon Code, at all times material, provided as follows, section 25-219: If the directors of a corporation declare and pay dividends when the corporation is insolvent, or which render it insolvent, or pay dividends out of assets other than*1361 net profits or surplus, such directors shall be jointly and severally liable for the debts of the corporation then existing or incurred while they remain in office to the extent of such dividends so declared * * *. As *240 a result of the threatened action petitioner and Charles A. Shea and Grant Phegley, who were directors in 1927, entered into an agreement with a committee for the bondholders whereby the latter released the directors from any liability arising from the dividend distribution by the company during 1927 in consideration of their undertaking and agreement, for each of the four years beginning November 30, 1932, and expiring November 30, 1936, to supply for distribution to the bondholders the funds necessary to meet any deficiency in any year's net income which failed to provide 6 percent upon the unpaid principal of the company's outstanding bonds of July 15, 1927. The agreement limited the liability of the "Guarantors" to 3 percent upon the bonds, provided for the deposit of collateral by the "Guarantors", and contained various other provisions regarding payment, computation of net income, etc., not here material. The agreement was executed December 30, 1933. *1362 As between themselves, petitioner and Charles A. Shea and Grant Phegley agreed that they would make the payments guaranteed to the bondholders in the proportions of one-half by Charles A. Shea, three-eighths by petitioner, and one-eighth by Grant Phegley, and that the collateral deposited under the agreement had all been deposited by Shea and petitioner, and should be returned to them when the obligations to the bondholders were fully performed. The collateral security deposited by petitioner consisted of 1,000 shares of Caterpillar Tractor Co. stock. During the taxable year 1936 the income of the company was insufficient to pay the interest on its bonds held by the aforesaid bondholders' committee, and petitioner was called upon to pay and did pay "$4,843.13 as interest on the said bonds pursuant to" the agreement with the bondholders' committee. Petitioner sustained a loss during the taxable year of $4,843.13 that was not compensated for by insurance or otherwise. Petitioner contends that he is entitled to the deduction either as interest, as an ordinary and necessary business expense, or as a loss. Although the argument is in the alternative, we deem it unnecessary to*1363 consider the first two contentions advanced since, in our opinion, the amount is deductible as a loss not compensated for by insurance or otherwise. The stipulated facts show that petitioner paid $4,843.13 during 1936 pursuant to his agreement that bondholders would receive at least 3 percent on their bonds for a period of four years. Our examination of the agreement convinces us that it was a contract of guaranty, ; certiorari denied, , which was given the bondholders in consideration of their release of petitioner, among others, from any and all liability, claims, *241 demands, and causes or rights of action against him as a director or stockholder growing out of the declaration and payment of dividends in July 1927. The guaranty definitely grew out of and resulted from petitioner's business relationship to the company. The payment by petitioner was made under a promise to the bondholders that, if the earnings of the company were insufficient to pay the 6 percent interest due on its bonds, petitioner and Shea and Phegley would pay at least 3 percent on the bonds. The payment was clearly*1364 a loss, , and petitioner is entitled to the deduction under section 23(e) of the Revenue Act of 1936, , and cases cited therein; . Since other adjustments were involved, the deficiency must be recomputed. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624904/ | Sidney M. Harvey v. Commissioner.Harvey v. CommissionerDocket No. 1056.United States Tax Court1944 Tax Ct. Memo LEXIS 105; 3 T.C.M. (CCH) 1002; T.C.M. (RIA) 44309; September 27, 1944*105 J. H. Amick, C.P.A., 809 Majestic Bldg., Detroit, Mich., for the petitioner. Melvin S. Huffaker, Esq., for the respondent. OPPERMemorandum Findings of Fact and Opinion OPPER, Judge: By this proceeding petitioner seeks a redetermination of a deficiency in income tax for the year 1940 in the amount of $12,722.44. Petitioner's contention is that a prior proceeding before the Board of Tax Appeals for the year 1939 is res judicata of the present issue of whether petitioner and his wife correctly reported the income of an electric welding company as partnership income It is urged that if the prior proceeding is not res judicata, the present record requires a similar holding. Certain commissions received pursuant to a sales contract with another company are seperately disputed, it being contended by respondent that they are in any event income to petitioner in toto. Findings of Fact Petitioner, an individual, filed his income tax return for 1940 in the collection district of Michigan. He has been engaged in business relating to the manufacture and sale of electric welding machines since 1922. In 1910 petitioner was working as an electrician for Parke, Davis & Co. He later *106 went to Mackinac Island where he operated the water, light, and power facilities. In 1917 he went to work for Chalmers Motor Car Co. and later the Chalmers Co. put him in charge of their electric welding machine work. While at Chalmers petitioner developed an electric welding machine, and in 1919 he went into the electric welding business for himself, using the machine which he had invented. He first did work for foundries and the tractor plant of the Ford Motor Co. His trade name was "Electric Welding Machine Company." The business was the manufacture of electric welding machines of all kinds. Around 1922 three girls were employed in the business to send out circular letters advertising the machines. Earlier proceeding involving this petitioner's income tax liability for 1939 before the United States Board of Tax Appeals bore Docket No. 109298. The error charged in the petition was that respondent included the amount of $19,178.40 in petitioner's taxable net income. The facts alleged, on which issue was joined, were that petitioner, by gift inter vivos, transferred a one-third interest in the assets and business of the Welding Machine Company to his wife on or about January*107 1, 1939, and they agreed that from that time the business should be conducted for their joint benefit and risk. The January 1, 1939, agreement was alleged to provide a division of profits as follows: the first $3,000 to petitioner's wife [as salary], and the remaining profits, one-third to the wife and two-thirds to petitioner. The losses were to be borne one-third by the wife and two-thirds by petitioner. It was further recited that both petitioner and his wife devoted their entire time to the conduct of the business. On the evidence adduced, the Board, in a Memorandum Findings of Fact and Opinion, found as facts that the husband and wife executed such an agreement; that the wife contributed services consisting of general office supervision, supervision of the purchase of materials, interviewing of customers, preparing invoices, keeping the books, entertaining customers, and generally doing what was required in furtherance of the business. It further found that after the execution of the contract no general public notice was given of any change in ownership and no accounts were set up on the books of the company evidencing it. And it was found that cash withdrawals from the company's*108 bank account were made during 1939 by petitioner in the aggregate sum of $15,967 and by his wife in the aggregate sum of $7,645, as to which they had a general practice of placing such cash in a safety deposit box to which each had access; but that of the cash withdrawn by the wife $5,970 was deposited in her separate bank account. It was further found that title to real estate on which a factory was subsequently erected was taken in the name of petitioner and his wife. Partnership and individual income tax returns referred to the business as "Electric Welding Machine Company." The issue was phrased in the opinion as being whether petitioner had sustained his burden of proving that there was "a partnership, within the meaning and intendment of the revenue act, composed of petitioner and his wife." In the course of the opinion, which recognized the issue as one of "fact." it was stated: "* * * The significant fact in the instant proceeding, tipping the scales at least slightly in petitioner's favor, is that his wife, unlike the wife in many of the cases to which reference has been made, was a real partner in the business for several years prior to 1939 in the sense that she was making, *109 and had made, a very substantial contribution to its success. This was recognized by petitioner, as is indicated in the agreement itself and shown more clearly in the evidence. The facts set out in the findings need not be repeated. * * * * * * * *"* * * While it is true that the success of the business depended in no small degree upon the skill, training and salesmanship of petitioner, the wife's contribution to it was also quite substantial. Petitioner and his wife were no doubt aware of the fact that a saving in tax would result from a division of the business and its income but there is no evidence upon which a finding can be made that this was the impelling motive for the gift and the creation of the partnership. The evidence indicates, and we think it must be held, that petitioner made a bona fide gift to his wife and subsequently, or perhaps contemporaneously, he and she entered into a partnership within the meaning of the revenue act." On or about January 2, 1940, petitioner made his wife a "gift" of an additional one-sixth interest in the business and at that time they entered into a supplemental agreement modifying their agreement of January 3, 1939. The supplemental*110 agreement stipulated that the provisions of the 1939 agreement relating to salary to petitioner's wife and the division of profits and losses was revoked, and that henceforth the profits and losses were to be shared equally and no salary allowance was to be made to either party. During 1940 petitioner's wife devoted practically all her time to the firm's affairs. Her services were not less than the services rendered by her in the year 1939. They included the detailed office work, the checking of blue prints on special jobs, and the ordering of raw materials. In addition, she supervised the building of a new factory, costing approximately $33,000, from funds which came from the business. Title to the new factory was in the joint names of petitioner and his wife. A superintendent employed in the business supervised the manufacture of machines. When he was in need of instructions he consulted petitioner or acted in accordance with instructions given by petitioner to his wife. Petitioner had always made a practice of putting back into the business the money he had taken out in the event it was needed in the business. Such a policy has always been followed, both before and after 1939, *111 and petitioner's wife understood that it would be continued after the January 3, 1939, agreement. At the time of the gift by petitioner to his wife the physical assets of the business wee small, aside from the machines on hand, accounts receivable, and good will. Within a few months after the execution of the agreement of January 3, 1939, about 10 percent of the business's creditors and customers had been orally notified of the transaction. If anyone asked petitioner, he told them of the change in interest. There was no general notification. The business has at all times been registered on the books of the County Clerk as being conducted by petitioner. Petitioner's wife, Tula, went to work for him in 1927, the year in which they were married. She ran the office and since that time has had charge of all the office work. She also assisted in entertaining customers. Up to 1939 she received a salary which never exceeded $3,000. In the office she checked invoices and statements, did telephone ordering, checked blue prints, and performed the general office work, with the exception of the telephone. At the time of her marriage, the wife had little or no property, and up until 1939 she*112 had never contributed any capital to the business. Since their marriage it has been the policy of petitioner and his wife to hold property in their joint names. Several parcels of property have been and are so held. Since their marriage they have registered themselves as on a "fifty-fifty" basis. Petitioner and his wife have only a joint bank account. The money which was put into the joint account was withdrawn from the business account. Petitioner had no personal checking account and has always used the Welding Machine Company checks. All checks received by petitioner, whether personal or business, were cleared through his business account. Petitioner and his wife have always spent what they needed for running the household. His wife had access to the company bank account and could have used any part of it in any year. Petitioner's wife has never made any investment directly for herself. Some of the money withdrawn from the business has been invested jointly by petitioner and his wife in war bonds and other items, and some of it has been put back in the business. In making the transfer of an additional one-sixth interest petitioner thought that he could thus legitimately lessen*113 his tax liability. The one-sixth interest was not considered by petitioner to be a taxable gift. No inventory was taken or schedules made to disclose the assets at the time of the execution of the supplemental agreement. It was understood that the interests were to remain in the business. Early in 1940 a written agreement was entered into with Expert Die & Tool Company (hereinafter sometimes referred to as Expert) to sell on a commission basis, during 1940, 1941, and 1942, welding machines manufactured by it. The contract was signed "Sidney M. Harvey doing business under the assumed name of Electric Welding Machine Company." Petitioner's wife's name was not referred to in the contract. Petitioner thought that there was really no occasion for her name to be mentioned. The contract with Expert provided that it could not be transferred to a third person without Expert's written consent and that on the death of petitioner commissions on completed transactions were to be paid to his heirs or estate for a period of one year. Petitioner was the only contact man Expert had at the Ford Motor Co. Petitioner would make the sale and Expert would handle the orders direct. Through petitioner's*114 efforts the different departments of the Ford Motor Co. gradually used the Expert machine. The welding machine manufactured by Expert had a speed feature not possessed by petitioner's machine. During 1940 petitioner was selling the Expert machine and did not devote as much time to his own business of manufacturing and selling the type welding machines his company had previously produced. During 1940 Expert paid $30,850.70 to petitioner as commissions earned under the sales agreement. These payments were by check, payable to petitioner, and were endorsed by him and the Electric Welding Machine Company and deposited in an account entitled "Electric Welding Machine Company or Sidney M. Harvey." The expenses incurred with respect to the contract with Expert, consisting of plant superintendent services relating to engineering and follow-up work, and car expenses were paid out of the account of Electric Welding Machine Company Petitioner's wife had knowledge of the negotiations leading to the contract with Expert, and both petitioner and his wife regarded the contractual relation as being between the two firms and not petitioner's separate undertaking. They estimated that as much money*115 would be made selling Expert machines as would be made manufacturing and selling its own machines. The Expert machine competed with the machines manufactured by Electric Welding Machine Cobpany. In 1939 petitioner did not have a contract with Expert, and his business in 1940 differed from 1939 in that respect. The partnership still engaged in the manufacture and sale of its own electric welding machines throughout 1940. Petitioner exercised the same degree of control and management over the company in 1940 which he had exercised in 1938. The business continued in much the same manner. A partnership return filed for 1940 disclosed net income of $55,630.99, $27,815.50 of which was indicated as petitioner's share and a like amount to his wife. In both the partnership and individual returns the business was described by the name "Weldrite Electric Welding Machine Co." Opinion The controversy as to the taxwise validity of the partnership between petitioner and his wife has been before us in a prior proceeding (Docket No. 109298). The first disagreement between the parties is as to the conclusive nature of that earlier adjudication. We need not attempt to apply the stricter phase *116 of the principle of res judicata which, where the issue is the same, has the effect of foreclosing any examination of the record. Concededly, the issue here is different as the circumstances surrounding the conduct of the partnership business might vary fundamentally from year to year. . The record is the prior proceeding, however, unlike that in M. M. Argo, is before us. It is essentially similar to this one, except in respect of the two subordinate issues, which, as subsequent discussion will develop, do not affect the primary question. The secondary aspect of res judicata is thus applicable, , and any "right question or fact" put in issue and necessarily determined previously is now conclusively established. , affirmed (other issue) (C.C.A., 2nd Cir.), . From the record in the previous case we find that the Board of Tax Appeals expressly held not only "that petitioner made a bona fide gift to his wife," but that "subsequently, or*117 perhaps contemporaneously, he and she entered into a partnership within the meaning of the revenue act." Since the important issue of fact in these cases is the good faith of the gift, , we thus have a distinct joinder of issue and an express decision as to the decisive questions, one of fact and the other of law. And since the same gift and the same partnership are primarily involved in the basic issue here, we regard the matter as concluded by the prior decision without further examination. By a supplementary document at the inception of the present tax year petitioner purported to give his wife an additional one-sixth interest in the partnership business, thereby increasing her share to one-half. The good faith of this additional transaction is also attacked by respondent and creates a subordinate issue. At the same time, however, the provision for payment to her of a stipulated salary of $3,000 was eliminated. It is thus unnecessary to examine this supplementary transfer as though it were an entirely uncompensated gift. Excluding the income from the so-called "Expert" contract, which will be separately discussed presently, *118 the total partnership income for the year in question was in the neighborhood of $25,000. One-sixth of this would amount only to something in excess of $4,000. Having regard to the relative desirability of an assured payment, as opposed to the problematical value of a percentage of future profits, we cannot say that the substitution of the additional interest was grossly out of proportion to the benefit of the salary relinquished or that two parties dealing at arm's length could not reasonably have arrived at a comparable agreement. That being so, it does not strike us that the good faith of this phase of the transaction can be seriously brought into question. As to the first two issues, accordingly, we disapprove respondent's action. The final question relates to the inclusion in partnership income, and hence to the divisibility, of commissions received by petitioner as a result of a selling contract between petitioner and a manufacturer in a related business operating under the name of Expert Die & Tool Company. Without repeating the facts which appear in the findings, this contract in form was a purely personal one with petitioner, the services involved were to be rendered by *119 him, and the contract was performed accordingly. The commission payments were made by check payable to petitioner alone and, although they were deposited in the partnership account, and certain expenses incidental to the performance of the contract were paid out of the same account, the circumstance entirely lacks significance when it is considered that petitioner had no personal account of his own and testified that he used the partnership account for all financial transactions, personal as well as business. It seems to us to follow that any arrangement between petitioner and his wife whereby the proceeds of the Expert contract were made available to her through the partnership or othewise was no more than the assignment of petitioner's earnings. . Even where a contract has already been performed, the assignment of its proceeds is ineffectual to shift the tax consequence. . To an even greater extent is this true where the assignment involves future earnings and the assignor retains the power through control over his own services to confer or withhold its benefit. *120 ; cf. Horst v. Commissioner (C.C.A., 2nd Cir.). , and its reversal, . We think it follows that all of the income from the Expert contract was for tax purposes that of petitioner, and that neither the existence of the separate partnership business nor any "anticipatory arrangement" between petitioner and his wife, nor the subsequent assignment of the income to the partnership, if such in fact took place, was effective to shift the burden of tax on this income away from petitioner. This portion of the deficiency is sustained. Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624905/ | Francisco T. Espinoza, Petitioner v. Commissioner of Internal Revenue, RespondentEspinoza v. CommissionerDocket No. 10562-80United States Tax Court78 T.C. 412; 1982 U.S. Tax Ct. LEXIS 125; 78 T.C. No. 28; March 16, 1982, Filed *125 P filed original returns for 1971 through 1974 which were allegedly fraudulent. On June 21, 1976, at a meeting in connection with an audit, P's attorney handed the revenue agent copies of documents labeled as "amended returns" for 1971 through 1974 which showed substantially increased income for such years. There was no payment of the taxes due on the increased income. Such documents were never processed as amended returns, and no assessment of the increased taxes has been made. The Commissioner has evidence that P executed a consent extending until Apr. 15, 1980, the period for assessing taxes for 1972. On Mar. 31, 1980, the Commissioner issued his notice of deficiency for 1971 through 1974. Held, P's motion for summary judgment that the notice of deficiency was barred by the statute of limitations is denied because there are questions as to whether the documents handed to the agent as amended returns were filed at that time and as to whether the time for assessing taxes for 1972 had been extended. William E. Frantz and Clarence H. Glover, Jr., for the petitioner.Lourdes M. DeSantis and Donald W. Williamson, Jr., for the respondent. Simpson, Judge. SIMPSON*412 OPINIONThe Commissioner determined deficiencies in the petitioner's Federal income taxes for 1971 through 1974 and additions to tax for each year under section 6653(b) of the Internal Revenue Code of 1954. 1 The petitioner has made a timely motion for summary judgment pursuant to Rule 121, Tax Court Rules of*128 Practice and Procedure, 2 wherein he seeks to establish that the statute of limitations bars the assessment and collection of such deficiencies and additions to tax.The petitioner, Francisco T. Espinoza, was a legal resident of Marietta, Ga., at the time he filed his petition in this case. He filed his original individual Federal income tax returns for 1971 through 1974 with the Internal Revenue Service Center, Chamblee, Ga.*413 The petitioner is a physician, and he reported the following amounts on his original returns for 1971 through 1974:NetProfessionalProfessionalprofessionalYearincomeexpenseincomeAGITax due1971$ 26,215.77$ 17,562.32$ 8,653.45$ 8,653.45$ 642.95197227,445.2520,715.326,729.936,729.93504.74197328,425.0023,150.265,274.745,288.63421.98197435,168.0024,829.7510,338.2510,338.25816.72Total 117,254.0286,257.6530,996.3731,010.262,386.39*129 In the early part of 1976, Revenue Agent Michael Rosser was assigned the investigation of Dr. Espinoza's Federal income tax liability. In connection with such investigation, the agent mailed a letter to the petitioner on March 29, 1976, informing him that an audit was being conducted of his Federal income tax return for 1974. Subsequently, the agent received a telephone call from the attorney then representing the petitioner, and a conference was scheduled to be held at the office of the accountant for Dr. Espinoza. On June 21, 1976, at the beginning of the conference, the attorney handed the revenue agent a letter signed by Dr. Espinoza transmitting four documents stamped "amended return" for 1971 through 1974. These documents were prepared by the accountant.The transmittal letter was addressed to the IRS at Franklin Square Office Park in Marietta and read:Dear Sir:I am filing amended U.S. individual income tax returns for the following years with balance due Internal Revenue Service as listed:Amended Return1971$ 5,871.1919724,380.89197311,872.85197416,457.77$ 38,582.70Please acknowledge receipt of the above returns by affixing your receiving stamp*130 on the enclosed copy of this letter, or indicate receipt by you in a similar manner.Yours very truly,(S)Francisco T. EspinozaFrancisco T. Espinoza513-44-5779*414 No payments accompanied the letter. The agent acknowledged receipt of such letter and returns by signing a copy of the letter. After the conference, the agent returned to his office, and the documents were stamped as "Received" by the Audit Division, Marietta, Ga., on June 21, 1976. On June 23, 1976, the agent forwarded these amended returns directly to the Intelligence Division in Atlanta, Ga. Such amended returns reported the following amounts:NetProfessionalProfessionalprofessionalYearincomeexpensesincomeAGITax due1971$ 55,410.80$ 20,711.81$ 34,698.99$ 34,870.43$ 6,514.14197255,584.8324,333.6031,251.2331,117.314,885.63197378,713.4027,207.7851,505.6250,945.2512,294.83197480,045.6125,938.1954,107.4252,936.0617,274.49Total 269,754.6498,191.38171,563.26169,869.0540,969.09The amended returns were not forwarded to the Service Center and were not assigned document locator numbers. The individual master file records*131 maintained by the Atlanta Service Center contain no record of any amended tax returns having been filed in the petitioner's name for 1971 through 1974. The additional taxes due on the amended returns were never assessed, and the certificate of assessments reveals that the petitioner never paid any additional taxes for the years 1971 through 1974 based on the submission of such amended returns.The Intelligence Division conducted an independent investigation of Dr. Espinoza's tax liability for the years 1971 through 1974. His income was computed on the basis of a bank deposit analysis, and many third parties were interviewed. After the Intelligence Division completed its investigation, Dr. Espinoza was indicted by the grand jury in the U.S. District Court for the Northern District of Georgia, Atlanta Division, on four counts of willfully and knowingly attempting to evade and defeat a large part of his income taxes for 1971 through 1974 in violation of section 7201. On June 27, 1978, he was acquitted of such charges after a jury trial. In September 1978, the Intelligence Division closed its case involving Dr. Espinoza *415 and referred the matter to the Chief of the Examination*132 Division for purposes of a civil examination.The records of the IRS contain a consent (Form 872) to extend the statute of limitations for 1972 until April 15, 1980. Such consent was executed by the petitioner on March 1, 1979, and by the IRS on March 9, 1979.On March 31, 1980, the Commissioner issued his notice of deficiency. In such notice, he determined that Dr. Espinoza had received the following amounts of net income from self-employment for the years 1971 through 1974 and that he was liable for the following amounts of deficiencies in income taxes and additions to tax under section 6653(b) for such years:YearNet incomeDeficiencyAddition to tax1971$ 25,258.78$ 2,567.68$ 1,283.84197227,915.733,307.941,653.97197348,471.329,942.024,971.01197447,563.0113,732.146,866.07In his motion for summary judgment, the petitioner claims that the Commissioner's proposed deficiencies for 1971 through 1974 are barred by the statute of limitations. For the limited purposes of this motion, Dr. Espinoza has conceded that his original returns were fraudulent. He takes the position that on June 21, 1976, he filed nonfraudulent amended returns and that*133 the filing of such amended returns started the running of the 3-year period of limitations under section 6501(a). Since the notice of deficiency was issued more than 3 years after the filing of such returns, he argues that it was untimely. In opposition, the Commissioner asserts that such notice was timely under section 6501(c) since the original returns were fraudulent and since the purported amended returns were never in fact "filed" so as to commence the running of any period of limitations. He also claims that the petitioner executed a consent extending to April 15, 1980, the period for assessing any deficiency for 1972. For these reasons, he maintains that there are material issues of fact so that the motion for summary judgment should not be granted.Summary judgment under Rule 121 is derived from rule 56 of the Federal Rules of Civil Procedure. Hence, in any question turning on the interpretation of Rule 121, the history of rule 56, Federal Rules of Civil Procedure, and the authorities *416 interpreting such rule are considered by the Tax Court. See Hoeme v. Commissioner, 63 T.C. 18">63 T.C. 18 (1974); Shiosaki v. Commissioner, 61 T.C. 861">61 T.C. 861 (1974).*134 Summary judgment is a device used to expedite litigation and is intended to avoid unnecessary and expensive trials of "phantom factual questions." Cox v. American Fidelity & Casualty Co., 249 F.2d 616">249 F.2d 616, 618 (9th Cir. 1957); Shiosaki v. Commissioner, supra. However, summary judgment is not a substitute for a trial in that disputes over factual issues are not to be resolved in such proceedings. Matson Navigation Co. v. Commissioner, 67 T.C. 938">67 T.C. 938 (1977); Giordano v. Commissioner, 63 T.C. 462">63 T.C. 462 (1975). Thus, in considering a motion for summary judgment, the Court must decide whether there are any factual issues to be tried. Hoeme v. Commissioner, supra; Vickery v. Fisher Governor Co., 417 F.2d 466">417 F.2d 466 (9th Cir. 1969); Byrnes v. Mutual Life Insurance Co. of N.Y., 217 F.2d 497">217 F.2d 497 (9th Cir. 1954).A motion for summary judgment is granted only when it is shown that "there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law." Rule 121(b). Since*135 the granting of a summary judgment motion is to decide an issue against a party without allowing him an opportunity for a trial, such action has been frequently called a "drastic remedy" to be cautiously invoked and used sparingly after a careful consideration of the case reveals that the requirements have clearly been met. See Associated Press v. United States, 326 U.S. 1">326 U.S. 1, 6 (1945); Flli Moretti Cereali v. Continental Grain Co., 563 F.2d 563">563 F.2d 563 (2d Cir. 1977); United States v. Bosurgi, 530 F.2d 1105">530 F.2d 1105 (2d Cir. 1976).The party moving for summary judgment has the burden of showing the absence of a genuine issue as to any material fact. Weinberger v. Hynson, Westcott & Dunning, 412 U.S. 609">412 U.S. 609, 621-622 (1973); Adickes v. Kress & Co., 398 U.S. 144">398 U.S. 144, 158-159 (1970). The opposing party is to be afforded the benefit of all reasonable doubt, and any inference to be drawn from the underlying facts contained in the record must be viewed in a light most favorable to the party opposing the motion for summary judgment. See United States v. Diebold, Inc., 369 U.S. 654">369 U.S. 654, 655 (1962);*136 American Mfrs. M. I. Co. v. American Broadcasting-Para. Th., 388 F.2d 272">388 F.2d 272, 279 (2d Cir. 1967); 10 C. Wright & A. Miller, Federal Practice and Procedure: Civil, sec. *417 2725 (1973), and cases cited therein. Ordinarily, summary judgment should not be granted in a case in which intent is an issue. Hoeme v. Commissioner, supra; Shiosaki v. Commissioner, supra.Summary judgment is particularly inappropriate where the inferences which the parties seek to have drawn deal with questions of motive and intent; such inferences of fact are to be drawn only at trial. See Cross v. United States, 336 F.2d 431">336 F.2d 431, 433 (2d Cir. 1964).We consider first the question of whether the petitioner filed amended returns that started the running of the 3-year period of limitations. Section 6501(a) sets out the general rule of limitations on assessment and provides, in part:Except as otherwise provided in this section, the amount of any tax * * * shall be assessed within 3 years after the return was filed (whether or not such return was filed on or after the date prescribed) * * *137 *Section 6501(c) contains a number of exceptions to this general rule, including the provisions of paragraph (1) that:In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax, may be begun without assessment, at any time.Section 6501(e) sets forth another exception and provides, in part:SEC. 6501(e). Substantial Omission of Items. -- Except as otherwise provided in subsection (c) -- (1) Income taxes. -- In the case of any tax imposed by subtitle A -- (A) General rule. -- If the taxpayer omits from gross income an amount properly includable therein which is in excess of 25 percent of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such may be begun without assessment, at any time within 6 years after the return was filed. * * *This issue was recently dealt with by this Court in Klemp v. Commissioner, 77 T.C. 201">77 T.C. 201 (1981), on appeal (9th Cir., Nov. 2, 1981). In that case, the petitioners had also filed a motion for summary judgment. For purposes of such motion, it*138 was stipulated that the petitioners had originally filed fraudulent returns and that they had later filed nonfraudulent amended returns. It was also stipulated that in the original returns, there was an omission of more than 25 percent of the income reported on the returns. We held that the filing of the nonfraudulent amended returns started the running of the 3-year *418 period of limitations and that since the notice of deficiency had not been issued until after the expiration of such period, we granted the motion for summary judgment. We reasoned that since the amended returns were not fraudulent, there was no basis for allowing the Commissioner an unlimited period to audit the returns and determine a deficiency. We also concluded that since the original returns were fraudulent, they were to be disregarded and that therefore they did not start the running of the 6-year period of limitations under section 6501(e). See also Dowell v. Commissioner, 614 F.2d 1263">614 F.2d 1263 (10th Cir. 1980), revg. 68 T.C. 646">68 T.C. 646 (1977).3*139 In the case now before us, the facts concerning the filing of the amended returns are materially different from those in Klemp and Dowell. In Klemp, the amended returns were also handed to the IRS agent; but, there, the parties stipulated that the amended returns were filed, and the deficiencies were based on the amended returns. 77 T.C. at 201 n. 2. In Klemp, there was no doubt that the petitioners in good faith intended to have the documents filed as amended returns. In Dowell, the amended returns were properly filed, except that two of them were not properly signed. The court concluded that since the IRS had accepted the returns and relied on them in both the criminal and civil cases, the IRS was in no position to claim that the unsigned returns did not start the running of the statute of limitations on assessment. 614 F.2d at 1267. In the present case, there is a substantial question as to whether the amended returns were filed.Section 6501does not define the word "filed." However, the statutory requirements for filing returns are contained in section 6091. In general, section 6091(b)(1)(A) provides*140 that a return of persons other than corporations shall be made to the Secretary:(i) in the internal revenue district in which is located the legal residence or principal place of business of the person making the return, or(ii) at a service center serving the internal revenue district referred to in clause (i), as the Secretary may by regulations designate.*419 Section 6091(b)(4) provides that when a tax return of an individual is hand carried, it shall be made in accordance with section 6091(b)(1)(A)(i).The regulations under section 6091 contain additional rules for the filing of tax returns. Section 1.6091-2(a)(1), Income Tax Regs., states, in part, that:income tax returns of individuals * * * shall be filed with the district director for the internal revenue district in which is located the legal residence * * * of the person required to make the return * * *However, paragraph (c) of such section provides, in part, that:whenever instructions applicable to income tax returns provide that the returns be filed with a service center, the returns must be so filed in accordance with the instructions.In 1976, paragraph (d)(1) of such section added that:Returns*141 of persons other than corporations which are filed by hand carrying shall be filed with the district director as provided in paragraph (a) of this section. 4Under paragraph (e) of such section, amended returns that are not hand carried are to be filed with a Service Center. Section 301.6091-1(c), Proced. & Admin. Regs., defines hand carrying in the following manner:a return or document will be considered to be hand carried if it is brought to the district director by the person required to file the return or other document, or by his agent. * * *Thus, an analysis of these provisions of section 6091 and the regulations thereunder indicates that hand carried amended returns are to be filed with the District Director.*142 In Lucas v. Pilliod Lumber Co., 281 U.S. 245">281 U.S. 245, 249 (1930), the Supreme Court declared that "meticulous compliance by the taxpayer with all named conditions" is necessary to start the running of a statute of limitations on assessment. See also Florsheim Bros. Dry Goods Co. v. United States, 280 U.S. 453">280 U.S. 453 (1930). In addition, it has been held that the hand delivery of a *420 return to an IRS agent does not constitute the filing of a return. See W. H. Hill Co. v. Commissioner, 64 F.2d 506">64 F.2d 506 (6th Cir. 1933), affg. 23 B.T.A. 605">23 B.T.A. 605 (1931); O'Bryan Bros. v. Commissioner, 127 F.2d 645">127 F.2d 645 (6th Cir. 1942), affg. 42 B.T.A. 18">42 B.T.A. 18 (1940).5In W. H. Hill Co., the taxpayer changed from a calendar*143 year to a fiscal year basis for filling its tax returns, but in making the change, there was a 3-month period ending March 31, 1920, for which no return was filed. Upon a subsequent audit, a revenue agent discovered the error and prepared an amended return covering such period. The corporate officers signed such return, and the agent promised the officers that he would attend to the filing. The agent forwarded such return, along with his examination report, to the revenue agent in charge, and the agent in charge in turn confirmed receipt by forwarding a copy of the return and the agent's report to the corporation. More than 5 years later, the Commissioner issued a notice of deficiency based on the corporation's failure to file a return for the 3-month period. The Board of Tax Appeals, in construing the predecessor of section 6091, 6 held that the notice was timely, writing that:It is no part of the duties of an internal revenue agent or of an internal revenue agent in charge to file returns for taxpayers. That is the duty which law places on the shoulders of the taxpayers. The petitioner did not file a return for the fiscal year ended March 31, 1920. Since no return has *144 been filed covering the income of such period, the statute of limitations has not begun to run as to this fiscal year. * * * [23 B.T.A. at 607-608.]In affirming such holding, the Sixth Circuit said:there seems to be a radical difference between lodging a paper, designated a return, with the commissioner, and filling the same paper with the collector. In the first case, no tax is assessed and no payment is required until the commissioner shall have acted on the record before him. In the other, the amount of the tax is immediately entered upon the appropriate list and collection is made in due course unless a claim for abatement is filed which will suspend the running of the statute. Here the law required that returns *421 be filed with the collector. [Emphasis in original.] This was obviously for the purpose of facilitating the prompt and orderly assessment and collection of taxes. At best the internal revenue agent was but the agent of the taxpayer for the purpose of filing the returns, and the situation is no different than it would have been had the taxpayer itself delivered the returns to the commissioner. [64 F.2d at 507-508;*145 emphasis added.]Similarly, in O'Bryan Bros., the court found that the submission of a gift tax return to an agent was insufficient to commence the running of the period of limitations on assessment. There, the taxpayer mailed his return to the internal revenue agent in charge, and after writing to the taxpayer, the agent in fact forwarded the return to the collector for filing. The notice of deficiency was issued more than 3 years after the taxpayer had mailed the return to the agent but less than 3 years after it had been filed with the collector. The taxpayer argued that the assessment was barred by the 3-year statute of limitations. There, too, the Sixth Circuit*146 insisted upon specific compliance with the statutory filing requirement 7 and held the notice to be timely; the court said:It was the duty of the taxpayer under this statute to file the return with the collector of the district. It was not the duty of the internal revenue agent in charge to file a return for the taxpayer. * * * 8 [127 F.2d at 647.]A long line of cases has established that the running *147 of the statute of limitations on assessment requires the taxpayer to prove the date of the filing of a return. See United States v. Gurley, 415 F.2d 144">415 F.2d 144, 147 (5th Cir. 1969); Young v. Commissioner, 208 F.2d 795">208 F.2d 795 (4th Cir. 1953), affg. a Memorandum Opinion of this Court; BJR Corp. v. Commissioner, 67 T.C. 111">67 T.C. 111, 119 (1976). Where there is a question as to whether the return was filed, the records of the IRS are an item of evidence. See, e.g., Parker v. Commissioner, 365 F.2d 792">365 F.2d 792, 800 (8th Cir. 1966), affg. on this issue a Memorandum Opinion of this Court; BJR Corp. v. Commissioner, supra at 121. Moreover, the absence of an entry on such record is evidence of the nonoccurrence of an *422 event ordinarily recorded. Fed. R. Evid. 803(10); see United States v. Johnson, 577 F.2d 1304">577 F.2d 1304, 1312 (5th Cir. 1978); United States v. Harris, 551 F.2d 621">551 F.2d 621, 622 (5th Cir. 1977); see also United States v. Lanier, 578 F.2d 1246">578 F.2d 1246, 1255 (8th Cir. 1978); United States v. Zeidman, 540 F.2d 314">540 F.2d 314 (7th Cir. 1976).*148 The record in this case leaves considerable doubt as to whether the amended returns were filed by the petitioner on June 21, 1976. They were handed to the revenue agent; they were not handed to the District Director. It was not the responsibility of the revenue agent to transmit such returns for filing, and in fact, the evidence indicates that they were never filed. Since they were not filed, the additional taxes shown thereon were never assessed. Moreover, although the petitioner's transmittal letter recognized that the amended returns called for the payment of additional taxes, he did not transmit such payments with the amended returns, and so far as we know, he never paid the additional taxes. His failure to pay the additional taxes raises a question as to whether he intended for the amended returns to be filed. Finally, the IRS did not rely on the amended returns in either the criminal or civil cases against the petitioner; instead, the IRS agents made an independent investigation to determine the petitioner's income, and they concluded that his income was somewhat different from that shown on the amended returns. In view of this record, we conclude and hold that the petitioner*149 has failed to prove that he is entitled to summary judgment that the statute of limitations bars a notice of deficiency for the years 1971 through 1974.There is an additional ground for denying the petitioner's motion with respect to 1972. Section 6501(c)(4) states, in part:Where, before the expiration of the time prescribed in this section for the assessment of any tax imposed by this title * * * both the Secretary and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. * * *In connection with his objections to the petitioner's motion, the Commissioner produced an extension which he claims was executed in accordance with such provision. The form appears to have been executed by both the petitioner and a representative of the Commissioner and to have been executed within 3 years after the alleged filing of the amended returns in 1976. *423 Accordingly, even if the amended returns were considered to be filed at such time, such consent, if validly executed, would have extended the time for assessing any deficiency for 1972. Thus, in any event, there is a question*150 as to whether the statute of limitations had expired for 1972 before the issuance of the notice of deficiency. For that reason, we would not, in any event, grant the petitioner's motion for summary judgment insofar as it relates to 1972.An appropriate order will be issued. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during 1976, unless otherwise indicated.↩2. All references to a Rule are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩3. For recent cases applying the Klemp rationale, see Nesmith v. Commissioner, T.C. Memo 1981-561">T.C. Memo. 1981-561; Badaracco v. Commissioner, T.C. Memo. 1981-404, on appeal (3d Cir., Nov. 6, 1981); Britton v. United States, 532 F. Supp. 275">532 F. Supp. 275 ( D. Vt. 1981, 49 AFTR 2d 82-471, 81-2 USTC par. 9739); Deleet Merchandising Corp. v. United States, 535 F. Supp. 402">535 F. Supp. 402 ( D. N.J. 1981, AFTR 2d , 82-1↩ USTC par. 9184).4. Such regulation was amended in 1977 by T.D. 7495, 2 C.B. 469">1977-2 C.B. 469↩, to insert after the words "district director" the following parenthetical phrase: "(or with any person assigned the administrative supervision of an area, zone or local office constituting a permanent post of duty within the internal revenue district of such director)." Such amendment was not applicable at the time of the alleged filing of the amended returns in this case, and in any event, the revenue agent is not such an official.5. See also Harrod v. Commissioner, T.C. Memo 1961-300">T.C. Memo. 1961-300; Kotovic v. Commissioner, T.C. Memo. 1959-177↩.6. Sec. 241(b), Revenue Act of 1918, provided that:"Returns shall be made to the collector of the district in which is located the principal place of business or principal office or agency of the corporation, or, if it has not principal place of business or principal office or agency in the United States, then to the collector at Baltimore, Maryland."↩7. Sec. 507(b) of the Revenue Act of 1932 required that returns be filed "with the collector for the district in which is located the legal residence of the donor."↩8. When the issue is not the running of the statute of limitations on assessment, the courts have adopted a less strict view of what constitutes the filing of a return. Compare Bookwalter v. Mayer, 345 F.2d 476">345 F.2d 476 (8th Cir. 1965); Ardbern Co. v. Commissioner, 120 F.2d 424">120 F.2d 424 (4th Cir. 1941), modifying and remanding 41 B.T.A. 910">41 B.T.A. 910↩ (1940). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624906/ | William S. Gilman II and Jean A. Gilman, Petitioners v. Commissioner of Internal Revenue, RespondentGilman v. CommissionerDocket No. 7641-77United States Tax Court72 T.C. 730; 1979 U.S. Tax Ct. LEXIS 84; August 1, 1979, Filed *84 Decision will be entered under Rule 155. Held: 1. Under sec. 1.165-3(b)(1), Income Tax Regs., the demolition cost of a roof to a building used in petitioner's business so that a second floor could be added to that building is a deductible loss;2. The cost of scrapping air conditioners belonging to petitioners' tenants and replacing them with air conditioners usable on second floor roof, necessitated by demolition of first floor roof, is part of the demolition cost of the roof;3. Petitioners failed to substantiate claimed deductions for entertainment expenses under the requirements of sec. 274(a) and (d), I.R.C. 1954, but did substantiate a few items of other business expenses disallowed by respondent; and4. Petitioners failed to show error in respondent's determination of an addition to tax under sec. 6653(a), I.R.C. 1954. John B. Bamberg, for the petitioners.Roger D. Osburn, for the respondent. Scott, Judge. SCOTT *730 Respondent determined deficiencies in petitioners' Federal income tax for the taxable years 1973 and 1974 in the amounts of $ 7,008.26 and $ 4,314.75, respectively, and determined additions to tax for those years under section 6653(a), I.R.C. 1954, 1 of $ 350.41 and $ 215.74, respectively.Some of the issues raised by the pleadings have been disposed of by agreement of the parties leaving for our decision:(1) Whether petitioners are entitled to deduct for the year 1973 expenses for the demolition of air conditioning units owned and maintained by tenants in petitioners' office building and replacement thereof and the costs incurred in demolishing the roof of their office building, both of which costs were incurred in order to construct*88 an additional story to the office building;(2) Whether petitioners have substantiated in accordance with the requirements of section 274 all or any part of the deduction for entertainment expenses claimed on their returns; and(3) Whether petitioners are liable for the additions to tax for negligence or intentional disregard of the rules and regulations.*731 FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Petitioners William S. Gilman II and Jean A. Gilman, who resided in Winter Park, Fla., at the time of the filing of their petition in this case, filed joint Federal income tax returns for the calendar years 1973 and 1974 with the Internal Revenue Service Center in Chamblee, Ga.Mr. Gilman (hereinafter referred to as petitioner) in 1973 and 1974 was a practicing attorney in the Florida communities of Winter Park and Orlando. Petitioner in the years here in issue was also engaged in the real estate business. His real estate activities included the ownership of a shopping mall in Winter Park, Fla., and being an officer and director of Roberts & Gilman, 2 a real estate sales company in Florida.*89 In 1964, petitioner acquired the Park Mall Building, a small, one-story office building with some retail shops. Pursuant to petitioner's standard procedures, the leases of the Park Mall tenants required them to provide and maintain their own heating and air conditioning systems. Traditionally, when a tenant would vacate the building, the new tenant would purchase the systems from the vacating tenant. Only once did a tenant remove the systems when he vacated the premises.The areas which were cooled and heated by the units were relatively small, 400- 600-square-foot rooms. Window air conditioners could have been used, but they would have been unattractive. For this reason, small compressors and air handling units were placed in the ceiling of the building.In 1973, petitioner decided to add a second level to the building. Construction of the addition was begun in February of 1973 and completed in September 1973. In order to move the existing air conditioners to the roof of the second floor, it would have been necessary to have large air ducts passing through the offices of the second floor. For this reason, petitioner decided to have the old air conditioning units removed and*90 provide new ones at his expense to the tenants. 3Petitioner expended $ 7,094.14 to remove the old air conditioners *732 which were scrapped and replace them with new ones. Petitioner spent $ 2,253.40 for the demolition of the first-level roof before addition of the second level. Demolition of the roof was necessary in order to pour the slab for the second floor.Between the years 1971 and 1975, petitioner's responsibility in his law firm was to obtain business for the firm. Petitioner traveled in connection with his law practice and also in the operation of his real estate business.Petitioner owned 50 percent of a corporation, W.S.G., Inc., which rented out a twin-engine Aero Commander airplane. Petitioner and his coowner in the corporation were given first call in renting the plane. In the years at issue, petitioner*91 rented the airplane from his corporation for business-related travel on numerous occasions. On these trips, petitioner often took business associates.Petitioner also maintained a 55-foot yacht on which he entertained for business and social purposes. In connection with the use of his yacht, petitioner incurred bills in 1973 at the Ocean Reef Club, Walker's Cay Club, Sombrero Club, and Cannonport Club. In 1974, petitioner incurred bills at the Sombrero Club and Cannonport Club.Petitioner also purchased liquor for use on his airplane and his yacht at Deluxe liquors in both 1973 and 1974.In both 1973 and 1974, petitioner was a dues paying member of the Orlando Country Club and the Orlando University Club. Petitioner and his wife both used the facilities of the Orlando Country Club during the years 1973 and 1974.During the years 1973 and 1974, petitioner paid by checks (1) a total of $ 479.95 and $ 582.67, respectively, to the University Club; (2) a total of $ 1,010.11 and $ 997.30, respectively, to the Orlando Country Club; (3) a total of $ 774 and $ 1,325, respectively, to Deluxe Liquors; (4) a total of $ 925 and $ 1,500.75, respectively, to American Express Co. for charges *92 made on his American Express card; (5) a total of $ 484 and $ 1,350, respectively, to BankAmericard for charges made to his BankAmericard account; (6) a total of $ 181 and $ 1,688, respectively, to the Cannonport Club; and (7) a total of $ 842 and $ 110, respectively, to the Sombrero Key Club. In 1973, petitioner paid by checks a total of $ 1,234 and $ 1,173.98 to the Ocean Reef Club and Walker's Cay Club, respectively. Also, petitioner in 1974 paid a total of $ 699 by three checks to a pilot of the plane owned by the *733 corporation in which he owned a 50-percent interest. In 1974, petitioner paid $ 21 by check to National Car Rental. Petitioner gave a check for $ 150 in 1974 to John Ivey, who was the foreman of the construction company that had done the work for the addition of the second floor to petitioner's Park Mall Building. Petitioner made this gift because of the good work the foreman had done. Petitioner paid $ 10 by check in 1974 to the Winter Park Chamber of Commerce. He paid $ 70 by check in 1973 to the Olympic dinner but did not attend. He paid $ 110 by check in 1974 to Brandel Stevens for rental of an airplane and $ 303 to Hook Travel. Petitioner in 1974*93 paid $ 10.40 by check to Lucy Little for flowers for a deceased client and wrote a $ 400 check for cash with the notation: "Dallas Trip." With the checks for payment of his American Express and BankAmericard bills petitioner had some receipts showing the establishments at which the items were purchased but these receipts contained no additional information. Among the American Express receipts is a payment made on November 6, 1973, to the St. Regis Sheraton Hotel in New York City of $ 39.24 and a payment made on November 6, 1973, to the Laurent Restaurant in New York City of $ 127.27. In August 1973, petitioner paid $ 95.28 to the Key Biscayne Yacht Club for dockage fees and food. Petitioner has some of the statements from the University Club and Orlando Country Club which he paid by check, but these statements show only the nature of the charge such as "restaurant" and "bar" and no other information.Petitioner did not keep a contemporaneous diary, account book, or the like for his 1973 and 1974 travel or entertainment expenses. Petitioner had his returns for both 1973 and 1974 prepared by certified public accountants. He turned his records over to the accountants for use in *94 preparation of his returns. Before signing the return for each of the years 1973 and 1974, petitioner read it over.At the time of the trial, petitioner did not have all the records he had furnished his accountants. He did not know where the balance of his records were or exactly how they might have been lost. Petitioner moved from one office to another after 1974. Also, his records were extensively examined by the Federal Bureau of Investigation (FBI) in connection with an investigation unrelated to him.Petitioner, on his 1973 Federal income tax return, claimed a *734 business expense deduction of $ 6,834 as "unreimbursed entertainment," and on his 1974 return, under this same designation, claimed a business expense deduction of $ 8,376.Respondent, in his notice of deficiency, disallowed all of petitioner's entertainment expenses with the following explanation:The deductions of $ 11,671.00 and $ 15,981.00 claimed for employee business expenses in 1973 and 1974, respectively, are not allowable in full, because it has not been established that any amount in excess of $ 5,523.00 and $ 7,953.00, respectively, for the years 1973 and 1974 represents an ordinary and necessary*95 business expense or was substantiated by adequate records or by sufficient evidence corroborating your own statements as to (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, recreation, or use of the facility, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship of persons entertained, using the facility, or receiving the gift. Accordingly, income is increased $ 6,148.00 for the tax year 1973 and $ 8,028.00 for the tax year 1974. 4*96 Petitioner, on Form 4831, Rental Income, attached to his 1973 income tax return, claimed under "Expenses" Item "21 -- Other (list)" a deduction of $ 9,348 explained as "Expense of moving tenants and equipment for new construction." Respondent in his *735 notice of deficiency disallowed this deduction with the following explanation:It is determined that the deduction of $ 9,348.00 claimed as the cost of moving tenants and equipment because of new construction represents a capital expenditure under section 263 of the Internal Revenue Code and, therefore, is not allowable. Accordingly, income for the tax year 1973 is increased $ 9,348.00.In respondent's notice of deficiency, it was also determined that part of the underpayment of tax as determined for 1973 and 1974 was due to negligence or intentional disregard of the rules and regulations. Therefore, a 5-percent addition to tax was asserted under section 6653(a) for each of these years.OPINIONPetitioner deducted the amount expended to remove the tenants' air conditioners and replace them with new ones and the cost of demolishing the roof on the Park Mall Building as an expense on the schedule of rental income on his 1973 *97 Federal income tax return. However, in his brief, he refers to section 1.165-3, Income Tax Regs., dealing with the deductibility of demolition losses. Although it is not completely clear from petitioner's argument, he is apparently contending that the $ 9,348 which he deducted from rental income is, in fact, a deductible loss under section 165.Respondent in his brief does not specifically address the issue of whether the cost of removing the tenants' air conditioners and replacing them with new ones and of demolishing the roof on the office building should be considered a demolition loss under section 165(a) and section 1.165-3(b)(1), Income Tax Regs.5*100 *736 Respondent argues that "the demolition expenses were clearly capital expenses within the meaning of section 263 rather than ordinary and necessary business expenses under section 162." In support of this argument, he cites such cases as Coors Porcelain Co. v. Commissioner, 52 T.C. 682">52 T.C. 682, 688-693 (1969); Jones v. Commissioner, 25 T.C. 1100">25 T.C. 1100 (1956), remanded on other grounds 259 F.2d 300">259 F.2d 300 (5th Cir. 1958); and Difco Laboratories, Inc. v. Commissioner, 10 T.C. 660">10 T.C. 660 (1948).*98 The Coors Porcelain Co. case deals with the deduction for obsolescence. In Jones v. Commissioner, supra at 1103, we stated with respect to the demolition of a small warehouse:Raymond decided in 1949 to demolish a small warehouse in order to make way for the construction of a new building or buildings. He had used the warehouse for some time prior thereto for the storage of tools and parts. The adjusted basis of the warehouse is not deductible from income of 1949 under such circumstances but must be added as a part of the cost of the new asset constructed in its place. Estate of Edgar S. Appleby, 41 B.T.A. 18">41 B.T.A. 18, affd. 123 F.2d 700">123 F.2d 700; Henry Phipps Estates, 5 T.C. 964">5 T.C. 964. 6*737 Difco Laboratories, Inc. v. Commissioner, supra, involved the issue of whether certain alterations to buildings were repairs and therefore deductible as business expenses or improvements which were required to be capitalized. Respondent also cites a number of cases holding that where work that might otherwise be considered as a repair which is a deductible*99 business expense is done in conjunction with an overall remodeling program the cost of the work must be capitalized as part of the overall remodeling program.*101 Other than Jones v. Commissioner, supra, the cases cited by respondent do not address directly the question of deductibility of a demolition loss or what constitutes a demolition loss. Jones v. Commissioner was decided prior to the adoption of the present regulations with respect to demolition losses. Since the adoption of these regulations, we have consistently held that if property was acquired with the intent to demolish a building located thereon, the building has no basis separate from the land and the total amount paid for the property plus the cost of demolition less salvage value received becomes a part of the cost of the land acquired, but if the intent to demolish is formed after the land is acquired, the demolition loss is a deductible loss under section 165(a). Storz v. Commissioner, 68 T.C. 84">68 T.C. 84, 97-98 (1977), revd. on another issue 583 F.2d 972">583 F.2d 972 (8th Cir. 1978). Since adoption of these regulations, a demolition loss, where the intent to demolish was formed after the acquisition of the business property or where the property had previously been used for personal purposes after*102 its conversion to business property, has been held to be deductible even though the demolition was for the purpose of permitting the erection of a new building on the land. McBride v. Commissioner, 50 T.C. 1">50 T.C. 1 (1968); Canelo v. Commissioner, 53 T.C. 217">53 T.C. 217, 229 (1969). 7 In Levinson v. Commissioner, 59 T.C. 676">59 T.C. 676, 679-680 (1973), we stated in this respect:*738 Nor are we impressed with petitioners' further argument that section 1.165-3(b)(2) is invalid because it establishes an arbitrary exception to the general rule of deductibility prescribed in section 1.165-3(b)(1). In support of this contention, petitioners have favored us with a comprehensive analysis of respondent's prior regulations and the case law in respect thereto, much of which is set forth in Herman Landerman, 54 T.C. at 1045-1047, and Landerman v. Commissioner, 454 F.2d 338">454 F.2d 338, 340-341 (C.A. 7, 1971). Under that case law, a taxpayer who demolished an old building in order to replace it with a new one was required to add the adjusted basis of the old building to the*103 basis of the new building rather than deduct it as a loss, even when the intent to demolish was formed subsequent to the acquisition of the demolished buildings. A. Raymond Jones, 25 T.C. 1100">25 T.C. 1100, 1103 (1956), reversed on another issue 259 F.2d 300">259 F.2d 300 (C.A. 5, 1958); Henry Phipps Estates, 5 T.C. 964">5 T.C. 964 (1945); Estate of Edgar S. Appleby, 41 B.T.A. 18 (1940), affd. 123 F.2d 700">123 F.2d 700, 702 (C.A. 2, 1941). As under current section 1.165-3(b)(2), however, the earlier cases held that a lessor who demolished a building in order to construct a new one was required to amortize the basis of the demolished building over the term of the lease, where the demolition was either permitted or required by the terms of the lease. Estate of Clara Nickoll, supra; Laurene Walker Berger, 7 T.C. 1339">7 T.C. 1339 (1946); Anahma Realty Corporation, 16 B.T.A. 749">16 B.T.A. 749 (1929), affd. 42 F.2d 128">42 F.2d 128 (C.A. 2, 1930); Chas. N. Manning, et al., 7 B.T.A. 286 (1927). See also Rev. Rul. 67-410, 2 C.B. 93">1967-2 C.B. 93.*104 Petitioners' contention is that the current regulation unlike the position taken in the earlier cases makes an arbitrary distinction in providing for different treatment of demolitions depending on whether or not an existing lease is involved. Petitioners maintain that a taxpayer is in the same economic position and should be entitled to deduct a loss in the year of demolition whether he (1) first demolishes the old building, erects a new building on the same site, and then leases the new building, or (2) first leases a new building to be constructed, demolishes the old building, and then erects the new building on the same site.Petitioners' argument ignores a critical distinction between the two situations. In one, the taxpayer has, by virtue of the lease, acquired a valuable right and the demolition is an essential precondition to his realization of the economic benefits therefrom. In the other such a direct causal relationship between the acquired right and the demolition is lacking, although admittedly every taxpayer who constructs a new building with the intention of leasing it necessarily recognizes that any existing building on the same site must be demolished before his*105 objective can be realized. In essence the respondent has simply adapted an old saying by incorporating into his regulations a recognition of the fact that a taxpayer with "a bird in the hand" is in a different *739 position than a taxpayer with "two in the bush." In this connection we note in passing that the provisions of section 1.165-3(b)(1) also apply where no lease is involved, i.e., where a taxpayer demolishes an old building and constructs a new one for his own use. [Fn. ref. omitted.]*106 If petitioner is correct in his contention that the cost of replacing the tenants' air conditioners which had to be demolished in connection with the addition of the second story and the cost of demolishing the roof of the office building should be considered as the demolition of a building, then it would appear that petitioner is correct in his contention that the loss is deductible under section 165(a) and section 1.165-3(b), Income Tax Regs. However, if a demolition loss applies only to the demolition of an entire building, the question becomes whether the cost of demolishing the roof and the replacement of the tenants' air conditioners was so directly tied to the construction of the second story of the Park Mall Building as to properly be considered capital expenditures rather than deductible business expenditures.Since the stipulation is that petitioner expended the $ 2,253.40 for demolition of the roof of the first level of the Park Mall Building before the addition of the second level, it is clear that if a demolition loss applies to a part of a building as well as to the whole building petitioner would be entitled to deduct the cost of demolishing the roof of the Park Mall*107 Building. While it is not specifically so stated, we interpret the stipulation to mean that the $ 2,253.40 was the net demolition cost of the roof. From the facts here, it is clear that petitioner did not intend to demolish the roof at the time he acquired the Park Mall Building in 1964. The evidence shows that petitioner's decision to add a second floor, thereby requiring the roof of the building to be demolished, was made shortly before the construction work for building the second floor began in 1973.We have found no recent cases specifically discussing the deductibility of the cost of partial demolition of a building. In a very early case, First National Bank of Evanston, Wyo. v. Commissioner, 1 B.T.A. 9 (1924), we held, under the provisions of article 142 of Regulations 62 as amended, 8*112 that a loss sustained *740 by a taxpayer as a result of a demolition of a part of a building in connection with an alteration of the building was a deductible loss. In that case we stated:The Commissioner has disallowed the deduction solely upon the ground that inasmuch as the building was not totally demolished the deduction claimed is not within *108 the purview of the law as interpreted by the regulation above quoted. The Board is of the opinion that this is not correct on principle; also, that the deduction is not inconsistent with the express language of the regulation. If it be admitted that an amount claimed as a deduction from gross income by a corporate taxpayer actually represents the depreciated cost of a portion of a building demolished, the Board is of the opinion that the amount claimed is a legal deduction from gross income when the alteration is made as an incident to the conduct of a business. * * *See also Steinbach Co. v. Commissioner, 3 B.T.A. 348">3 B.T.A. 348, 351, 355 (1926). Neither party has cited us to a case, nor have we found one, precisely discussing the point of whether a demolition of a part of a building in connection with an addition to or alteration of the building falls within the provisions of section 1.165-3(b), Income Tax Regs., allowing deduction for demolition losses. In Union Bed & Spring Co. v. Commissioner, 9 B.T.A. 352">9 B.T.A. 352-356 (1927), revd. 39 F.2d 383">39 F.2d 383 (7th Cir. 1930), we held the cost of demolition of part of *109 a building in connection with an alteration of the building not to be deductible on the ground that the taxpayer knew when he acquired the building that the alteration would be necessary, thereby requiring partial demolition of the building. In reversing our holding, the Circuit Court held that the partial demolition of a building in connection with making alterations should be recognized as a demolition loss and reversed our holding that the taxpayer intended to demolish a portion of the building when he acquired it rather than forming that intent at a later date. In Heyman v. Commissioner, 6 T.C. 799">6 T.C. 799, 801 (1946), in discussing the Circuit Court's opinion in Union Bed & Spring Co. v. Commissioner, supra, we did not question the holding that demolition of part of a building could give rise to a demolition loss but rejected the method of computation of that loss used by the Circuit Court. In Estate of Nickoll v. Commissioner, 32 T.C. 1346">32 T.C. 1346, 1349 (1959), affd. 282 F.2d 895">282 F.2d 895 (7th *741 Cir. 1960), we held that where a whole building was substantially demolished *110 as a necessary condition to the execution of a lease, the value of the demolished building was not a deductible loss but was a proper charge to the cost of acquiring the lease. In the Estate of Nickoll case we cited the Circuit Court opinion in Union Bed & Spring Co. v. Commissioner, supra, but considered it distinguishable. 9 The Seventh Circuit Court in affirming our decision, stated as follows in this regard (p. 898):Throughout this litigation taxpayers have relied on a line of cases based upon Union Bed & Spring Co. v. Commissioner of Internal Revenue, 7 Cir., 1930, 39 F.2d 383">39 F.2d 383. See also, Providence Journal Co. v. Broderick, 1 Cir., 1939, 104 F.2d 614">104 F.2d 614; Liberty Baking Co. v. Heiner, 3 Cir., 1930, 37 F.2d 703">37 F.2d 703; Lynchburg National Bank & Trust Co., 20 T.C. 670">20 T.C. 670, 674, affirmed 4 Cir., 1953, 208 F.2d 757">208 F.2d 757; N. W. Ayer & Son, Inc., 1951, 17 T.C. 631">17 T.C. 631. Taxpayers argue that these cases stand for the following propositions which control this case: that the intent of the taxpayer, with respect to*111 demolition, on the date of acquisition of the property is a controlling factor in determining whether a loss deduction is proper; that no loss is deductible if at the time of acquisition there was an intent to demolish; but that if the decision to demolish was made subsequent to acquisition because of an intervening event that made the building unusable, then a loss deduction is proper.We agree with these principles as an abstract statement of law.Taxpayers concede and the record amply demonstrates that taxpayers had no intent to demolish at the time of acquisition of the property. However, we find no intervening event that made the building in question unusable. Further, these cases on which taxpayers rely do not involve situations where the subsequent intent to demolish was intimately connected with and incidental to taxpayers' securing a valuable lease and ownership of a remodeled building as is the case here. They are not applicable to the situation before us.While cases such as McBride v. Commissioner, supra, and Canelo v. Commissioner, supra, make it clear that the fact that the old building was demolished in order to permit the new construction does not control the deduction of the demolition loss under section 165(a) and section 1.165-3(b), Income Tax Regs., now in effect, we have found no case under these regulations dealing with a demolition of a part*113 of a building. However, we find nothing in any of the cases, either before or after the promulgation of the present regulations, distinguishing between *742 demolition of a part of a building and demolition of the entire building as controlling whether a taxpayer is entitled to a demolition loss. Under section 1.165-3(b), Income Tax Regs., we conclude that petitioner is entitled to a deduction for the $ 2,253.40 for demolition of the roof of the Park Mall Building.The question with respect to the demolishing or scrapping of the air conditioners belonging to petitioner's tenants and replacing them at petitioner's expense with new air conditioners belonging to the tenants is more difficult. Because of the tenants' air conditioners being in the roof of petitioner's building it was necessary that they be removed in order for the roof to be demolished. The old air conditioners were scrapped and replaced by new air conditioners. It appears from the record that these air conditioners could have been removed without being scrapped but would not have been satisfactory to use on a second floor roof. The indication is that they were scrapped because the structure of the new building*114 was not suitable for use of these air conditioners. The scrapped air conditioners did not belong to petitioner. If the air conditioners had belonged to petitioner, any portion of their basis which had not been recovered by depreciation at the time they were scrapped would be deductible when they were scrapped, and the new air conditioners placed on the second story roof would be depreciable over their useful life. See Coors Porcelain Co. v. Commissioner, supra.However, the air conditioners were the property of the tenants and their scrapping in connection with the demolition of the roof of the building was effectively a part of the demolition cost of the roof. Since the new air conditioners, as were the old, were owned by the tenants, it appears realistic to consider the cost of these new air conditioners as a part of the cost of the demolition of the roof. Obviously, petitioner was obligated to compensate his tenants for their air conditioners when his demolition of the roof to the building required a scrapping of these air conditioners. Petitioner decided to discharge this obligation by replacement of the air conditioners scrapped with new air*115 conditioners. In our view, demolishing and replacing the air conditioners is so directly tied to the demolishing of the first floor roof that it was an integral part of that demolition cost. For this reason, we conclude that petitioners are entitled to deduct as a demolition loss under section 1.165-3(b)(1), Income Tax Regs., the $ 7,094.14 cost of *743 removing the old air conditioners and replacing them with new ones to be owned by the tenants.The second issue is how much, if any, of the amount petitioner claimed as deductible entertainment expenses for each of the years 1973 and 1974 has been substantiated under section 274 and the regulations issued pursuant thereto. Section 162(a) provides a deduction for all ordinary and necessary expenses paid or incurred in carrying on a trade or business. Section 162(a) deductions, however, are limited by the provisions of section 274. Section 274(a) limits deductions for items with respect to entertainment, amusement, or recreation activities and with respect to facilities used in connection with those activities. 10*118 Section 274(d) limits deductions for business expenses for entertainment, amusement, and recreation to those *116 items with respect to which --the taxpayer substantiates by adequate records or by sufficient evidence corroborating his own statement (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, recreation, or use of the facility, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons entertained, using the facility, or receiving the gift. * * * 11*744 Section 1.274-5(b)(1), Income Tax Regs., provides that no deduction shall be allowed for entertainment or a gift unless the taxpayer establishes the amount of each separate expenditure, the time, place, and business purpose of the expenditure, and the business relationship of the person entertained. 12Section 1.274-5(c), *745 Income Tax Regs., provides the rules for substantiation of each of the elements of the expenditures required by section 1.274-5(b), Income Tax Regs., to be shown. This section provides *746 for contemporaneously made written substantiation or, absent complete written substantiation, testimony of the person entertained. Section 1.274-5(c)(6)(b)(iii), *117 Income Tax Regs., provides for the rules governing primary use of a facility.*119 Respondent argues that in many instances petitioner has not even established that the amounts petitioner claims to be deductible as entertainment expenses were ordinary and necessary business expenses under section 162(a). Respondent contends that none of the expenditures meet the stringent requirements of section 274(a) or 274(d).Petitioner argues that he has met the requirements of section 274(d) by the records submitted into evidence coupled with petitioner's own testimony and respondent's acceptance of the business purpose of petitioner's traveling expenses during 1973 and 1974.We have reviewed in detail the records submitted and have considered those records in conjunction with petitioner's testimony and the records with respect to petitioner's travel. Except for a few items set forth below, we conclude that the records submitted by petitioner considered in conjunction with his testimony and travel records do not meet the requirements of section 274(d) and the regulations issued pursuant thereto.Petitioner claims $ 479.95 and $ 582.67 for University Club dues and business entertainment expenses at that club in 1973 and 1974, respectively. Petitioner maintains that he made*120 no personal use of the facility. Section 274(a)(1)(B) denies deductions for items with respect to a facility used for business entertainment unless the taxpayer establishes that the facility was used primarily for furtherance of his business and that the particular item was directly related to the active conduct of his business. Section 274(a)(2)(A) includes dues to social, athletic, or sporting clubs as subsec. (a)(1)(B) items.Section 1.274-5(c)(6)(iii), Income Tax Regs., provides that, unless a taxpayer keeps records to show for each claimed business use of a facility the amount of the expense, the time and business purpose of the entertainment, and the name and business relationship of the person entertained, a facility which is likely to serve a personal purpose shall be presumed to be primarily used for personal purposes.The only records petitioner kept of his use of the University Club were his checks made payable to that club. The club would *747 appear to be one serving personal purposes. Therefore, it must be presumed that the use of the facility was primarily personal.Section 274(d) requires substantiation of each of the uses of the facility by either adequate*121 records or sufficient evidence corroborating the taxpayer's own statement. In this case, there are no adequate records, no detailed statement by petitioner pertaining to the persons entertained at the facility, and no corroborative evidence. Petitioner has failed to substantiate the claimed deduction under section 274(d). See Rutz v. Commissioner, 66 T.C. 879">66 T.C. 879, 884 (1976), wherein it was noted that section 274(d) was meant to disallow deductions based on a taxpayer's unsupported, self-serving testimony. Also see Dowell v. United States, 522 F.2d 708">522 F.2d 708 (5th Cir. 1975).Petitioner also claims $ 1,010.11 and $ 997.30 for expenses incurred with respect to his membership in the Orlando Country Club in 1973 and 1974, respectively. Although petitioner did submit some 1973 statements sent him by the country club as well as checks made payable to that club, these statements do not show for what the expenditure was made or who, if anyone, was entertained. Petitioner has totally failed to meet the requirements of section 274(a)(1)(B) and section 274(d) with respect to his claimed deduction of the country club expenses.For the *122 same reasons, petitioner has failed to substantiate his claimed deductions of expenses incurred at the Cannonport Club, the Sombrero Key Club, the Ocean Reef Club, and Walker's Cay Club. With the exception of a couple of statements from the Ocean Reef Club, we are presented with no breakdown of the expenses petitioner incurred at these clubs. The statements from the Ocean Reef Club give no names or other necessary information. Most of the expenses, however, appear to have been in connection with a yacht owned by petitioner. As with the University Club and the Orlando Country Club, petitioner has failed to show that the yacht qualifies under section 274(a)(1)(B). Petitioner testified that he used the yacht both for personal and business entertainment. He has not shown the extent of either use and therefore has not shown that the yacht was used primarily for business. Additionally, the record is completely lacking the detailed information and the corroborative evidence required for substantiation under section 274(d). See Rutz v. Commissioner, supra.Petitioner claims that he is entitled to deduct $ 774 and $ 1,325 *748 paid to Deluxe Liquors*123 for beverages in the years 1973 and 1974, respectively. Petitioner has not met the requirements of section 274(d) with respect to these claimed deductions. Petitioner produced some checks made payable to Deluxe Liquors. Other than his testimony estimating that 75 percent of the beverages were used in a business context and 25 percent in a personal one, petitioner has offered no evidence of the actual use of the beverages. The individual check stubs which he retained were claimed by petitioner to represent primarily purchases for the yacht and aircraft, for a cocktail party for tenants, and for guests at the Winter Park Art Festival. There is no corroborative evidence of the latter two events so that section 274(d) bars the deductions of those expenses. As for the aircraft and yacht beverage expenditure, there is some corroboration of the business purpose of some of the trips taken on board the aircraft and the yacht. Petitioner points out that respondent accepted his traveling expenditure deductions under section 274(d) as being substantiated by the pilot invoices and other receipts for travel and concludes that this is sufficient to corroborate his testimony that the alcohol*124 purchased was drunk in connection with business. The fact that the plane and yacht were sometimes used for business travel is not corroborative evidence of the use of the beverages petitioner purchased from Deluxe Liquors. For this reason, section 274(a)(1)(A) and section 274(d) bar petitioner from deducting the Deluxe Liquor expenses.Petitioner claims deductions for $ 925 and $ 1,500.75 paid to American Express for credit card charges in 1973 and 1974, respectively. But petitioner placed in evidence only the canceled checks or stubs from his checkbook to show payment of these amounts to American Express. He testified that he always used his credit cards for business and that his wife did not use them. Clearly, this testimony does not establish the business connection of the entertainment required by section 274(a) and section 274(d). The detailed information and corroborative evidence necessary are completely lacking. See Dowell v. United States, supra.Petitioner produced only four receipts from his many American Express charges and the one statement from American Express which referred to those four expenditures. One of those receipts was*125 from a local, Orlando/Winter Park, restaurant and another from a local motel. Petitioner did not testify as to the *749 section 274(d) elements of these expenditures, and produced no other evidence of the business nature of these expenditures. The other two receipts are apparently being claimed not as entertainment but as travel expenditures for a 1973 business trip to New York. Respondent apparently did allow petitioner a deduction for air fare to New York and return paid to a travel agent in 1974 as a business travel expense. This amount had also apparently been claimed as an entertainment expense. However, the date of the travel for which this payment was made is not shown. If the travel allowed was in 1974, certainly a 1973 hotel and restaurant payment was not part of this travel. 13 This record fails to show sufficient facts to substantiate any of the American Express payments as deductible under section 274.*126 Petitioner, also, claims deductions for $ 484 and $ 1,350 paid to BankAmericard for credit card charges in 1973 and 1974, respectively. But again, petitioner offers only the canceled checks or stubs, along with his self-serving statements as to the general use of his credit cards for business purposes, except for 12 receipts placed in evidence. Ten of those receipts were from Orlando/Winter Park restaurants or inns. Since petitioner makes no mention of these local expenditures and offers no corroborative evidence of their business purpose, it is clear that neither section 274(a) nor section 274(d) is met. Another of the receipts is from Hertz Corp. in Palm Beach, Fla. There is no testimony or other evidence in the record to tie this expenditure to a business purpose in accordance with the requirements of section 274(a) or section 274(d). The 12th receipt is from the Grand Bahama Hotel. Petitioner testified generally about trips to the Bahamas. However, there is nothing in the record to tie this $ 67.50 receipt to a business purpose. Thus, the section 274(a) and section 274(d) requirements are not met with respect to the Grand Bahama's receipt.The $ 21 check written to the*127 National Car Rental in 1974, the $ 400 check marked "Dallas Trip," and the $ 110 check to Brandel Stevens are not explained in the record.The three checks totaling $ 699 paid to Robert Butch are not deductible employee expenses. Petitioner testified that the aircraft rental corporation, and not petitioner, was obligated to *750 pay the pilot expenses and that Robert Butch was a pilot. Therefore, the $ 699 was not a section 162(a) ordinary and necessary expense of petitioner. Petitioner's payment of that expense was as a volunteer and he is therefore not entitled to a deduction under section 162(a). See Hawkins v. Commissioner, 20 T.C. 1069">20 T.C. 1069, 1075 (1953).Petitioner claims a $ 150 deduction for a check written to John Ivey in 1974. John Ivey was the foreman of the construction work on petitioner's Park Mall Building. Petitioner testified that he made this gift to the foreman because of his excellent work in getting the project finished very quickly. It seems reasonable that petitioner would make a gift to the construction foreman. However, under section 1.274-3, Income Tax Regs., deductible gifts to any one individual are limited to $ 25 *128 a year. We, therefore, hold that petitioner is entitled to deduct $ 25 but not the balance of this $ 150 gift.Petitioner claims a $ 10 deduction for his dues paid to the Winter Park Chamber of Commerce. Petitioner was in the real estate business in Winter Park and this $ 10 appears to be a properly deductible expense. While the evidence with respect to the necessity for petitioner to pay dues to the Chamber of Commerce is sparse, we conclude that this $ 10 payment is deductible.Petitioner claims a $ 10.40 deduction for a check written to Lucy Little for flowers sent to a deceased client. Although the evidence with respect to this item is not as complete as would be desirable, we conclude that this $ 10.40 has been shown to be deductible.Petitioner also claims a $ 70 entertainment expense deduction in 1973 for an expenditure for dinner tickets to the Olympic dinner at Disney World in Orlando. He did not attend; he purchased the tickets merely as a goodwill gesture. Considering petitioner's profession and various business activities, we conclude that this $ 70 payment is properly deductible.Petitioner claims a $ 95.28 deduction for payment of dockage fees and perhaps a lunch*129 to the Key Biscayne Yacht Club in 1973. Petitioner testified that when he attended the law seminar, the cost of which was allowed by respondent as an employee business expense deduction, he used the boat in place *751 of a hotel room. Petitioner and his wife and his law partner and his wife were on the boat. The seminar was a 2-day seminar. It is reasonably clear that the dockage fees would have been the same if only petitioner had been on the yacht. Technically, if the lunch purchased included lunch for petitioner's wife or his law partner's wife, these amounts would not be allowable. However, the record in this regard is not clear and, in any event, the amount would be small. We, therefore, conclude that the $ 95.28 paid by petitioner to the Key Biscayne Yacht Club in 1973 is an additional deductible travel expense, although petitioner claimed the deduction as an entertainment expense. The record is clear that this $ 95.28 was not part of the travel expense deduction allowed by respondent.The final issue is whether petitioner is liable for the addition to tax for negligence or intentional disregard of the rules and regulations under section 6653(a). 14 On brief, *130 petitioner makes no argument on this point. He may have abandoned his position that he is not liable for this addition to tax. In any event, on this record, petitioner has failed to show error in respondent's determination of an addition to tax under section 6653(a). See Courtney v. Commissioner, 28 T.C. 658">28 T.C. 658, 663-664 (1957). We find that petitioner's underpayment of tax was at least in part due to negligence in failing to keep adequate records. 15*131 Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years here involved.↩2. Petitioner's brother, Dan Gilman, was the president of Roberts & Gilman. He, not petitioner, was the one after whom the company was named.↩3. The new air conditioners avoided the ducting problems by having the compressors located on the roof with relatively small freon lines running down to air handlers located on the first floor.↩4. The sum of adjustments for petitioner's employee business expenses in 1973 and 1974 were as follows:1973Disallowedor deduction(increased)ClaimedAllowedby respondentUnreimbursed businesstravel$ 3,785$ 4,285.95($ 500.95)Unreimbursed entertainment6,8340 6,834.00 Auto expense1,0521,052.000 Law seminar185.00(185.00)Total11,6715,522.956,148.05 ↩1974Disallowedor deduction(increased)ClaimedAllowedby respondentAuto$ 3,540$ 3,540.00Unreimbursed travel4,0654,412.75($ 347.75)Unreimbursed entertainment8,3760 8,376.00 Total15,9817,952.758,028.25 5. Sec. 1.165-3, Income Tax Regs., dealing with demolition of buildings was promulgated as T.D. 6445, 1 C.B. 93">1960-1 C.B. 93, 98-99, in the Federal Register at 25 Fed. Reg. 381, on Jan. 16, 1960. Notice of the proposed rulemaking regarding the regulations under sec. 165, I.R.C. 1954, as amended, relating to deductions for losses, was published on Oct. 8, 1959, in the Federal Register (24 Fed. Reg. 8167). It was made applicable to all taxable years after Dec. 31, 1953, and ending after Aug. 16, 1954, except as otherwise specifically provided therein. Sec. 1.165-3(a), Income Tax Regs., which deals with demolition of buildings where intent to demolish was formed at the time of purchase, provides in part as follows:Sec. 1.165-3 Demolition of buildings.(a) Intent to demolish formed at time of purchase. (1) Except as provided in subparagraph (2) of this paragraph, the following rule shall apply when, in the course of a trade or business or in a transaction entered into for profit, real property is purchased with the intention of demolishing either immediately or subsequently the buildings situated thereon: No deduction shall be allowed under section 165(a) on account of the demolition of the old buildings even though any demolition originally planned is subsequently deferred or abandoned. The entire basis of the property so purchased shall, notwithstanding the provisions of sec. 1.167(a)-5, be allocated to the land only. Such basis shall be increased by the net cost of demolition or decreased by the net proceeds from demolition.Sec. 1.165-3(b), Income Tax Regs., which deals with the intent to demolish the building formed subsequent to the time it is acquired, provides in part as follows:(b) Intent to demolish formed subsequent to the time of acquisition. (1) Except as provided in subparagraph (2) of this paragraph, the loss incurred in a trade or business or in a transaction entered into for profit and arising from a demolition of old buildings shall be allowed as a deduction under section 165(a) if the demolition occurs as a result of a plan formed subsequent to the acquisition of the buildings demolished. The amount of the loss shall be the adjusted basis of the buildings demolished increased by the net cost of demolition or decreased by the net proceeds from demolition. See paragraph (c) of sec. 1.165-1 relating to amount deductible under section 165↩. The basis of any building acquired in replacement of the old buildings shall not include any part of the basis of the property demolished.6. While Jones v. Commissioner, 25 T.C. 1100 (1956), remanded on other grounds 259 F.2d 300">259 F.2d 300 (5th Cir. 1958), does not explain the rational for disallowance of the adjusted basis of the demolished warehouse, the cases cited therein made it clear that prior to the adoption in 1960 of present sec. 1.165-3(b)(1), Income Tax Regs., this Court held that no demolition loss was allowable both where the intent to demolish was formed at the time of acquisition of the land and where intent was formed to demolish after acquisition for the specific purpose of building a new building as distinguished from the building becoming useless or demolition being required by the new construction where not initially intended. In this respect, we stated in Henry Phipps Estates v. Commissioner, 5 T.C. 964">5 T.C. 964, 969 (1945):"Examination of the various cases cited to us clearly indicates that petitioner's contention should be sustained. It is true that cases hold that, where there is at time of acquisition of property intent to demolish and rebuild, no deductible loss occurs and the basis of the former property may be used in computation of depreciation; but it does not follow that such former basis may not likewise be included in other circumstances, that is, where, as here, there is the requisite intention to rebuild at the time of demolition. The Circuit Court of Appeals for the Second Circuit in the Appleby case so states, saying (referring to the contention that the rule allowing the use of former basis does not apply where there is no intent at time of purchase to raze and rebuild or where taxpayer acquires otherwise than by purchase):"'* * * It would be unreasonable to hold that the statement of a rule for this single instance excludes application of a similar rule to cases where the intent to raze and rebuild was formed after the property was acquired. Losses are recognized only when they result from a closed transaction. If a building is demolished because unsuitable for further use, the transaction with respect to the building is closed and the taxpayer may take his loss; but if the purpose of demolition is to make way for the erection of a new structure, the result is merely to substitute a more valuable asset for the less valuable and the loss from demolition may reasonably be considered as part of the cost of the new asset and to be depreciated during its life, * * *.'"↩7. Neither of these cases discuss such cases as Jones v. Commissioner, supra;Henry Phipps Estates v. Commissioner, supra;Estate of Appleby v. Commissioner, 41 B.T.A. 18 (1940), affd. 123 F.2d 700">123 F.2d 700 (2d Cir. 1941), but merely rely on respondent's 1960 regulations. However, from the facts found in these cases, it is clear that absent the change in the regulations they would be in conflict with such cases. However, Levinson v. Commissioner, 59 T.C. 676↩ (1973), does discuss the change in the regulations and specifically states that under the 1960 regulations the deduction is allowable, absent the lease issue there involved, when the building is demolished with the intent to build a new building.8. This regulation provided:"Loss due to the voluntary removal or demolition of old buildings, the scrapping of old machinery, equipment, etc., incident to removal and replacements will be deductible from gross income in a sum representing the difference between the cost of such property demolished or scrapped, less salvage, and the amount of depreciation sustained with respect to the property prior to its demolition or scrapping, and allowable as a deduction in computing net income."↩9. Sec. 1.165-3(b)(2), Income Tax Regs., as adopted in 1960 deals with the issue involved in Estate of Nickoll v. Commissioner, 32 T.C. 1346">32 T.C. 1346 (1959), affd. 282 F.2d 895">282 F.2d 895 (7th Cir. 1960), of the demolition of a building pursuant to a lease. An exception to the provision of sec. 1.165-3(b)(1), Income Tax Regs., is made under this circumstance. See Landerman v. Commissioner, 54 T.C. 1042">54 T.C. 1042, 1045 (1970), affd. 454 F.2d 338">454 F.2d 338 (7th Cir. 1971). Cf. Hightower v. United States, 463 F.2d 182↩ (5th Cir. 1972).10. Sec. 274(a) provides:(a) Entertainment, Amusement, or Recreation. -- (1) In general. -- No deduction otherwise allowable under this chapter shall be allowed for any item -- (A) Activity. -- With respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer establishes that the item was directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such item was associated with, the active conduct of the taxpayer's trade or business, or(B) Facility. -- With respect to a facility used in connection with an activity referred to in subparagraph (A), unless the taxpayer establishes that the facility was used primarily for the furtherance of the taxpayer's trade or business and that the item was directly related to the active conduct of such trade or business,and such deduction shall in no event exceed the portion of such item directly related to, or, in the case of an item described in subparagraph (A) directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), the portion of such item associated with, the active conduct of the taxpayer's trade or business.(2) Special rules. -- For purposes of applying paragraph (1) -- (A) Dues or fees to any social, athletic, or sporting club or organization shall be treated as items with respect to facilities.(B) An activity described in section 212↩ shall be treated as a trade or business.11. In full, sec. 274(d) provides:(d) Substantiation Required -- No deduction shall be allowed -- (1) under section 162 or 212 for any traveling expense (including meals and lodging while away from home),(2) for any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity, or(3) for any expense for gifts,↩unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating his own statement (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, recreation, or use of the facility, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons entertained, using the facility, or receiving the gift. The Secretary or his delegate may by regulations provide that some or all of the requirements of the preceding sentence shall not apply in the case of an expense which does not exceed an amount prescribed pursuant to such regulations.12. Sec. 1.274-5 [Income Tax Regs.] Substantiation requirements.(b) Elements of an expenditure -- (1) In general. Section 274(d) and this section contemplate that no deduction shall be allowed for any expenditure for travel, entertainment, or a gift unless the taxpayer substantiates the following elements for each such expenditure:(i) Amount;(ii) Time and place of travel or entertainment (or use of a facility with respect to entertainment), or date and description of a gift;(iii) Business purpose; and(iv) Business relationship to the taxpayer of each person entertained, using an entertainment facility or receiving a gift.* * * *(3) Entertainment in general. Elements to be proved with respect to an expenditure for entertainment are --(i) Amount. Amount of each separate expenditure for entertainment, except that such incidental items as taxi fares or telephone calls may be aggregated on a daily basis;(ii) Time. Date of entertainment;(iii) Place. Name, if any, address or location, and designation of type of entertainment, such as dinner or theater, if such information is not apparent from the designation of the place;(iv) Business purpose. Business reason for the entertainment or nature of business benefit derived or expected to be derived as a result of the entertainment and, except in the case of business meals described in section 274(e)(1), the nature of any business discussion or activity;(v) Business relationship. Occupation or other information relating to the person or persons entertained, including name, title, or other designation, sufficient to establish business relationship to the taxpayer.* * * *(c) Rules for substantiation -- (1) In general. A taxpayer must substantiate each element of an expenditure (described in paragraph (b) of this section) by adequate records or by sufficient evidence corroborating his own statement except as otherwise provided in this section. Section 274(d) contemplates that a taxpayer will maintain and produce such substantiation as will constitute clear proof of an expenditure for travel, entertainment, or gifts referred to in section 274. A record of the elements of an expenditure made at or near the time of the expenditure, supported by sufficient documentary evidence, has a high degree of credibility not present with respect to a statement prepared subsequent thereto when generally there is a lack of accurate recall. Thus, the corroborative evidence required to support a statement not made at or near the time of the expenditure must have a high degree of probative value to elevate such statement and evidence to the level of credibility reflected by a record made at or near the time of the expenditure supported by sufficient documentary evidence. The substantiation requirements of section 274(d) are designed to encourage taxpayers to maintain the records, together with documentary evidence, as provided in subparagraph (2) of this paragraph. To obtain a deduction for an expenditure for travel, entertainment, or gifts, a taxpayer must substantiate, in accordance with the provisions of this paragraph, each element of such an expenditure.(2) Substantiation by adequate records -- (i) In general. To meet the "adequate records" requirements of section 274(d), a taxpayer shall maintain an account book, diary, statement of expense or similar record (as provided in subdivision (ii) of this subparagraph) and documentary evidence (as provided in subdivision (iii) of this subparagraph) which, in combination, are sufficient to establish each element of an expenditure specified in paragraph (b) of this section. It is not necessary to record information in an account book, diary, statement of expense or similar record which duplicates information reflected on a receipt so long as such account book and receipt complement each other in an orderly manner.(ii) Account book, diary, etc. An account book, diary, statement of expense or similar record must be prepared or maintained in such manner that each recording of an element of an expenditure is made at or near the time of the expenditure.* * * *(c)(2)(ii)(b) Substantiation of business purpose. In order to constitute an adequate record of business purpose within the meaning of section 274(d) and this subparagraph, a written statement of business purpose generally is required. However, the degree of substantiation necessary to establish business purpose will vary depending upon the facts and circumstances of each case. Where the business purpose of an expenditure is evident from the surrounding facts and circumstances, a written explanation of such business purpose will not be required. For example, in the case of a salesman calling on customers on an established sales route, a written explanation of the business purpose of such travel ordinarily will not be required. Similarly, in the case of a business meal described in section 274(e)(1), if the business purpose of such meal is evident from the business relationship to the taxpayer of the persons entertained and other surrounding circumstances, a written explanation of such business purpose will not be required.* * * *(iii) Documentary evidence. Documentary evidence, such as receipts, paid bills, or similar evidence sufficient to support an expenditure shall be required for --(a) Any expenditure for lodging while traveling away from home, and(b) Any other expenditure of $ 25 or more, except, for transportation charges, documentary evidence will not be required if not readily available.provided, however that the Commissioner, in his discretion, may prescribe rules waiving such requirements in circumstances where he determines it is impracticable for such documentary evidence to be required. * * ** * * *(3) Substantiation by other sufficient evidence. If a taxpayer fails to establish to the satisfaction of the district director that he has substantially complied with the "adequate records" requirements of subparagraph (2) of this paragraph with respect to an element of an expenditure, then, except as otherwise provided in this paragraph, the taxpayer must establish such element --(i) By his own statement, whether written or oral, containing specific information in detail as to such element; and(ii) By other corroborative evidence sufficient to establish such element.If such element is the description of a gift, or the cost, time, place, or date of an expenditure, the corroborative evidence shall be direct evidence, such as a statement in writing or the oral testimony of persons entertained or other witness setting forth detailed information about such element, or the documentary evidence described in subparagraph (2) of this paragraph. If such element is either the business relationship to the taxpayer of persons entertained or the business purpose of an expenditure, the corroborative evidence may be circumstantial evidence.↩13. Similarly, whether respondent has already allowed these expenses as 1973 travel expenses is not present in our record and respondent makes no mention of these specific receipts in his briefs.↩14. Sec. 6653(a) provides:(a) Negligence or Intentional Disregard of Rules and Regulations With Respect to Income or Gift Taxes. -- If any part of any underpayment (as defined in subsection (c)(1)) of any tax imposed by subtitle A or by chapter 12 of subtitle B (relating to income taxes and gift taxes) is due to negligence or intentional disregard of rules and regulations (but without intent to defraud), there shall be added to the tax an amount equal to 5 percent of the underpayment.↩15. Petitioner testified that in 1973 and 1974 he did not keep adequate records as defined by sec. 1.274-5(c)(1) and (2), Income Tax Regs. The record is clear that the records he did keep, even assuming he had those he claimed to have lost subsequent to filing his returns, were not sufficient to meet the strict substantiation requirements of sec. 274(d)↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624908/ | EDWIN J. RABER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Raber v. CommissionerDocket No. 29930.United States Board of Tax Appeals20 B.T.A. 975; 1930 BTA LEXIS 1988; September 25, 1930, Promulgated *1988 An attorney appointed by the Attorney General of Illinois to assist in the investigation of certain municipal affairs of the city of Chicago and to aid in the prosecution of certain criminal cases in connection with charges of misconduct against certain members of the Chicago Board of Education and other city officials, is not an officer or employee of the State of Illinois or of Cook County and the compensation paid to him for such services from funds duly appropriated by the County Board of Cook County, Illinois, is not exempt from income tax. Jay C. Halls, Esq., for the petitioner. L. A. Luce, Esq., for the respondent. MATTHEWS*975 The Commissioner has determined deficiencies in income tax against the petitioner for the years 1923 and 1924 in the respective sums of $328.56 and $139.46. These deficiencies grow out of the action of the Commissioner in including in taxable income for the *976 years in question the sums of $3,962 and $4,650, respectively, which sums were received by the petitioner as compensation for professional services rendered to Cook County, Illinois, in connection with the making of certain grand jury investigations*1989 and the prosecution of criminal cases brought against certain officials as a result of such investigations. FINDINGS OF FACT. The petitioner is an attorney, practicing law in the city of Chicago, Ill.In the latter part of 1922 the Attorney General of the State of Illinois, at the request of the State's Attorney of Cook County, took over the grand jury investigation of the affairs of the Board of Education of the city of Chicago. This investigation was subsequently extended to cover certain other municipal affairs. Frederick A. Brown, an attorney, was appointed by the attorney general as a special assistant attorney general, to be in direct charge of the investigation. With the approval of the attorney general, several other attorneys, including the petitioner, were employed to assist Mr. Brown in this particular investigation. Special offices were provided for the attorney general, where the work incident to the investigation was carried on. The petitioner was employed in April, 1923, under a verbal agreement by which he was to receive the sum of $100 per day. No arrangement was made with the petitioner as to the length of time that he should serve. He discontinued*1990 his services in June, 1923, when he left on a vacation trip to Europe, and resumed his employment on the same basis in the early part of 1924. The exact dates of his employment are not disclosed by the evidence but he received as compensation for his services in 1923 and in 1924 the respective sums of $3,962 and $4,650. These amounts were paid by Cook County out of funds appropriated by the County Board. The petitioner appeared before the grand jury several times and assisted with the trial work in one case. He interviewed many witnesses and examined the evidence. He drafted a great many indictments and appeared in court on motions in connection with the indictments. The petitioner had the oath of office administered in order that no question would be raised with respect to his appearance before the grand jury and that no attack might be made upon the validity of the indictments on the ground that an unauthorized person had appeared before the grand jury. The other attorneys did not take an oath of office. Mr. Brown held frequent conferences with the petitioner and the other attorneys assisting in the work. The investigation was made in the name of the attorney general *1991 *977 and the work was under his supervision, but Mr. Brown was the chief of the investigators. The direct contacts of the attorney general were always with Mr. Brown. Questions of policy were decided by the attorney general. All of the services rendered by the petitioner were performed in the offices provided for the attorney general and in court, except that one indictment was dictated to a court reporter on the outside. During the period the petitioner was engaged in this work he devoted his entire time to it and carried on no private law practice. The amounts of income for legal services shown on his income-tax returns for 1923 and 1924 were not received for any services rendered during the time he was engaged in rendering services to Cook County. The petitioner did not report in his returns of income for 1923 and 1924 the amounts received as compensation for professional services rendered to Cook County. OPINION. MATTHEWS: The sole issue presented in this case is whether the amounts received by the petitioner in 1923 and 1924 as compensation for legal services rendered under a contract with the Attorney General of Illinois to assist in conducting certain grand*1992 jury investigations in Cook County, Illinois, under the circumstances set out in our findings of fact, constitute taxable income. The petitioner received from Cook County as compensation for his professional services in 1923 and 1924 the respective sums of $3,962 and $4,650, and treated these amounts as nontaxable income in his income-tax returns for those years. Upon auditing these returns the Commissioner included these amounts as taxable income and proposed the deficiencies which we are here called upon to redetermine. It is alleged by the petitioner that the compensation paid to him by Cook County is exempt from Federal income tax by virtue of the provisions contained in section 1211 of the Revenue Act of 1926, as follows: Any taxes imposed by the Revenue Act of 1924 or prior revenue Acts upon any individual in respect of amounts received by him as compensation for personal services as an officer or employee of any State or political subdivision thereof (except to the extent that such compensation is paid by the United States Government directly or indirectly), shall, subject to the statutory period of limitations properly applicable thereto, be abated, credited, or refunded. *1993 In order to bring the compensation involved herein within the exemption claimed, it is necessary that the petitioner prove himself to be either an officer or an employee of the State of Illinois or of Cook County, as those terms are defined and construed by the courts. *978 In , the Supreme Court of the United States said: An office is a public station conferred by the appointment of government. The term embraces the idea of tenure, duration, emolument, and duties fixed by law. Where an office is created, the law usually fixes its incidents, including its term, its duties and its compensation. ; . The term "officer" is one inseparably connected with an office; but there was no office of sewage or water supply expert or sanitary engineer, to which either of the plaintiffs was appointed. The contracts with them, although entered into by authority of law and prescribing their duties, could not operate to create an office or give to plaintiffs the status of officers. *1994 ;. There were lacking in each instance the essential elements of a public station, permanent in character, created by law, whose incidents and duties were prescribed by law. See ; ; . Applying this definition to the facts of the instance case, we are of the opinion that the petitioner clearly was not an officer of the State of Illinois or of Cook County. In , the court said: The terms "officers" and "employees" both, alike, refer to those in regular and continual service. Within the ordinary acceptation of the terms, one who is engaged to render service in a particular transaction is neither an officer or employee. They imply continuity of service, and exclude those employed for a special and single transaction. An attorney of an individual, retained for a single suit, is not his employee. It is true, he was engaged*1995 to render services; but his engagement is rather that of a contractor than that of an employee. In view of these decisions of the Supreme Court with respect to the character of service to be performed before it can be said that a person is an officer or employee, it is evident that continuity of service is an essential element and that one engaged to render service in one or more particular transactions is neither an officer or employee. The facts of the instant case are very similar to those presented in the case of , in which case the petitioner was designated by the Attorney General of Pennsylvania as special counsel to represent the Commonwealth in the matter of inheritance taxes due by certain estates. During the pendency of the litigation in which Reed was acting in the interest of the Commonwealth of Pennsylvania, he was in frequent communication with the attorney general with regard to the several cases and no important questions of policy were decided without his previous consultation with and authority from the attorney general. His duties were not expressly prescribed by contract. As in the Reed case, the petitioner*1996 in the instant case never entered into any written contract or agreement with the attorney general relative to his employment. *979 His services were engaged for no definite period and the implication of continuity is negatived by the fact that he was chosen specifically to prepare indictments and to render other legal services in connection with a particular investigation. The petitioner testified that he took an oath of office in order that he might appear before the grand jury. The record does not disclose what oath was administered to the petitioner. There appears to be no express statutory provision in the Illinois laws for a special assistant attorney general. Counsel for the petitioner in the instant case has endeavored to distinguish it from the Reed case by pointing out that Reed was a member of a law firm in Harrisburg and maintained his offices there and did not devote his entire time to the services he rendered for the Commonwealth of Pennsylvania. Our attention has also been directed to the fact that Reed's duties related solely to civil litigation, whereas the petitioner in the instant case was engaged to prosecute crime. We do not agree that any fundamental*1997 distinction has been made upon which a contrary decision might be based. We can not see that a lawyer employed by an officer of a State or county to assist him in a criminal prosecution stands on any different footing from a lawyer employed to assist such an officer in civil litigation. We think that neither the amount of time devoted to performing legal services, nor the place where they are performed, is a controlling point in determining whether an attorney is an employee or an independent contractor. An independent contractor may devote his entire time for a period to a special job and still fall short of being an officer or employee of a State or political subdivision thereof. In other words, it is possible for an officer or employee to accept outside employment without changing the character of the services rendered by him, but it does not follow that one who is engaged to render service in a particular transaction and who must devote his entire time to such employment for the duration thereof, becomes an officer or employee within the meaning of the statute. With respect to the right of control, or lack of it, exercised by the attorney general with respect to the manner*1998 in which the services were performed by the attorneys chosen to assist him, and the means used to accomplish the purpose for which they were employed, the petitioner in the instant case appears to have been in a position equivalent to that occupied by Reed. In the Reed case it was held that the taxpayer was not an employee of the Commonwealth of Pennsylvania and that the compensation paid to him for his legal services was subject to the Federal income tax. Our decision was reversed by the , but this latter decision was in turn reversed by the Supreme Court of the United States in a memorandum opinion dated May 5, 1930, , upon the authority of , and We think the ruling in the Reed case is applicable to the instant case and we hold that the compensation received by the petitioner from Cook County is taxable income as determined by the respondent. This conclusion is in accord with our decision in the case of *1999 , where the petitioner was also an attorney employed to assist the Attorney General of Illinois is this same investigation of the municipal affairs of the city of Chicago, and where the terms of employment and the attending facts are practically identical with those set out herein. Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4653930/ | IN THE SUPREME COURT OF PENNSYLVANIA
WESTERN DISTRICT
C.P. AND D.P. : No. 115 WM 2020
:
:
v. :
:
:
S.C. AND C.P. :
:
:
PETITION OF: S.C. :
ORDER
PER CURIAM
AND NOW, this 20th day of January, 2021, the Petition for Leave to File Petition
for Allowance of Appeal Nunc Pro Tunc is DENIED. | 01-04-2023 | 01-22-2021 |
https://www.courtlistener.com/api/rest/v3/opinions/4624954/ | KEVIN WADE HAMBLIN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHAMBLIN v. COMMISSIONERNo. 17397-99United States Tax Court2001 Tax Ct. Memo LEXIS 147; May 21, 2001, Filed *147 An appropriate order will be issued. Kevin Wade Hamblin, pro se.Sara J. Barkley, for respondent. Couvillion, D. IrvinCOUVILLIONCOUVILLION, SPECIAL TRIAL JUDGE: This case was heard pursuant to section 7463 in effect when the petition was filed. 1 The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority.Respondent determined a deficiency of $ 6,137 in petitioner's Federal income tax for 1995.The issue for decision is whether certain amounts received by petitioner from his former employer during 1995 in connection with the settlement of a class action against his former employer are excludable from gross income under section 104(a)(2). In his petition, petitioner alleged "my ex-wife filed for the year of 1995 and I do not remember*148 signing a 1040 for that tax season, so I cannot attest to its correctness, nor should I be held accountable if it is incorrect as to her income." At trial, petitioner filed a trial memorandum in which he stated that his former spouse, Carol L. Fuhr Hamblin (Mrs. Hamblin), falsely reported on their joint return income from a trade or business activity conducted by her in the amount of $ 5,670, and the reason for reporting such income was solely for the purpose of claiming an earned income credit under section 32. With respect to the tax on that income, petitioner claims relief from joint liability under section 6015. Respondent agrees, while not making any concession, that the issue is appropriate but cannot now be considered by the Court for the reason that respondent had no knowledge prior to trial that petitioner intended to claim relief from joint liability, and, accordingly, petitioner's former spouse was not provided notice as required by section 6015(e)(4). See also King v. Commissioner, 115 T.C. 118">115 T.C. 118 (2000); 2 Interim Rule 325.*149 Some of the facts were stipulated. Those facts, with the annexed exhibits, are so found and are incorporated herein by reference. At the time the petition was filed, petitioner was a legal resident of Canon City, Colorado.Petitioner was an employee of PayLess Drug Stores Northwest, Inc. (PayLess), in Colorado from sometime during 1991 until June 23, 1992. He worked in several different positions, including that of floor supervisor, although his assignments varied, ranging from stocking shelves to the supervision of employees. Shortly after his employment began with PayLess, petitioner realized that his employer was overly demanding. He and other employees were required to work from 80 to 100 hours per week, at least 6 and sometimes 7 days per week. He found the work overwhelming and finally realized he could no longer bear the emotional and physical strains of the job. He left the employment with PayLess in June 1992 and went into real estate.On March 16, 1993, an action was filed in the U.S. District Court for the District of Idaho against PayLess by four of its former employees for themselves and on behalf of other present and former employees of PayLess. The complaint alleged*150 that the purpose of the action was to recover on behalf of the class of employees unpaid overtime compensation, liquidated damages, attorney's fees, and costs under section 16(b) of the Fair Labor Standards Act of 1938, ch. 676, 52 Stat. 1069, currently codified at 29 U.S.C. secs. 201-209 (1994). Petitioner was not one of the plaintiffs instituting the action; however, petitioner qualified for participation as a member of the class of employees for whom the action was filed. Petitioner never elected to be excluded from the class, nor did petitioner ever claim or institute any separate action against PayLess. The class action did not proceed to trial but was settled. PayLess agreed to pay $ 5 million for the benefit of all qualifying members of the class, including petitioner. As part of the settlement, the plaintiffs in the class action executed a written Settlement Agreement and Release (the Settlement Agreement) effective January 25, 1995, in consideration for payment of the $ 5 million by PayLess. The Settlement Agreement included a release by the plaintiffs of PayLess that was embodied as section 3 and provided in pertinent part: the * * * Plaintiffs*151 * * * hereby release and discharge PayLess * * * from all actions, claims, or demands for damages, liabilities, costs, or expenses, which the Plaintiffs * * * have against PayLess on account of, or in any way arising out of the claims that were asserted or that could have been asserted in the Lawsuit by the Plaintiffs * * * including, but not limited to, claims for personal injuries, intentional infliction of emotional distress, negligent infliction of emotional distress, and from all known claims, whether based on tort, statute or contract, which are based in whole or in part, or arise out of, or in any way relate to: (1) the Lawsuit; and (2) anything done or allegedly done by PayLess arising out of, or in conjunction with or relating to, the employment of any and/or all Plaintiffs * * * by PayLess.The Settlement Agreement additionally included section 8, entitled Liability Denial and Basis For Settlement, which provided: PayLess denies any liability on its part and enters into this agreement solely to avoid litigation and to buy its peace. *152 ALL SETTLEMENT PROCEEDS ARE PAID TO PLAINTIFFS ON ACCOUNT OF PERSONAL INJURIES. This Settlement Agreement and the releases contained herein settle and resolve all claims which have to this point been contested and denied by the parties, as well as all other claims released by paragraphs 3 and 4 of this Settlement Agreement. None of the provisions of this Settlement Agreement and nothing contained in this Settlement Agreement shall be construed as an admission of any liability whatsoever by any party hereto to any other party hereto. [Emphasis added.]As a member of the class of former employees of PayLess, petitioner, during 1995, received $ 40,611.46, from which $ 14,023 was deducted for attorney's fees and costs, for a net amount of $ 26,588.46. The amount recovered included back pay, liquidated damages, an amount for participating as a member of the class, and another amount for testifying in a deposition. The parties did not provide an itemization of these various amounts except that the notice of deficiency listed $ 24,210 as liquidated damages and $ 16,401 as wages or back pay.As part of the settlement, petitioner*153 executed an Individual Certification and Release in favor of PayLess wherein he acknowledged receipt of documents regarding settlement of the class action, acknowledged receiving a copy of the Settlement Agreement that was incorporated by reference as part of his release, expressly affirmed "the authority of the named Plaintiffs to release my claims and settle the Lawsuit", and individually released PayLess in paragraph 8 of the release that provided, in pertinent part: In exchange for the payment of the amount * * * [to petitioner] I hereby release and discharge PayLess * * * from all actions, claims, or demands for damages, liabilities, costs, or expenses, which the Plaintiffs, individually or collectively, have against PayLess on account of, or in any way arising out [of] the claims that were asserted or that could have been asserted in the Lawsuit by the Plaintiffs, which Lawsuit is hereby acknowledged as not fully plead, FURTHER INCLUDING, BUT NOT LIMITED TO, CLAIMS FOR PERSONAL INJURIES, INTENTIONAL INFLICTION OF EMOTIONAL DISTRESS, NEGLIGENT INFLICTION OF EMOTIONAL DISTRESS,*154 AND FROM ALL KNOWN CLAIMS, WHETHER BASED ON TORT, STATUTE OR CONTRACT, which are based in whole or in part, or arise out of, or in any way relate to: (1) the Lawsuit; and (2) anything done or allegedly done by PayLess arising out of, or in conjunction with or relating to, the employment of any and/or all Plaintiffs prior to November 1, 1992 by PayLess. [Emphasis added.]Petitioner and his then wife, Mrs. Hamblin, filed a joint Federal income tax return for 1995. The amount received by petitioner from PayLess was not included as income on the return. At the time the return was filed in February 1996, petitioner was incarcerated. The return was not signed by petitioner; however, Mrs. Hamblin signed the return on his behalf pursuant to a General Durable Power of Attorney petitioner had previously executed appointing Mrs. Hamblin as his agent with authority to perform such acts on his behalf. The items of income reported on the return are as follows: Wages and salaries $ 2,960 Taxable interest income 75 Schedule C business income *155 5,670 Other income: House cleaning 300 ______ Total $ 9,005The earned income reported on the return was attributable solely to Mrs. Hamblin and included Schedule C income from a real estate sales activity conducted by Mrs. Hamblin under the business name of Heritage Realtors. The return also included an Internal Revenue Service form, Schedule EIC, Earned Income Credit, which listed two qualifying children. The amount of the earned income credit claimed was $ 2,961. Petitioner and Mrs. Hamblin separated in 1995 and were divorced in 1999.Respondent issued one notice of deficiency to petitioner and Mrs. Hamblin and determined that the $ 40,611 gross amount received by petitioner from PayLess constituted gross income, and $ 13,039 of the attorney's fees and costs related to the PayLess award was allowable as an itemized deduction. 3 Because the standard deduction claimed on the return was less than the allowed itemized deduction, respondent substituted the $ 13,039 in attorney's fees and costs for the standard deduction claimed*156 on the return. 4 The $ 2,961 in earned income credit on the return was also disallowed in full. See supra note 2.Petitioner filed a timely petition in this Court. Mrs. Hamblin did not petition this Court.Petitioner contends that the amount he received in the settlement represented damages for the physical and mental strain he suffered in the undue hours and days he was required to work for PayLess, which he could no longer endure and resulted in his leaving the employment. *157 More specifically, when questioned at trial as to what was the personal injury he sustained, petitioner answered: It was fatigue, stress, headaches, the fact that I was going around like a zombie, the fact that I had -- that I was making bad decisions. There's -- that pretty much covers everything, but it was such a tremendous amount of stress that I was having a hard time dealing with life, and it was manifesting itself.Petitioner also contends that his physical and emotional injuries were a contributing cause of his subsequent commission of a felony for which he was sentenced to prison.No action was ever instituted by petitioner against PayLess for the above injuries petitioner described, nor do any of the settlement documents between PayLess and its former employees address any specific injury to any of the former employees who instituted the action, including petitioner as a member of the class.Section 104(a)(2) provides that gross income does not include "the amount of any damages received (whether by suit or agreement * * *) on account of personal injuries or sickness". Under section 1.104-1(c), Income Tax Regs.*158 , "damages" means a recovery "based upon tort or tort type rights". See also Commissioner v. Schleier, 515 U.S. 323">515 U.S. 323, 132 L. Ed. 2d 294">132 L. Ed. 2d 294, 115 S. Ct. 2159">115 S. Ct. 2159 (1995). While personal injuries, under section 104(a)(2), may generally include both physical as well as nonphysical emotional injuries, such as "pain and suffering, emotional distress, harm to reputation, or other consequential damages (e.g., a ruined credit rating)", the Supreme Court has distinguished such personal injuries from "legal injuries of an economic character" such as those arising out of the unlawful deprivation of the opportunity to earn wages through a wrongful termination. United States v. Burke, 504 U.S. 229">504 U.S. 229, 239, 245, 119 L. Ed. 2d 34">119 L. Ed. 2d 34, 112 S. Ct. 1867">112 S. Ct. 1867 (1992). Damages received for lost wages in connection with the settlement of economic rights, such as those arising out of a breach of contract, are not excludable from income under section 104(a)(2). See Robinson v. Commissioner, 102 T.C. 116">102 T.C. 116, 126 (1994), affd. in part, revd. in part on another issue 70 F.3d 34">70 F.3d 34 (5th Cir. 1995).Section 1.104-1(c), Income Tax Regs., provides: "The term 'damages received (whether by suit or agreement)' means an amount received*159 * * * through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution." Thus, in order to exclude damages from gross income pursuant to section 104(a)(2), the taxpayer must prove: (1) The underlying cause of action is "based upon tort or tort type rights", and (2) the damages were received "on account of personal injuries or sickness". Commissioner v. Schleier, supra 515 U.S. at 336-337.Where amounts are received pursuant to a settlement agreement, the nature of the claim that was the actual basis for settlement controls whether such amounts are excludable from gross income under section 104(a)(2). See United States v. Burke, supra at 237. The crucial question is "in lieu of what was the settlement amount paid." Bagley v. Commissioner, 105 T.C. 396">105 T.C. 396, 406 (1995), affd. 121 F.3d 393">121 F.3d 393 (8th Cir. 1997). Determining the nature of the claim is a factual inquiry. See Robinson v. Commissioner, supra at 127.Here, the complaint in the class action was exclusively for recovery of "overtime compensation, liquidated damages, attorney fees and costs" *160 under the Fair Labor Standards Act of 1938. Nowhere in the complaint or in the Settlement Agreement is there any reference to or any indication that the recovery included damages for physical or mental injuries. Moreover, the record satisfies the Court that petitioner's claim to physical and mental injuries was not called to the attention of PayLess or its attorneys in connection with the class action. Since there was no claim made for such injuries by petitioner, the rhetorical question posed in Bagley v. Commissioner, supra, is that whatever the settlement was for, it certainly was not for personal injuries attributable to the injuries petitioner claims. 5 Moreover, the general language relied on by petitioner in the Settlement Agreement that "all settlement proceeds are paid to plaintiffs on account of personal injuries" is inconsistent with the other provisions of the agreement that quite clearly indicate and establish that the settlement was intended to satisfy the claims made in the class action. Such language relied on by petitioner in the Settlement Agreement, therefore, can be ignored. See Peaco v. Commissioner, T.C. Memo 2000-122">T.C. Memo 2000-122. An express allocation, *161 such as petitioner relies on, may be disregarded if the facts and circumstances surrounding a payment, such as exists in this case, indicate that the payment was intended by the parties to be for a different purpose. See Bagley v. Commissioner, supra; Robinson v. Commissioner, supra; Threlkeld v. Commissioner, 87 T.C. 1294">87 T.C. 1294, 1307 (1986), affd. 848 F.2d 81">848 F.2d 81 (6th Cir. 1988); Burditt v. Commissioner, T.C. Memo 1999-117">T.C. Memo 1999-117. The Court, therefore, finds that the amounts awarded to petitioner were for back pay and liquidated damages under the Fair Labor Standards Act pursuant to the class action initiated by the former employees of PayLess. As such, the amount paid to petitioner constituted gross income, and such amount is not excludable under section 104(a)(2). See Commissioner v. Schleier, supra.Respondent, therefore, is sustained.Reviewed*162 and adopted as the report of the Small Tax Case Division. In order to present petitioner's claim to relief from joint liability under section 6015 as an issue before this Court, which includes the right of intervention by petitioner's former spouse,An appropriate order will be issued. Footnotes1. Unless otherwise indicated, section references hereafter are to the Internal Revenue Code in effect for the year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. In the notice of deficiency, respondent disallowed the earned income credit of $ 2,961 claimed on petitioner's joint return for 1995 for the reason that the inclusion of petitioner's class action award in income exceeded the earned income amount as provided in sec. 32(a)(2) and (b). If the Court sustains respondent on the class action income issue, respondent's adjustment disallowing the earned income credit would likewise be sustained; however, the question of whether petitioner is entitled to relief from joint liability under sec. 6015 with respect to the trade or business income attributable to his former spouse would remain. Additional information regarding petitioner's 1995 joint return relative to this issue is provided later in the body of the opinion.↩3. The allowed amount presumably consists of the $ 14,023 withheld from petitioner's award less 2 percent of adjusted gross income that is not allowable under sec. 67(a).↩4. Petitioner has not challenged respondent's inclusion of the $ 14,023 in attorney's fees in gross income and allowance of that amount as an itemized deduction, reduced by the sec. 67(a) limitation. See Miller v. Commissioner, T.C. Memo 2001-55">T.C. Memo 2001-55; Benci-Woodward v. Commissioner, 219 F.3d 941">219 F.3d 941 (9th Cir. 2000), affg. T.C. Memo 1998-395">T.C. Memo 1998-395↩.5. Indeed, some of the injuries petitioner complains of occurred long after his employment with PayLess.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624955/ | Ethel M. Bonn, Petitioner, v. Commissioner of Internal Revenue, RespondentBonn v. CommissionerDocket No. 71835United States Tax Court34 T.C. 64; 1960 U.S. Tax Ct. LEXIS 172; April 15, 1960, Filed *172 Decision will be entered for the respondent. Petitioner, a graduate physician, was accepted as a fellow in the school of psychiatry operated by the Menninger Foundation, and was appointed by the Veterans' Administration to a residency in psychiatry at one of the latter organization's hospitals, where she performed valuable professional services. During 1954, and while a resident at the hospital, she received $ 2,959.11 directly from the Veterans' Administration. The primary purpose of the hospital was the care and treatment of patients, and its standards for admission of patients were based on veteran status and need of treatment. Held, the amount received constituted compensation for services rendered, and is not excludible from income as a fellowship grant under section 117, I.R.C. 1954. William E. Haney, Esq., for the petitioner.William J. McNamara, Esq., for the respondent. Forrester, Judge. FORRESTER*64 Respondent has determined a deficiency in petitioner's 1954 income tax in the amount of $ 415. The sole issue is whether the amount of $ 2,959.11 received by petitioner in 1954 from the Veterans' Administration is excludible from income under section 117 of the Internal Revenue Code of 1954. 1FINDINGS OF FACT.The stipulated facts are so found.Petitioner is an individual residing in Topeka, Kansas. Her original and an amended income*174 tax return for the calendar year 1954 were filed on the cash basis with the director of internal revenue for the district of Kansas.In her original return petitioner reported the amount of $ 2,959.11 as wages received from the Veterans' Administration (hereinafter *65 called the VA) and claimed a credit for income tax withheld in the amount of $ 416.40. On her amended return she excluded the foregoing $ 2,959.11 as exempt from tax and claimed and received a refund in the amount of $ 415.On July 19, 1951, a contract was entered into by the VA and the Menninger Foundation (hereinafter called the Foundation), whereby the Foundation agreed to furnish a course of instruction and training (hereinafter called the Program) at the Winter VA Hospital (hereinafter called the Hospital) at Topeka, Kansas. Such contract reads as follows:Whereas, the Veterans Administration, in the execution of laws it is charged with administering, has determined the necessity of maintaining a course of instruction and training in psychiatry for Veterans Administration residents at the Veterans Administration Hospital at Topeka, Kansas, which the Veterans Administration with present personnel and facilities*175 is not able to furnish, andWhereas, The Menninger Foundation, a corporation, situated at Topeka, Kansas, is available to render professional services necessary for the operation and maintenance of such course of instruction and training in psychiatry to the extent specified in paragraphs 1 and 2 hereof, agreement is hereby entered into between the Veterans Administration and The Menninger Foundation, hereinafter referred to as the Contractor, as follows:1. The Contractor agrees, subject to approval by the Veterans Administration, to plan and to provide general supervision of a course of instruction and training to be given residents in psychiatry at Veterans Administration Hospital, Topeka, Kansas. This includes lecture courses, seminars, section conferences, training in neuropathology and neurophysiology, and other appropriate instruction and training as required by the Veterans Administration for residents in psychiatry. The instruction and training planned and supervised by the Contractor must meet all the requirements to qualify Veterans Administration residents for acceptance to examination given by the American Board of Psychiatry and Neurology in addition to the requirements*176 hereinafter required by the Veterans Administration. Schedule No. 1, attached hereto, is provided as a guide for the Contractor in preparing material for conducting the training required herein. The Manager, Veterans Administration Hospital, Topeka, Kansas, is authorized to make such deviations to Schedule No. 1, attached, as required by the Veterans Administration and to meet current or future requirements of the American Board of Psychiatry and Neurology or the Veterans Administration.2. In addition to the services to be rendered as described in paragraph 1, hereinabove, the Contractor agrees to provide all necessary supervision of the course of instruction and training for residents in psychiatry at Veterans Administration Hospital, Topeka, Kansas. This not only includes supervision of the program of instruction and training, but also includes supervision of such supplementary instruction and training as may be furnished by the Veterans Administration from its own staff or otherwise, when such supplementary instruction or training is deemed necessary by the Veterans Administration. It is understood that any supplementary instruction and training as referred to in the foregoing*177 will be so provided at the expense of the Veterans Administration, apart from and independently of the compensation hereinafter provided for the services of the Contractor under the terms of this agreement, provided that employees of the Contractor or designates thereof will be accorded permission for attendance at or participation in such supplementary instruction *66 or training, subject to such accommodations as may be available after the needs of Veterans Administration residents are first met in all respects and provided further that, reciprocally, Veterans Administration residents or designates are provided like accommodations at lectures, seminars, or other instruction or training afforded by the Contractor in relation to the administration of its own activities in addition to the services provided above.3. In consideration of the services as provided in paragraphs 1 and 2 above, the Veterans Administration agrees to pay the Contractor the sum of $ 50,000 per year for such services when between 40 and 60 Veterans Administration residents, inclusive, are in training in psychiatry at Veterans Administration Hospital, Topeka, Kansas. The Veterans Administration further *178 agrees to pay the Contractor an additional sum of $ 12,50 [sic] per year for each group of residents numbering from one to five, inclusive, in excess of 60 residents undergoing training in psychiatry at Veterans Administration Hospital, Topeka, Kansas. The sum for which the Contractor is entitled to reimbursement as described hereinabove will be reduced by $ 833 per year for each position for residents in psychiatry not filled below the number of 40.4. The Veterans Administration agrees to furnish the Contractor space and facilities at the Veterans Administration Hospital, Topeka, Kansas, for the purposes of providing the services in paragraphs 1 and 2, above. Such space and facilities will be furnished only to the extent determined necessary by the Manager, Veterans Administration Hospital, Topeka, Kansas.5. No separate charge will be made by the Contractor or any employee thereof, for the supervision of the care and treatment of veteran patients in the Veterans Administration Hospital, Topeka, Kansas, when such supervision of care and treatment is incident in whole or in part to the services for which reimbursement is provided in paragraph 3 above. This agreement does not*179 preclude the Contractor or employees thereof from performing services on a temporary full-time, part-time or fee basis, subject to the provisions of existing laws, for the care and treatment of patients of the Veterans Administration Hospital, Topeka, Kansas, or elsewhere, Provided such services are wholly apart from and independent of the services outlined in paragraphs 1 and 2 above, and for which reimbursement is provided in paragraph 3 above, Provided further that the Contractor, or any employee thereof, will make no charge against the Veterans Administration for consultation, care, or treatment of any patient or any consultation service rendered on the same day that the person participates in the services performed by the Contractor under the provisions of paragraphs 1 and 2 above. This provision is expressly intended to eliminate any possibility of duplicate payment by the Veterans Administration for services rendered; however, if any such charge is made and erroneously paid by the Veterans Administration, it will be refunded by the Contractor.6. It is recognized by the Veterans Administration that the curriculum of study, instruction, and training, as outlined in Schedule*180 No. 1, attached, is subject to variation and change. Schedule No. 1, attached, is therefore a guide only for the use of the Contractor and the Manager, Veterans Administration Hospital, Topeka, Kansas. The Manager, Veterans Administration Hospital, Topeka, Kansas is charged with the responsibility of insuring that the services performed by the Contractor, as specified in paragraphs 1 and 2 above, meet the requirements of the Veterans Administration and that the training, instruction, and supervision, furnished by the Contractor, fully meet the requirements of the American Board of Psychiatry and Neurology at all times. Any changes to Schedule No. 1, attached, authorized or required by the Manager, Veterans Administration Hospital, Topeka, Kansas, will not affect the compensation to be paid the Contractor as specified in paragraph 3 above.*67 7. The Contractor agrees to submit in writing to the Veterans Administration during the period of the contract, at intervals specified by the Veterans Administration, reports of the progress of the residents receiving instruction and training under the terms of this agreement, furnishing such information as the Veterans Administration*181 may require.8. Duly authorized representatives of the Veterans Administration shall be permitted to visit the Contractor and to examine the training facilities and the work of the residents receiving instruction and training under this agreement. A copy of the schedule of studies to be followed by each resident shall be made available to the Veterans Administration.9. [Manner of presentation and payment of invoices.]10. Services by the Contractor under this agreement will be rendered at the Veterans Administration Hospital, Topeka, Kansas, or at The Menninger Foundation situated at Topeka, Kansas, or at such other place or places as may be designated or approved by the Veterans Administration.11. The Contractor warrants that the tuition charges provided for herein are not in excess of those charged residents from sources other than the Veterans Administration. For the purposes of this paragraph it is understood that the tuition rate per resident per year is $ 833.12.-16. [Formal provisions regarding nondiscrimination, effective dates, settlement of disputes, etc.]The attached Schedule No. 1 reads as follows:SCHEDULE NO. 1FOR FISCAL YEAR 1952 CONTRACTa. Program for first-year residentsSubjectNumber(1) Lectures and lecture coursesofmeetingsHours(a) OrientationPsychiatric Case Study1515(b) General Psychopathology3535(c) Psychiatric Treatment Methods2222(d) Basic Neurology1717(2) SeminarsBasic Psychiatric Literature4080b. Program for second-year residents(1) Lecture courses(a) Principles of psychotherapy (second course)2525(b) Clinical Neurology2020(c) Personology2020(2) SeminarsPractical Applications of Psychiatry to Social Situations816(3) Control Groups -- Psychotherapy Techniques3 groups -- each 40 meetings,80 hoursTotal120240(4) Neurological Laboratory Work(a) Neuroanatomy1734(b) Neuropathology1734(c) Psychosomatic Concepts of Automanic Physiology55(5) And in addition complete supervision of residentsassigned to The Menninger Clinic Adult Division forHospital and/or Out Patient Services.c. Program for third-year residents(1) Lecture courses(a) Principles of Psychotherapy (third course)2030(b) Marriage and Family Counselling1212(2) Seminars(a) Principles of Dynamic Psychiatry70140(3) Control Groups -- Psychotherapy Techniques3 groups -- each 40 meetings,80 hoursTotal120240(4) Individual Control Sessions in the Application ofPsychotherapy250(5) And in addition complete supervision of residentsassigned to The Menninger Clinic Adult Division forHospital and/or Out Patient Services; also completesupervision of residents assigned to the Children'sDivision of the Menninger Clinic.d. Miscellaneous teaching hours not restricted to anyparticular year of study300*182 *68 Residents under the Program accumulate annual and sick leave. Deductions are made from such leave or from pay for any periods of leave taken. Residents are paid solely by the VA, which withholds a portion of such payments as income tax withheld at source. The Hospital charges payments made to residents to the same account as salaries paid to staff physicians, but sometimes refers to the former class of payments as "stipends," rather than "salaries."The VA has the ultimate authority under its contract with the Foundation to determine the nature of instruction and training to be given a resident placed under the Program. Such instruction and training must meet the requirements both of the VA and of the American Board of Psychiatry and Neurology (hereinafter called the Board). In addition to payments to the residents themselves, the VA pays the Foundation an amount for its part in the Program, designating the latter as "Training Funds."Residents in psychiatry under the Program are sometimes referred to as fellows in the Menninger School of Psychiatry. Upon successful completion of the residency, each resident receives a certificate from the foregoing school attesting*183 the completion of the course of instruction.A resident receiving payments from the VA of the type here in issue may be assigned to one or more of several affiliated institutions for training unavailable at a VA hospital. The VA continues to pay the resident during such periods and retains responsibility for his training. Such affiliated training may not in any instance exceed one-third of the residency period, and is based upon the needs and requirements of the VA. Where it has been determined that a resident is to be assigned to an affiliated program, he must accept *69 such assignment or terminate his residency, in which case he receives no further payments from the VA.The Hospital is a general service hospital, with no preference as to admission for chronically ill patients over those with mental disturbances of a more or less common nature. The only preference or priority patients are those with a service-connected disability, others being admitted in the order of application, as soon as facilities are available.The principal purpose of the Hospital is the care and treatment of patients. There are 783 beds in the psychiatric section and 67 additional beds in the neurological*184 section, normally with about 95 per cent occupancy. Approximately 14 staff physicians and 21 residents are attached to the psychiatric and neurological wards.Residents are normally used in the treatment of patients. A resident in the psychiatric section will have a certain number of patients, perhaps 25, assigned to him. His typical workday is in part approximately as follows:HoursConference with other ward personnel1/2Check on activities of some of assigned patients1 to 1 1/2Consultation with consultant or section chief1 to 2 Individual treatment of patients1 1/2Total4 to 5 1/2In addition, residents are required to supervise and train other personnel, such as nurses aides and psychological therapists, and to interview or process new admissions. The latter task requires 5 to 6 hours per patient if undertaken by an experienced full-time staff psychiatrist and somewhat more time when performed by a resident.The normal workday of a resident is from 8 a.m. to 4:30 or 5:30 p.m., Monday through Saturday. Approximately 8 hours per week during this period are devoted to instruction courses given by the Foundation. The remaining workday time is *185 spent chiefly in performing services for the Hospital, with some relatively minor portion devoted to instruction or educational courses offered by the Hospital itself.Residents at the Hospital under the Program are not degree candidates. Their ultimate objective is to acquire proficiency as psychiatrists, usually with the hope of qualifying for certification by the Board, which requires 3 years of residency and 2 years of practical experience. They perform professional services for the Hospital in the course of their residencies and are under the supervision and control of the VA while so engaged.In 1952 petitioner applied to the Foundation for a fellowship and to the VA for a residency in psychiatry. She was accepted under *70 the Program, and commenced her activity at the Hospital in July 1953. During 1954 she received from the VA the amount of $ 2,959.11.Petitioner has been employed at the Hospital as a staff psychiatrist since January 1, 1956. In 1956 she received a certificate from the Foundation, and in 1957 she was certified by the Board.Petitioner is presently in charge of the women's branch of the psychiatric section, which has approximately 120 patients. This*186 branch has 2 staff psychiatrists, including petitioner, and 5 residents, each of whom performs essential professional services. Elimination of residents from the psychiatric section would require substantial changes in the method of operation at the Hospital.OPINION.Petitioner received $ 2,959.11 from the VA during 1954. The sole question is whether this amount constituted compensation for personal services, as determined by respondent, or a fellowship grant within the purview of section 117 of the Internal Revenue Code of 1954, as contended by petitioner.Section 1.117-4 of respondent's Income Tax Regulations provides in part as follows:Sec. 1.117-4 Items not Considered as Scholarships or Fellowship Grants. -- The following payments or allowances shall not be considered to be amounts received as a scholarship or a fellowship grant for the purpose of section 117:* * * *(c) Amounts paid as compensation for services or primarily for the benefit of the grantor. (1) Except as provided in § 1.117-2(a), any amount paid or allowed to, or on behalf of, an individual to enable him to pursue studies or research, if such amount represents either compensation for past, present, *187 or future employment services or represents payment for services which are subject to the direction or supervision of the grantor.Section 1.117-2(a) applies solely to candidates for a degree, and is concededly inapplicable here.Petitioner does not contend that this regulation is an incorrect interpretation of the statute. We believe the regulation is sound. Accordingly, the sole question is whether the amount received by petitioner in fact represented compensation for services. Our review of the entire record here convinces us that this question must receive an affirmative answer.Whatever petitioner's purpose in accepting a residency at the Hospital, it is apparent that she and the other residents there, all graduate physicians, performed valuable and essential professional services of a substantial nature, both in terms of time spent on duty and of the importance of the services to the Hospital.*71 To be sure, one of petitioner's witnesses testified in answer to a general question, that the residents do not replace personnel who would otherwise have to be hired. This conclusion seems plainly at variance with the picture we derive from the detailed testimony of record*188 as to the operations and purposes of the Hospital, the nature and extent of services performed, and the number of patients compared to the number of staff physicians.Petitioner relies principally upon George Winchester Stone, Jr., 23 T.C. 254">23 T.C. 254, and Wrobleski v. Bingler, (W.D. Pa.) 161 F. Supp. 901">161 F. Supp. 901. Both cases are readily distinguishable on their facts.In the Stone case the taxpayer received a grant from the Guggenheim Foundation, an organization formed "to promote the advancement and diffusion of knowledge and understanding and the appreciation of beauty, by aiding * * * scholars, scientists and artists * * * in the prosecution of their labors." Fellowships had been granted in 60 different fields of study, with no economic benefit derived by the grantor. Typically a grant would be made to permit the recipient to carry on his chosen projects, using his own work methods.Stone had received a grant to assist him in carrying on a project selected by him, embracing certain research and data respecting 18th century English dramatic performances. The grantor exercised no supervision, made no suggestions, received no*189 economic benefit, and required no accounting either of time or money. The sole condition of the grant was that the grantee engage in no other activity.In holding that the amount received was a gift under section 22(b)(3) of the Internal Revenue Code of 1939, we said at page 261:We have found that the fellowship payment to the petitioner was a gift. On this issue the controlling factor is the intent of the payor. Bogardus v. Commissioner, 34">302 U.S. 34 (1937). It is obvious that the foundation intended it as a gift. The object of the foundation is to aid scholars, scientists, and artists in the prosecution of their labors. The donor of the capital fund stated that the income was to be used to provide opportunities for men and women to carry on advanced study. The secretary of the foundation testified that the fellowship awards were intended as gifts.And the following language appears at pages 262-3:The grant was in the nature of a scholarship to facilitate the further education or training of the recipient even though in this case he held several degrees. His research was in a field of his own selection. He was under no obligation*190 to perform services for the foundation or any other person. The arrangement between the foundation and the fellow is not an employment contract. The foundation does not assume or stipulate for authority to direct and control the fellow as to the details and means by which the project is carried out, to require conformity with a schedule of working hours, to supervise the work to see that it is satisfactorily done, or to require reports on the progress of or the completion of the task. The payments are not for services.*72 In the instant proceeding the VA not only determined what type of work petitioner was to do, but retained and exercised control and supervision at all times over the method of its performance, including the length and number of workdays per week. She was subject to reassignment not only within the Hospital, but to other institutions as well. And, finally, her activities resulted in substantial economic benefit to the grantor, since she performed valuable professional services of a nature essential to the carrying out by the Hospital of its principal purpose, the care and treatment of patients.In Wrobleski the taxpayer, a physician, received a stipend*191 from the University of Pittsburgh as a participating graduate physician in its training program at the Western State Psychiatric Institute and Clinic. Its purposes are described in the Findings of Fact as follows:6. The Western State Psychiatric Institute and Clinic, established by the Commonwealth of Pennsylvania and leased to the University of Pittsburgh for the sum of $ 1 a year, was designed to serve primarily as a center for research and education of students and specialists in the field of emotional illness and health. The use and some of the purposes of the Institute have been defined by statute which provides, in part, as follows: "The Western State Psychiatric Institute and Clinic, located in Allegheny County, shall be used for study and research into the causes, treatment, prevention and cure of the various types of nervous disorders and mental diseases. This institute shall also provide training and teaching both at the undergraduate and at the graduate level of students who, upon graduation, will enter the practice of general medicine, with a technical background of training in mental illness, as well as for the purpose of taking up the great gap between the number*192 of qualified psychiatrists and the number who are needed as a result of the constantly mounting number of persons needing attention for mental disorders." 1949, May 20, P.L. 1643, § 1, 50 P.S. Pa. § 575.1.Other purposes, described by the statute, are the provision of courses of study for personnel of the various mental hospitals throughout the Commonwealth, the pursuit of studies for the prevention of mental and nervous disorders of children, the training and teaching of nurses and other personnel needed in the treatment, care and prevention of mental disorders and the study of problems of administration to the end of developing an effective, humane and economical policy for the care of mental illness in Pennsylvania.The purpose of admitting and treating patients, and the purpose and value of any services performed by taxpayer and those similarly situated are described in the Findings of Fact in the following language:13. Because it is not primarily a service organization, the Institute has fewer patients than the ordinary state mental hospital. Its patients are carefully selected, in part, from persons already confined to state mental hospitals and, in part, from persons *193 with mental or emotional disturbances who volunteer for admission to the Institute.14. The admission of selected patients is designed to bring into the Institute a cross-section of the types of cases the staff believes necessary for teaching, *73 research and training, including the training of the fellows in the training program in psychiatry.15. The Institute employs a full time staff of 17 psychiatrists; in addition it enjoys the services of the psychiatric staff of the Medical School of the University of Pittsburgh, of which it is a part. The fellows do not replace personnel who would otherwise have to be employed by the Institute to care for patients.16. In addition to participation in the care and treatment of patients, fellows in the training program in psychiatry are required to serve as instructors for nurses and medical students. Such instruction is closely supervised and is intended primarily to improve the ability of those in the training program to transmit knowledge of complex subject matters of their field as well as to aid in their own learning and investigations.It was found as an ultimate fact that the taxpayer was not primarily performing services for *194 the Institute or University. The grant was accordingly afforded the benefits of section 117.Here the Hospital was organized and operated for the care and treatment of patients, who were admitted solely on the basis of veteran status and actual need for hospitalization. The value or worthlessness of any given case to the training of residents or advancement of science was a matter of total indifference insofar as admissions were concerned. The adoption of a resident trainee program and the appointment of persons such as petitioner to residencies were merely incidental to and for the purpose of facilitating the raison d'etre of the Hospital, namely, the care of its patients.Thus, the case at bar presents a picture diametrically opposed to that in Wrobleski, where the institution existed for training purposes, and the admission of patients was merely incidental to and based primarily on the needs of the training program, rather than those of the patient.Whatever the value to petitioner of any training and experience received by her, and whatever her aims and purposes in accepting the position, she in fact performed valuable services and received the amount in question as*195 compensation therefor. Respondent's determination must be sustained.Decision will be entered for the respondent. Footnotes1. SEC. 117. SCHOLARSHIPS AND FELLOWSHIP GRANTS.(a) General Rule. -- In the case of an individual, gross income does not include -- (1) any amount received -- (A) as a scholarship at an educational institution (as defined in section 151(e)(4)), or(B) as a fellowship grant * * *↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624956/ | JAMES M. CAHILL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCahill v. CommissionerDocket No. 9112-80.United States Tax CourtT.C. Memo 1982-233; 1982 Tax Ct. Memo LEXIS 516; 43 T.C.M. (CCH) 1250; T.C.M. (RIA) 82233; April 29, 1982. James M. Cahill, pro se. Victoria Wilson, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined a deficiency in petitioner's income tax for the calendar year 1976 in the amount of $ 162. The only issue*517 for decision is whether petitioner understated interest income on his return in the amount of $ 606. FINDING OF FACT Some of the facts have been stipulated and are found accordingly. Petitioner, whose legal residence at the time of the filing of his petition in this case was Manorville, New York, filed a joint Federal income tax return with his then wife, Gloria G. Cahill, for the calendar year 1976. Petitioner and Gloria G. Cahill (Gloria George Cahill) were married in 1971. At the time of their marriage, petitioner had no knowledge of any property or of any cash or bank accounts that either he or Gloria owned. Gloria was born on March 24, 1948, and was therefore 23 years old when she and petitioner were married. During their entire marriage, the only checking account which they maintained was maintained in petitioner's name. All of the salary checks of both petitioner and his wife were deposited in this account. Their bills were paid from this account and from time to time moneys were withdrawn from this account and deposited in savings accounts in their joint names. During the year 1976, petitioner and his wife maintained a joint savings account at the Long Island*518 Trust Company from which they received interest of $ 288. They also maintained a joint savings account at Suffolk County Federal from which they received interest of $ 63. The addresses shown on these accounts were addresses in Patchogue, New York, where petitioner and his wife resided. So far as petitioner knew, all moneys received by either petitioner or his wife during their entire married life were deposited in his checking account or one of these two savings accounts in their joint names. In January 1977 petitioner and his wife were divorced. At the time of the trial and for some time prior thereto, petitioner has not known the address of his former wife, Gloria George Cahill, and although he has attempted to obtain that address, including requesting representatives of respondent to give him the address, he has been unable to obtain any address for his former wife and unable after reasonable efforts to locate her. Petitioner also does not know the address of Gloria George Cahill's father and has been unable to obtain his address. The joint Federal income tax return filed by petitioner and Gloria George Cahill for the year 1976 was prepared by a return preparer. On*519 this return they reported income from wages or salaries of $ 23,636, composed of $ 9,000.36 received by Gloria George Cahill from Dayton T. Brown, Inc., and $ 14,635.41 received by petitioner from the State of New York. The only other income they reported was $ 390 of interest income. On their return they itemized their deductions and included in their itemized deductions was interest paid of $ 3,000, which consisted of $ 30 of interest on a school loan, $ 400 of interest on bank cards, $ 69 of interest to a clothing store, $ 1,801 of mortgage interest, and $ 700 of interest on a bank loan for the purchase of a car. On October 7, 1968, an account was opened in the name of Gloria G. George in trust for Joseph O. George at the County Federal Savings and Loan Association, Rockville Centre, New York. The account number was 110636. On April 11, 1975, this account was closed and account number C1-22261 in the name of Gloria G. George in trust for Joseph D. George was opened by a transfer of $ 5,000 from account number 110636. Also on April 11, 1975, account number 153467 was opened in the name of Gloria G. George in trust for Joseph D. George with a transfer of funds from account*520 number 110636. Account number 153467 was closed on August 14, 1975, by the transfer of the $ 5,000 balance in the account to account number 12-7-1034 in the name of Gloria G. George in trust for D. Joseph George. On November 5, 1976, account number C1-22261 and account number 153467 were both closed and the funds in these accounts, each in the amount of $ 5,032.38, were transferred to account number 12-7-1633 in the name of Dimitri J. George in trust for Gloria G. George. The address shown for Gloria G. (Miss) George, trustee for D. Joseph George, on account number C-12-1034 was 62-49 83rd Street, Rego Park, New York. On the top of the individual trust account card at the bank was printed "Special Handling," and the relationship of the named beneficiary to the trustee was shown to be "father." At the time this account was closed on November 5, 1976, the residence of Gloria G. George was shown as P.O. Box 631, Margaretville, New York. Gloria George Cahill did not live in either Rego Park, New York, or Margaretville, New York, at any time during the years 1971 through 1976. Her father at one time lived in Rego Park, New York, and for a part of certain years lived in Margaretville, *521 New York. From the time of the opening of accounts numbered C1-22261 and 153467, all interest on these accounts was paid to D. Joseph George. Likewise, all interest on acount number 12-7-1034 was paid in quarterly payments to D. Joseph George. The County Federal Savings and Loan Association had on file an undated document attached to the signature card of account number 153467 which stated as follows: I hereby authorize County Federal Savings and Loan Association to draw a Quarterly interest check to the order of D. Joseph George from the above account and mail it to him at the following address: 62-49 83rd St., Rego Park, New York 11374 The above statement was typed and underneath was typed a line under which was typed "Gloria G. George." Next to the line was a check mark and next to the check mark appeared in handwriting "Gloria G. George." To the left-hand side of the line on which the name "Gloria G. George" appeared in handwriting was "SPECIAL HANDLING." Petitioner was of the opinion that his former wife's father had used the names of Joseph George, Brent George, D. Joseph George, Dimitri Joseph George, and Dimitri J. George. Petitioner had no knowledge of nor*522 did he receive any benefit from any of the bank accounts at County Federal Savings and Loan Association maintained in the name of Gloria G. George. The interest paid out by quarterly checks to D. Joseph George from accounts numbered C1-22261 and 12-7-1034 during the year 1976 totaled $ 645.06. Pursuant to its custom where an account was held in the name of a trustee in trust for another individual, the County Federal Savings and Loan Association reported to the Internal Revenue Service the interest on accounts numbered C1-22261 and 12-7-1034 in the name of Gloria G. George, P.O. Box 631, Margaretville, New York, under the name and social security number of Gloria G. George. The social security number was that of Gloria George Cahill. Respondent mailed a joint notice of deficiency to James and Gloria Cahill, 34 9 Winding Path, Manorville, New York, for the year 1976. In this notice the income as reported by petitioner and his wife was increased by the amount of $ 609 with the following explanation: ALL INTEREST INCOME IS INCLUDIBLE IN INCOMESHOWN ON RETURN OR AS PREV. ADJUSTED $ 390.00CORRECTED AMOUNT1 $ 999.00*523 OPINION Respondent takes the position that the mere fact that the two accounts at the County Federal Savings and Loan Association were carried in the name of Gloria G. George is conclusive proof that the money in these accounts belonged to her and the interest income paid on these accounts was her income. Respondent contends no evidence that might be offered could rebut this presumed fact. In support of his contention, respondent relies on a misstatement of the holding in the case of In re Totten,179 N.Y. 112">179 N.Y. 112, 71 N.E. 748">71 N.E. 748 (1904), and in the many cases following that case as well as a misinterpretation of N.Y. Est. Powers & Trusts Law sec. 7-5.1 through 7-5.7 (McKinney 1967), which became effective the beginning of September 1975. Respondent states in citing the Totten case and a number of cases which have relied on and followed that case as follows: When a trust account is opened, a revocable trust is created, and the trustee is considered to be the owner of the account. The beneficiary has no legal interest in the funds whatsoever. * * * Respondent further states: Similarly under the statute, the only method by which a*524 gift can be made of funds on deposit in a "Totten trust" during the depositor's lifetime is for the depositor to withdraw the funds and give them to the beneficiary. * * * Respondent's misrepresentation or misunderstanding of the law is clearly apparent from the following often quoted part of the Totten case: After much reflection upon the subject, guided by the principles established by our former decisions, we announce the following as our conclusion: A deposit by one person of his own money in his own name as trustee for another, standing alone, does not establish an irrevocable trust during the lifetime of the depositor. It is a tentative trust merely, revocable at will, until the depositor dies or completes the gift in his lifetime by some unequivocal act or declaration, such as delivery of the passbook or notice to the beneficiary. In case the depositor dies before the beneficiary without revocation, or some decisive act or declaration of disaffirmance, the presumption arises that an absolute trust was created as to the balance on hand at the death of the depositor. * * * [Emphasis supplied; 71 N.E. at 752.] In the many cases that have been decided*525 since 1904 involving "Totten trusts," the Courts have made it unequivocally clear that a "Totten trust" or revocable trust is presumed to arise only where the deposit by the depositor is of his own funds. Several cases following the Totten case have dealt with a situation where the money deposited has not been that of the trustee but in fact has been the funds of the beneficiary. The Court in In re Miller's Estate,109 N.Y.S.2d 516">109 N.Y.S.2d 516 (Surr. Ct. Monroe County 1951), held that money placed by a decedent in an account in his sister-in-law's name as trustee for him did not create a "Totten trust" and that the funds in the account belonged to the decedent and not to the sister-in-law. In so holding, the Court discussed the Totten case and cases following the Totten case which dealt with whether the trustee had taken action which caused an irreovocable trust to be created during his lifetime and then stated (at 518): But it is doubtful that the above situations have any direct bearing on the case at bar, for in those cases admittedly a Totten trust had been created, and the rules of law with respect thereto were applied. Here there is no proof that*526 a true Totten trust was created. The money belonged to the beneficiary, as was the case in Matter of McLaughlin's Estate, 148 Misc. 113">148 Misc. 113, 265 N.Y.S. 332">265 N.Y.S. 332; Matter of Milton's Estate, 148 Misc. 315">148 Misc. 315, 265 N.Y.S. 735">265 N.Y.S. 735; Matter of Farrell's Estate, 177 Misc. 389">177 Misc. 389, 30 N.Y.S.2d 742">30 N.Y.S.2d 742, wherein it was held that upon the death of the respective beneficiaries before the trustees, the legal representatives of the beneficiaries were entitled to the funds. * * * In the case of Application of Wheeler,72 N.Y.S.2d 115">72 N.Y.S.2d 115 (Surr. Ct. Otsego County 1947), the issue was whether upon the death of the named beneficiary of a savings account the named trustee had a right to the funds. The administratrix of the decedent's estate claimed that the funds were property of the decedent. The facts were that a Mrs. Genevieve Merrill had deposited her own funds in an account in the name of "Mrs. Mabel Simmons, Trustee for Mrs. Genevieve Merrill." Mrs. Simmons was Mrs. Merrill's daughter. The record showed that during Mrs. Merrill's lifetime, Mrs. Simmons acted as trustee of the account and there is no showing as to who had control of the passbook during this period. *527 The Court concluded that the funds in the account belonged to Mrs. Merrill at the time of her death. After noting that, counsel for Mrs. Simmons urged that the trust was a so-called "Totten trust," the Court stated that a "Totten trust" is one created by the deposit of one's own money in one's own name as the trustee for another and that such a trust has been held to be revocable during the lifetime of the depositor but irrevocable upon the death of the depositor prior to the death of the beneficiary. The Court, however, pointed out that in the case that was being considered, the funds deposited were not those of the trustee but of the person designated as the beneficiary and that there was a total absence of evidence of a gift by Mrs. Merrill of the funds during her lifetime. The Court stated: On the contrary it appears that the decedent was infirm and unable to write. It also appears that she was living in another city from that in which the funds were on deposit with petitioner and that she had ceased to live with petitioner. It is impossible to make any positive finding as to the reason for the creation of the account in question in the Schenectady Savings Bank in the form*528 in which it existed at the time of decedent's death. However, the probability that the funds of this elderly woman, unable to write, were deposited in her daughter's name as Trustee for convenience is stronger than the probability that it was so deposited with the idea of divesting decedent of her title thereto either during her lifetime or upon her death. * * * [Application of Wheeler,72 N.Y.S.2d at 117.] It is clear from the New York law that only where a person deposits his own funds as trustee for another is a "Totten trust" created. As respondent points out in his brief, N.Y. Est. Powers & Trusts Law (McKinney 1967), was amended effective September 1, 1975, to codify the law as it had developed with respect to "Totten trusts" with certain changes. N.Y. Est. Powers & Trusts Law sec. 7-5.1(b) (McKinney 1967), as amended effective September 1, 1975, states that "A 'depositor' is a person in whose name a trust account subject to this part is established or maintained," and section 7-5.1(d) provides as follows: (d) A "trust account" includes a savings, share, certificate or deposit account in a financial institution established*529 by a depositor describing himself as trustee for another, other than a depositor describing himself as acting under a will, trust instrument or other instrument, court order or decree. Section 7-5.2 provides in part as follows: The funds in a trust account, which shall include any dividends or interest thereon, shall be trust funds subject to the following terms: (1) The trust can be revoked, terminated or modified by the depositor during his lifetime only by means of, and to the extent of, withdrawals from or charges against the trust account made or authorized by the depositor. Further provisions of the statute concern termination or modification of the trust by will, termination of the trust upon the death of the beneficiary with title to the funds then being in the depositor clear of the trust, and termination of the trust upon the death of the depositor with title to the funds vesting in the beneficiary clear of the trust. The statute further provides for protection of a financial institution where payment of the funds is made in accordance with the stated rights of the depositor and beneficiary absent the serving upon it of some form of restraining order or other process*530 prior to the funds being paid to the beneficiary upon the death of the depositor. In the Practice Commentary explaining N.Y. Est. Powers & Trusts Law secs. 7-5.1 through 7-5.7 (McKinney Suppl. 1981-1982), the following statement appears: It would also appear that, as an unstated premise, the depositor would have to be depositing his own funds in such a trust account. Where, for example, an attorney, fiduciary or agent deposited funds of a third party in such an account, this section would not govern, even if the attorney, fiduciary or agent neglected to state the true nature of the transaction on the bank account cards. * * * However, in this case we need not decide whether this commentary correctly expresses the application of the statute since section 7-5.7 entitled "Application" states as follows: This part shall apply to all funds in trust accounts, as defined in paragraph (d) of section 7-5.1, which are in existence on its effective date, except that its provisions shall not impair or defeat any rights which have accrued prior to such date. Since all of the deposits involved in the instant case, except the transfer of the funds from accounts in*531 the name of Gloria G. George in trust for Joseph D. George to an account entitled "Dimitri J. George as trustee for Gloria G. George" on November 5, 1976, were made prior to September 1, 1975, the rights that existed in those accounts as of September 1, 1975, were preserved by the provisions of N.Y. Est. Powers & Trusts Law sec. 7-5.7 (McKinney 1967). Therefore, applying the New York law in this case, it is necessary for us to determine the true owner of the funds in the accounts in the name of Gloria G. George in order to determine to whom the interest on those accounts is taxable. If the funds deposited in the accounts were funds of Gloria G. George, then under New York law a revocable trust was created. Section 676(a) 2 provides that the grantor shall be treated s the owner of any portion of a trust where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a nonadverse party or both. While cases involving the application of section 676 have dealt with factual situations more complicated than those involved in "Totten trust," these cases have consistently held that where a grantor creates a trust with*532 his own funds, the income from that trust is taxable to the grantor if the trust is revocable within a period of 10 years from the date it was created. See Garland v. Commissioner,42 B.T.A. 324">42 B.T.A. 324, 328 (1940); section 676(b). It is also settled that the determination of whether a trust is revocable depends on the law of the state in which it was created. See Blair v. Commissioner,300 U.S. 5">300 U.S. 5 (1937). It would therefore follow that a "Totten trust,"being a revocable trust under New York law, the income from such a trust would be taxable to the grantortrustee regardless of who actually received the income. 3*533 Since respondent has determined in this case that the income from the two accounts created in the name of Gloria G. George in trust for Joseph D. George is includable in the income of petitioner's former wife, the burden of proof is on petitioner to establish that Gloria G. George was not in fact the owner of the funds in th two accounts. Clearly, if the two accounts were opened by Gloria G. George with her own funds, the interest received on those accounts is taxable to her even though the amounts were actually paid to her father. 4 Section 676(a). It is incumbent upon petitioner to establish that the funds with which the two accounts were established were not the property of Gloria G. George. We will therefore review the evidence presented to us to determine whether it is sufficient to establish that the funds in the two accounts were not the property of Gloria G. George. If we so conclude, then petitioner has sustained his burden so that it is incumbent on respondent to go forward with rebuttal evidence. *534 It is respondent's position that the evidence produced in this record is insufficient to carry petitioner's burden and that even though the address of Gloria G. George and her father are within respondent's knowledge but not within petitioner's knowledge, it is not incumbent on respondent to either furnish these addresses to petitioner or to produce either petitioner's former wife or her father as a witness. With respect to the failure to supply petitioner with the addresses when he requested such information, respondent relies on the Privacy Act. In explanation of why he did not call either petitioner's former wife or her father as a witness, respondent's counsel stated that the expense involved was too great as compared to the amount of the deficiency involved in this case. This record shows that the funds in the two accounts here involved came from funds originally deposited in the name of Gloria G. George in trust for Joseph O. George in 1968 when petitioner's former wife was only 20 years old. The record further shows that all interest on these accounts had for some time prior to the year here involved been paid to D. Joseph George and the inference from the record is*535 that all interest was paid to D. Joseph George from the date of creation of the original account in 1968. The evidence further shows that during the five years of their married life, petitioner and his former wife were of modest means, living on relatively small salaries with no property other than property they were able to acquire with their relatively small income. The evidence also shows that during the year here in issue, petitioner and his former wife paid interest not only on their home mortgage but also on a car loan, on credit card accounts, on a school loan, and to a clothing store. The record further shows that on November 5, 1976, the funds in the two accounts were transferred to a fund in the name of Dimitri J. George in trust for Gloria G. George. It also shows that the addresses given for all of the accounts here involved were addresses of Gloria G. George's father and not addresses of Gloria G. George. To accept respondent's position in this case, we would have to conclude that a 20-year-old woman in some way obtained $ 10,000 in her own right which of her own free will she deposited in an account in trust for her father with the interest payable to her father*536 and, through a period of eight years when she was in modest financial circumstances, continued making gifts to her father of the interest on her own funds by having the interest paid to her father. We would further have to conclude that after this period of over eight years, she voluntarily transferred her own funds to an account in her father's name in trust for her. The evidence petitioner produced is not conclusive proof that this scenario did not occur. However, in our view, the evidence here as in the case of Application of Wheeler,supra, creates a much higher probability that the funds deposited in the accounts here involved were those of petitioner's former wife's father than that they were funds owned by petitioner's former wife. In many instances it is necessary to reach a conclusion in a factual case on the basis of evidence which is not totally conclusive, particularly where, as here, the ability to produce the testimony of the only two people who knew the facts was under respondent's control and respondent chose not to produce either witness. In fact, the indication from the record is that petitioner on numerous occasions had attempted to have*537 employees of the Internal Revenue Service, including respondent's counsel in this case, contact his former wife or his former wife's father and inquire as to the source of the funds which were deposited in the two accounts here involved. The result of these efforts was that none of the employees of respondent, or respondent's counsel in this case, were willing to or had agreed to comply with his request. Petitioner also requested employees of respondent to check the income tax return of Joseph D. George to see if he had reported the income on the accounts here involved and this request was not granted. Respondent cites In re Cohen's Will,90 N.Y.S.2d 776">90 N.Y.S.2d 776, 779 (Surr.Ct. Weschester County, 1949), as holding that where there is no evidence of the parties' intent other than the form of the deposit, the Courts infer that the depositor intended to create a revocable trust of the deposit. Respondent, however, ignores the fact that in In re Cohen's Will,supra, the Court concluded that the funds there in issue were the funds of the beneficiary and stated (at 779): The sole evidence as to the aim of the deposit, however, is not here the form of the*538 account. A brother of decedent testified to statements made by decedent three or four years before the hearing herein to he effect that "every nickel Hymie gave her she saved for him", and in referring to a bank account: "What I got here belongs to Hymie" and that "He is working for the money and that money belongs to him".These statements were designed to establish that the decedent regarded the proceeds of the account as monies being held by her for her son, the respondent herein. Similarly, in the instant case, petitioner in effect testified that during their married life he and his former wife had an understanding that each was contributing to their joint support and their joint savings accodunts, all the income he or she received and he had no reason to doubt that all income of his former wife was so used. In our view, petitioner has shown by a preponderance of the evidence that the funds in the two accounts at the County Federal Savings and Loan Association in the name of Gloria G. George in trust for Joseph D. George were not in fact owned by his former wife but were the property of her father, Joseph D. George, the person to whom the interest was paid. 5 Under the*539 circumstances, we conclude that the interest was not the income of Gloria G. George.*540 Decision will be entered for the petitioner.Footnotes1. Although in the notice of deficiency petitioner's interest income was increased by $ 609, on brief respondent conceded that the proper amount of the increase should have been $ 606.↩2. Unless othewise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue. ↩3. In Rev. Rul. 62-148, 2 C.B. 153">1962-2 C.B. 153, respondent held that a taxpayer who deposits his own funds in a New York savings bank in trust for his minor son is taxable under sec. 676(a) on the interest on the account absent any evidence to show his intention in making the deposit. This ruling relies on In re Totten,179 N.Y. 112">179 N.Y. 112, 71 N.E. 748">71 N.E. 748↩ (1904), for its conclusion that the taxpayer has created a revocable trust.4. Petitioner makes no claim that he is an innocent spouse within the meaning of section 6013(e) of the Internal Revenue Code of 1954↩ and clearly he would not be since there has been no omission from gross income of 25 percent of the reported income. Petitioner did attempt to make some issue of the fact that the notice of deficiency which was mailed to him and his former wife on March 26, 1980, was not mailed to his former wife's last known address and that, insofar as he knew, she never received a copy of the notice since he has not known her address or where to get in touch with her for a period well before the date of the issuance of the notice. Petitioner raised no issue in this regard in the case and, since he timely received the notice, it is clear that no issue in this respect exists in this case.5. Although the fact is not entirely clear from the record, we infer that neither petitioner nor employees of respondent nor counsel for respondent in this case were fully aware of the entire history of the accounts in the name of Gloria G. George at the County Federal Savings and Loan Association until shortly before the trial of this case and possibly only when the representative of the savings and loan association, who had been subpoenaed by both petitioner and respondent, testified and produced the documents. As set forth in our findings of fact, the report of the interest payments by the savings and loan association to the Internal Revenue Service gave no indication that the account in the name of Gloria G. George was set up as a trust account. The record shows that petitioner had made numerous efforts to obtain complete information on the accounts from the savings and loan association to no avail until a witness appeared at the trial in response to the subpoenas and produced all the documents which the employees under his supervision had been able to find. Some of the documents with respect to the accounts had not been located. However, the information was much more complete than the very sketchy information previously furnished to petitioner. The record also shows that petitioner had attempted unsuccessfully prior to the trial to obtain assistance from employees of the Internal Revenue Service in obtaining complete records of the savings and loan association of accounts showing the name of Gloria G. George. Furthermore, we have not overlooked the fact that petitioner was far from consistent in the various positions he took. It is clear that he was of the opinion that the accounts here involved had actually been opened by his former wife's father without her knowledge and that his former wife, if contacted, would have no knowledge of these accounts. There is some indication in the record, from a comparison of signatures of Gloria G. George on the bank signature cards with the signature of petitioner's former wife on the tax return filed by petitioner and his former wife for the year 1976, that this in fact might be the case. Notably, the G's in the signature on the tax return are totally different from the G's on the signature cards. There are other letters which are differently formed. Petitioner testified that he knew that the signature on the tax return was that of his former wife. However, no testimony of a handwriting expert was produced and without such testimony the Court is unable to conclude that the signatures on the various signature cards were not the signatures of Gloria G. George although the dissimilarity of the writing does arouse suspicion.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624957/ | RANDALL HARRISON BORDERS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBorders v. CommissionerDocket No. 30220-83.United States Tax CourtT.C. Memo 1986-466; 1986 Tax Ct. Memo LEXIS 148; 52 T.C.M. (CCH) 617; T.C.M. (RIA) 86466; September 22, 1986Randall Harrison Borders, pro se. Mary Jansing, for the respondent. WRIGHTMEMORANDUM FINDINGS OF FACT AND OPINION WRIGHT, Judge: Respondent determined a deficiency in petitioner's Federal income tax for taxable year 1981 in the amount of*150 $10,164 and additions to tax of $2,450 under section 6651(a); 1 $508.20 plus 50 percent of the interest due on an underpayment of $10,164 under section 6653(a)(1) and (2), respectively; and $744.01 under section 6654(a). Respondent also filed a motion for award of damages under section 6673 when this case was called for trial. The issues for decision are: (1) whether petitioner received income in the amount of $36,154 during taxable year 1981 which should be included in his taxable income under section 61(a); (2) whether petitioner is liable for the addition to tax for failure to file a Federal income tax return under section 6651(a)(1); (3) whether petitioner is liable for the additions to tax due to negligence under section 6653(a)(1) and (2); (4) whether petitioner is liable for the addition to tax for the underpayment of estimated tax under section 6654(a); and (5) whether damages should be awarded to the United States under section 6673. *151 FINDINGS OF FACT At the time the petition in this case was filed, petitioner resided in Modesto, California. Petitioner did not file a Federal income tax return for taxable year 1981. He filed Forms W-4 with his employer during that year on which he claimed to be exempt from taxation. Petitioner did file Federal income tax returns for 1979 and 1980. A substitute return was prepared for petitioner by the Internal Revenue Service from Forms 1099 and W-2 submitted to the Internal Revenue Service from petitioner's banking institutions and employers for taxable year 1981. The sum of these amounts was $36,154. On August 1, 1983, respondent issued a statutory notice of deficiency to petitioner in which he determined that petitioner was liable for Federal income tax on this amount, together with additions to tax for failure to file, negligence, and underpayment of estimated tax. OPINION Respondent's determinations are presumptively correct; petitioner bears the burden of proving that he is not liable for the deficiencies determined in the statutory notice. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). The petition which was filed in the instant case*152 did not contain clear and concise assignments of error and clear and concise statements of fact on which petitioner based assignments of error. See Rule 34(b)(4) and (5). At trial, petitioner's principal argument was that the compensation he received for his services was not paid on the basis of a percentage of profits, and consequently that respondent erred in determining that it was taxable income to him under section 61. In support of this position, petitioner cited section 1.61-2(a), Income Tax Regs. This section provides, in pertinent part: Wages, salaries, commissions paid to salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses (including Christmas bonuses), termination or severence pay, rewards, jury fees, marriage fees and other contributions received by a clergyman for services, pay of persons in the military or naval forces of the United States, retirement pay of employees, pensions, and retirement allowances are income to the recipients unless excluded by law. * * * Petitioner's position is that because the compensation he received was not based on a percentage of profits, it is not income to*153 him within the meaning of section 1.61-2(a), Income Tax Regs. Petitioner fails to note, however, that this section is written in the conjunctive rather than the disjunctive, and therefore the hourly wages which he received as reported to the Internal Revenue Service by his employers on Forms W-2, as well as the interest income reported by various banking institutions on Forms 1099 and the unemployment income received by petitioner in the year in issue constitute income within the meaning of section 61 and section 1.61-2(a), Income Tax Regs.Petitioner further alleges that respondent erred in referring to him in the notice of deficiency as a "taxpayer." Petitioner bases this allegation on his claim that he paid no taxes during taxable year 1981 and that he does not have a taxpayer identification number. A taxpayer is defined as any person subject to any Internal Revenue tax. Sec. 7701(a)(14). During the year in issue, petitioner had income in excess of the required amount plus the zero bracket amount and was therefore subject to Federal income tax. Sec. 1. Despite his failure to pay tax that year, he fits within the definition of the term taxpayer in the Internal Revenue Code. *154 Petitioner also stated that he had no social security number which would constitute an identifying number under section 6109. However, at trial, petitioner identified the social security number appearing on documents used by respondent to compute petitioner's taxable income for the year in issue as his social security number. Petitioner did not dispute the amount of compensation determined by respondent in the notice of deficiency. He argued, however, that these amounts were not wages and that he was not a taxpayer. Because we find these arguments unpersuasive, we hold that petitioner received taxable income in the amount of $36,154 during taxable year 1981. Respondent determined an addition to tax under section 6651(a)(1) based on petitioner's failure to file a Federal income tax return for taxable year 1981. Section 6651(a)(1) provides, in pertinent part: (a) Addition to the Tax. -- In case of failure -- (1) to file any return, * * * unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more*155 than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate[.] Petitioner bears the burden of proving that the failure to file a timely return is due to reasonable cause. Lee v. Commissioner,227 F.2d 181">227 F.2d 181, 184 (5th Cir. 1955), cert. denied 351 U.S. 982">351 U.S. 982 (1956). Petitioner did not file an income tax return for taxable year 1981. Despite petitioner's claim to the contrary, he had sufficient income to require the filing of such a return. Sec. 6012(a). Petitioner argues, however, that the Forms W-2 and 1099 received by the Internal Revenue Service contained sufficient information to constitute a return. 2 Petitioner offers no support for this proposition, nor have we found any. The fact that the amounts of wages and interest income received by petitioner were reported to the Internal Revenue Service does not excuse petitioner from his duty to file a Federal income tax return. Therefore, we find that petitioner is liable for the addition to tax under section 6651(a)(1) as determined by respondent. *156 Respondent has also determined that petitioner is liable for additions to tax under section 6653(a)(1) and (2) for taxable year 1981. Section 6653(a)(1) provides that if any part of any underpayment is due to negligence or intentional disregard of rules or regulations (but without intent to defraud), there shall be added to the tax an amount equal to 5 percent of the underpayment. Section 6653(a)(2) provides, in pertinent part, that there shall be added to the tax (in addition to the amount determined under paragraph (1)) an amount equal to 50 percent of the interest payable under section 6601 with respect to the portion of the underpayment described in paragraph (1) which is attributable to the negligence or intentional disregard of rules or regulations. Petitioner bears the burden of proving that no part of the underpayment herein is due to negligence or intentional disregard of rules or regulations. Barton v. Commissioner,424 F.2d 1295">424 F.2d 1295 (7th Cir. 1970), cert. denied 400 U.S. 949">400 U.S. 949 (1970). Petitioner offered no evidence in an attempt to overcome the presumption of correctness in respondent's determination of the addition to tax under section 6653(a). *157 Further, petitioner had filed Federal income tax returns for taxable years 1979 and 1980. Petitioner was aware of his duty to file Federal income tax returns. Therefore, we sustain respondent's determination with respect to the additions to tax under section 6653(a)(1). Respondent also determined an addition to tax under section 6654 for the failure to pay estimated income tax for taxably year 1981. Section 6654 provides for an addition to tax in the case of any underpayment of estimated tax by an individual. This addition to tax is mandatory. Estate of Ruben v. Commissioner,33 T.C. 1071">33 T.C. 1071 (1960). Petitioner did not file estimated tax payments for taxable year 1981 and he filed Forms W-4 with his employers claiming he was exempt from Federal income tax for that year. Consequently, his employers did not withhold any income tax from petitioner's wages. Therefore, petitioner made no payments of estimated tax for taxable year 1981 and is liable for the addition to tax under section 6654. Finally, respondent seeks damages under section 6673 in the amount of $5,000. Section 6673 provides: Whenever it appears to the Tax Court that proceedings before it have*158 been instituted or maintained by the taxpayer primarily for delay or that the taxpayer's position in such proceedings is frivolous or groundless, damages in an amount not in excess of $5,000 shall be awarded to the United States by the Tax Court in its decision. Damages so awarded shall be assessed at the same time as the deficiency and shall be paid upon notice and demand from the Secretary and shall be collected as a part of the tax. As noted above, the petition in the instant case contained no clear and concise assignments of error with respect to the statutory notice of deficiency. Subsequent to the filing of the petition, petitioner refused to meet with or speak to counsel for respondent. Petitioner further refused to enter into a stipulation of fact with respect to the instant litigation. The arguments he made at trial were frivolous and groundless. Petitioner was informed, prior to trial, that refusal to cooperate in an attempt to reach a stipulation which would conserve the time of this Court and of the parties would result in a request for damages pursuant to section 6673. However, petitioner remained steadfast in his refusal to cooperate. Petitioner has abused the process*159 of this Court and wasted its resources and those of respondent. Basic Bible Church v. Commissioner,739 F.2d 266">739 F.2d 266 (7th Cir. 1984); Abrams v. Commissioner,82 T.C. 403">82 T.C. 403 (1984). Therefore, damages shall be awarded to the United States in the amount of $5,000. Based on the foregoing, Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the year here in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩2. In Reiff v. Commissioner,77 T.C. 1169">77 T.C. 1169 (1981), this Court held that a 32-page document filed by the taxpayer did not constitute a return and that the attachment of a Form W-2 to said document was insufficient to enable it to be treated as a return. 77 T.C. at 1178↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4476861/ | OPINION. Raum, Judge: This is primarily a factual controversy, which has been resolved in large part by our findings of fact. The Commissioner determined the deficiencies by use of the increase in net worth method, making appropriate adjustments for nondeductible expenditures. The net worth method is not a system of accounting. Where the taxpayer’s increase in net worth is substantially in excess of his reported income and where the discrepancy cannot be reasonably explained as being attributable to gifts or inheritances or other nontaxable receipts, the net worth method furnishes persuasive evidence of unrepórted income. And in determining the amount of net income for any such period it is necessary to add all nondeductible expenditures made by the taxpayer during that period, for such expenditures represent additional unexplained resources available to the taxpayer, over and above the increase in net worth.1 Other adjustments, such as deductions for depreciation, must also be made. The taxpayer has made no effort whatever to show his correct income for any of the years in controversy,2 and does not contest many of the items on the Commissioner’s net worth statement; however, he challenges certain items in that statement. The record is voluminous and it would serve no useful purpose to analyze the evidence and set forth the reasons for our findings. The crucial facts in dispute turned largely upon the credibility of petitioner and his alleged wife, Eose Potson. We had ample opportunity to observe both of them on the witness stand for extended periods and it is our conclusion that both of them were careless with the truth.3 Our findings in many instances reflect our lack of confidence in their credibility. We did not, of course, resolve every issue of fact against petitioner; we appraised the evidence in the light of its credibility, taking into account the entire record, and made our findings accordingly. Our task was a difficult one, but we conscientiously undertook to perform it, exercising our best judgment on all the evidence. Although, as already indicated, we do not intend to discuss all the evidence, we shall comment upon some of the major points of difference between the parties. 1. At the outset there is a sharp dispute between the parties as to the amount of cash on hand or deposited in banks which petitioner had on December 31, 1935. The Commissioner contends that petitioner had only $15.03 at that time. Petitioner asserts that he had over $200,000. There is support in the record for the Commissioner’s contention. Starting with facts disclosed in an application for a bank loan in 1930 and after making adjustments based on reported income and known expenditures from 1930 through 1935, the Commissioner has made out a logical case for his position. He has also undertaken to fortify that position with evidence tending to show that petitioner was short of money in dealing with his creditors. However, we are convinced by other evidence that the Commissioner’s position is unrealistic. Potson was a man who had been engaged in illegal activities on an extensive scale. He operated a thriving night club business. There was considerable evidence that he had available substantial amounts of cash during this period. However, we do not accept petitioner’s testimony as to the amount of cash on hand on December 31, 1935, for we think that the amount urged by him was considerably inflated. We cannot, therefore, make either the finding requested by the Commissioner or the finding requested by petitioner. Neither would be in accord with our appraisal of the facts. In the circumstances, we have used our best judgment, based on a study of all the evidence, and in our Findings of Fact we have set forth our determination of the amount of cash owned by petitioner on December 31 of each of the years 1935 to 1943, inclusive. Cf. Cohan v. Commissioner, 39 F. 2d 540, 544 (C. A. 2). 2. The Commissioner disallowed the marital exemption for Rose Potson, claimed by petitioner on his returns, on the ground that Potson and Rose were not married during any of the taxable years or living together during the years 1940 to 1943, inclusive. Petitioner contends that they were married in Milwaukee, Wisconsin, in 1908. As a basis for that disallowance, the Commissioner introduced evidence that Potson, on numerous occasions in various documents (such as his application for naturalization in 1915), claimed that he was unmarried and that the records of the city of Milwaukee, Wisconsin, did not disclose a marriage between petitioner and his alleged wife. That evidence is highly persuasive, and the matter is not free from doubt. However, after considering other evidence to the contrary, and taking into account the entire record it is our best judgment on all the evidence that Potson and Rose were married during the taxable years. We also have concluded that they were living together during the years 1940 to 1943, inclusive, although Rose was in California and Potson spent part of his time in Chicago. He maintained and owned a residence in California and when he was there, he lived in that home with Rose. We decide this issue in petitioner’s favor. 3. A major point of disagreement between the parties concerns the extent of Rose Potson’s investment in certain properties, title to which was taken in the name of the “Harrison and State Building Corporation,” and other real properties; her investment in United States savings bonds; and her ownership of funds deposited in an account in the California Bank, Beverly Hills, California. Petitioner argues that payment in whole or in part for certain of the properties which the Government has charged to him on his net -worth statement was made by his wife from her personal funds and that the amount charged to him should be decreased by the amount of her contribution. This contention is based primarily on testimony given by him and his wife. We have not accepted this testimony, since we did not find it credible. We have rejected as unworthy of belief Rose Potson’s story of the large accumulation of cash which she allegedly derived from her operation of the two “hotels” in the vice district up to 1912 and which in large part she allegedly retained intact up to the taxable years. Among other things, petitioner had made prior admissions to the effect that his wife had no assets other than what he had furnished to her. Moreover, the protective mortgages which petitioner took from the Harrison and State Building Corporation cast grave doubt upon the truthfulness of the testimony that Rose Potson supplied funds for the purchase of such properties. Although some of the stock in that corporation stood in her name, we are satisfied that she was not the real owner of such stock; she and the other stockholders of record were merely the nominal owners of stock which in fact belonged to petitioner. While it may have been true that Rose Potson had custody of cash which she made available to consummate several of the disputed purchases, we are convinced that such cash had its source in pé-titioner, that it actually belonged to him, and must therefore be charged to him. We have also resolved the issues of ownership of the United States savings bonds and the account in the California Bank contrary to Potson’s position. The difficulties with that position are due, here also, to the lack of credibility of Potson and his wife. Money from the California Bank was used to pay personal expenses of Potson and money belonging to him was deposited therein. Potson’s position as to the United States savings bonds must be examined in the light of admissions 4 made by him as to his ownership of bonds in an amount that was not less than the aggregate amount of bonds purportedly owned by him and his wife. We have carefully considered all of the evidence and have decided that the issue of how much of the assets and expenditures charged to Potson was in fact his must be fully resolved in favor of the Commissioner. 4. Petitioner contends that he should be given credit in determining his increase in net worth in 1942 and 1943 for payments of $10,000 which he received in each of those years from the Harrison and State Building Corporation. His position in substance is that such payments were made upon the mortgage notes held by him, that they merely reduced his investment, and that therefore his increase in net worth for those years must be reduced by the amount of those pay-meats. If such payments were in fact distributions of capital by the corporation, petitioner’s position would be correct. The parties did indeed stipulate orally at the trial that payments in those amounts were made on the mortgages, but the Government made it clear that it was not conceding that such payments had the legal effect of being merely a return of capital. And we are satisfied on the evidence that they did not in fact constitute a return of capital. The evidence is clear that petitioner had not made any loans to the building corporation, and that the mortgages had been executed in his favor, not as security for any loans, but merely to protect his interest in the corporation. Petitioner himself made it plain that these mortgages did not represent any indebtedness to him, and he characterized them as “funny mortgages, just for the business sake.” The corporation never declared any dividends as such, and it is obvious that the payments in controversy represented in effect merely distributions of corporate profits.5 They must therefore be treated as dividends as a matter of law, regardless of the form in which they were cast. Accordingly, we cannot accept petitioner’s position that the payments which he thus received must be subtracted from his increase in net worth. A like contention is made by petitioner in relation to the net excess withdrawals in 1937 and 1938 from the 2126 South Wabash Restaurant Corporation. Similarly, we think that such withdrawals did not decrease his investment in that corporation. Colosimo’s was a large, successful establishment. We have found that its records were inadequate and a correct determination of income could not be made therefrom. We have found that on occasions the cash register did not accurately reflect the gross receipts. We think, therefore, that withdrawals from that corporation were withdrawals of earnings, and that petitioner is not entitled to have them treated as capital payments. 5. The Commissioner has determined that a part of the deficiency for each of the taxable years was due to fraud with intent to evade tax. We think that such fraud has been proved by clear and convincing evidence. There were substantial amounts of unreported income during the period in controversy, indicating a consistent intention to evade tax. Potson was less than frank with the agents when they asked for a statement of net worth. His efforts to explain the failings of the statement were lame indeed and are not worthy of belief. He had been found guilty of the crime of willfully attempting to defeat and evade a part of the income tax due and owing from him for the years 1940 to 1943, inclusive.6 These considerations are merely illustrative, and, on the basis of the entire record, we have concluded that the Commissioner has sustained his burden of proving that a part of the deficiency for each of the taxable years is due to fraud with intent to evade tax.7 Accordingly, because of such fraud, petitioner is not entitled to the benefits of section 6 of the Current Tax Payment Act of 1943. Decision will he entered under Bule 50. No adjustments are required for deductible expenditures. While it is true that such expenditures reflect additional resources available to the taxpayer during the period which would augment his gross income, the fact that they are deductible would neutralize their effect in determining the taxpayer’s net income. The burden of proof was, of course, upon the petitioner to show that the basic deficiencies determine'’ by the respondent, except for the 2 years not covered by waivers, were erroneous. Cf. Louis Halle, 7 T. C. 245, affirmed, 175 F. 2d 500 (C. A. 2), certiorari denied, 338 U. S. 949. The burden was on the respondent to prove fraud for all the years in controversy. On one occasion during the hearing when Rose Potson was on the stand, nine series of questions and answers were read to her and she was asked whether such questions had been put to her by the investigating agent and whether she gave such answers. 'In some instances she denied both that she had been asked the questions and had given the answers ; in other instances she denied only giving the answers. The agent was later called as a witness and testified that he had put the questions to her and that she had given the answers as read. We are fully satisfied that the agent told the truth and that Rose Potson lied. This was only one of a number of instances in the record casting doubt upon her credibility. Such admissions were made at the prior criminal trial and in the net worth statement filed by him with the California Bank. The face amount of the bonds registered in petitioner’s name and in the name of his wife was very close to the amount stated by petitioner in such prior admissions. The returns filed on behalf of the corporation disclosed an “earned surplus” of over $10,000 in 1942 and $16,000 in 1943. This does not necessarily preclude the existence of earnings and profits sufficient to support dividend distributions in the amounts in question. Petitioner made no effort to show that the earnings and profits of the corporation were insufficient for that purpose. Almost the entire transcript of that trial was Introduced in evidence in this proceeding as a joint exhibit. Since we have found fraud for the taxable years 1936 and 1937, the period of limitations for those years has not expired. Sec. 276, I. R. C. | 01-04-2023 | 01-16-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4476862/ | OPINION. BRUCE, Judge: The issues presented for decision require the determination of the nature of certain corporate distributions under sections 112 and 115 of the Internal Revenue Code. Sponge-Aire, a corporation, distributed $149,000 in cash to its stockholders, retained $482,585.25 to meet outstanding liabilities, and transferred $166,317.24 net to Chandler, a new corporation. Chandler distributed its shares among the stockholders of Sponge-Aire. Respondent determined that petitioners, as stockholders of Sponge-Aire, received the Chandler stock in a tax-free exchange within the purview of section 112 (b) (3), and that the cash received by petitioners represented a “boot” paid out of earnings and profits taxable as an ordinary dividend under section 112' (c) (2), or in any event taxable as a dividend under section 115 (g). Petitioners argue that the transaction did not represent a reorganization within the purview of section 112, and, if it did, the cash was received as a liquidating distribution and should not be taxed as an ordinary dividend. Respondent asserts that a reorganization was effected within the purview of either section 112 (g) (1) (C) or (D).1 For section 112 (g) (1) (C) to be applicable the transfer to Chandler must be found to have constituted “substantially all” of Sponge-Aire’s assets. The transfer in question was of all of the capital and earned surplus then possessed by Sponge-Aire. The only assets not conveyed were those earmarked and set aside to pay liabilities of Sponge-Aire in substantially the same amount, the latter being kept in technical legal existence merely for the purpose of applying those assets in the discharge of these liabilities. After the transfer to Chandler, the only asset of value remaining in Sponge-Aire or its stockholders, in the retained assets, was a possible equity which in no event could be more than a trivial amount. It would seem that under these circumstances there was a substantial compliance with section 112 (g) (1) (C). However, a determination to this effect is unnecessary in view of the admission by petitioners that in the light of the decision of this Court in Reilly Oil Co., 13 T. C. 919, affd. (C. A. 5) 189 F. 2d 382, there was literal compliance with section 112 (g) (1) (D). Their insistence is that no statutory reorganization was effected under the doctrine of Gregory v. Helvering, 293 U. S. 465. Petitioners agree that there was a sound “business purpose” for the creation of Chandler and the transfer to it of Sponge-Aire’s assets. They contend, however, that there is no reorganization where, as in the instant case, the assets were acquired by the transferee corporation with the purpose of carrying on by the new corporation of a business of manufacturing a product different from that manufactured by the predecessor. In our opinion, section 112 (g) cannot be so narrowly construed. The doctrine of Gregory v. Helvering, supra, does not support petitioners’ contention. There the Supreme Court held (293 U. S. at p. 469), that a reorganization was not effected by a transfer of assets by one corporaton to another in pursuance of a plan having no relation to the business of either * * * an operation having no .business or corporate purpose — a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, * * * Although the opinion in the Gregory case states that a reorganization presupposes an intent to reorganize a business or a part of a business, there is no implication that the business when reorganized must be the same, or even bear any similarity to the business previously conducted. “Keorganization presupposes continuance of business under modified corporate forms.” Cortland Specialty Co. v. Commissioner, (C. A. 2) 60 F. 2d 937, but does not require that the business conducted be the same. Nor is it material that the business of Sponge-Aire was wiped out by the termination of the war, that it transferred merely assets and not a going business to Chandler, or that the assets acquired by Chandler consisted primarily of cash and assets which were to be converted into cash. The important factor is that Chandler was created to carry on corporate business indefinitely, although with a different line of manufacture from that conducted by its predecessor. Cf. Lewis v. Commissioner, (C. A. 1) 176 F. 2d 646. In the instant case the reorganization was effected for a sound “business purpose.” Corporate business was to be continued indefinitely, and the same shareholders remained in “control” and their investment remained “in solution.” Therefore, there was compliance with both the letter and spirit of section 112 (g). Morley Cypress Trust, Schedule “B”, 3 T. C. 84, is closely in point. The Morley Cypress Company having completed its timber operations, resolved to discontinue and surrender its franchise. The State authorized its dissolution. The directors distributed substantially all the assets except 16,000 acres of cutover, low, swampy land for which there was no market. Thereafter, oil was discovered on the 16,000 acres, the Southern Land Products Company was organized, and the land was transferred to it. Southern’s shares were distributed to the Morley shareholders who surrendered their Morley shares to Southern for cancellation. The Court held: The fact that the exchange by the shareholders of their old shares for new was an incident of the liquidation of the old corporation did not deprive the exchange of the character of a reorganization exchange, which in truth it was. We know of no rule of law which requires that a reorganization, otherwise within any of the definitions of section 112 (g) (1), is not to be so regarded because it occurs in the progress of a liquidation. * * * The Morley corporation had ceased timber operations 12 years prior to the reorganization. It did not have a going business to transfer, only land valuable in the business of the new corporation. The old corporation had been in the timber business. The new corporation was created to enter the oil business. Nevertheless, a statutory reorganization was effectuated. Petitioners argue that the Morley case is distinguishable because oil was discovered prior to the reorganization. This factor has no more significance than the hiring of Westcott by Sponge-Aire prior to the creation of Chandler in order that he might begin preparing for the manufacture of upholstered furniture or Chandler’s production of products similar to those of Sponge-Aire in order to liquidate Sponge-Aire’s inventories. Unlike the companies in George D. Graham, 37 B. T. A. 623, and Standard Realization Co., 10 T. C. 708, cited by petitioners, Chandler was not created merely to complete the orderly liquidation of the assets transferred to it. It was created primarily to carry on an upholstered furniture business. Also, unlike the company in Hendee v. Commissioner, (C. A. 7) 98 F. 2d 934, affirming 36 B. T. A. 1327, Chandler transacted “substantial business” and was not availed of simply for the purpose of selling assets, as in Fairfield Steamship Corporation v. Commissioner, (C. A. 2) 157 F. 2d 321, affirming 5 T. C. 566, certiorari denied 329 U. S. 774. The Gregory case, supra, simply barred as a reorganization a transfer of assets from one corporation to another according to “a plan having no relation to the business of either.” (293 U. S. at p. 469). There is nothing in the Supreme Court’s opinion which intimates that the reconstruction of one business to form another is not clearly within the spirit of section 112. Liability for income tax is determined by transactions giving rise to realized gain or loss. It is not concerned with decisions of the owners of an enterprise to change its manufactured product to one considered more likely to realize a profit. Such decisions are wholly personal to those owning and directing the enterprise and the Treasury is interested only in the profit resulting from such changed activities. As stated in Electrical Securities Corporation v. Commissioner, (C. A. 2) 92 F. 2d 593, 595: The purpose of the section is apparent; it was meant to allow businesses to be reconstructed when the resulting interests were substantially unchanged; but it presupposed that the enterprises were in fact businesses; financial, commercial, industrial and the like. * * * Having determined that the transaction represented a statutory reorganization within the purview of section 112 (g) (1) (D), it follows that the petitioners received the Chandler stock, as contended by respondent, in a tax-free exchange under section 112 (b) (3).2 The final issue for decision concerns the nature of the $149,000 cash distribution to the stockholders of Sponge-Aire. Respondent contends that the pro rata share distributed to each petitioner should be “taxed as a dividend” under section 112 (c) (2) .3 Petitioners argue that this represented a liquidating distribution and should be taxed as a sale of a capital asset. Section 112 (c) (2) is not applicable unless the transaction falls within section 112 (c) (1), which provides: If an exchange would be within the provisions of subsection (b) * * * (3) * * * of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph * * * to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, hut in an amount not in excess of the sum of such money and the fair market value of such other property. We cannot agree with the contention of the respondent that the $149,000 in question represented a “boot” received by the stockholders of Sponge-Aire as part of the consideration moving from Chandler to them in its acquisition of the Sponge-Aire properties. The cash in question was never the property of Chandler but was distributed to stockholders of Sponge-Aire in proportion to their stockholdings and distributed prior to the transfer of Sponge-Aire assets to Chandler. The plan of liquidation in the instant case proposed a series of three distinct distributions in complete liquidation. Each represented a separate “partial liquidation” and a separate “exchange for the stock” of Sponge-Áire under section 115 (c) and (i). The second distribution constituted an exchange of Sponge-Aire’s stock “solely for stock” in Chandler. Therefore the requirements of section 112 (b) (3) are satisfied without applying section 112 (c) (1), and that fact specifically bars the use of section 112 (c) (1) for other purposes. See Wolf Envelope Co., 17 T. C. 471. The first distribution of $149,000 in cash, therefore, does not fall within the provisions of section 112 (c) (1) and, hence, is not within section 112 (c) (2). Although the first and second distributions of cash and stock, respectively, were made only one day apart and pursuant to the same over-all plan, they were nevertheless distinct. They were made at separate times. Each was one of a series of distributions in complete liquidation, but the .statute makes each such distribution a separate partial liquidation. The distributions of cash and stock were not a part of the same exchange any more than was the final liquidating distribution made 7 or 8 years later. The $149,000 cash distribution does not come within the provisions of section 112 (c) (2) for an additional reason. That section requires that the distribution be “made in pursuance of a plan of reorganization.” The cash distribution was the first in a series of three distributions pursuant to a plan of “complete liquidation.” The reorganization encompassed only the second in the series of distributions and was merely incidental to the plan of liquidation. Cf. Morley Cypress Trust Schedule “B,” supra. Although the $149,000 cash distribution represents a separate partial liquidation under section 115 (c), it must still run the gauntlet of section 115 (g).4 If that section is properly applied, a distribution equivalent to a dividend should not escape as a capital gain,5 regardless of whether or not it falls within the provisions of section 112 (c) (2). Cf. Kirschenbaum v. Commissioner, (C. A. 2) 155 F. 2d 23, certiorari denied 229 U. S. 726. We have held that the distribution of the $149,000 to Sponge-Aire stockholders was essentially equivalent to the distribution of a taxable dividend. We think this holding is justified under the facts disclosed by the record. The question is one of fact. In Joseph W. Imler, 11 T. C. 836, involving this same question, the nature of a distribution, we stated: The issue here raised presents a question of fact depending on the circumstances of the particular case. Rheinstrom v. Conner, 125 Fed. (2d) 790; certiorari denied, 317 U. S. 654. No sole or universally- applicable test can be laid down. Flanagan v. Helvering, 116 Fed. (2d) 937. The statutory provision is couched in broad terms — “at such time and in such manner.” Though decided cases are not controlling, they are helpful as indicating what elements have been considered important, viz., the presence or absence of a real business purpose, the motives of the corporation at the time of the distribution, the size of the corporate surplus, the past dividend policy, and the presence of any special circumstances relating to the distribution. In the Imler case we found upon the facts there presented that the distribution was not equivalent to one of a dividend. A similar conclusion was reached in the case of John L. Sullivan, 17 T. C. 1420, affd. 210 F. 2d 607, in which the facts were essentially similar. The Imler and Sullivan cases are relied on by petitioners but we think the facts of the instant case differ from those there presented to such a substantial extent as to make those decisions inapplicable. In both of the cited cases the result of the distribution of cash was a reduction in the capital of the corporation, a condition inconsistent with the theory of a taxable dividend distribution. The recent case of Zenz v. Quinlivan, (C. A. 6, 1954) 213 F. 2d 914, where substantially the entire accumulated surplus of a corporation was paid out to one stockholder as consideration for the surrender to the corporation of her stock, is likewise distinguishable. In the instant case the distribution was one wholly from earned surplus. No impairment of capital was involved and the situation of Sponge-Aire following the distribution was similar to that in the case of any corporation making a dividend distribution to its stockholders, to wit, nothing more than a reduction in the amount of its earned surplus. It had, prior to this time, been precluded by the terms of its loan contracts from declaring a dividend although it had desired to do so and had asked and been denied permission. The distribution caused no “contraction of the capital structure.” It was not an incident of the transfer of assets of Sponge-Aire to Chandler in the nontaxable reorganization constituting the second step in the liquidation of Sponge-Aire. It was a distribution essential only to the purpose of placing in the hands of certain stockholders of Sponge-Aire the necessary funds to carry out personal and independent transactions by them in the acquisition of certain of the stock interests of other stockholders. After the distribution in question Sponge-Aire possessed its entire capital and a substantial amount in surplus. We think that under these conditions this distribution must be held as one substantially equivalent to the distribution of a taxable dividend. Cf. Commissioner v. Estate of Bedford, 325 U. S. 283, Kirschenbaum v. Commissioner, supra. It follows that petitioners are not entitled to treat the amount received by them in this distribution as capital gain taxable under section 117. Decisions will be entered for the respondent. SEC. 112. RECOGNITION OF GAIN OR LOSS. (s) Definition of Reokganization. — As used in this section (other than subsection (b) (10) and subsection (1) and in section 113 (other than subsection (a) (22))— (1) The term “reorganization” means * * * (C) the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of substantially all the properties of another corporation, but in determining whether the exchange is solely for voting stock the assumption by the acquiring corporation of a liability of the other, or the fact that property acquired is subject to a liability, shall be disregarded, or (D) 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 shareholders or both are in control of the corporation to which the assets are transferred. * * * SEC. 112. RECOGNITION OF GAIN OR LOSS. (b) Exchanges Solely in Kind.— ******* (3) Stock fob stock on keorganization. — No gain or loss shall be recognized if stock or securities In a corporation a party to a reorganization are, In pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. SEC. 112. RECOGNITION OF GAIN OR LOSS. (c) Gain Fkom Exchanges Not Solely in Kind. * * * * * * * (2) If a distribution made in pursuance of a plan of reorganization is within the provisions of paragraph (1) of this subsection but has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be taxed as a gain from the exchange of property. SEC. 115. DISTRIBUTIONS BY CORPORATIONS. (g) Redemption of Stock.— (1) In gbnekaIi. — If a corporation cancels or redeems Its stock (whether or not such stock was issued as a stock dividend) at' such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. See S. Rept. No. 1631, 77th Cong., 2d Sess., 1942-2 C. B. 504, 591. | 01-04-2023 | 01-16-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4476863/ | OPINION. TURNER, Judge: Under the provisions of section 22 (b) (5) of the Internal Revenue Code,3 the amount of any damages received on account of personal injuries is specifically excluded from gross income. Petitioner has alleged that the president of Interstate, Samuel Berg-stein, physically assaulted him in the presence of various company employees, an event which he claims seriously damaged him in his trade or business; that $10,000 of the above settlement was received as damages on account of such injuries; and that respondent, in making his determination, has erred in including the said amount as taxable income. As to whether an assault actually occurred, as alleged, the testimony is in direct conflict. The petitioner testified that he was assaulted by Samuel Bergstein, whereas Bergstein testified that there was no assault; and although petitioner testified further that the assault was in the presence of witnesses, he did not call any of them to corroborate his story. From the testimony as we heard it, we are neither convinced nor persuaded that there was an assault as alleged, and even if there was, the proof does not show that any part of the settlement was in payment of damages on account thereof. Petitioner attended only the first and the last conferences having to do with the settlement of his claims, and he has admitted his own inability to state what transpired at the negotiation meetings. The attorney who represented petitioner in the settlement negotiations had died prior to the trial herein, and we do not have the benefit of his testimony. And while there is some indication of record that at least on one occasion a second attorney appeared in petitioner’s behalf, no such attorney was called to testify. Council for Interstate did testify and while he did remember that negotiations were had concerning the acquisition of petitioner’s Interstate stock and that petitioner’s original bonus claim was for “a very fantastic sum,” he could recall no claim for damages by reason of any assault. Furthermore, while we note specific reference to the stock purchase and the bonus claim on the checks issued in payment of the settlement amount agreed to and in the releases signed by petitioner, there is no mention of any claim for damages on account of the assault, or of an allowance therefor. The evidence not only does not establish, but tends to refute, petitioner’s claim that $10,000, or any part, of the lump-sum settlement between him and Interstate was received by him as damages for assault. His claim with respect thereto is accordingly denied. Petitioner’s second allegation of error is that the respondent erroneously included in taxable income for 1946, as constructively received in that year, that part of the settlement, $13,034.29, which was not in fact actually paid to him until 1947. As a general rule, there must be actual receipt of income in the case of a taxpayer reporting on a cash basis of accounting before income tax liability with respect thereto is incurred. An exception to this rule is found in the theory, or doctrine, of constructive receipt, which treats as taxable that income which is unqualifiedly made subject to the demand of the taxpayer, whether or not such income is actually reduced to possession. Regs. 111, sec. 29.42-2. In short, a taxpayer may not avoid the tax by turning his back on income which is available to him and may be taken by him at will. Hamilton Nat. Bank of Chattanooga, Administrator, 29 B. T. A. 63. For the converse of this case, see Walter I. Bones, 4 T. C. 415. Compare Hedrick v. Commissioner, 154 F. 2d 90. Petitioner and Interstate, through their respective counsel, arrived at the final settlement of $50,641.30 for bonus and stock not later than December 28, 1946. The record amply shows that Interstate was ready, able, and willing to pay the full amount of the settlement at that time, and there is nothing to indicate that from its standpoint any purpose would be served or any advantage would inure to it by not doing so. Interstate regularly kept its books of account and reported its income on the basis of a fiscal year ending July 31, and tax-wise, the result would have been the same if the settlement had been paid in full in December of 1946, January of 1947, or partly in one month and partly in the other. Furthermore, there is no indication, money-wise, that it was of any moment to Interstate whether the payment was made in full in December or in January, or divided between the two months. The payments were not made through the bank in Middletown regularly used by Interstate in its day-to-day operations, but through a bank in Cincinnati, and in which funds sufficient for making the payment in full were on deposit and had been since November 30, 1946. Looking at the other side of the picture, it is to be noted that the payment of the $13,034.29 was postponed from December 1946, to January 3,1947, solely at the request of petitioner’s counsel. Such being the record on the matter, we are of the opinion and hold that the said $13,034.29 was constructively received by petitioner in 1946, and that the respondent did not err in including the amount in petitioner’s gross income for that year. By amended answer, filed at the. trial herein, it is the claim of the respondent that $1,237.84 of the fees paid by petitioner to his attorneys in negotiating and collecting the amount of the above settlement was an expense in the sale of petitioner’s Interstate stock and therefore an offset against the selling price in determining the amount of capital gain realized thereon, and not therefore deductible against gross income. By reply, belatedly filed, and in a proposed computation of tax attached as Appendix B to his brief, petitioner seemingly accepts respondent’s claim in principle, but does have some points of difference as to the ratio by which the portion of the fees allocable to the stock sale should be computed. While the proposed computation is not clear, there is some indication that the results under the respondent’s claim may be the more favorable to petitioner. In any event, we have found on the evidence that $1,237.84 of the amount paid to the attorneys was for services in connection with the sale by petitioner of his Interstate stock, leaving any mathematical differences which may exist between the parties to be resolved in the computations hereunder. Decision will he entered wnder Bule 50. SEC. 22. GROSS INCOME. (b) Exclusions Erom Gross Income. — j-The following Items sliall not be Included In gross Income and shall be exempt from taxation under this chapter: ******* (5) Compensation for injuries OR SICKNESS. — Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 23 (x) in any prior taxable year, amounts received through accident or health insurance or under workmen’s compensation acts, as compensation for personal injuries or sickness, plus the amount of any damages received whether by suit or agreement on account of such injuries or sickness, and amounts received as a pension, annuity, or similar allowance for personal injuries or sickness resulting from active servio" in the armed forces of any country; | 01-04-2023 | 01-16-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624960/ | Everett Pozzi and Lucy Pozzi, Petitioners v. Commissioner of Internal Revenue, RespondentPozzi v. CommissionerDocket No. 7074-65United States Tax Court49 T.C. 119; 1967 U.S. Tax Ct. LEXIS 16; November 28, 1967, Filed *16 Decision will be entered for the respondent. 1. For several years prior to 1963 Shamrock had sought to purchase a ready-mix concrete plant and business conducted by petitioners as a sole proprietorship. In 1963 petitioners agreed to sell the properties to Shamrock for $ 200,000. At that time it was the desire and intention of Shamrock to make a cash payment of the total sales price. The petitioners insisted that the sale be made on an installment payment basis and would not accept cash payment of the total sales price. Thereafter extended negotiations followed between petitioners and Shamrock as to security to be furnished for the unpaid portion of the sales price. In order to comply with the requests and demands of petitioners for making sale of the properties, Shamrock, with participation of petitioners, established a detailed and elaborate escrow arrangement whereby $ 200,000 was placed in escrow as security for the payment of the sales price which the purchaser was to make in stated installments over a subsequent 10-year period. At the time of the sale and transfer of the properties by petitioners, Shamrock was ready, willing, and able to make payment in full of the *17 total sales price. At that time receipt of the total sales price was available to the petitioners at their command. Held, that the sale of the properties did not constitute a true statutory installment sale.2. Held, that petitioners have not shown that a deduction of $ 2,000 taken by them for a payment to public accountants was allowable as an ordinary and necessary business expense or as a reduction of the proceeds received by the petitioners from the sale of their properties. A. D. McNeil, for the petitioners.Roger A. Pott, for the respondent. Withey, *18 Judge. WITHEY*120 The respondent has determined a deficiency of $ 33,664.94 in the income tax of the petitioners for 1963. As a result of concessions made by the petitioners, the only issues for determination are the correctness of the respondent's action (1) in determining that the sale by petitioners of their business and assets did not qualify as an installment sale within the purview of section 453 of the Internal Revenue Code of 1954 and that the gain realized thereon was includable in the income tax return of the petitioners for 1963, and (2) in disallowing as a deduction for an ordinary and necessary business expense an accountants' fee of $ 2,000.FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.The petitioners are husband and wife and resided at all times herein material in Novato, Calif. They filed a Federal joint income tax return for the year 1963 with the district director of internal revenue in San Francisco, Calif.Petitioners owned and successfully operated for a number of years a sole proprietorship doing business as E. Pozzi Co., a ready-mix concrete and associated products business located in Novato, Calif. The accrual*19 method of accounting was employed by petitioners in keeping the books and records of their business and in reporting income (or loss) from the business on the Federal income tax returns filed by them.For several years prior to 1963, Shamrock Materials, Inc., of San Rafael, Calif., sometimes hereinafter referred to as Shamrock, had sought to purchase the E. Pozzi Co. ready-mix plant and business. Finally, in 1963, petitioners agreed to sell them to Shamrock for $ 200,000. At the time the petitioners agreed to make such sale, it was the desire and intention of Shamrock to make a down cash payment of the total sales price of $ 200,000. However, the petitioners insisted that the sale be made on an installment payment basis and would not accept a down cash payment of the total sales price.Thereafter and since the petitioners desired to sell the business and assets on an installment payment basis, they made a proposal of sale to Shamrock by letter dated August 16, 1963. A copy of that letter is not contained in the record. In response thereto, Shamrock being desirous of purchasing the properties and being aware that petitioners would not sell the properties on the cash basis, replied*20 by letter dated August 22, 1963, as follows:*121 You have presented to us an offer dated August 16, 1963, to purchase your business. Our board of directors at their regular meeting last night authorized the acceptance of said offer as presented, viz., Shamrock Materials Inc., a corporation, will purchase all of the assets of E. Pozzi Co. for a total price of $ 200,000, plus the cost of any inventory on hand at the date of transfer. The purchase price will be paid as follows: (1) $ 5000 with the delivery of this letter, receipt of which is acknowledged by your signature on a copy of this letter. (2) The sum of $ 25,000 as an additional down payment to be deposited in a local title company by us prior to September 1, 1963. (3) The balance of $ 170,000 to be payable over a ten-year period, with 6% interest per annum on the unpaid balance, principal and interest payable in monthly installments so as to amortize the balance over the ten years.The payment for the inventory is to be deposited in escrow immediately after completing the actual inventory count, said escrow to be established with either our attorneys, Gardner, Riede & Elliott, or an escrow agent agreeable to both *21 of us. This escrow is for the purpose of complying with the laws on the sale of a business and any sales taxes due by reason of the transfer of the assets will be split between us. The cost of the escrow on the sale of the business will also be split.The title company escrow shall close, as to the real property, as soon as possible and all charges of that escrow will be paid by us, except the revenue stamps on the deed which are normally paid by a seller. Title to the real property shall be free and clear of all encumbrances. To secure the aforesaid balance of $ 170,000 we shall give back to you a first mortgage on the real property, and a chattel mortgage on the equipment, if you so desire.Possession of the business shall be given to us on September 1, 1963, or as soon thereafter as possible.The assets included are all those associated with your business, including, without limitation, the batch plant, real property of one acre, more or less, equipment, office and office equipment, the name E. Pozzi Co., shop and shop equipment and trucks, plus all inventory items.Since your offer to us was not actually signed, [then] by your, and your wife's, signature on a copy of this letter, *22 we shall then have a binding agreement as to the sale on the terms indicated. But, unless you do so indicate your approval at the time of the presentation of this letter and check, we shall have no agreement.Following receipt of Shamrock's letter of August 22, 1963, the petitioners signed their agreements thereto on a copy of the letter, subject to the following conditions which Shamrock later accepted:The above signed subject to the following:1: Mutual agreement between the Seller and buyer as to the liability for payment of Sales Tax.2: Security in addition to that mentioned above, to secure Note in the amount of $ 170,000.00, as deemed adequate by sellers.Shamrock Materials Inc.By (S) Lee R. Ceccotti, PresidentE. Pozzi Co.By (S) E. Pozzi(S) Lucy PozziShamrock paid to the petitioners on August 22, 1963, the $ 5,000 mentioned in the letter of that date. On August 29, 1963, Shamrock *122 deposited an additional downpayment of $ 25,000 with the Title Insurance & Trust Co., San Rafael, Calif., as mentioned in the letter of August 22, 1963, and in addition, an escrow, identified by No. 74777, was established with that company.About the end of August 1963, petitioner*23 Everett Pozzi went on a trip to Alaska. Prior to his departure he informed his accountant, J. W. Deaton, that he desired that the sale of the E. Pozzi Co. plant and assets be made on an installment payment basis plan, that security for the note for the unpaid portion of the sales price consist not only of the properties involved in the sale but also of additional security and requested Deaton to determine the character and value of such additional security that Shamrock might offer and its acceptableness. Thereafter Deaton, being of the opinion that marketable securities having a loan value by a bank of $ 120,000 would constitute adequate additional security, so informed Shamrock's accountant.Thereafter negotiations, the details of which are not disclosed by the record, were carried on by petitioners and Shamrock which culminated in the execution of a new and final agreement dated October 14, 1963, with petitioners as sellers and E. Pozzi Co., Inc., sometimes hereinafter referred to as Pozzi, Inc., as buyer. Shamrock also signed the agreement as guarantor of the performance of all agreements and conditions thereof to be performed by Pozzi, Inc. Pozzi, Inc., was a new corporation*24 formed prior to October 14, 1963, by the officers and shareholders of Shamrock under the laws of the State of California for the purpose of taking title to the properties in issue. All of the capital stock of Pozzi, Inc., was issued to the shareholders of Shamrock, Lee R. Ceccotti, Mario Ghilotti, and Dino Ghilotti, the president, secretary, and treasurer of Shamrock, respectively, who were also elected to like offices of Pozzi, Inc., by the board of directors of that corporation.Under the October 14, 1963, agreement petitioners agreed to sell to Pozzi, Inc., the real property and all other assets of the business, and the parties allocated the purchase price of $ 200,000 as follows:Automotive equipment$ 54,900Office equipment1,000Batch plant and miscellaneous items37,000Spur track, real property, buildings, and improvementsthereon100,000Goodwill7,000Total purchase price200,000The October 14, 1963, agreement provided that Pozzi, Inc., would pay the purchase price of $ 200,000, with interest at the rate of 6 percent per year on the unpaid balance, to the petitioners at the Pacific *123 National Bank of San Francisco (hereinafter referred to*25 as Pacific National), beginning with a $ 30,000 payment, without interest, on January 2, 1964, followed by 20 successive installments of $ 8,500 each, plus interest, on every first day of July and second day of January thereafter until the balance was paid, meaning that the last payment would be due on January 2, 1974.The parties further provided in the agreement of October 14, 1963, that the purchase price would be secured by collateral to be deposited by Pozzi, Inc., with Pacific National pursuant to a basic escrow agreement dated October 11, 1963, and executed by the parties on October 14, 1963. Shamrock also guaranteed the performance of all agreements and conditions of the basic escrow agreement to be performed by Pozzi, Inc.The agreement of October 14, 1963, and the basic escrow agreement required Pozzi, Inc., to remit the installment payments, including interest, to Pacific National as they became due and payable. Pacific National was instructed to deposit the payments in a savings account in the name of the petitioners and, simultaneously, to release from the collateral deposit an amount equal in principal to the purchase price installment paid, plus accrued interest. *26 Pacific National agreed to notify both Pozzi, Inc., and the petitioners of the failure on the part of Pozzi, Inc., to timely remit an installment payment. If the default in payment were to remain unpaid for 5 days after the bank's receipt of written notice from petitioners demanding payment of the collateral deposit, the bank was required to liquidate the collateral security and deposit the entire proceeds therefrom to the account of petitioners.In order to obtain $ 200,000 in cash which petitioners demanded as a collateral deposit, Pozzi, Inc., borrowed $ 50,000 on October 9, 1963, from the Bank of Marin, San Rafael, Calif. The loan was secured by a first deed of trust on the real property involved in the sales transaction. Interest on this loan was fixed at 6 percent per year on the unpaid principal. Pozzi, Inc., also borrowed $ 120,000 on October 9, 1963, from the same bank, and this loan was secured by a chattel mortgage on the equipment of the business which it was acquiring from petitioners. Pozzi, Inc., agreed to repay to the bank $ 139,200 in 48 monthly installments of $ 2,900 each, which includes interest at the rate of 4 percent.Petitioners on October 14, 1963, transferred*27 to Pozzi, Inc., free of all encumbrances, absolute title to the real property and the assets of the business.Title Insurance and Trust Co., on or shortly after October 14, 1963, recorded the deed to the subject property subject to the note *124 of Pozzi, Inc., and first deed of trust to the Bank of Marin in the sum of $ 50,000.Title Insurance and Trust Co. disbursed to Pacific National on October 16, 1963, $ 75,000, including the $ 50,000 borrowed by Pozzi, Inc., on the subject real property and $ 25,000 previously deposited with the title company as downpayment on the purchase of the petitioners' business.The Bank of Marin remitted on October 14, 1963, to Pacific National its cashier's check in the amount of $ 120,000 representing proceeds of the loan of Pozzi, Inc., secured by a chattel mortgage.The parties, pursuant to their agreement, established an escrow at Pacific National, No. 3-1992, and as early as October 15, 1963, Pacific National held the sum of $ 200,000 as escrow holder. Pozzi, Inc., had deposited, either directly or indirectly, $ 195,000 of this total. The title company remitted $ 75,000 into the Pacific National escrow, including the $ 50,000 borrowed by*28 Pozzi, Inc., from the Bank of Marin secured by the realty, and the $ 25,000 which Shamrock had paid as a portion of the downpayment under the August 22, 1963, agreement. The Bank of Marin sent the moneys borrowed by Pozzi, Inc., on the personalty of the business, i.e., $ 120,000, to Pacific National at the behest of Pozzi, Inc. Petitioners deposited into escrow the $ 5,000 previously paid to them by Shamrock. Accordingly, a sum equal to the full purchase price agreed to by the parties, $ 200,000, was deposited in cash as collateral security.Pacific National through its trust officer purchased on October 22, 1963, the following Pacific National time certificates of deposit: 1. $ 30,000, at 1%, due January 2, 1964;2. $ 8,500, at 3 3/4%, due July 1, 1964;3. $ 8,500, at 3 3/4%, due January 2, 1965;4. $ 8,500, at 3 3/4%, due July 1, 1965; and5. $ 144,500, at 4%, due October 22, 1965.The latter purchase was made because of the probability of a premature payoff of the purchase price, and also because a certificate of deposit has to be held for a minimum period of 2 years in order that the owner thereof may earn interest at the rate of 4 percent per year.As of November 30, *29 1966, Pozzi, Inc., had paid Pacific National the principal payments when due, plus 6-percent interest, as determined by Pacific National, on the unpaid balance of the purchase price. Pozzi, Inc., made its payments in the form of a cashier's check or certified check. When Pacific National received each check, it then wrote its own check in each instance in favor of petitioners' account at Crocker-Citizens National Bank of Novato, Calif. Simultaneously, Pacific National collected the proceeds from the then matured certificate of deposit and paid them, plus the accrued interest thereon, to *125 Pozzi, Inc., with its check. The general practice has been that a messenger or the general manager of Shamrock has personally delivered Pozzi, Inc.'s check for payment, taking back Pacific National's check of the proceeds due the buyer from the matured certificate of deposit.Pacific National was a solvent institution at all times in question, having enjoyed many years of uninterrupted service in the San Francisco Bay area.The reason why Pozzi, Inc., entered into the provisions of the sales agreement and the basic escrow agreement respecting installment payments and Shamrock's guaranties*30 as to Pozzi, Inc.'s performance thereof was because that was the only way the petitioners would sell their business and properties here in issue.In their income tax return for 1963 the petitioners included as a part thereof a schedule entitled "Installment Sales Computation" in which the description of the property was shown as "Business," the date acquired as 1950 and 1961, date sold as 1963, the gross sales price as $ 200,000, adjusted cost as $ 103,666.09, and net profit as $ 96,339.91. No amount was shown as payment received during the year nor was any amount shown in the schedule or otherwise in the return as taxable gain for the year.In determining the deficiency in issue the respondent determined that the sale of the petitioners' business and assets did not qualify as an installment sale and that the gain realized was includable in the petitioners' return for 1963. The respondent also determined that a capital gain of $ 89,978.28 was realized on the sale and that of that amount $ 44,989.14 computed as shown below, was includable as taxable gain in the petitioners' 1963 income tax return:Gain on sale of goodwill$ 7,000.00Gain on sale of other assets82,978.28Total89,978.28Less 50-percent deduction44,989.14Gain includable in income44,989.14*31 ULTIMATE FINDINGSAside from an amount to be agreed upon and paid for inventory, the petitioners were willing to sell their business and assets for $ 200,000 and Shamrock desired to purchase them for that sum. On October 14, 1963, the date on which the petitioners transferred free of all encumbrances absolute title to the business and assets, Shamrock was ready, willing, and able to make payment in full of the total sales price. On that date, receipt of the total sales price was available to the petitioners *126 at their command. The sale of the properties was not a statutory installment sale.Petitioners declined to accept immediate payment in full. Instead, they arranged with the buyer that $ 200,000, an amount equal to the sales price, be deposited in a bank escrow as security for installment payments of the sales price of $ 200,000 later to be made by the buyer semiannually over a 10-year period.Under the foregoing circumstances, the entire sales price of $ 200,000 was available to and constructively received by petitioners in the year 1963, since it was then within their power and control to have received the full sum for their business and assets.The arrangement for*32 the sales price to be disbursed semiannually by Pacific National to the petitioners was made to comply with the insistence of petitioners that the sale be made on the basis of installment payments and as that was the only way the petitioners would sell their business and assets.The sale did not constitute a true statutory installment sale and petitioners are not entitled to report gain from the sale on the installment basis but must report the gain in 1963 because in 1963 the full purchase price was either actually received by them in the form of a financial benefit or, at the least, constructively received by them.A deduction of $ 2,000 taken by petitioners for payment in 1963 to Begley and Deaton, public accountants, has not been shown to have been allowable by petitioners either as an ordinary and necessary business expense or as a reduction of the proceeds received by petitioners from the sale of their business and assets.OPINIONThe petitioners take the position that the arrangement which finally evolved between them and Shamrock and Pozzi, Inc., under which they transferred their business and assets to the latter, qualified as an installment sale under section 453 of the *33 Code of 1954, and that the respondent's determination with respect thereto was erroneous and should not be sustained. The petitioners recognize that the burden of sustaining their position was upon them and urge that they have fully sustained it. The respondent, however, contends otherwise.The purpose of the installment method of reporting income is to permit the spreading of the tax over the period during which payments of the sales price are made and thereby to enable the seller to actually realize the profit arising out of each installment before the tax was paid so that the tax could be paid from the proceeds collected rather than be advanced by the taxpayer. S. & L. Bldg. Corporation v. Commissioner, 60 F. 2d 719 (C.A. 2, 1932); Consolidated Dry Goods Company v. United States, 180 F. Supp. 878 (D. Mass. 1960); Thomas F. Prendergast, Executor, 22 B.T.A. 1259">22 B.T.A. 1259, 1262 (1931).*127 Under section 453(b)(2)(A) of the Code a seller of property is not entitled to report on the installment basis where the payments (exclusive of evidences of indebtedness of the purchaser) actually*34 and/or constructively received during the year of the sale exceed 30 percent of the selling price of the property. Williams v. United States, 219 F. 2d 523 (C.A. 5, 1955); Williams v. United States, 185 F. Supp. 615">185 F. Supp. 615 (D. Mont. 1960).The statutory provisions authorizing the use of the installment method of reporting income are relief provisions and are exceptions to the general rule as to the year for reporting income. Being such they must be strictly construed. Cappel House Furnishing Co. v. United States, 244 F. 2d 525, 529 (C.A. 6, 1957); Blum's, Incorporated, 17 B.T.A. 386">17 B.T.A. 386, 389 (1929). A transaction purporting to be a sale on the installment basis that lacks reality will be no more effective in avoiding taxes than any other type of sale. Griffiths v. Commissioner, 308 U.S. 355">308 U.S. 355 (1939); Williams v. United States, 219 F. 2d 523 (C.A. 5, 1955).The petitioners have requested that we make certain findings of fact, the implications of which would absolve petitioners from responsibility*35 for the detailed and elaborate escrow arrangements under which the amount of the sales price, $ 200,000, was deposited in cash in escrow by the buyer of the properties in issue and the manner in which future installment payments of the sales price made by the buyer would be remitted to the petitioners and portions of the $ 200,000 deposited in escrow would be remitted to the buyer. From our consideration of the record we are satisfied that the escrow arrangements were attributable to the requests and demands made by petitioners and were not attributable to any demand made by the buyer.The petitioners also have requested that we make certain findings of fact relative to their reason or motive in causing the sale in issue to take the form shown herein. In our view whatever may have been such reason or motive, the fact remains that receipt of the total sales price of the properties was available to petitioners at their command at the time of the transfer of the properties to the buyer. Effect must be given to the existence of such command.Griffiths v. Commissioner, supra, involved the installment sales provisions of the Revenue Act of 1932. In*36 holding adversely to the taxpayer, the Supreme Court there said:The facts leave little scope for legal explication. Griffiths had a claim for fraud against Lay which, when satisfied, wiped out the loss for which he had received an earlier deduction. Had satisfaction of the claim come to him without any conduit, it would have indisputably been his income. The claim having been recognized by Lay and cast into a form realizable by Griffiths, a lawyer's ingenuity devised a technically elegant arrangement whereby an intricate outward appearance was given to the simple sale from Griffiths to Lay and the *128 passage of money from Lay to Griffiths. That was the crux of the business to Griffiths, and that is the crux of the business to us.We cannot too often reiterate that "taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed -- the actual benefit for which the tax is paid." Corliss v. Bowers, 281 U.S. 367">281 U.S. 367, 378. And it makes no difference that such "command" may be exercised through specific retention of legal title or the creation of a new equitable but controlled interest, or the*37 maintenance of effective benefit through the interposition of a subservient agency. Cf. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465. "A given result at the end of a straight path," this Court said in Minnesota Tea Co. v. Helvering, 302 U.S. 609">302 U.S. 609, 613, "is not made a different result because reached by following a devious path." Legislative words are not inert, and derive vitality from the obvious purposes at which they are aimed, particularly in the provisions of a tax law like those governing installment sales in § 44 of the Revenue Act of 1932. Taxes cannot be escaped "by anticipatory arrangements and contracts however skillfully devised * * * by which the fruits are attributed to a different tree from that on which they grew." Lucas v. Earl, 281 U.S. 111">281 U.S. 111, 115. * * *This is not to say however that had petitioner herein actually carried through an installment sale transaction he would be prevented from so reporting it even though the payments were made in installments at his insistence alone and even though the buyer was willing and prepared to pay the entire purchase price at once. *38 In substance this transaction brings about the same result as though petitioners had collected the full sales price of the properties sold at once and invested the same in a promissory note bearing 6-percent interest. This we think is the "straight path" and petitioners' escrow arrangement the "devious path" referred to above.In our view, the principles enunciated by the Supreme Court in the foregoing case and its holding therein are applicable and controlling here and accordingly we have found as a fact that the sale of the properties here involved was not a statutory installment sale.The remaining issue has been disposed of by our finding that the deduction of a payment of $ 2,000 made to public accountants has not been shown to have been allowable either as an ordinary and necessary business expense or as a reduction of the proceeds received by petitioners from the sale of their business and assets.Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624961/ | WILLIAM H. GAIL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentGail v. CommissionerDocket Nos. 508-77 and 345-78.United States Tax CourtT.C. Memo 1979-179; 1979 Tax Ct. Memo LEXIS 342; 38 T.C.M. (CCH) 753; T.C.M. (RIA) 79179; May 9, 1979, Filed *342 William H. Gail, prose. Joseph C. Hollywood, for the respondent. HALL MEMORANDUM OPINION HALL, Judge: On November 6, 1978, respondent filed a motion for summary judgment in this case. On December 6, 1978, petitioner filed a response to respondent's motion for summary judgment. Oral argument on this motion was heard on March 13, 1979, in Detroit, Michigan, at which time no appearance was made by or on behalf of petitioner. Respondent determined deficiencies in petitioner's income tax, plus additions to the tax, as follows: Additions to Tax YearDeficiencySec.6651(a)(1) 1Sec. 6653(a)Sec. 66541974$1,352.83$338.21$67.64$43.2919751,784.00446.0089.2077'04Respondent's determinations for both years were based on respondent's recomputation of petitioner's income. Petitioner filed a Form 1040 for the taxable year 1974 which contained no information regarding his income. Subsequently, petitioner filed an unsigned Form 1040 for 1974 in which he stated that he received income in the*343 amount of $1,160. For the taxable year 1975, petitioner filed a Form 1040 which showed income in the amount of $900. In a letter to petitioner dated May j, 1975, respondent advised petitioner that the documents which petitioner submitted for 1975 were incomplete. Petitioner replied that because he was unaware of the meaning of a dollar, he was unable to complete the Form 1040. In his petitions, 2 petitioner did not dispute the factual basis of respondent's determinations. Rather, petitioner stated that respondent lacked Congressional authorization for recomputing petitioner's income in Federal reserve notes and that respondent "has failed to supply a Congressional definition of the meaning of the $ (dollar sign) which the Commissioner uses to state the amount of the deficiency allegedly due from petitioner." In his response to respondent's motion for summary judgment, petitioner similarly contends that the issue before us is "the legality of Federal Reserve notes." *344 Petitioner's contention that Federal Reserve notes do not constitute legal tender -- money -- is without any legal justification and is frivolous. ; ; , affd. . Petitioner has not raised any other legal or factual objections to either the deficiency determinations or the additions to the tax. Petitioner, too, must pay his taxes. Accordingly, since he has raised neither a valid legal objection to respondent's determinations nor a factual question, respondent's motion is granted. An appropriate order will be entered. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the years in issue.↩2. The petition in Docket Number 508-77, with respect to the deficiencies and additions to the tax for 1974, was filed on January 17, 1977. The petition in Docket Number 345-78, with respect to the deficiencies and additions to the tax for 1975, was filed on January 10, 1978. At the time he filed both petitions, petitioner was a resident of Michigan. On March 28, 1978, respondent's motion to consolidate Dockets Numbers 508-77 and 345-78 for purposes of trial, briefing and opinion was granted.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624963/ | Morris Marks Landau, Petitioner, v. Commissioner of Internal Revenue, RespondentLandau v. CommissionerDocket No. 2318United States Tax Court7 T.C. 12; 1946 U.S. Tax Ct. LEXIS 169; June 4, 1946, Promulgated *169 Decision will be entered for the petitioner. In 1941 petitioner, a resident alien, was a creditor of a South African firm. The Emergency Finance Regulations imposed by the Union of South Africa in 1939 prevented petitioner from withdrawing funds against this indebtedness. In May 1941 petitioner executed a power of attorney, pursuant to which his attorney in Johannesburg, South Africa, on December 22, 1941, transferred 27,500 pounds of the indebtedness in trust for the benefit of petitioner's children and grandchildren. Petitioner valued the gift for tax purposes at $ 2 per pound. Respondent valued the gift at $ 3.98 per pound, the official rate of exchange in this country for free pounds. Held, petitioner properly valued the gift in this country, taking into consideration the governmental restrictions imposed upon foreign exchange by the Union of South Africa. Raymond C. Sandler, Esq., and Nathan Schwartz, Esq., for the petitioner.B. H. Neblett, Esq., for the respondent. Arnold, Judge. ARNOLD *13 Respondent determined a gift tax deficiency of $ 4,070.55 for 1941. The sole issue is the value of the property that was the subject matter of the gift. Petitioner claims he overpaid the gift tax for the taxable year.FINDINGS OF FACT.Petitioner, a citizen of Great Britain, resided in Holmby Hills, Los Angeles, California. He filed a gift tax return for the taxable year with the collector for the sixth district of California. This return showed total gifts of $ 55,000, claimed a specific exemption of $ 40,000, net gifts of $ 15,000, and a gift tax liability of $ 330. The return reported a gift of 27,500 South African pounds in trust to petitioner's children and grandchildren. Seven of the named beneficiaries resided in England; one resided in Johannesburg, South Africa. The gift tax return carried the following explanation: "The above gifts were made in trust in South Africa. The gift was made in South African pounds which had no market value in the United States and which is here*171 estimated as having a value of $ 2.00 per pound."Respondent increased the value of the gift in trust from $ 55,000 to $ 109,450. He explained the adjustment as follows:The values of gifts of South African pounds to an irrevocable trust created by you in 1941 have been determined on the basis of an exchange rate of $ 3.98 per South African pound as published by the Federal Reserve Bank of New York.The trust instrument was executed for petitioner on December 22, 1941, in Johannesburg, South Africa, by Herbert Cranko, acting under and pursuant to a power of attorney executed by petitioner on May 26, 1941. The property conveyed in trust was "a portion of the debt owing by Landau Bros. Limited of Bulawayo Southern Rhodesia, to the Donor, which portion when collected and converted into money will amount to # 27,500 (Twenty-seven thousand, five hundred pounds) * * *."Prior to September 1939, when England became involved in World War II, petitioner withdrew funds from South Africa against this indebtedness as he needed them for the purpose of investing them in the United States. No withdrawals were made after September 1939.On September 9, 1939, the Governor General of the Union of*172 South Africa issued certain "Emergency Finance Regulations" under section 9 of the Currency and Exchanges Act, 1933, which restricted the purchase, sale, and loans of foreign currency and gold, and the export of currency, gold, and securities.*14 The pertinent portions of these regulations are as follows:3. (1) Subject to any exemption which may be granted by the Treasury, no person shall, except with permission granted by the Treasury -- (a) take or send out of the Union any bank notes, gold securities or foreign currency, or transfer any securities from the Union elsewhere; or(b) draw or negotiate any bill of exchange or promissory note, transfer any security or acknowledge any debt, so that a right (whether actual or contingent) to receive a payment in the Union is created or transferred as consideration -- (i) for receiving a payment, or acquiring property, outside the Union, or(ii) for a right (whether actual or contingent) to receive a payment, or acquire property, outside the Union,or make any payment as such consideration.(2) Paragraph (1) of this regulation shall not prohibit the doing of anything, within the scope of his authority, by a person authorized*173 by the Treasury to deal in foreign exchange, and shall not prohibit the doing of anything which is certified by the Treasury to be necessary for the purpose -- (a) of meeting the reasonable requirements of a trade or business carried on in the Union; or(b) of performing a contract made before the sixth day of September, 1939; or(c) of defraying reasonable travelling or other personal expenses.The Emergency Finance Regulations provided that Standard Bank of South Africa, Ltd., was appointed as an authorized dealer under the regulations. This bank advised petitioner in 1941 that he could not draw on his funds in South Africa and that an indebtedness of $ 14,250 to the bank would have to be paid by petitioner in American dollars.Petitioner's brothers in South Africa advised him that they could not send him the money they owed him. Inquiries at various California banks revealed that the banks were not buying any South African pounds. Petitioner received no income from his South African funds, as they were not invested in any enterprise, nor could they be used as collateral for loans. He decided that, as the funds were not doing him any good, he might as well give a part*174 thereof to his children and grandchildren. The gift involved no transfer of currency out of or into the Union of South Africa.The official rate of exchange, as published by the Federal Reserve Bank of New York, applies only to so-called "free pounds," i. e., pounds that can be used for regular trading transactions by virtue of a permit from the Bank of England or the Central Bank of South Africa. The official rate of exchange does not apply to "blocked pounds," i. e., pounds subject to the restrictions imposed by the Emergency Finance Regulations.The fair market value of the gift was $ 55,000.*15 OPINION.The parties are agreed that petitioner made a taxable gift; the dispute between them is over the amount of the gift. Section 1005 of the Internal Revenue Code provides that "If the gift is made in property, the value thereof at the date of the gift shall be considered the amount of the gift." The subject matter of the gift here was blocked South African pounds in South Africa. The petitioner valued the pounds at $ 2 per pound, due to the governmental restrictions placed on South African currency. The respondent valued the pounds at the official rate of exchange, $ 3.98*175 per free pound. The question that we must decide, while essentially one of fact, namely, the value of the gift subject to tax, is complicated by the legal question of whether value shall be determined at the residence of the donor or at the situs of the property transferred.We have found as a fact that petitioner made a gift during the taxable year of $ 55,000. This finding is based largely upon the uncontradicted testimony that "blocked" South African pounds in the United States had a fair market value in December 1941 of $ 1.75 to $ 2.25 per pound, and $ 2 per pound; that such pounds had no collateral value whatever; that the official rate of exchange applied to "free" pounds as distinguished from blocked pounds; that it was practically impossible to free any South African pounds from exchange control restrictions; and that the value fixed for these South African pounds must take into consideration the fact that they can not be transferred from the Union of South Africa.Respondent contends that, since the beneficiaries resided in England and South Africa, there is no occasion to transfer the pounds to the United States or to fix a value based upon the restricted market existing*176 in this country. He insists that the donor derived and the donees received complete economic satisfaction from the gift, which should be measured at the official rate of exchange. Respondent cites and relies upon I. T. 3568, C. B. 1942-2, page 112, 1 as being a controlling *16 force. We can find no support for respondent in this ruling. On the contrary, we understand it to mean that, despite disturbed conditions and the control of trading and exchange by foreign countries, conversion rates lower than the official or controlled rates were in some cases available on December 31, 1941, and that the rates of exchange as of that date, certified by the Federal Reserve Bank of New York for customs purposes, are not to be considered as definitely reflecting the rates acceptable for Federal income and excess profits tax purposes.*177 Neither party has directed our attention to a gift tax case involving foreign currency. Petitioner relies upon two income tax cases, International Mortgage & Investment Corporation, 36 B. T. A. 187, and Eder v. Commissioner, 138 Fed. (2d) 27, modifying 47 B. T. A. 235, which involved blocked foreign currencies. In the International case we held that no gain was realized on blocked German marks, but that gain was realized on German marks which were unrestricted at the time of receipt, but were later blocked by law before their removal from Germany.In the Eder case the taxpayers were shareholders in a foreign personal holding company organized under the laws of Colombia. The laws of that country prohibited the transfer of pesos outside the country in excess of 1,000 pesos per month. The Circuit Court remanded the case to this Court to determine the fair market value of the blocked pesos in terms of American dollars, holding that this Court and the Commissioner had committed error in valuing the pesos at the exchange rate applicable to free pesos. Thus it is apparent that the Circuit*178 Court did not consider the current rates of exchange acceptable conversion rates for valuing blocked pesos, and on remand this Court fixed the value on a basis of blocked pesos. Credit & Investment Corporation, 47 B. T. A. 673, is to the same effect with respect to blocked German marks.It seems clear from the gift tax regulations, Regulations 108, section 86.18, that intangible personal property situated abroad, "constitutes property within the United States if consisting of a property right issuing from or enforceable against a resident of the United States * * *." Cf. Burnet v. Brooks, 288 U.S. 378">288 U.S. 378. The right to transfer and to give possession of the South African pounds to another or others was a property right issuing from a resident of the United States. Both parties have treated the value of this property as equivalent to the value of the 27,500 pounds. South African pounds were subject to control restrictions imposed upon South African currency by the Union of South Africa. These exchange restrictions reduced the value of petitioner's property right. Neither he nor the trustee could remove the pounds from*179 South Africa. Under such circumstances we think the value of the property should be determined by taking into account the governmental restrictions.*17 In addition to his own testimony, petitioner offered the testimony of the manager of the international banking department of the Bank of America. This witness had dealt continuously in foreign exchange and foreign currency since about 1923. He had had four years of banking experience in Germany, two and one-half years in Holland, five years in New York, and thirteen years with the Bank of America. He was familiar with the restrictions and regulations issued by the Union of South Africa and the United Kingdom with respect to the exchange, withdrawal, and use of currency. He stated unqualifiedly that the governmental restrictions imposed by the Union of South Africa affected the value of South African pounds in the United States, and expressed the opinion that the value thereof was anywhere between $ 1.75 and $ 2.25 per pound. He testified that the Bank of America bought and sold them at that price and, when pressed on cross-examination as to whether the value in December 1941 was $ 2.25 or $ 1.75, he fixed the value at $ *180 2 per pound. The witness testified to the extreme difficulty of securing a permit from London or South Africa to free the pounds of either for use and, in the light of his own experience, he stated that it would have been impossible for this petitioner to have secured any exemption under the Emergency Finance Regulations in order to bring South African pounds to the United States for investment purposes. In view of this testimony and all the other facts and circumstances of record, we are of the opinion that the value of petitioner's gift was $ 55,000, and a finding to that effect has been made.Petitioner's claim that he overpaid his gift tax liability for 1941 is unsupported by the record.Decision will be entered for the petitioner. Footnotes1. Advice is requested whether the foreign exchange rates as of December 31, 1941, certified by the Federal Reserve Bank of New York for customs purposes, will be accepted by the Bureau of Internal Revenue for Federal income and excess profits tax purposes.Notwithstanding present conditions of disturbance and the control of trading and exchange by foreign countries, free or open market rates lower than either official or controlled rates were in certain cases realizable on December 31, 1941, dependent upon the regulations of the particular foreign country and the degree of control which was exercised. In any case in which conversion rates as of that date are to be used, such rates shall be those giving a result most clearly reflecting the proper amounts of the items to which they relate as affected by the conditions and available means and rates of conversion as of that date. The rates of exchange used will be subject to verification and check upon the examination of the taxpayer's books and records by internal revenue agents.In view of the foregoing, the rates of exchange as of December 31, 1941, certified by the Federal Reserve Bank of New York for customs purposes, or adopted by any other agency, are not to be considered as definitely reflecting the rates which will be accepted by the Bureau of Internal Revenue for Federal income and excess profits tax purposes.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624965/ | WARD AND MARION FRENCH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentFrench v. CommissionerDocket No. 14678-90United States Tax CourtT.C. Memo 1991-417; 1991 Tax Ct. Memo LEXIS 466; 62 T.C.M. (CCH) 599; T.C.M. (RIA) 91417; August 26, 1991, Filed *466 Decision will be entered for the respondent. Ward W. French, pro se. Gail K. Gibson, for the respondent. DINAN, Special Trial Judge. DINANMEMORANDUM OPINION This case was heard pursuant to the provisions of section 7443A(b) and Rules 180, 181, and 182. 1Respondent determined a deficiency of $ 1,189 in petitioners' Federal income tax for the taxable year 1987. The issue for decision is whether petitioners may exclude from gross income the amount of the civil service annuity received by petitioner Ward French (hereinafter petitioner) during 1987. Some of the facts have been stipulated. The stipulations of fact and accompanying exhibits are incorporated by this reference. Petitioners resided in Kenmare, North Dakota, at the time they filed their petition. Petitioner was born on August 3, 1915, and reached the*467 age of 65 during the calendar year 1980. Petitioner served in the armed forces during World War II. While in the service, he sustained ankle injuries in a paratroop jump. As a result thereof, the Veterans' Administration (VA) awarded him a VA pension based on a 10-percent disability; this was later increased to 20 percent. The parties agree that the amounts received by petitioner as a VA pension are not includable in his gross income, and, therefore, they are not at issue in this proceeding. Petitioner was employed by the United States Postal Service as a mail carrier from 1951 until 1966. On April 25, 1966, petitioner retired on disability from the United States Postal Service. In 1987, petitioner received a civil service annuity payment of $ 8,748.00. It is petitioner's position that the civil service annuity payment which he received in 1987 is excludable from gross income. In particular, petitioner claims that the injuries he received while in the armed forces were the cause of the termination of his employment with the United States Postal Service. Petitioner, therefore, argues that the civil service annuity payment represents payment to him because of service-incurred*468 injuries and are not taxable income. Further, petitioner contends that his position is supported by Internal Revenue Service Publication 525, Taxable and Non-Taxable Income (hereinafter Publication 525). Section 104(a)(4) provides, in pertinent part, that gross income does not include "amounts received as a pension, annuity, or similar allowance for personal injuries or sickness resulting from active service in the armed forces." In interpreting that language, we have held that payments from the Civil Service Retirement and Disability Fund cannot be excluded from income under section 104(a)(4) because such payments are not made because of an injury or illness incurred while serving in the military. Instead, the payments are made because the taxpayer is unable to perform the work required of him in his civilian job. , affd. per curiam ; . The payments which petitioner received as a civil service annuity were made because he could not perform his duties as a mail carrier for the United States Postal Service. Applying*469 the rationale of Haar and French, we hold that petitioner may not exclude the annuity payments from income under section 104(a)(4). In addition, we note that any reliance by petitioner on Publication 525 is misplaced. The publication generally states that disability retirement income is taxable. However, the publication goes on, in part, to describe certain disability retirement benefits which are not subject to taxation, namely, benefits received as the result of injuries or sickness resulting from active service in the armed forces of any country, the National Oceanic and Atmospheric Administration, the Public Health Service, or the Foreign Service. Since the annuity payments at issue were received from the United States Postal Service because petitioner could not perform his duties as a mail carrier, petitioner does not fall within the ambit of the exclusion discussed in Publication 525. Even if Publication 525 were to be construed in petitioner's favor, respondent is not estopped from taking a different position. Publications of the Internal Revenue Service are merely guides and if such publications are erroneous, then statutes, regulations, and judicial decisions*470 to the contrary govern. , affd. without published opinion . Accordingly, we sustain respondent's determination that petitioner's civil service disability retirement annuity is taxable. Decision will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code as amended and in effect for the taxable year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624911/ | JOHN L. CONNELL and KETNA S. CONNELL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentConnell v. CommissionerDocket No. 10233-78.United States Tax CourtT.C. Memo 1981-370; 1981 Tax Ct. Memo LEXIS 371; 42 T.C.M. (CCH) 423; T.C.M. (RIA) 81370; July 20, 1981*371 Petitioner sold his 51-percent interest in a trailer park to Deen and reported the sale on the installment method as prescribed in sec. 453, I.R.C. 1954. As part of the consideration for such sale, Deen executed a $ 230,000 note in petitioner's favor. Prior to this sale, petitioner had been indebted to Deen on a $ 200,000 note which originally arose as part of an independent sales transaction. Both petitioner and Deen pledged the amounts due them under their respective notes as an additional source of payment to satisfy their obligations under each of the notes. Held, the mutual notes between petitioner and Deed were independent and did not, in substance, offset each other. Held further, petitioner did not receive payments in the year of sale in excess of 30 percent of the selling price of his interest in the trailer park. Held further, petitioner was entitled to report his gain on the sale on the installment method under sec. 453, I.R.C. 1954. D. L. Middlebrooks, James L. Cooney, Jr., and E. Gary Work, Jr., for the petitioners. Thomas K. Purcell, for the respondent. STERRETTMEMORANDUM FINDINGS OF FACT AND OPINION STERRETT, Judge: By notice of deficiency dated June 6, 1978, *372 respondent determined a deficiency of $ 62,282.48 in petitioners' Federal income taxes for their 1974 tax year. The sole issue for our determination is whether the petitioners, in the year of sale, received payments in excess of 30 percent of the selling price of Prairie View Mobile Village, thereby disqualifying the sale from installment sales treatment under section 453, I.R.C. 1954. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference. Petitoners John L. Connell and Ketna S. Connell, husband and wife, resided in Gainesville, Florida at the time the petition herein was filed. A timely joint Federal income tax return for the calendar year 1974 was filed by petitioners with the Internal Revenue Service Center, Chamblee, Georgia. Ketna S. Connell is a party herein solely by virtue of her filing a joint return with John L. Connell (hereinafter petitioner). On December 22, 1971, John D. Deen entered into a contract to purchase certain real estate from Lovette Jackson and Dorothy M. Jackson. This contract, as amended, provided that the purchase of *373 the Jackson real estate would be closed by January 15, 1974. The contract also provided for an option to purchase additional real estate, such option expiring on January 15, 1977. Thereafter, on June 4, 1973, petitioner and Billy A. Myrick entered into an agreement (Agreement) ith Deen whereby they agreed to pay Deen $ 500,000 in exchange for Deen's assignment to them of his rights and interest in the December 22, 1971 contract. As part payment of the purchase price to Deen, petitioner and Myrick executed a promissory note dated June 4, 1973 and payable to Deen in the face amount of $ 400,000, bearing an interest rate of 8 percent per annum. The note was payable in eight equal annual installments of $ 50,000 plus accrued interest, commencing on June 5, 1974 and continuing on June 5 of each succeeding year until fully paid. The note also incorporated by reference all the terms and conditions of the Agreement. In addition to the payment terms, the Agreement provided in pertinent part as follows: 5. In the event CONNELL and MYRICK default in the performance of any of the conditions of this Agreement, including the payment of all monies due on or before the due dates, the Assignment *374 as contemplated herein shall become null and void and of no further force or effect and DEEN shall have the sole right to perform the Contract for Sale and Purchase free and clear of all rights of CONNELL and MYRICK. In this event or in the event CONNELL and MYRICK fail to perform the Contract for Sale and Purchase for any reason, other than one caused by DEEN, it is expressly agreed that the total consideration of $ 500,000.00 is to be paid according to the required terms and there shall be no reduction in the said required $ 500,000.00 payment due to the fact that DEEN may perform the Contract for Sale and Purchase or the fact that CONNELL and MYRICK may fail to perform the Contract for Sale and Purchase. 7. CONNELL and MYRICK hereby waive any and all objections to the terms and conditions of the Contract for Sale and Purchase and any all [sic] objections to the state of the title to the subject property, other than those which may have been caused by DEEN, arising prior to December 22, 1971, and, notwithstanding any possible further objections to the conditions of the Contract for Sale and Purchase, other than objections to the state of the title arising subsequent to December *375 22, 1971, CONNELL and MYRICK expressly agree to perform the obligations contained herein. In the event of defect in title arising subsequent to December 22, 1971, caused by any party other than CONNELL and MYRICK, and, upon such defect being unable to be cured according to the terms of the Contract for Sale and Purchase, CONNELL and MYRICK shall be entitled, at their sole option, to return of all monies paid herewith and a cancellation of all rights and obligations contained herein. 10. In the event CONNELL and MYRICK close the transaction as contemplated by the Contract for Sale and Purchase, at the closing of the said sale, CONNELL and MYRICK hereby agree to execute a mortgage to DEEN for the purpose of securing the prompt and full payment of the said $ 400,000.00 promissory note. The mortgage shall be a lien upon all of the property purchased by CONNELL and MYRICK * * *. 11. In the event CONNELL and MYRICK sell any portion of the property as contemplated by the Contract for Sale and Purchase, including all property under option and including all property released by DEEN, or, in the event CONNELL and MYRICK assign any options contained in the said Contract for Sale and Purchase, *376 it is agreed that all monies received by CONNELL and MYRICK shall be applied in the following order of priority: A. First to the reasonable costs of sale, including a real estate commission, B. Second to the reimbursement to CONNELL and MYRICK of the principal amount of all payments made to the seller and to DEEN, C. Third to DEEN as a credit on the said $ 400,000.00 promissory note and D. After said promissory note is paid in full, all remaining payments shall be the property of CONNELL and MYRICK. Any purchase money mortgages received by CONNELL and MYRICK from the purchaser as security for the unpaid balance shall be assigned to DEEN as collateral security for the payment of the said $ 400,000.00 promissory note. Several months after the above assignment was executed, Deen approached petitioner in the hopes of purchasing the Prairie View Mobile Home Village (Prairie View), then owned by petitioner (51 percent) and John B. Morgan (49 percent). As the due date of the first payment on the note from petitioner and Myrick to Deen approached and the management of Prairie View became more difficult, 1 petitioner and Morgan decided to sell Prairie View to Deen. To this end, on March *377 13, 1974 petitioner and Morgan individually sold their interests in Prairie View to Deen and John C. Morris for a total purchase price of $ 1,097,946.95. Petitioner's share of the purchase price was $ 604,452.94, consisting of $ 95,000 in cash received at the closing, a promissory note executed by Deen in the amount of $ 230,000 and the assumption by the purchaser of petitioner's $ 279,452.94 share of a mortgage to the First Federal Savings and Loan Association with an outstanding balance of $ 547,946.95. The unsecured promissory note in the principal amount of $ 230,000 was payable in eight equal annual installments of $ 28,750 plus accrued interest at 8 1/4 percent per annum, commencing on March 13, 1975 and continuing on March 13 of each succeeding year until fully paid. This note had the following typewritten legend on its reverse side: NOTICETO WHOM IT MAY CONCERN: You will take notice that I have irrevocably pledged any and all payments that are due to me or any of my legal successors or assigns, as owner of the foregoing Note, as an additional source of payment of the *378 amounts owed by me under my Promissory Note dated June 4, 1973, in the original amount of $ 200,000.00, and any person, firm or corporation acquiring this Note by Assignment or operation of law, will do so with full knowledge of this Pledge of the receipts from the Note on the reverse side to full payment of said $ 200,000.00 insofar as the monies due thereunder will suffice. Dated: 13th day of March, 1974. /s/ John L. Connell / JOHN L. CONNELL The basis of petitioner's interest in Prairie View was $ 240,065.86. Consequently, the excess of the mortgage assumed over such basis, includable as a payment in the year of sale, was $ 39,387.08. On June 3, 1974, the $ 400,000 note payable to Deen and jointly executed by petitioner and Myrick was cancelled and replaced by two individual notes in the face amount of $ 200,000 each which were executed separately by petitioner any Myrick. The primary reason for this division was to improve the appearance of petitioner's and Myrick's financial statements and thereby more readily enable each to obtain or maintain outside financing for their separate businesses. 2*379 The new note executed by petitioner provided that it was executed as a modification and clarification of the $ 400,000 note. Further, petitioner's note bore the date June 4, 1974, called for accrued interest to be paid through March 13, 1974 and was thereafter payable in eight equal annual installments of $ 25,000 plus accrued interest at 8 percent per annum, commencing on March 13, 1975 and continuing on March 13 of each succeeding year until fully paid. This note also had the following typewritten legend on the reverse side of the note: NOTICETO WHOM IT MAY CONCERN: You will take notice that I have irrevocably pledged any and all payments that are due to me or any of my legal successors or assigns as owner of the foregoing Note, as an additional *380 source of payment of the amounts owed by me under my Promissory Note dated March 13, 1974, in the original amount of $ 230,000.00, and any person, firm, or corporation acquiring this Note by Assignment or operation of law, will do so with full knowledge of this Pledge of the receipts from the Note on the reverse side to full payment of said $ 230,000.00 insofar as the monies due thereunder will suffice. Dated: 13th day of March, 1974. /s/ John David Deen / JOHN DAVID DEEN The notice on the note from Deen to petitioner was placed there on the closing date of the Prairie View sale pursuant to the advice of counsel, 3*381 in order to destroy its negotiability and to prevent anyone from acquiring the note as a bona fide purchaser for value. The notice on the note from petitioner to Deen was placed there at the request of petitioner after he executed a similar pledge of the payments due under the note from Deen to petitioner. While the parties agreed to execute these pledges for the aforementioned reasons, they never discussed the possibility of structuring the transaction in a manner that would cancel or offset these notes. On March 13, 1975, the due date for the first payment on both notes, petitioner went to Deen's house ready and willing to tender payment according to the terms of his instrument. However, Deen suggested that only one check from Deen to petitioner was necessary. Accordingly, on that date, Deen made a payment to petitioner of $ 3,750, which represented the difference between Deen's principal payment of $ 28,750 and petitioner's principal payment of $ 25,000. In addition, the parties gave each other a credit for a principal payment of $ 25,000 and for interest due under the notes. 4 The balance due petitioner after the March 31, 1975 transaction was $ 201,250. Deen died in 1975 shortly after the aforementioned payment. Petitioner filed a claim against the Estate of Deen with respect to the $ 230,000 promissory note executed *382 by Deen. In addition, petitioner's claim asserted a vendor's lien on the Prairie View property, which lien was established on December 1, 1975 by order of the Circuit Court of Florida, Eighth Judicial Circuit, in and for Alachua County, Florida. On December 3, 1975, petitioner agreed to release his lien on the Prairie View property in exchange for an advance principal payment from the estate of $ 20,000 plus accrued interest. In March 1976, pursuant to a court order reflecting an agreement between petitioner and Deen's executor, the claim of petitioner against the estate and the claim of the estate against petitioner regarding the $ 200,000 promissory note were compromised by way of offset. The offset resulted in petitioner making a payment to the estate in the amount of $ 3,907.28, representing the amount of principal and accrued interest owed the estate in excess of the principal and interest owed petitioner by the estate. On his Federal income tax return for his 1974 taxable year petitioner made a timely election to report the sale of his interest in Prairie View on the installment method of accounting prescribed by section 453. Respondent, in his statutory notice of deficiency, *383 determined that petitioner received payments in excess of 30 percent of the selling price in the year of sale by operation of a setoff of mutual debts between petitioner and Deen, thereby disqualifying such sale from installment sale treatment. OPINION As a general rule, gain from the sale or other disposition of property is the excess of the amount realized over the adjusted basis of the property. Section 1001(a). 5 Such gain is generally included in the taxpayer's computation of taxable income according to his normal accounting method. Section 446(a).6 However, in certain circumstances section 4537*385 provides for the reporting of income on the installment method. For instance, in the case of sales of realty and casual sales of personalty a taxpayer may report income on the installment method if he disposes of property and the payments received in the taxable year of sale, if any, do not exceed 30 percent of the selling price. Section 453(b)(2)(A)(ii); Pozzi v. Commissioner, 49 T.C. 119">49 T.C. 119, 127 (1967). The purpose of section 453 is to provide relief for the taxpayer by matching the payment of the tax with the receipt of the sales proceeds. Commissioner v. South Texas Lumber Co., 333 U.S. 496">333 U.S. 496, 503 (1948). *384 Being a relief provision and an exception to the general rule with respect to the year for reporting income, section 453 must be strictly construed. Cappel House Furnishing Co. v. United States, 244 F.2d 525">244 F.2d 525, 529 (6th Cir. 1957). With respect to the 30 percent limitation, the amount considered received by a taxpayer in the year of the installment sale is computed by taking into account *386 payments constructively as well as actually received. Williams v. United States, 219 F.2d 523">219 F.2d 523, 527 (5th Cir. 1955); Cisler v. Commissioner, 39 T.C. 458">39 T.C. 458, 466 (1962); McInerney v. Commissioner, 29 B.T.A. 1">29 B.T.A. 1, 6 (1933), affd. 82 F.2d 665">82 F.2d 665 (6th Cir. 1936). The receipt by a seller of a purchaser's evidence of indebtedness (e.g., installment note) does not constitute payment in the year of sale. Section 453(b)(2)(A)(ii). Furthermore, securing a purchaser's indebtedness with collateral, a pledge or otherwise, does not transform the debt into a completed payment. Sprague v. United States, 627 F.2d 1044">627 F.2d 1044, 1048 (10th Cir. 1980). It has long been settled that secured notes stand on the same plane as unsecured notes for purposes of the installment sale limitation on year-of-sale payments. R.L. Brown Coal & Coke Co. v. Commissioner, 14 B.T.A. 609 (1928). Both are mere promises to pay. * * * The giving of security * * * merely makes the promise more certain of fulfillment. See Williams v. Commissioner, 429 U.S. 569">429 U.S. 569, 578, 97 S. Ct. 850">97 S. Ct. 850, 856, 51 L. Ed. 2d 48">51 L. Ed.2d 48 (1977). [Fn. omitted. 627 F.2d at 1047-1048.] On the other hand, cancellation or reduction of a seller's indebtedness to a purchaser as partial *387 consideration in an installment sale is included in determining year-of-sale payments. Sprague v. United States, supra at 1050; United States v. Ingalls, 399 F.2d 143">399 F.2d 143, 145-146 (5th Cir. 1968), cert. denied 393 U.S. 1094">393 U.S. 1094 (1969); Riss v. Commissioner, 368 F.2d 965">368 F.2d 965, 968-969 (10th Cir. 1966), affg. a Memorandum Opinion of this Court. However, mutual or cross debts between a seller and purchaser do not automatically cancel or reduce each other. Bailey v. Commissioner, 103 F.2d 448">103 F.2d 448, 449 (5th Cir. 1939), affg. a Memorandum Opinion of this Court; Rickey v. Commissioner, 54 T.C. 680">54 T.C. 680, 695 (1970), affd. 502 F.2d 748">502 F.2d 748 (9th Cir. 1974). To the extent that a cancellation, in substance, has occurred at the time of sale, the amount of the indebtedness cancelled must be included in computing year-of-sale payments. See United States v. Ingalls, supra at 145-146. As the Supreme Court stated in Commissioner v. Court Holding Co., 324 U.S. 331">324 U.S. 331, 334 (1945): The incidence of taxation depends upon the substance of the transaction. * * * To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration *388 of the tax policies of Congress. It follows, as this and other courts have recognized, that substance, and not form, will determine whether a transaction qualifies for installment sale treatment; an arrangement lacking reality will not be given effect. Griffiths v. Commissioner, 308 U.S. 355">308 U.S. 355, 357-358 (1939); United States v. Ingalls, supra at 145; Pozzi v. Commissioner, supra at 127. We therefore must examine the particular transaction at issue to determine whether the form chosen by the parties reflects the substance of what was accomplished. The resolution of the question of whether the substance of a transaction is in conformity with its form necessarily depends on the facts and circumstances of each particular case. Sprague v. United States, supra at 1049. The burden of proving that the substance and form of the transaction herein are congruent lies with petitioner. Rule 142(a), Tax Court Rules of Practice and Procedure; Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). For the most part, the facts in the instant case are undisputed. Prior to the transaction involved herein, petitioner was jointly liable with another individual on a $ 400,000 note payable to Deen. The transaction *389 upon which this case is based involved the March 13, 1974 sale of Prairie View, owned jointly by petitioner and Morgan, to Deen and Morris. In part payment of the purchase price, Deen individually executed a note payable to petitioner in the amount of $ 230,000 with interest at 8 1/4 percent per annum. That note was payable in eight equal annual installments of $ 28,750 plus accrued interest, such payments commencing on March 13, 1975 and continuing on March 13 of each succeeding year until fully paid. In order to destroy its negotiability, the note contained on its back a pledge by petitioner of payments due under that note as an "additional source of payment" for amounts owed by petitioner to Deen under a second note. Contemporaneous with the closing of the transaction in question, the $ 400,000 note was cancelled and replaced by two individual notes in the face amount of $ 200,000 each, one executed by petitioner and one executed by the other party to the original note. Petitioner's note was payable in equal annual installments of $ 25,000 plus accrued interest at 8 percent per annum, payments commencing on March 13, 1975 and continuing on March 13 of each succeeding year until *390 fully paid. At the request of petitioner, that note contained on its back a pledge by Deen of the payments due under that note as an "additional source of payment" for amounts owed by Deen to petitioner under the $ 230,000 note. In his notice of deficiency, respondent determined that-- the mutual pledging of payments on notes receivable in the amounts of $ 230,000.00 and $ 200,000.00 by you and John D. Deen, respectively, constitutes a cancellation and payment of your debt to John D. Deen to the extent of $ 200,000.00, which disqualifies the installment sale of Prairie View Mobile Village reported by you on your 1974 return, since payments in the year of sale are in excess of 30% of selling price pursuant to section 453 of the Internal Revenue Code. * * * On brief, respondent theorizes that the doctrines of constructive receipt and substance over form dictate such a result. the gist of his theory is that petitioner, in substance, was relieved of his debt obligation to Deen by virtue of the transaction in question and therefore petitioner constructively received payments in the year of sale in excess of 30 percent of the selling price. Petitioner counters that the pledges did not *391 amount to a cancellation of the debts. Instead, claims petitioner, each pledge was intended merely as security for payment of the other note. Reasoning that the giving of security is not a year-of-sale payment for purposes of section 453, petitioner argues that he has not received payments in the year of sale exceeding 30 percent of the selling price of his interest in Prairie View. Our decision turns on the intent or motive of the parties; that is, whether the cross pledges were intended as a security arrangement or were intended effectively to cancel mutual indebtedness. See Sprague v. United States, supra at 1049; United States v. Ingalls, supra at 146; Newmark v. Commissioner, 311 F.2d 913">311 F.2d 913, 915 (2d Cir. 1962), affg. a Memorandum Opinion of this Court; Griffith v. Commissioner, 73 T.C. 933">73 T.C. 933, 943 (1980). Under the circumstances in the instant case, we are convinced that a security arrangement was intended. Evidence of the negotiations between the parties to the notes demonstrates that the pledges were not intended to affect an offset or cancellation of mutual debts. Rather, the idea of a pledge was introduced into the transaction solely on the initiative of Mr. Paul Carmichael, *392 Deen's attorney. Carmichael's expressed purpose for the pledge executed by petitioner was to destroy the negotiability of the subject note and to eliminate the possibility of a bona fide purchaser for value. The corresponding pledge by Deen first was requested by petitioner only after petitioner had executed his pledge. Further, the testimonies of petitioner and Carmichael indicate that the possibility of cross pledges and the debt relief that, in substance, might be construed to result therefrom were never discussed by the parties to the transaction; nor was there such an understanding between petitioner and Deen. In fact, a fair inference can be drawn that these pledges would not have seen the light of day absent Carmichael's last minute initiative. Truly, mutual pledges were not bargained for, but were the consequence of spur-of-the-moment thought. Therefore, we do not believe that the parties intended to cancel their mutual debts but instead intended to secure repayment by virtue of pledges. Respondent, however, argues that the Fifth Circuit's decision in United States v. Ingalls, supra, mandates a finding in his favor. The issue in that case was whether the compromise of *393 an employment contract claim was legally effective to defer income over the compromise period. The taxpayer was a shareholder in a family owned corporation. He entered into a long-term employment contract with this corporation. Prior to entering into the employment contract, the taxpayer had borrowed heavily from the corporation. A dispute arose among the shareholders with regard to the validity of the employment contract and the amount of the indebtedness owed by the taxpayer to the corporation. Negotiations between the opposing factions culminated in a contract settlement agreement. The Court of Appeals described the contract as follows: Under its terms the company purchased the employment contract for $ 228,360 payable in equal installments of $ 22,836 on February 1st of the ten next succeeding years and, in turn, taxpayer agreed to pay off his outstanding indebtedness to the company of $ 228,360 in equal installments of $ 22,836 on February 1st of the ten next succeeding years * * * the only security for the new note being taxpayer's promise to pay and the following provision: "[Taxpayer] * * * further agrees that so long as any part of said indebtedness or any interest thereon *394 remains unpaid, the company may make the payments hereinabove agreed to be paid to him by currently crediting said indebtedness with such payments as they accrue." [399 F.2d at 145.] Based on this contract, the court found that, in substance, the disputed employment contract claim was compromised by way of a forgiveness of indebtedness. The taxpayer was held to be in receipt of income equal to the discharged indebtedness in the year of compromise. The court recognized that mutual debts do not automatically cancel each other. However, the court went on to state that, under the circumstances presented, the formality of pleading the set-off would be the only barrier to cancellation of mutual debts contracted on the credit of each other. The agreement here eliminates even the formality of having to plead the set-off since by contract the parties agree that if the taxpayer fails to pay the company the company is authorized to effect a private setoff by making the bookkeeping entry mentioned above. The agreement speaks for itself and makes clear that the taxpayer had to perform no additional act for the debt to be discharged. A simple bookkeeping entry by the company each February 1st *395 was all that was necessary. The exchange of checks by the company and the taxpayer was thus an empty ritual acted out for the benefit of the Commissioner and, in reality, the taxpayer was discharged from his indebtedness * * *. [399 F.2d at 146.] In analogizing the Ingalls rationale to the present case, respondent argues that, to the extent of their mutual debts, petitioner and Deen were relieved of their continuing obligation to pay each other. Respondent claims that petitioner's obligation to pay on the original $ 400,000 note was extinguished when the new $ 200,000 notes were executed. Continuing his line of reasoning, respondent claims that the execution of new notes in conjunction with the subject cross pledges proves that petitioner's $ 200,000 note and Deen's $ 230,000 note were mutual debts contracted on the credit of each other. Respondent insists that at the time of the sale the transaction was essentially complete in that petitioner and Deen had shed all tangible obligations to each other, leaving only a hollow annual ritual of exchanging checks and/or credits. Respondent posits that nothing further needed to be done other than to plead the setoff, an unnecessary formality *396 under Ingalls. Respondents concludes that petitioner effectively was discharged of his debt obligation to Deen by virtue of the transaction described herein and therefore received payments in the year of sale in excess of 30 percent of the selling price. While we consider the legal and factual analysis in Ingalls to be applicable to the case at bar, we do not believe that Ingalls favors a decision for respondent herein. At first blush, there are some immediately recognizable differences between Ingalls and the present case. Contrary to Ingalls, the face amounts and interest rates on the notes between petitioner and Deen differed. In addition, Ingalls involved a settlement agreement (one document) reached by the parties which provided that their opposing obligations would be used as offsets against each other through their bookkeeping system. In the instant case, on the other hand, no automatic offset was authorized or intended by the parties. Instead, as we have previously found, the cross pledges were in the nature of security for a default in payment. Beyond these differences, the key factor distinguishing the cases relates to the independence of the debts. In Ingalls, the *397 opposing parties intended to compromise disputed claims and did so by way of a settlement agreement. It was clear that the agreement was intended to compromise mutual debts of equal amount. While the Ingalls court recognized that independent debts would not be set off, 8*398 it went on to find that the parties' agreement effected a discharge of "mutual debts contracted on the credit of each other." 399 F.2d at 146. However, the present situation lacks similar characteristics. Indeed, the mutual debts between petitioner and Deen were independent of each other, arising out of separate and distinct transactions and involving differing rights and obligations. The original $ 400,000 note to Deen evidenced a portion of the Agreement whereby Deen assigned a contract right to petitioner and Myrick. The new $ 200,000 note, being an outgrowth of the original note, remained subject to the terms of the Agreement.For example, under Article 5, petitioner's failure to pay moneys when due would be a default in the performance of his obligations under the Agreement. In addition, petitioner and Myrick: (1) were obligated to execute a mortgage in Deen's favor upon purchasing certain property pursuant to contract rights assigned from Deen (Article 10) and (2) were required under certain circumstances to transfer funds to Deen in satisfaction of their debt in the event the aforementioned property was sold (Article 11). Furthermore, in the *399 event of a defect in title to such property arising after December 22, 1971, petitioner and Myrick had the option of cancelling all rights and obligations under the Agreement (Article 7). Moreover, the new $ 200,000 note was not specifically created in preparation for the installment sale and the resulting cross pledges. Rather, the primary motive for subdividing the $ 400,000 note was to improve the appearances of petitioner's and Myrick's financial statements for credit purposes.The $ 230,000 note from Deen to petitioner was not subject to similar terms and was the creature of a separate sale.Based on the foregoing, we find that these mutual notes between petitioner and Deen were independent and should not be deemed to set off one another for Federal income tax purposes. Therefore, we hold that petitioner has not received payments, in the year of sale, in excess of 30 percent of the selling price of his interest in Prairie View and is entitled to report his gain on that sale on the installment method under section 453. Decision will be entered for the petitioner. Footnotes1. Prairie View was a mobile home park catering to a rental contingent consisting mostly of college students.↩2. Mr. Paul Carmichael, the attorney who represented Deen, testified that petitioner, Myrick and Deen each operated his own business, each of which to a large extent depended on credit. Obtaining and maintaining credit necessarily required the submission of individual financial statements to financial institutions. It was his understanding that the note was individualized into $ 200,000 subnotes so that "when they made the financial statement they wouldn't have to say they were jointly liable of [sic↩] a $ 400,000 note."3. Mr. Carmichael testified that the notice was placed on this note at his direction and on his own initiative. In addition, he stated that the terminology used in the notice "was my language."4. Although the record is not totally clear on this point, it appears that no adjustment was made for the difference in the interest due under the respective notes for the one-year period ending on March 13, 1975 (the payment date).↩5. Sec. 1001(a) provides in pertinent part as follows: SEC. 1001. DETERMINATION OF AMOUNT OF AND RECOGNITION OF GAIN OR LOSS. (a) Computation of Gain or Loss.--The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis * * *. ↩6. 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. ↩7. Sec. 453 provides in pertinent part as follows: SEC. 453. INSTALLMENT METHOD. (a) Dealers in Personal Property.-- (1) In general.-- * * * a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the gross profit, realized or to be realized when payment is completed, bears to the total contract price. (2) Total contract price.--For purposes of paragraph (1), the total contract price of all sales of personal property on the installment plan includes the amount of carrying charges or interest which is determined with respect to such sales and is added on the books of account of the seller to the established cash selling price of such property. * * * (b) Sales of Realty and Casual Sales of Personalty.-- (1) General rule.--Income from-- (A) a sale or other disposition of real property, or (B) a casual sale or other casual disposition of personal property * * * for a price exceeding $ 1,000, may (under regulations prescribed by the Secretary or his delegate) be returned on the basis and in the manner prescribed in subsection (a). (2) Limitation.--Paragraph (1) shall apply-- (A) * * * only if in the taxable year of the sale or other disposition-- (i) there are no payments, or (ii) the payments (exclusive of evidences of indebtedness of the purchaser) do not exceed 30 percent of the selling price.↩8. Similarly, in Big "D" Development Corp. v. Commissioner, T.C. Memo. 1971-148, affd. per curiam 453 F.2d 1365">453 F.2d 1365 (5th Cir. 1972), cert. denied 406 U.S. 945">406 U.S. 945 (1972), this Court recognized that mutual debts would not be deemed cancelled where petitioner proved that the installment sale transaction and the corresponding debt from the buyer to the seller were independent of a second debt flowing from the seller to the buyer. In that case, the buyer was controlled by the seller. The mutual debts between the parties were periodically reduced by a series of bookkeeping entries. We found it significant that petitioner, in its discretion, had the power to effect an immediate offset of the mutual indebtedness by virtue of its position of control. Further, petitioner failed to prove the requisite independence. Accordingly, we found that the cross indebtedness was lacking in reality and therefore, petitioner was not entitled to installment sale treatment. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624912/ | LOYD H. WILBUR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Wilbur v. CommissionerDocket Nos. 5636 and 10611.United States Board of Tax Appeals5 B.T.A. 597; 1926 BTA LEXIS 2834; November 23, 1926, Decided *2834 1. Husband and wife, domiciled in the State of California, may not file separate returns, each reporting one-half of the community income. 2. Depreciation on prune orchard and vineyard determined. Lawrence Schillig, Esq., for the petitioner. George E. Adams, Esq., for the respondent. MORRIS*597 This proceeding is for the redetermination of deficiencies in income tax of $4,664.08, $2,925.43 and $2,254.68 for the calendar years 1920, 1921 and 1922, respectively. The questions presented are the right of husband and wife, domiciled in California, to file separate returns, each reporting one-half of the community income, and the amount of depreciation allowable on certain assets. FINDINGS OF FACT. The petitioner is a citizen of the United States and a resident of Yuba City, Calif. During the years 1920, 1921 and 1922, he was a married man, his wife's name being Ethel E. Wilbur. All the property shown by the petitioner's income-tax return is community property of himself and wife, except an interest in a piece of rented land which returned about $32.50 a year. The petitioner is a vineyardist and orchardist, having been engaged in*2835 such business about twenty-seven years. During that time he planted, bought and sold vineyards and orchards. It cost about $400 an acre to bring a prune orchard into bearing. A french prune orchard will bear at the fifth year and the Robe Sergeant and Imperial orchards, at the sixth year. The petitioner's prune orchard had a bearing life of about 20 years. The petitioner's vineyard consisted of Thompson seedless grapes. Prior to 1924 there was a series of dry years during which phylloxera flourished and destroyed the vines more than during wet periods. The average bearing life for such vineyard in the vicinity in which the petitioner's vineyard was located was seven years. The Commissioner determined that the cost of bringing petitioner's prune orchard into bearing was $200 an acre and that such orchard had a bearing life of 33 1/3 years. He therefore allowed depreciation thereon for 1921 of $6 per acre. He determined the cost of petitioner's vineyard to be $200 per acre and that it had a bearing life of 10 years, thus allowing depreciation for the years 1920 and *598 1921 of $20 per acre. At the hearing counsel for the Commissioner moved that the deficiency*2836 for 1922 be computed by allowing the same depreciation rates as those used by the Commissioner for 1920 and 1921. OPINION. MORRIS: The question of the right of husband and wife, domiciled in the State of California, to file separate returns, each reporting one-half of the community income, has already been decided adversely to the petitioner and the determination of the Commissioner in that respect is therefore approved. . The petitioner alleges, for the years 1920 and 1921, that the Commissioner erred in allowing depreciation at the rate of 10 per cent, instead of 20 per cent, on a truck and raisin stemmer, but no evidence was introduced to sustain the allegation of error. The determination of the Commissioner on these two items is therefore approved. The next question involves the amount of depreciation to which petitioner is entitled on his vineyard and prune orchard. We are satisfied from the evidence that the petitioner's vineyard had a life of 7 years and that depreciation should be computed for the years 1920, 1921, and 1922 on that basis on a cost of $200 per acre. The evidence also convinces us that the cost*2837 to the petitioner of bringing his prune orchard into bearing was $400 per acre, instead of $200 as determined by the Commissioner, and that its bearing life is 20 years. A depreciation deduction of $20 per acre should therefore be allowed for the years 1921 and 1922. Judgment will be entered on 15 days' notice, under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624913/ | THE SOUTHERN CALIFORNIA ROCK AND GRAVEL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. PACIFIC ROCK AND GRAVEL COMPANY, W. L. HODGES, TRUSTEE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Southern Cal. Rock & Gravel Co. v. CommissionerDocket Nos. 28776, 30898.United States Board of Tax Appeals26 B.T.A. 296; 1932 BTA LEXIS 1328; June 8, 1932, Promulgated *1328 The petitioners exchanged property for stock before Dec. 31, 1920. Held that the basis for computing profit upon sale of the stock is the fair market value of the property exchanged therefor. A. Calder Mackay, Esq., George M. Thompson, C.P.A., John B. Milliken, Esq., and Dan J. Chapin, Esq., for the petitioners. J. A. Lyon, Esq., and E. L. Updike, Esq., for the respondent. LANSDON *297 The respondent has asserted deficiencies against the Southern California Rock and Gravel Company and the Pacific Rock and Gravel Company for the calendar year 1922, in the respective amounts of $31,049.45 and $53,509.11. The deficiencies arise from the respondent's determination that the basis for computing profit on the sale of stock owned by each of the petitioners was to be determined under section 202 of the Revenue Act of 1921, and was the cost of certain property exchanged for stock pursuant to a plan of reorganization. The petitioners contend that such stock was acquired in exchange for property on November 2, 1919, and that under the provisions of the Revenue Act of 1918, the basis for computing profit upon the sale of the stock is the*1329 fair market value of the assets exchanged therefor. FINDINGS OF FACT. The Southern California Rock and Gravel Company, hereinafter referred to as the Southern Company, is a California corporation, with its principal office in Los Angeles. Prior to its merger with the Pacific Rock and Gravel Company it was engaged in extracting, manufacturing and selling crushed rock, sand and gravel. The Pacific Rock and Gravel Company, hereinafter referred to as the Pacific Company, is a California corporation, organized to engage in extracting, manufacturing and selling crushed rock, sand and gravel. It was dissolved by order of the Superior Court of California on October 25, 1923, and the appeal here was filed by its statutory trustee, W. L. Hodges. Prior to April, 1919, the petitioners and the Russell-Green-Foell Corporation were competitors in the rock, sand and gravel business. In order to eliminate ruinous competition the three companies organized the Union Rock Company in April, 1919, to market the products of all three on a commission basis. On November 2, 1919, the petitioners acquired a four-year lease, with option to purchase, on the entire properties of the Russell-Green-Foell*1330 Corporation. Also, on November 2, 1919, the petitioners entered into an agreement providing that they would transfer all of their plants, equipment and assets to the Union Rock Company in exchange for 4,000 shares of preferred stock having a par value of $100 per share and 16,000 shares of common stock having no par value, to be divided equally between them. On that date the Union Rock Company took physical possession of the tangible assets and thereafter operated them as a unit. *298 On December 6, 1920, the stockholders of the Union Rock Company met and adopted a resolution to amend the certificate of incorporation increasing that company's authorized capital stock from 250 shares of common having a par value of $100 to 4,000 shares of preferred having a par value of $100 per share and 16,000 shares of common, without par value. Such resolution approved the action taken by the board of directors on December 4, 1920. On December 24, 1920, the board of directors of the Pacific Company met and adopted a resolution to the effect that the terms of a certain agreement theretofore executed by the officers of the company under date of November 2, 1919, and providing for a*1331 transfer of assets to the Union Rock Company in exchange for stock, should be forwarded to the Union Rock Company in the form of an offer. The officers of the company were directed forthwith to make such offer to the Union Rock Company. On the same date the board of directors of the Southern Company met and adopted a similar resolution. The board of directors of the Union Rock Company also met on December 24, 1920. The minutes of such meeting state that the Pacific Company and the Southern Company had offered to transfer all of their real and personal property to the Union Rock Company in exchange for 4,000 shares of preferred stock and 16,000 shares of common stock. A resolution was adopted accepting such offer and directing the president and secretary to carry out the details of the transaction. On January 20, 1921, the Union Rock Company, pursuant to the laws of California, filed an application with the commissioner of corporations, requesting permission to issue 3,970 shares of preferred stock and 16,000 shares of common stock in exchange for assets acquired from the Pacific Company and the Southern Company. On January 24, 1921, the commissioner of corporations granted*1332 such permission and the stock was issued and delivered to trustees for the Southern Company and the Pacific Company in February, 1921. One-half of such stock was held for each of the companies. At various times between February 10, 1921, and April 18, 1922, instruments of assignment, transfer or conveyance were executed by each of the petitioners and delivered to the Union Rock Company, covering the properties to be transferred under the agreement of November 2, 1919, and referred to in the minutes of the board of directors' meeting of each of the three corporations on December 24, 1920. Attached to each of the several instruments of transfer was a document executed and acknowledged by individuals purporting to be stockholders of the corporation, executing such instrument in the following form: *299 We, the undersigned, being the holders of record of more than 2/3rds of the issued capital stock of * * * the above named corporation, do hereby consent and agree to the making of the transfer * * * of the property described in the foregoing instrument. * * * The parties have stipulated that if the Pacific Company and the Southern Company are entitled to use any other*1333 basis than that determined by the respondent in computing profit from the sale in 1922 of their stock in the Union Rock Company, such basis to be used in each case is the amount of $537,604.75. They further stipulate that if the basis used by the Commissioner in determining profit on such sale is correct in law, the deficiencies set forth in his notices of deficiency are in all respects correct. The parties also agree that in 1922 the Pacific Company and the Southern Company sold their stock in the Union Rock Company for $573,007.56 and $550,000, respectively. OPINION. LANSDON: The proceeding at Docket No. 28776 was brought by the Pacific Company through its statutory trustee, W. L. Hodges. At the hearing counsel for the respondent suggested the death of Hodges and moved to dismiss the appeal for lack of jurisdiction, on the ground that no successor trustee had been appointed. Counsel for the petitioner then moved to substitute Agnes Wiley Hodges, Executrix of the estate of W. L. Hodges. The deficiency notice was addressed to the Pacific Company, W. L. Hodges, Trustee, and the petition was filed by Hodges, acting for the corporation. Upon filing of the petition with deficiency*1334 notice attached, the Board acquired jurisdiction over the proceeding. At the hearing, counsel for the taxpayer, who had been employed prior to Hodges' death, appeared and offered evidence in support of allegations in the petition. In such circumstances, we think this Board has jurisdiction to hear the appeal and redetermine the deficiency. The petitioner, the Pacific Company, is still in existence for purposes of dissolution, and while there is a vacancy in the trusteeship, the Superior Court of California will doubtless appoint a successor upon proper application of any interested creditor or stockholder. Accordingly, both the respondent's motion to dismiss and the petitioner's motion to substitute the executrix of the estate of W. L. Hodges are denied. Cf. . The only controversy here relates to the basis for computing profit on the sale in 1922 of Union Rock Company stock by each of the petitioners. If the exchange by which the Union Rock Company stock was acquired occurred prior to December 31, 1920, the basis *300 for valuing the stock in petitioner's hands will be cost, which is the fair market value of the property exchanged*1335 therefor. If the exchange occurred after December 31, 1920, the stock will be treated as taking the place of the property and the basis for computing profit will be cost of the property exchanged for the stock. Section 202(d)(1) of the Revenue Act of 1921. The petitioners contend that the transfer of assets in exchange for stock actually occurred on November 2, 1919, and that only the legal formalities incident to such transfer and issue of stock remained to be done thereafter. The respondent contends that while physical possession of the assets was transferred on November 2, 1919, no title passed under the laws of California until stockholders of the petitioners consented to the transaction, either in a meeting called for that purpose, or by an instrument attached to each assignment or conveyance. The facts disclose that for several years prior to 1919 the Pacific Company, the Southern Company and the Russell-Green-Foell Company were engaged in ruinous competition in the rock, sand and gravel business in Los Angeles. To eliminate such competition the three concerns organized the Union Rock Company in March, 1919, which thereafter marketed the products of all three. Apparently*1336 such arrangement did not prove satisfactory for on November 2, 1919, the two petitioners bought out the Russell-Green-Foell Company and transferred the combined assets of the three companies to the Union Rock Company under a contract providing that they should receive 4,000 shares of preferred stock and 16,000 shares of common stock in exchange therefor. Thereafter the Union Company operated the combined properties. By December 24, 1920, possession of all of the property covered by the agreement of November 2, 1919, had been transferred by the petitioners to the Union Company and on that date the board of directors of each of the petitioners met and adopted a resolution directing that the terms of the agreement of November 2, 1919, be forwarded to the Union Rock Company as a formal offer. On the same date the directors of the Union Rock Company met and accepted the offer. While there had been no meeting of stockholders of either petitioner on or before December 31, 1920, all of the stockholders were directors, and, having voted in favor of the sale as directors, they could not avoid the sale on the ground that the stokcholders had not assented. *1337 . Tax liability resulting from sales of property is not determined by the date when legal title is transferred or the date on which certificates of stock are received in payment. Such liability is fixed as of the date the real benefits and burdens of ownership are transferred. ; Grace Harbor*301 ; ; and . Ownership of corporate stock may vest prior to delivery of stock certificates. ; ; ; and In our opinion the exchange was effected prior to December 31, 1920, and the basis for computing profit upon sale of the stock acquired in exchange for the business and assets of each of the petitioners is the fair market value of such property. The basis stipulated by the parties will be used in the recomputation under Rule 50. Decision will be entered under Rule 50.*1338 | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624914/ | KATIE J. LEWIS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentLewis v. CommissionerDocket No. 11541-78United States Tax CourtT.C. Memo 1982-12; 1982 Tax Ct. Memo LEXIS 727; 43 T.C.M. (CCH) 280; T.C.M. (RIA) 82012; January 12, 1982. Katie J. Lewis, pro se. Keith Fogg, for the respondent. DRENNENMEMORANDUM FINDINGS OF FACT AND OPINION DRENNEN, Judge: This case was assigned to and heard by Special Trial Judge Fred R. Tansill pursuant to the provisions of section 7456(c) of the Internal Revenue Code1 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. *728 OPINION OF THE SPECIAL TRIAL JUDGE TANSILL, Special Trial Judge: Respondent determined a $ 1,632 deficiency in petitioner's 1976 federal income tax. Respondent's disallowance of the claimed dependency exemption for petitioner's mother-in-law has been conceded by petitioner. There remains at issue the extent to which petitioner is entitled to: 1) an automobile expense deduction under section 162; 2) a charitable contribution deduction under section 170; and 3) a credit for child care expenses under section 44A. FINDINGS OF FACTS Some of the facts have been stipulated and those facts are so found. Petitioner timely filed a joint income tax return for 1976 with her former husband, Joe Lewis, whom she divorced in March, 1977. At the time of filing the petition 3 in this case, petitioner resided in Stillwater, Oklahoma. On February 2, 1976, petitioner began employment as a secretary and administrative assistant with the Association of Central Arizona. Once a week her employer required her to deposit the Association's money in a bank*729 located one mile away from her office. Petitioner used her personal automobile to drive to the bank and back, a round trip distance of 2 miles, which trip she made 48 times in 1976 for a total of 96 miles, for which she was not reimbursed. During 1976 petitioner's former husband, Joe Lewis, was employed as a Human Resource Specialist by the Central Arizona Association of Governments (CAAG). In 1976, Joe Lewis leased an automobile in which he traveled 15,366 miles in connection with his employment, as reflected in records kept by CAAG. He was reimbursed by CAAG at a rate of 12 cents per mile, or a total of $ 1,843.928 which was not reported on the return. On their return, petitioner and her former husband deducted amounts for depreciation and automobile expenses with respect to the automobiles used by them in connection with their respective employments. Respondent disallowed the deductions for lack of sus-stantiation. Petitioner and her husband claimed itemized deductions on their 1976 return, which totaled $ 2,891. Included among the claimed deductions were cash contributions totaling $ 360 and contributions other than cash in the amount of $ 342. 4 Respondent disallowed*730 all of these contributions for lack of substantiation and since this adjustment alone reduced the allowable itemized deductions below the $ 2,800 allowable standard deduction, respondent disallowed all the itemized deductions and allowed the standard deduction. Petitioner's husband did not file a petition in this Court and did not testify at the trial, petitioner being the only witness. Petitioner, herself, did not personally make any charitable contributions. Her former husband made some cash contributions*731 at work for which petitioner has no written receipts. However, it is unlikely that he made any of the $ 275 claimed contributions to churches since he never attended church. Petitioner was unable to substantiate the cost or fair market value at the time of contribution of any tangible property that might have been given to the Salvation Army. On their return petitioner and her former husband claimed a $ 360 credit for child care expenses in the amount of $ 1,800. At trial, petitioner testified that the amount of child care expenses incurred by her during 1976 was only $ 1,275 paid to the Merry Moppets Daycare Center. Respondent conceded that petitioner was entitled to a credit based on child care expenses in the amount of $ 1,275 but not in the amount of $ 1,800 as claimed on the return. OPINION The basic issue presented in this case is one of substantiation. Records kept by CAAG reflect that petitioner's former husband traveled 15,366 miles in connection with his employment and received reimbursement in the amount of $ .12 per mile or $ 1,843.92. With respect to business miles traveled by petitioner, she testified that she drove a total of 96 miles for which she was not*732 reimbursed. Respondent conceded on brief that petitioner is entitled to a deduction of $ .15 per mile for these 96 miles. Beyond the above figure, the record contains no other evidence of unreimbursed business miles traveled by either petitioner or her former husband. On their return, petitioner and her former husband used the regular method to compute their respective automobile expenses, which included amounts for depreciation. However, petitioner did not even attempt to substantiate those expenses. Moreover, it is clear that her former husband was not entitled to claim a deduction for depreciation on the automobile which he leased. In the absence of substantiation other than for total business miles traveled in the amount of 15,462 (15,366 + 96) we find that petitioner is entitled to compute her automobile expense deduction using the optional method (i.e., $ .15/mile for the first 15,000 miles and $ .10/mile thereafter). See Rev. Proc. 74-23, 1974-2 CB 476, applicable to the year 1976. Of course, the resuling figure must be reduced by the $ 1,843.92 reimbursement which petitioner's former husband received from CAAG. With respect to the charitable contributions,*733 petitioner presented no evidence other than her oral testimony. While we believe that petitioner's husband made some cash contributions to charities and that the furniture given to the Salvation Army had some value, petitioner has failed to prove that the total charitable contributions allowable are $ 611 or more. If the charitable contributions allowable are less than $ 611, the total itemized deductions claimed on the return will total less than the $ 2,800 standard deduction allowed by respondent in the notice of deficiency. We therefore approve respondent's adjustment with respect to the itemized deductions. Lastly, petitioner testified that her child care expenses in 1976 amounted only to $ 1,275, and not to $ 1,800 as claimed on the return. Respondent conceded that petitioner was entitled to claim a child care credit based on expenses of $ 1,275. There being no disagreement between the parties, petitioner is entitled to a child care credit based on expenses of $ 1,275. Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. ↩2. Pursuant to the order of assignment, 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 to this case.3. Petitioner's former husband did not join in the filing of this petition and therefore he is not a party to this proceeding.↩4. While this amount was listed as a contribution other than cash and petitioner testified it was probably for some used furniture contributed to the Salvation Army when she and her husband moved out of an old mobile home into a new one, there is attached to the return a schedule reflecting use of a part of their home for a business office in the amount of $ 342. This dollar amount does not appear to be claimed anywhere else on the return except as a contribution. Since respondent disallowed the contribution and petitioner offered no specific evidence to prove that it was a deductible office-in-home expense, we will view the amount as a contribution as claimed on the return.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624917/ | ROBERT L. COX, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCox v. CommissionerDocket No. 7792-75.United States Tax CourtT.C. Memo 1977-360; 1977 Tax Ct. Memo LEXIS 79; 36 T.C.M. (CCH) 1435; T.C.M. (RIA) 770360; October 11, 1977, Filed *79 Held, the amount of allowable deductions for child care, medical care, business expenses, and personal exemptions, determined. Held, further, the addition to tax of sec. 6653(a), I.R.C. 1954, for negligence, imposed. Robert L. Cox, pro se. Milton J. Carter, Jr., for the respondent. SIMPSONMEMORANDUM FINDINGS OF FACT AND OPINION SIMPSON, Judge: The Commissioner determined a deficiency of $2,400.50 in the petitioner's 1972 Federal income tax and an addition thereto of $120.03 under section 6653(a) of the Internal Revenue Code of 1954. 1 Due to concessions by the petitioner, the only issues remaining for decision are: (1) Whether he is entitled to claim Robert and Shannon Cox and Traci Easter as dependents; (2) whether he is entitled to deduct the costs of child care provided to Lisa and Kenneth Cox and Traci Easter; (3) whether he is entitled to deduct the medical expenses he claims to have paid on behalf of Edith Easter; (4) whether the petitioner is*82 entitled to a deduction for business expenses in excess of the amount allowed by the Commissioner; and (5) whether any part of the petitioner's underpayment was due to negligence or intentional disregard of the rules and regulations within the meaning of section 6653(a). FINDINGS OF FACT Some of the facts have been stipulated, and those facts are so found. The petitioner, Robert L. Cox, resided in Phoenix, Ariz., when he timely filed the petition herein. He filed his 1972 Federal income tax return with the Internal Revenue Service, Ogden, Utah. During 1972, the petitioner was an insurance agent affiliated with the New York Life Insurance Company. In April 1972, he purchased a Hermes typewriter, which he believes cost $492. In May 1972, he had personal stationery printed, which he used in his insurance business. He estimates that such stationery cost $375, and such price apparently included the cost of the plates. During the trial of this case in December 1976, the petitioner still had some of the stationery. The petitioner paid a part-time typist to set up*83 and type certain standard letters on his new stationery. From May through December 1972, he employed a typist 2 or 3 days a week at an hourly rate of $1.25 or $1.50 an hour. He usually paid such amounts by check, but he did not save his cancelled checks, nor did he use them in computing the deduction he claimed for such expense. During 1972, the petitioner also incurred advertising expenses in connection with his insurance business. Seventy-five percent of such advertising expenses was paid by New York Life Insurance Company. The total cost of such advertising was approximately $225. Finally, the petitioner paid dues of $35 to NALU, a professional organization. Sometime prior to 1970, while the petitioner was in the military, he began dating Edith Easter. After they had dated for about 3 months, the petitioner decided to end the relationship, but within 3 weeks thereafter, Edith told him shw was pregnant. In 1970, Edith gave birth to their daughter, Lisa Cox. Although the petitioner had been living with Edith, he moved out sometime prior to October 1970 because of certain difficulties, but he returned in October 1970. Shortly thereafter, Edith became pregnant again and, *84 in June 1971, gave birth to their son, Kenneth. Between June and September 1971, Edith was having medical problems requiring her to have major surgery in September 1971. After the surgery, Edith was found to have cancer, and during the latter part of 1971 and January of 1972, she received cobalt treatments. The petitioner estimates Edith's medical costs to total $2,700, in addition to a surgeon's fee of $500, all of which was paid in 1972 except for $100 paid in 1971 to secure her release from the hospital. In 1971, Edith was employed by a legal aid office until May when she took a leave of absence in preparation for the birth of her child. She resumed working in April or May 1972. Until August 1972, the petitioner lived with Edith Easter and their children Lisa and Kenneth Cox in Phoenix, Ariz. Also residing in that household was Traci Easter, a child Edith had with another man. Although the petitioner considered Edith to be his common law wife prior to and throughout the year in issue, he never married her in a religious or civil ceremony. Nothing of record suggests that the petitioner and Edith Easter ever lived together in any State other than Arizona. Due to various*85 difficulties, in August 1972, the petitioner left the home he shared with Edith and the three children and moved into an apartment. He continued to see all three children; they spent about 25 percent of the time with him and 75 percent of the time with Edith. Throughout 1972, Lisa and Kenneth Cox and Traci Easter were sent to a nursery. The petitioner paid the cost of such child care through August 1972 and thereafter frequently reimbursed Edith for the cost of such care. The total cost of child care for the three children was $2,220. The petitioner was also the father of two other children--Robert and Shannon Cox. Those children did not live with the petitioner during 1972; they lived with their mother, Violetta Brown. The petitioner gave Violetta some cash during 1972, and he bought Robert and Shannon clothes at various times during the year and toys at Christmas. He did not pay Violetta's rent or utility costs and does not know what amounts she contributed to the support of the children. He believes that she received governmental aid of about $39 a month for Robert but does not know what other amounts she may have received on behalf of the children. On his 1972 Federal*86 income tax return, the petitioner deducted child care expenses of $2,400.00, various business expenses totaling $3,417.00, medical and dental expenses of $2,713.48, six personal exemptions, and other expenses not in issue. In claiming various deductions, the petitioner did not consult any records that he claims to have had; he merely approximated the amounts of such deductions. The Commissioner determined that the petitioner was not entitled to any deduction for child care expenses, that he was entitled to business expenses of only $828, that he was entitled to a medical expense deduction of $68 for premiums for medical insurance, and that he was entitled to only three personal exemptions. OPINION The first issue we must decide is whether the petitioner may claim as personal exemptions Robert and Shannon Cox and Traci Easter. The legal issue arising with respect to his two children differs somewhat from that arising with respect to Traci; thus, we will deal with each in turn. Section 151(a) allows a deduction for each personal exemption to which an individual is entitled.Section 151(e) provides an exemption for a child of a taxpayer if that child is a "dependent" as defined*87 in section 152.Section 152(a) defines a "dependent" to mean a taxpayer's son or daughter if the taxpayer provides more than half of his or her support. The petitioner bears the burden of establishing that he furnished the requisite support to obtain a dependency exemption. Stafford v. Commissioner,46 T.C. 515">46 T.C. 515, 517-518 (1966); Rivers v. Commissioner,33 T.C. 935">33 T.C. 935, 937 (1960). It is the Commissioner's position that the petitioner is not entitled in 1972 to claim exemptions for Robert and Shannon Cox because he has failed to establish that he provided more than one-half of their support during such year. We agree with the Commissioner. According to the petitioner's best guess, in 1972, he supplied Violetta Brown with $600 in cash for the children, and in addition, he gave the children toys and clothing costing $600. In other words, the petitioner claims, without any supporting records or documents, that he paid about $50 a month for each child.However, there is no evidence relating to the total costs of support of the children--that is, we do not know the cost of their housing, food, and other necessities. Consequently, on this record, we are unable*88 to find that the petitioner furnished more than one-half of the support for Robert and Shannon Cox. We appreciate that the petitioner furnished some support for the two children, and we understand his difficulties in proving the total support for the children; nevertheless, on this record, we are required to hold that he is not entitled to deductions for such children. Since Traci Easter is not related to the petitioner in any of the ways specified in section 152(a)(1) through (8), she can qualify as his dependent only under paragraph (9) thereof, which applies to an individual "who, for the taxable year of the taxpayer, has as * * * [her] principal place of abode the home of the taxpayer and is a member of the taxpayer's household." Section 1.152-1(b), Income Tax Regs., provides that section 152(a)(9) applies to an individual who lives with the taxpayer and is a member of the taxpayer's household during the "entire taxable year of the taxpayer." We have upheld the validity of such regulations in Trowbridge v. Commissioner,30 T.C. 879">30 T.C. 879 (1958), affd. per curiam 268 F. 2d 208 (9th Cir. 1959); see McMillan v. Commissioner,31 T.C. 1143">31 T.C. 1143 (1959).*89 It is undisputed that Traci lived in the petitioner's household only through August 1972, at which time the petitioner established his household elsewhere. While thereafter Traci visited the petitioner on weekends, she lived in her mother's household, and spent 75 percent of her time with her mother. Clearly, thereofre, Traci did not, during all of 1972, have her principal place of abode in the petitioner's home, nor was she during all of 1972 a member of his household. Hence, despite the petitioner's attitude toward Traci and the support furnished her, the law provides that he is not entitled to claim her as a dependent during such year. The next issue for decision is whether the petitioner is entitled to deduct the cost of child care provided for Lisa and Kenneth Cox and for Traci Easter during 1972. During that year, section 214, in general, provided a deduction for amounts paid for the care of a "qualifying individual," but only if such expenses are incurred to enable the taxpayer to be gainfully employed. A "qualifying individual" under section 214(b)(1) was limited to a taxpayer's spouse or his dependents.Since we have held that Traci Easter does not qualify as the petitioner's*90 dependent, he is not entitled to any deduction for her under section 214. The Commissioner does not dispute that Lisa and Kenneth Cox were "qualifying individuals" and that the petitioner otherwise complied with section 214; however, he contends that the petitioner has not established what portion of the total $2,220 expended for child care was attributable to Lisa and Kenneth. In addition, the Commissioner argues that Edith Easter paid part of the cost of child care and the petitioner has not established what portion of the $2,220 was actually paid by him. After reviewing the evidence of record, we have concluded that the Commissioner's total disallowance of the petitioner's child care deduction was in error; of the $2,220 paid for child care, we are convinced that the petitioner paid 90 percent of such amount and two-thirds of the amount he paid was allocable to the services provided Lisa and Kenneth. Cf. Cohan v. Commissioner,39 F. 2d 540 (2d Cir. 1930). The next issue is whether the petitioner is entitled to a medical expense deduction for 1972 in excess of the amount allowed by the Commissioner. In large part, this issue turns on whether the petitioner*91 is entitled to deduct the payments he made in 1972 for medical services provided to Edith Easter. The petitioner claims that since he and Edith were living together, he made the payments to the hospital when it demanded payment for the medical care; he belives that because he made such payments, he should be entitled to deduct them. In general, section 213(a) allows a taxpayer to deduct the cost of medical care for himself, his spouse, or his dependents. Under section 1.213-1(e)(3), Income Tax Regs., one's status as a spouse or dependent can be determined either at the time the expense was incurred or at the time the expense was paid. Edith Easter cannot qualify as the petitioner's spouse because they were never married in a religious or civil ceremony. In addition, Arizona does not recognize common law marriages unless validly created outside the State. Ariz. Rev. Stat. Ann. sec. 25-111 (1956); In re Estate of Trigg,3 Ariz. App. 385">3 Ariz. App. 385, 414 P. 2d 988 (Ct. App. 1966), affd. 102 Ariz. 140">102 Ariz. 140, 426 P. 2d 637 (1967). Since there is no evidence that the petitioner and Edith ever lived together in any State other than Arizona, he*92 cannot establish that Edith was his spouse either in 1971, when she received the medical care, or in 1972, when he paid for such care. Furthermore, Edith Easter cannot qualify as the petitioner's dependent during 1972 because she was not related to the petitioner as set forth in section 152(a)(1) through (8), and because her principal place of abode during 1972 was not with the petitioner for the entire taxable year as required by section 152(a)(9). Nor can she qualify as the petitioner's dependent during 1971, even though she lived in his household for the full year, because there has been no showing that he provided more than one-half of her support during that year. Stafford v. Commissioner,supra; Rivers v. Commissioner,supra. We know that she was employed until May 1971, but there is insufficient evidence to conclude that the petitioner furnished more than onehalf of her support during that year. 2 Thus, even though the petitioner paid for the medical care of Edith, the relationship between them does not satisfy the restrictions placed on the allowance of a deduction for such payments, and accordingly, we must sustain the Commissioner's*93 determination in this respect. The next issue is whether the petitioner is entitled to business expenses in excess of $828, the amount of such expenses the Commissioner allowed him to deduct. The petitioner claimed business expenses totaling $3,417 on his 1972 Federal income tax return, but he now recognizes that such claim was overstated. He concedes that $1,350 represents an amount he already deducted elsewhere in his return. He also concedes that he improperly deducted the cost of a Hermes typewriter and now accepts the Commissioner's depreciation deduction of $28 for such typewriter. The business expenses still in dispute include the petitioner's claim that he incurred advertising expenses of $225.00. However, he acknowledges that the New York Life Insurance Company paid 75 percent of such expenses; thus, he paid only $56.25 for advertising.*94 We have found as a fact that he paid $35 to NALU as professional dues. On the other hand, we cannot accept the petitioner's claim that he spent $1,100 for typists. He had no records to support this claim, and an analysis of the figures given in his own testimony shows that the total may have been substantially less than that claimed by him. On this record, we are not persuaded that he spent more than $500 for typing costs. Nor can we accept the petitioner's claim that he is entitled to deduct $375 for the cost of business stationery. According to his testimony, the purchase price included the cost of the plates, and the cost of the plates is a capital expenditure, not deductible in the year of acquisition. Sec. 263. In addition, he used only a small portion of such stationery during the year at issue, and his deduction is limited to the cost of that stationery used in 1972.Using our best judgment ( Cohan v. Commissioner,supra), we find the petitioner is entitled to a stationery deduction of $75. Since the total of his allowable business expenses does not $828exceed, the Commissioner's determination of a deduction in that amount is approved. The last issue*95 is whether the petitioner is liable for the 5-percent addition to tax provided in section 6653(a). Resolution of that question turns on whether any part of the petitioner's underpayment of tax was due to negligence or intentional disregard of rules and regulations within the meaning of section 6653(a).Since the Commissioner determined that such addition to tax was applicable, the petitioner bears the burden of proving that he was not negligent and did not intentionally disregard the Commissioner's rules and regulations. Vaira v. Commissioner,444 F. 2d 770 (3d Cir. 1971), affg. on this issue 52 T.C. 986">52 T.C. 986 (1969); Bixby v. Commissioner,58 T.C. 757">58 T.C. 757 (1972); Rosano v. Commissioner,46 T.C. 681">46 T.C. 681 (1966). Under section 1.6001-1(a) and (e), Income Tax Regs., a taxpayer must keep "permanent books of account or records * * * as are sufficient to establish the amount of * * * deductions" and such records must be retained "so long as the contents thereof may become material in the administration of any internal revenue law." Yet, without any explanation whatever, the petitioner admitted that in 1974, when the IRS first contacted*96 him about his 1972 return, he had no receipts, checks, or other documents to support the bulk of his claimed deductions. In addition, although he claims he had available various records by which to compute the amount of deductions to which he was entitled, he admits that he did not consult such documents when he filled out his 1972 income tax return; he merely approximated such amounts. We have found that he claimed a number of deductions to which he was not entitled and grossly overstated other deductions, and these mistakes are clearly attributable to his failure to maintain and use records in the computation of his income. Even though we were favorably impressed by the petitioner's attitude and sense of responsibility, there remains the fact that he was negligent in the keeping and use of records and that such negligence caused an underpayment of his taxes. Under these circumstances, we must sustain the Commissioner's imposition of the addition to tax under section 6653(a). Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during the year in issue.↩2. We do not pass on whether during 1972, the relationship between the petitioner and Edith was in violation of local law within the meaning of sec. 152(b)(5) so that she could not qualify as his dependent under sec. 152(a)(9); the Commissioner has not raised this issue, and in light of our holding, its resolution is unnecessary.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624918/ | MED JAMES, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMed James, Inc. v. Comm'rNo. 366-01 United States Tax Court121 T.C. 147; 2003 U.S. Tax Ct. LEXIS 31; 121 T.C. No. 9; September 9, 2003, Filed *31 Decision will be entered for petitioner. R sent P a 30-day letter proposing a deficiency in excess of $ 100,000 for P's tax year ended Jan. 31, 1994. R subsequently issued a notice of deficiency to P determining deficiencies in P's corporate income taxes for its tax years ended Jan. 31, 1994, 1995, and 1996. P filed a petition to this Court. R and P stipulated that P's deficiency in income tax for the tax year ended Jan. 31, 1994, computed before allowance for a net operating loss (NOL) carryback from the subsequent tax year was $ 225,753. After allowance for the NOL carryback, P's deficiency for the tax year ended Jan. 31, 1994, was $ 63,573. The Court entered a decision that there was a deficiency in income tax due from P for the tax year ended Jan. 31, 1994, of $ 63,573. The decision became final on Sept. 3, 2002, and R then assessed the $ 63,573 deficiency plus interest. R applied the increased interest rate under sec. 6621(c), I.R.C., for the period beginning 30 days after the 30-day letter was sent. P paid the deficiency and interest. *32 On Mar. 17, 2003, P filed a motion to redetermine interest. Held: The Court has jurisdiction under sec. 7481(c), I.R.C., to redetermine interest because P paid the deficiency plus interest claimed by R, filed the motion within 1 year of the date the Court's decision became final, and the deficiency and interest were assessed under sec. 6215, I.R.C. Held, further : Under sec. 6621(c), I.R.C., and the regulations promulgated thereunder, a large corporate underpayment exists if the excess of the amount of tax imposed by the Internal Revenue Code (excluding interest, penalties, additional amounts, and additions to tax) for the taxable period over the amount of tax paid on or before the return due date ("the threshold underpayment") exceeds $ 100,000. Because the Code allows a deduction for NOL carrybacks for purposes of determining the tax imposed for the taxable year, the tax imposed by the Code for the year in issue was $ 63,573. Held, further: For purposes of sec. 6621(c), *33 I.R.C., threshold underpayments of tax are generally determined only when an assessment is made with respect to a taxable period. Sec. 301.6621-3(b)(2)(iii)(A), Proced. & Admin. Regs. The interest rate under sec. 6621(c), I.R.C., "hot interest", does not apply if, after a Federal court determines a taxpayer's liability for a period, the threshold underpayment for that taxable period does not exceed $ 100,000. Sec. 301.6621-3(b)(2)(iii)(B), Proced. & Admin. Regs. After the Court entered its decision, P's liability for the tax year in issue was $ 63,573. Therefore, sec. 6621(c), I.R.C., does not apply. Ron R. Morgan, for petitioner.Eric Johnson, for respondent. Goeke, Joseph RobertGOEKE*148 OPINIONGOEKE, Judge: On March 17, 2003, petitioner filed a motion to redetermine interest under section 7481(c) and Rule 261. 1 Petitioner, a C corporation, claims that it overpaid interest relating to its income tax liability for its tax year ended January 31, 1994, because respondent erroneously applied the increased interest rate under section *34 6621(c) ("hot interest"). The substantive issue for decision is whether a net operating loss (NOL) carryback which reduces an underpayment of tax for a preceding year below $ 100,000 is disregarded for purposes of determining whether a large corporate underpayment exists and whether hot interest applies. We hold that the NOL is not disregarded and hot interest does not apply. Before we address the substantive issue, we explain the Court's jurisdiction to decide the matter. Background 2On November 5, 1998, respondent sent a letter of proposed deficiency (30-day letter) to petitioner proposing a deficiency in excess of $ 100,000 for petitioner's tax year ended January 31, 1994. On October 6, 2000, respondent issued a notice of deficiency to petitioner for its tax*35 years ended January 31, *149 1994, 1995, and 1996. In the notice, respondent determined deficiencies in petitioner's corporate income tax of $ 225,753, $ 111,191, and $ 184,219, respectively, for those years. Respondent also determined that petitioner was liable for an addition to tax under section 6651(a)(1) of $ 24,923.25 for the tax year ended January 31, 1995.Petitioner filed a petition and an amended petition with this Court seeking a redetermination. In the petitions, petitioner disputed the entire amounts determined by respondent for the tax years ended January 31, 1994, and January 31, 1995, and $ 14,745 of the amount determined for the tax year ended January 31, 1996. Among other allegations, petitioner alleged that it was entitled to an additional*36 deduction of $ 900,000 for the tax year ended January 31, 1995, for an accrued liability to an insurance company. On the basis of this allegation, petitioner alleged that it was entitled to an NOL of $ 605,067 for the tax year ended January 31, 1995.On March 18, 2002, the parties filed a stipulation of agreed issues with the Court. Among other concessions, respondent conceded that for the tax year ended January 31, 1995, petitioner was entitled to an additional deduction of $ 900,000 and incurred an NOL of $ 605,067. In addition, the parties stipulated that they had not reached an agreement as to the application of all or part of the NOL carryback to the tax year ended January 31, 1994.On June 4, 2002, the parties filed the following stipulation with respect to petitioner's income tax liability for the tax year ended January 31, 1994:Tax liability, computed without allowancefor net operating loss carrybackfrom the tax year ended January 31, 1995,to the tax year ended January 31, 1994 $ 225,753.00Tax assessed and paid 0.00Deficiency, without allowance for netoperating loss carryback *37 225,753.00Reduction in liability due to netoperating loss carryback 162,180.00Deficiency, after allowance for netoperating loss carryback 63,573.00 ==========*150 It is further stipulated that interest will be assessed as providedby law on the deficiencies due from petitioner.It is further stipulated that, effective upon the entry of thisdecision by the Court, the petitioner waives the restrictionscontained in I.R.C. section 6213(a) prohibiting assessment andcollection of the deficiencies (plus statutory interest) until thedecision of the Tax Court becomes final.On June 5, 2002, the Court entered a decision that there were deficiencies in income tax due from petitioner for the tax years ended January 31, 1994, 1995, and 1996, in the amounts of $ 63,573, $ 0, and $ 169,474, respectively, and that there was no addition to tax under section 6651(a)(1) for the tax year ended January 31, 1995. The decision document reflected an agreement by the parties: (1) The Court could enter*38 the decision in accordance with the stipulation of the parties submitted therewith; (2) interest would be assessed as provided by law on the deficiencies due from petitioner; and (3) effective upon the entry of decision, petitioner waived the restrictions prohibiting assessment and collection of the deficiencies, plus statutory interest, until the decision of the Court became final. The decision became final on September 3, 2002.On September 9, 2002, respondent issued a notice to petitioner reflecting an assessment of tax and interest of $ 63,573 and $ 99,100.97, respectively, for the tax year ended January 31, 1994. Respondent subsequently issued a second notice, dated October 14, 2002, which included a tax due of $ 162,673.97. This notice also included a penalty of $ 317.86. 3 In calculating interest, respondent applied the normal interest rate prescribed under section 6621(a)(2) for the period April 15, 1994, until December 5, 1998. This computation included restricted interest on $ 225,753 for the period April 15, 1994, until April 15, 1995, and normal interest on $ 63,573 from April 15, 1995, until December 5, 1998. On December 5, 1998, respondent began applying the increased*39 interest rate prescribed under section 6621(c). Petitioner has paid the deficiency assessed for the tax year ended January 31, 1994, plus the interest and penalties claimed by respondent.Petitioner provided interest and penalty detail reports calculating petitioner's interest liability applying section 6621(c)*151 and not applying section 6621(c). If we decide that section 6621(c) does apply, petitioner does not dispute the accuracy of respondent's original interest computation. In the event we decide that section 6621(c) does not apply, respondent concedes that petitioner's interest computation is correct. The interest in dispute is $ 12,104.88. DiscussionThe parties dispute whether the increased interest rate prescribed under section 6621(c), or "hot interest", applies. 4 Petitioner claims that hot interest does not apply because the deficiency amount*40 decided by this Court and assessed by respondent did not exceed $ 100,000. Respondent contends that for purposes of applying hot interest the underpayment of tax is the amount computed before allowance of any NOL carryback. Before we address this issue, we explain this Court's jurisdiction to redetermine interest. 5*41 I. JurisdictionGenerally, this Court lacks jurisdiction over issues involving interest. Bax v. Commissioner, 13 F.3d 54">13 F.3d 54, 56 (2d Cir. 1993); ASA Investerings Pship. v. Commissioner, 118 T.C. 423">118 T.C. 423, 424 (2002); LTV Corp. v. Commissioner, 64 T.C. 589">64 T.C. 589, 597 (1975). However, we do have jurisdiction to redetermine interest in certain limited circumstances. Section 7481(c) provides: SEC. 7481(c). Jurisdiction Over Interest Determinations. -- (1) In General. -- Notwithstanding subsection (a), if, within 1 year after the date the decision of the Tax Court becomes final under subsection (a) in a case to which this subsection applies, the taxpayer files a motion in the Tax Court for a redetermination of the amount of interest involved, then the Tax Court may reopen the case solely to determine whether the taxpayer has made an overpayment of such interest or the Secretary has made an underpayment of such interest and the amount thereof. *152 (2) Cases to which this subsection applies. -- This subsection shall apply where --*42 (A)(i) an assessment has been made by the Secretary under section 6215 which includes interest as imposed by this title, and (ii) the taxpayer has paid the entire amount of the deficiency plus interest claimed by the Secretary, and (B) the Tax Court finds under section 6512(b) that the taxpayer has made an overpayment. (3) Special rules. -- If the Tax Court determines under this subsection that the taxpayer has made an overpayment of interest or that the Secretary has made an underpayment of interest, then that determination shall be treated under section 6512(b)(1) as a determination of an overpayment of tax. An order of the Tax Court redetermining interest, when entered upon the records of the court, shall be reviewable in the same manner as a decision of the Tax Court. 6We have jurisdiction to redetermine interest under section 7481(c) when: (1) The entire amount of the deficiency plus the entire amount claimed by the Commissioner as interest on the deficiency has*43 been paid; (2) a timely motion to redetermine interest has been filed; and (3) an assessment has been made by the Commissioner under section 6215 which includes interest. Rule 261; ASA Investerings Pship. v. Commissioner, supra at 425; Bankamerica Corp. v. Commissioner, 109 T.C. 1">109 T.C. 1, 6-7 (1997).Petitioner has paid the entire amount of the deficiency for the tax year ended January 31, 1994, plus the entire amount of interest (and penalties) related to the deficiency. Petitioner's motion to redetermine interest was filed on March 17, 2003, which date was within 1 year of the date the Court's decision became final. Thus, petitioner has satisfied the first two jurisdictional prerequisites.Section 6215 requires a petition filed by the taxpayer with this Court and an amount redetermined as a deficiency by a decision of the Court which has become final. ASA Investerings Pship. v. Commissioner, supra at 426. These requirements have been met because a petition was filed to this Court and the Court entered a decision, which has become final, redetermining an amount as a deficiency. The*153 evidence in the record reflects that respondent has assessed the deficiency*44 and interest for the tax year ended January 31, 1994. Accordingly, we hold that the requirements of section 7481(c) have been met and we have jurisdiction to determine whether petitioner made an overpayment of interest.II. Applicable Interest RateInterest on underpayments of tax is generally imposed at the normal underpayment rate of the Federal short-term rate plus 3 percentage points. Secs. 6601(a), 6621(a)(2). Section 6621(c) imposes an additional 2-percent interest rate, called hot interest, on large corporate underpayments. In the present case, if applicable, this additional interest would be imposed by section 6621(c)(2)(A)(i) 30 days after November 5, 1998, the date respondent sent the 30-day letter. At all times that hot interest might apply in this case, the underlying tax to which it would apply was $ 63,573, which is less than the $ 100,000 threshold for a large corporate underpayment and the application of hot interest. 7Sec. 6621(c)(3)(A). Nevertheless, respondent maintains that because the pre-NOL liability for the year ended January 31, 1994, was $ 225,753, hot interest should apply. 8 Thus, the case before us turns on whether the amount subject to the threshold*45 determination should be reduced by the NOL 9 from the tax year ended January 31, 1995. Hot interest applies only to periods after the "applicable date". Sec. 6621(c)(1); sec. 301.6621-3(c)(1), Proced. & Admin. Regs. In the case of any underpayment of a tax to which the deficiency procedures apply, the applicable date is the 30th day after the earlier of the date on which the Commissioner sends the 30-day letter or the notice of deficiency. Sec. 6621(c)(2); sec. 301.6621-3(c)(2), Proced. & Admin. Regs.*154 Letters or notices involving amounts not greater than $ 100,000 (determined by not taking into account any interest, penalties, or additions to tax) are disregarded for purposes of determining the applicable date. 10Sec. 6621(c)(2)(B)(iii).*46 It is undisputed that petitioner was liable for interest on the original understatement of $ 225,753 for the period from the due date of the return for the tax year ended January 31, 1994, to the due date of the return for the tax year ended January 31, 1995. Additionally, it is undisputed that from the due date of the return for the taxable year ended January 31, 1995, until the date paid in full, petitioner was generally liable for interest on the reduced amount of $ 63,573. 11 The parties agree that the normal underpayment rate under section 6621(a)(1) applies from the due date of the return for the tax year ended January 31, 1994, until December 5, 1998. 12*47 Petitioner argues that hot interest does not apply because the underpayment of tax for the tax year ended January 31, 1994, was $ 63,573, which is below the $ 100,000 amount required to trigger application of the increased interest rate. Petitioner claims that the deficiency amount decided by this Court and then assessed by respondent is the proper amount to use in determining whether hot interest applies.Respondent contends that hot interest applies because it is undisputed that before the carryback of the NOL from the tax year ended January 31, 1995, petitioner's corporate income tax was understated by $ 225,753. Respondent's argument is based on the position that an NOL carryback, regardless of whether it is applied preassessment or postassessment, does *155 not reduce the amount of the underpayment for an earlier taxable period.A threshold underpayment of tax is defined for this purpose as the excess of a tax imposed by the Internal Revenue Code (the Code) (exclusive of interest, penalties, additional amounts, and additions to tax) for the taxable period over the amount of tax paid on or before the last date prescribed for payment. Sec. 301.6621- 3(b)(2)(ii), Proced. & Admin. Regs. *48 This case turns on when the tax imposed by the Internal Revenue Code for purposes of determining the amount of a threshold underpayment is determined. If determined at the time hot interest starts to accrue, when the tax was assessed, or after this Court's decision, petitioner prevails. If determined at the time petitioner's return was filed, respondent prevails. On the basis of the Code and the regulations, we hold that the determination in this case is made no sooner than the time of entry of our decision that there was a deficiency of $ 63,573.The first step is to determine the amount of tax imposed by the Code on petitioner for the tax year ended January 31, 1994. 13Section 11(a) imposes a tax for each tax year on the taxable income of a corporation. Taxable income is the corporation's gross income minus the deductions allowed by chapter 1 of the Code. Lastarmco, Inc. v. Commissioner, 79 T.C. 810">79 T.C. 810, 812 (1982), affd. 737 F.2d 1440">737 F.2d 1440 (5th Cir. 1984); sec. 1.11-1(b), Income Tax Regs. Section 172(a) allows as a deduction for the taxable year an NOL carryback. NOLs in tax years beginning before August 6, 1997, may generally be carried*49 back to the 3 years preceding the loss year and then forward to 15 years following the loss year. Sec. 172(b)(1)(A); Taxpayer Relief Act of 1997, Pub. L. 105-34, sec. 1082(a), 111 Stat. 950">111 Stat. 950; see also Intermet Corp. & Subs. v. Commissioner, 117 T.C. 133">117 T.C. 133, 136 n. 1 (2001).At the time petitioner filed its Federal income tax return for the tax year ended January 31, 1994, it understated its income tax by $ 225,753. The tax shown as due on petitioner's return for the year was zero. The parties agree that for the tax year ended January 31, 1995, petitioner incurred an NOL which it was entitled to carry back to the year in issue. Section 172(a)*156 treats the NOL carryback as a deduction from petitioner's income. This deduction reduced petitioner's taxable income, and correspondingly reduced its tax, as imposed*50 by the Code, for the tax year ended January 31, 1994, to $ 63,573. Therefore, under a straightforward application of the statute and the Commissioner's own regulations, the excess of the tax imposed by the Code for the tax year at issue over the amount of tax paid on or before the return due date was $ 63,573.This interpretation is consistent with other parts of the regulations that discuss when an underpayment is determined. Section 301.6621-3(b)(2)(iii), Proced. & Admin. Regs., provides: (iii) When determined -- (A) In general. The existence of a threshold underpayment of a tax and the amount of a large corporate underpayment are generally determined only when an assessment is made with respect to the taxable period. Thus, the amount of a deficiency or proposed deficiency set forth in a letter or notice pursuant to which the applicable date is determined (under paragraph (c) of this section) does not determine whether there is a large corporate underpayment. (B) Judicial determinations. Notwithstanding any prior assessment made with respect to a taxable period, the section*51 6621(c) rate does not apply if, after a federal court determines the taxpayer's liability for a period, the threshold underpayment for that taxable period does not exceed $ 100,000. See Example 3 in paragraph (d) of this section.Section 301.6621-3(d), Examples (2) and (3), Proced. & Admin. Regs., illustrate the application of the above regulations. In Example 2, involving a corporation that petitions the Tax Court for redetermination of a deficiency in its income tax, the date of the Tax Court's determination is the operative date for purposes of determining the threshold underpayment of tax. In Example 3, the Commissioner examines the taxpayer's return and subsequently sends a 30-day letter proposing a deficiency of $ 450,000 and then a notice of deficiency determining a $ 300,000 deficiency. The taxpayer does not file a petition to the Tax Court, and the Commissioner assesses the $ 300,000. The taxpayer then pays the amount assessed and files a claim for refund. A Federal district court determines that, exclusive of interest and penalties, the taxpayer overpaid its income tax by $ 250,000.Example 3 states that at the time of the assessment there*52 was a large corporate underpayment of $ 300,000. However, *157 the example goes on to state that because of the district court's decision that the taxpayer's underpayment, exclusive of interest and penalties, was only $ 50,000, the taxpayer does not have a large corporate underpayment.Respondent argues that despite the language contained in the above regulations, petitioner had a large corporate underpayment. With respect to section 301.6621-3(b)(2)(iii)(A), Proced. & Admin. Regs., respondent claims that the term "generally" indicates that assessments and abatements of assessment are not necessarily dispositive. We disagree with respondent's interpretation.Section 301.6621-3(b)(2)(iii), Proced. & Admin. Regs., and Examples 2and 3 indicate that the assessment date is generally the operative date for purposes of determining whether there is an underpayment of tax exceeding $ 100,000. If the assessment reflects an underpayment exceeding $ 100,000, then there is a large corporate underpayment at that time. However, if after a judicial determination the taxpayer's liability is determined to not exceed $ 100,000, then there is no large corporate underpayment and hot interest does not apply. *53 The use of the word "generally" in section 301.6621- 3(b)(2)(iii)(A), Proced. & Admin. Regs., accounts for judicial determinations. A subsequent judicial determination overrides a previous assessment and represents the operative date for purposes of determining whether there is a large corporate underpayment. As illustrated by example 3 in the regulations, this concept is important in the case of a taxpayer seeking a refund in a Federal district court because any deficiency will generally be assessed before the judicial determination is made. However, in proceedings properly before this Court, the Commissioner generally does not assess the deficiency until the Court's decision becomes final. In this case, after the decision became final, respondent assessed the deficiency of $ 63,573. Therefore, the assessment in this case did not reflect a threshold underpayment of tax exceeding $ 100,000.With respect to section 301.6621-3(b)(2)(iii)(B), Proced. & Admin. Regs., respondent claims that the Court's decision determined a deficiency, but it did not determine any issue with respect to the existence of a large corporate underpayment. Respondent contends that there was a large corporate*54 underpayment because from at least the return due date for the tax year ended January 31, 1994, until the return due *158 date for the tax year ended January 31, 1995, petitioner had an underpayment with respect to the tax year ended January 31, 1994, that exceeded $ 100,000.Section 301.6621-3(b)(2)(iii)(B), Proced. & Admin. Regs., plainly provides that section 6621(c) does not apply if, after this Court determines the taxpayer's liability for a period, the threshold underpayment for the taxable period does not exceed $ 100,000. The Court had no jurisdiction to make a determination with respect to petitioner's interest liability because section 7481(c) was triggered only after the decision became final and respondent assessed the deficiency. Pen Coal Corp. v. Commissioner, 107 T.C. 249">107 T.C. 249, 254 (1996). The Court did decide that the deficiency in petitioner's income tax for the tax year ended January 31, 1994, was $ 63,573. Respondent assessed this amount after the decision became final. Under the regulations, the Court's decision and subsequent assessment establish that there was not a threshold underpayment of tax exceeding $ 100,000 for purposes of section 6621(c).Finally, *55 respondent relies on one sentence in the preamble to the regulations to support his position that the amount of the underpayment should be determined without consideration of any NOL carryback. The entire paragraph containing the sentence provides: Post-Assessment Determinations of the Amount of the Threshold Underpayment Commentators argued that the section 6621(c) rate should not apply if it is determined after assessment that the threshold underpayment is less than $ 100,000. The section 6621(c) rate does not apply if, as a result of a full or partial abatement of an assessment to correct an administrative error on the part of the Service, the taxpayer's threshold underpayment does not exceed $ 100,000. The final regulations also provide that the section 6621(c) rate does not apply, if, as a result of a court determination of the taxpayer's liability, the threshold underpayment is less than $ 100,000. However, a net operating loss or credit carryback does not reduce the amount of the threshold underpayment for an earlier taxable period.[T.D. 8447, *56 2 C.B. 313">1992-2 C.B. 313, 315; emphasis added.]The heading of the paragraph indicates that this portion of the preamble is referring to postassessment determinations that potentially affect the amount of a threshold underpayment. In such a situation, the preamble states that an*159 NOL does not reduce the amount of an underpayment for an earlier taxable period. The instant case does not involve a postassessment determination. Rather, at the time of the Court's decision and the subsequent assessment, the parties were fully aware of the NOL, and petitioner's liability for the tax year at issue was computed with allowance for the NOL carryback.The regulations do not state that a liability or threshold underpayment is not adjusted to account for an NOL for purposes of determining whether section 6621(c) applies. Rather, the regulations generally provide that if the liability assessed by respondent or decided by this Court does not exceed $ 100,000, then hot interest does not apply. As explained earlier, the assessment date is generally the operative date for purposes of determining whether there is a large corporate underpayment and hot interest applies. If the liability is subsequently*57 redetermined by a Federal court, then the operative date is when the judicial determination is made. Because petitioner did not have a threshold underpayment of tax exceeding $ 100,000 after this Court's decision or on the assessment date, section 6621(c) does not apply. 14Respondent's arguments in this case focus on petitioner's liability as of the return due date, without reference to any future events that might ultimately reduce petitioner's liability for the taxable year. This is consistent with the general rule of section 6601(d) that if the amount of income tax is reduced by the carryback of NOLs and capital losses, the reduction does not affect the computation of interest for the period ending with the filing date for the taxable year in which the NOL or capital loss arose. However, unlike normal interest, *58 hot interest does not start to accrue until the applicable date. 15 This distinguishes the rule regarding NOLs in section 6601(d) from the position advanced by respondent in the context of section 6621(c), and it highlights the distinction *160 in the statutory scheme between liability for interest and the proper rates of interest to apply. Our holding today is consistent with this statutory scheme and incorporates the mandate of the statute, the guidance set forth in respondent's own regulations, and the legislative history associated with the enactment of the increased interest rate rules.*59 III. ConclusionThe statutes and regulations containing the interest provisions indicate that the purpose of section 6621(c) is to impose a higher rate of interest on corporate taxpayers if, after a letter or notice proposing or determining a deficiency exceeding $ 100,000 is sent to a taxpayer and payment is not promptly made, a judicial determination or assessment is made reflecting an underpayment exceeding $ 100,000. In the instant case, the parties agreed and this Court decided that petitioner had a deficiency of $ 63,573 for the tax year ended January 31, 1994, computed after allowance of the NOL carryback. That amount was assessed by respondent after this Court's decision became final. Although petitioner's underpayment at the time of the due date for the 1994 return was $ 225,753, petitioner was entitled under the Code to carry back its NOL from the subsequent year, resulting in a tax of $ 63,573 for petitioner's tax year ended January 31, 1994. The NOL arose more than 3-1/2 years before respondent sent the 30-day letter containing the proposed deficiency exceeding $100,000. Applying hot interest in this situation, where the amount of petitioner's*60 liability decided by the Court, the amount assessed by respondent, and the tax imposed by the Code does not exceed $100,000, is contrary to the regulations. Accordingly, we hold that section 6621(c) does not apply under the facts of this case. An appropriate order will be entered. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect at the time of the filing of the motion, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. For purposes of deciding this motion, we rely in part on the information contained in the petitions, answer, stipulations, and decision document. The facts subsequent to the date the decision was entered are based on the parties' undisputed factual allegations.↩3. The evidence in the record reflects that the penalty was based on the failure to timely pay the assessment amount.↩4. The increased interest rate assessed on large corporate underpayments is commonly known as "hot interest". RHI Holdings, Inc. v. United States, 142 F.3d 1459">142 F.3d 1459, 1460 (Fed. Cir. 1998); Saltzman, IRS Practice and Procedure, par. 6.02[3][e] (2d ed. 1991); Abreau, "Distinguishing Interest from Damages: A Proposal for a New Perspective", 40 Buff. L. Rev. 373">40 Buff. L. Rev. 373, 395↩ (1992).5. In Pen Coal Corp. v. Commissioner, 107 T.C. 249">107 T.C. 249, 254 (1996), we held that we lacked jurisdiction to redetermine a taxpayer's liability for hot interest in deficiency proceedings. We explicitly left for another day whether we have jurisdiction to determine liability for hot interest in a supplemental proceeding commenced pursuant to sec. 7481(c) and Rule 261↩. Id.6. Under sec. 7481(a), a decision of this Court becomes final "after the exhaustion of the possibilities of direct review". This finality generally precludes any subsequent consideration by the Court. Kenner v. Commissioner, 387 F.2d 689">387 F.2d 689, 690 (7th Cir. 1968); ASA Investerings Pship. v. Commissioner, 118 T.C. 423">118 T.C. 423, 425 n. 3 (2002). Sec. 7481(c) "' specifically carves out an exception to the rule on the finality of our decisions'; a prerequisite for invoking that exception is a final decision of this Court." ASA Investerings Pship. v. Commissioner, supra at 425 n. 3 (quoting Bankamerica Corp. v. Commissioner, 109 T.C. 1">109 T.C. 1, 8-9↩ (1997)).7. In addition to applying to the underlying tax, hot interest applies to any interest, penalties, additional amounts, and additions to tax imposed with respect to the underlying tax; however, the threshold amount is determined based only on the underlying tax. Sec. 301.6621-3(b)(2)(i) and (ii), Proced. & Admin. Regs↩.8. The evidence in the record reflects that the tax shown as due on petitioner's return for the tax year ended Jan. 31, 1994, was zero.↩9. An NOL is generally defined as the excess of deductions over gross income. Sec. 172(c). Sec. 172 provides specific rules allowing NOLs to be carried back to preceding taxable years and carried forward to future years to reduce a taxpayer's taxable income. Sec. 172(a) allows as a deduction for the taxable year an NOL carryback. If the amount of tax is reduced by reason of an NOL carryback, the reduction in tax does not affect the computation of interest under sec. 6601 for the period ending with the filing date for the taxable year in which the NOL arises. Sec. 6601(d)(1); see also Manning v. Seeley Tube & Box Co., 338 U.S. 561">338 U.S. 561, 570, 94 L. Ed. 346">94 L. Ed. 346, 70 S. Ct. 386">70 S. Ct. 386 (1950); Intel Corp. & Consol. Subs. v. Commissioner, 111 T.C. 90">111 T.C. 90, 95↩ (1998).10. As originally enacted, sec. 6621(c) did not contain the provision disregarding letters or notices involving amounts not greater than $ 100,000. The Taxpayer Relief Act of 1997, Pub. L. 105- 34, sec. 1463(a), 111 Stat. 1057">111 Stat. 1057, added sec. 6621(c)(2)(B)(iii), applicable for purposes of determining interest for periods after Dec. 31, 1997. The legislative history indicates that Congress was concerned that minor mathematical errors by the taxpayer might result in the application of hot interest to a subsequently identified income tax deficiency. H. Rept. 105-148, at 642 (1997), 1997-4 C.B. (Vol. 1) 319, 964. The Commissioner has not updated the regulations promulgated under sec. 6621(c)↩ to reflect this change.11. The interest and penalty detail reports computing the amount of interest owed by petitioner state that the period from July 5, 2002, through Sept. 9, 2002, was an "interest free period".↩12. The interest computation report prepared by respondent states that the 30-day letter date was Nov. 5, 1998. Respondent started imposing hot interest on Dec. 5, 1998. If we decide that there was a large corporate underpayment, then petitioner does not challenge the use of this date as the applicable date.↩13. The taxable period in this case is the taxable year because the taxes at issue are income taxes imposed by subtitle A of the Code. Sec. 6621(c)(3)(B); sec. 301.6621-3(b)(4), Proced. & Admin. Regs.↩14. We leave to another day whether an NOL carryback determination made postassessment or after a final judicial determination would affect the existence or amount of a threshold underpayment of tax.↩15. The legislative history of sec. 6621(c) indicates that Congress was concerned that corporations were allowed to deduct interest on tax obligations but that individuals were not. Imposing a $ 100,000 threshold and allowing corporations to avoid hot interest by paying the underpayment within 30 days after notice was provided indicates that Congress was reluctant to allow arbitrage activities by corporations accruing interest but did not want to penalize corporations with small underpayments or which promptly paid their tax liabilities. H. Conf. Rept. 101-964 (1990), 2 C.B. 560">1991-2 C.B. 560↩, 591. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624919/ | JOHN T. BENSON, JR., AND JIMMIE L. BENSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBenson v. CommissionerDocket No. 5885-76.United States Tax CourtT.C. Memo 1978-231; 1978 Tax Ct. Memo LEXIS 286; 37 T.C.M. (CCH) 989; T.C.M. (RIA) 78231; June 21, 1978, Filed William Waller, for the petitioners. W. Robert Pope, Jr., for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined deficiencies in petitioners' 1972 and 1973 Federal income taxes of $ 14,141.60 and $ 590.28 1 respectively. The sole issue for decision is whether petitioners realized gain on the transfer of stock to their sons where the transfer was conditioned upon the sons' promise to pay the resulting federal and state gift tax liability. FINDINGS OF FACT All of the facts have been stipulated. Those necessary to an understanding of the case are as follows: Petitioners, husband and wife, resided in Sumner County, Tennessee, *287 at the time they filed their petition herein. On or about September 28, 1972, petitioner John T. Benson, Jr. gave each of his two sons 132 shares of stock in the John T. Benson Publishing Company. As a condition to the gifts, each son orally agreed to pay the federal and state gift tax liability arising from the transfers. At the time the gifts were made Benson's basis in the 264 shares of stock given was $ 34,763.56. Petitioners had agreed to split John's gift of the stock, and on November 14, 1972, each filed a federal gift tax return for the third quarter of 1972. On each return petitioners valued the transferred stock at $ 219,620.28 and reported gift tax liability of $ 31,937.84. On the same day the returns were filed each of petitioners' sons issued a check to petitioners in the amount of $ 31,937.84 in payment of petitioners' federal gift tax liability. Subsequently on March 12, 1973, each son issued a check to the Tennessee Department of Revenue in the amount of $ 8,736.43 in payment of petitioners' state gift tax liability. In 1973 respondent audited petitioners' third quarter 1972 gift tax returns and determined that with respect to each return the fair market*288 value of the transferred stock was $ 244,200 rather than $ 219,620.28. As a result respondent determined total deficiencies of $ 16,496.18 in petitioners' gift taxes. The deficiencies were subsequently paid by petitioners' sons sometime after 1973 in fulfillment of their original promise to pay petitioners' gift tax liability. On their income tax returns for 1972 and 1973 petitioners did not report any gain by reason of the transfers of stock. In his statutory notice respondent determined that the transfers constituted exchanges of stock resulting in taxable gain in 1972 and 1973, or alternatively in 1972.OPINION The sole issue for decision is whether petitioners realized gain upon the transfer of stock to their sons where the transfer was conditioned upon the sons' paying the resulting gift tax liability. This case is another of a number of recent cases 2 involving the net gift versus part-gift-part-sale issue. All of these cases arose after the decision of the Sixth Circuit Court of Appeals in , affg. , and in each instance appeal from the decision of this Court normally*289 would lie in the Sixth Circuit. See section 7482(b)(1). The question of whether a gift conditioned upon the donees' payment of the resulting gift taxes constitutes a net gift or a part-gift-part-sale has been addressed by this Court on numerous occasions. 3 In each instance involving facts similar to those herein, we have held that the transfer constituted a net gift resulting in no income tax liability to the donor. In , however, we found that the transfers constituted part gifts and part sales. *290 There the donor paid the resulting gift taxes with funds borrowed prior to his gift. After the gift the trust assumed responsibility for the loan. On appeal the Sixth Circuit affirmed our decision. In so doing the Sixth Circuit limited to its facts its decision in , affg. , where it had held that a gift conditioned upon the donees' payment of the resulting gift taxes constituted a net gift. As a consequence of the Sixth Circuit's opinion in Johnson, respondent urges us to reject our decision in Turner on the "net gift" issue and argues that in any event, our decision in , affd. on the substantive issue , cert. denied requires us to follow Johnson.After this case was submitted and after the parties filed their briefs, , on appeal (6th Cir. May 5, 1978), was decided by this Court. There respondent raised the identical arguments he presents in the instant case.4 For*291 the reasons set forth in Estate of Henry, we adhere to our prior decisions. We are also of the opinion our decision in Golsen does not require us to follow Johnson in deciding this case. The Golsen doctrine was designed to provide "better judicial administration" and to avoid superfluous appeals where a Court of Appeals has decided the particular issue in a manner contrary to the view of this Court. The Sixth Circuit in Johnson did not directly address the issue currently before this Court. Instead, by way of dicta, it limited its affirmance in Turner to its facts. Thus Turner "remains, at least as to gifts to individuals, as a decision of this Court affirmed by the Sixth Circuit." 5 Since the facts herein are indistinguishable from those in Turner, our Golsen doctrine, if applicable here, would require that we follow Turner and not Johnson.6*292 Decision will be entered for the petitioners. Footnotes1. In an amendment to his answer respondent increased the 1973 deficiency to $ 4,958.49.↩2. See ; P-H Memo T.C. par. 78,051 (1978).↩3. , affd. per curiam ; ; P-H Memo T.C. par. 71,318 (1971), affd. per curiam ; , affd. .↩4. In fact, respondent's opening brief filed in Estate of Henry↩ is substantially identical to his opening brief filed herein.5. , affd. . ↩6. Respondent also contends that, because petitioners' sons issued checks to petitioners in payment of the federal gift tax liability rather than directly paying the liability, this case is "not significantly distinguishable" from Johnson as to this amount. While this case may not be significantly distinguishable from Johnson, it is indistinguishable from Turner.↩ As a consequence, we reject respondent's contention. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624921/ | PANTLIND HOTEL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Pantlind Hotel Co. v. CommissionerDocket No. 40886.United States Board of Tax Appeals23 B.T.A. 1207; 1931 BTA LEXIS 1750; July 20, 1931, Promulgated *1750 Petitioner and the Pantlind Building Company are not entitled to file an affiliated return for the taxable period involved. F. E. Seidman, C.P.A., and J. S. Seidman, Esq., for the petitioner. B. M. Coon, Esq., for the respondent. LOVE *1207 This proceeding is for the redetermination of a deficiency in income tax in the amount of $905.10, covering the period January 1 to June 29, 1926, and asserted against the petitioner as a transferee of assets of the Pantlind Building Company, hereafter termed the *1208 Building Company. A similar deficiency in the amount of $157.10 for the year 1924 is uncontested. The petitioner makes no issue of its liability as a transferee, the only error alleged being the respondent's refusal to accept a consolidated return of the petitioner and the Building Company for the taxable period involved. FINDINGS OF FACT. The facts were submitted by a stipulation reading as follows: It is hereby stipulated by and between the parties hereto, through their respective counsel, that for the purposes of this appeal, the Board may find the following as facts: 1. The Pantlind Building Company was organized*1751 as a Michigan corporation in 1912, and until the consolidation later referred to, owned the building containing the Pantlind Hotel, Grand Rapids, Michigan. 2. The petitioner is a Delaware corporation, organized in 1915 to operate the Pantling Hotel. 3. On June 30, 1926, the Pantlind Hotel Company acquired all of the outstanding capital stock of the Pantlind Building Company, which thereupon became merged with the Pantlind Hotel Company. On August 5, 1926, the Pantlind Building Company transferred to the Pantlind Hotel Company all of the property, rights and privileges, and all things of value of every kind and nature of the Pantlind Building Company, and it is agreed that the value of the same was more than the amount of the deficiencies involved in this appeal. 4. Throughout the period from January 1, 1926, to June 30, 1926, the capitalization of the Building Company consisted of 3,989 shares of common stock, of a par value of $398,900, and 4,453 shares of preferred stock, of a par value of $445,400. 5. Throughout this period the Hotel Company owned 3,971 shares of common stock and 1,016 shares of preferred stock of the Building Company. 6. The preferred stock*1752 of the Building Company had no voting powers other than as provided by law. It was also limited and preferred as to dividends. Dividends were payable at the rate of 6% semi-annually. The preferred stock was subject to redemption on or before February 1, 1940, at par and accrued dividends. 7. At the March 2, 1925 meeting of the Board of Directors of the Building Company, the customary semi-annual dividend on the preferred stock was omitted and was not resumed by June 30, 1926. On August 4, 1926, the preferred stock was redeemed. 8. At the January 15, 1926 meeting of stockholders, 3,988 shares of common stock and 3,116 shares of preferred stock were represented and voted. Of these amounts, 3,971 shares of common stock and 1,003 shares of preferred stock were shares of the Hotel Company. One thousand three hundred and forty-five shares of preferred and 18 shares of common stock were of directors of the Building Company who were also directors of the Hotel Company. Two of these directors also represented 533 shares of preferred stock by proxies. Seven shares of preferred stock were of the Secretary of the Hotel Company, who was also Assistant Secretary and Treasurer of*1753 the Building Company. *1209 9. On August 20, 1926 the charter of the Pantlind Building Company expired and the said corporation was dissolved in accordance with the statute of Michigan. 10. The Hotel and Building Companies filed a consolidated return of their income for the period January 1 to June 29, 1926. 11. The respondent denied the right to file consolidated return, thereby giving rise to the deficiency here in question. OPINION. LOVE: The petitioner concedes that it is a transferee of assets of the Building Company within the intendment of section 280 of the Revenue Act of 1926. The sole issue presented is whether the petitioner and the Building Company were affiliated from January 1 to June 29, 1926, and therefore were entitled to file a consolidated return for that period. The deficiency results from the respondent's denial of the claimed affiliated status. It has been stipulated that during the taxable period petitioner owned 3,971 out of a total of 3,989 outstanding shares of the common stock of the Building Company, or approximately 99.55 per cent. During that period petitioner also owned 1,016 out of a total of 4,987 outstanding shares of*1754 the preferred stock of the Building Company, or approximately 22.82 per cent. Considering the two classes of stock together, petitioner owned 4,987 shares out of a total of 8,976 shares outstanding, or approximately 55.56 per cent. Certain of the directors of both companies owned stock in each and some of them also represented preferred stock by proxy. The petitioner's secretary was also an officer of the Building Company and the holder of seven shares of its preferred stock. However, it appears that petitioner is not relying upon the stockholdings of its directors or officers to establish its point and their holdings, which in any event are not sufficient to be decisive of the issue, will be disregarded in the discussion to follow. As stated in the petitioner's brief the question is whether the outstanding preferred stock is to be considered in determining if the two companies involved meet the statutory requirements for affiliation. The statute is section 240(d) of the Revenue Act of 1926, reading as follows: For the purpose of this section two or more domestic corporations shall be deemed affiliated (1) if one corporation owns at least 95 per centum of the stock of the*1755 other or others, or (2) if at least 95 per centum of the stock of two or more corporations is owned by the same interests. As used in this subdivision the term "stock" does not include nonvoting stock which is limited and preferred as to dividends. * * * The preferred stock of the Building Company had no voting rights except as provided by law. The applicable statute of Michigan is *1210 the General Corporation Act of 1921, Public Act No. 84 of 1921, Part II, ch. 2, sec. 9050 (Compiled Laws Michigan, Cahill, annotated supplement, 1922, p. 942), which, so far as material, provides: If at any time * * * any dividend due on the preferred stock shall remain unpaid for sixty days, then holders of such preferred stock shall have an equal right with the common stock, share and share alike, and notwithstanding any provision in the articles to the contrary, to participate in the election of directors and control of said corporation. * * * At a meeting of directors of the Building Company on March 2, 1925, the customary semiannual dividend on the company's preferred stock was omitted and it was not resumed by June 30, 1926. The stock was redeemed on August 4, 1926. During*1756 the period involved in this proceeding, i.e., the period January 1 to June 29, 1926, preferred stock of the Building Company possessed and most of it exercised equal voting rights with the common stock. Despite its exercise of such voting power, petitioner contends that the preferred stock should not be taken into consideration in determining affiliation, the argument being that the statute involved does not contemplate consideration of stock having only a contingent and/or temporary voting power. We think the provisions of section 240(d) of the Revenue Act of 1926 are both mandatory and explicit. By its terms "stock does not include nonvoting stock which is limited and preferred as to dividends." The definitions of affiliation and of "stock" given in this section were designed, we believe, to establish a definite inflexible standard, to remove the uncertainties and obviate the variables constantly impeding efficient administration of prior statutes governing affiliation. In our opinion, this is the only construction compatible with the purpose and the intent of the Congress in enacting the statute in the terms it used and in the light of previous legislation on the subject. *1757 We think that for any period under this statute during which a claim for affiliation is not predicated upon ownership of at least 95 per cent of the actual outstanding voting stock, the claim must fail. Petitioner suggests that under the statutes of most States, preferred stock, while ordinarily nonvoting, may, under certain conditions acquire voting privileges at least for some purposes, and that it was not intended that an affiliation should be dissolved upon such occurrences. Among the provisions mentioned are those which afford voting power to preferred stock upon such questions as consolidations or reorganizations, increase or decrease of authorized capital, change of corporate name, termination or extension of corporate life, etc. Without deciding the effect of such provision upon affiliation, we may point out that the voting power they confer upon preferred stock is in general strictly limited. The voting *1211 power acquired by the preferred stock involved in this proceeding was quite different. By that power preferred stock acquired "an equal right with the common stock, * * * to participate in the election of directors and control of said corporation." *1758 Petitioner cites , and , both involving the Revenue Act of 1918, as supporting in effect the principle it contends for herein. In the Shillito case, supra, the preferred stock involved had, by its terms, full voting power with the common stock. Sixty-six per cent of all classes of stock was owned by the same interests and the remaining 34 per cent, all preferred stock, was owned by business associates of the president of both of the companies involved, and was voted by proxies given a committee of which he was chairman. The court, affirming the decision of the ), held that upon the circumstances no "adverse interest could be perceived in the ownership of outside preferred stock." We do not regard this, nor any other pronouncement in the Shillito decision, as holding that preferred stock with full voting power should not be considered in determining affiliation. Indeed, in that case the court did consider the preferred stock. In the Schlafly case, supra, the Circuit Court*1759 affirmed an order of the District Court allowing the claim of the United States for income and profits taxes from the estate of the Temtor Corn and Fruit Products Company, bankrupt. The trustee of the bankrupt, resisting the claim of the United States, was contesting a determination of the Commissioner of Internal Revenue, holding the bankrupt affiliated with the Best-Clymer Company for the year 1920. It appeared that the Temtor Company owned all the common stock of the Best-Clymer Company but that the preferred stock was held by a number of persons who apparently had no other connection with the alleged affiliates. The trustee contended that by reason of such "outside" ownership of the preferred stock, and because that stock would acquire voting rights if cumulative dividends upon it remained unpaid for two years, it should be considered in determining whether or not "substantially all" of the stock of the Best-Clymer Company was owned by the bankrupt. The Circuit Court held that affiliation depended upon ownership or control of the voting stock and that it existed in that case although 3,000 persons held preferred stock of the Best-Clymer Company. The real point for our purpose*1760 is, however, that there was no default in preferred dividends during the taxable period involved, and, therefore, the preferred stock never acquired its contingent voting rights. See referee's opinion and District Court decision, . *1212 We have discussed the Shillito and Schlafly cases, supra, because petitioner appears to rely upon them, but in our opinion neither is in point and, considering the differences in the 1918 and 1926 Revenue Acts, neither could be determinative of the issue here presented. A case closer to our problem but equally as unauthoritative as those last mentioned, was decided by the Board in a prior appeal of this petitioner relating to the year 1921. . The fact that the preferred stock herein involved had acquired voting rights by reason of dividend default prior to the taxable year was instrumental in our reaching a decision in that proceeding that the petitioner and the Building Company were affiliated. The parties there took positions opposite to those maintained herein, the petitioner contending that the effect of the voting preferred stock be considered, *1761 and the respondent opposing that view. Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624922/ | ROBERT V. RAFTER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRafter v. CommissionerDocket No. 23200-89United States Tax CourtT.C. Memo 1991-349; 1991 Tax Ct. Memo LEXIS 393; 62 T.C.M. (CCH) 272; T.C.M. (RIA) 91349; July 30, 1991, Filed *393 Decision will be entered for the respondent. Robert V. Rafter, pro se. Steven M. Diamond, for the respondent. GUSSIS, Special Trial Judge. GUSSISMEMORANDUM OPINION This case was assigned pursuant to the provisions of section 7443A(b) of the Internal Revenue Code. 1Respondent determined a deficiency in petitioner's 1986 Federal income tax in the amount of $ 396. The issue to be decided is whether petitioner is required to include in gross income a portion ($ 3,107) of the social security benefits received by him during 1986. Ancillary to that issue, we must decide whether, under the facts described below, petitioner may elect to change his filing status for 1986 from married filing separate to married filing jointly. Some of the facts have been stipulated and they are so found. Petitioner*394 resided in Rye, New York, when the petition herein was filed. Petitioner is an attorney in the State of New York. During the 1986 tax year, petitioner received $ 6,214 in social security benefits. This amount was reported as paid to petitioner on a Form SSA-1099, which was received by petitioner in February, 1987, approximately two months before the April 15 due date of his tax return. Petitioner mailed in his 1986 tax return early on January 30, 1987, claiming the filing status of married filing separate. Under section 6501(b)(1), the return is treated as filed as of April 15, 1987. Petitioner's spouse also filed her 1986 return as married filing separate. Petitioner and his wife resided together during the 1986 tax year. Petitioner did not include any portion of the social security benefits received in 1986 in his gross income. Petitioner cites as a reason for the omission that he had not yet received the Form SSA-1099 at the time of filing and was thus unable to accurately report the amounts he received. However, at no time subsequent to receiving the Form SSA-1099 and prior to the petition in this case (some two and one-half years later) did petitioner file an amended*395 return reporting the receipt of any portion of the social security benefits he received in 1986. On June 28, 1989, respondent issued a notice of deficiency to petitioner. Petitioner timely filed a petition with this Court on September 21, 1989. Thereafter, on April 9, 1990, petitioner filed an amended return with the Internal Revenue Service attempting to change his filing status for 1986 from married filing separate to married filing jointly. Petitioner's spouse did not sign the amended return. If petitioner is entitled to change his filing status to married filing jointly, no part of the social security benefits he received will be taxable. Petitioner bears the burden of proof. Rule 142(a). Section 6013(b)(1) provides that if an individual has filed a separate return for a taxable year for which a joint return could have been made by him and his spouse and the time prescribed by law for filing the return for such taxable year has expired, such individual and his spouse may nevertheless make a joint return for such taxable year. However, this election is expressly limited by section 6013(b)(2)(C), which provides that no election to change the filing status to married filing*396 jointly may be made "after there has been mailed to either spouse, with respect to such taxable year, a notice of deficiency under section 6212, if the spouse, as to such notice, files a petition with the Tax Court within the time prescribed in section 6213." The notice of deficiency in this case was dated June 28, 1989, and petitioner timely filed a petition in this Court on September 21, 1989. Some seven months after filing his petition in this Court, petitioner filed an amended return Form 1040X with respondent, attempting to change his filing status. Under the clear language of section 6013(b)(2)(C), petitioner is precluded from doing so. We note that respondent, in an attachment to the statutory notice of deficiency, informed petitioner of his right to file an amended return changing his filing status to that of married filing jointly. Petitioner thus had an opportunity to make a timely change in his filing status. Petitioner, however, chose to file a petition with the Court without previously filing the suggested amended return for 1986. Consequently, under the express provisions of the statute, he is now precluded from changing his filing status for 1986. We fail to*397 see how petitioner's unexplained failure to make a timely election to change his filing status can somehow be attributed to respondent. On these facts, petitioner's contention that a denial of his belated election to change his filing status violates constitutional principles is without merit. Moreover, it appears that the amended return filed April 9, 1990, was not signed by petitioner's spouse. To be valid, a joint return must be signed by both parties. Sec. 1.6013-1(a)(2), Income Tax Regs. Whether a return, in the absence of the signatures of both spouses, constitutes a joint return is a factual issue based upon the intention of the parties. See Hurd v. Commissioner, T.C. Memo 1975-6">T.C. Memo 1975-6. The record is devoid of any persuasive evidence to show that petitioner's spouse intended the amended return in question to be a joint return. Consequently, the April 9, 1990, amended return filed by petitioner would not, in any event, constitute an effective election to change his filing status to married filing jointly. Petitioner's reliance on Millsap v. Commissioner, 91 T.C. 926">91 T.C. 926 (1988), is misplaced. In the Millsap case, the taxpayer failed*398 to file individual income tax returns for several years and, accordingly, respondent prepared substitute returns indicating the taxpayer's filing status as married filing separate. Respondent issued a notice of deficiency, and the taxpayer thereupon petitioned this Court. Thereafter, the taxpayer and his spouse filed tax returns for the years at issue attempting to elect joint status. We concluded that the returns utilized by respondent were substitute returns within the meaning of section 6020(b) and did not constitute prior returns filed by the taxpayer which would, under the provisions of section 6013(b)(2)(C), preclude taxpayer from subsequently electing to file joint returns. Here, petitioner did in fact file a return for 1986 and hence, at the very onset, the rationale of the Millsap case cannot apply here to permit a subsequent election, after the issuance of the notice of deficiency and the filing of the petition, to elect joint status. Petitioner states that without the Form SSA-1099 he was unable to report his 1986 social security benefits on his 1986 return. Petitioner's contention that, under such circumstances, his omission of social security benefits from his*399 return is somehow tantamount to a failure to file a return as to that particular item is singularly unpersuasive and we reject it. Finally, petitioner's passing reference to material in an Internal Revenue Service publication concerning the availability of a special election where benefits received during the taxable year are for prior years was not pursued at trial. There is nothing in the record to establish that the special election is applicable under the facts of this case. Section 86(a) provides that gross income for the taxable year of a taxpayer described in subsection (b) includes social security benefits in an amount equal to the lesser of: (1) one-half of the social security benefits received during the taxable year, or (2) one-half of the excess described in subsection (b)(1).Section 86(b) provides that subsection (a) applies to a taxpayer if: (A) the sum of -- (i) the modified adjusted gross income of the taxpayer for the taxable year, plus (ii) one-half of the social security benefits received during the taxable year, exceeds (B) the base amount.The term base amount, as relevant here, is defined in subsection 86(c) as $ 32,000 in the*400 case of a joint return and zero in the case of a taxpayer who is married at the close of the year, who does not live apart from his spouse at all times during the taxable year and who does not file a joint return for the taxable year. Here, petitioner's modified adjusted gross income on his 1986 return ($ 4,580.94) plus one-half of his 1986 social security benefits ($ 3,107) equal a total of $ 7,687.94. Since petitioner filed his 1986 return indicating a filing status of married filing separate, his base amount is zero. Sec. 86(c)(3). Consequently, in accordance with the provisions of section 86(a)(1), one-half of the social security benefits received by petitioner in 1986, or $ 3,107, is includable in gross income for the year 1986. Respondent is sustained. Decision will be entered for the respondent.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624925/ | Appeal of G. C. KRACK.Krack v. CommissionerDocket No. 1407.United States Board of Tax Appeals1 B.T.A. 1119; 1925 BTA LEXIS 2655; May 7, 1925, decided Submitted March 30, 1925. *2655 Under the facts stated, held, that the worthlessness of a debt was not ascertained in the taxable years in question. H. A. Mihills, C.P.A., for the taxpayer. Benjamin H. Saunders, Esq., for the Commissioner. GREEN *1119 Before GRAUPNER, LANSDON, and GREEN. This appeal involves income taxes for the years 1917 to 1920, inclusive. The Commissioner disallowed as deductions certain losses and bad debts set up in the taxpayer's return and determined deficiency totaling $10,323.89. FINDINGS OF FACT. The taxpayer is a stockholder in and the president of the Erie business of this company is the publication of a daily and weekly newspaper in the German language. The company was operated at a profit prior to 1917. Immediately after the United States declared war on Germany, the subscriptions and advertising fell off and operating expenses increased with the result that the company has operated at a loss ever since. The taxpayer, beginning in 1917 and continuing through the years in question, advanced to the company funds sufficient to enable it to continue the publication of the newspaper. The advances were in each year made periodically, *2656 and ordinarily monthly, to cover pay rolls and operating expense. Occasionally, larger amounts would be advanced to cover repairs or the purchase of machinery. In 1917 they totaled $10,827.37; in 1918, $6,875; in 1919, $10,820.11, and in 1920, $17,111.30. The company has been insolvent since 1917. The taxpayer alleged "that these advances were worthless at the time advanced." He testified that he never, at any time after the early part of 1917, expected that the company would be able to repay him. The advances were made from patriotic motives and with the hope that the company might be self-sustaining after the war. *1120 Certain of the stockholders were dissatisfied with the policy and management of the company. The taxpayer bought the stock of disgruntled stockholders when, according to his own testimony, he knew it to be worthless. The record is not clear as to the price paid for the stock, except to indicate that the price ranged from $50 to $100 per share. The amounts thus expended were: In 1917, $489.92; in 1919, $2,127.90; and in 1920, $200. The company is still publishing the paper and hopes to show a profit for this year. DECISION. The determination*2657 of the Commissioner is approved. OPINION. GREEN: We are unable to agree with the taxpayer in his contention that the advances should be charged off as bad debts. To be deductible in the years in question the debts must meet the requirements of section 214(a)(7) of the Revenue Act of 1918, which is, "Debts ascertained to be worthless and charged off within the taxable year." In any year there were assets sufficient to have satisfied a part of the taxpayer's claim, and this fact was known to him at all times. The disinclination of a creditor to force payment does not make a debt "worthless," as that term is used in the Act. The taxpayer's contention that he has sustained a loss as the result of purchasing the stock is answered by saying that he still holds the stock of a going concern which hopes to show a profit for 1925. The transaction is not closed. The loss, if any, has not been realized. The taxpayer can have no deductible loss until such loss has been actually sustained. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624926/ | R. L. BLAFFER & COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.R. L. Blaffer & Co. v. CommissionerDocket Nos. 81007, 87762.United States Board of Tax Appeals37 B.T.A. 851; 1938 BTA LEXIS 971; May 17, 1938, Promulgated *971 A mere holding or investment corporation held, upon the evidence, subject to the 50 percent tax of section 104, Revenue Act of 1932, notwithstanding the diminution in market value of its assets. Walter E. Barton, Esq., and J. L. Block, C.P.A., for the petitioner. DeWitt M. Evans, Esq., for the respondent. STERNHAGEN *851 The Commissioner determined deficiencies of $15,734.03, $11,866.06, and $12,649.78 in petitioner's income tax for the fiscal years ending September 30, 1932, 1933, and 1934, respectively, by computing income and applying the rate of tax prescribed by section 104(a) of the Revenue Act of 1932. Petitioner charges error in the application *852 of this section, denying that it was formed, used, or availed of to prevent the imposition of surtax on its shareholders. In an amended answer, the Commissioner prays the addition to income for the fiscal years ending in 1933 and 1934 of gains from the sales of securities by petitioner to its shareholders, but only in the event that section 104(a) is held applicable. FINDINGS OF FACT. The petitioner, a Texas corporation with principal office at Houston, Texas, was*972 organized on September 18, 1929, by %.r. l. b/laffer: * * * to subscribe for, purchase, invest in, hold, own, assign, pledge, and otherwise deal in and dispose of shares of capital stocks, bonds, mortgages, debentures, notes, warrants, rights, and other securities or obligations, contracts and evidences of indebtedness of foreign or domestic companies as permitted under the laws of Texas, and to have and to perform all powers necessary and incidental to the conduct of such a business. Blaffer organized petitioner on the recommendation of W. E. Barton, his attorney, and J. L. Block, a certified public accountant and tax consultant, who recommended the step as a means of facilitating stock trading. Blaffer also expected that his son, then in college, would take an active interest in petitioner's business. The son was later made a director and assistant secretary. Two years before petitioner was formed, Barton and Block had made a survey of Blaffer's properties, consisting chiefly of securities, and, after an extensive consideration of the tax laws, had advised that a transfer of all the property to a corporation would decrease prospective inheritance taxes and facilitate the*973 estate's administration. They did not think that it would effect any substantial saving in income taxes, partly because "* * * it would be necessary * * * for the corporation to distribute a portion of its earnings, * * *" to avoid the 50 percent tax imposed on corporate income if gains and profits were accumulated to relieve shareholders of surtaxes. They also recommended that portions of the stock of the proposed corporation be transferred to trusts for the benefit of the several members of Blaffer's family. Blaffer's properties then had a value of about five million dollars. When petitioner was formed, the community property of Blaffer and his wife had a value of thirteen and a quarter million dollars, of which thirteen million dollars was the value of stocks and bonds of eighty corporations organized in eighteen different states and Canada. Their liabilities were three million dollars. Petitioner's capital of $250,000 was represented by 2,500 shares of a par value of $100 each. Of these shares, 1,275 were issued to Blaffer, 1,222 to his wife, and one qualifying share each to three other *853 individuals, in consideration of Blaffer's transfer to petitioner of*974 stocks and bonds issued by corporations of 12 states. The fair market value of these stocks and bonds was $1,540,158.80. They had cost Blaffer $968,961.75, and when transferred to petitioner they were held as collateral by brokerage firms for Blaffer's indebtedness of $968,961.75, which petitioner assumed. On petitioner's opening balance sheet, the transferred securities were listed as assets at a value of $1,218,961.75, which amount comprised their cost to Blaffer and the par value of the capital stock. The excess of fair market value over the book value, $321,197.05, was not entered on the books. Petitioner's business and activities consisted of buying, selling, and investing in stocks and bonds. Petitioner kept its books and filed its income tax returns on the basis of a fiscal year ending September 30. For the fiscal years 1930 to 1934, inclusive, its books indicate the following receipts, losses, and disbursements: DividendsInterest receivedTrading profitsTotal1930$64,332.32$3,530.43$100,227.85$168,090.60193160,500.002,457.967,714.5070,672.46193240,415.902,032.50130,422.91172,871.31193338,972.532,706.5032,341.0874,020.11193452,234.514,409.7132,736.4989,380.71*975 Interest paidTrading lossesMinor expensesTotal1930$109,856.59$48,986.09$2,057.38$160,900.06193164,147.002,185.00738.0567,070.05193262,601.6375,141.92106.91137,850.46193338,953.9810,487.53837.8950,279.40193438,371.40Nil1,212.3339,583.73Net1930$7,190.5419313,602.41193235,020.85193323,740.71193449,796.98Petitioner never declared or paid a dividend. Its shareholders did not include in their reported gross income their distributive shares of petitioner's net income for any year. Earned surplus based upon petitioner's books was as follows: 1930$6,900.54193110,502.95193258,003.87193371,843.601934123,552.28*854 Comparative balance sheets, as of the end of the fiscal years, taken from petitioner's books, indicate: AssetsLiabilitiesNet worth1930$2,616,293.94$2,356,733.17$259,560.7719313,133,945.602,404,146.54263,163.1819322,554,963.711,761,598.73793,364.9819332,752,558.471,945,353.76807,204.7119343,230,107.451,923,694.061,306,413.39The assets consisted*976 almost entirely of stocks and bonds, all of which were held by brokers as collateral, and of cash of $342.51 in 1932, $23,950.09 in 1933, and $3,966.84 in 1934. The liabilities were practically all to brokers; $7,035.25 was owed to Blaffer in 1932 and 1933. The net worth comprised a contributed capital surplus of $485,361.11 in 1932 and 1933, and of $932,861.11 in 1934. Shortly after petitioner's organization, sharp drops in the stock market greatly reduced the market value of its assets, and on December 10, 1931, Blaffer and his wife transferred to it, as paid-in surplus, 13,563 shares of Humble Oil & Refining Co. stock having a value of $637,461. Petitioner sold the stock at that price on December 26, following, and applied the proceeds to its brokerage accounts. The cost of these shares to Blaffer was $486,686.65. Again, on December 26, 1933, Blaffer and his wife made a further contribution to paid-in surplus of 10,000 shares of Standard Oil Co. of New Jersey having a value of $447,500. This stock was used as collateral for petitioner's brokerage accounts. As a result of the great decline in market values, petitioner's securities were worth much less at the end of its*977 fiscal years than the figure at which they were carried on its books; its total assets' value was in fact less than its liabilities, as shown by the table below: Book valueMarket valueLiabilities1931$2,667,309.72$906,127.54$2,404,146.5419322,554,963.71801,841.381,761,598.7319332,752,558.471,453,712.821,945,353.7619343,230,107.451,800,075.711,923,694.06Petitioner's brokerage accounts were personally guaranteed by Blaffer, and all of its securities were kept on deposit with brokers as collateral for the accounts. Blaffer was petitioner's president and sole directing head. In October 1929 he and his wife sold securities through a broker for $627,542.03, and on the same day had petitioner purchase through brokers an equal amount of the same kind. In November 1929 he and his wife sold to petitioner stock and bonds for $260,807.01, receiving petitioner's check in payment. On account of these sales they claimed a loss deduction of $417,752.11 on their income tax *855 return for 1929, on advice of Block. The sales were made for this purpose and the deduction was allowed. In 1932 and 1933 Blaffer and his wife made*978 further sales of securities to petitioner, claiming loss deductions of about $338,000 and $30,000 in their income tax returns for those respective years. These deductions were allowed after review by this Board. In 1933 and 1934 petitioner made sales of stock to the Blaffers, on which it reported gains of $19,687.87 and $16,075, respectively. The Commissioner refused to recognize the sales and eliminated the gains from petitioner's income. In their personal income tax returns, Blaffer and his wife reported gains or losses from security sales, dividends received, and net income, as follows: Gains or lossesDividendsNet income1932-$27,222.91$189,301.26$53,382.801933-23,475.77132,407.5590,457.681934718.34145,299.45149,082.07Blaffer has been actively connected with the Humble Oil & Refining Co., as an officer, director, and shareholder, since its organization in 1917. In 1929 he owned between sixty and seventy thousand shares, of which he transferred seven hundred to petitioner in 1929. He and his wife each maintained individual accounts with stock brokers. Petitioner was a mere holding or investment company. It was formed*979 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. OPINION. STERNHAGEN: The principal question is whether, in the fiscal years ended September 30, 1932, 1933, and 1934, the petitioner was "formed or availed of for the purpose of preventing the imposition of the surtax upon its stockholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed" and thus subject to the 50 percent tax provided in section 104, Revenue Act of 1932. The Commissioner determined that it was, and the taxpayer in contesting the determination has undertaken to prove that it was not. In its brief, petitioner says (p. 26): It may be admitted that the petitioner is a holding or investment company and that the prima facie presumption raised by section 104(b) 1 applies. *980 *856 This admission is supported by Blaffer's testimony that he had petitioner do nothing but invest in and sell stocks, that it was a trading company, and that the only way he expected it to make money was through trading. Consideration of the issue must therefore start with the postulate that the corporation was formed or availed of for the condemned purpose, and must continue with the inquiry whether the evidence proves affirmatively that it was not. Drastic as the tax may be, the statute clearly expresses the legislative intent to apply it to a mere holding or investment corporation unless the corporation succeeds in establishing its purpose to be wholly other than that of preventing surtax upon its shareholders - not only that there was another purpose, but that there was a complete absence of the disapproved purpose. Obviously a holding or investment corporation may be formed or availed of for several purposes, but it can not escape this tax unless it proves that it had no purpose to enable the escape of surtax. It is to this complete lack of the condemned purpose that its evidence must be directed, and if it does not fairly prove an absence of such purpose it must*981 fail, regardless of what other purposes it may prove. This is, in our opinion, the effect of subdivision (b), and the evidence must be examined in its entirety to determine whether it disproves the statutory presumption and the Commissioner's determination. The organization and existence of the corporation and the transfer to it by the Blaffers of dividend paying stocks had the effect of relieving them of the surtaxes which would have been attributable to such dividends had they continued to come to the Blaffers as owners of the stocks. The statute, however, does not operate merely because of such actual effect; it operates if such effect was the purpose. ; affd., ; certiorari denied, ; . In the absence of the condemned purpose, the effect alone is no foundation for the tax. This is not to say that the effect is of no significance, for it may, and perhaps often does, indicate the probability of a purpose to induce it. In ordinary life it is not unreasonable to infer that the effect of a voluntary act is among the*982 purposes of the actor. So long as the inference be not arbitrary and evidence of the contrary be entertained and fairly weighed, it may be regarded as reasonable. And in determining the purpose, the actor's categorical statement may be of less weight than the facts and circumstances which affect it. To be skeptical of the weight to be accorded an interested witness' statement in view of other evidence is not the same as wholly to reject the statement as if it were dishonest. The petitioner was wholly owned by Blaffer and his wife. It was organized when they were actively trading in the stock market and *857 after they had accumulated a fortune of over thirteen million dollars, represented by securities of many corporations in many states. It is said that the reasons for its formation grew out of the survey made by Barton and Block in 1927. It was to facilitate the administration of Blaffer's estate at death, because the transfer of various securities was a cumbersome process. Yet only a small portion of the securities was transferred to the corporation, and those retained were still various and spread over six states. Such a purpose is not inconsistent with a further*983 purpose to effect a saving in surtaxes. Barton and Block advised that such a corporation must make distributions to avoid this very tax. Thus Blaffer was fully advised of the use to which such a corporation could be put, and he frankly admits that he knew that a failure of the corporation to distribute would invite the tax. But he says that in the tax years he could not properly permit the corporation to distribute because it was insolvent. This is the principal point upon which petitioner's argument is based. The insolvency is predicated not on petitioner's books, for they showed a steadily increasing earned surplus; they showed gross receipts each year in excess of outlay and a resulting annual net, and an annually expanding net worth. The insolvency is predicated on the comparison each year after the market collapse of the market value of its assets, consisting wholly of securities, and the amount of its liabilities, consisting wholly of its brokerage accounts guaranteed by himself. This argument of insolvency would circumvent the clear intendment of the statute. The Board has already held that when considering a holding or investment company the diminution in market value*984 of its securities may not be offset against income derived through gains and profits, interest, and dividends, so as to establish that the corporation was not availed of to save the shareholders from surtax. (on review C.C.A., 6th Cir.); (on review C.C.A., 2d Cir.). As to a business corporation actually engaged in commercial operations, the effect of market values upon its surplus has been recognized as more substantial and the argument more engaging, In the present case the point has little force when the alleged insolvency is analyzed with regard for its substance. Blaffer and his wife were the sole shareholders. The brokers were the sole creditors (except for $7,000 owed to Blaffer in 1932 and 1933), and these creditors held the securities and Blaffer's personal guaranty. No one else was to the slightest extent interested in the affairs of the corporation. Insolvency was a mathematical abstraction, for the creditors were fully secured by Blaffer's individual guaranty and Blaffer had ample assets to assure*985 *858 it. Even article 1347 of the Texas Civil Statutes, 2 which petitioner cites, would go no farther than to make the directors jointly and severally liable for the corporation's debts, to the extent of the dividend; and such liability Blaffer had already assumed by his guaranty. To say, under these circumstances, that the large trading profits, dividends, and interest are not indicative of the purpose which underlies the tax is to give mere words and doctrine a force greater than the truth which lies behind them. Ordinarily, for purposes of income tax, the rise and fall in value of retained assets is not a factor for consideration, 3 and if the market value of petitioner's securities had risen, the rise would not have had significance either in measuring its income or discovering the applicability of section 104. In Blaffer's own hands the dividends, interest, and gains from trading would have been taxable, irrespective of the fall in the market value of securities he did not sell, and hence the purpose to enable him to escape surtax is not disproved by evidence of market value of securities held by his corporate instrument. *986 ;;; and , are illustrations of the extent to which the argument would operate to frustrate the statutory intent. It may not be forgotten that by section 104(d) it was open to the shareholders to treat their distributive shares of the corporation's income as constructively received by them and within their taxable income even though it was deemed wiser for any reason that there should be no actual distribution. *987 The petitioner argues that since the Blaffers transferred to it only a comparatively small portion of their securities, it may not be believed that their purpose or that of the corporation was to save surtax, for the retention of the larger portion is inconsistent with such a purpose. There is no explanation to be found in the evidence for the retention. It does not, however, overcome the prima facie purpose attaching to the corporation within the sphere and to the extent of its operations. The statute operates upon the corporation and the tax is measured by its income. The fact that the creators and shareholders limited its operations and withheld a majority of *859 their assets still leaves the inquiry open as to the application of the statute to the corporation such as it was. Neither the desire of Blaffer to provide an occupation for his minor son then in college nor to facilitate the administration of his estate after death is inconsistent with a purpose to escape surtaxes, It is said that the condemned purpose is disproved by the evidence that the Blaffers not only transferred stocks yielding taxable dividends, but also rid*988 themselves of liabilities carrying deductible interest, the relinquished deductions being greater than the gross income of the dividends. For example, it appears that for the fiscal year 1930, the interest paid by the corporation was $109,856.59, while the dividends received amounted to $64,332.32, having the effect, it is said, of depriving the shareholders of a substantial factor of tax reduction. This comparison is regarded as a demonstration that there was no purpose to effect a saving of surtaxes. Again the argument falls short of the mark. The failure of the corporation to distribute to its shareholders is not considered solely with regard for the income which it may derive through corporate dividends, but with regard for its gains and profits from all sources. The corporation had trading profits of $100,227.85, which was $51,241.76 greater than its trading losses, and each year the profits exceeded the losses. This performance was the very expectation of Blaffer when he formed the corporation and transferred both the securities and the interest bearing liabilities. He said that he expected it to make money through trading. The purpose to renounce an advantageous interest*989 deduction thus loses force, especially since in each year the net result to the corporation was a taxable net income the distribution of which would have imposed surtax upon its shareholders. The arguments of petitioner to overcome the prima facie effect of the Commissioner's determination have been considered separately and found inadequate. But it should not be thought that the decision is based alone on a piecemeal examination of the logical effect of each circumstance disclosed by the evidence. Dealing with a holding or investment corporation, the inquiry is a broad one of substance; that is, whether all the evidence taken together leads reasonably to the conclusion that the corporation was not within the description of the statute. Congress has said that holding and investment corporations are vulnerable. The considerations applicable to them are not like those applicable to a manufacturing or merchandising corporation. Arguments which might be moving as to the latter, because of the nature and exigencies of its business, will have no substance when made by a holding or investment company of a single individual. *860 The 50 percent tax was properly applied. *990 In determining the deficiency, the Commissioner excluded from petitioner's gross income gains from sales to Blaffer of $19,687.87 in 1933 and $16,075 in 1934, which petitioner had included in its returns. This exclusion by the Commissioner was because he thought it consistent with a contemporaneous disallowance by him of deductions taken by Blaffer for losses in sales by him to the corporation. In separate proceedings the Board has held such losses deductible since recognition of the transactions may not be denied. There is no dispute about the facts. The amounts should be restored to petitioner's income. Reviewed by the Board. Judgment will be entered under Rule 50.HILL HILL, dissenting: The majority opinion is predicated upon the findings of fact that "petitioner was a mere holding or investment company", and that "it was 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." It is said that petitioner has the burden of proving a complete lack of the condemned purpose, and if it does not do so it*991 must fail, regardless of what other purposes it may prove. The evidence submitted is, in my opinion, amply sufficient to meet the test thus laid down. That petitioner was not "a mere holding or investment company" is clearly established by the record. A "mere" holding or investment company is obviously one whose sole function is to hold property or make investments. Petitioner may not fairly be placed in such category. It was also a business or trading corporation, actively engaged during the taxable years in carrying on business operations for profit. During the year 1932 petitioner derived net profit from trading in securities in the amount of $55,280.99. Its total net profit for the year was $35,020.85. Thus, except for the profit realized from its business operations it would have had no income for that year subject to tax under section 104, but would have had a substantial loss representing interest paid and other expenses. For the year 1933 petitioner's total net profits amounted to $23,740.71, which included $21,853.55 net gain from trading operations. For the year 1934 petitioner derived total net profits of $49,796.98, including net gain from trading in the amount*992 of $31,059.40. So far as taxable income is concerned, these facts, it seems to me, indicate that during the years before us petitioner's function as a holding or investment company was negligible and only incidental to its business operations, *861 rather than exclusive. The admission of its counsel that petitioner is a holding or investment company, and that the prima facie presumption raised by section 104(b) applies, to which reference is made in the majority opinion, appears to be a legal conclusion without support in the record. However, if it may be said that such presumption ever attached, it is sufficiently rebutted by the evidence. The next question arising for consideration is whether petitioner was formed, or availed of in the taxable years, for the purpose of enabling its shareholders to escape surtax through the medium of permitting its gains and profits to accumulate instead of being divided or distributed. As suggested by respondent in his brief, it may well be that one of the primary purposes of organizing the petitioner corporation was to permit its shareholders to realize large losses deductible from their individual incomes through sales by them to*993 it of securities which had depreciated greatly in value below their original cost bases. But such a purpose, if it existed, is not within the ambit of section 104, and we are not here concerned with that phase of the case. The record contains no evidence which fairly indicates, in my opinion, that petitioner was either formed or availed of for the prohibited purpose, but on the other hand discloses affirmative and uncontradicted proof to the contrary. blaffer testified in effect that he was advised by both his attorney and accountant that it would be necessary for the corporation to declare dividends whenever earnings were available, or subject itself to the penalty tax of section 104, and that in forming the corporation he had no purpose whatever of attempting to escape surtax through accumulation of the company's gains and profits. He further testified at length as to the motives which actuated him in organizing the corporation. A purpose to escape surtax through accumulation of gains and profits was wholly absent. The purposes as stated by Blaffer were both reasonable and sufficient to explain and justify his actions. We may not, therefore, disregard his testimony merely*994 because he is an interested party; particularly so, when such testimony is supported by all the surrounding facts and circumstances. . However, if it were true that petitioner was originally formed for the purpose stated in the statute, or as the majority opinion holds, the evidence is insufficient to overcome the prima facie presumption of the statute and respondent's determination, still petitioner would not be subject to the penalty tax of section 104, because it had no accumulation of gains and profits in the taxable years which could lawfully be divided or distributed. For the same reason it can not be said that it was "availed of" for the prohibited purpose. *862 This brings us to the principal and most important question presented in this case, namely, whether a corporation whose capital has been lost or substantially impaired through depreciation in value of its capital assets to the extent of rendering it insolvent can accumulate gains and profits distributable as dividends prior to restoration of such impairment, and, if not, whether an insolvent corporation in such circumstances is nevertheless subject*995 to the tax imposed by section 104. At the close of the fiscal year 1932 petitioner owned assets of the fair market value of $801,841.38, and its total liabilities, other than capital, amounted to $1,761,598.73. Its current liabilities then exceeded the fair market value of its assets in the amount of $959,757.35. It operated largely on money borrowed from brokers, and in 1932 of its total indebtedness it owed brokers the sum of $1,687,563.48. On the same basis, petitioner's current liabilities exceeded its assets in 1933 and 1934 by the amounts of $491,640.94 and $123,618.35, respectively. All the stocks and bonds owned by petitioner, which constituted its principal assets, were hypothecated with brokers as collateral security for loans, in addition to which petitioner's accounts with the brokers were personally guaranteed by its stockholders. Clearly petitioner was insolvent throughout all the taxable years. It was insolvent in 1932, 1933, and 1934 to the extent of $959,757.35, $491,640.94, and $123,618.35, respectively, on the basis of current liabilities alone, in addition to capital stock liability. The impairment of its capital stock for each of those years was far*996 in excess of the respective amounts above set forth. The value of its assets in each of the taxable years was insufficient to pay even the indebtedness owing to the brokers, and obviously it could not have continued to operate except by reason of the guaranteeing of its accounts by its stockholders. In these circumstances petitioner could not lawfully have declared and paid a dividend out of current earnings. A corporation can not declare and pay a dividend when it is insolvent or when the payment thereof would render it insolvent. ; ; ; ; ; . A corporation must maintain its capital stock at its original value before any dividends may be lawfully paid. ; ; ; ; ; *997 ; ; ; ; ; . With the exception of dividends in liquidation, a corporation can declare and pay dividends only out of net profits, or when such payment *863 does not impair its capital stock. ; Main v. Mills, 6 Bliss, 98; ; ; . Whether a corporation is solvent and has surplus or net profits out of which a dividend may be paid must be determined on the basis of the then actual cash or fair market value of its assets. ;; *998 ; ; ;; . In the case last cited, the court said: Manifestly, for the purpose of determining the amount to be declared and paid as a dividend, it is necessary that the true value of the assets, in cash, and not the mere book value, should be ascertained, for no dividend can be lawfully declared and paid except from the surplus or net profits of the business. * * * The terms "net profits" or "surplus profits" have been defined as what remains after deducting from the present value of the assets of a corporation the amount of all the liabilities including the capital stock. [Italics supplied.] In , the Supreme Court defined "surplus" or "net profits" of a corporation as the difference between the total present value of its assets, after deducting losses and liabilities, and the amount of its capital stock. See also *999 ;;; ; affd., ; ; ;; . In , the Court of Appeals of Georgia held that the difference between the present value of all the corporate assets and the amount of all losses, expenses, other charges, and liabilities, including the capital stock, constitutes net earnings for the purpose of dividends, and in its opinion further stated: * * * it is not possible for an insolvent corporation to lawfully declare and distribute a dividend, for the very simple reason that it can not have any surplus or net earnings as long as it is unable to pay its indebtedness. 5 Thompson on Corporations, § 5311. As dividends can only be declared and paid out of profits, it is clear that they can not be declared unless there are profits; and even if there are profits, still they*1000 can not be declared and paid where the corporation is clearly insolvent. 5 Thompson on Corporations, § 5383. See also , where it is held by this court that no declaration of a dividend is lawful in a condition of insolvency or impairment of capital stock; for any profits that may be made must first be applied to the payment of the debts of the corporation and to the restoration of the capital stock. In , this Board held that, in determining whether accumulations of gains and profits are beyond the *864 reasonable needs of a business, it is erroneous to compute a surplus based on cost of assets which are useful to the business only to the extent of their lower market value. If petitioner in the instant case had distributed its gains and profits in the taxable years, such distribution would not only have been unlawful and in violation of generally recognized principles of corporation law, above referred to, but would have been in direct violation of Texas law. See art. 1347, vol. 3, Vernon's Annotated Texas Statutes (Civil). In the circumstances shown, *1001 the gains and profits of the taxable years were certainly not beyond the reasonable needs of petitioner's business, and I think it can not fairly be said under the facts that petitioner was "availed of" for the purpose of preventing the imposition of tax upon its shareholders through the medium prescribed by the statute. I think it is too plain for argument that petitioner had no accumulation of "gains and profits" in the taxable years which could be lawfully divided or distributed. Coincidental with receipt, its net profits became capital, and such process must continue until impairment of its paid-in capital has been restored. Although a distribution (except in liquidation) could not lawfully be made, is an insolvent corporation in such situation nevertheless subject to the penalty tax of section 104? The majority opinion points out "that by section 104(d) it was open to the shareholders to treat their distributive shares of the corporation's income as constructively received by them and within their taxable income even though it was deemed wiser for any reason that there should be no actual distribution." This view, it seems to me, places an unreasonable and strained construction*1002 upon the statute. The provision referred to has no legitimate application here. Whenever a corporation has gains and profits which may be lawfully distributed as dividends, and the stockholders prefer for any reason that no actual distribution should be made, they may under the statute include their distributive shares in their own taxable income and thus avoid the making of a distribution and also the penalty tax of section 104. But here the corporation had no gains and profits which could be lawfully distributed. Did the Congress by the cited statute intend nevertheless to compel an unlawful distribution not of gains and profits but of capital equal to the amount of current earnings, or in the absence of a distribution to impose a penalty tax of 50 percent? To justify the imputation of such a legislative intent, we must, in my opinion, find plainer and more mandatory language than is contained in any of the subdivisions of section 104. Reference is made in the opinion of the majority to the cases of ; affd., *1003 ; *865 ; affd., ; ; and , as supporting the conclusion reached therein. In neither Saenger, Inc., nor R. & L., Inc., was there an impairment of capital, nor in either was it shown that if it had distributed its current gains and profits there would have been an invasion of capital. Nor was it shown in either of those cases that the accumulation of the gains and profits was necessary to meet the reasonable needs of the business. Those cases are, therefore, clearly distinguishable on the facts from the case here, where the petitioner corporation required the use of large amounts of capital to carry on its business operations. Rands, Inc., and , can not be distinguished on principle from the instant proceeding to the extent that they hold in effect that where a corporation's paid-in capital has been diminished in excess of its current earnings through*1004 depreciation in value of its capital assets, such corporation may nevertheless be said to have been availed of for the purpose of preventing the imposition of surtax upon its shareholders through accumulation of its gains and profits, if not distributed as dividends. Such holding, I think, is erroneous, and, therefore, should not be followed in the instant case. For the reasons above indicated, the decision in this case should be for the petitioner. SMITH agrees with this dissent. Footnotes1. SEC. 104. ACCUMULATION OF SURPLUS TO EVADE SURTAXES. * * * (b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax. ↩2. If the directors of any corporation shall knowingly declare and pay any dividend when the corporation is insolvent, or any dividend the payment of which would render it insolvent, they shall be jointly and severally liable for all the debts of the corporation then existing, and for all debts of the corporation which thereafter, during the time such directors respectively remain in office, shall be contracted. The amount for which they shall be so liable shall not exceed the amount of such dividend. If any director is absent at the time of declaring the dividend, or shall object thereto at the time such dividend is declared, and shall file his objections in writing with the secretary or other officer of the corporation having charge of the books, he shall be exempt from said liability. ↩3. Law of Federal Income Tax, Paul and Mertens, vol. 1, § 5.10, p. 112; cf. § 26.54. vol. 3, p. 290. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624927/ | Stanley G. Calafut v. Commissioner.Calafut v. CommissionerDocket No. 2092-63.United States Tax CourtT.C. Memo 1964-239; 1964 Tax Ct. Memo LEXIS 100; 23 T.C.M. (CCH) 1431; T.C.M. (RIA) 64239; September 10, 1964*100 Petitioner's 8-year-old daughter as severely afflicted with cerebral palsy from the date of her birth. The medical treatment prescribed for her was a continuing program of physical and occupational therapy. In order to receive this treatment she had to be transported to a cerebral palsy clinic in Binghamton, N. Y., for at least two treatments a week. In 1959, petitioner purchased a new Ford automobile for $2,045, primarily to provide transportation for her to and from the clinic. On his income tax return petitioner claimed as medical expense, among other things, depreciation on his 1959 Ford in the amount of $450. The Commissioner disallowed the deduction for depreciation because automobile depreciation is not an "expense paid" or "amount paid" as provided by section 213, I.R.C. 1954, which provides for allowance as deductions, medical, dental, etc., expenses. Held, the Commissioner is sustained in his disallowance of depreciation on the Ford automobile - depreciation is not an amount paid but represents a decrease in value of the automobile. Maurice S. Gordon, 37 T.C. 986">37 T.C. 986 (1962), followed. Stanley G. Calafut, pro se., 410 2nd St., Eynon, Pa. Francis J. Cantrel, for the respondent. BLACK Memorandum Findings of Fact and Opinion The Commissioner has determined a deficiency in petitioner's income tax for the year 1960 in the amount of $9.27. All of the deficiency is contested and petitioner claims an overpayment. The deficiency is due to several adjustments which the Commissioner made to the taxable income as disclosed by petitioner's income tax return (amended) for the year 1960. The only issue which now remains for our decision is whether depreciation claimed by petitioner on a Ford automobile purchased in 1959 and used to transport petitioner's dependent daughter to and*102 from a cerebral palsy clinic for treatment is an allowable medical deduction within the purview of section 213 of the 1954 Code. Petitioner contends that such depreciation deduction is allowable and has claimed it as a medical deduction on his income tax return for 1960. Respondent contends that such deduction is not allowable as a medical deduction and has disallowed it in his deficiency notice. Findings of Fact Some of the facts have been stipulated and are incorporated herein by this reference. There was some oral testimony. Petitioner is an individual whose principal residence during the year involved herein was Apalachin, N. Y. His present residence is Eynon, Pa. An original joint income tax return for the calendar year 1960, signed by petitioner and his wife, Mary Calafut, was filed with the district director of internal revenue, Syracuse, N. Y. An amended joint income tax return for said year, signed by petitioner and his wife, was filed with the district director of internal revenue, Scranton, Pa.Petitioner is married and the father of four young children, all of whom are under 10 years of age. Petitioner's daughter, Mary Rosalie, now 8 years old is a severely*103 handicapped victim of cerebral palsy, a condition from which she has suffered from the time of her birth on March 27, 1956. The medical treatment prescribed for Mary Rosalie was a continuing rehabilitation program of physical and occupational therapy to be administered in a clinic having the specialized facilities for the treatment of handicapped children. These treatments were to be continued indefinitely on a schedule of at least two treatments a week. The treatments were available only during the normal weekday working hours. From February 1960 to May 1961, inclusive, Mary Rosalie attended a cerebral palsy clinic in Binghampton, N. Y., for these treatments. During 1960, petitioner and his family lived in Apalachin, N. Y. Since it was impossible for the clinic to provide transportation to and from the clinic for Mary Rosalie, petitioner was compelled to provide this transportation. It was not possible for Mary Rosalie to come to the clinic in a bus as their schedules did not coincide with the hours during which the clinic was open for treatment. No other means of transportation other than the direct use of the family automobile was practical. Conflicting needs for the family automobile*104 arose on those days when petitioner's wife and children were scheduled to bring Mary Rosalie to the clinic for treatment since petitioner also required the use of the family automobile in his employment. This necessity of having two automobiles in petitioner's family would not exist under normal circumstances. In 1959, petitioner purchased a new Ford for $2,045, primarily to provide the necessary transportation to and from the clinic during 1960 for Mary Rosalie. The round trip distance from Apalachin, N. Y., to Binghamton, N. Y. is approximately 32 miles. During 1960, Mary Rosalie attended the clinic for treatment twice a week for a period of approximately 40 weeks. In his amended joint income tax return for the calendar year 1960 petitioner claimed, in connection with the transportation for Mary Rosalie, deductions for medical expenses for automobile insurance, automobile maintenance and repairs, and gasoline, the amounts of $60, $65, and $75, respectively, all of which expenses have been allowed by respondent. In addition, petitioner also claimed as a medical expense in connection with Mary Rosalie's transportation depreciation on the 1959 Ford in the amount of $450, which expense*105 has been disallowed by respondent. The 1959 Ford was used during 1960 for purposes other than transporting Mary Rosalie to and from the clinic for treatment. Opinion BLACK, Judge: In his determination of the deficiency in petitioner's income tax for the year 1960 the Commissioner has made several adjustments to the taxable income as disclosed by petitioner's return (amended) for the year 1960. None of these adjustments are now in issue except the depreciation on an automobile which was purchased by petitioner in 1959 primarily for the transportation of his invalid daughter for medical treatment to a cerebral palsy clinic in Binghamton. The Commissioner, in his determination of the deficiency, disallowed the deduction stating in his deficiency notice: The deductions of $450.00, representing depreciation on a Ford automobile used in transporting your daughter Mary Rosalie to and from a Cerebral Palsy Clinic * * * have been disallowed as deductions, as they do not qualify as medical expense within the meaning of Section 213 of the Internal Revenue Code of 1954. The only question we have to decide is whether or not the Commissioner is correct in his interpretation*106 of section 213 of the 1954 Code in determining that depreciation on an automobile used for the purpose named is not an allowable medical expense. There is no issue between the parties as to the cost of the automobile in 1959 or that it was purchased primarily for the purpose of transporting Mary Rosalie to and from the clinic at Binghamton. The automobile was used during the taxable year for purposes other than the transportation of Mary Rosalie to and from the clinic. However, it has been stipulated that it was purchased primarily for the purpose of transporting Mary Rosalie to and from the clinic and we shall so treat it. Therefore, the question is whether the depreciation on the Ford automobile in 1960 is deductible as a medical expense under section 213. 1*107 It, of course, goes without saying that we are sympathetic toward petitioner because of the severe illness of his daughter and we are anxious that he be allowed all the medical expenses paid by him in 1960 on account of her illness which the law allows. However, we must give effect to the law as written. Our function is to construe the law as written and not attempt to rewrite it in our opinion. It seems to us that the precise issue involved in the instant case has been decided in Maurice S. Gordon, 37 T.C. 986">37 T.C. 986 (1962), and it was decided contrary to the contention made by petitioner here. In that case, among other things, we said: The said statute, in plain and unambiguous language, limits the medical care deduction to "expenses paid" and "amounts paid." These terms imply the existence of debts incurred for medical care which are satisfied by payment in the taxable year ( Robert S. Bassett, 26 T.C. 619">26 T.C. 619) or out-of-pocket expenditures for medical care, which, since 1954, has been defined in the statute to include "transportation primarily for and essential to medical care." The statute permits the deduction for "expenses paid" and "amounts paid" and respondent*108 correctly interprets the statute as permitting deduction for "medical expenses actually paid." Sec. 1.213-1(a), Income Tax Regs. Depreciation is a "decrease in value." Massey Motors Inc. v. United States, 364 U.S. 92">364 U.S. 92, 96. Any allowance for depreciation is not an "expense paid" or "amount paid." We see no distinction as to the depreciation claimed by petitioner in the instant case on the Ford automobile which was used by him in transporting Mary Rosalie to and from the clinic, and the deduction claimed by the taxpayer on the Rambler automobile purchased and paid for by the taxpayer in Maurice S. Gordon, supra, for the transportation of his dependent son who required the services of a psychiatrist who had his office 35 miles from where the taxpayer lived. So far as we can see, Maurice S. Gordon is precisely in point. Therefore, the only issue involved herein is decided for the respondent. Decision will be entered under Rule 50. Footnotes1. SEC. 213. MEDICAL, DENTAL, ETC., EXPENCES. (a) Allowance of Deduction. - There shall be allowed as a deduction the following amounts of the expenses paid during the taxable year, an compensated for by insurance or otherwise, for medical care of the taxpayer, his spouse, or a accident (as defined in section 152): * * *(b) Definitions. - For purposes of this section. - (1) The term "medical care" means amounts paid - (A) for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body (including amounts paid for accident or health insurance), or (B) for transportation primarily for and essential to medical care referred to in subparagraph (A). * * *↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624928/ | BARNEY G. JOHNSTON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Johnston v. CommissionerDocket No. 8276-73United States Tax CourtT.C. Memo 1976-20; 1976 Tax Ct. Memo LEXIS 382; 35 T.C.M. (CCH) 74; T.C.M. (RIA) 760020; January 27, 1976, Filed Barry G. West,Reece B. Morrel,W. Kirk Clausing and James R. Hays, for the petitioner. James D. Thomas, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent determined a deficiency in petitioner's Federal income tax for 1970 in the amount of $5,313. Due to concessions by the parties, the only issue remaining for decision is whether petitioner is entitled to deduct operating expenses and depreciation of his private airplanes under sections 162 and 167. 1*383 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioner, Barney G. Johnston, was a resident of Tulsa, Oklahoma at the time the petition was filed in this case. During the taxable year 1970 petitioner owned and operated Barney's Club, a private club located in Tulsa. Petitioner owned a Mooney airplane during the entire taxable year 1970 and acquired a Cessna twin-engine airplane in June 1970 which he owned for the remainder of 1970. Petitioner logged a total of 119.1 hours of flying time in his airplanes. Petitioner claimed that 76.8 of those hours were attributable to business use. The date, destination and flying time of the alleged business trips are as follows: 2 DATEHRS.DESTINATIONDATEHRS.DESTINATION2/14/701.0Muskogee, Okla.2/16/702.8Oklahoma City, Okla.2/17/701.2Muskogee, Okla.2/18/701.3Hot Springs, Ark.2/19/701.7Tulsa, Okla.3/13/702.1Oklahoma City, Okla.4/5/701.5Norman, Okla.4/5/70.9Tulsa, Okla.4/10/701.2Muskogee, Okla.4/25/702.1Woodward, Okla.5/4/702.5Oklahoma City, Okla.5/17/702.4Memphis, Tenn.5/17/702.3Tulsa, Okla.6/23/701.7Various towns6/27/701.2Various towns6/28/702.2Various towns6/29/701.0Various towns6/30/701.4Various towns6/30/701.1Various towns7/1/701.5Muskogee, Okla.7/8/702.0Muskogee, Okla.7/14/701.5Tahlequah, Okla.7/23/701.0Various towns7/24/701.5Various towns7/30/701.0Various towns7/31/70.5Various towns7/31/701.5Oklahoma City, Okla.8/1/701.5Bartlesville, Okla.8/9/703.9Pascagula, Miss.8/11/704.5Tulsa, Okla.8/15/701.2Oklahoma City, Okla.8/28/701.1Tahlequah, Okla.9/8/701.5Oklahoma City, Okla.9/15/701.9Oklahoma City,okla.9/24/701.0Stillwater, Okla.10/6/701.3Muskogee, Okla.11/15/701.5Oklahoma City, Okla.12/13/703.1Galveston, Tex.12/14/703.0Tulsa, Okla.12/21/70.9Joplin, Mo.12/21/70.8Rogers, Ark.12/21/701.3Tulsa, Okla.12/28/702.9Galveston, Texas12/28/703.3Tulsa, Okla.*384 Petitioner claimed a deduction for depreciation attributable to business use of the Cessna of $4,187. He also deducted operating expenses attributable to business use of both airplanes in the amount of $1,101. Since petitioner, as a private pilot, was not certified to operate a center-line thrust twin-engine airplane such as the Cessna, his use of that plane was solely devoted to obtaining the requisite proficiency and the authorization. Petitioner was accompanied on most of those flights by his instructor. Petitioner's training flights during or as a result of which no business was conducted consumed 19.1 hours of the alleged business use. Petitioner and a friend, Jess Sample, traveled to Hot Springs, Arkansas on February 18, 1970, and to Pascagoula, Mississippi on August 9, 1970 for recreational purposes. On April 5, 1970 petitioner traveled to Norman, Oklahoma to visit his daughter. Petitioner did not sell any franchise, acquire any property or engage in any business transaction as a result of the remainder of the flights for which he took a deduction. *385 Petitioner incurred total operating expenses for both airplanes in the amount of $1,885.20. OPINION Petitioner contends that he is entitled to deduct depreciation and operating expenses incurred in connection with his private airplanes as ordinary and necessary business expenses. Clearly, expenses and depreciation attributable to business use of the airplanes are deductible under section 162. Petitioner does, however, bear the burden of proving that the purpose of the expenditures was primarily business rather than social or personal. Buddy Schoell-kopf Products, Inc., 58 (filed December 31, 1975), . The flight hours which petitioner alleges were business related fall into two categories: proficiency and training flights and trips which petitioner alleges were part of a search for additional locations for his business. Expenses and depreciation attributable to the proficiency flights are nondeductible. No business was transacted during or as a result of those flights. Those flights were primarily personal and no deduction is available for expenses or depreciation allocable thereto. Gibson*386 . 3 Similarly, since the record does not support the alleged business nature of the remaining flights, we must also deny the deductions relating to those trips. Petitioner contends that during all the flights for which he claimed deductions he engaged in business activities. His theory proceeds thus: Since petitioner's club in Tulsa was a financial success, petitioner formulated a plan to expand the enterprise by establishing additional clubs in other Southwestern cities. He intended to implement the plan by selling franchises. During the flights in issue petitioner could discern the character of various sections of the cities and could thus select a site which would enhance the possibility of a successful operation. In addition, the trips provided an opportunity for petitioner to discuss the expansion with both prospective investors and established club owners. Unfortunately, petitioner has failed to produce evidence to substantiate his theory. Although petitioner testified that a tentative franchise*387 agreement was drafted, a copy of the agreement was not produced. No notes or files on the proposed franchise operation and related trips were introduced. 4 No feasibility study of either the expansion plan or the potential locations was conducted. Neither the proposed locations nor the club owners with whom the petitioner discussed the expansion idea were specifically identified. Finally, the record provides no indication of the capacity or proclivity of the prospective purchasers to invest in the franchises. Only petitioner's vague, selfserving testimony supports his theory. 5Further, although the fact that petitioner did not sell any franchises or open any new club either in 1970 or thereafter is not conclusive, it does reinforce*388 our conclusion that the trips were not primarily business related. Since petitioner has failed to carry his burden of proof, we must sustain respondent's disallowance of the deductions in issue. Decision will be enteredfor respondent.Footnotes1. Unless otherwise noted, all statutory references are to the Internal Revenue Code of 1954 as amended.↩2. All flights prior to June 23, 1970 were in the Mooney. All flights on and after that date were in the Cessna.↩3. See also and Henrya.↩.4. In fact, the record indicates that no such documents existed. Petitioner testified that he had to reconstruct the purposes and destination of his trips from his airplane log book. ↩5. The testimony of petitioner's only corroborating witness, Jess Sample, indicates that one of the trips on which he accompanied petitioner was intended as a fishing trip. Moreover, petitioner himself testified that another of the trips was in part a personal one.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624930/ | Charles L. Johnson v. Commissioner.Johnson v. CommissionerDocket No. 1410.United States Tax Court1943 Tax Ct. Memo LEXIS 56; 2 T.C.M. (CCH) 983; T.C.M. (RIA) 43484; November 12, 1943*56 A. P. Lowell, Esq., 1 Federal St., Boston, Mass., for the petitioner. W. R. Murrin, Esq., for the respondent. ARUNDELLMemorandum Opinion ARUNDELL, Judge: The Commissioner determined a deficiency in income tax for the year 1939 in the amount of $1,049.68. The only adjustment that remains in issue is the disallowance of an alleged interest deduction in the sum of $5,760.42, which represents a part of certain payments made by petitioner to the estate of W. H. Graham. Respondent determined that the total payments made to said estate by petitioner constituted a capital investment, no part of which was allowable as a deduction for interest paid. The facts are stipulated. [The Facts] Petitioner is an individual residing in Providence, Rhode Island. On January 31, 1930 he entered into an agreement with William H. Graham with respect to the purchase by petitioner of the controlling capital stock interest in W. H. Graham Corporation, a Massachusetts corporation carrying on an undertaking business. By the terms of the agreement petitioner paid Graham the sum of $100,000, receipt of which was acknowledged therein, and agreed further to pay Graham the sum of $900 each month during the*57 lifetime of Graham and to pay the same amount to his estate or to a person or persons designated in Graham's will for a period of five years after his death. The agreement provided that $900the payments during Graham's lifetime were to be reduced by the amounts, if any, received by Graham as salary from the W. H. Graham Corporation. The agreement further provided that petitioner at any time could satisfy all his obligations under said contract by the payment of $150,000 to Graham or his legal representatives or the person or persons designated in his will. The shares of stock that were the subject of the agreement were conveyed by Graham to petitioner and the latter, in accordance with the requirements of the contract, forthwith assigned such stock to a bank in escrow to secure the monthly payments hereinabove referred to. Provision was made for the delivery of the stock by the escrow agent to Graham, at the latter's option, upon default by petitioner in making any of said monthly payments for a period of thirty days, in which event all sums theretofore paid by petitioner were to remain the property of Graham. Graham covenanted to cooperate in furthering the interests of the corporation*58 while he was in New England, and he also agreed not to compete in any way with the business of petitioner or the corporation. He agreed at any time upon request to present his resignation as president and director of the corporation. Graham was born June 22, 1874. He ceased to be employed by the W. H. Graham Corporation on February 8, 1930. He died on March 28, 1938. During the calendar year 1939 petitioner paid to his estate eleven installments in the amount of $900 each under the above contract. In his return for 1939 and in his returns for prior years petitioner treated a portion of the payments made under said contract as interest, and a portion thereof as principal. The apportionment was based upon the following computation: on the date of the agreement, January 31, 1930, Graham's life expectancy, plus the five years thereafter during which the payments were to be made, amounted to approximately twenty-two years. The present value of an annuity of $10,800 per year at six per cent interest for twenty-two years is $130,049.08. In the year 1930 petitioner deducted as interest six per cent of that sum, treating the balance of his payments in that year as a reduction of principal. *59 Similarly in 1931 petitioner computed interest at six per cent upon the balance due at the beginning of that year and treated the difference between that figure and the total payments made in that year as principal repayments. This meant that each year the interest payments became smaller and the principal payments became larger. [Opinion] To support his contention that a portion of the amounts paid in the taxable year represented deductible interest petitioner relies almost exclusively upon the case of John C. Moore Corporation, 15 B.T.A. 1140">15 B.T.A. 1140, affirmed 42 Fed. (2d) 186. We think that case is distinguishable. The parties there agreed upon the present fair market value of the annuity, the value of the property received in exchange, and the life expectancy of the annuitant, although the taxpayer had been satisfied to write the annuity upon a basis that the annuitant, by reason of poor health, would not live as long as she would according to mortality tables. Having agreed upon these figures it was evident that payments over the period of the agreed life expectancy would exceed the compensation received for the annuity. *60 The case held, as did Florence L. Klein, 6 B.T.A. 617">6 B.T.A. 617, that the excess was a deductible amount, and the deduction was allowed in those instances as interest (though computed differently in each case), rather than as loss or expense after full recovery of principal. Petitioner can not bring himself within the rule of those cases upon the present facts. He is seeking to deduct an amount as interest paid upon indebtedness. Since the contract itself said nothing whatever about interest the only plausible explanation of petitioner's claim is that he has promised to pay more over a period of years than he would have been required to pay immediately. We can gather nothing from the contract or facts before us to say that this is so. We do not know the value of what he received for his promise to make installment payments in the future. He received not only stock but Graham's promises to cooperate and not to compete. At one point in his brief counsel for petitioner appears to assume that the stock was worth $250,000, which is alleged to have been the selling price, for petitioner could have acquired full title to and possession of it by paying $150,000 in addition*61 to the down payment of $100,000. We do not think this establishes the fair market value. This was not a sale for an unpaid balance of $150,000 against which installment payments were to be credited. The full amount of $150,000 would have had to be paid to discharge the obligation regardless of the amounts previously paid as installments. Nor do we think it is permissible to compute the present value of the annuity by using mortality tables and an assumed rate of interest and then to conclude that the value so found must be presumed to be equivalent to the value of the property received in exchange. The Moore case itself is sufficient illustration of the plain fact that the contemplated life expectancy of a particular individual has no necessary relation to the life expectancy of an average person of his age according to experience tables. Petitioner's obligation in the instant case was not absolute. Edwin M. Klein, 31 B.T.A. 910">31 B.T.A. 910, 919, affd. 84 Fed. (2d) 310. It was contingent not only upon the continued life of Graham but upon the possibility that salary payments by the corporation might reduce it in amount or discharge*62 it altogether. From the above considerations we think it is clear that petitioner can not prevail. Petitioner contracted for the purchase of a capital asset in consideration, among other things, of his promise to make installment payments. Nothing was said as to interest on the deferred payments. There is no basis in the present facts for inferring that interest was intended to be or was in fact paid. See Elliott Paint & Varnish Co., 44 B.T.A. 241">44 B.T.A. 241, 247; Steinbach Kresge Co. v. Sturgess, 33 Fed. Supp. 897; Edward M. Klein, supra;I.T. 1242, C.B. I-1, p. 61. The parties have stipulated other issues, Accordingly, Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624931/ | APPEAL OF BRADT DRUG CO.Bradt Drug Co. v. CommissionerDocket No. 6676.United States Board of Tax Appeals4 B.T.A. 36; 1926 BTA LEXIS 2403; April 21, 1926, Decided Submitted February 24, 1926. *2403 John D. Foley, Esq., for the Commissioner. *36 Before JAMES, LITTLETON, SMITH, and TRUSSELL. This is an appeal from the determination of a deficiency of $1,427.76 for the calendar year 1921. FINDINGS OF FACT. The taxpayer is a New York corporation with principal office at Albany. In his answer to taxpayer's petition, the Commissioner admitted the allegations of fact contained therein as follows: The taxpayer corporation was organized March 7, 1917, with an authorized capital stock of $10,000.00, all of which was outstanding at the beginning of the taxable year. In 1921 this organization was increased to $60,000.00. The increase in capital stock was issued to Mr. Warren L. Bradt for a leasehold owned by him. The lease was acquired upon a building for the purpose of conducting a retail drug business. This lease had a life of twenty years from January 1, 1920 to December 31, 1939, on a rental basis as follows: 1920 to 1925$12,000.00 per annum.1925 to 1930$13,000.00 per annum.1930 to 1940$14,000.00 per annum.The taxpayer corporation in making its return for the year 1921 claimed as a deduction from income 7/12 of 1/19, (one*2404 year of the lease having expired) of $50,000.00 as amortization. The Revenue Agent disallowed this deduction on account of amortization of the leasehold. Later under date of November 10, 1924, the taxpayer received a letter from the Income Tax Unit also disallowing the deduction on account of amortization of the leasehold. This action on the part of the Income Tax Unit was protested by the taxpayer but the Income Tax Unit still held that the taxpayer was not entitled to this deduction. Upon audit of the return for 1921 the Commissioner denied the taxpayer's claim for a deduction for exhaustion based upon a value for the lease of $50,000. The deficiency is $1,427.76. Order will be entered accordingly. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624939/ | McClure-Tritschler-Parrish Company v. Commissioner.McClure-Tritschler-Parrish Co. v. CommissionerDocket No. 9783.United States Tax Court1947 Tax Ct. Memo LEXIS 90; 6 T.C.M. (CCH) 1032; T.C.M. (RIA) 47254; September 22, 1947*90 Roger K. Powell, Esq., 702 Huntington Bank Bldg., Columbus 15, O., for the petitioner. John O. Durkan, Esq., for the respondent. LEMIRE Memorandum Findings of Fact and Opinion The Commissioner has determined a deficiency of $860.75 in declared value excess profits tax and a deficiency of $9,276.75 in excess profits tax in petitioner's return for the year 1942. The deficiencies are due in principle part to the refusal of the Commissioner to allow the deduction of a bad debt loss of $13,000, as reported by petitioner in its 1942 return. The petitioner contends that the Commissioner erred in refusing to allow this deduction. Findings of Fact The petitioner, McClure-Tritschler-Parrish Company, is an Ohio corporation with its business address in Columbia, Ohio. The return for the period involved was filed with the collector of internal revenue for the 11th district of Ohio, at Columbus. Petitioner is a wholesaler and sells hosiery, underwear and most types of work clothing, and also hard surface floor covering, to independent retailers in Ohio and surrounding states. It was engaged in this business in 1939 through 1942 and for years prior thereto. Prior to May 1, 1939, petitioner*91 had sold merchandise on extended credit to a retail store known as Curley's Five Cent and Dollar Store, at Wellston, Ohio. On or about that date petitioner was advised that the store had gone into receivership and that a relative of the owner of the store had been appointed as receiver. Thereupon petitioner called in its attorney, Cable M. Gibson, and advised him that it had a substantial debt due from the store and directed him to go to Wellston and look after petitioner's interest. Gibson went to Wellston and prepared and filed in the Common Pleas Court a motion to remove the receiver and to require immediate sale of the assets of the store. This motion was granted and the assets of the store were later sold to a representative of the petitioner in a receivership sale. The petitioner wanted the store kept in operation as a possible outlet for its merchandise. Gibson, its attorney, was a man who had had considerable experience in the handling of similar stores in bankruptcy and receivership proceedings. The petitioner entered into an arrangement with him whereby it agreed to lend him money to purchase the stock of a corporation to be formed to take over the assets which it had purchased*92 and to operate the store. Pursuant to this arrangement Gibson incorporated an Ohio company with an authorized capital of $25,000, called the Ace Dime Stores, Inc., and petitioner loaned Gibson $7,000, on his promissory note, to pay for 70 shares of its stock. The stock was issued to Gibson and he delivered it to petitioner as collateral security on his note. This note was as follows: "CONDITIONAL PROMISSORY NOTE "$7000.00 Columbus, Ohio, May 4th, 1939 "ON DEMAND after date for value received, without interest, I promise to pay to the order of The McClure-Tritschler-Parrish Company, the sum of SEVEN THOUSAND and 00/100 DOLLARS ($7000.00), conditionally as follows: "1. I am delivering concurrently with the signing of this note to the payee hereof, seventy (70) shares of the Capital Stock of Ace Dime Stores, Inc., as security for the within note, upon the following conditions: "(a) At any time, upon my request, the security will be accepted in full payment of this obligation, and this note surrendered to me. "(b) In the event of my death, the security for this obligation will become the payee's property in full payment of the obligation. "(c) At any time upon the payee's*93 request, they may return this note to me marked "Paid," and accept and keep the security in full payment thereof. "(d) My liability shall not exceed the surrender of the security on this note at any time, or to any person, firm, or corporation. "(e) This note may be pledged or used as security, so long as the terms and conditions herein contained are binding upon the person, firm, or corporation accepting the same as security." With the $7,000 which Gibson paid in for its stock Ace Dime Stores, Inc., purchased the assets and merchandise from the petitioner and proceeded to operate the business. A manager was employed to take charge of the store under the supervision of Gibson, the latter keeping the books and files of the company in his office at Columbus, Ohio. Gibson was president and treasurer, his wife vice-president, and his personal secretary was the secretary of the company. The company's bank account, except for minor sums, was kept in a Columbus, Ohio, bank. Between April 1, 1940, and November 15, 1940, Ace Dime Stores, Inc., opened three other stores in Ohio, one at Granville, one at Centerburg, and one at Belleville. A manager was employed to operate all of these stores*94 under the direct supervision of Gibson. The store at Wellston was closed in July, 1940. Gibson devoted a considerable part of his time to the supervision of the operation of Act Dime Stores, Inc., without remuneration from that corporation, although it paid him a small rental for the space occupied by its books and files in his law office. Ace Dime Stores, Inc., bought some of its merchandise from the petitioner and some from other wholesalers who were the competitors of petitioner. Petitioner did not exercise any active control over the operation of Ace Dime Stores, Inc. That was left to Gibson and others employed by him. During the years 1939 and 1940 petitioner extended credit to Ace Dime Stores, Inc., for merchandise purchased and money advanced to it and took five notes of the corporation totaling $6,000. In December, 1940, in order to enable Ace Dime Stores, Inc., to make a better financial statement, Gibson subscribed for, and was issued for cash an additional 60 shares of its capital stock. The petitioner advanced $6,000 to Gibson to pay for these shares. Ace Dime Stores, Inc., then repaid the $6,000 to the petitioner in satisfaction of its five notes totaling $6,000. Gibson*95 then gave the petitioner his note for $6,000, similar in every respect to the one for $7,000 heretofore mentioned, except that it was dated December 31, 1940, and recited the delivery of 60 shares of capital stock of Ace Dime Stores, Inc., as collateral security. The $13,000 of stock issued to Gibson and held by petitioner as collateral was all the stock ever issued by Ace Dime Stores, Inc. Under the provisions of the notes in question petitioner could at any time take over the stock and assets of the corporation and assume absolute control and management thereof. Ace Dime Stores, Inc., continued in business during most of the year 1942 but was not successful. In December, 1942, all of its assets were sold in liquidation and all general creditors paid off. After the payment of all general creditors Gibson, the sole stockholder, was left with $600, which he turned over to the petitioner together with all of the company's stock. The petitioner then canceled Gibson's notes, as prescribed by the conditions therein. The petitioner in its 1942 tax return claimed a deduction of $13,000 as a bad debt on account of the Gibson notes. This was disallowed by the Commissioner and the determination*96 of a deficiency in declared value excess profits tax in the amount of $860.75 and a deficiency in excess profits tax in the amount of $9,276.75 for the year ended December 31, 1942, resulted. Opinion LEMIRE, Judge. The evidence in this case indicates that the petitioner was the real owner of the stock of the Ace Dime Stores, Inc. The money invested in the capital stock of the company was all advanced by petitioner; and under the plan and agreement between it and Gibson there never was a moment after the delivery of the stock as collateral security for the Gibson conditional notes when petitioner could not have declared its ownershio thereof, canceled the notes, and assumed active control and management of the corporation. As a matter of fact Gibson, in explaining the provision in the notes enabling the petitioner to do so, said: "I've always attempted to keep my transactions with my clients that I represent, whether in dealing with them personally or in my capacity as an attorney, on the basis of where they controlled the matter entirely." As we view the situation in this case the petitioner, from the date of organization of Ace Dime Stores, Inc., until its liquidation, was in*97 a position to exercise the same control of the corporation as if the stock had been issued to it directly. Gibson personally had nothing invested in the corporation and had no personal obligation to pay the conditional notes involved. The collateral deposited belonged to the petitioner any time it elected to declare ownership and cancel the notes. This could be done without the consent of Gibson and petitioner was not obligated to pay Gibson anything whatsoever for the stock even though it might have value far in excess of $13,000, the face amount of the notes. Under the circumstances, we think that Gibson was under no legal liability to pay the notes and consequently no indebtedness existed. See , affirmed, (C.A.D.C.); ; ; (C.C.A., 1st Cir., 1941). Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624940/ | LONNIE F. TARVER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentTarver v. CommissionerDocket No. 39060-86.United States Tax CourtT.C. Memo 1989-123; 1989 Tax Ct. Memo LEXIS 123; 56 T.C.M. (CCH) 1535; T.C.M. (RIA) 89123; March 27, 1989. Lonnie F. Tarver, pro se. Blake W. Ferguson, for the respondent. COHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined deficiencies in and additions to petitioner's Federal income taxes as follows: Additions to TaxSec.Sec.Sec.Sec.YearDeficiency6651(a) 16653(b)(1)6653(b)(2)66541981$ 11,979.00$ 1,621.00$ 5,989.50 * $ 390.00198212,156.001,584.006,078.00 ** 476.0019836,720.001,506.003,360.00 ***357.00*124 In his answer, respondent admitted that the additions to tax determined under section 6651(a) were improper. (See section 6653(d), prohibiting cumulation of additions to tax for delinquency with additions to tax for fraud.) Further, the determination under section 6653(b)(2) for 1981 is erroneous as a matter of law. Respondent has conceded that the amounts determined for 1983 should be reduced to exclude from the computation nontaxable retirement pay received by petitioner. Because petitioner has made only frivolous arguments, the only issues remaining for decision are whether he is liable for additions to tax for fraud and whether damages should be awarded to the United States under section 6673. FINDINGS OF FACT Most of the material facts have been admitted by petitioner's failure properly to respond*125 to requests for admissions served by respondent. Petitioner was a resident of Lomita, California, at the time his petition was filed. On or about April 15, 1981, petitioner tendered to the Internal Revenue Service Forms 1040, U.S. Individual Income Tax Return, for 1979 and 1980. On each form, petitioner reported wages exceeding $ 33,000, marked by an asterisk. The asterisk referred to a note at the bottom of the page as follows: * Earned but not received; received only non-redeemable "Federal Reserve 'Notes'" On each Form 1040, petitioner reported taxable income as "none" and tax due as "none," and he claimed a refund of Federal income taxes withheld. During 1981, 1982, and 1983, petitioner received wages of $ 39,928.04, $ 42,652.00, and $ 17,632.83, respectively, from the Department of Transportation, Federal Aviation Administration. Petitioner failed to file income tax returns for 1981, 1982, or 1983. In January 1983, he submitted to his employer Forms W-4 on which he falsely claimed to be exempt from Federal income taxes. In 1985, petitioner was contacted by the Internal Revenue Service about his failure to file returns for 1981, 1982, and 1983. He responded by*126 sending to the Internal Revenue Service tax protester materials in which he claimed that he was not required to pay income tax because his wages were not income. In his petition filed herein in response to a notice of deficiency sent June 26, 1986, petitioner claimed that he was a "nontaxpayer" and set forth other frivolous arguments. Throughout the pendency of this case, he has filed a variety of frivolous documents and has failed and refused to set forth any facts concerning any deductions to which he might be entitled. OPINION With the exception of the additions to tax for fraud, petitioner has the burden of proving that respondent's determination is erroneous. , affg. a Memorandum Opinion of this Court; Rule 142(a). He has failed to show any error in the deficiencies determined for 1981 and 1982 or in the additions to tax determined under section 6654. Those adjustments, therefore, are sustained. During trial, petitioner pointed out that for 1983 he had received a "Statement for Federal Civil Service Annuitants" reporting payment of an annuity in the amount of $ 14,007 and showing the "taxable amount" *127 to be "none." The amount of $ 14,007 was included as taxable income in the adjustments forming the basis of the notice of deficiency. Respondent's counsel asserted that the statement might be in error and that the retirement pay might be subject to tax. Solely because of uncertainty as to the correct taxable income for 1983, the Court ordered seriatim briefs, with respondent filing the first brief. Respondent's brief began by conceding that the retirement income was not taxable and proceeded to discuss indicia of fraud in this case, the frivolity of petitioner's arguments, and pertinent authority. Petitioner's reply brief ignored all adverse precedents and persisted in his contention that he is a "nontaxpayer." He has shown no other error in respondent's determinations. See, e.g., . The 50 percent addition to tax in the case of fraud is a civil sanction provided primarily as a safeguard for the protection of the revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from the taxpayer's fraud. . Respondent*128 has the burden of proving, by clear and convincing evidence, that some part of the underpayment for each year was due to fraud. Section 7454(a); Rule 142(b). This burden is met if it is shown that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. The existence of fraud is a question to be resolved upon consideration of the entire record. See generally . Failure to file tax returns, without more, is not proof of fraud. . Failure to file, however, may be considered in connection with other facts in determining whether an underpayment of tax is due to fraud, and failure to file may be viewed as conduct intended to conceal petitioner's noncompliance with the law. The burden on respondent to both locate and assess a delinquent taxpayer is, in a sense, greater than the verification of items reported on a filed return that may be false. See . In ,*129 the Court of Appeals identified various indicia of fraud, including repeated failure to file returns, failure to report income known to be taxable, filing of false Forms W-4, failure to make estimated tax payments, failure to cooperate with revenue agents, and failure to maintain adequate records. Failure to file returns and the filing of false W-4 forms satisfies respondent's burden where nothing but frivolous arguments are offered as an excuse. ; . Criminal sanctions have been imposed in comparable situations. See, e.g., . The evidence in this case establishes a pattern of failure to file returns. Petitioner is intelligent and educated, and he claims to have studied the Internal Revenue Code and "a lot of Court cases." We do not believe that he thought that his wages were not taxable income. Petitioner's persistence in maintaining frivolous arguments despite citation of authority and warnings of respondent and the Court that they were meritless is evidence that he intended, by whatever*130 means, to evade the payment of taxes. The false withholding certificate tendered to his employer in 1983 is further evidence of this fraudulent intent. The additions to tax for fraud will be sustained. At the conclusion of the trial, the Court indicated uncertainty about whether damages would be awarded because of the confusion about the taxability of petitioner's retirement pay. In petitioner's reply brief, he ignored the authorities cited in respondent's brief and persisted in arguing that he was not a taxpayer and had no income subject to tax. There is no need to respond individually to each of his arguments. See . Petitioner continues to assert claims that are frivolous and groundless, and it is apparent that these proceedings have been instituted and maintained by petitioner primarily for delay. Damages shall be awarded to the United States in the amount of $ 5,000 under section 6673. To take account of respondent's concession, Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended and in effect for the years in issue. All references to Rules are to the Tax Court Rules of Practice and Procedure. * 50 percent of the interest due on $ 11,979.00. ** 50 percent of the interest due on $ 12,156.00. *** 50 percent of the interest due on $ 6,720.00.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624941/ | FRANCES C. BROOKS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Brooks v. CommissionerDocket No. 99708.United States Board of Tax Appeals43 B.T.A. 860; 1941 BTA LEXIS 1439; March 11, 1941, Promulgated *1439 Petitioner in 1936 and 1937 failed to report one-half of the income of her husband derived from personal services, alleging that by virtue of a contract entered into with her husband she had agreed that his entire income should be his separate property. Held, the evidence is insufficient to disclose a contract of the nature contended for by petitioner, and accordingly she must report one-half of her husband's income from personal services. Lester Whitmore, Esq., for the petitioner. Edward C. Adams, Esq., for the respondent. HILL*861 The respondent has determined deficiencies in income tax for the calendar years 1936 and 1937 in the respective amounts of $240.83 and $247.97, which arise from his determination that salary and director's fees received by petitioner's husband during these years constitute community property and are thus taxable in one-half part to the petitioner. Petitioner's contentions in answer to this position raise two issues: (1) Whether there existed during the taxable years a valid agreement between petitioner and her husband by which the latter's earnings from personal services were declared to be his separate*1440 income, and (2) whether, if no such agreement existed, the petitioner is entitled to credits not already allowed for personal and dependent exemptions against the community income which she must then report. FINDINGS OF FACT. Petitioner is an individual, residing in Bellingham, Whatcom County, Washington, where she moved with her husband, Frank N. Brooks, in the year 1919. After moving to Washington both the petitioner and her husband inherited properties which each retained and managed as his or her separate property. During the year 1923 Frank N. Brooks engaged in the lumber business, investing his separate funds in corporations engaged in the manufacture and sale of lumber. Brooks became the president of one of these corporations, the Warnick Lumber Co. The petitioner did not regard these enterprises as financially sound and as early as 1923 expressed to her husband her desire to keep her property entirely free from involvement in any liability growing out of them. The lumber companies owned by Brooks were operated at a loss during a part of the period following 1923, continuing down to the year 1935. In the latter year their financial condition became increasingly*1441 grave. Near the end of that year, in view of these circumstances, petitioner and her husband consulted and agreed that "each would keep his own income and each file their own separate returns." On this occasion Brooks stated to petitioner that they "did not have to file community property returns." It was agreed in addition at that time that petitioner would manage her separate property, although she had assumed its sole management prior to *862 that year, with the exception of infrequent advice from her husband and from her bankers. During all of the years from 1936 through 1939 the petitioner and her husband filed separate income tax returns. In the taxable years Brooks reported as his separate income the entire amounts which he received as salary and director's fees. The Commissioner thereafter eliminated from his returns one-half of these sums and, determining that the salaries and fees were community property, taxed one-half of them to the petitioner. On December 28, 1938, Brooks filed with the internal revenue agent an affidavit requesting a hearing on the 1936 deficiency involved herein and stating that there was no obligation either under state or Federal law*1442 requiring a husband and wife in Washington to divide equally the salary of the husband. Petitioner, on January 5, 1939, filed a similar affidavit contesting the 1937 deficiency in question here. Frank N. Brooks died in the month of September 1939 and petitioner was appointed administratrix of his estate. In an inventory filed with the Probate Court by petitioner on April 1, 1940, there was included in his estate as his separate property bank deposits, stocks and bonds, and as his share of community property one-half of the realty used by petitioner and Brooks as a home. OPINION. HILL: We are called on here to say, viewing the evidence which has been presented to us, whether petitioner must report as her income one-half of the fees and salaries received by her husband during the taxable years. The answer to this question depends on whether we are able to make out a definite, binding agreement between petitioner and Brooks which set apart as the latter's separate property his director's fees and salaries. The effect of such an agreement, if proof of it is made, is to make separate income of what is otherwise community property. *1443 ; ; ; so much is agreed. Without such a contract earnings from personal services are community property and must be reported one-half by each spouse for income taxation. Sec. 6892, Washington Revised Statutes (Remington, 1932); ; ; . The evidence before us we deem insufficient to show a definite agreement between petitioner and her husband affecting the earnings of Brooks arising from personal services. Proof is made only that petitioner's husband, at the time of the agreement, stated that they "did *863 not have to file community property returns" and it was thereupon agreed that "each would keep his own income and each file their own separate returns." The meaning of these statements, taking all of the testimony into account, is not plain. It appears that Brooks had largely in mind the mere mechanics of reporting the income, whether by joint or separate*1444 return, which does not affect the character of the income. Prior thereto it is stated and emphasized that petitioner and Brooks made joint returns and, thereafter, utilized separate returns. If it be assumed, however, that in the statements of the parties may be found contemplation that the character of the income was altered, we are yet unable to make out an agreement which reaches the conclusion argued by the petitioner. The contract so far as disclosed does not in itself purport to alter the nature of the income. This was thought by Brooks to be done by operation of law, both of Washington and of the Federal Government. Evidence of this is found in the affidavits filed with reference to these deficiencies in which it was stated by petitioner that it was her contention that under , the taxpayer has a right to either divide his earned income with his wife or report it entirely in his own return, with or without an agreement to that effect. This position is reiterated in the petition in this proceeding. The agreement here involved, therefore, appears to be no more than an understanding of the parties that, in view of their conception*1445 of the law giving a freely exercisable option, each should report his or her income separately. The contract thus can not stand alone when deprived of the support of the law and can have no effect on the nature of the income here in question. Petitioner's efforts to make clearer the meaning of the contract here involved through proof of petitioner's method of listing Brooks' estate on inventory can not, we think, avail her here. No question is made that Brooks' securities were his separate property. The bank deposits alone appear significant and even these lose their significance when no proof is made of their source, whether or not arising from personal services. The whole evidence adduced is insufficient to justify our sustaining petitioner's contentions for an agreement altering the community nature of Brooks' earnings during the taxable years. Accordingly, respondent's position must be sustained. Petitioner's requests for credits for personal exemption and for dependents appear from the deficiency notice here involved to have been taken into account by respondent in computing the additional tax due. In the absence of more specific criticism or facts on which to base*1446 such a criticism of respondent's computations, these contentions of petitioner must also be passed over. Decision will be entered for respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4624942/ | SHAFPA REALTY CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Shafpa Realty Corp. v. CommissionerDocket No. 10105.United States Board of Tax Appeals8 B.T.A. 283; 1927 BTA LEXIS 2935; September 22, 1927, Promulgated *2935 1. A corporation receiving during the taxable year a part payment on a mortgage note acquired at a 20 per cent discount from its face value received income to the extent of 20 per cent of the amount of the payment. 2. The evidence is insufficient to show that the Commissioner was in error in failing to credit any part of an overpayment of tax for the fiscal year ending within the calendar year 1922 against a tax due upon the calendar year return for 1921. Benjamin Mahler, Esq., for the petitioner. J. W. Fisher, Esq., for the respondent. SMITH *283 The petitioner complains against a deficiency of $609.26 for the calendar year 1921. There are two questions in issue: (1) Whether a payment received on account of amortization of a mortgage note acquired at a discount of 20 per cent of the face value includes part income or is wholly a return of principal, and (2) the proper credit for taxes paid. FINDINGS OF FACT. 1. The petitioner is a New York corporation. 2. During the years 1920, 1921, and 1922 it filed its returns on a fiscal year basis ended September 30. The basis of its return was changed by the Commissioner to a calendar*2936 year, which change was acceptable to the petitioner. 3. During the year 1920 the petitioner sold a building and received in part payment a second mortgage with a face value of $300,000. For the purpose of arriving at the profit or loss sustained from the transaction in 1920 the petitioner and the respondent agreed upon the market value of the second mortgage of $240,000. The mortgage was to be paid off at the rate of $20,000 a year. 4. During 1921 the mortgagor made a payment of $10,000, which was considered by the petitioner as a return of principal. The respondent held that since the mortgage was acquired for $240,000, or at a discount of 20 per cent from its face value, the petitioner realized income to the extent of 20 per cent of each installment payment made. He held that $2,000 of the $10,000 received in 1921 represented income and increased the petitioner's reported income accordingly. 5. For the fiscal year ended September 30, 1921, the petitioner paid on its income-tax return for such year a tax of $1,396.08. One-fourth of the income of such fiscal year was thrown into a prior *284 period for the purpose of arriving at the income for the calendar year*2937 1920. Accordingly, one-fourth of the tax paid on such return, or $349.02, was applied against the tax due and payable for the calendar year 1920, leaving $1,047.06 as being unapplied tax paid for the fiscal year ended September 30, 1921. 6. For the fiscal year ended September 30, 1922, the petitioner paid upon its income-tax return for such fiscal year a tax of $1,563.52. One-fourth of the income shown for that fiscal year was placed by the respondent in the income of the calendar year 1921 and forms a part of the income of which the deficiency in tax is computed. The respondent this time did not take one-fourth of the tax paid for the fiscal year ended September 30, 1922, although he had taken one-fourth of the income and had taken one-fourth of the tax paid for the fiscal year ended September 30, 1921, and applied it against the prior year's income. The result is that the deficiency for the calendar year 1921 has not been reduced by any part of the tax paid by the petitioner for the fiscal year ended June 30, 1922. OPINION. SMITH: On the basis of the decision of the Board in *2938 , and of the decision of the Supreme Court in , the petitioner contends that no part of the installment payment of $10,000 on the mortgage received during the calendar year 1921 constituted income of 1921, but that the entire amount was a return of principal. It is the petitioner's contention that it could receive no income from the mortgage until it had received $240,000 representing its investment in the mortgage. The decisions cited are clearly not authority for the contention made. In , we held that the amounts by which bonds purchased at a discount were written up in each year did not represent accrued income within the year and that the bank was not required to return any income in respect of such a bookkeeping transaction. The New York Life Insurance case was of similar import. The amortization of discounts and premiums representing nothing more than bookkeeping transactions are not accrued income or deductible losses within the meaning of the taxing statutes. *2939 The situation in the case at bar is entirely different. The petitioner received a part payment on the mortgage note held by it. It is no more correct to say that the part payment was all a return of principal than it is to say that it was all a return of income. Since the Commissioner in computing the gain discounted the mortgage 20 per cent, only 80 per cent of the face value represented the basis for computing the gain upon the payments made on the mortgage. Each *285 payment made was a payment on the face of the mortgage, 80 per cent of which represented a return on the principal and 20 per cent a realization of discount or of income. Cf. . The petitioner complains that the respondent in determining the deficiency for the calendar year 1921 has not applied against that deficiency any part of the payment of the income tax for the fiscal year ended September 30, 1922. In argument the respondent contended that one-fourth of the tax paid upon the return for the fiscal year ended September 30, 1921, had been applied against the tax due upon the calendar year return for 1920 and three-fourths of the tax upon the return for the*2940 calendar year 1921, that due to a change in the practice of the respondent no part of the tax paid for the fiscal year ended September 30, 1922, was applied against the tax due for the calendar year 1921 but against taxes due for other periods. The evidence does not show whether this was done or not. Under section 284(a) of the Revenue Act of 1926 the Commissioner has authority to credit an overpayment of any income, war-profits or excess-profits tax against any like tax due from the taxpayer. We are of the opinion that the evidence does not show that the Commissioner was in error in refusing to credit against the tax due for the calendar year 1921 any part of the tax paid for the fiscal year ended September 30, 1922. Reviewed by the Board. Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
Subsets and Splits