Split (1)

train · 657k rows

url stringlengths 56 59	text stringlengths 3 913k	downloaded_timestamp stringclasses 1 value	created_timestamp stringlengths 10 10
https://www.courtlistener.com/api/rest/v3/opinions/4619291/	J & S Carburetor Company, Redfish Bay Terminal, Inc., BQP Industries, Inc., Southland Technology, Inc., Synfuel Systems, Inc., and Synfuel Industries, Inc., Petitioners v. Commissioner of Internal Revenue, RespondentJ & S Carburetor Co. v. CommissionerDocket No. 41003-85United States Tax Court93 T.C. 166; 1989 U.S. Tax Ct. LEXIS 113; 93 T.C. No. 17; August 3, 1989August 3, 1989, Filed 1989 U.S. Tax Ct. LEXIS 113">113 An appropriate order granting respondent's motion to dismiss will be entered. Subsidiaries in an affiliated group of corporations filing a consolidated return petitioned this Court while the common parent corporation was in bankruptcy. Respondent moved to dismiss for lack of jurisdiction. Held, sec. 1.1502-77(a), Income Tax Regs., precludes the subsidiaries from petitioning this Court; accordingly, respondent's motion to dismiss for lack of jurisdiction is granted. Robert I. White, Shelley Cashion, and Ruth E. Salek, for the petitioners.Deborah A. Butler, Rebecca W. Wolfe, and Paula M. Jung, for the respondent. Jacobs, Judge. JACOBS93 T.C. 166">167 OPINIONThis matter is before the Court on respondent's motion to dismiss for lack of jurisdiction. The issue presented is whether subsidiaries in an affiliated group of corporations filing a consolidated tax return can invoke the Court's jurisdiction by filing a petition while the common parent corporation has a bankruptcy petition pending and is stayed from commencing an action in this Court by virtue of 11 U.S.C. 362(a)(8) (1982). 1 All of the facts have been stipulated 1989 U.S. Tax Ct. LEXIS 113">114 for purposes of deciding this motion and are so found.For the fiscal years ending April 30, 1979, 1980, and 1981, Sutton Investments, Inc. (Sutton Investments) and its nine wholly-owned subsidiaries filed consolidated corporate income tax returns.Petitions for bankruptcy were filed on behalf of Sutton Investments and three of its subsidiaries, BPM, Ltd., Modern Marine Power, Inc. (Modern Marine), and Industrial Manufacturing Co. of Texas (Industrial Manufacturing) on April 25, 1984, July 11, 1983, May 9, 1983, and January 10, 1985, respectively. Petitioners are the remaining subsidiaries which did not file bankruptcy petitions (nonbankrupt1989 U.S. Tax Ct. LEXIS 113">115 subsidiaries).On August 9, 1985, respondent issued a statutory notice of deficiency to "Sutton Investments, Inc. and Subsidiary 93 T.C. 166">168 [sic]" with respect to the taxable years ending April 30, 1979, 1980, and 1981. On November 12, 1985, the nonbankrupt subsidiaries, as well as Modern Marine and Industrial Manufacturing, filed a petition with respect to the August 9, 1985, notice of deficiency. Neither Sutton Investments nor BPM, Ltd. joined in the petition. On December 24, 1985, respondent filed a motion to dismiss petitioners Modern Marine and Industrial Manufacturing for lack of jurisdiction; the motion was granted on June 27, 1986. On November 29, 1988, respondent moved to dismiss the petition of the nonbankrupt subsidiaries for lack of jurisdiction.Pursuant to section 362(a)(8) of the Bankruptcy Code a petition for bankruptcy stays "the commencement or continuation of a proceeding before the United States Tax Court concerning the debtor." Thus, Sutton Investments is prohibited from challenging respondent's determinations in the notice of deficiency in this Court until the bankruptcy proceedings are terminated or until the bankruptcy judge chooses to lift the stay. 11 U.S.C. secs. 3621989 U.S. Tax Ct. LEXIS 113">116 (c) and (d) (1982).The consolidated return regulations, promulgated under the authority of section 1502, 2 are legislative in character. Central to the provisions of the consolidated return regulations is the common parent's role as exclusive agent for the affiliated group with respect to all procedural matters. Southern Pacific Transportation Co. v. Commissioner, 84 T.C. 395">84 T.C. 395, 84 T.C. 395">401 (1985).Section 1.1502-77(a), Income Tax Regs., provides:The common parent, for all purposes * * * shall be the sole agent for each subsidiary in the group, duly authorized to act in its own name in all matters relating to the tax liability for the consolidated return year. * * * [No] subsidiary shall have authority to act for or to represent itself in any such matter. * * * [The] common parent will file petitions and conduct proceedings before the Tax Court of the United States, and any such petition1989 U.S. Tax Ct. LEXIS 113">117 shall be considered as also having been filed by each such subsidiary. * Each member of the affiliated group (e.g., the common parent and each subsidiary) is severally liable for the entire 93 T.C. 166">169 amount of any tax deficiency determined for the consolidated return. Sec. 1.1502-6(a), Income Tax Regs.Respondent contends that pursuant to the consolidated return regulations the nonbankrupt subsidiaries lack authority to file a petition and conduct a proceeding before this Court. Petitioners contend that the nonbankrupt subsidiaries should not be deprived of a chance of "pre-payment review of the notice of deficiency simply because the parent is legally incapable of acting on behalf of its subsidiaries" and that therefore, we should create an exception to the sole agency rule contained in section 1.1502-77(a), Income Tax Regs., when the common parent is in bankruptcy.Being legislative in character, the consolidated return regulations are entitled to great weight. Section 1.1502-77(a), Income Tax Regs., makes no mention of the bankruptcy of the common parent corporation. In contrast, in the context of the partnership audit and litigation procedures, the applicable regulations1989 U.S. Tax Ct. LEXIS 113">118 require the selection of a successor tax matters partner in the event the tax matters partner files for bankruptcy. Secs. 301.6231(a)(7)-1T and 301.6231(c)-7(T), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6793 (Mar. 5, 1987).Having elected the benefits associated with filing a consolidated return, petitioners are subject to the attendant burdens. 3 We, therefore, decline petitioners' invitation to create an exception to the longstanding sole agency rule. Creation of such an exception properly rests within the province of the legislature or regulation writing authorities rather than this Court. As Sutton Investments, the common parent, is vested with exclusive authority to file a petition in this Court on behalf of the affiliated group, and since it is precluded from doing so by virtue of its pending bankruptcy, we lack jurisdiction to determine the tax liability of the affiliated group, as well as the tax liability of each member thereof.1989 U.S. Tax Ct. LEXIS 113">119 Petitioners cite McClamma v. Commissioner, 76 T.C. 754">76 T.C. 754 (1981), to support their position that they should be permitted to file a petition when their common parent is in bankruptcy. In McClamma, the taxpayers, husband and 93 T.C. 166">170 wife, filed a joint petition challenging respondent's notice of deficiency. However, prior to filing their joint petition, husband-taxpayer individually filed for bankruptcy. We therein concluded that the filing for bankruptcy automatically stayed the petition of the husband-taxpayer but not the wife-taxpayer since she was not in bankruptcy, and the husband's bankruptcy had no effect on the validity of her petition. McClamma v. Commissioner, 76 T.C. 754">76 T.C. 758. McClamma involved the tax liability of individual taxpayers and thus is distinguishable from the instant case which involves the consolidated corporate income tax liability of an affiliated group and the sole agency rule under section 1.1502-77(a), Income Tax Regs. Moreover, our decision in McClamma was premised on our conclusion in Baron v. Commissioner, 71 T.C. 1028">71 T.C. 1028 (1979) that a husband and1989 U.S. Tax Ct. LEXIS 113">120 wife filing joint returns are to be treated as separate taxpayers rather than as a single taxpaying entity. McClamma v. Commissioner, 76 T.C. 754">76 T.C. 758. Here, it is appropriate to treat the affiliated group as a single taxpaying entity.Although not determinative, we note that our disposition of respondent's motion avoids an anomalous result. Here, neither the Government nor any of the corporations in bankruptcy requested the bankruptcy court to lift the stay. Thus, if we were to deny respondent's motion, this Court and the bankruptcy court (exercising its jurisdiction to decide tax issues under 11 U.S.C. section 505 (1982)) each might proceed to decide the consolidated corporate tax liability issue, a result contrary to the exercise of judicial economy and consistency.To reflect the foregoing,An appropriate order granting respondent's motion to dismiss will be entered. Footnotes1. 11 U.S.C. 362(a)(8) (1982) provides in relevant part:(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title * * * operates as a stay, applicable to all entities, of* * * *(8) the commencement or continuation of a proceeding before the United States Tax Court concerning the debtor.↩2. Unless otherwise noted, all section references are to the Internal Revenue Code of 1954 as amended.↩3. We need not decide whether one of these burdens is the loss of a prepayment forum. See secs. 6213(f) and 6503(a).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619292/	Dora S. Hughes, Petitioner, v. Commissioner of Internal Revenue, RespondentHughes v. CommissionerDocket No. 38765United States Tax Court26 T.C. 23; 1956 U.S. Tax Ct. LEXIS 222; April 9, 1956, Filed 1956 U.S. Tax Ct. LEXIS 222">222 Decision will be entered for the respondent. Individual Income Tax Returns -- Joint or Separate. -- Return forms captioned in the names of both spouses and signed by both, in which it was stated that no separate returns were being filed, and in which the tax was computed on aggregate income, held to be joint returns on which the wife is jointly and severally liable for the deficiencies and additions for fraud, even though the fraudulent acts were solely those of the husband. Schedules attached to the returns which listed separately the income and deductions of the spouses do not, in the light of other evidence, establish intent to file separate returns. W. L. Clifton, Esq., for the petitioner.Raymond Whiteaker, Esq., for the respondent. Atkins, Judge. ATKINS26 T.C. 23">23 The respondent in a notice of deficiency addressed to Mr. John A. Hughes and Mrs. Dora S. Hughes, husband and wife, determined deficiencies in income tax and additions to the tax for the years and in the amounts as follows:50 per centAmount ofadditionYeardeficiency(sec. 293 (b))1941$ 895.56$ 447.7819423,238.151,619.0819431 10,118.055,059.03194646,587.7423,293.87194735,010.6717,505.34The petition filed 1956 U.S. Tax Ct. LEXIS 222">223 with this Court is captioned in the name of Dora S. Hughes, alone, and it is verified by her alone. The petitioner challenges the respondent's determination that she is liable for the tax deficiencies and additions to tax. The basis for the challenge is that although the returns filed purported to be joint returns of husband and wife, each one was in reality two separate returns, one for the petitioner and one for her husband. The petitioner alleges that because her income was separately reported, she is not liable for any omissions on the part of her husband in the reporting of his income, or any consequences thereof.By answer, the respondent alleges that the returns were false and fraudulent with intent to evade tax, that a part of the deficiency for each year is due to fraud with intent to evade taxes, and that the petitioner and her husband are jointly and severally liable for the additions to the tax. By reply, the petitioner denies liability, contending that the returns were not joint returns and that there was no fraud in her returns.26 T.C. 23">24 FINDINGS OF FACT.Some of the facts were stipulated and are found as stipulated.The petitioner is an individual who resides in Sumter, South 1956 U.S. Tax Ct. LEXIS 222">224 Carolina. She and John A. Hughes were married when she was 22 years of age, and at the time of the hearing of this proceeding they had been married for 33 years.John A. Hughes was a salesman. He was given to drinking, some of it excessive. While away from home on his job he wrote checks against his bank account and returned home without funds, and without recollection of having written checks. The petitioner, although employed, could not properly support herself and children. Because of the inability of John to care for his money, he began the practice of depositing funds in banks in the name of the petitioner, and continued to do so in the following years. It was always understood that funds so deposited were in fact the property of John and that the petitioner was not to write checks against such deposits unless he directed her to do so. John not only checked money out of the bank, but also cashed checks received in payment of lumber sold by him, and would spend the money while drinking.In the fall of 1939, while John was employed as a traveling salesman for a lumber company, he started, on his own account, selling and filling small orders for lumber which were not acceptable 1956 U.S. Tax Ct. LEXIS 222">225 to his employer. In this way he established his own business of selling lumber. It was entirely his business, and the petitioner was never a partner in it. John prepared in pencil his invoices covering his sales of lumber. At night the petitioner copied the invoices on the typewriter. She noted on the invoices the cost of the lumber and the amount of the profits. She also checked the monthly bank statements. She performed these tasks as the wife of John, and not as his employee. In performing these tasks, she learned enough about John's business, and she knew enough about his personality, to cause her to be concerned as to whether he was making accurate income tax returns. She questioned him about his returns, and he always assured her that he was making accurate returns, but his manner was such that she could not believe him.During the years 1941 and 1942, and for a part of 1943, the petitioner was employed and received a salary for such employment. In each of those years she also received unemployment compensation from the State of South Carolina. The petitioner and John had three children, all of whom were minors during the entire year 1941, two were minors during the entire 1956 U.S. Tax Ct. LEXIS 222">226 year 1942, one was a minor during the entire year 1943, and one a minor during part of that year. The couple had no dependents in 1946 and 1947.26 T.C. 23">25 For each of the years 1941, 1942, 1943, 1946, and 1947 there was filed with the collector (now district director) of internal revenue for the district of South Carolina a Treasury Department Form 1040, in each of which was typed the names "JOHN A. AND DORA S. HUGHES" in the space provided for the name of the taxpayer. The names were typed in immediately above the printed instruction on the forms for 1941, 1942, and 1943 to "Use given names of both husband and wife, if this is a joint return," and the instructions on the forms for 1946 and 1947 that "If this return is for a husband and wife, use both first names." Each return bore the ink-written signatures of John A. Hughes and Dora S. Hughes. The signatures were written immediately above the printed instructions which, with slight variation in phraseology, directed on each form that if it was a joint return it must be signed by both husband and wife. The answer "No" was given to the question on the return for 1946 which read: "Is your wife (or husband) making a separate return for 1946?" 1956 U.S. Tax Ct. LEXIS 222">227 The answer "No" was given to the question on the return for 1947 which read: "Is your wife (or husband) making a separate return for 1947?" On page 2 of the 1941 and 1942 returns and on page 3 of the 1943 return the taxpayers left blank the spaces in the provisions which read:If separate return was made for the current year, state: (a) Name of husband or wife (b) Personal exemption, if any, claimed thereon (c) Collector's office to which was sent On the face of each of the Forms 1040, figures were typed in which, based on schedules attached to the forms, purported to be the aggregate of the gross income, deductions, and net income of the petitioner and her husband. The tax shown on each return was computed on such aggregate net income.Attached to each of the Forms 1040 were schedules which set out separately, and in detail, the purported income of the petitioner and her husband, and the sources thereof. Such schedules also show the amount and character of all deductions taken on the returns, such as expenses, charitable contributions, medical expenses, taxes, interest, losses, and depreciation. Except for a relatively few of such deductions in comparatively small amounts, 1956 U.S. Tax Ct. LEXIS 222">228 the schedules show separately the deductions attributable to the petitioner and to her husband. The schedules in each instance bore a caption stating that it was in support of "Income Tax Returns" for the particular year. A footnote typed on the face of the Form 1040 for 1947 recites: "EXTENSION OF TIME FOR FILING RETURNS."Except for minor adjustments, explained in the revenue agent's report which is in evidence, the separate gross income and deductions 26 T.C. 23">26 of the petitioner were correctly shown in the Forms 1040 that were filed. Such adjustments, which represent unallowable deductions, and are reflected in the computations in the notice of deficiency, consisted of expense and depreciation on an automobile used by the petitioner in 1941, 1942, and 1943 in commuting to and from work.During the years 1941, 1942, 1943, 1946, and 1947, John A. Hughes was engaged in the business of buying and selling lumber, and realized therefrom profits in each of those years which were not disclosed in the income tax returns that were filed. During the year 1947, he received taxable income in the amount of $ 15,946.95 from a partnership known as Kelly and Hughes, which income he did not disclose on 1956 U.S. Tax Ct. LEXIS 222">229 the income tax return filed for that year.The net income shown in the returns and the amount of net income determined by the respondent were as follows:Determined byYearShown on returnrespondent1941$ 3,621.46$ 9,625.9319422,572.3713,923.371943 2,762.2926,159.00(Victory tax net income)3,709.4327,129.0219469,496.9182,129.3719478,815.4466,689.71John A. Hughes, with willful intent to evade tax, fraudulently failed to disclose his correct taxable income from his lumber business for the taxable years, and from the partnership of Kelly and Hughes for the year 1947 on the income tax returns that were filed. A part of the deficiency in income tax for each of the years 1941, 1942, 1943, 1946, and 1947 is due to fraud on the part of John A. Hughes with intent to evade taxes.On February 21, 1950, John A. Hughes was indicted at Columbia, South Carolina, under section 145 (b) of the Internal Revenue Code of 1939, for willful evasion of income taxes for the years 1943, 1944, 1945, 1946, and 1947. On October 23, 1950, he entered a plea of guilty to the indictment in the United States District Court for the Eastern District of South Carolina, and was sentenced to serve 1 year and 1 day in the custody 1956 U.S. Tax Ct. LEXIS 222">230 of the Attorney General of the United States, and to pay a fine of $ 10,000.On November 6, 1951, the respondent, by registered mail, sent a notice of deficiency in income taxes for the years 1941, 1942, 1943, 1946, and 1947 addressed to "Mr. John A. Hughes and Mrs. Dora S. Hughes, Husband and Wife * ." The petition in this proceeding, which is based on that notice of deficiency, is captioned in the name of Dora S. Hughes and is verified by her. John A. Hughes did not file a petition with this Court for redetermination of the deficiencies determined in the notice of November 6, 1951.26 T.C. 23">27 The return for each of the years in controversy was a joint return of the petitioner and her husband, John A. Hughes. Each of such returns was fraudulent with intent to evade tax. A part of the deficiency for each year is due to fraud with intent to evade tax.OPINION.The petitioner's contention is that the returns filed for the years in question, 1941, 1942, 1943, 1946, and 1947, were not, in fact and law, joint returns and that consequently there is no joint or several liability on her part, under section 51(b) of the Internal Revenue Code of 1939, 11956 U.S. Tax Ct. LEXIS 222">232 for any deficiency or addition to the tax resulting 1956 U.S. Tax Ct. LEXIS 222">231 from the fraud on the part of her husband. It is her position that each one of the returns in effect constitutes two separate returns, one for her husband and one for herself for each of the years, inasmuch as the schedules attached to each return set forth information showing separately the items and sources of income and deductions of herself and her husband. She claims, and it has been stipulated, that except for minor adjustments made by the respondent, the separate gross income and deductions pertaining to her were correctly shown in the Forms 1040 that were filed. If she is correct in her contention that in effect she filed separate returns it would also follow that the statute of limitations would bar assessment and collection of any deficiency which might be due from her as a result of the adjustments made by the respondent in the notice of deficiency, since there was no fraud on her part in reporting her income and deductions. Secs. 275 (a) and 276 (a) of the 1939 Code. 21956 U.S. Tax Ct. LEXIS 222">233 26 T.C. 23">28 Section 51 (b) of the Code makes it clear that if a joint return is filed the spouses are jointly and severally liable for the full tax liability. It is well established that the joint and several liability extends to any addition to the tax on account of fraud, even though the fraud may be attributable only to one spouse. Myrna S. Howell, 10 T. C. 859, affd. (C. A. 6) 175 F.2d 240; W. L. Kann, 18 T.C. 1032, affd. (C. A. 3) 210 F.2d 247; Arthur N. Dellit, 24 T.C. 434; Boyett v. Commissioner, (C. A. 5) 204 F.2d 205, affirming a decision of this Court.We turn then to the primary question presented as to whether the returns in question were joint returns of the petitioner and her husband. The respondent's determination in this respect is prima facie correct, and 1956 U.S. Tax Ct. LEXIS 222">234 the burden of proof is upon the petitioner to show error on his part. Myrna S. Howell, supra;Virginia M. Wilkins, 19 T.C. 752; Hyman B. Stone, 22 T.C. 893.For each year the return on its face purports to be a joint return in that in the space provided for the name of the taxpayer, the names of both the petitioner and her husband are typed. Each return was signed by both the petitioner and her husband. Each return indicated, in the proper place, that a separate return was not being filed for each spouse. In each return the tax liability was computed upon the aggregate income and deductions of both the petitioner and her husband. The petitioner does not contend that her signature was obtained by coercion, by fraud, or by mistake. Her action in joining with her husband and signing the returns was voluntary. See Estate of Merlin H. Aylesworth, 24 T.C. 134. Her claim that the returns in question constituted separate returns is based upon the fact that schedules attached to each return show separately the income and the deductions attributable to her and to her husband, the fact that each schedule bears a caption stating that it is in support of "Income Tax Returns" and the fact 1956 U.S. Tax Ct. LEXIS 222">235 that a footnote typed on the face of the Form 1040 filed for 1947 recites "EXTENSION OF TIME FOR FILING RETURNS." It is contended that the fact that the plural is used is evidence of the petitioner's intent that each return should be treated as two separate returns.The petitioner herself did not appear to testify at the hearing because of illness. However, her affidavit was taken and was received in evidence. In her affidavit she stated "I did not add or commingle any of my earnings and deductions for income tax purposes with my husband. I did not make joint returns with him. I made entirely separate report in my income tax returns for the years in question of my individual earnings, my individual deductions and of my individual net income." The affidavit was received in evidence with the understanding of both counsel that the petitioner's conclusion that 26 T.C. 23">29 she did not make joint returns with her husband was merely evidentiary and that the question whether the returns were joint returns would be determined in the light of not only the affidavit, but also of all other evidence in the record. Her statement in this respect is a legal conclusion and is not determinative. Such statement 1956 U.S. Tax Ct. LEXIS 222">236 is not tantamount to a statement that it was her intention, at the time of preparing and filing the returns, not to file joint returns. We are of the opinion that if she had intended to file separate returns she would have prepared and filed separate Forms 1040. Here the income and deductions of each spouse were included in one Form 1040 for each year, the tax was computed on a combined basis, and each spouse signed. There was no statement on the returns, or any other notice given to respondent, that the returns were other than what they purported to be, namely, joint returns. No authority has come to our attention which would justify a holding that these were not joint returns. In many cases it has been held that even though a wife did not sign returns, they nevertheless constituted joint returns in the absence of proof that she did not consent to their being filed in the joint names of husband and wife. Joseph Carroro, 29 B. T. A. 646; Myrna S. Howell, supra;W. L. Kann, supra;Hyman B. Stone, supra.Where, as here, the returns bear the admitted signature of the petitioner the burden of overcoming the presumptive correctness of the respondent's determination is substantially 1956 U.S. Tax Ct. LEXIS 222">237 increased. Virginia M. Wilkins, supra.The respondent has, in his rulings, recognized that under some circumstances a single return form filed by husband and wife may constitute separate returns, dependent upon intent. 31956 U.S. Tax Ct. LEXIS 222">238 However, the facts in the instant case do not establish an intent of the parties to file separate returns. The cases of Paul Gordon Whitmore, 25 T.C. 293, and Strich v. Westover, (S. D., Cal.) 87 F. Supp. 40">87 F. Supp. 40, are distinguishable from the instant case on the facts. In those cases it appeared that the computations on the face of the returns showed that the intention was to file separate returns on a community property basis, rather than joint returns. Upon a consideration of the whole record we have found as an ultimate fact, and hold, that the return for each of the years in question was a joint return.26 T.C. 23">30 Since the deficiencies determined by the respondent are presumed prima facie to be correct, and the petitioner has not adduced any proof whatsoever to show error in the respondent's determination, we approve the determined deficiencies. The burden of proof as to the fraud issue is upon the respondent. However, the stipulated facts show that a part of each deficiency is due to fraud with intent to evade tax and that each return was false or fraudulent with intent to evade tax, and we have so found. We accordingly hold that the additions to tax under section 293 (b) of the Code were proper, that the statute of limitations does not bar assessment and collection of the deficiencies and additional amounts, and that the petitioner 1956 U.S. Tax Ct. LEXIS 222">239 is liable jointly and severally for the deficiencies and additions to the tax determined by the respondent.Decision will be entered for the respondent. Footnotes1. Including Victory tax.↩1. Section 51 (b) as in effect for the years 1941, 1942, and 1943 provided as follows:SEC. 51. INDIVIDUAL RETURNS.(b) Husband and Wife. -- In the case of a husband and wife living together the income of each (even though one has no gross income) may be included in a single return made by them jointly, in which case the tax shall be computed on the aggregate income, and the liability with respect to the tax shall be joint and several. No joint return may be made if either the husband or wife is a nonresident alien.Section 51 (b) as in effect for the years 1946 and 1947 provided as follows:(b) Husband and Wife. -- A husband and wife may make a single return jointly. Such a return may be made even though one of the spouses has neither gross income nor deductions. If a joint return is made the tax shall be computed on the aggregate income and the liability with respect to the tax shall be joint and several. No joint return may be made if either the husband or wife is a nonresident alien or if the husband and wife have different taxable years. The status of individuals as husband and wife shall be determined as of the last day of the taxable year.↩2. SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.Except as provided in section 276 --(a) General Rule. -- The amount of income taxes imposed by this chapter shall be assessed within three years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.SEC. 276. SAME -- EXCEPTIONS.(a) False Return or No Return. -- In the case of a false or fraudulent return with intent to evade tax or of a failure to file a return the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time.↩3. O. D. 960, 4 C. B. 255 states:Where husband and wife clearly indicate on a single return form the net income of each, such a return does not necessarily constitute a joint return. It is a matter of intent. Having separated their respective incomes, in the absence of a showing to the contrary the presumption is that they intended to file separate returns of income, but that for convenience they have used one form. In such case both the normal and surtax should be computed on the separate income of each. This presumption is, however, overcome if the tax has been computed by the taxpayer on the combined net income; in which case, even though their incomes have been separated and can be identified, the return is held to be a joint return, and both the normal and surtax should be assessed on the basis of combined net income.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619293/	UNIVERSITY HEIGHTS AT HAMILTON CORP., JOSEPH CELLER, A PERSON OTHER THAN THE TAX MATTERS PERSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentUniversity Heights at Hamilton Corp. v. CommissionerDocket No. 7956-90United States Tax Court97 T.C. 278; 1991 U.S. Tax Ct. LEXIS 76; 97 T.C. No. 17; August 20, 1991, Filed 1991 U.S. Tax Ct. LEXIS 76">76 An order denying petitioner's Motion to Dismiss for Lack of Jurisdiction will be issued. Respondent mailed notices of FSAA's in which he determined adjustments to enumerated subchapter S items and determined that two of the three shareholders had insufficient bases to support their distributive share of subchapter S corporation losses claimed on their individual tax returns. Held: We have no jurisdiction to determine the amount of individual shareholders' bases, but we do have jurisdiction over those subchapter S items enumerated in the FSAA's, even though these items affect shareholders' bases. Andrew P. Fradkin, for the petitioner. William A. Heard, III and Curtis G. Wilson, for the respondent. CLAPP, Judge. CLAPP97 T.C. 278">278 OPINION This matter is before the Court on petitioner's Motion to Dismiss for Lack of Jurisdiction filed August 22, 1990. On December 15, 1989, respondent mailed notices of final S corporation administrative adjustment (FSAA) to Paul Celler, the tax matters person (TMP) of University Heights At Hamilton Corp. (University Heights) for the taxable years ending October 31, 1984, October 31, 1985, and October 31, 1986. The Explanation of Items 1991 U.S. Tax Ct. LEXIS 76">77 forms attached to each FSAA stated that University Heights was a "no change." The deductions and losses of University Heights and their allocation among shareholders as reported on the corporate returns were not adjusted in the FSAA's. Respondent determined adjustments which affected shareholders' 97 T.C. 278">279 bases by determining or making adjustments to the following items: Capital Stock Loans Payable (Corp.) Loans Receivable (Corp.) 1984 Corporate Loss Allowable Contributions Capital Loss - ST Capital Losses Investment Interest Section 179 Deduction Allowable 1984 net operating lossRespondent determined the amounts and allocation of cash contributions and loans from a review of University Heights' corporate books and records. Respondent determined that two of the three shareholders had insufficient bases to support their distributive share of subchapter S corporate losses claimed on their individual tax returns. University Heights is a subchapter S corporation subject to the subchapter S corporation audit and litigation procedures contained in section 6241 et seq.1Section 6244 incorporates four categories of partnership audit and litigation provisions into the subchapter1991 U.S. Tax Ct. LEXIS 76">78 S corporation audit and litigation procedures, those relating to: (1) Assessments of deficiencies, (2) filing claims for credit or refund, (3) judicial determinations of partnership items, and (4) partnership items. The subchapter S corporation audit and litigation procedures provide that the tax treatment of items of subchapter S income, loss, deductions, and credits generally will be determined at the corporate level in a unified proceeding rather than in separate proceedings at the shareholder level. Subchapter S Revision Act of 1982, Pub. L. 97-354, sec. 4(a), 96 Stat. 1691-1692; see S. Rept. 97-640, at 25 (1982), 1982-2 C.B. 718, 729. The TMP did not file a petition with this Court, nor with a United States District Court or the Claims Court, within the applicable period pursuant to section 6226(a). A person other than the TMP filed with this Court a Petition For Readjustment Of S Corporation1991 U.S. Tax Ct. LEXIS 76">79 Items Under Code Section 6226. Petitioner 97 T.C. 278">280 argues that the "adjustments" made by respondent in the FSAA's did not in any way change University Heights' income, losses, deductions, or credits, and that respondent's agent did not allege that his calculations differed from those set forth in the corporation's tax returns, books, and records. Petitioner contends that because respondent determined adjustments only to shareholders' bases in their subchapter S corporation stock and failed to determine any adjustments to subchapter S items, this Court must dismiss the case for lack of subject matter jurisdiction. Respondent agrees that shareholder basis is not a subchapter S item over which this Court has jurisdiction in this corporate level proceeding. He concedes that he improperly raised the issue of shareholders' bases and the issue of the allowable amount of a 1984 net operating loss carryforward in his FSAA's, and he agrees that these issues should be dismissed for lack of jurisdiction. However, he contends that this Court does have jurisdiction over the other items enumerated in the FSAA's, whether they were adjusted, reallocated, or accepted as reported on the corporate returns, 1991 U.S. Tax Ct. LEXIS 76">80 as those other items are subchapter S items. Both parties cite Dial U.S.A., Inc. v. Commissioner, 95 T.C. 1">95 T.C. 1 (1990), to support their positions. In Dial U.S.A., Inc., this Court held that an individual shareholder's basis in a subchapter S corporation is not a subchapter S item that can be determined in a corporate level proceeding pursuant to section 6241 et seq. Respondent contends, however, that the FSAA's issued in this case were premised on adjustments, allocations, or "no changes" to subchapter S items, and although such items constitute components of shareholders' bases, he argues that Dial U.S.A., Inc. does not stand for the proposition that we lose jurisdiction over subchapter S items merely because a determination of them may affect shareholder basis. We agree. A subchapter S item is defined as "any item of an S corporation to the extent regulations prescribed by the Secretary provide that, for purposes of this subtitle, such item is more appropriately determined at the corporate level than at the shareholder level." Sec. 6245. The tax treatment of any subchapter S item is determined at the corporate 97 T.C. 278">281 level. Sec. 6241. Pursuant to temporary1991 U.S. Tax Ct. LEXIS 76">81 regulations promulgated by the Secretary, subchapter S items are those "items which are required to be taken into account for the taxable year of an S corporation." Sec. 301.6245-1T(a), Temporary Proced. & Admin. Regs., 52 FR 3003 (Jan. 30, 1987). The regulations define subchapter S items in part as follows: (1) The S corporation aggregate and each shareholder's share of, and any factor necessary to determine, each of the following: (i) Items of income, gain, loss, deduction, or credit of the corporation; * * * (v) Corporate liabilities (including determinations of the amount of the liability, whether the corporate liability is to a shareholder of the corporation, and changes from the preceding year);* * * * * * (5) Items relating to the following transactions, to the extent that a determination of such items can be made from determinations that the corporation is required to make with respect to an amount, the character of an amount, or the percentage of stock ownership of a shareholder in the corporation, for purposes of the corporation's books and records or for purposes of furnishing information to a shareholder: (i) Contributions to the1991 U.S. Tax Ct. LEXIS 76">82 corporation; and (ii) Distributions from the corporation.[Sec. 301.6245-1T(a), Temporary Proced. & Admin. Regs., supra.]The explanation of adjustments made in respondent's FSAA's specifically stated that respondent's agent "only adjusted taxpayer's basis." These adjustments to basis, however, resulted directly from respondent's review of each shareholder's allocable share of corporate deductions and losses, of loans between the shareholders and the corporation, and of the amounts of capital stock purchased and cash contributions made by the shareholders. These items are specifically defined as subchapter S items as noted above. The treatment by University Heights of these items is more appropriately determined at the corporate level than at the shareholder level. See sec. 301.6245-1T(a) and (b), Temporary Proced. & Admin. Regs., supra. Although in this case these items affect shareholders' bases, they are subchapter S items that are required to be determined at the corporate level proceeding. Therefore, they are items over which we have jurisdiction in this proceeding. 97 T.C. 278">282 Further, the fact that respondent determined no adjustments to University Heights' income1991 U.S. Tax Ct. LEXIS 76">83 or losses does not prevent us from having jurisdiction in this case. The prerequisites to this Court's jurisdiction are the issuance of an FSAA and the timely filing of a petition. Secs. 6223, 6226; cf. Rule 240(c)(1). The issuance of an FSAA, even one recommending that no change be made to corporate income or losses, serves to meet the statutory requirement of section 6223(a) to give notice of the completion of the administrative proceeding. In some instances, respondent may choose to issue a "no change" FSAA to prevent a shareholder from later filing an administrative adjustment request with respect to the subchapter S items in question. See sec. 6227; see also sec. 6228. In any event, petitioner received a valid FSAA as required by section 6223 and filed a timely petition as required by section 6226. Once this has occurred, the scope of our judicial review allows us to determine all subchapter S items of the corporation for the corporate taxable year to which the notice of FSAA relates and the proper allocation of such items among the shareholders. Sec. 6226(f); see Hang v. Commissioner, 95 T.C. 74">95 T.C. 74 (1990). The parties agree that we do not have jurisdiction1991 U.S. Tax Ct. LEXIS 76">84 over shareholders' bases in University Heights. Respondent also has withdrawn the net operating loss carryforward issue. Accordingly, petitioner's motion to dismiss for lack of jurisdiction as to petitioner's taxable years 1984, 1985, and 1986 will be denied. An order denying petitioner's Motion to Dismiss for Lack of Jurisdiction will be issued. Footnotes1. All section references are to the Internal Revenue Code as amended and in effect for the years at issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619295/	William S. Gray & Company v. Commissioner.William S. Gray & Co. v. CommissionerDocket No. 15501.United States Tax Court1950 Tax Ct. Memo LEXIS 235; 9 T.C.M. 267; T.C.M. (RIA) 50079; March 29, 19501950 Tax Ct. Memo LEXIS 235">235 Equity invested capital. - Held, that petitioner has not established that the good will of its predecessor proprietorship had any fair market value at the time petitioner acquired the predecessor's business for its stock in December 1904, and respondent properly excluded such claimed good will in computing petitioner's equity invested capital under section 718, I.R.C.J. Marvin Haynes, Esq., Investment Bldg., Washington, D.C., and Philip Bardes, Esq., for the petitioner. Harold D. Thomas, Esq., for the respondent. TYSON Memorandum Findings of Fact and Opinion TYSON, Judge: The respondent has determined a deficiency in petitioner's excess profits tax in the amount of $11,022.64, for the calendar year 1941. Petitioner assigns error in respondent's elimination of an amount claimed as good will in computation of petitioner's equity invested capital. Further adjustments made by respondent to petitioner's income and excess profits tax liability are not in controversy. Petitioner claims a refund of excess profits tax in the amount of $77,350.04 for the above year. The proceeding was submitted upon a stipulation of facts, oral testimony, 1950 Tax Ct. Memo LEXIS 235">236 and exhibits. The stipulation, included herein by reference, is adopted as a part of our findings of fact, but only such portions thereof as are deemed necessary to the disposition of this proceeding are set forth in our findings of fact. Findings of Fact The petitioner, William S. Gray & Company, is a corporation organized under the laws of New York in December 1904, with its principal office at 342 Madison Avenue, New York, New York. It filed a timely excess profits tax return for the calendar year 1941 on an accrual basis with the collector of internal revenue for the third district of New York. The excess profits tax disclosed by the return in the amount of $77,350.04 was paid before the statutory due dates. Prior to March 15, 1945, and within three years from the time the return was filed, both petitioner and respondent executed an agreement on Form 872 extending the period of limitation on assessment of 1941 income and excess profits taxes to June 30, 1946. The 1941 excess profits tax in the amount of $77,350.04 was paid during the three years immediately preceding the execution of such agreement. Prior to June 30, 1946, both petitioner and respondent executed another1950 Tax Ct. Memo LEXIS 235">237 agreement on Form 872 further extending the period of limitation on assessment of 1941 income and excess profits taxes to June 30, 1947. On December 18, 1946, petitioner filed a claim for refund of 1941 excess profits tax in the amount of $77,350.04, on the ground that its equity invested capital should include good will in the amount of $770,000 rather than $250,000 as shown on the return. Petitioner claimed an unused excess profits credit carry-over from 1940 and unused excess profits credit carry-backs from 1942 and 1943. With regard to that carry-over and those carry-backs it is stipulated that they shall be computed under Rule 50 consistent with the amount of good will, if any, determined in this proceeding. On June 16, 1947, respondent mailed to the petitioner a notice of deficiency for the year 1941 in the amount of $11,022.64, eliminating from petitioner's equity invested capital the amount of $250,000 claimed in the return as good will. Petitioner's invested capital shown by its return was $1,196,443.51. Respondent computed petitioner's invested capital at $966,742.77, after eliminating the $250,000 claimed as good will and recomputing in conjunction therewith the reduction1950 Tax Ct. Memo LEXIS 235">238 on account of inadmissible assets. The petition herein was filed August 11, 1947. Petitioner is the successor to the business which was founded by William S. Gray (hereinafter sometimes referred to as Gray) in 1880 and carried on by him as a sole proprietorship until the organization of petitioner in 1904. The business of petitioner and the predecessor proprietorship (hereinafter sometimes referred to as the proprietorship) was a commission business in chemicals, principally acetate of lime and wood alcohol in which the petitioner and the proprietorship acted as selling agent for manufacturers receiving commissions therefor. Neither petitioner nor the proprietorship did any manufacturing. Both products were derived from the distillation of wood, although wood alcohol, unlike acetate of lime, had to be further refined. Approximately 75 per cent of all acetate of lime manufactured in the United States and either sold in the domestic trade or exported was handled by the proprietorship prior to its incorporation. It was the exclusive selling agent for Wood Products Company, one of the largest manufacturers of wood alcohol in the country. Written agency contracts on an annual basis were1950 Tax Ct. Memo LEXIS 235">239 executed in the fall of each year between the manufacturers of acetate of lime and of wood alcohol and the proprietorship. Gray was a very forceful man in the industry and had personal contact with every manufacturer every year making all the contracts with them. The retention of the business represented by these contracts was partly attributable to the personal relationship between the manufacturers and Gray and Crawford, one of the proprietorship's employees. The proprietorship had a very good reputation in the trade. The relationship between the proprietorship and the manufacturers was very cooperative. The manufacturers shipped to the proprietorship which then sold the products at a commission of two per cent on acetate of lime and two and one-half per cent to five per cent on wood alcohol. The proprietorship guaranteed the accounts of the customers to whom it sold. Prior to incorporation of petitioner the key employees of the proprietorship were James J. Crawford and Ezra J. Wright. From about 1895 Gray permitted the latter two to participate with him in the profits of the proprietorship by paying them a low fixed salary and then giving them as additional compensation a bonus1950 Tax Ct. Memo LEXIS 235">240 from the profits. Petitioner was incorporated on December 29, 1904, with an authorized capital stock of 2,500 shares of par value of $100 each. On December 31, 1904, at the first meeting of the incorporators, the five incorporators, William S. Gray, Ezra J. Wright, James J. Crawford, Edmund L. Mooney, and W. Paxton Little, paid cash to petitioner for the subscription price of the 25 shares of the capital stock of petitioner ($2,500 par value) to which they had subscribed in the amount of $2,500. Also at that meeting an offer was received from William S. Gray "to sell to this corporation all the assets and property of the business now conducted by him * * * together with all outstanding contracts for purchase and sales, the lease of the premises and good will of the business, for the sum of * * * $247,500 in stock of this company at par and $2,500. - in cash, upon this company assuming and agreeing to pay all outstanding debts obligations and liabilities incurred in said business." Ezra J. Wright, chairman of the meeting, stated: "that he was familiar with the value of the assets of the said business and that in his opinion the same were of the value at which they were offered1950 Tax Ct. Memo LEXIS 235">241 to this company." James J. Crawford, secretary of the meeting, stated: "that he was familiar with the business above referred to and that in his opinion the property was of the value at which it was offered to the company and was necessary for the transaction of the business of the company." After these statements the offer of Gray was duly accepted by proper resolution. The transactions provided for at the first meeting were completed as of December 31, 1904; 25 shares of stock being issued at par to the five incorporators for $2,500 cash and the remaining 2,475 shares being issued to Gray in exchange for the assets of the proprietorship as specified in the offer and acceptance. When petitioner's books were opened on December 31, 1904, no amount was entered for good will, but the accounts representing the assets and liabilities of the proprietorship were transferred to petitioner's books at the amounts shown by the books of the proprietorship which reflected no amount as good will. The assets of the proprietorship transferred by Gray to petitioner consisted largely of cash, inventories, (apparently products shipped to the proprietorship by manufacturers and on hand until shipment1950 Tax Ct. Memo LEXIS 235">242 by the proprietorship to parties to which it sold such products) and some investments in bonds made through use of "idle money". At a meeting of petitioner's board of directors on January 22, 1906, the following resolutions were adopted: "Resolved - That salaries for extra services rendered shall be paid from the profits of 1905 as follows: Wm. S. Gray, $105,083.24, E. J. Wright $16,194.42 and James J. Crawford $8,098.41 "Resolved - That the salaries for 1906 are arranged as follows William S. Gray $12,000.00 per annum Ezra J. Wright $5,200.00 per annum James J. Crawford $2,600.00 per annum" The foregoing amounts stated to be for "extra services" were in reality compensation for ordinary services and were paid to the named persons from the profits of 1905 after deducting a six per cent dividend of $15,000 on the outstanding capital stock. 1905 was a very prosperous year. The only available records of the proprietorship at the time of the hearing herein consisted of two accounts on a general ledger, one of the accounts being entitled "Profit and Loss", and the other being entitled "Wm. S. Gray (Business A/C)"; and each embracing the years 1886 to 1891, inclusive. 1950 Tax Ct. Memo LEXIS 235">243 Opinion Petitioner contests respondent's eliminating from petitioner's equity invested capital the sum of $250,000 claimed as good will on its 1941 excess profits tax return, and now contends that its good will should properly be valued at $770,000, and has filed a claim for refund based on such valuation. The sole question involved is: What was the fair market value of the good will of the proprietorship on December 31, 1904, when all of its assets were transferred to petitioner. If the good will then had a fair market value such value was includible in petitioner's equity invested capital under section 718, I.R.C.The petitioner contends that the value of the good will of the proprietorship on December 31, 1904, when it transferred all its assets, including good will, to the petitioner, was not less than $770,000, or if not in such amount then in a substantial amount to be determined by this Court under the principle announced in Cohan v. Commissioner, 39 Fed. (2d) 540. The respondent contends that the good will of the proprietorship in 1904 had only a nominal value, if any. At the outset it should be noted that the offer of sale of the1950 Tax Ct. Memo LEXIS 235">244 proprietorship as accepted by petitioner specifically included good will among the assets to be sold to petitioner for $250,000 ($247,500 par value of stock and $2,500 cash). If the tangible assets had a value of $250,000, as the parties apparently agree that they had, then the good will acquired by petitioner could have possessed only nominal value and confirmation of this premise appears in petitioner's failure to set up an account for good will when it opened its corporate books. In the absence of other comparably good evidence of the fair market value of good will, the price agreed upon by buyer and seller at the date of acquisition will be accepted. Cf. McKinney Manufacturing Co., 10 T.C. 135">10 T.C. 135. We now turn to the other evidence to see if a different result is warranted. In support of its contention petitioner takes the primary positions: (1) That the only available books of account of the proprietorship establish the earnings of the proprietorship and the amounts of its tangible assets invested in the business in each of the years 1887 to 1891, inclusive; (2) that by applying the formula in A.R.M. 34, 2 C.B. 31, and using a rate of eight per cent return1950 Tax Ct. Memo LEXIS 235">245 on tangibles and capitalizing the remaining earnings at 15 per cent, the good will of the proprietorship is shown to have had a value of approximately $225,000 in 1891; (3) that the business of the proprietorship increased very materially during the period from 1893 to 1904; and (4) that a fair market value of $770,000, or otherwise a substantial value on December 31, 1904, is established for the good will of the proprietorship by the factors in (1), (2), and (3) above. Do the available books of account of the proprietorship for the years 1887 to 1891, inclusive, and the supporting testimony disclose sufficient facts which, through application thereto of the formula in A.R.M. 34, invoked by petitioner, establish the value of the proprietorship's good will to be approximately $225,000 in 1891, as petitioner takes the position in (1) and (2) above that they do? We think not. The only accounts from the books of the proprietorship in evidence are from an "old ledger", one of the accounts being entitled "Profit and Loss", and the other being entitled "Wm S. Gray (Business A/C)", and each account covering the years 1886 to 1891, inclusive. The only explanation with regard to either account1950 Tax Ct. Memo LEXIS 235">246 was the testimony of one witness that certain entries on both accounts were in red, although appearing as black on the photostatic copy introduced in evidence, and the testimony of another witness, the hereinabove mentioned Crawford, who had been in the employ of the proprietorship from 1893 to 1904, part of the time as assistant bookkeeper and part of the time as bookkeeper, and thereafter in the employ of petitioner as office manager from 1904 until his retirement in 1928. The latter witness testified with respect to the "Wm S. Gray (Business A/C)", that he did not keep the account but that it looked like a business account representing Gray's investment. As to both these accounts there is a complete lack of testimony as to the method of accounting used, the nature of the various entries, including entries listed merely as "sundries", and as to the character and purpose of numerous entries in red. The petitioner in reaching its conclusion that the value of the good will of the proprietorship as of 1891 was approximately $225,000, claims as one factor that the "Profit and Loss" account does not disclose the profits of the proprietorship for 1889, but that it does disclose the profits1950 Tax Ct. Memo LEXIS 235">247 for other years as follows: YearAmount1887$22,910.92188830,006.40189032,812.03189137,304.40 We do not so analyze that account, but can say only that the account seems to indicate the following profits and losses: YearAmount1886$22,910.92 Profit188730,006.40 Profit1888(770.14) Loss1889(498.10) Loss189032,812.03 ProfitWe are unable to make a finding of those amounts as either profits or losses because of the lack of testimony in the above-mentioned particulars and also because of a failure of proof as to how such purported amounts of profit and loss for each year were arrived at. The unexplained "Wm S. Gray (Business A/C)" claimed by petitioner as another factor in reaching its conclusion that the value of the good will of the proprietorship was approximately $225,000 as of 1891 is wholly unacceptable as indicating what amounts may have constituted Gray's investment in, or the tangible assets of, the proprietorship in the various years embraced in that account. From a consideration of all the facts and circumstances, it is our opinion that the fragmentary accounts of the proprietorship in evidence fail to1950 Tax Ct. Memo LEXIS 235">248 show as facts either what the average net earnings of the proprietorship were or what its tangible assets were during the period 1887 to 1891, inclusive, or the period 1886 to 1890, inclusive, and, consequently, that there are insufficient basic facts to which the formula in A.R.M. 34 may be applied. Accordingly, we hold that petitioner has failed to establish the value of the good will of the proprietorship as of 1891 to be $225,000, or any other amount. Moreover, assuming, but not deciding, that the profits of the proprietorship from 1887 to 1891 are shown by the books of account to be in the amounts claimed by petitioner or in the different indicated amounts shown in the fourth preceding paragraph, it is still not shown, and the burden is on the petitioner to so show, that these profits were after allowances for each year of reasonable compensation to William S. Gray, the sole owner of the proprietorship; and this is necessary in order to arrive at a correct basis for estimating average profits in order to apply the formula in A.R.M. 34. Sanderson v. Commissioner, 42 Fed. (2d) 160, affirming 16 B.T.A. 1022">16 B.T.A. 1022; Edwin Schiele Distilling Co., 3 B.T.A. 873">3 B.T.A. 873;1950 Tax Ct. Memo LEXIS 235">249 Robert Thal, 3 B.T.A. 1229">3 B.T.A. 1229. Furthermore, it may be said that if the value of the good will of the proprietorship in 1891 was approximately $225,000 that fact in itself would not tend to prove the value of the good will in 1904 unless the factors upon which that fact was predicated related to years not so remote from 1904. The petitioner apparently has attempted to so relate those factors to a period of years immediately preceding 1904 by the testimony of the witness, James J. Crawford; that the business of the proprietorship increased "very materially" between 1893 and 1904. But such testimony falls far short of establishing that the factors as to earnings and value of tangible assets existing in years immediately preceding 1891 also existed in years immediately preceding 1904. We hold that as to petitioner's positions (1), (2), and (3) petitioner has failed to establish that the good will of the proprietorship when it transferred its assets to petitioner on December 31, 1904 had a value of $770,000, or any other amount. In further support of its contention as to the value of the proprietorship's good will on December 31, 1904, petitioner argues: That its profits1950 Tax Ct. Memo LEXIS 235">250 for 1905 were $161,970.20, arrived at by taking Crawford's compensation of $8,098.41 from the profits of 1905 shown by the resolution of January 22, 1906 as representing five per cent of the profits for that year; that the profits of the proprietorship for each of the years immediately preceding 1905 were approximately the same as those of petitioner for 1905; and that by applying the formula in A.R.M. 34, its contention as to the value of the good will of the proprietorship on December 31, 1904 is correct. In other words, petitioner seeks to estimate earnings for a year later than the proper valuation date and project them back as the probable earnings for each of several years immediately preceding the proper valuation date. In so doing and in applying, as it does, the formula in A.R.M. 34, it necessarily assumes a fact not shown by the record, i.e., that the $250,000 valuation of the tangible assets on December 31, 1904 of the proprietorship is likewise the valuation of such assets in each of the several years immediately preceding the proper valuation date. While Crawford testified at the hearing that the $8,098.41 represented a percentage of the profits of 1905 which petitioner1950 Tax Ct. Memo LEXIS 235">251 had agreed to, and did, pay him and that he thought that percentage was five per cent, he testified in 1925, (when his memory obviously was fresher than in 1948, the year of the hearing herein), by deposition taken in a former suit and admitted in evidence in the instant proceeding without objection, that the percentage of profits he received from petitioner had been ten per cent from the organization of petitioner until 1909. So, we think that petitioner's estimate of approximately $160,000 for its profits for 1905, based upon Crawford's compensation of $8,098.41 representing five per cent of its profits for 1905, is for these reasons obviously incorrect. It also obviously is incorrect as shown on the face of the resolution itself, since even if the profits approximated $160,000 it would be necessary, in order to arrive at the net profits of the character with which we are concerned, to deduct the total amount of $129,376.07 received by the three parties named in the resolution as compensation for their services. With reference to the profits of the proprietorship being for several years preceding the proper valuation date approximately the same as the profits of the petitioner1950 Tax Ct. Memo LEXIS 235">252 for 1905, the following testimony of Crawford is the only evidence in the record: "Q. * * * using the Minute as shown on page 19 of the Minute Book, [shown in our findings] which shows that the profits for the year 1905 were not less than $145,000.00, what would you estimate was the profits of the proprietorship immediately prior to the incorporation of the corporation? "A. I can't answer that without having the books. I know that we were doing a very good business. "Q. Would you say that the profits of the years immediately preceding 1905 were anywhere near the profits that were earned in the year 1905, the first year of the corporation? "A. I would say so." In view of Crawford's conflicting testimony as to the percentage of profits represented by the $8,098.41, and in view of his indefinite testimony as to the profit of the proprietorship in the years immediately preceding 1905, we do not think the record presents the facts necessary to sustain petitioner in its contention that the profits of the petitioner for 1905 were $161,970.20 and that the earnings of the proprietorship for several years immediately preceding January 31, 1904 were approximately the same as those1950 Tax Ct. Memo LEXIS 235">253 of petitioner in 1905; and for this reason as well as the further reason that the value of the tangible assets of the proprietorship for those immediately preceding years is not shown, but is assumed in petitioner's computation to be $250,000, (the same as the value of such tangible assets on December 31, 1904), we cannot agree with petitioner's argument in further support of its contention as to the value of the proprietorship's good will on December 31, 1904. Also, it may be further said that it is not shown that in arriving at the estimated net earnings of the proprietorship for the years immediately preceding 1905 any reasonable compensation for William S. Gray in those years was taken into consideration by petitioner. We do not glean from this record sufficient facts to justify a conclusion that the determination of the respondent that the good will of the proprietorship had no value when all its assets were transferred to petitioner is erroneous, and, consequently, that determination is approved. This being true, the principle of the Cohan case, supra, has no application. Petitioner also relies upon the testimony of a witness it presented as an expert and who testified that1950 Tax Ct. Memo LEXIS 235">254 in his opinion the value of the good will of the proprietorship at the valuation date was about $700,000. Without regard to whether or not the witness qualified as an expert we accord no weight to his opinion which was based, in material part, upon facts not shown in the record. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619296/	C. W. SEIBERLING, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Seiberling v. CommissionerDocket No. 14089.United States Board of Tax Appeals13 B.T.A. 55; 1928 BTA LEXIS 3321; July 25, 1928, Promulgated 1928 BTA LEXIS 3321">3321 Petitioner in 1920 loaned stock to several persons to enable them to pledge such stock as additional collateral in respect of debts incurred in the purchase of other stock. Collateral was not sold or forfeited in 1920. Held that deductibel loss was not established. E. W. Wallick, Esq., and Ben Jenkins, Esq., for the petitioner. W. F. Wattles, Esq., for the respondent. STERNHAGEN 13 B.T.A. 55">55 Petitioner attacks respondent's determination of a deficiency of $30,878.39, income tax for 1920. He claims a deduction for loss in respect of stock loaned to several individuals and also that the measure of a loss resulting from a loan to one Zigler should be based upon a cost higher than that recognized by respondent. FINDINGS OF FACT. The petitioner was in 1920 a resident of Ohio and vice president of the Goodyear Tire & Rubber Co. Between May 15, 1909, and November 13, 1920, inclusive, he had at various times acquired an aggregate of 37,735.30 shares of Goodyear 13 B.T.A. 55">56 stock, of which 32,512.70 shares had been acquired by stock dividends and 5,222.60 by purchase or otherwise. During this period he had in one way or another disposed1928 BTA LEXIS 3321">3322 of 4,917.30 shares, leaving him on November 13, 1920, the owner of 32,818 shares. On February 21, 1913, a sale of Goodyear stock had been made on the Cleveland Stock Exchange at $365 per share. Between April 14, 1914, and March 17, 1917, inclusive, this stock had been variously priced either in actual transactions or in market quotations at figures ranging from $173 per share to $340 per share. On March 17, 1917, a sale occurred at $280. On September 29, 1920, 10 shares were sold at $75, and the stock exchange quotations were 85 1/2 high and 80 low. From this date the price went steadily downward, and on December 23, 1920, was quoted at 22 3/4 high and 17 low. In 1920 some of the employees of the Goodyear Company were indebted in various amounts to various creditors either for the purchase of Goodyear stock or otherwise, and had pledged their stock as collateral for such indebtedness. As the market value of the Goodyear stock went down the creditors of these employees demanded payment or additional security. At the request of such employees the petitioner loaned to them in 1920 various amounts of Goodyear stock and in each instance took from the borrower a receipt in the1928 BTA LEXIS 3321">3323 following form: Received of C. W. Seiberling as a loan the following certificates of common stock of The Goodyear Tire and Rubber Company to be used as additional collateral for my loan at . Said certificates to be returned to said C. W. Seiberling when loan has been paid. At the end of 1920 the stock borrowed by Zigler had been sold by the creditors and the entire proceeds applied to Zigler's debt. The remaining shares were still being held as collateral. In some cases the collateral was sold after 1920. In some cases the borrower of the stock was in poor financial condition. In some cases the petitioner has not since 1920 received the return of the stock or any payment therefor. OPINION. STERNHAGEN: The petitioner claims the right to deduct as a loss sustained in 1920 an alleged value of the stock loaned by the petitioner to various employees of the Goodyear Company to enable them to carry their accounts. In our opinion the claim must fail for several reasons. The stock represented merely a loan by the petitioner, and its sale by the bank did not necessarily reflect a final loss to the petitioner. He might still look for reimbursement from his individual debtor1928 BTA LEXIS 3321">3324 who borrowed the stock. Furthermore, in most instances the stock 13 B.T.A. 55">57 held as collateral had in 1920 not yet been sold. Obviously, the petitioner could not claim a loss if he voluntarily relinquished his right against the borrower or refrained from exercising it. This would be particularly true in cases where the borrower of the stock was otherwise financially able to pay. But even assuming that at the end of 1920 some of this stock was irrevocably gone without hope of any recoupment, the basis for deductible loss is not in evidence. As to such stock as was acquired prior to March 1, 1913, the loss would be based upon the lower of cost or value on March 1, 1913. ; . The cost is not in evidence. As to the stock acquired subsequent to March 1, 1913, the basis would be cost, and this figure is likewise not in evidence, either as to stock purchased or that acquired by stock dividend. . It can not be said that the stock market quotations appearing in the record represent the cost to the petitioner. 1928 BTA LEXIS 3321">3325 Since, therefore, the evidence falls short of establishing either the fact that a loss was sustained in 1920 or the basis upon which a loss may be measured, the respondent is sustained. As to the loss claimed in respect of stock loaned to Zigler, the respondent allowed a deduction upon the basis of an alleged cost of $8.08 per share. The petitioner has not established that this basis is incorrect and the respondent is therefore sustained. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619297/	Charlotte Union Bus Station, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentCharlotte Union Bus Station, Inc. v. CommissionerDocket No. 31330United States Tax Court19 T.C. 336; 1952 U.S. Tax Ct. LEXIS 34; November 26, 1952, Promulgated 1952 U.S. Tax Ct. LEXIS 34">34 Decision will be entered under Rule 50. Petitioner corporation on November 26, 1940, entered into a written agreement wherein petitioner agreed to erect a bus terminal with all necessary terminal facilities, and the bus companies agreed to lease and use the facilities for a period of 15 years and to pay to petitioner as rent amounts to be determined under a prescribed formula. The respective parties entered into a written amendatory agreement on June 14, 1945.Held:1. Respondent properly computed petitioner's income for the respective taxable years involved in accordance with the terms of the original agreement until the execution of the amendatory agreement on June 14, 1945, and thereafter in accordance with the terms of the original agreement as amended.2. Under the aforesaid agreement prior to its amendment, income taxes and/or excess profits taxes asserted against petitioner were payable by the operating bus companies as rent and constituted additional income taxable to petitioner.3. Depreciation sustained by petitioner and billed to the operating companies as rent constituted taxable income to petitioner in the respective taxable years in question. Shearon Harris, Esq., and Leslie A. Heath, C. P. A., for the petitioner.Paul E. Waring, Esq., for the respondent. LeMire, Judge. LeMIRE 19 T.C. 336">336 This proceeding involves deficiencies in income, declared value excess-profits, and excess profits taxes for the years and in the amounts as follows:Declared valueYear ended July 31Income taxexcess-profitsExcess profitstaxtax1945$ 18.53$ 94.54$ 42,001.0619463,879.461,791.9419471,373.48The issues involved are:1. Whether the rental income of the petitioner is to be computed under the provisions of an agreement dated November 26, 1940, as amended June 14, 1945, as determined by the respondent rather than on the1952 U.S. Tax Ct. LEXIS 34">36 basis of actual billings as reported by petitioner.2. Whether under the aforesaid agreement income and excess profits taxes asserted against the petitioner were payable by the lessees to the petitioner as rent and constitute additional income taxable to the petitioner.19 T.C. 336">337 3. Whether depreciation sustained by the petitioner in the taxable years involved and which was billed to the lessees as rent constitutes income taxable to the petitioner.Certain facts have been stipulated and they are found accordingly. Other facts are found from the evidence.FINDINGS OF FACT.The petitioner is a North Carolina corporation with its principal office in Charlotte, North Carolina. Its returns for the periods involved were filed with the collector of internal revenue for the North Carolina district, at Greensboro. Petitioner kept its books and filed its returns on an accrual basis of accounting.During the taxable years involved the capital stock of the petitioner was owned as follows:SharesCostQueen City Coach, Co., Charlotte N. C2$ 200Carolina Coach Co., Raleigh, N. C1100Smoky Mountain Stages, Inc., Asheville, N. C1100The petitioner was incorporated for1952 U.S. Tax Ct. LEXIS 34">37 the purpose of erecting and operating a bus terminal at Charlotte, North Carolina. The three stockholders of petitioner severally owned and operated motor bus lines entering into the city of Charlotte, North Carolina.On November 26, 1940, petitioner, as lessor, and Queen City Coach Company, Carolina Coach Company, and Smoky Mountain Stages, Inc., as lessees, entered into an agreement and lease under which the petitioner agreed to erect a bus terminal, with all the necessary operating facilities, at Charlotte, North Carolina, and the bus companies agreed to lease and use jointly and in common the terminal facilities for a period of 15 years and to pay as rent the sums specifically provided for therein.The material covenants pertaining to the rental are contained in sections 9, 10 and 11 of the agreement and read as follows:Sec. 9. That in order to afford a basis for determining the amount of rental to be paid to Terminal Company by each of said Bus Companies, the Terminal Company will render to each of said Bus Companies on or before the fifth day of each calendar month during the term hereof statements showing the results of its account of and for the preceding calendar month 1952 U.S. Tax Ct. LEXIS 34">38 as follows, to-wit:(a) A statement of the total gross receipts for tickets sold by Terminal Company for each of said Bus Companies.(b) A statement of the sums received by each of said Bus Companies of all tickets and fares received by each of said Bus Companies for transportation of passengers whose journey originated in the tariff zone of Charlotte, North Carolina, during the preceding month and for which no ticket was sold or issued by Terminal Company as provided for in Section 8 of this agreement.(c) A statement of the total gross receipts of the Terminal Company for rental of its terminal facilities to other bus companies or common carriers.(d) A statement of the total gross receipts of the Terminal Company for rental of restaurants, barber shops, news stands, telephone and telegraph stations, or 19 T.C. 336">338 other concessions included in said premises, and such other revenues as may be received by said Terminal Company.(e) A statement of the total expenses of the Terminal Company during said month, including the following:(1) All items of expenses of the Terminal Company for the operation of its terminal facilities, including taxes on furniture, fixtures and equipment, maintenance, 1952 U.S. Tax Ct. LEXIS 34">39 insurance, renewals, rentals and depreciation, as well as all repairs and extraordinary operating expense, or expenses growing out of operation of the terminal which may be necessary.(2) One-twelfth of the taxes due the City of Charlotte and Mecklenburg County annually on said terminal facilities and the real estate upon which the same is situate.(3) The sums paid by Terminal Company to apply on the amortization of mortgage indebtedness, as is herein provided for, of said Terminal Company on said terminal facilities and the real estate upon which the same is situated. (It is understood by and between the parties hereto that Terminal Company, in order to defray the cost and expenses of acquisition of the property and the erection of the terminal facilities herein provided for thereon, will obtain loans aggregating the sum of one hundred and seventy-three thousand dollars ($ 173,000.00). It is further understood and agreed by and between the parties hereto that such indebtedness of the Terminal Company shall be created not more than three months from the date of this agreement, shall not exceed the aggregate principal amount of one hundred and seventy-three thousand dollars ($ 173,000.00), 1952 U.S. Tax Ct. LEXIS 34">40 which aggregate principal amount shall be secured by a first mortgage loan in the sum of one hundred and forty thousand dollars ($ 140,000.00) bearing interest at a rate not to exceed four and one-half percent (4 1/2%) per annum, payable on an amortization plan, and shall mature in equal annual installments, with equal monthly payments, over a period of thirteen years, which monthly payments shall include principal and interest due on said loan; and by a second mortgage loan not to exceed the aggregate principal amount of thirty-three thousand dollars ($ 33,000.00), bearing interest at a rate not to exceed six percent (6%) per annum, payable on an amortization plan and which shall mature in equal annual installments, with equal monthly payments, over a period of ten years. The first and second mortgage loans provided for herein covering the terminal facilities and the real estate upon which the same is situate, shall be the only indebtedness of the Terminal Company. It is mutually understood and agreed that the Terminal Company is limited to the creation of the mortgage indebtedness, herein referred to, in the total amounts aggregating one hundred and seventy three thousand ($ 173,000.00) 1952 U.S. Tax Ct. LEXIS 34">41 dollars, and any debt which may be subsequently issued to refund any unpaid balance on said mortgage indebtedness aggregating the sum of one hundred and seventy three thousand ($ 173,000.00) dollars; provided, however, that such refunding of such mortgage indebtedness shall not involve a rate of interest or principal amount in excess of the present rate of interest and the then unpaid principal balance.(f) A statement showing the net expenses of Terminal Company during said month, the amount of such net expenses to be ascertained by crediting to the total expenses as provided for in sub-section (e) hereof, the receipts of the Terminal Company as provided for in sub-sections (c) and (d) hereof; so computed shall constitute the total rental due the Terminal Company from said Bus Companies, and the amount due from each of said Bus Companies shall be billed to each of said Bus Companies in accordance with the provisions of Section 10 hereof.(g) The said Bus Companies shall have such access to, and all reasonable facilities for examining the books of the Terminal Company as may be necessary 19 T.C. 336">339 for checking the details of all of said statements and the verification of the items1952 U.S. Tax Ct. LEXIS 34">42 thereof.Sec. 10. Each of said Bus Companies agree [sic] to pay on or before the fifteenth day of each month in which such statements are rendered as rent for the use of the terminal and terminal facilities such proportion of the total rent due, as hereinbefore provided, as the total gross receipts from the tickets sold at said terminal for each of the Bus Companies, together with fares of each of said Bus Companies received according to the provisions of Section 8 hereinabove, during the period for which said rent then due shall be payable, as shown by the statement of the Terminal Company, shall bear to the total gross receipts of tickets sold at the said terminal for said Bus Companies, together with the total fares of said Bus Companies received according to the provisions of Section 8 hereinabove.Sec. 11. If the amount of any charge for rental to be made against any Bus Company cannot be definitely ascertained and fixed for any month during the term hereof, the board of directors of the Terminal Company shall estimate the same as nearly as may be, and each of the Bus Companies agree [sic] to be bound by such estimate and payment shall be made accordingly; provided, however, 1952 U.S. Tax Ct. LEXIS 34">43 that if such estimated rental shall exceed the average rental paid by said Bus Companies for the preceding three months then, and in that event, upon request in writing by any of said Bus Companies, the books and records of the Terminal Company shall be submitted to a competent and reliable accounting firm to compute the rental due for such month according to the provisions of Sections 9 and 10 hereof.The petitioner erected and equipped the terminal at a cost of approximately $ 186,000, of which amount the sum of $ 183,477.39 represented notes and mortgages payable. A construction loan in the amount of $ 138,477.39 was obtained from the American Trust Company, which was paid in full by October 31, 1942.On August 31, 1942, the petitioner borrowed from the Jefferson Standard Life Insurance Company the sum of $ 135,000, which was payable quarterly in the amount of $ 2,025. The obligation was reduced on the dates and in the amounts as follows:YearAmount1942$ 2,025.007 months ended July 31, 194312,150.00Fiscal year ended July 31, 194416,200.00Fiscal year ended July 31, 194516,200.00Fiscal year ended July 31, 194616,200.00Fiscal year ended July 31, 194716,402.50Total$ 79,177.501952 U.S. Tax Ct. LEXIS 34">44 The balance remaining on the obligation is the sum of $ 55,822.50. The agreement of November 26, 1940, was pledged with the Jefferson Standard Life Insurance Company as security. The loan was repaid in full in July 1951. On December 24, 1940, Queen City Coach Company loaned petitioner $ 33,000, and on July 30, 1941, an additional sum of $ 4,000. Between April 1942 and May 1944 petitioner repaid to Queen City Coach Company the sum of $ 37,000. In August 1941 19 T.C. 336">340 Smoky Mountain Stages, Inc., and Charlotte Coach Company each loaned petitioner the sum of $ 4,000. These loans were repaid by petitioner during the months of August and September 1942.The petitioner filed its returns on the calendar year basis for the years 1940, 1941, and 1942, and for the years 1943 and 1944 based on a fiscal year ended July 31, in which it reported income on the basis of 10 percent of all ticket sales, plus miscellaneous rental and concession income, less expenses paid and accrued. These returns reported net income and income and/or excess profits taxes as follows:Income andYearIncomedeclared valueExcessexcess-profitsprofits taxtax1940($ 111.00)NoneNone1941(2,515.16)NoneNone194221,790.81 $ 3,194.48$ 9,007.51July 31, 194328,263.14 1,141.3219,211.11July 31, 1944None NoneNone1952 U.S. Tax Ct. LEXIS 34">45 The aforesaid taxes were billed currently on a pro rata basis and were paid by the operating bus companies.On March 22, 1945, an internal revenue agent's report was prepared in connection with the examination of petitioner's returns for the calendar years 1940, 1941, and 1942, and for the fiscal years ended July 31, 1943, and 1944, which disclosed the following:YearIncome194019411942Payment on mortgageNoneNone$ 20,502.39 Income and/or excess profits taxes on prioryear's incomeNoneNoneNone Total incomeNoneNone20,502.39 Income or excess profits taxes on above11,291.95 Previously assessed12,201.99 Net deficiency (overassessment)($ 910.04)Fiscal year ended July 31Income19431944Payment on mortgage$ 14,150.00 $ 44,200.00Income and/or excess profits taxes on prioryear's income11,291.95 18,104.70Total income25,441.95 62,304.70Income or excess profits taxes on above18,104.70 45,150.16Previously assessed20,352.43 NoneNet deficiency (overassessment)($ 2,247.73)$ 45,150.16The petitioner agreed to the method of computing taxable income as used by the revenue1952 U.S. Tax Ct. LEXIS 34">46 agent in his report of March 22, 1945, in determining its tax liabilities.In arriving at petitioner's taxable net income as set forth in the preceding paragraph, respondent held that the petitioner's taxable net income was to be determined under the provisions of the agreement of November 26, 1940, and that while petitioner was on an accrual basis the rent payable was predicated upon payments theretofore made and was represented by payments on the mortgages and payments of income and excess profits taxes for each prior year.19 T.C. 336">341 The large deficiency of $ 45,150.16, as determined against petitioner for the fiscal year ended July 31, 1944, caused the operating bus companies to realize the effect taxwise of the provisions of its agreement of November 26, 1940. Thereupon, the three directors of petitioner, consisting of R. C. Hoffman, Jr., president of Carolina Coach Company; L. A. Love, president of petitioner and vice president and general manager of Queen City Coach Company; and Joel W. Wright, president of Smoky Mountain Stages, Inc., informally discussed the tax situation of petitioner and the payment of deficiencies assessed against it and orally agreed to a modification1952 U.S. Tax Ct. LEXIS 34">47 of the lease agreement of November 26, 1940.On June 14, 1945, the directors of petitioner adopted the following resolution:WHEREAS, this Company is a party to said agreement dated November 26, 1940; andWHEREAS, this Company and the other parties to said agreement, named above, desire to amend said agreement in the several respects provided in the proposed amendment submitted at this meeting,NOW, THEREFORE, BE IT RESOLVED, that the President or any Vice-President of this Company be and each is hereby authorized and directed to execute and deliver for, on behalf and in the name of this Company and under its corporate seal an amendment to said agreement dated November 26, 1940, such amendment to be in the form of the copy submitted at this meeting, said copy being ordered attached to and made a part of the minutes of this meeting; and be itFURTHER RESOLVED, that the officers of the Company be and they are hereby authorized, empowered and directed in the name and for the account of this Company, to take or cause to be taken any and all such other and further action, and to make any and all such payments, and to execute, acknowledge and deliver any and all such other instruments as, 1952 U.S. Tax Ct. LEXIS 34">48 in the judgment of such officers, may be necessary, proper or convenient in order to carry out the intendment of these resolutions.On June 14, 1945, all of the parties to the agreement dated November 26, 1940, executed the following amendment:THIS FIRST AMENDATORY AGREEMENT made and entered into as of July 31, 1944, by and between Charlotte Union Bus Station, Inc., a North Carolina Corporation (herein called "the Terminal Company"), and Carolina Coach Company, Queen City Coach Company, and Smoky Mountain Stages, Inc., each a North Carolina Corporation (herein called "the Bus Companies"),WITNESSETH:WHEREAS, the parties hereto are parties to an agreement dated November 26, 1940, relating to the construction, operation and use of a motor bus terminal in the City of Charlotte, N. C., andWHEREAS, the parties hereto desire to amend such agreement in the several respects herein provided for;NOW, THEREFORE, the parties hereto covenant and agree as follows:Section 9 (e) (1) is supplemented by adding thereto the following: 19 T.C. 336">342 Such expenses shall exclude all taxes, both Federal and State, on the earnings or income of the Terminal Company, owing by the Terminal Company on or 1952 U.S. Tax Ct. LEXIS 34">49 after the date of this Amendatory Agreement.Each of the Bus Companies shall loan to the Terminal Company on or before October 1, 1945, and October 1st of each succeeding year in which the Terminal Company is under a liability for the payment of Federal or State Income Taxes, such loan (a) to be represented on the books of the Terminal Company as open account indebtedness, and (b) to be, with respect to each of the Bus Companies, in the amount representing that proportion of such taxes which each of said Bus Companies would have been required to pay if such sums had been included in the respective periods as items of expenses under Section 9 (e) (1), as it existed prior to the amendment contained in this Amendatory Agreement.Each of the Bus Companies shall, promptly after the discharge in full of the mortgage indebtedness of the Terminal Company created pursuant to Section 9 (e) (3) of said agreement of November 26, 1940, surrender to the Terminal Company all such open account indebtedness owing to it by the Terminal Company, as a capital contribution to the Terminal Company. The result of such surrender will be that promptly after the discharge of said mortgage indebtedness of the1952 U.S. Tax Ct. LEXIS 34">50 Terminal Company, the Terminal Company will not be indebted to the Bus Companies or any of them by virture [sic] of the aforementioned annual loans.IN WITNESS WHEREOF, the parties hereto have caused this agreement to be executed and have affixed their seals as of the date and year first above written.In accordance with the amendatory agreement petitioner assessed against the operating bus companies the following net deficiencies, as determined for the years 1942 to 1946, inclusive:Fiscal yearFiscal yearJuly 31,July 31,19461947Deficiency -- fiscal year July31, 1944$ 45,150.16 Overassessment -- 1942(910.04)Overassessment -- fiscal year July 31,1943(2,247.73)$ 41,992.39North Carolina State to July 31, 19443,309.29Federal liability -- fiscal year July31, 19453,801.47North Carolina liability -- fiscal yearJuly 31, 1945922.33Federal liability -- fiscal year July31, 1946$ 548.39North Carolina liability -- fiscal yearJuly 31, 1946140.01Total$ 50,025.48$ 688.40On September 14, 1945, the petitioner assessed the following amounts against the three operating bus companies as their pro1952 U.S. Tax Ct. LEXIS 34">51 rata share of the aforesaid additional taxes due the Federal Government and the State of North Carolina:NameAmountQueen City Coach Co$ 29,725.95Carolina Coach Co14,536.03Smoky Mountain Stages, Inc1,039.70Total$ 45,301.6819 T.C. 336">343 These amounts were itemized on the vouchers as "loan for taxes."In October 1945 petitioner also assessed against the three operating bus companies North Carolina revenue taxes in the amount of $ 922.33 and Federal income taxes for the year ended July 31, 1946, in the amount of $ 3,801.47.The petitioner set up "Accounts Payable" (stated to represent "advances" or "loans" from the operating bus companies) on its books and records in the respective names of the operating bus companies and credited such account with its respective amount of the aforesaid additional Federal income and North Carolina state taxes during the fiscal year ended July 31, 1946, totaling $ 50,025.48:Balance payableName of accountJuly 31, 1946Queen City Coach Co$ 32,825.60Carolina Coach Co16,051.77Smoky Mountain Stages, Inc1,148.11Total$ 50,025.48There was also credited to these respective "Accounts Payable" on the petitioner's1952 U.S. Tax Ct. LEXIS 34">52 books, representing additional Federal income and North Carolina state taxes assessed against the operating bus companies during the fiscal year ended July 31, 1947, the following sums:Balance payableNameJuly 31, 1947Queen City Coach Co$ 441.75Carolina Coach Co221.11Smoky Mountain Stages, Inc25.54Total$ 688.40During the fiscal years ended July 31, 1945, 1946, and 1947, petitioner did not follow the terms of the amendatory agreement in billing the lessee bus companies for rental for such years. The petitioner billed the bus companies for its cash requirements only. In computing its rental income from the three operating bus companies the petitioner considered only actual billings. On the basis of such computation the petitioner reported the following net income and tax liability:Income taxYear ended July 31Net incomeliability1945$ 14,449.87$ 3,801.4719462,193.55548.39194710,312.392,271.85In his deficiency notice the respondent computed the petitioner's rental income for the fiscal year ended July 31, 1945, in accordance with the provisions of the agreement of November 26, 1940. For the fiscal years ended July1952 U.S. Tax Ct. LEXIS 34">53 31, 1946, and 1947, the rental income was computed under the amendatory agreement executed June 14, 1945.19 T.C. 336">344 The difference in income, as reported by petitioner and as determined by respondent, is set forth in the following schedule:Fiscal year ended July 31194519461947(a) Net income per return$ 14,449.87$ 2,193.55$ 10,312.39Depreciation claimed as a deductionfrom gross income, but not reportedas income5,017.484,752.384,868.44Increase in withholding tax reserve41.3430.48Federal income tax accrued45,150.16North Carolina income tax accrued3,309.29Decrease in bank balance4,039.99492.00Paid-in surplus by stockholders(expended)11,300.00Increase in accrued wages end of year225.44882.80Increase in ad valorem taxes at end ofyear75.23(b) Subtotal (increase income)$ 53,518.27$ 20,348.29$ 6,318.47Less:Decrease as valorem taxes$ 1,262.57$ 1,928.85Decrease in withholding tax at end ofyear$ 331.78Decrease accrued wages114.90Adjustment prior years Federal and Stateincome taxes245.74Increase bank balance2,607.81Working fund addition15.00(c) Subtotal (decrease in income)$ 4,231.02$ 1,928.85$ 346.78(d) Difference income reported perreturns and notice of deficiency(b) minus (c)49,287.2518,419.445,971.69(e) Income notice of deficiency (a)plus (d)$ 63,737.12$ 20,612.99$ 16,284.081952 U.S. Tax Ct. LEXIS 34">54 In his deficiency notice respondent computed petitioner's taxable net income for each of the taxable years involved as follows:Fiscal year ended July 31194519461947Rental income represented by:Payments on mortgage$ 16,200.00$ 16,200.00$ 16,200.00Capital expenditures4,553.00539.82Federal income and/or excess profitstax for F/Y July 31, 194445,150.16Deficiency in North Carolina Stateincome tax for years ended on orbefore July 31, 19443,309.29$ 64,459.45$ 20,753.00$ 16,942.32Less: North Carolina State income taxdeducted on returns922.33140.01658.24Corrected income$ 63,737.12$ 20,612.99$ 16,284.08In computing petitioner's income for the taxable years ended on or before July 31, 1944, the respondent determined that Federal income and excess profits taxes, as well as the North Carolina state income tax, were reimbursable by the lessee bus companies as part of their rental under the agreement of November 26, 1940. The petitioner accepted the determination and agreed to the deficiencies and/or overassessment of $ 41,992.39. Deficiencies in state income taxes for the same period amounted to $ 3,309.29, aggregating1952 U.S. Tax Ct. LEXIS 34">55 the sum of $ 45,301.68.19 T.C. 336">345 During the fiscal year ended July 31, 1946, the petitioner was advanced sums necessary to pay the deficiencies, aggregating $ 45,301.68, and the reported liabilities due for Federal and state income taxes for the fiscal year ended July 31, 1945, in the amounts of $ 3,801.47 and $ 922.33, respectively. During the fiscal year ended July 31, 1947, the petitioner was advanced $ 688.40 to pay reported Federal and state income taxes of $ 548.39 and $ 140.01, respectively, for the fiscal year ended July 31, 1946. The respondent included the so called advances of $ 41,992.39 and $ 3,309.29 in determining rental income due from the bus companies for the fiscal year ended July 31, 1945.During June 1946 the stockholders of petitioner contributed cash in the amount of $ 11,300, which was credited to paid-in surplus. Pursuant to a resolution of the stockholders of petitioner, dated October 31, 1947, one hundred sixteen shares of petitioner's stock, representing a stated value of $ 11,600, were issued for the $ 11,300 paid-in surplus and additional cash contributions of $ 300, as follows:Number ofNamesharesPar valueCostQueen City Coach Co59$ 5,900$ 5,650L. A. Love (president of Queen City Coach Co.)1100100Carolina Coach Co292,9002,825R. C. Hoffman (president of Carolina Coach Co.)1100100Smoky Mountain Stages, Inc292,9002,825J. W. Wright (president of Smoky MountainStages, Inc.)11001001952 U.S. Tax Ct. LEXIS 34">56 For the fiscal year ended July 31, 1945, petitioner billed the three bus companies monthly for their pro rata share of depreciation sustained on its building and equipment. Depreciation was computed at the rate of $ 418.13 per month, or a total of $ 5,017.56.In assessing the operating bus companies quarterly for the amount due and payable on the petitioner's mortgage principal indebtedness during the fiscal year ended July 31, 1945, there was deducted from the quarterly principal payments on the mortgage of $ 4,050 three months' depreciation of $ 418.13 per month, or $ 1,254.39. Thus, only the net amount of $ 2,795.61 was billed as principal payments due on the mortgage. The total amount deducted by petitioner as depreciation from the quarterly mortgage principal payments payable and so billed during the fiscal year was $ 5,017.48, the amount deducted by petitioner as depreciation on its return for 1945.For the fiscal year ended July 31, 1946, petitioner billed the three operating bus companies monthly for their pro rata share of depreciation sustained on its building and equipment. Depreciation was computed at the rate of $ 418.13 for the month of August, $ 373.93 for the month1952 U.S. Tax Ct. LEXIS 34">57 of September, and $ 396.03 for the remaining 10 months, or a total of $ 4,752.38.19 T.C. 336">346 In assessing the three operating bus companies quarterly for the amount due on the mortgage principal indebtedness during said fiscal year there was deducted from the quarterly principal payment of $ 4,050 three months' depreciation at the rate of $ 396.03, or a total of $ 1,188.09. Thus, only the net amount of $ 2,861.91 was billed as principal payment due on the mortgage by the operating companies. The total amount deducted as depreciation from quarterly mortgage payments payable and so billed during said fiscal year totaled $ 4,752.38, the amount deducted by petitioner on its return.For the fiscal year ended July 31, 1947, petitioner billed the three operating bus companies monthly for their pro rata share of depreciation at the rate of $ 396.03, or a total of $ 4,752.36. In addition thereto depreciation in the amount of $ 116.08, computed on the new equipment acquired during such year, was deducted by petitioner on its return but was not billed to the three operating companies.In assessing the three operating bus companies quarterly for the amount due and payable on the mortgage principal1952 U.S. Tax Ct. LEXIS 34">58 indebtedness during the fiscal year ended July 31, 1947, there was deducted from the quarterly mortgage principal payments of $ 4,050 three months' depreciation at the rate of $ 396.03, or $ 1,188.09. Only the net amount of $ 2,861.91 was billed as principal payment due on the mortgage principal by the operating bus companies. The total amount deducted by petitioner as depreciation from quarterly mortgage payments payable and so billed during such fiscal year totaled $ 4,752.36, which amount, plus the $ 116.08 depreciation on new equipment, equals the sum of $ 4,868.44, deducted by the petitioner as depreciation on its return for such year.The agreement and lease dated November 26, 1940, was in effect and governed the rights, privileges, and obligations of the respective parties thereto until the amendatory agreement was executed on June 14, 1945. Subsequent to June 14, 1945, the agreement and lease of November 26, 1940, as modified by the amendatory agreement executed on June 14, 1945, was in effect and governed the rights, privileges, and obligations of the respective parties thereto.OPINION.The primary question presented is whether the income of petitioner is to be computed1952 U.S. Tax Ct. LEXIS 34">59 under the provisions of the agreement and lease dated November 26, 1940, as modified by an amendatory agreement executed June 14, 1945, as the respondent determined, or on the basis of actual billings, as reported by petitioner.The contention of petitioner appears to be that the agreement of November 26, 1940, was one which the parties could alter, amend or abrogate by parol at any time, and that the parties by parol agreements 19 T.C. 336">347 and conduct contrary to its provisions, in effect, abandoned the agreement and substituted therefor a new agreement of monthly billings.The petitioner is a North Carolina corporation organized for the purpose of erecting and operating a bus terminal with appropriate facilities. All of its capital stock issued at the time of its incorporation was owned by three operating bus companies. Petitioner is a separate taxable entity. Where business is conducted through separate corporate entities separateness will be recognized in matters relating to taxation regardless of the disadvantages entailed. ; .1952 U.S. Tax Ct. LEXIS 34">60 On November 26, 1940, petitioner and the three operating bus companies entered into a written agreement under which petitioner agreed to erect a terminal with the necessary facilities, and the operating bus companies agreed to use such facilities for a period of 15 years and to pay, as rent, an amount to be determined under a prescribed formula. Such agreement refers to the respective parties as "lessor" and "lessees." The payments to be made thereunder are denominated "rent." In many of its provisions the agreement is referred to as a "lease." Whether the agreement in question is in fact a lease is not, for present purposes, necessary for us to determine, since, in our opinion, the agreement touches an interest in realty or concerns realty and is one required to be in writing. General Statutes of North Carolina, 1943, sec. 22-2. ; . According to the weight of authority, a written contract within the statute of frauds cannot be varied by any subsequent agreement of the parties, 1952 U.S. Tax Ct. LEXIS 34">61 unless such new agreement is also in writing. ; ; Stowell v. Robinson, 3 Bing. N. C. 927.If the agreement is one which the statute requires to be in writing any material modifications or alterations resting in parol would be ineffective to the extent they were unexecuted.This record establishes that the first written amendatory agreement was executed on June 14, 1945. The parties have attempted to make it retroactive to July 31, 1944. If the original agreement is one required to be in writing, to permit the amendatory agreement to be made retroactive, we think, would in effect annul the statute.Assuming that we are in error in concluding that the original agreement was one required to be in writing and that it could be altered or modified at the will of the parties, this record does not establish with sufficient clearness what the parol modifications were or a definite time when they were entered into. The respondent has given recognition 19 T.C. 336">348 to the written amendatory agreement as of the date of its1952 U.S. Tax Ct. LEXIS 34">62 actual execution on June 14, 1945.We think the agreement of November 26, 1940, as amended by the amendatory agreement of June 14, 1945, fixed the rights, privileges, and obligations of the respective parties thereto and that the respondent properly computed the income of petitioner under its terms and provisions.The second issue involves the question whether, under the agreement of November 26, 1940, the income and excess profits taxes asserted against petitioner were to be reimbursed to it by the three operating bus companies, and constituted rental income of petitioner.It is contended by petitioner that the agreement of November 26, 1940, makes no specific mention of income and excess profits taxes and that it was the intention of the operating bus companies that petitioner should be operated on a nonprofit basis and was to earn no income that would subject it to income and excess profits taxes. The respondent contends that under section 9 of the agreement the operating bus companies were to pay to petitioner as rent all net expenses determined, as provided therein. Section 9 of the agreement is set forth in full in our findings of fact and need not be repeated here.The term1952 U.S. Tax Ct. LEXIS 34">63 "expenses" is a word of broad meaning. It has no fixed definition. It is comprehensive enough to include a wide range of disbursements. . We think the use of the term "expenses" renders the agreement ambiguous. Where ambiguity exists the construction given by the parties will be given great, if not controlling, influence. . As said in the case of , there is no surer way to find out what the parties meant than to see what they have done.Income taxes paid by petitioner for the calendar year 1942 and for the fiscal year ended July 31, 1943, were included and billed to the operating bus companies in computing rentals due for the fiscal years ended July 31, 1943, and 1944, respectively. In view of the interpretation given to the provisions of the agreement of November 26, 1940, by the conduct of the parties, we think the agreement is to be construed as requiring the operating bus companies to pay1952 U.S. Tax Ct. LEXIS 34">64 to petitioner, as a part of their rent, the income and excess profits taxes asserted against petitioner.The record shows that petitioner first realized in March 1945 that it would have to include as taxable income to it for the current fiscal year all additional taxes accrued for the prior fiscal year. Such knowledge gave rise to the desire of the parties to amend the agreement so as to specifically provide that income and excess profits taxes 19 T.C. 336">349 were not to be included as an expense. The written amendatory agreement executed June 14, 1945, so provided. The petitioner contends that the parties had orally agreed to a modification of the original agreement with respect to the payment of such taxes and that the written agreement was predated to the time when such oral agreement was entered into. As heretofore stated, we think the amendatory agreement could not be made retroactive. If any retroactive effect is to be given to it, such retroactive effect should not be carried back to a time preceding the making of the alleged parol agreement with respect to the payment of income and excess profits taxes, which is shown by the evidence to have occurred about March 1945.The 1952 U.S. Tax Ct. LEXIS 34">65 additional Federal income taxes of $ 45,150.16 and North Carolina income tax of $ 3,309.29, asserted against petitioner for the fiscal year ended July 31, 1944, accrued on October 15, 1944, as a debt payable by petitioner. Under the agreement of November 26, 1940, petitioner was entitled to reimbursement of such amounts as rent. As of the beginning of the fiscal year July 31, 1945, the petitioner had the right to receive as rental income for that year the income taxes payable on income earned in the preceding year. ; ; ; .The respondent has recognized the amendatory agreement as of June 14, 1945, and has not included in petitioner's taxable income for the fiscal years ended July 31, 1946, and 1947, the additional income taxes asserted for the respective taxable years ended July 31, 1945, and 1946.The amendatory agreement of 1952 U.S. Tax Ct. LEXIS 34">66 June 14, 1945, contains a provision to the effect that the operating bus companies would "loan" the petitioner the money to pay taxes then due and to make similar loans for succeeding years, all of which loans were to be made by the operating bus companies in the amount representing that portion of such taxes which such companies would have been required to pay if such sums had been included in the respective taxable periods as items of expenses under section 9 (e) (1), as it existed prior to the amendment contained in the amendatory agreement.The respondent contends that the attempt to treat as "loans" the payments to cover income taxes for prior years which accrued during the taxable year was in violation of the agreement of November 26, 1940, and a tax avoidance scheme which should not be recognized for tax purposes.We find it unnecessary to characterize the motives which prompted the parties to make such agreement. Unless retroactive effect is to be 19 T.C. 336">350 given to the amendatory agreement, which we have declined to do, income taxes of petitioner which accrued and were payable to it by the operating bus companies as rent under the agreement prior to its amendment constitute1952 U.S. Tax Ct. LEXIS 34">67 income taxable to petitioner notwithstanding the parties have treated the payments as loans. To hold otherwise, in our opinion, would permit petitioner to distort its income.The final issue involves the question of depreciation as representing taxable income of petitioner. The total depreciation sustained by petitioner on its buildings and equipment in the fiscal years ended July 31, 1945, 1946, and 1947, in the respective amounts of $ 5,017.48, $ 4,752.38, and $ 4,868.44, has been included by the respondent in petitioner's income for such respective years. All the aforesaid amounts, except the sum of $ 116.08 for the fiscal year ended July 31, 1947, were billed to and paid by the operating bus companies to petitioner on a prorated basis as rent. Depreciation is specifically mentioned in section 9 (e) (1) of the agreement of November 26, 1940, as one of the items to be included in the statement of total expenses of the terminal company, petitioner herein.Petitioner contends that the inclusion of the term "depreciation" in the agreement was the result of a mutual mistake. This record, however, does not show, nor does petitioner contend, that the agreement was amended in such1952 U.S. Tax Ct. LEXIS 34">*68 respect either orally or in writing prior to or during the taxable years involved. Nor have the parties ever instituted any proceeding to have the agreement reformed to express their real intention. In the absence of any such affirmative action, we think, the agreement is to be given effect as written. We hold, therefore, that depreciation sustained by petitioner which was billed to and paid by the operating bus companies as rent constituted income taxable to petitioner in each such fiscal year.Therefore, we hold that the income of petitioner in the respective taxable years involved is to be computed in accordance with the terms of the agreement of November 26, 1940, until the execution of the amendatory agreement on June 14, 1945, and thereafter in accordance with the terms of such agreement as modified, and not on the basis of actual billings as reported by petitioner.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619298/	PHILLIP G. CLINE, SR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCline v. CommissionerDocket No. 11835-88.United States Tax CourtT.C. Memo 1989-316; 1989 Tax Ct. Memo LEXIS 316; 57 T.C.M. 821; T.C.M. (RIA) 89316; June 27, 1989. Phillip G. Cline, Sr., pro se. Douglas S. Polsky, for the respondent PARRMEMORANDUM OPINION PARR, Judge: Respondent determined deficiencies in and additions to income taxes for petitioner as follows: Additions to TaxYearDeficiency§ 6653(a)(1) 1§ 6653(a)(2)§ 66611982$ 13,123$ 656.15 $ 3,280.75198311,509575.45 2,877.25198413,875693.75 3,468.75The issues raised in the notice of deficiency are as follows: (1) Whether and to what extent petitioner is entitled to deduct meal expenses while away from1989 Tax Ct. Memo LEXIS 316">317 home; (2) whether petitioner's farming activity was entered into for profit; (3) whether petitioner is liable for additions to tax for a substantial understatement of liability under section 6661; and (4) whether petitioner is liable for an addition to tax for negligence. After the trial began, the parties settled all issues except the negligence additions. The settlement reflected mutual concessions on issue one. Respondent conceded that petitioner had an actual and honest objective of making a profit from his farming activity and petitioner conceded certain individual items relating to losses claimed on his returns. Respondent conceded petitioner is not liable for an addition to tax for a substantial understatement of liability under section 6661. The only issue remaining for decision is the negligence addition. Some of the facts have been stipulated and are adopted and made a part of the record. Petitioner's legal residence was McLouth, Kansas, when he filed his petition with this Court. Petitioner's income tax returns for 1982, 1983, and 1984 were timely filed. During the years in issue, petitioner was a full time employee of the Santa Fe Railroad and a small farmer. 1989 Tax Ct. Memo LEXIS 316">318 He raised sheep, cattle, dogs, and chickens during the years in issue. Petitioner has a high school education. He has never had any courses in accounting or bookkeeping. During the years in issue he used paid tax return preparers. He kept his receipts and other records in manila envelopes which were fastened to the wall. There were separate envelopes for different categories of expenses. At the end of each year he totaled up the receipts by category and took them to a tax service for preparation of his income tax returns. During the years in issue petitioner was undergoing serious personal and financial difficulties. He was working full-time as a railroad employee and struggling to keep his farm afloat. We believe he intended to keep accurate records and to file accurate returns. However, he acknowledged at trial -- after he hired an accountant for trial preparation -- that he had mistakenly overstated farm losses in the amounts of $ 12,574 for 1982, $ 15,411 for 1983, and $ 9,679 for 1984. While these amounts are significantly less than those determined by respondent, they are not small. We recognize that at trial petitioner conservatively claimed only those expenses1989 Tax Ct. Memo LEXIS 316">319 which were supported by a cancelled check or other appropriate documentation and that he undoubtedly did incur other expenses. Nevertheless, we think the size and recurrence of petitioner's mistakes indicates a lack of care on his part. We therefore reluctantly hold that petitioner is liable for additions to tax for negligence under section 6653(a)(1) and an additional amount, under section 6653(a)(2), equal to 50 percent of the interest payable on the portion of the deficiency attributable to the overstated farm losses. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code as amended and in effect for the years in issue, except as otherwise noted. * 50 percent of interest due on full deficiencies.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619301/	William G. Johnston Company v. Commissioner.William G. Johnston Co. v. CommissionerDocket No. 6691.United States Tax Court1945 Tax Ct. Memo LEXIS 10; 4 T.C.M. 1101; T.C.M. (RIA) 45376; December 18, 19451945 Tax Ct. Memo LEXIS 10">10 Marcus W. Stoner, Esq., 730 Oliver Bldg., Pittsburgh, Pa., and W. H. Specht, C.P.A., 917 Park Bldg., Pittsburgh, Pa., for the petitioner. Richard L. Shook, Esq., for the respondent. SMITH Memorandum Opinion SMITH, Judge: The Commissioner has determined a deficiency of $3,436.21 in petitioner's income tax for 1942. Most of the deficiency results from the partial disallowance of an item of accrued interest. The facts have been stipulated and are in substance as follows: [The Facts] Petitioner is a Pennsylvania corporation with its principal place of business located at 1130 Ridge Avenue, Pittsburgh. It filed its income and declared value excess profits tax return for 1942 with the collector of internal revenue for the twenty-third district of Pennsylvania, at Pittsburgh. Petitioner kept its accounts and made its returns on the accrual basis. Petitioner conducts a printing and binding business which purchases its supplies on credit from various paper supply concerns in and around Pittsburgh. In the latter part of 1935 petitioner found that it was financially unable to meet its current obligations and on December 3rd of that year a Creditors' Committee was1945 Tax Ct. Memo LEXIS 10">11 organized to take over the management of the business. As of December 11, 1935, there were 44 creditors with claims aggregating $82,295. The amounts owing to the 3 principal creditors and the aggregate amount owing to the other 41 creditors were as follows: The Alling & Cory Company$13,015.28Chatfield & Woods Company ofPennsylvania15,340.54Whitaker Paper Company4,472.6941 creditors49,466.49Total$82,295.00A letter was mailed to the creditors by the Creditors' Committee on December 11, 1935, outlining a plan of operation which was accepted by a majority of the creditors. Petitioner was operated by the Creditors' Committee during 1936. On December 11, 1936, the Committee sent another letter to the creditors advising them of the state of petitioner's business affairs and recommending a further extension of the plan which was to expire December 31, 1936. This letter stated in part that: "In consideration of creditors' extensions to December 31, 1937, the Board of Directors of William G. Johnston Company authorizes a 1% monthly payment to be paid out of earnings on or before the 25th of each month during 1937, on balances as of record of September 1, 1935, with1945 Tax Ct. Memo LEXIS 10">12 the further understanding that interest at the rate of 4% per annum shall be accrued from January 1, 1936, to December 31, 1936, and thereafter at the same yearly rate on all unpaid balances. It is further recommended that power be vested in the Creditors' Committee to increase the amount of such proportionate payments or omit said payments if in its judgment either of such actions is deemed advisable for the best interests of all concerned." The creditors accepted the recommendations set forth in the letter referred to above and the Committee continued to operate petitioner's business until the close of 1942. The 3 principal creditors all had representatives on the Committee. Prior to December 31, 1942, the claims of the 41 minor creditors were all settled and no interest was ever paid to any of such creditors. No accruals of interest on the claims of any of the creditors were ever made on petitioner's books for any of the years 1935 to 1941, inclusive, and no deductions for such interest were claimed in petitioner's returns for those years. In 1942, however, petitioner accrued on its books, and deducted in its return for 1942, the following amounts of interest on the accounts1945 Tax Ct. Memo LEXIS 10">13 of its 3 principal creditors for the years 1935 to 1942, inclusive: YearInterest Accrued1935$ 438.0819361,313.5319371,240.0419381,085.211939951.121940702.781941708.131942695.96$7,134.85The interest so accrued remained unpaid at the close of 1942. The petitioner's operating profits or losses as disclosed on its income tax returns for the years 1936 to 1941, or as subsequently adjusted, were: YearProfit or LossTax PaidNet1936($7,629.49)None($7,629.49)19372,814.07$ 429.072,385.001938( 4,635.74)None( 4,635.74)19398,640.171,115.887,524.2919404,483.23657.253,825.9819413,126.09646.442,479.65In determining the deficiency herein the respondent allowed $695.96 of the accrued interest deduction claimed of $7,134.85, that being the interest accruing on the accounts of the 3 principal creditors for the taxable year 1942, and disallowed the balance. Whether or not he erred in so doing is the only issue raised in this proceeding. The respondent also allowed a similar deduction of $708.13 for 1941 but that year is not before us here. According to the stipulated1945 Tax Ct. Memo LEXIS 10">14 facts petitioner was legally obligated to pay interest on all of the creditors' accounts upon the terms stated in its agreement of December 11, 1936. The evidence does not show why petitioner did not regularly accrue such interest in its books from year to year, neither does it show why the interest on the 3 principal accounts for all of the years 1935 to 1942, inclusive, was accrued in the books in 1942. Petitioner states in its brief that there was nothing in the conduct of the creditors until 1942 to indicate that the interest would be demanded and that: " * * Not until the demand for interest was made by the three creditors in 1942 was the liability established in such definite status that it might be accrued as a liability of the petitioner. Hence, the petitioner was correct in accruing in 1942 the interest which had accumulated since 1936 on the claims of the three creditors who demanded their interest in that year." The respondent's position is that the interest for the years prior to 1942 was accruable in those years and not in 1942; that nothing occurred in 1942 which gave rise to an accrual in that year of any interest for the prior years. In its brief petitioner further1945 Tax Ct. Memo LEXIS 10">15 states "as propositions of law" that until liability of the taxpayer for a claim is definitely established, no accrual thereof may be made for tax purposes. Accrual must be made in the year in which the liability is finally established. Petitioner cites ; ; ; and . Assuming that petitioner is correct both in its statement of facts and its propositions of law, it would still not be entitled to the deduction claimed. For it can not be disputed that petitioner's liability for interest on all of the creditors' accounts was definitely established by its agreement with the creditors as set forth in the letter of December 11, 1936. That liability was in no sense contingent upon a demand for payment of the interest by the creditors. It was a presently existing liability which continued until the obligations were finally satisfied. The liability accrued each year and was deductible each year to the petitioner keeping its books and1945 Tax Ct. Memo LEXIS 10">16 making its returns upon the accrual basis. See . We think that the respondent has correctly determined that only the interest accruing on the unpaid indebtedness in the taxable year 1942 is deductible for that year. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619302/	GABRIEL AND NATALIE PODLOFSKY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPodlofsky v. CommissionerDocket No. 4393-78.United States Tax CourtT.C. Memo 1981-703; 1981 Tax Ct. Memo LEXIS 42; 43 T.C.M. 74; T.C.M. (RIA) 81703; December 10, 1981. Murray S. Lubitz, for the petitioners. Bernard S. Mark, for the respondent. FORRESTERMEMORANDUM FINDINGS OF FACT AND OPINION FORRESTER, Judge: Respondent has determined a deficiency in petitioners' Federal income tax for the calendar year 1972, in the amount of $ 82,430, and additions to tax, pursuant to section 6651(a), 1 in the amount of $ 4,121.50. 2 Concessions having been made, the only issue remaining for decision is whether the petitioners are entitled to deduct rental expenses incurred for the use of hotel facilities operated by petitioner husband's wholly owned corporation. 1981 Tax Ct. Memo LEXIS 42">43 FINDINGS OF FACT Some of the facts have been stipulated and are so found. Petitioners are husband and wife who resided in Atlantic Beach, New York, at the time the petition herein was filed. They filed their joint Federal income tax return for 1972 with the Internal Revenue Service Center in Philadelphia, Pennsylvania. Natalie Podlofsky is a party to this proceeding solely by virtue of having filed a joint income tax return with her husband; consequently, Gabriel Podlofsky will hereinafter be In late 1971 the petitioner, either then residing in In late 1971 the petitioner, eithe then residing in Puerto Rico or planning to move there, became aware of a hotel for rent in St. Croix, Virgin Islands, known as the Estate Carlton hotel (hereinafter the hotel). The hotel was owned by Maidmore Realty Co. (hereinafter Maidmore), whose vice president and general counsel was Robert Maidman (hereinafter Maidman). 3 Petitioner initiated negotiations with Maidmore in late 1971. His attorney, Bernard Samuelson, set certain conditions for the agreement, and the lease was then prepared by Maidman. The lease was for a 10-year term, beginning January 15, 1972. The rent was to increase1981 Tax Ct. Memo LEXIS 42">44 with time ($ 125,000 for the first year, $ 135,000 for the second year, and so forth, up to $ 225,000 for each of the last two years). Rent was to be paid in equal quarterly installments on the first days of November, February, May, and August of each year of the lease term. Although the lease as originally drafted contained a printed clause requiring Maidmore's written consent to an assignment of the lease, upon the insistence of petitioner's counsel the following clause was typed in: 44. RIGHT TO ASSIGN. Notwithstanding the provisions of Article 4 [nonassignment clause] hereinbefore set forth, Tenant hereunder shall have the right to assign this lease to a corporation to be formed and upon such assignment the Tenant hereunder, Gabriel Podlofsky, shall be released from all personal liability under the terms and provisions of this lease. The lease between Maidmore and petitioner was executed on November 30, 1971. At or about that time petitioner tendered a personal check for $ 35,375 to Maidmore1981 Tax Ct. Memo LEXIS 42">45 pursuant to a clause in the contract requiring advance payment of the first installment of annual rent for 1972. In January 1972, petitioner formed a corporation in the Virgin Islands known as Estate Carlton, Inc. (hereinafter the corporation). The corporation was formed primarily for the purpose of insulating the petitioner from personal liability. Petitioner remained at all relevant times the sole shareholder and president of the corporation. Also in January 1972, the corporation began to actively operate the hotel. It, inter alia, hired employees, engaged in repairing the premises, advertised, joined a hotel association, and filed income tax returns. On January 20, 1972, Maidman, on behalf of Maidmore, was informed that the petitioner had assigned the lease of the hotel to the corporation. Subsequently, Maidman conformed Maidmore's ledger sheets to reflect the assignment. Furthermore, in written communications, seeking late payments for rent, dated March 7, 1972, September 14, 1972, and February 13, 1973, he addressed the letters to the corporation at its offices in Puerto Rico. All responses to these written communications by Maidman were oral, and at no time was he1981 Tax Ct. Memo LEXIS 42">46 informed by the petitioner or otherwise that he had addressed these letters to the wrong party. According to Maidmore's ledger accounts, the following payments were made to Maidmore, pursuant to the lease agreement, during 1972: DateAmountPayor3/72$ 17,687.50Estate Carlton, Inc.5/7235,375.00Gabriel Podlofsky9/7235,375.00Estate Carlton, Inc.Additionally, petitioner made contributions to the capital of the corporation in the amounts of $ 10,000, $ 10,000, and $ 35,000, respectively, on June 19, 1972, July 7, 1972, and December 12, 1972. As a result of racial violence, culminating in the deaths of several vacationers in St. Croix in 1973, the corporation's business failed. After discussions with Irving Maidman the petitioner personally prepared an agreement, effectively terminating the lease. It provided: AGREEMENTThis is to confirm our agreement this day, 14th March 1973, re: Estate Carlton Hotel, Inc.The rent due Maidmore Realty Co is hereby deferred until November 1, 1973 at which time the regular payments shall resume. In addition, commencing February 1, 1974 additional payments of $ 7,500 per quarter will be paid1981 Tax Ct. Memo LEXIS 42">47 until such time as all back payments are met. Within three months of this date Gabriel Podlofsky President of Estate Carlton, Inc shall notify Irving Maidman and/or Maidmore Realty of its intention to continue or not continue its operation of Estate Carlton Hotel. In the event Podlofsky decides not to remain, he will continue to operate the Hotel for one more month. If the Estate Carlton Inc ceases operation at any time, it will deliver legal possession to Irving Maidman and/or Maidmore Realty Corp. together with all fixture, furnishings and equipment appurtenant thereto with the further proviso that Podlofsky shall be held free and harmless of all liabilities and obligations, both individual and corporate as to Irving Madiman and/or Maidmore Realty Co. Nothing in this agreement shall obligate Irving Maidman or Maidmore Realty to assume and obligations whatsoever of the Estate Carlton Inc. In the event Podlofsky decides to remain and so notifies Maidman, the parties will continue as above. /S/ Gabriel Podlofsky / Estate Carlton, Inc. Gabriel Podlofsky, President /S/ Irving Maidman / Maidmore Realty Co. Irving Madiman In June or July 1973 the corporation vacated the1981 Tax Ct. Memo LEXIS 42">48 hotel. On August 23, 1973, petitioner signed a printed "surrender of lease," both personally and as a represented of the corporation, which contained the following typewritten clause: [the said party of the second part, by a certain Indenture of Lease bearing date the 30th day of November 1971 did demise and to farm let unto] 4GABRIEL PODLOFSKY, all of the premises known as the Estate Carlton Hotel, Fredricksted, St. Croix, U.S.Virgin Islands and more particularly described on Schedule "A" attached hereto and made a part hereof, which said lease was recorded on January 19, 1972 in P.C. 157M, page 374 as No. 177, and Which said lease was assigned by GABRIEL PODLOFSKY to ESTATE CARLTON, INC. by assignment dated January 20, 1972. [Emphasis supplied.] On his tax return for 1972 petitioner deducted $ 125,750 for rents paid to Maidmore on the lease of the hotel in St. Croix. 5 Respondent has disallowed this deduction on the basis that the corporation, not the petitioner, is the entity entitled to claim a deduction for rents paid to Maidmore. 1981 Tax Ct. Memo LEXIS 42">49 OPINION The crux of the matter before the Court is whether petitioner assigned the hotel lease to the corporation in January 1972. The petitioner maintains that he never assigned the lease to the corporation, while respondent adheres to a contrary position. 6 If such an assignment did occur, then, according to the typed provisions in the lease agreement, the petitioner was relieved of all liability under that agreement and only the corporation was liable for rent. It is well established that a shareholder is not entitled to a deduction for the payment of an expense attributable to a corporation; such amounts constitute loans or contributions to capital, and are deductible, if at all, only by the corporation. Deputy v. duPont, 308 U.S. 488">308 U.S. 488 (1940); Rink v. Commissioner, 51 T.C. 746">51 T.C. 746 (1969). Upon our review of all of the objective evidence presented, we conclude that prior to its effective date the petitioner assigned the lease to the corporation. 1981 Tax Ct. Memo LEXIS 42">50 When the petitioner decided to become involved in a hotel venture in St. Croix he consulted at length with his advisors. His attorney stressed the need for limiting personal liability, not only as to hotel operations, through the use of the corporate form, but also apparently as to the hotel lease which carried potential liability of $ 1,770,000. On the other hand, petitioner's accountant suggested that the lease be held by petitioner as an individual to gain the tax benefits. It is apparent that petitioner proceeded to act in a manner by which he sought to accomplish both limited personal liability and tax benefits. In early January 1972, petitioner formed the corporation to operate the hotel. Shortly thereafter he informed Madiman that he had assigned the lease to the corporation. Maidman, 7 acting upon this news, changed the ledgers of Maidmore to reflect the assignment and directed all further correspondence to the corporation. Of the three rent checks for use of the hotel property subsequent to January 1972, two were drawn on the corporation's account and one was drawn on petitioner's own account. The petitioner explained that payments by the corporation were merely1981 Tax Ct. Memo LEXIS 42">51 the result of petitioner's poor cash flow position at the time, but there is no evidence that the petitioner either repaid (or intended to repay) the corporation these funds. There then being no writing to establish an assignment the petitioner reported all of the rent payments for 1972 as a business expense on his personal tax return. Finally, although the agreement between Maidmore and petitioner, dated March 14, 1973, providing for future termination of the lease, is ambiguous as to the identity of the actual lessee (stating that the corporation will deliver possession of the hotel and that petitioner will be held harmless and signed by petitioner only in his capacity as president of the corporation), their agreement of August 23, 1973, which petitioner executed, both as an individual and as the president of the corporation, clearly stated that the corporation became the assignee of the lease on January 20, 1972. 1981 Tax Ct. Memo LEXIS 42">52 From the facts presented it is not entirely clear whether a pro forma assignment existed, with Maidmore the prospective patsy, 8 whether no such assignment existed, with the Treasury as the prospective patsy, or whether the petitioner had never actually decided until it became clear which result would yield him the greatest benefit. Thus, the petitioner has failed to carry the burden of proof, Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1973); Rule 142, Tax Court Rules of Practice and Procedure. Moreover, the overwhelming preponderance of the objective evidence weighs in favor of a conclusion that an assignment of the lease from petitioner to the corporation did occur on or before January 20, 1972. Accordingly, we hold that the rent paid to Maidmore for the lease term beginning January 1972 is deductible only by the corporation, and any payments made by petitioner were in fact contributions to the corporation's capital. 91981 Tax Ct. Memo LEXIS 42">*53 Because of concessions, 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 taxable year in issue. ↩2. spondent has conceded that this asserted addition to tax was improper.↩3. Although not entirely clear from the record, it appears that Robert Maidman's father, Irving Maidman, was the president and/or controlling shareholder in Maidmore Realty Co.↩4. Bracketed portion contains typed and printed words.↩5. Petitioners arrived at this figure by adding the $ 35,375 paid in December 1971, plus the $ 88,437.50 received by Maidmore in 1972. The sum of these figures, however, is $ 123,812.50. Petitioners have offered no explanation as to why the deduction taken exceeds their asserted entitledment by nearly $ 2,000.↩6. Petitioner also apparently maintains that the corporation was in fact a "dummy" or "sham" corporation, which should be disregarded for tax purposes. We find this argument entirely without merit. The evidence clearly establishes that the corporation was very actively engaged in the business of operating a resort hotel. It, inter alia, hired employees, repaired the premises, was the member of a hotel association, and filed income tax returns. It was formed for the purpose of shielding petitioner from personal liability. The petitioner has chosen and accepted the business advantages of incorporation. He may not now reject the resulting tax disadvantages. Moline Properties v. Commissioner, 319 U.S. 436">319 U.S. 436 (1943); Harrison Property Management Co. v. United States, 201 Ct. Cl. 77">201 Ct. Cl. 77, 475 F.2d 623">475 F.2d 623 (1973); Strong v. Commissioner, 66 T.C. 12">66 T.C. 12 (1976), affd. 553 F.2d 94">553 F.2d 94↩ (2d Cir. 1977).7. At the time of trial Robert Maidman was a practicing attorney, village justice, and deputy town attorney in Rockland County, New York. His participation in the instant litigation is entirely that of a disinterested witness. For these reasons we place great weight on his testimony herein.↩8. There is little doubt that had Maidmore held petitioner to the lease contract, the petitioner would have vehemently argued that an assignment had occurred. ↩9. Although not argued by the parties, the payment of $ 35,375 by petitioner upon signing the lease in 1971 is also a corporate deduction in 1972. No payment could have been deductible until the lease commenced in mid-January 1972. By or before that time, however, the corporation had been formed and the lease assigned (as contemplated at the time the lease was executed). Because the effective date of the first lease payment so closely, if not exactly, coincides with the formation of the corporation, and the assignment of the lease to it, and because petitioner contemplated these events at the time the lease was executed, and payment made, this payment also is deductible only by the corporation and should be considered a contribution by petitioner to the corporation's capital, and we so hold.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619304/	Barone v. Comm'rDocket No. 5038-08United States Tax Court2012 U.S. Tax Ct. LEXIS 54; March 6, 2012, Entered2012 U.S. Tax Ct. LEXIS 54">54 For Daren J. Barone, Primary Petitioner: Ernest Scribner Ryder, Richard V. Vermazen, San Diego, CA; Lauren A. Rinsky, Palo Alto, CA; Steven Richard Toscher, Lacey E. Strachan, Hochman, Salkin, Rettig, etc., Beverly Hills, CA.For Colleen R. Barone, Primary Petn Spouse Diff Name: Ernest Scribner Ryder, Richard V. Vermazen, San Diego, CA; Lauren A. Rinsky, Palo Alto, CA; Steven Richard Toscher, Lacey E. Strachan, Hochman, Salkin, Rettig, etc., Beverly Hills, CA.For Commissioner of Internal Revenue, Respondent: Monica D. Polo, San Diego, CA.Harry A. Haines, Judge.Harry A. HainesORDER AND DECISIONOn January 5, 2011, the Court filed petitioners' motion for summary judgment in the above-docketed case. On March 10, 2011, the Court filed respondent's opposition to petitioners' motion for summary judgement. On February 29, 2012, the Court issued an order in error granting petitioners' motion for summary judgment. That order must be vacated and set aside.A decision granting summary judgment may be rendered if the pleadings and other materials in the record 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); Sundstrand Corp. & Subs. v. Commissioner. 98 T.C. 518">98 T.C. 518, 98 T.C. 518">520 (1992), affd. 17 F.3d 965">17 F.3d 965 (7th Cir. 1994). We have considered2012 U.S. Tax Ct. LEXIS 54">55 the pleadings and other materials in the record and conclude that there is no genuine issue of any material fact and that a decision may be rendered as a matter of law.On October 7, 2009, the Court filed petitioners' motion to dismiss in the above-docketed case. On November 4, 2009, the parties held a hearing with respect to petitioners' motion to dismiss. In that hearing, respondent took the position that this Court had jurisdiction to hear this case because petitioner Daren J. Barone (Barone) made a valid election to treat partnership items from WB Partners as non-partnership items under section 6223(e)(3)(B). Respondent argued that Barone was an indirect partner of WB partners because both the S corporation and ESOP through which he allegedly held an interest in WB Partners were "pass-thru partners" pursuant to section 6231(a)(9). Respondent also conceded that the ESOP was not a sham. Respondent's memorandum brief with respect to the motion to dismiss stated that if the Court were to determine that the section 6223(e)(3)(B) election was invalid, then all of adjustments for 2003 would be outside of the Court's jurisdiction, In other words, there are no non-partnership items in dispute for 2003.On April 22, 2010, the Court issued an order2012 U.S. Tax Ct. LEXIS 54">56 denying with respect to 2003 and granting with respect to 2004 and 2005 petitioners' motion to dismiss. Citing Abelein v. United States, 323 F.3d 1210">323 F.3d 1210 (9th Cir. 2003), we held that Barone made a valid speculative election for 2003 to treat partnership items from WB Partners as non-partnership items under section 6223(e)(3)(B). We did not pass judgment on the issue of whether Barone was a partner of WB Partners in 2003.In WB Acquisition, Inc. & Subs. v. Commissioner. T.C. Memo 2011-36, a related case, we held that Barone was not a direct partner of WB Partners. Rather, Barone was the lone participant in a valid ESOP that was the sole shareholder of a valid S corporation that held a 50% interest in WB Partners in 2003. Petitioners' motion for summary judgement argues that because Barone was not a partner of WB Partners, his section 6223(e)(3)(B) election is meaningless, and there are no partnership items attributable to Barohe to convert to non-partnership items. As a result, no issues remain for trial.Respondent's opposition to petitioners' motion for summary judgment states that the substantive issue in this case is whether petitioners "received unreported taxable income". Respondent argues that this issue is not determinative on our decision in WB Acquisition that Barone was not a direct partner in WB Partners in 2003. Additionally, respondent2012 U.S. Tax Ct. LEXIS 54">57 refers to the "constructive dividend and/or compensation income" issues set forth in petitioners 2003 notice of deficiency. However, respondent does not provide any explanation of whether these issues gave rise to partnership or non-partnership items. Respondent also does not expressly argue his previously stated position that Barone was an indirect partner of WB partners because both the S corporation and ESOP are "pass-thru partners" pursuant to section 6231(a)(9). Nonetheless, because respondent has previously taken this position, and appears to infer it again here, we are compelled to address its merits.Where no issue of amount or allocation of partnership income is involved, as is here, determining the true partners of a partnership is properly considered at a partner-level proceeding. Grigoraci v. Commissioner, T.C. Memo. 2002-202. Section 6231(a)(2)(B) provides that a "partner" includes any "person whose income tax liability under subtitle A is determined in whole or in part by taking into account directly or indirectly partnership items of the partnership". An "indirect partner" is a person holding an interest in a partnership through one or more pass-thru partners. Sec. 6231(a)(10). Section 6231(a)(9) provides that the term "pass-thru partner" means a "partnership, estate, trust, S corporation,2012 U.S. Tax Ct. LEXIS 54">58 nominee, or other similar person through whom other persons hold an interest in the partnership..."In Weekend Warrior Trailers, Inc. v. Comm'r, T.C. Memo. 2011-105, we examined the legislative history of ESOPs as S corporation shareholders, stating:In 1996 Congress expanded the definition of a small business corporation to allow certain tax-exempt organizations to own S corporation stock. See Small Business Job Protection Act of 1996, Pub.L. 104—188, sec. 1316(a), 110 Stat. 1785; see also Taproot Admin. Servs., Inc. v. Commissioner. [133 T.C. 202">133 T.C. 202, 133 T.C. 202">205 (2009)]. Section 1361(c)(6) now permits qualified pension, profit-sharing, and stock bonus plans (within the meaning of section 401(a)) and exempt organizations (within the meaning of section 501(a) and (c)(3)) to hold S corporation stock. See also 133 T.C. 202">Taproot Admin. Servs., Inc. v. Commissioner, supra at 205 n. 5. In expanding the list of eligible shareholders in this manner, Congress intended to encourage employee ownership of closely held businesses and to facilitate the establishment of ESOPs by S corporations. S. Rept. 104—281, at 60—61 (1996); see also S. Prt. 107—30, at 123 (2001).We further held that "as a consequence of ESOPs holding shares in S corporations, S corporation profits may generally escape current taxation." Id. Accordingly, an ESOP is not a "pass-thru partner" pursuant to section 6231(a)(9).In the instant case, the parties do not dispute the legitimacy of the ESOP.1 Because2012 U.S. Tax Ct. LEXIS 54">59 the ESOP is not a "pass-thru partner" pursuant to section 6231(a)(9), the profits of the S corporation in 2003 would not be taxed unless a distribution was made to Barone as the ESOP participant. Respondent has not presented any evidence of a distribution from the ESOP to Barone in 2003. There are no material facts in dispute and respondent has failed to show that petitioners' received unreported taxable income. Therefore, a decision may be entered for petitioners as a matter of law.Upon due consideration, it isORDERED that the Court's order granting petitioners' motion for summary judgment, dated February 29, 2012, is vacated and set aside. It is furtherORDERED that petitioners' motion for summary judgment is granted. It is furtherORDERED AND2012 U.S. Tax Ct. LEXIS 54">*60 DECIDED that there is no deficiency in income tax or penalty under section 6662(a) due from, and no overpayment due to, petitioners for the tax year 2003.(Signed) Harry A. HainesJudgeENTERED: MAR-6 2012Footnotes1. In 2001, Congress addressed concerns regarding ownership structures involving S corporations and ESOPs, enacting section 409(p) to limit the tax benefits of ESOPs maintained by S corporations to situations where the ESOP provides meaningful benefits to rank-and-file employees. See Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. 107-16, sec. 656(a), 115 Stat. 131. However, section 409(p) is only effective for ESOPs created after March 14, 2001. See id. sec. 656(d), 115 Stat. 135↩. The ESOP at issue here was created on September 13, 2000.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619305/	WILLIAM NELSON CROMWELL, AND JOHN FOSTER DULLES, SURVIVING EXECUTORS OF THE ESTATE OF AUGUSTUS COE GURNEE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Cromwell v. CommissionerDocket No. 42619.United States Board of Tax Appeals24 B.T.A. 461; 1931 BTA LEXIS 1637; October 26, 1931, Promulgated 1931 BTA LEXIS 1637">1637 1. Value of personalty located abroad held properly included in gross estate of a resident decedent. Guaranty Trust Co., Executor,21 B.T.A. 330">21 B.T.A. 330, followed. 2. Inclusion in decedent's gross estate of value of property transferred within two years prior to death, the transfer not being admitted or shown in fact to have been made in contemplation of or intended to take effect at or after death, held to be erroneous, following Estate of Robert Todd Lincoln,24 B.T.A. 334">24 B.T.A. 334. 3. Respondent's method of valuing bequest to educational institution sustained. Frederick R. Bangs, Esq., Emmet McCaffery, Esq., and Raymond B. Goodell, Esq., for the petitioners. Harold Allen, Esq., for the respondent. ARUNDELL24 B.T.A. 461">461 The respondent determined a deficiency in estate tax under the Revenue Act of 1926 in the amount of $71,141.62, and notified the executor of decedent's estate thereof by letter of December 10, 1928. Several of the original issues have been disposed of by stipulation, leaving in issue the questions of (1) the propriety of including in the estate the value of personalty having its actual situs1931 BTA LEXIS 1637">1638 abroad and stock disposed of by gift within two years of decedent's death; and (2) the value of annuities created by decedent in his will. The facts were stipulated. FINDINGS OF FACT. The decedent, Augustus Coe Gurnee, died July 5, 1926, and at the time of his death was a resident of Bar Harbor, Me. He left two wills, one herein called the American will, disposing of property located in the United States, and the other herein called the French will, disposing of property in France. Letters testamentary were issued to petitioners as executors out of the Surrogate's Court of the County of New York, State of New York, and out of the Probate Court of Hancock County, State of Maine. At the date of decedent's death there was located in the Republic of France tangible personel property then owned by him and having a fair market value of $31,485.05, which was disposed of under his will executed in France. Said tangible personal property has been included by the respondent in the gross estate of the decedent at its fair market value, and the net estate upon which respondent computed the estate tax is based on such inclusion. In computing the 24 B.T.A. 461">462 net value of the property1931 BTA LEXIS 1637">1639 the respondent has allowed no deduction for succession and transfer taxes paid thereon to the Republic of France. On May 18, 1926, the decedent transferred to Gustave Frederick Dutschke as a gift 500 shares of the common stock of United States Steel Corporation. The fair market value of said shares at the date of decedent's death was $71,750. The respondent has deducted from said $71,750 the sum of $5,000 by reason of the provisions of the Revenue Act of 1926, section 302(c), and has included said stock in the gross estate of the decedent for Federal estate-tax purposes at its value as so diminished, namely, $66,750. This transfer is not admitted or shown in fact to have been made in contemplation of or intended to take effect in possession or enjoyment at or after decedent's death; it has been treated by the respondent as presumptively made in contemplation of death to the extent in excess of $5,000, by reason of the fact of having been made within two years prior to decedent's death as described in the second sentence of section 302(c) of the Revenue Act of 1926. Under the ninth clause of decedent's American will an annuity of $2,500 is given to Jeanne Baumgartner. The1931 BTA LEXIS 1637">1640 annuitant, at the death of the decedent, was 74 years of age. The respondent has valued the annuity at $14,865.62, and has included that amount in the gross estate of the decedent. Under the tenth clause of decedent's American will an annuity of $5,000 is given to Kate Freeman Carter. The annuitant, at the death of the decedent, was 56 years of age. The respondent has valued the annuity at $56,105, and has included that amount in decedent's gross estate. Under the thirteenth clause of decedent's American will the residue of his estate is bequeathed to "the President and Fellows of Harvard College for the general purposes of the University." OPINION. ARUNDELL: We have set out as our findings of fact only the facts that relate to the issues left for decision. Other stipulations of fact and waivers of issues will be mentioned briefly here. Petitioners waived an issue relating to the inclusion in the estate of certain cash securities and cash held by Bankers Trust Company as trustee for Gustave Frederick Dutschke and consented to the inclusion thereof at the value of $164,813.49 as fixed by respondent. The parties agree that the amount of the residuary estate passing1931 BTA LEXIS 1637">1641 to Harvard University, which is stipulated to be an educational institution and exempt from Federal estate tax, shall be computed without deduction of the estate and inheritance taxes in the amount of 24 B.T.A. 461">463 $262,971.22 paid by the estate to various States of the United States and to the Republic of France upon noncharitable bequests. Respondent in the notice of deficiency determined the credit to which the estate was entitled against the Federal estate tax (including the deficiency asserted) for estate and inheritance taxes paid as amounting to $280,000, of which $55,451.83 was determined to be applicable as a credit against the deficiency asserted. The parties are agreed that by reason of the payments actually made, the proper amount of such credit on the basis of the tax asserted in the deficiency notice is $281,461.47, of which $56,913.30 is applicable as a credit against the asserted deficiency. It was further stipulated that inheritance and estate taxes have been actually paid by the estate to States of the United States in the amount of $327,224.97. Proper proof of such payment and claim for the allowance of such taxes as part of the 80 per cent credit against the1931 BTA LEXIS 1637">1642 Federal estate tax has been filed in accordance with the provisions of section 301(b) of the Revenue Act of 1926 and article 9 of Regulations 70 and allowed by the respondent. The petitioners are entitled to a credit for State inheritance taxes paid against the Federal estate tax as ultimately fixed of such part of $327,224.97 as does not exceed 80 per cent of the Federal tax. The above matters will be given effect in the settlement under Rule 50. The first question for decision is whether the value of the personal property left by decedent, having its actual situs in France, should be included in the gross estate. It is agreed by the parties that decedent was a resident of the State of Maine at the time of his death. In Guaranty Trust Co.,21 B.T.A. 330">21 B.T.A. 330, we had the identical question that is raised here. Counsel for petitioners urge with much earnestness that perhaps some of the underlying principles involved in this question were not presented in that case. We have carefully considered petitioners' arguments and considered the cases cited, and, while admitting that the matter is not entirely free from doubt, we find nothing in the presentation of the present1931 BTA LEXIS 1637">1643 case to cause us to alter our views. We accordingly find no error in the inclusion in decedent's estate of the personal property located in France. The next question is whether respondent erred in including the value of shares of United States Steel corporation stock that decedent gave to his secretary, Dutschke, within two years prior to his death. The agreed value of this stock in excess of $5,000 has been included in the estate by respondent as a gift in contemplation of death under the second sentence of section 302(c) of the Revenue Act of 1926, reading as follows: 24 B.T.A. 461">464 Where within two years prior to his death but after the enactment of this Act and without such a consideration the decedent has made a transfer or transfers, by trust or otherwise, of any of his property, or an interest therein, not admitted or shown to have been made in contemplation of or intended to take effect in possession or enjoyment at or after his death, and the value or aggregate value, at the time of such death, of the property or interest so transferred to any one person is in excess of $5,000, then, to the extent of such excess, such transfer or transfers shall be deemed and held to have1931 BTA LEXIS 1637">1644 been made in contemplation of death within the meaning of this title. It is stipulated in regard to this transfer that it "is not admitted or shown in fact to have been made in contemplation of or intended to take effect in possession or enjoyment at or after death." On this phase of the case the only issue raised by the pleadings is the validity of the above quoted part of the statute. The issue as framed and the facts as limited by the stipulation do not bring into controversy any question as to whether the transfer might have been included under the first sentence of section 302(c). Petitioners' claim is that that part of the statute above set out is invalid and unconstitutional as in violation of the due process clause of the Fifth Amendment. This issue is decided in favor of the petitioners on authority of our decision in American Security & Trust Co. et al., Executors,24 B.T.A. 334">24 B.T.A. 334. The final question involves the annuities created by the ninth and tenth clauses of decedent's American will. Petitioners allege that the respondent erred in determining the values at which the annuities were included in decedent's gross estate. Decedent, by his will, 1931 BTA LEXIS 1637">1645 made a number of specific bequests and created the annuities here involved and left the residue of his estate to Harvard University, an admittedly educational institution. The plan of the Federal estate tax act is to include in the gross estate all of the decedent's property and then to determine the value of the net estate - upon the transfer of which the tax is imposed - by allowing specified exemptions and deductions. Among the deductions allowed are bequests to educational institutions. In this case the bequest to the educational institution is not a specific sum, but is the residuary estate after providing, among other things, for the annuities created, and so it becomes necessary to calculate the value of the residue in order to determine the amount to be deducted in arriving at the net estate. Henry R. Ickelheimer et al., Executors,14 B.T.A. 1317">14 B.T.A. 1317. While the stipulation of the parties would indicate that our problem is to value the annuities to determine the value at which they would be included in the gross estate, as we conceive the question, this is not technically correct. As we have pointed out above, the entire gross estate is included, from which1931 BTA LEXIS 1637">1646 is substracted those deductions allowed by law, and the remainder constitutes the net taxable estate. The 24 B.T.A. 461">465 manner of the approach becomes important, as both parties rely on the actuarial tables found in article 13 of Regulations 70, which are used for the purpose of determining the present values of various interests in estates. The difference between the parties is illustrated by the following computations as they relate to clause nine of the will, which provides for an annuity of $2,500 for Jeanne Baumgartner, who was seventy-four years of age at the time of decedent's death. Petitioners contend that the present value of that annuity is $12,960.05, computed as follows: Amount of annuity$2,500Present worth of annuity of $1 at age 74 (taken from column 2 ofTable A in Reg. 70) is $5.184.02 $2,500 multiplied by 5.18402 gives$12,960.05Respondent has not informed us how he arrived at his value of $14,865.62, but petitioners explain the computation as having been made in this way: Amount of annuity$2,500Amount of fund which at 4% would$62,500produce annuityPresent worth of $1 due at end of year.76215of death of annuitant at age 74 (takenfrom column 3 of table above referred to)$62,500 X .76215$47,634.38$62,500 minus $47,634.38$14,865.621931 BTA LEXIS 1637">1647 A similar method of computation, according to petitioners, was used with respect to the Carter annuity. Column 2 of Table A is designed to give the present value of annuities, and column 3 the present value of remainder or reversionary interests. In this case the residue of the estate, which is the part deductible, is subject to the annuities and so it becomes a remainder. Accordingly, in our opinion, the respondent has pursued the correct method of determining the value of the net estate in that he has determined the value of the residuary estate and reduced the value of the gross estate by that amount. It is suggested by petitioners that the difference in the result obtained by their method of calculation and that followed by the respondent is due to an improper factor in column 3 of the table. On the state of the record we can not say whether this is so or not. Both parties rely on the same table and the only dispute between them is whether column 2 or column 3 shall be applied, and as the petitioners have not attempted to show what is a proper factor in place of the one said to be wrong, we must take the table as it stands. We accordingly find no error in respondent's1931 BTA LEXIS 1637">1648 determination on this phase of the case. 24 B.T.A. 461">466 We may say in passing that there is no issue as to the use of actuarial tables to determine present values (Cf. Ithaca Trust Co. v. United States,279 U.S. 151">279 U.S. 151), nor as to the use of a 4 per cent interest rate, which is the basis of the tables above mentioned. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619306/	East New York Sanitary Bagel Bakery, Inc. v. Commissioner.East New York Sanitary Bagel Bakery, Inc. v. CommissionerDocket No. 61472.United States Tax CourtT.C. Memo 1957-144; 1957 Tax Ct. Memo LEXIS 100; 16 T.C.M. 624; T.C.M. (RIA) 57144; July 31, 19571957 Tax Ct. Memo LEXIS 100">100 Vincent B. Lewin, Esq., for the petitioner. Anthony S. Del Guidice, Esq., for the respondent. TIETJENSMemorandum Opinion TIETJENS, Judge: The Commissioner determined deficiencies in the petitioner's income tax for the years 1948, 1949 and 1950 and made additions to the tax for fraud and for failure to file timely returns; he also made additions to the petitioner's 1951 income tax for fraud and for failure to file a timely return, as follows: I.R.C. 1939Additions to the TaxSectionSectionYearDeficiency293(b)291(a)1948$20,512.78$10,256.39$5,128.19194917,105.178,552.594,276.29195026,828.6515,589.547,794.771951397.03198.51The petitioner, East New York Sanitary Bagel Bakery, Inc., is a corporation organized and existing under the laws of the State of New York, with its principal office located in Brooklyn, New York. The petitioner filed its income tax returns for the taxable years with the district director of internal revenue for the Brooklyn district of New York. The returns were filed on April 22, 1954, which date was after the expiration of the period of time prescribed by law1957 Tax Ct. Memo LEXIS 100">101 for the filing of those returns. The petitioner's officers thought that the employee who filed its payroll tax returns also filed its income tax returns during the taxable years. That employee however thought that the petitioner's regular accountant filed the income tax returns. Consequently timely tax returns were not filed by the petitioner for the taxable years. However, in 1954 delinquent income tax returns for the taxable years were filed by the petitioner. The returns were prepared by an employee of the petitioner with the help of one of the revenue agents who investigated the petitioner and the amount of gross income reported was arrived at by using a formula developed after an investigation of the bagel industry by the Internal Revenue Bureau. The income tax returns showed deductions for wages in the amounts of $89,073.18 in 1948, $101,825.23 in 1949, $109,569.85 in 1950 and $110,653.25 in 1951. However, the petitioner's payroll tax returns only showed wages paid in the amounts of $34,984.68 in 1948, $38,569.50 in 1949 and $41,386 for 1950. Wages shown on the payroll tax returns for 1951 agreed with the deduction claimed for wages on the 1951 income tax return. The Commissioner1957 Tax Ct. Memo LEXIS 100">102 disallowed the wages claimed in excess of the amount of wages shown on the petitioner's payroll tax returns. The petitioner's sales, wages allowed and the percentage of such wages to the sales, for the years 1948 through 1951, were as follows: WagesPer-YearSalesAllowedcentage1948$160,289.76$ 34,984.68221949184,991.8038,569.50211950196,830.8041,386.00211951200,347.20110,653.2555Inferences derived from the petitioner's cross-examination of the Commissioner's witnesses, who were called to prove the fraud issue, make the petitioner's position more understandable. It was inferred that in the bagel baking industry in New York, it was a "custom" to pay the workers a part of their wages in cash, which amounts were not reported on the payroll tax returns, and that the petitioner followed this custom in 1948, 1949 and 1950. When the industry was investigated by the Internal Revenue Bureau in 1951, the cash wage custom was abruptly discontinued, thus accounting for the sharp increase in wages reported on the 1951 payroll tax returns. It was also inferred that although the petitioner could not directly prove the amount of1957 Tax Ct. Memo LEXIS 100">103 cash wages paid in 1948, 1949 and 1950, that amount could indirectly be proven because bagel bakers were paid on a piece work basis and thus all that one needed to know was the number of bagels sold, which could be determined from the bagel sales reported on the income tax returns. The petitioner, however, offered no direct evidence on the question of the deficiency which was based solely on the disallowance of wages as shown above. The petitioner argued that its income tax returns would speak for themselves and that it would be apparent from comparing the returns for 1948, 1949 and 1950, with the return for 1951, that the petitioner must have had additional payroll in the former years. Aside from the fact that petitioner could not directly substantiate the wages claimed on the returns, there is nothing in the record to show fraud. The failure of the petitioner to call any witnesses or introduce any direct evidence to support its position leaves us no choice but to sustain the deficiencies determined by the Commissioner, and we so held at the conclusion of the hearing of this case. At that time we also held that the Commissioner had failed to sustain his burden of showing by clear1957 Tax Ct. Memo LEXIS 100">*104 and convincing evidence that the petitioner's income tax returns for the taxable years were fraudulent with intent to evade tax. The additions to tax for failure to file timely returns were conceded by the petitioner to be proper. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619307/	HUDSON-DUGGER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Hudson-Dugger Co. v. CommissionerDocket No. 6918.United States Board of Tax Appeals7 B.T.A. 357; 1927 BTA LEXIS 3199; June 15, 1927, Promulgated 1927 BTA LEXIS 3199">3199 Where the tax shown by a petitioner upon its return as filed exceeds the total tax liability as determined by the Commissioner, the Board is without jurisdiction to entertain the proceeding, even though assessment has not been made by the Commissioner of the entire amount shown due on petitioner's return as filed. J. S. Y. Ivins, Esq., and Taylor E. Cress, C.P.A., for the petitioner. W. Frank Gibbs, Esq., for the respondent. LITTLETON7 B.T.A. 357">357 This proceeding came on for hearing on the Commissioner's motion to dismiss for lack of jurisdiction, for the reason that he had 7 B.T.A. 357">358 not determined that there was a deficiency within the meaning of section 274 of the Revenue Act of 1926 in respect of the tax of this petitioner for the fiscal year ending May 31, 1920. The proceeding involves alleged additional income and profits tax for the fiscal year ending May 31, 1920, in the amount of $6,801.20. FINDINGS OF FACT. The petitioner, a Tennessee corporation, filed its return for 1918 and prior years on a calendar year basis, and likewise filed a return for 1919 in March, 1920, on the same basis, paying the first installment of the tax shown1927 BTA LEXIS 3199">3200 to be due thereon. For the aforementioned years, as well as for 1920, the petitioner's books were kept on the On June 5, 1920, petitioner advised the collector for its district on June 5, 1920, petitioner advised the collector for its dis trict of the manner of keeping its books and was instructed, in a series of correspondence, that under the Revenue Act of 1918 returns must be filed on the basis on which a taxpayer keeps its books and that correct returns should be submitted for 1918 and subsequent years on its fiscal year basis. On July 20, 1920, petitioner filed the necessary returns, including a return on the proper basis for the fiscal year ended May 31, 1920. In the meantime petitioner inquired of the collector on at least two occasions as to how remaining payments should be made on account of the 1919 calendar year return which had been filed and was advised to continue making payment of the installments until the return for the fiscal year ended May 31, 1920, was filed and that proper credit would be given at that time for payments made on the erroneous basis. Further correspondence took place between the collector and the petitioner with respect to the fiscal year1927 BTA LEXIS 3199">3201 return so that it was not until on or about September 22, 1920, that the petitioner satisfied the collector that proper returns had been filed for 1920 and prior years. Prior to this time petitioner had paid three installments of the tax shown due on the calendar year return for 1919, or $5,127.93, the total tax shown on this return being $6,837.24. The return as filed for the fiscal year ended May 31, 1920, showed a tax due of $8,500.69, against which the collector advised the petitioner that he was crediting the $6,837.24 assessed on the 1919 calendar year return and stated that the remaining installment shown due on the 1919 calendar year return, and the difference between that assessed on the calendar year return and that shown due on the fiscal 1920 return should be paid at the same time as though the return had been filed on the basis of the fiscal year ended May 31, 1920, or a total of $3,372.76. The collector, however, made an assessment of only $1,663.45 on the fiscal 1920 return, though the petitioner, 7 B.T.A. 357">359 on December 15, 1920, made payment to the collector of $3,372.76 as the remaining amount shown due by the collector on account of the calendar year 1919 return1927 BTA LEXIS 3199">3202 and the fiscal 1920 return. The return for the fiscal year ending May 31, 1920, shows the following in "Schedule D, Computation of Taxes": Total tax (items 3, 4, or 8 plus item 11)$8,500.69Balance of Tax (item 12 minus items 13 and 14) 8,500.69Assessed. - Paid under return filed 12-31-19 6,837.24 O.K.Balance to be assessed$1,663.45In 1924, a revenue agent audited the books of the petitioner and submitted a copy of his report to the petitioner in which he showed the total amount assessed for the fiscal year ended May 31, 1920, as $8,500.69. On March 20, 1925, the Commissioner advised the petitioner of the results of an examination of its return for the fiscal year ended May 31, 1920, in connection with the foregoing revenue agent's report showing in the communication a tax previously assessed for the fiscal year ended May 31, 1920, of $8,500.69 and a refund due for this year of $13.63. Subsequently, on July 11, 1925, the Commissioner advised the petitioner that the determination of its tax liability as shown in letter of March 20, 1925, had been changed so that instead of a refund being due for the fiscal year ended May 31, 1920, there was now a1927 BTA LEXIS 3199">3203 tax to be collected in the amount of $6,801.20. In this communication the tax previously assessed was shown as $1,663.45 and the total tax liability as $8,464.65. The explanation made in a later communication from the Commissioner of the change was that the tax of $6,837.24 assessed on the return filed for the calendar year 1919 and credited by the collector and therefore approved by him against the tax for the fiscal year ended May 31, 1920, was applicable only to the fiscal year ended in 1919, and that refund could not then be made on account of the proper crediting of this amount to the 1919 fiscal year return since the period within which refunds could be made of taxes erroneously collected in 1919 had expired. After further correspondence with the Department, the petitioner received the following advice from the collector: In accordance with your inquiry of even date as to whether or not there were any outstanding income and profits taxes against your company for either of the fiscal years ended May 31, 1918, 1919, 1920 and 1921, I beg to advise that my records fail to indicate that there are any taxes due for these years that have not been paid. I might further state1927 BTA LEXIS 3199">3204 that my records show that your company filed returns on the calendar year basis ended December 31, 1918 and 1919, but it was discovered during the early part of 1920, either by the officers of the company or the auditor employed by you, that your returns were erroneously made and that they should be made on the fiscal year basis ending May 31st, instead of the calendar year basis and, accordingly, on July 20, 1920, a return for the fiscal year ended May 31, 1920 was filed together with amended returns for the 7 B.T.A. 357">360 period ended May 31, 1918 and 1919. The report for the fiscal year ended May 31, 1920, showed a total tax of $8,500.69 and this office credited the account with $6,837.24, assessed for the period ended Dec. 31, 1919, which assessment appears on my March 1920 Assessment List, account #43150. After applying this credit there remained a tax of $1,663.45 which was also charged into the account above mentioned number 43150. Payments were made on this account as follows: 3/11$1709.316/151709.319/151709.3112/153372.76This latter payment covered the fourth installment as assessed on the original account plus $1663.45, the amount shown to1927 BTA LEXIS 3199">3205 be due on the full fiscal year return ended May 31, 1920. This office thought it proper to credit the tax as disclosed by the return filed for the period ended May 31, 1920 with the assessment shown on the return for Dec. 31, 1919, as the latter report covered the period closing nearest and prior to the fiscal year ended May 31, 1920. Notwithstanding all of the foregoing facts, the Commissioner on July 11, 1925, mailed to petitioner a 60-day notice, Form NP-2, as follows: The determination of your income tax liability for the fiscal years ended May 31, 1920 and May 31, 1921, pursuant to an examination of your books of account an records as set forth in office letter dated March 20, 1925, has been changed to disclose a deficiency in tax of $6801.20 for the fiscal year 1920, and an overassessment of $7.61 for the fiscal year 1921, as shown in the attached statement. In accordance with the provisions of Section 274 of the Revenue Act of 1924, you are allowed 60 days from the date of mailing of this letter within which to file an appeal to the United States Board of Tax Appeals contesting in whole or in part the correctness of this determination. * * The statement attached1927 BTA LEXIS 3199">3206 to the above notice, so far as is material here, sets forth the following: Total tax assessable for year$8,464.65Assessed on return, Account Number 431501,663.45Deficiency6,801.20 * * The change from an overassessment to a deficiency in tax is due to the fact that there was erroneously credited against the tax disclosed, the tax previously assessed for the calendar year 1919 as well as that computed on the return filed for the fiscal year ended May 31, 1920. As it is the practice of the Bureau to credit against a fiscal year ended in any year, the tax assessed for the calendar year, the tax for 1919 should not have been taken into consideration. The petitioner executed no waiver of the statute of limitations in respect of the fiscal year ending May 31, 1920. The return for that fiscal year was filed on July 21, 1920. 7 B.T.A. 357">361 OPINION. LITTLETON: The purported notice of deficiency on account of which the Board is asked to take jurisdiction shows a total tax liability for the year in question of $8,464.65. Of the amount shown as due by the petitioner on the return as filed only $1,663.45 was ever assessed, which amount has not subsequently1927 BTA LEXIS 3199">3207 been changed by additional assessments, abatements, credits, or refunds. As a condition precedent to the Board taking jurisdiction of a proceeding, it is necessary that the Commissioner must have found a deficiency. Section 273(1) of the Revenue Acts of 1924 and 1926 define a deficiency, so far as is pertinent here, as "The amount by which the tax imposed by this title exceeds the amount shown as the tax by the taxpayer upon his return." It should be noted that the definition of deficiency in the statute does not set out as a requirement that the taxes shown due on the return must be assessed, but merely says "the amount shown as the tax by the taxpayer upon his return." When the petitioner filed a proper return admitting a tax liability of $8,500.69, this amount was shown as due on its return regardless of what the Commissioner may have done with respect to making assessment thereof. . The Commissioner has determined that the total tax liability of the petitioner for the fiscal year in question is $8,464.65. Since this amount is less than that shown as the tax by the petitioner upon its return, namely, $8,500, 1927 BTA LEXIS 3199">*3208 the Board is without jurisdiction and the proceedings is Dismissed.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619309/	CLAUDE NEON LIGHTS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Claude Neon Lights v. CommissionerDocket No. 59391.United States Board of Tax Appeals35 B.T.A. 424; 1937 BTA LEXIS 874; February 10, 1937, Promulgated 1937 BTA LEXIS 874">874 1. Eight transactions whereby petitioner granted patent rights to corporations for stock considered and held to be nontaxable exchanges. 2. The granting of patent rights held to be assignments and not licenses; basis for gain determined. 3. Cost of conducting experiments directed to creating patentable inventions held to be capital expenditures and not deductible expenses. Raymond M. White, Esq., for the petitioner. James K. Polk, Jr., Esq., and John H. Pigg, Esq., for the respondent. ARUNDELL35 B.T.A. 424">425 ARUNDELL: This proceeding arises on respondent's determination of deficiencies in petitioner's income tax for the fiscal years ended June 30, 1927 and 1929, in the amounts, respectively, of $11,939.81 and $34,643.42. Petitioner raised a number of issues in its petition, but only two remain for our determination, both of which are present in each of the years in question: (1) Whether any gain should be recognized on eight separate transactions by which petitioner transferred rights to use its neon light patents to several corporations organized in various parts of the United States for that purpose in exchange for capital1937 BTA LEXIS 874">875 stock of each corporation. Petitioner contends that no gain is recognizable on the several transactions under the Revenue Acts of 1926 and 1928, since they were either exchanges of property for stock and, as such, nontaxable, or were reorganizations; or, in the alternative, that it may deduct a proportionate part of the cost of the patents as representing the cost of the patent rights exchanged for stock. (2) Whether the petitioner may deduct as expenses the expenditures incurred in carrying on experiments in development of patents. We have made our findings of fact from certain facts stipulated, the testimony, and documents in evidence. FINDINGS OF FACT. Organization of Petitioner and Acquisition of Patents.Petitioner is a New York corporation, with its principal place of business in New York City. Its authorized capital stock at organization in March 1924 consisted of 500 shares of preferred stock of a par value of $100 per share, and 50,000 shares of no par value common stock. Petitioner was organized primarily for the purpose of acquiring certain patents and patent rights from the French inventor, Georges Claude, and for the purpose of deriving income brom1937 BTA LEXIS 874">876 developing and promoting the use of the inventions covered by those patents in the United States for electric signs and illuminating purposes. The petitioner is authorized to engage in business generally and in particular to engage in the manufacture and sale of neon signs directly or through others, and to acquire and dispose of patents, rights, and inventions in connection therewith. Petitioner was organized in accordance with a contract of March 6, 1924, between Claude (by his attorney in fact, William T. P. Hollingsworth) and Pritchitt & Co., which provided, inter alia, that Claude would transfer his patents to the new corporation for stock. The patents which were the subject of the above contract were five in number, all relating to the so-called neon lights, and are described 35 B.T.A. 424">426 in the stipulation. The consideration for the assignment of the patents was the issue to Claude of 500 shares of petitioner's preferred stock and 30,000 shares of its common stock. It was further provided that in the event of any increase in the capital stock of the petitioner, Claude should receive either a royalty of 10 percent of the annual increase in net sales, or, at the option1937 BTA LEXIS 874">877 of the petitioner, 20 percent of the additional stock. Claude formally assigned his five patents to the petitioner by an instrument dated March 29, 1924. The petitioner issued its stock to Claude in accordance with the contract. Of the 30,000 shares of common stock received by Claude he returned as donated stock 15,000 shares which were to be issued to the general public to provide the petitioner with working capital. The petitioner from time to time thereafter issued additional common stock to Claude in lieu of royalties until at the close of 1928 it had issued to him a total of 29,000 shares. The common stock issued to Claude had a value of $494,375. During the same period the petitioner sold 71,000 shares for cash in the total amount of $1,527,500. The stock was split 10 for 1 in April 1929. In June 1929 petitioner sold 49,623 shares for $992,460. The sale prices ranged from $10 per share in 1924 to $60 per share in 1928. The stock sold in 1929 after the split at $20 per share. The common stock received by Claude in 1924 had a fair market value at that time of $10 per share, and the preferred stock had a fair market value at that time equal to its par value. In1937 BTA LEXIS 874">878 1926 and 1927 the petitioner paid to Claude additional cash for patents in the sums, respectively, of $13,997.57 and $30,511.60. No description of these patents is given in the stipulation. The petitioner maintained its books and accounts and prepared and filed its income tax returns on an accrual basis. The petitioner, in addition to manufacturing and selling neon lights in a limited territory in New York State, granted exclusive rights to the use of the neon patents in specified territories to a number of corporations in exchange for stock of such corporations. One of such transactions, in which petitioner received stock of the Electric Products Corporation, is by stipulation to be treated as a taxable exchange, "for lack of proof to the contrary." The net values, after allowing certain credits and deductions, of the stock of other corporations received by the petitioner in the fiscal years 1927 and 1929, are as follows: Fiscal year 1927Stock in - Net valueBellows Corporation$146,475.45Claude Neon Federal Co240,660.35Total387,135.80Fiscal year 1929Stock in - Net valueClaude Neon Displays, Inc$169,600.00Elliott Claude Neon Lights78,605.75Alpha Claude Neon Corporation164,690.93Claude Neon Lights of Maryland87,835.50New Jersey Claude Neon Corporation202,379.10Claude Neon of Connecticut145,031.25Total848,142.531937 BTA LEXIS 874">879 35 B.T.A. 424">427 The respondent determined the above amounts to be income to the petitioner. He disallowed claimed deductions for the cost of the patents and allowed deductions in each year for amortization of the cost over the life of the patents. In the transactions with the eight corporations listed above, hereinafter more fully described, the petitioner granted to each of them patent rights for certain territory in the United States. The following opinion is in regard to the nature of the rights granted. OPINION. Nature of rights granted. - The respondent argues that the patent rights granted were licenses as distinguished from assignments or other species of rights which might be considered as exchangeable property under the exchange and reorganization provisions of the statute. The general rule laid down by the cases is that the granting of an exclusive right to manufacture, use, and vend under a patent in a specified territory vests pro tanto title to the patent itself in the grantee. ; 1937 BTA LEXIS 874">880 ; ; . The same legal effect follows from a grant of all right, title, and interest for a specified territory. ; . In the case before us some of the grants of rights under the patent are termed licenses, but this is not determinative of the interest conveyed. This is plainly brought out in , where it is said: Whether a transfer of a particular right or interest under a patent is an assignment or a license does not depend upon the name by which it calls itself, but upon the legal effect of its provisions. Whether a transfer is an assignment or license depends upon the effect of the whole contract. 48 C.J. § 370. The case before us involves the granting of patent rights to each of eight corporations in specified territory. The several grants are variously phrased, but upon an examination of them we conclude that each was intended1937 BTA LEXIS 874">881 to and did grant the exclusive right to make, use, and vend the patented articles in a specified territory for the full term of the patents. They 35 B.T.A. 424">428 were therefore assignments. As such, the grants were property susceptible of exchange within the meaning of the taxing statutes. We may also say at this point that each of the several transactions hereinafter considered was a genuine business deal, engaged in for the purpose of developing petitioner's business under its patents, and they are not open to the charge of being shams entered into to avoid tax, as in . FINDINGS OF FACT. Transactions in Which Petitioner Acquired Stock. 1. Bellows Corporation. - This was a Michigan corporation, organized in 1926 with an authorized capital stock of 15,000 shares of preferred stock of $100 per share par value and 45,000 shares of no par value common stock. It was organized pursuant to a contract entered into on June 25, 1926, between the petitioner, L. F. R. Bellows & Co., a partnership, and W. T. P. Hollingsworth. It was agreed therein that upon incorporation of the Bellows Corporation the petitioner would assign1937 BTA LEXIS 874">882 to it exclusive rights under its Claude patents in the States of Michigan, Ohio, and Indiana. The partnership agreed to transfer to the Bellows Corporation all of the partnership assets then being used in the electric sign business except real estate, contracts, cash, and receivables. Hollingsworth agreed that he would procure cash subscriptions to stock of the Bellows Corporation in the sum of $300,000. It was further provided that the subscribers for the 3,000 shares of preferred stock to be procured by Hollingsworth should receive as a bonus two shares of common stock with each share of preferred purchased. On June 28, 1926, the petitioner formally granted to the new corporation the exclusive right to manufacture, use, and sell the Claude inventions in the aforesaid three states. On October 21, 1926, a formal transfer of the partnership assets was made to the new corporation in accordance with the June agreement. By that time Hollingsworth had procured the subscriptions to the stock of the new corporation in accordance with the June agreement, and $90,000 cash had been paid in on the subscriptions. Stock of the Bellows Corporation was issued on October 21, 1926, as follows: 1937 BTA LEXIS 874">883 Issued to - Preferred stockCommon stockSharesSharesPetitioner1,6506,000Bellows partners1,6506,000Outside interests3,0006,000The balance due on the cash subscriptions was all paid in prior to September 1927. 35 B.T.A. 424">429 On organization of the Bellows Corporation the three partners became its only officers. The partnership thereafter continued in existence for the purpose of holding real estate. About December 1, 1927, 6,300 additional shares of preferred stock were issued by the Bellows Corporation for cash and 12,600 shares of common stock were issued as bonus stock with the preferred. Most of this stock was taken by the original holders. The stock of the Bellows Corporation received by the petitioner had a fair market value of $206,000 at the time of receipt. OPINION. Petitioner claims that the Bellows transaction was nontaxable on two grounds: First, that there was an exchange of property solely for stock of a corporation and immediately after the exchange the transferors were in control of the transferee corporation; second, that property was exchanged pursuant to a plan of reorganization solely for stock1937 BTA LEXIS 874">884 in another corporation a party to the reorganization. The second ground is plainly without merit. The transaction meets none of the requirements of the definition of reorganization in section 203(h)(1) of the Revenue Act of 1926. 1 There was no merger or consolidation; no acquisition by either corporation of stock or assets as prescribed by the parenthetical clause; there was no transfer of assets by either corporation followed by control in the transferor; there was no recapitalization, or mere change in identity, form or place of reorganization. 1937 BTA LEXIS 874">885 The first ground urged is put forth under section 203(b)(4), 2 which, in brief, provides for the nonrecognition of gain or loss upon the transfer of property to a corporation solely for stock or securities of the corporation if immediately after the exchange the transferors of the property are in control of the corporation through the ownership of at least 80 percent of each class of stock. Where two or more persons exchange property for stock, nonrecognition is granted only if the amount of stock received by each is substantially in proportion to his interest in the property before the exchange. 35 B.T.A. 424">430 The facts here are similar to those in 1937 BTA LEXIS 874">886 , in which a partnership exchanged property for stock in a new corporation, and a group of corporations paid in cash for stock of the new corporation. In that case the court pointed out that the statute (sec. 203(b)(4), Revenue Act of 1924, which is the same as the corresponding section of the 1926 Act) does not expressly exclude money from consideration, and that in other court decisions money has been held to be "property." It is further pointed out that under other sections of the exchange provisions care is taken to specify the particular kind of property intended to be excluded from the generic term. For instance, section 204(a)(6) uses the expression "property (other than money", and subsections (7) and (8) use the expression "property (other than stock or securities * )." The opinion proceeds: Not only is the word "property" used in said paragraph (4) without qualification, but no apparent reason suggests itself why money paid for stock should not be considered property within the contemplation of that provision of the statute. * * In addition to other capital assets corporations engaged in business require1937 BTA LEXIS 874">887 money. In the instant case the partnership had developed a valuable business based largely upon the ownership of a patented process for cementing oil wells. Their patrons necessarily included, doubtless largely, corporations engaged in the oil industry. Apparently there was a field open for the expansion of the business which required a larger money capital. Such excpansion could be to the benefit of the oil industry generally, and the oil companies purchasing stock in particular, in the event the demand was in excess of the ability of the partnership as such to supply. We think it clear that the statute comprehends a situation such as presented in the instant case where certain persons transfer to a corporation certain property and property rights, other than money, while others transfer money only, and stock in the corporation is issued in exchange for such transfers. The reasoning in the Halliburton case is applicable here, and the payment in of money for stock is to be regarded as an exchange of property for stock. There is no question here as to whether or not the amount of stock acquired was in proportion to the interests of the transferors in the property prior1937 BTA LEXIS 874">888 to the exchange. The parties have stipulated that in any of the transactions here involved which are held to be exchanges, such as we hold this to be, the stock received was substantially in proportion to the respective interests of the transferors. FINDINGS OF FACT. 2. Claude Neon Federal Co. - This company, hereinafter called the new Federal Co., was chartered under the laws of Delaware in 1927. It was organized by the Federal Electric Co., hereinafter called the old Federal Co., a New York corporation, engaged in the business 35 B.T.A. 424">431 of manufacturing electric signs and specialties. Its principal office was at Chicago, Illinois. The purpose of organizing the new Federal Co. was to acquire from the petitioner the exclusive right under its Clause patents to manufacture, use, sell, or rent neon signs in a group of midwestern states. Contracts covering the details of the arrangements were entered into under dates of June 1 and July 14, 1927. In accordance with the agreements the new Federal Co. was organized with an authorized capital of 50,000 shares of common stock and 25,000 shares of preferred. The preferred had no voting rights. The petitioner on July 14, 1927, transferred1937 BTA LEXIS 874">889 to the new Federal Co. the exclusive right to manufacture, use, sell, and rent the inventions covered by the Claude patents in sixteen midwestern states. The new Federal Co. issued to the petitioner 20,000 shares of its common and 3,333 shares of its preferred stock. The petitioner, in accordance with its agreement, assigned 13,334 shares of the common stock (13,333 on August 20, 1927, and 1 share on April 23, 1931) to the old Federal Co. Capital for the new company was to be supplied by the old Federal Co. through stock purchases. The old Federal Co. was to buy 5,000 shares of preferred stock for cash at $100 per share, of which 1,000 shares were to be purchased, and were so purchased, on July 14, 1927. The balance of the 5,000 shares were to be purchased on notice to be given by the new Federal Co. On completion of purchase of the 5,000 shares the old Federal Co. was to have an option to acquire an additional 1,667 shares of preferred at $100 per share. The preferred stock was issued to the old Federal Co. as follows, including the initial issue of 1,000 shares: DateSharesJuly 14, 19271,000September 27, 19271,200December 31, 19271,000April 23, 19281,000July 25, 19281,000April 1, 19291,467Total6,6671937 BTA LEXIS 874">890 It was contemplated by the parties, and provided in the agreement between them, that upon completion of the stock issue the petitioner would have a one-third interest in the new Federal Co. and the old Federal Co. would have a two-thirds interest. The officers of the new Federal Co. were all officers of the old Federal Co.; none of them were officers of the petitioner. The stock of the new Federal Co. received by petitioner had a fair market value at the time of receipt of $339,967. OPINION. The Federal Co. transaction in our opinion, comes within section 203(b)(4) of the Revenue Act of 1926 3 as a nontaxable exchange 35 B.T.A. 424">432 of property for stock, followed by control of the new corporation by the transferors. Under the decision in , the cash paid in by the old Federal Co. is to be considered as property exchanged for stock. On completion of the transaction the petitioner and the old Federal Co. were in control of the new corporation through ownership of all the stock which they had acquired in exchange for property. Under the stipulation above referred to, the stock of the new Federal Co. is to be1937 BTA LEXIS 874">891 treated as being held in substantial proportion to the respective interests of the transferors in the property prior to the exchange. This state of facts brings the transaction within section 203(b)(4), and we accordingly hold that no gain is to be recognized on the petitioner's exchange of patent rights for stock of the new Federal Co. FINDINGS OF FACT. 3. Claude Neon Displays, Inc. - This company, hereinafter called the Displays Co., was incorporated under the laws of New York on July 13, 1928. Its authorized capital consisted of 10,000 shares of preferred stock of a par value of $100 per share, and 25,000 shares of no par common stock. On July 13, 1928, the Displays Co. entered into a contract with Frazier-Wilson, Inc., which was then engaged in the manufacture and sale of advertising displays and signs. On July 16, 1928, the Displays Co. entered into a contract with the petitioner. Pursuant to these contracts the Displays Co. acquired (a) all the assets of Frazier-Wilson, Inc., and (b) exclusive rights under the Claude patents in the western part of New York State, the limits of the territory being described in the contract1937 BTA LEXIS 874">892 of July 16. The assets of Frazier-Wilson, Inc., were acquired in exchange for 1,150 shares of preferred stock and 5,300 shares of common stock of the Displays Co., certificates for which were issued, dated July 13, 1928. The 5,300 shares of common were first to go to the petitioner and then to be transferred to Frazier-Wilson, Inc., or its stockholders. The patent rights were acquired from petitioner for 2,000 shares of preferred stock and 19,000 shares of common stock of the Displays Co. to be issued to petitioner or its nominees. Petitioner did not actually receive the full 19,000 common shares called for by the contract. The 5,300 shares mentioned above were, by petitioner's direction, issued to Frazier-Wilson, Inc., which in turn distributed that stock and the 1,150 shares of Displays Co. preferred stock among its shareholders. Frazier-Wilson, Inc., then dissolved. Another block, 7,700 shares, of the 19,000 shares, was by petitioner's direction issued as a bonus to purchasers of 2,850 shares of the preferred stock of the Displays 35 B.T.A. 424">433 Co. The 2,850 shares of preferred stock were purchased at par. Subscriptions for this block of preferred stock were in hand by July 16, 1928. 1937 BTA LEXIS 874">893 Upon conclusion of the above steps, all of which were completed in July 1928, the outstanding stock of the Displays Co. was held as follows: StockholderPreferred stockCommon stockSharesSharesPetitioner2,0006,000Frazier-Wilson, Inc., stockholders1,1505,300Cash subscribers2,8507,700Total6,00019,000The preferred stock had no voting rights except on default of dividends. The stock of the Displays Co. received by petitioner in the above transaction had a fair market value of $206,000 at the time of receipt. OPINION. The petitioner argues that in the Displays Co. transaction it was a "party to a reorganization" exchanging property "solely for stock" of the Displays Co., which was "a party to the reorganization", hence the transaction was within section 112(b)(4) of the Revenue Act of 1928. 4It is clear that there was a reorganization in this transaction1937 BTA LEXIS 874">894 in so far as Frazier-Wilson, Inc., and the Displays Co. are concerned. The transfer of Frazier-Wilson assets for stock, followed by dissolution of the Frazier-Wilson Co., was a merger. It is equally clear that petitioner, "in pursuance of the plan of reorganization", exchanged property solely for stock of the Displays Co. The only question remaining on this transaction is whether or not petitioner can qualify as "a party to a reorganization." No comprehensive definition of this term has been given in the cases. The statutory description (sec. 112(i)(2)) is not by its term all-inclusive and we have so held. See , affd., ; . But see , holding contra. On a finding that there was a reorganization, the determination of which corporations were parties to it must depend on all the facts and circumstances surrounding the transaction. The statute does not make the answer dependent on any particular mode of 35 B.T.A. 424">434 participation or any specific amount of stock ownership by1937 BTA LEXIS 874">895 any of the participants. In this case, as we have pointed out, there was a reorganization in the merger of Frazier-Wilson, Inc., and the Displays Co. It was effected at the instance of petitioner and for the purpose of enlarging the scope of petitioner's operations. The petitioner was in a very substantial way a party to the deal; in fact, the acquisition by the Displays Co. of patent rights from the petitioner was an indispensable element of the transaction. The petitioner emerged from the "reorganization" with a substantial block of stock. In our opinion, on the facts here, the petitioner must be held to have been "a party to a reorganization." Thus it meets all the requirements of section 112(b)(4), and the gain on the exchange of patent rights for stock is not to be recognized. FINDINGS OF FACT. 4. Elliott Claude Neon Lights, Inc. - This corporation was organized in 1928 under the laws of Florida, with an authorized capital of 3,000 shares of preferred stock of a par value of $100 per share, and 10,000 shares of no par common stock. It was organized by E. B. Elliott and the petitioner pursuant to a contract between them, dated June 20, 1928. It was to acquire, 1937 BTA LEXIS 874">896 and did acquire, from the E. B. Elliott Advertising Co., a Florida corporation, the latter's electrical sign business, including all assets and good will. It was also to acquire, and did acquire, from the petitioner exclusive rights to make, use, and sell devices under the Claude patents in the State of Florida. The petitioner also agreed to provide a neon tube plant for the new corporation. Pursuant to the preorganization agreement, the patent rights were granted by petitioner to the new corporation, hereinafter called the Elliott Co., on July 17, 1928. On the same date the Elliott Advertising Co. transferred to the Elliott Co. the assets as provided in the contract of June 20. At the same time the Elliott Co. issued to the petitioner 1,000 shares of its preferred stock and 2,000 shares of its common stock. At the same time the Elliott Co. issued 8,000 shares of its common stock to E. B. Elliott, who at the same time transferred 4,500 shares back to the Elliott Co. It was provided in an agreement between Elliott and the Elliott Co. that, of the stock so transferred, 2,000 shares were to be issued as a bonus, with 1,000 shares of preferred stock to b sold to outside interests1937 BTA LEXIS 874">897 at a price of $100 per unit of one share of preferred and two shares of common stock. In the agreement of June 20, 1928, the petitioner had contracted to procure subscriptions for this stock. The subscriptions were obtained about the time the new corporation was formed, and 35 B.T.A. 424">435 the stock was issued to the cash subscribers some weeks later, about September 1928. Of the remaining shares transferred back by Elliott, 1,000 shares were to be disposed of "for the purpose of securing additional capital" or "other corporate purposes" and when it was issued the remaining 1,500 shares were to be issued to Elliott and the petitioner in equal amounts. The stock of the Elliott Co. received by the petitioner had a fair market value of $102,000 when received. OPINION. Petitioner contends that the Elliott deal was a nontaxable exchange under either section 12(b)(5) or section 112(b)(4) of the Revenue Act of 1928. This transaction is very similar to the one last discussed - the Displays Co. matter. There was a reorganization as between the Elliott Advertising and the new Elliott Co. in that the new company acquired for stock all the assets of the old. The petitioner was in1937 BTA LEXIS 874">898 a very substantial way a party to the reorganization through the granting of patent rights for stock of the new company. The transaction meets all the requirements of section 112(b)(4) and we hold that no gain is to be recognized to the petitioner on receipt of the Elliott Co. stock. It is unnecessary to decide whether the transaction might also come within section 112(b)(5)9 FINDINGS OF FACT. 5. Alpha Claude Neon Corporation. - This corporation, hereinafter called Alpha Neon, was organized in Pennsylvania on July 12, 1928, pursuant to an agreement of June 22, 1928, between petitioner and the Alpha Sign Co., a Pennsylvania corporation. Alpha Neon was organized for the purpose of taking over the assets of the Alpha Sign Co. and manufacturing and selling neon signs under petitioner's neon patents in certain western counties of Pennsylvania and Maryland and the whole of the State of West Virginia. The agreement was carried out in all respects and stock was issued as hereinafter set out. Alpha Neon's authorized stock consisted of 13,457 shares of preferred stock, par $100, without voting rights, and 46,914 shares of commin without par value. The Alpha Sign Co. conveyed1937 BTA LEXIS 874">899 its assets to Alpha Neon in August 1928 for stock of Alpha Neon as follows: 2,472.8 shares of preferred and 4,945.6 shares of common, which were issued to the holders of Alpha Sign Co. preferred stocks; 3,457 shares of preferred and 18,164 shares of common, of which the preferred 35 B.T.A. 424">436 shares and 6,914 common shares were issued to the holders of Alpha Sign Co. common stock, 7,500 shares of the new common stock went to the president of the Alpha Sign Co., and the rest, 3,750 shares, was returned to the treasury of Alpha Neon for use as bonus stock on the sale of its preferred shares. The petitioner on August 29, 1928, granted to Alpha Neon the exclusive right to make, use, and sell devices under the Claude patents in the aforesaid territory and it received therefor 2,500 shares of Alpha Neon preferred and 23,750 shares of common. Of the common stock so received it was understood and agreed that 10,000 shares were to go to cash subscribers to Alpha Neon's preferred stock, and 3,750 shares were to be returned to Alpha Neon for use as bonus stock in future sales of preferred or for other corporate purposes. The petitioner contracted to and did procure subscriptions to 5,0001937 BTA LEXIS 874">900 shares of Alpha Neon's preferred stock at par, with initial payments of 25 percent of the subscription price, the balance to be paid in through installments on call. Except for a few shares on which the final installment was not met, all of the preferred subscriptions were paid up on call. With each share of preferred thus sold, two shares of common were issued as a bonus; this bonus stock came out of the common stock issued to the petitioner. The Alpha Sign Co. subsequently dissolved. The stock of Alpha Neon received by petitioner in August 1928 had a fair market value of $196,875 when received. OPINION. Summarizing the facts above set out, at August 30, 1928, Alpha Neon's stock was actually held or contracted for as follows: Preferred stockCommon stockSharesSharesAlpha Sign preferred shareholders2,472.84,945.6Alpha Sign common shareholders3,4576,914Cash subscribers5,00010,000President of Alpha Sign7,500Petitioner2,50010,000Donated by Alpha Sign3,750Donated by petitioner3,750Total13,429.846,859.6Thus, at August 30, 1928, all of Alpha Neon's stock, except 27.2 shares of preferred and1937 BTA LEXIS 874">901 54.4 shares of common stock, was either issued or contracted for. Petitioner claims that it and the newly organized Alpha Neon were parties to a reorganization, hence the exchange of patent rights for Alpha Neon stock was a nontaxable exchange under section 11235 B.T.A. 424">437 (b)(4) of the Revenue Act of 1928. This transaction is much like the two last discussed. There is no doubt that there was a "reorganization" as between the Alpha Sign Co. and the new Alpha Neon Co. The Alpha Sign Co. exchanged its assets for stock and then dissolved. The petitioner transferred to the new company patent rights in exchange for stock. The stock so received was substantial in amount - 2,500 shares of preferred and, initially, 23,750 shares of common. Part of the common was returned and part went to cash subscribers, but when the transaction was concluded the petitioner had the full 2,500 shares of preferred and 10,000 shares of common. This was a substantial interest. The petitioner was the instigator of the transaction, which had for its purpose the furtherance of the petitioner's business. In our opinion, and we so hold, the petitioner was "a party to a reorganization." The matter was carried1937 BTA LEXIS 874">902 out pursuant to "the plan of reorganization" set forth in the contract of June 22, 1928. Petitioner thus meets every test prescribed by section 112(b)(4), and we hold that no gain is to be recognized on the exchange of patent rights for Alpha Neon stock. FINDINGS OF FACT. 6. Claude Neon Lights of Maryland, Inc. - This company was incorporated under the laws of Maryland. It is hereinafter called the Maryland Co. It was originally incorporated on February 15, 1928, with 1,000 shares of no par common stock. On June 8, 1928, it entered into a contract with petitioner for the acquisition of patent rights, which was superseded by another contract under date of November 1, 1928. On August 25, 1928, it increased its authorized capital to 9,000 shares of no par common and 2,500 shares of preferred. Pursuant to the contract of November 1, 1928, the Maryland Co. again in November 1928 increased its authorized capital to 18,000 shares of no par common and 5,000 shares of nonvoting preferred stock of the par value of $100 per share. In December 1928 it acquired from the petitioner the exclusive right to make, use, and vend the devices covered by the Claude Neon patents in eastern1937 BTA LEXIS 874">903 Maryland and the District of Columbia, with the exception of a designated small part of the State of Maryland. For these patent rights it issued to the petitioner 1,000 shares of its preferred stock and all (18,000 shares) of its common stock. The petitioner donated back to the Maryland Co. 11,000 shares of the common stock. No other stock was outstanding immediately following the issue of stock to the petitioner. It was provided in the contract that the petitioner was to procure subscriptions in cash at par for 1,700 shares of preferred 35 B.T.A. 424">438 stock of the Maryland Co. and that such subscribers were to receive a bonus of two shares of common stock with each share of preferred. Further, the president of the Maryland Co. was to procure subscriptions to 300 shares of preferred, which stock when issued was to carry the same bonus. The subscriptions so contracted for were obtained in the latter part of 1928. The stock of the Maryland Co. received by petitioner had a fair market value of $107,000 when received. OPINION. The petitioner claims that the Maryland Co. transaction was a nontaxable exchange under either subsection (4) or (5) of section 112(b) of the Revenue1937 BTA LEXIS 874">904 Act of 1928. We will consider first the claim under subsection (5). The requirements of this subsection are the same as those of section 203(b)(4) of the Revenue Act of 1926 quoted above under the Bellows transaction. The Maryland Co. was originally organized with 1,000 shares of stock, which in August 1928 were increased, and again, in November, pursuant to the contract with petitioner of November 1, 1928, its capitalization was increased to 5,000 shares of preferred and 18,000 shares of common stock. Following the change of its capitalization, its initial issue of stock was 1,000 shares of preferred and all of its common stock, issued to the petitioner in exchange for patent rights. Apparently no stock had been issued prior to that issued to the petitioner, as the evidence is that upon completion of the transaction with the petitioner no other stock was outstanding. Some preferred stock was later sold. The granting of the patent rights was a transfer of property by the petitioner, and immediately after the transfer the petitioner was in control of the outstanding stock of the Maryland Co. These facts bring the transaction within section 112(b)(5), and no gain is to be1937 BTA LEXIS 874">905 recognized on the exchange. In view of this conclusion, it is not necessary to consider whether subsection (4) is applicable. FINDINGS OF FACT. 7. New Jersey Claude Neon Corporation. - This corporation was organized under the laws of New Jersey on December 27, 1928, with an authorized capital stock of 15,000 nonvoting preferred shares, par value $100 per share, and 36,000 no par common shares. It was organized pursuant to a contract between the petitioner and the Neonlite Corporation of America, a New Jersey corporation, hereinafter called Neonlite. Neonlite was engaged in the sign business and was a competitor of the petitioner. Under the contract Neonlite, on or about February 1, 35 B.T.A. 424">439 1929, transferred to the new corporation its going business and good will, and all its assets except cash and receivables, and received therefor 750 shares of preferred stock and 6,500 shares of common stock of the new corporation. The contract provided that 5,000 shares of the common stock were to be issued to Neonlite for its going business and good will, and the preferred and the balance of the common stock for all other assets. Neonlite's total assets amounted to $459,924.73, 1937 BTA LEXIS 874">906 of which $54,924.73 represented cash and receivables. The cash and receivables, amounting to only about 11 percent of the total assets, were retained for the purpose of liquidating Neonlite's liabilities. At the same time the petitioner granted to the new corporation exclusive rights under its Claude Neon patents in the State of New Jersey (excepting Camden, Gloucester, and Salem counties) and received therefor 2,250 shares of the new corporation's preferred stock and 7,000 shares of common stock. The contract required the petitioner and Neonlite together to procure subscriptions to 3,750 shares of preferred stock of the new corporation at par for cash to provide working capital for the corporation. Each share of preferred was to carry a bonus to two shares of common. By February 1, 1929, the required subscriptions had been obtained. By that time cash had been paid in on 250 of the preferred shares and at that time certificates for that number of preferred shares and 500 shares of common were issued. The balance of the cash subscriptions were subsequently paid on call. The stock of the New Jersey Claude Neon Corporation received by petitioner had a fair market value of $232,0001937 BTA LEXIS 874">907 when received. OPINION. The transaction between petitioner, Neonlite, and the New Jersey Claude Neon Corporation is claimed by petitioner to come within both subsections (4) and (5) of section 112(b) of the Revenue Act of 1928. In our opinion it falls within subsection (4) as a transaction whereby "a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization." There was a reorganization as between Neonlite and the New Jersey Claude Neon Corporation within the parenthetical clause of paragraph (A) of section 112(i)(1). That is, New Jersey Claude Neon acquired for stock substantially all the properties of Neonlite, only cash and receivables being retained by Neonlite for the purpose of liquidating liabilities. Cf. ; . The petitioner, by reason of its interest in the transaction and its exchange of patent 35 B.T.A. 424">440 rights for stock, was a party to the reorganization. It received only stock which represented a definite and substantial1937 BTA LEXIS 874">908 interest in the transferee. Cf. The exchange was made pursuant to the contract which set out the plan of reorganization, and was therefore an exchange in pursuance of the plan of reorganization and no gain is to be recognized. We are further of the opinion that the transaction here was a nontaxable exchange under the case of Two parties, Neonlite and the petitioner, paid in property for stock, while a third group paid in cash for stock, which cash under the Halliburton decision is to be considered as property. FINDINGS OF FACT. 8. Claude Neon of Connecticut, Inc. - This corporation, hereinafter called the Connecticut Co., was organized pursuant to an agreement between petitioner and James T. Kane, who owned all the 650 outstanding shares of stock of the Kane Sign Service, Inc. The first meeting of the incorporators of the Connecticut Co. was held on May 18, 1929. In accordance with formal resolutions adopted at that meeting Kane transferred his 650 shares of Kane Sign stock to the Connecticut Co. for 250 shares of its preferred stock, par $100, 1937 BTA LEXIS 874">909 and 1,500 shares of its common stock, par $5, plus $34,100 in cash. At the same time the petitioner granted to the Connecticut Co. the exclusive right to make, use, and sell under the Claude Neon patents in the whole of the State of Connecticut and one township in the State of New York. In exchange for the patent rights the petitioner received 2,000 shares of the Connecticut Co.'s preferred stock and 9,498 shares of its common stock. Two shares of common were issued to individuals who had subscribed therefor in behalf of the petitioner. Subsequently, preferred stock was issued for cash in accordance with the original understanding of the parties to the transaction. The stock of the Connecticut Co. received by the petitioner had a fair market value of $204,000 when received. OPINION. It is claimed that the Connecticut Co. exchange is not taxable on the ground that it comes under both subsections (4) and (5) of section 112(b) of the Revenue Act of 1928. We need not pass on whether or not it comes under subsection (5) as in our opinion it does come within subsection (4). Kane transferred all the outstanding stock of the Kane Sign Service, Inc., to the new corporation1937 BTA LEXIS 874">910 for 250 shares of preferred and 1,500 35 B.T.A. 424">441 shares of common stock of the latter, and cash. This was a reorganization under section 112(i)(1)(A). While Kane's receipt of cash might render him taxable, it does not change the fact that the new corporation acquired all the stock of the old and that Kane's stock interest in the new corporation was definite and material and represented a substantial part of the value of the property that he transferred. . In resolutions of directors of the new corporation the stock acquired from Kane was declared to be worth at least $66,600. There is no evidence of any lower value, and on the basis of that figure the stock of the new corporation of the par value of $32,500 must be said to represent a "material part of the value of the transferred assets." There are in evidence resolutions of the incorporators of the new corporation which, with the deposition of one of its incorporators and directors, who was also a director of the petitioner, establish the existence of the plan of reorganization and also that the exchange1937 BTA LEXIS 874">911 of patent rights for stock was in accordance with the plan. The petitioner's participation in the plan made it, in our opinion, "a party to the reorganization" within the meaning of section 112(b)(4). See discussion and cases cited under the Claude Neon Displays, Inc., transaction above. We accordingly hold that the present transaction is nontaxable. MISCELLANEOUS FINDINGS OF FACT. Income from manufacturer and sale of signs. - The petitioner during the fiscal years 1925 to 1930, inclusive, carried on the manufacture, sale, and maintenance of neon signs in New York City and other territory not covered by exclusive licenses to other corporations. Gross receipts from this source were as follows for the following fiscal years ended June 30: 1925$103,263.001926224,588.001927392,358.081928$723,437.571929975,803.291930951,168.20Gross income was reported as follows: Fiscal years ended June 30192519261927Sales, signs, and service$73,170.86$166,032.36$423,802.40Cost72,779.03187,805.22363,502.03Gross profit on sales391.831 21,772.8660,300.37Receipts from licenses, royalties7,214.54Interest and discounts1,258.851,826.762,999.33Patent rights50,266.71409,500.00Dividends6,457.508,750.001937 BTA LEXIS 874">912 Fiscal years ended June 30192819291930$425,033.72$660,180.85$890,491.87315,797.85470,146.51596,145.03109,235.87190,034.34294,346.8417,825.6934,563.1834,933.015,351.5711,967.5010,419.18983,481.5014,214.0882,912.10163,288.2435 B.T.A. 424">442 Experimental expenses. - Petitioner maintained a laboratory in Long Island City where it employed 20 or 22 engineers in research in electricity, rare gases and tubular lighting. Its purpose was two-fold; to improve petitioner's existing product, and to develop new ideas on tubular lighting for petitioner and its licensees. In 1927 the laboratory work was done in a space partitioned off from the general shop but in later years it was done in a separate building. The laboratory expense in petitioner's fiscal year 1927 was $11,358.66; in 1928, $7,699.37; and in 1929, $46,472.76; of which about 50 percent in 1927 and 1928, and 60 percent in 1929 represented salaries of engineers, the remainder being for rent, traveling expenses, electricity, and laboratory materials. Beginning with January 1, 1929, the experimental laboratory was carried on under the "Associated1937 BTA LEXIS 874">913 Claude Neon Plan", by which the subsidiaries contributed pro rata for its upkeep, but only so much is here claimed as was paid by petitioner in the first half of its fiscal year 1929. The engineers whose salaries are included above were engaged also in perfecting new patents, for which application was made in 1928 or 1929, and patents issued in 1929, 1930, 1931, and 1932. The evidence is clear that petitioner filed in 1928 and 1929 patent applications as a result of this experimental research, and that patents were issued thereon in 1929, 1930, 1931, and 1932. We think in these circumstances that the laboratory expenditures were not in the nature of ordinary and necessary expenses, but were capital expenditures, and should therefore not be deducted in computing net income, but exhausted over the life of the new patents. ; ; affd., C.C.A. 6th Cir. (unreported); certiorari denied, . If any part of them was not a capital expenditure, the petitioner has failed to show how much, and must accordingly fail on this claim. The petitioner's claim of the1937 BTA LEXIS 874">914 deduction of amounts spent in patent litigation having been abandoned, it is not considered. OPINION. Basis for gain or loss. - We have held above in our consideration of the eight corporations organized to operate under petitioner's patents that the receipt of stock for patent rights did not give rise to taxable gain. In view of this conclusion it is perhaps unnecessary to decide the basis for gain or loss, but, as both parties have gone into the matter in their presentation of the case and in their briefs, we think it not improper to state our opinion of the question. The respondent in computing gain on all eight transactions determined the value of the stock received by the petitioner in each case, against which he allowed certain deductions for expenses. There is no 35 B.T.A. 424">443 evidence of error in these figures and in each case we have accepted and found as a fact the value determined by the respondent. The petitioner's view is that in any transaction held to result in gain the basis is that part of the cost of the patents represented by the ratio that the value of the stock received for the particular territory bears to the value of all the territory throughout1937 BTA LEXIS 874">915 the United States. That formula appears to us to be a proper one to be applied under the facts in this case. Manifestly the cost of the grant for a particular territory can not be exactly determined. As far as the record shows all the transactions here involved were consummated at arm's length and presumably each one represents to a fair degree the value of the particular territory. In reaching the total value which the petitioner says represents the assignment value of each of the several territories in the United States, the petitioner starts with the values ascribed by the respondent to the territories assigned in and prior to the taxable years, aggregating $1,353,545.04. To this it adds the value of stock received in subsequent years for one other territory and the estimated value of the remaining territories, less in each case commissions and territorial development costs. The total figure thus reached is $1,818,545.04. The figures given are supported by credible evidence and the result reached represents a reasonable estimate of value. We find as a fact that $1,818,545.04 represents the value of all territories in the United States assigned and/or susceptible of assignment1937 BTA LEXIS 874">916 under exclusive grants. So much for the formula. The stipulation filed shows that the petitioner issued to Georges Claude its common stock of the value, when issued, of $494,375, preferred stock of the value of $50,000, and paid him cash in the amount of $44,509.17, making a total of $588,884.17. There is in one tabulation contained in the stipulation an amount of $80,000 purporting to represent stock issued to Claude, without any date or explanation, which does not appear in another tabulation which shows all the stock issued by petitioner. This amount is claimed by petitioner as being part of the cost of the patents. It appears that this amount may have been inserted in the one tabulation in error. At any rate, standing as it does, we do not feel justified in finding that it should go into cost. If it is a proper item, it may be explained in the settlement under Rule 50. As the record now stands, we find the cost of the patents to petitioner to be $588,884.17. Taking a specific case, the Bellows transaction, if taxable, would have as a basis for gain or loss a figure found by multiplying total cost ($588,884.17) by the fraction 146,475.45/1,818,545.04. Reviewed by the1937 BTA LEXIS 874">917 Board. Decision will be entered under Rule 50.MURDOCK, MELLOTT, and DISNEY dissent. Footnotes1. Sec. 203. (h) (1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferer or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected. ↩2. Sec. 203. (b) (4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. ↩3. See footnote No. 2, supra.↩4. SAME - GAIN OF CORPORATION. - No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization. ↩1. Loss. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619310/	Philadelphia Manufacturers Mutual Insurance Company (Formerly Philadelphia Manufacturers Mutual Fire Insurance Company), Petitioner, v. Commissioner of Internal Revenue, RespondentPhiladelphia Mfrs. Mut. Ins. Co. v. CommissionerDocket No. 66243United States Tax Court33 T.C. 490; 1959 U.S. Tax Ct. LEXIS 15; December 10, 1959, Filed 1959 U.S. Tax Ct. LEXIS 15">15 Decision will be entered under Rule 50. Petitioner is a mutual fire insurance company, specializing in insuring large industrial risks of around $ 2 million. It issues policies for terms up to 5 years upon insured making a large premium deposit, from which petitioner "absorbed" a certain sum each month and the "unabsorbed premium deposit" was returned to insured at the termination of the policy. Held, petitioner was taxable under the provisions of section 207, I.R.C. 1939, and section 821, I.R.C. 1954, applicable to mutual fire insurance companies generally and not under section 204, I.R.C. 1939, and section 831, I.R.C. 1954, applicable to fire insurance companies issuing perpetual policies or such similar termless policies where the losses and expenses are paid out of investment income. Harry L. Brown, Esq., and Ambrose B. Kelly, Esq., for the petitioner.William J. Hagan, Esq., for the respondent. Mulroney, Judge. MULRONEY 33 T.C. 490">490 The respondent determined deficiencies in income tax of petitioner for the years 1952 and 1954 in the amounts of $ 12,985.01 and $ 43,410.35, respectively.The sole question is whether petitioner, a mutual fire insurance company, is entitled to file its return and be taxed according to section 204, I.R.C. 1939, and section 831, I.R.C. 1954.FINDINGS OF FACT.Petitioner is engaged in carrying on a mutual fire insurance business as a separate corporate entity in cooperation with and as a 33 T.C. 490">491 1959 U.S. Tax Ct. LEXIS 15">17 member of a voluntary association known as the Associated Factory Mutual Fire Insurance Companies. This association consists of eight companies, all doing business in exactly the same way.Petitioner specializes in insuring large industrial risks of good quality where the average risk is around $ 2 million. The policies it issues are for periods up to 5 years with the bulk of the business constituting 3-year policies. Petitioner's method of charging for insurance consists of requiring, at the time the policy is issued, a premium deposit, the amount of which, on a given dollar risk, is the same regardless of the length of term for which the policies are written and from which petitioner "absorbs" certain sums each month. The policies provide that upon termination the portion of the premium deposit that is "unabsorbed" shall be returned to the policyholder. The amount which is absorbed each month is determined by petitioner according to a formula whereby petitioner for each month takes its total expenses, adds thereto its total incurred losses, and then subtracts therefrom its investment income. Petitioner then calculates an appropriate contribution to reserve and the result is1959 U.S. Tax Ct. LEXIS 15">18 translated into a percentage of its premium deposits in force and such percentage is absorbed or deducted and retained by petitioner. As stated, the balance or unabsorbed portion of the premium deposit in the month of termination is returned to the policyholder. It may also be used by the insured as a part of the deposit premium on renewal. The premium deposit rates are fixed by the Factory Mutual Rating Bureau, which is an organization whose members consist of the eight Factory Mutual Companies.The large deposits required by the factory mutual group is to furnish the companies the necessary large amounts of capital or surplus, to enable them to meet the capital and surplus requirements of the various States, for the issuance of so many large risk policies. A general line mutual fire insurance company would not ordinarily acquire sufficient surplus to permit its writing such large risks as are written by the factory mutual group.Petitioner filed its income tax returns for the years 1952 and 1954 with the district director of internal revenue at Philadelphia, Pennsylvania. Its 1952 return was filed on Form 1120M pursuant to the provisions of section 207, I.R.C. 1939. Respondent1959 U.S. Tax Ct. LEXIS 15">19 made a determination of deficiency for said year and petitioner filed a claim for refund with the district director of internal revenue at Philadelphia on the ground its tax should be computed under section 204, I.R.C. 1939. The 1954 return filed by taxpayer was on Form 1120, pursuant to section 831, I.R.C. 1954, the counterpart of section 204, I.R.C. 1939.33 T.C. 490">492 The petition asserts error in respondent's determination that petitioner is subject to the provisions of section 207, I.R.C. 1939, for the years prior to 1954 and to sections 821, 822, and 823 of the Internal Revenue Code of 1954 for the year 1954 rather than to the provisions of section 204, I.R.C. 1939, and sections 831 and 832, I.R.C. 1954, for the respective years here involved. The portion of the deficiencies for the years involved, now in dispute, results from respondent's computation under sections 207, I.R.C. 1939, and 821, I.R.C. 1954.OPINION.The parties stipulate:The sole issue now before this Court relates to the respondent's denial of petitioner's assertion that it is entitled to compute its Federal income tax liabilities on Form 1120 pursuant to the provisions of section 204 of the Internal Revenue Code1959 U.S. Tax Ct. LEXIS 15">20 of 1939 and section 831 of the Internal Revenue Code of 1954, rather than on Form 1120M pursuant to the provisions of section 207 of the Internal Revenue Code of 1939 and section 821 of the Internal Revenue Code of 1954.Section 831 of the Internal Revenue Code of 1954 is the counterpart of section 204, I.R.C. 1939, and section 821 of the Internal Revenue Code of 1954 is the counterpart of section 207, I.R.C. 1939. Hereafter discussion of the statutes will be confined to the statutes as they appear in the 1939 Code.Section 207, as amended by the Revenue Act of 1942, provides, in general, for the taxing of mutual fire insurance companies either on their net investment income at regular corporation rates or on the sum of their net premiums (after deduction of dividends) and gross investment income at 1 per cent, whichever method produced the larger tax. The statute provides, in part, as follows:SEC. 207. MUTUAL INSURANCE COMPANIES OTHER THAN LIFE OR MARINE.(a) Imposition of Tax. -- There shall be levied, collected, and paid for each taxable year upon the income of every mutual insurance company (other than a life or a marine insurance company or a fire insurance company subject1959 U.S. Tax Ct. LEXIS 15">21 to the tax imposed by section 204 and other than an interinsurer or reciprocal underwriter) a tax computed under paragraph (1) or paragraph (2) whichever is the greater and upon the income of every mutual insurance company (other than a life or a marine insurance company or a fire insurance company subject to the tax imposed by section 204) which is an interinsurer or reciprocal underwriter, a tax computed under paragraph (3):Petitioner admits it is a mutual fire insurance company and therefore taxable under section 207 unless it is within the parenthetical exception of said section as "a fire insurance company subject to the tax imposed by section 204."Section 204, as amended by the Revenue Act of 1943, provides, in part, as follows: 33 T.C. 490">493 SEC. 204. INSURANCE COMPANIES OTHER THAN LIFE OR MUTUAL.(a) Imposition of Tax. --(1) In general. -- There shall be levied, collected, and paid for each taxable year upon the normal-tax net income and upon the corporation surtax net income of every insurance company (other than a life or mutual insurance company) and every mutual marine insurance company and every mutual fire insurance company exclusively issuing either perpetual1959 U.S. Tax Ct. LEXIS 15">22 policies, or policies for which the sole premium charged is a single deposit which (except for such deduction of underwriting costs as may be provided) is refundable upon cancellation or expiration of the policy taxes computed as provided in section 13(b) and in section 15(b).The parties are agreed that a perpetual policy is one that, by its terms at least, is unending (though it can be terminated) and it has the requirement of a single premium deposit large enough so that the earnings thereon, together with the earnings on other reserve funds, may be sufficient to pay all losses and expenses. Such policies provide in general for the return in full of the premium deposit upon termination, though termination in early years generally results in the deposit returned being reduced by a termination charge.Petitioner admits it does not issue perpetual policies. But petitioner argues that, in section 204, Congress was legislating with respect to two types of policies. Petitioner's entire argument starts with the contention that section 204, rightly construed, includes not only the mutual fire insurance companies issuing perpetual policies, but also companies such as petitioner, issuing1959 U.S. Tax Ct. LEXIS 15">23 short-term policies of 1 to 5 years, where the method of operation involves the deposit of one sum, called a premium deposit, at the inception of the policy, and a return of the unabsorbed premium deposit when the policy is canceled or expires at the end of the term. Petitioner finds this latter inclusion in the following words of section 204 (a)(1):every mutual fire insurance company exclusively issuing either perpetual policies, or policies for which the sole premium charged is a single deposit which (except for such deduction of underwriting costs as may be provided) is refundable upon cancellation or expiration of the policy * * It is petitioner's argument that it falls squarely within the "or" provision; that it issues policies "for which the sole premium charged is a single deposit," and that this premium, except for deduction of underwriting costs (equivalent, so petitioner argues, to its "absorbed" amounts), "is refundable upon cancellation or expiration of the policy."Respondent's position is that the "or" provision of the statute is not to be construed as descriptive of another type of insurance policy, other than the perpetual type, but merely explanatory of the 1959 U.S. Tax Ct. LEXIS 15">24 perpetual type policy and it has the function of describing policies that might be term in form but perpetual in fact. Petitioner, while admitting the word "or" can sometimes have an interpretive meaning, 33 T.C. 490">494 argues on brief "the expression 'either-or' must be taken as a correlative conjunction clearly presenting two completely distinct types of mutual fire insurance company operations, either of which is intended to qualify under the statute." We would agree with petitioner that the "either-or" expression indicates the use of the word "or" as disjunctive, indicating an alternative. But it does not follow that as so used in this statute, it presents "two completely distinct types" of policies. If the word "or" is given its disjunctive meaning, the alternatives can still be between policies of the same type. The either-or expression is given its disjunctive, alternative meaning, if the statute is construed as either perpetual policies by virtue of designation or name, or other policies of the termless continuing type, when not actually called perpetuals.The point is that the intent of Congress to present different, alternative types of policies, is not decided, 1959 U.S. Tax Ct. LEXIS 15">25 as petitioner seems to assume, by the grammatical construction of the "either-or" expression. If we give the expression "either-or" a grammatical construction, as presenting alternatives, as petitioner contends, the question still remains whether the "or" alternative was to be a policy of the same continuing type, as respondent suggests, or a completely different type, as petitioner suggests.Petitioner's argument is that the "or" provision does not say the policy there described is to be termless and, therefore, a term policy, for a term as short as 1 year, is within the alternative presented. But there are other plain indications in the statute, and in the history of this legislation that show quite clearly the "or" provision was employed merely to present an alternative policy of the same continuing type as a perpetual policy, even though it might not be specially termed a perpetual.The general history of the legislation imposing taxes on mutual and stock insurance companies shows the two are taxed on very different bases. Stock, fire, and casualty insurance companies have long been subject to tax under the provisions of section 204 and antecedent statutes. The general tax1959 U.S. Tax Ct. LEXIS 15">26 scheme for such companies is much like other corporation taxation, and the tax base has been approximately the net income as shown on the statements filed with State insurance commissioners.Until 1942 almost all mutual fire insurance companies were specifically exempt from taxation (section 101 (11) exempting mutuals with gross income of not more than $ 75,000) and those not so exempt were taxable under section 207. Actually but few mutual fire insurance companies ever paid any tax under section 207 prior to 1942. The mutuals which required their members to make premium deposits to provide for losses and expenses were, under section 207, 33 T.C. 490">495 prior to 1942, required to include the deposit premiums in gross income but they were allowed to deduct both premium deposits returned to their policyholders and those retained for the payment of losses, expenses, and reinsurance reserves. Moreover, it was conceded by Regulations 103, section 19.207-6, and Regulations 45, art. 572, that in determining the amount of premium deposit so retained, losses and expenses were to be considered as defrayed by investment income first and then by premium income. The result was that no taxable income1959 U.S. Tax Ct. LEXIS 15">27 would remain unless the investment income exceeded both losses and expenses -- a situation that would not likely occur in the ordinary mutual fire insurance company. 52 Yale L. J. 573.The Revenue Act of 1942 made no substantial change in the tax scheme of stock companies other than life. However, it did tax most mutual insurance companies on either their net investment income at the corporation rates, or on the sum of their net premiums (after deduction of dividends) and gross investment income at 1 per cent, whichever method produced the larger tax. The new taxing provisions in the Revenue Act of 1942 constituted a complete revision of section 207 of the Internal Revenue Code of 1939. 1The general legislative intent was to provide a base which would guarantee some tax would1959 U.S. Tax Ct. LEXIS 15">28 be paid by all mutuals taxed thereunder. In its report the Senate Finance Committee stated:The committee bill, therefore, proposes to tax mutual insurance companies other than life or marine upon that one of the following two bases which produces the greater tax. One of these bases is net investment income, to which are applied the rates applicable to corporate incomes generally. The other base is the gross amount of income from interest, dividends, rents, and net premiums, less dividends to policyholders and wholly tax-exempt interest. To this base the rate of 1 per cent is to apply. * * * [S. Rept. No. 1631, 77th Cong. 2d Sess., 1942-2 C.B. 504, 531.]There is no question but that petitioner became taxable under the Revenue Act of 1942. Petitioner admits this. Moreover there is specific reference in the legislative history to the factory mutual fire insurance companies.In section 207(b)(2) and (3), as it was revised by the 1942 Revenue Act, it is provided:(b)(2) Net premiums. -- "Net premiums" means gross premiums (including deposits and assessments) written or received on insurance contracts during the taxable year less return premiums and 1959 U.S. Tax Ct. LEXIS 15">29 premiums paid or incurred for reinsurance. Amounts returned where the amount is not fixed in the insurance contract but depends upon the experience of the company or the discretion of the management shall not be included in return premiums but shall be treated as dividends to policyholders under paragraph (3);33 T.C. 490">496 (3) Dividends to policyholders. -- "Dividends to policyholders" means dividends and similar distributions paid or declared to policyholders. The term "paid or declared" shall be construed according to the method regularly employed in keeping the books of the insurance company;In the Ways and Means Committee Report on the Revenue Act of 1942, there is discussion of the effect of section 207 and the phrase "similar distributions" as used in section 207(b)(2) is explained and defined as follows:"Similar distributions" include such payments as the so-called unabsorbed premium deposits returned to policyholders by factory mutual fire insurance companies. This is distinguished from the more usual "return premium" where the amount is fixed in the insurance contract and does not depend upon the experience of the company or the discretion of the management. [H. 1959 U.S. Tax Ct. LEXIS 15">30 Rept. No. 2333, 77th Cong., 1st Sess., 1942-2 C.B. 372, 458. Emphasis supplied.]The Senate Finance Committee Report on the Revenue Act of 1942 also specifically mentioned the factory mutual companies. The Senate Report No. 1631, 77th Cong., 2d Sess., 1942-2 C.B. 504, 617, states:Section 207(b)(2) defines "net premiums" in a manner that produces substantially the same effect as in section 204(b)(5) of the Code, and includes deposits and assessments, but excludes amounts returned to policyholders which are treated as dividends under section 207(b)(3).Section 207(b)(3) defines "dividends to policyholders" as dividends and similar distributions paid or declared to policyholders. Similar distributions include such payments as the so-called unabsorbed premium deposits returned to policyholders by factory mutual fire insurance companies. [Emphasis supplied.]Regulations 111, section 29.207-3, make further specific reference to the factory mutual fire insurance companies, again stating the words "similar distributions" as used in the statute "include such payments as the so-called unabsorbed premium deposits returned to policyholders1959 U.S. Tax Ct. LEXIS 15">31 by factory mutual fire insurance companies."After the passage of the Revenue Act of 1942, petitioner filed its returns as a mutual company under section 207 of the Internal Revenue Code of 1939. It continued to file its returns under said section each year until 1954. In 1954 the entire Code was revised without changing the substantive sections of the law here involved. It was not until 1954 that petitioner filed an amended return for the year 1952 under the provisions of section 204, and also a return for the year 1954 under section 204.We turn now to the legislative history of the pertinent part of section 204. When the Revenue Act of 1942 was enacted it became immediately apparent the plan of taxation therein provided would work inequitably for the mutual perpetual companies. That plan for taxing mutuals, as previously stated, provided for a tax of 1 per cent on the mutuals' principal source of income, premiums -- out 33 T.C. 490">497 of which losses and expenses were paid. As earlier stated, the perpetuals derive by far the largest portion of their income from investments and pay their losses and expenses from the investment fund income. It is readily apparent that, if the perpetuals1959 U.S. Tax Ct. LEXIS 15">32 were to be denied deductions for their losses and expenses, the result would be an overstatement of their true income. It was to correct this inequity that Congress, in 1943, amended section 204, making perpetuals taxable under the provisions of that section, with certain adjustments; amended section 207 by taking fire insurance companies taxable under section 204 out from under section 207, and made the law retroactive to 1942.The addition to section 204 was made by the Senate Finance Committee in executive session in December 1943. This addition provides, in part:SEC. 129. MUTUAL FIRE INSURANCE COMPANIES ISSUING PERPETUAL POLICIES.(a) Taxability Under Section 204. -- Section 204 (a) (relating to tax on insurance companies other than life or mutual) is amended as follows: (1) by inserting in paragraph (1) after "every mutual marine insurance company" the following: "and every mutual fire insurance company exclusively issuing either perpetual policies, or policies for which the sole premium charged is a single deposit which (except for such deduction of underwriting costs as may be provided) is refundable upon cancellation or expiration of the policy";The bill, which 1959 U.S. Tax Ct. LEXIS 15">33 was passed by the Senate and concurred in by the House (with a change of the section number to 135) goes on to provide in subsequent sections that the single premium deposit for the described companies shall not be included in gross income; that the described companies shall not be taxable under section 207; and that the law shall be applicable to the years after December 31, 1941.The motive force behind the enactment of this amendment was the inequitable treatment of section 207 when applied to a mutual like a perpetual that paid losses out of investment income.The report of the Senate Finance Committee with respect to this bill explains the difficulties of companies issuing perpetual policies or single premium policies where losses were paid out of investment income. It shows quite clearly the purpose of the bill was to grant relief to those companies.We have set forth in a footnote extracts from the report of the Senate Finance Committee and the Conference Committee report with respect to this bill. 2 These statements preclude any intention 33 T.C. 490">498 of Congress to cover the factory mutuals under the bill; or, in fact, any mutuals other than those paying losses from investment1959 U.S. Tax Ct. LEXIS 15">34 income.1959 U.S. Tax Ct. LEXIS 15">35 The fact that the amendment is entitled "Mutual Fire Insurance Companies Issuing Perpetual Policies" is an indication that the amendment is to be limited to companies that can be said to be perpetuals or single premium continuing policies. As pointed out earlier, the legislative history of the Revenue Act of 1942 shows references to the factory mutuals and the deliberate inclusion of these companies under that statute. There is not a word in the legislative history of the 1943 amendment of section 204 which shows any intention to take the factory mutuals issuing short-term policies out from under section 207. The wording of the reports shows clearly the amendment was to be confined to the companies requiring single premiums for permanent insurance. These reports contain "or" clauses: "mutual fire insurance companies * * * issuing perpetual 33 T.C. 490">499 or refundable single premium policies" (H. Rept. No. 1079), "fire insurance companies issuing * * perpetual or refundable single insurance premium policies * * ." (S. Rept. No. 627.) This wording indicates the language of the amendment was not to describe two different types, such as perpetual and short-term policies, as petitioner1959 U.S. Tax Ct. LEXIS 15">36 argues, but rather policies that might be different in name but of the same type, to-wit, policies providing for a single refundable premium that purchased continuing, termless insurance.Other language of the reports shows the amendment was to apply to those companies that derive by far the largest part of their income from investments and meet their losses from this fund. This is true of the perpetuals but not at all true of the factory mutuals, where the largest proportion of income is from premiums.Examination of the annual statement submitted to the State insurance commissioners and the tax returns of the petitioner show that it had the following:Statutory premiumsPremiums earned onYearInvestment incomeearnedfactory mutual basis1952$ 266,061.36$ 3,379,067.22$ 942,883.061954347,187.623,761,514.00994,543.13Taking the figures most favorable for the petitioner, those which adjust the earned premiums to the factory mutual basis, it is quite apparent that petitioner does not "derive by far the largest portion of their [its] income from investments" nor does it meet its losses and expenses from this fund; rather its "main income is from premiums" 1959 U.S. Tax Ct. LEXIS 15">37 which applies to mutual companies as a class issuing the "ordinary type of short-term policies." (S. Rept. No. 627.) It is obvious such a company as the petitioner was not meant to fit under section 204 according to the report of the Senate Finance Committee; since its main income is from premiums, it was meant to be among the ordinary type of mutual company covered by section 207 of the 1939 Code.When we proceed to the provisions of the 1943 amendment with respect to the tax base of the described companies, it is even more clear that a factory mutual such as petitioner was not intended to be included. The amendment provided the described companies were not to include the premium deposits in income, and, likewise, they were to receive no deduction for dividends paid to the policyholders. If petitioner is right, then the amendment does not provide for any source of income to it except its investment income. Since it is obvious that petitioner's operation is such that it is not intended it will ever have enough investment income to pay losses and expenses, the amendment would, if literally applied to petitioner, provide for no tax.33 T.C. 490">500 Even petitioner would not argue for a1959 U.S. Tax Ct. LEXIS 15">38 legislative intent that it be exempt. Petitioner tries to adjust the law to its operation by reporting its premium income (absorptions of deposit premiums) in the returns it filed under section 204. This was done upon a strange theory that first likens the absorptions to the "surrender charge" of perpetuals and then concluding the amendment did not intend such charges to be excluded from income.In petitioner's operation the "absorptions" are for the purpose of creating a fund to pay losses -- the usual purpose of premium payments in the ordinary mutual -- and such absorptions are not at all similar to the "surrender charge" or "termination charge" of a perpetual (made only in early years) where losses are paid out of investment income.A reading of section 204 shows that the statute cannot apply equitably or reasonably to a company that operates on the perpetual principle where it pays its losses and expenses from investment income and a company that operates like petitioner, which pays its losses and expenses from premium income.The interpretation placed upon section 204 to the effect that it applies to a mutual issuing short-term policies and paying losses out of premium payments, 1959 U.S. Tax Ct. LEXIS 15">39 would flout the whole history and purpose of the 1943 amendment. It is abundantly clear from the authoritative legislative history that the need for the amendment of 1943 arose from the fact that the mutuals there described paid losses and expenses from investment income. Such companies had need for relief from a taxing plan (section 207) designed for the ordinary mutual that paid losses out of premium funds. It could never have been intended that petitioner, which did not suffer the trouble to be relieved, would be covered by the 1943 amendment.The fact that the provisions of the Act do not fit petitioner's operation, and the overwhelming legislative history, compel us to hold petitioner was not within the mutual fire insurance companies described in section 204(a)(1), I.R.C. 1939, or section 831, I.R.C. 1954, and that respondent was right in determining that petitioner is taxable for the year 1952 under the provisions of section 207, I.R.C. 1939, and for the year 1954 under the provisions of section 821, I.R.C. 1954.Decision will be entered under Rule 50. Footnotes1. The pertinent portions of section 207, incorporating amendments made after 1942 and applicable to 1952, are set forth in a footnote in Penn Mutual Indemnity Co., 32 T.C. 653">32 T.C. 653↩ (1959).2. Mutual Fire Insurance Companies Issuing Perpetual Policies.Under existing law, fire insurance companies issuing perpetual premium policies are discriminated against by being taxed under section 207 of the Internal Revenue Code. One of the bases upon which companies are taxed under that section is net premium income. Since perpetual companies derive the largest part of their income from investments, and meet their losses and expenses from that source, it is clear that section 207 does not reach an equitable result as applied to them. Accordingly, your committee bill provides that fire insurance companies issuing exclusively perpetual or refundable single insurance premium policies are made taxable under section 204 of the Internal Revenue Code, which is applicable to stock companies. Under this provision, these companies are not required to include single deposit premiums in income and are denied any deduction for dividends paid or declared. This amendment is made applicable to taxable years beginning after December 31, 1941.* * * Section 129. Mutual Fire Insurance Companies Issuing Perpetual Policies.This section, for which there is no corresponding provision in the House bill, provides for the taxability of fire insurance companies exclusively issuing perpetual or refundable single premium policies under section 204 of the Code, relating to stock insurance companies other than life and mutual marine insurance companies, instead of as at present under the provisions of section 207 of the Code, relating to mutual insurance companies other than life or marine.Section 207, as amended by the Revenue Act of 1942, affects companies issuing perpetual and single premium policies in a discriminatory manner. The 1942 amendments were designed to obtain a suitable tax base for mutual companies as a class. The most important group were the companies issuing the usual type of renewable short-term policies. Generally speaking, the tax imposed by section 207 is levied either on investment income at regular corporate rates, or on the gross amount of income from interest, dividends, rents, and net premiums (less certain deductions) at the rate of 1 per cent, whichever tax is greater. No deductions are allowed from investment income for losses or general business expenses. The plan works equitably for companies issuing the ordinary type of short-term policies, since their main income is from premiums and their losses and expenses are paid out of this income which is taxed only at the 1 per cent rate. The perpetual companies, however, derive by far the largest portion of their income from investments, and meet their losses and expenses from that fund. The denial of deductions for such losses and expenses results in an overstatement of their true income. This is corrected by applying to these companies the provisions of section 204 with slight adjustments. Principally these adjustments consist of excluding from gross income of such companies single deposit premiums received (but not payments of quotas or assessments), and of disallowing any deduction for dividends paid to policyholders. [S. Rept. No. 627, 78th Cong., 1st Sess., 1944 C.B. 973">1944 C.B. 973, 996 and 1024.] * * *Amendment No. 80: This section, for which there is no corresponding provision in the House bill, provides that mutual fire insurance companies exclusively issuing perpetual or refundable single premium policies, shall be taxed substantially as stock insurance companies other than life and mutual marine insurance companies under section 204 of the Code instead of as at present under the provisions of section 207 of the Code, applicable to mutual insurance companies other than life or marine. The House recedes with a change in section number. [H. Rept. No. 1079, 78th Cong., 2d Sess., 1944 C.B. 1059">1944 C.B. 1059↩, 1073.]	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619311/	RANDY HAMES AND CAROLYN HAMES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHames v. CommissionerDocket No. 30807-81.United States Tax CourtT.C. Memo 1983-532; 1983 Tax Ct. Memo LEXIS 256; 46 T.C.M. 1236; T.C.M. (RIA) 83532; August 29, 1983. Randy Hames and Carolyn Hames, pro se. Frank Simmons, for the respondent. SHIELDSMEMORANDUM FINDINGS OF FACT AND OPINION SHIELDS, Judge: Respondent determined a deficiency of $2,000 in petitioners' income tax for the taxable year 1978. The sole issue to be decided is whether a new principal residence tax credit claimed in 1975 under section 44(a) 1 must be recaptured in 1978 under section 44(d). FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and the exhibits attached thereto are incorporated herein by reference. On September 1, 1975, petitioners purchased a house in Port Byron, Illinois, which qualified for a new residence credit of $2,000 under section 44(a). 2 On August 27, 1976, petitioners purchased a house in Afton, Minnesota which had been occupied by the previous owners. On March 8, 1977, petitioners sold the Port Byron house for which they had previously claimed the new residence credit. 1983 Tax Ct. Memo LEXIS 256">258 In the notice of deficiency dated September 23, 1981, respondent determined that petitioners must recapture in 1978 all of the $2,000 new residence credit claimed in 1975. OPINION The sole issue for our decision is whether petitioners must recapture the credit claimed on their purchase of a residence in 1975. Section 44(d) provides that the new principal residence credit is subject to recapture when a taxpayer disposes of the property which qualified for the credit within 36 months after the date on which it was acquired. However, no recapture is required if the taxpayer purchases a new principal residence within the applicable period prescribed in section 1034. Section 44(d)(2). Respondent contends petitioners must recapture the entire credit since they purchased a "used" home to replace the original residence. We agree with respondent. In order to avoid recapture, section 44(d)(2) requires the replacement home to be a "new principal residence." That term is defined as a principal residence, "the original use of which commences with the taxpayer." Section 44(c)(1). The statute does not allow a taxpayer to avoid recapture if he replaces his residence with a previously1983 Tax Ct. Memo LEXIS 256">259 occupied residence. 3Petitioners argue that they should not be required to recapture the credit because they purchased the previously occupied residence on the advice of an Internal Revenue Service agent and in reliance upon certain language appearing in publications and forms issued by the Treasury Department. They are in error, however, because misstatements of the law by revenue agents are not binding on respondent. , cert. denied , reh. denied ; affd. , cert. denied .It is also well settled that the statute is controlling, not the Treasury publications and forms called to our attention by the petitioner. See, e.g., . In other words, even though ambiguous, or even erroneous, we cannot apply statements of the law made by revenue agents or which1983 Tax Ct. Memo LEXIS 256">*260 appear in Treasury publications in such a manner as to allow a credit not permitted by statute. Dixon v. United States, 381U.S. 68 (1965). Accordingly, we sustain respondent's recapture of petitioner's new residence tax credit. Decision will be entered for respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, in effect during the years in issue, unless otherwise provided.↩2. Section 44(a) provides: In the case of an individual there is allowed, as a credit against the tax imposed by this chapter for the taxable year, an amount equal to 5 percent of the purchase price of a new principal residence purchased or constructed by the taxpayer.↩3. .↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619312/	Stevens Brothers and The Miller-Hutchinson Company, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentStevens Bros. & Miller-Hutchinson Co. v. CommissionerDocket No. 49117United States Tax Court24 T.C. 953; 1955 U.S. Tax Ct. LEXIS 111; August 29, 1955, Filed 1955 U.S. Tax Ct. LEXIS 111">111 Decision will be entered under Rule 50. Division of Profits -- Money Furnished at Risk of Job. -- A taxpayer contractor is not taxable with entire profits from a job where, in order to obtain required $ 75,000 of funds subrogated to the rights of all creditors, it agreed that the corporation furnishing the funds should have one-half of the profits from the job. A. J. Schmitt, Jr., Esq., for the petitioner.J. Marvin Kelley, Esq., for the respondent. Murdock, Judge. MURDOCK 24 T.C. 953">954 The Commissioner determined a deficiency in income tax of $ 24,693.16 for 1948 and one of $ 37,621.49 for 1949. The issue for decision is whether one-half of the profits from a construction contract was properly a part of the net income of the petitioner although paid to Stevens Brothers Foundation, Inc., under an agreement pursuant to which the Foundation1955 U.S. Tax Ct. LEXIS 111">112 advanced to the petitioner money essential to the earning of the profits.FINDINGS OF FACT.The petitioner's returns for the taxable years were filed with the collector of internal revenue for the district of Louisiana.The petitioner was incorporated in 1936 and succeeded to the business formerly carried on by partnerships. The business was that of heavy construction. The principal office of the petitioner is in New Orleans. The stock of the petitioner was owned two-thirds by Stevens Brothers, a partnership of St. Paul, Minnesota, and one-third by R. C. Hutchinson. The partners of Stevens Brothers were E. F. Stevens, C. R. Stevens and H. O. Stevens, brothers, and S. A. Stevens, the wife of E. F. Stevens. Hutchinson was secretary-treasurer and the active manager of the petitioner. Stevens Brothers did not carry on any business in the Louisiana area.The United States Engineers of the New Orleans District advertised in the early part of May 1947 for bids for laying reinforced concrete floors for the Algiers Locks. The bids were to be opened on June 3. The petitioner had had prior experience in such work. Hutchinson anticipated that its equipment would be released from other1955 U.S. Tax Ct. LEXIS 111">113 work about the time it would be needed on this prospective job. He obtained a copy of the plans for the lock floor job, studied them, estimated the cost, realized that it would require more money than the petitioner had available, and consulted the Whitney National Bank of New Orleans about a loan for the purpose of the job. That bank had been lending money to the business for many years. The bank not only refused to lend money for the purpose but requested that existing loans amounting to about $ 60,000 be reduced. The financial condition of the petitioner was not as good as it had been, due to unprofitable contracts in recent years. Hutchinson also consulted its bonding source, the Maryland Casualty Company, about a bid bond and a construction bond and was told that neither bond would be furnished unless $ 50,000 of additional capital was put into the petitioner. He then advised the Stevenses in St. Paul of the situation and conferred with them in St. Paul. They required that material commitments be obtained and then told him that Stevens 24 T.C. 953">955 Brothers Foundation, Inc., would furnish the additional capital of $ 50,000 for this job upon condition that it would receive1955 U.S. Tax Ct. LEXIS 111">114 one-third of the net profits from the job. Hutchinson returned to New Orleans where he learned from Maryland that it would require the petitioner to have $ 75,000, instead of $ 50,000, of additional capital. Hutchinson again communicated with the Stevenses in St. Paul and was advised that the Foundation would supply the $ 75,000 provided it would receive one-half of the profits from the job. The Foundation and the petitioner adopted appropriate resolutions and entered into a contract under which the Foundation agreed to furnish the $ 75,000 immediately which would remain under the complete control of the petitioner until completion of the lock floor contract and the payment of all accounts due. The Foundation was to receive one-half of any profit, before income taxes, from the job and was to share any losses up to the $ 75,000.Hutchinson bid on the job for the petitioner, that bid was the lowest of three submitted, and the petitioner was awarded the contract. The petitioner's bid was "approximately" $ 1,053,409.80. The other two bids submitted were for $ 1,322,088 and $ 1,599,994. Maryland furnished the bonds but reinsured 80 per cent of the construction bond because of the1955 U.S. Tax Ct. LEXIS 111">115 lowness of the petitioner's bid. The reinsurers would not have taken any of the risk had the $ 75,000 not been in as capital.Foundation loaned $ 40,000 to the petitioner in 1948. That amount was needed for a short period as a revolving fund with which to pay for steel shipments until promptly reimbursed by the Government after which the money would be used again to pay for another shipment. The bank had refused to lend money for that purpose. Foundation received no additional remuneration for supplying the $ 40,000. That money was repaid to it by the petitioner.The petitioner completed the contract in July 1949. Foundation received, as its one-half of the profits from the lock floor contract performed by the petitioner, $ 34,252.39 in 1948 and $ 87,203.91 for 1949. Later the $ 75,000 was returned to Foundation but meanwhile its use was required under similar circumstances and arrangements and it was actually used, on a contract obtained by the petitioner in 1949 and completed in 1950 for the construction of the sidewalls of the Algiers Locks. No profits from that contract were received in 1949.Hutchinson knew of no other way of obtaining the necessary bonds except through1955 U.S. Tax Ct. LEXIS 111">116 his long-established relations with Maryland and he knew of no other way of obtaining the required $ 75,000 of funds subrogated to the rights of all creditors, particularly in the short time available. He considered the contract with Foundation a fair one to both parties. That contract was bona fide. Hutchinson had no interest in Foundation and had had no previous dealings with it.24 T.C. 953">956 Foundation was a corporation organized in December 1942 by members of the Stevens family. The Commissioner ruled on May 1, 1947, that it was exempt under section 101 (6) but reversed that ruling in 1954. Foundation had 10 members during the years 1947 through 1949 including the 4 partners of Stevens Brothers. They took active parts in its affairs and tried to increase its capital. Its net worth was substantially in excess of the $ 75,000 which it provided for the use of the petitioner. No part of its net earnings inured to the benefit of any stockholder or member. The members served without pay. Foundation was not owned or controlled by the same interests which owned and controlled the petitioner.The petitioner, on its returns for 1948 and 1949, showed the net profits from the Algiers1955 U.S. Tax Ct. LEXIS 111">117 Locks floor contract, subtracted one-half thereof as belonging to the Foundation, and did not report that one-half as its income. The amounts subtracted were added back to the petitioner's income by the Commissioner in determining the deficiencies. The amounts of $ 34,252.39 for 1948 and $ 87,203.71 for 1949 were not a part of the income of the petitioner but belonged to Foundation.OPINION.The Commissioner takes the untenable position, under various theories in which he refuses to face the facts, that the petitioner owed nothing to anyone for the use of the $ 75,000 and owned all of the income from the Algiers Locks floor contract, without diminution for any payment of any kind for the use of that money. The facts refute all of those contentions. The need for the money, the difficulty of obtaining it, the source from which it was obtained, the conditions of the contract for the payment of one-half of the net profits, and the actual payment of the agreed amounts to Foundation are clearly established by the evidence. The evidence also shows that the terms of the contract between the petitioner and Foundation were fair to both parties and the contract was bona fide in all respects. 1955 U.S. Tax Ct. LEXIS 111">118 There was no tax avoidance scheme. Hutchinson's interests were adverse to those of Foundation and he was satisfied to obtain the $ 75,000 in the way he obtained it. Hindsight makes the agreement appear very favorable to Foundation but it risked the loss of its $ 75,000 on a job which the insurers, at least, deemed quite risky. The agreement cannot be ignored or rewritten to suit the Commissioner. Seminole Flavor Co., 4 T.C. 1215, 1235. Nor can the Commissioner apply section 45 under his amended answer since the petitioner and Foundation were not owned or controlled directly or indirectly by the same interests, and there was no evasion of taxes or failure to reflect income clearly. Briggs-Killian Co., 40 B. T. A. 895; Miles Conley Co., 24 T.C. 953">957 10 T.C. 754, appealed on another issue 173 F.2d 958. Cf. Epsen Lithographers v. O'Malley, 67 F. Supp. 181">67 F. Supp. 181.The Commissioner finally suggests that no more than 3 or 4 per cent be allowed as an interest deduction for the use of the $ 75,000 since Stevens Brothers of St. Paul loaned1955 U.S. Tax Ct. LEXIS 111">*119 money to Foundation at lesser rates and could have loaned the $ 75,000 directly to the petitioner at 3 or 4 per cent. No statutory authority for any such arbitrary action has been disclosed.The Foundation was entitled to one-half of the income from the job, regardless of what the relationship between it and the petitioner may be called, and that part of the income was not taxable to the petitioner. Cf. Dorzback v. Collison, 195 F.2d 69; Edwin de Reitzes-Marienwert, 21 T.C. 846; Kena, Inc., 44 B. T. A. 217.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619314/	Estate of Elise W. Hill, Deceased, By Frederick Weyerhaeuser, Carl A. Weyerhaeuser, and Mary Ellen Reid, As Executors of Said Estate, Petitioners, v. Commissioner of Internal Revenue, RespondentHill v. CommissionerDocket No. 10131United States Tax Court10 T.C. 1090; 1948 U.S. Tax Ct. LEXIS 163; June 10, 1948, Promulgated 1948 U.S. Tax Ct. LEXIS 163">163 Decision will be entered for the respondent. In 1936 decedent was a stockholder in Corporation A, a family personal holding company having a portfolio of about $ 35,000,000 of investments. With the advent of personal holding company surtaxes, the interested parties determined that it would be unwise to continue with so large a portfolio of investments. Approximately 56 per cent of the assets of Corporation A, which produced about 90 per cent of its income, were of a kind easily divisible and distributable pro rata to the stockholders. The remaining 44 per cent of the assets, for one reason or another, were not. After much discussion, the interested parties decided to transfer the 44 per cent of the assets to Corporation B in exchange for all of B's stock and to liquidate A and distribute its assets, together with B's stock to the A stockholders. This plan was adopted and carried out in October 1936. B thereafter continued to manage the assets transferred to it, and it made new acquisitions and investments and reinvestments. It has had taxable income in each succeeding year, except 1941, and has paid dividends to its stockholders. It is still an active personal holding 1948 U.S. Tax Ct. LEXIS 163">164 company. Held, the transaction in 1936 effected a statutory reorganization under section 112 (g) (1) (C) of the Revenue Act of 1936; the distribution to A stockholders was made pursuant thereto; and the distribution received by the decedent, to the extent of her pro rata share of the accumulated earnings and profits of A, had the effect of a taxable dividend under section 112 (c) (2) of that act. Wayne C. Gilbert, Esq., for the petitioners.E. C. Adams, Esq., for the respondent. Arundell, Judge. ARUNDELL10 T.C. 1090">1091 This case involves an income tax deficiency for 1936 in the amount of $ 79,040.62. The question presented is whether a distribution received by petitioners' decedent in 1936 from the Timber Securities Co. was a distribution in liquidation of that corporation, taxable under the provisions of section 115 (c) of the Revenue Act of 1936 as a capital gain, or whether it was a distribution made in pursuance of a plan of reorganization and taxable under the provisions of section 112 (c) (2) of the same act.FINDINGS OF FACT.Elise W. Hill, the taxpayer to whom the deficiency notice was mailed, died January 10, 1946, 1948 U.S. Tax Ct. LEXIS 163">166 a resident of Poughkeepsie, New York. Her 1936 income tax return was filed with the collector of internal revenue for the fourteenth district of New York.Timber Securities Co. (hereinafter called Timber) was organized under the laws of Delaware on March 8, 1916. It was a personal holding company within the meaning of section 351 of the Revenue Acts of 1934 and 1936. On December 31, 1935, it had a portfolio of approximately $ 35,000,000 of investments, which included stocks and bonds of domestic and foreign corporations, government obligations, notes and accounts receivable, and approximately $ 2,000,000 in cash. All the capital stock of Timber was owned directly or controlled through family trusts by the members of seven branches of the Weyerhaeuser family. Timber was managed mainly by F. E. Weyerhaeuser and in part by his two brothers, John P. and R. M. Weyerhaeuser.With the imposition of surtaxes upon personal holding companies and particularly when the rates were increased by the Revenue Act of 1935, the Weyerhaeusers became apprehensive as to what might be the tax situation of their family holding company. Representatives of all branches of the family held a two or three-day1948 U.S. Tax Ct. LEXIS 163">167 meeting in St. Paul, where the affairs of Timber were discussed with their legal 10 T.C. 1090">1092 adviser. He and F. E. Weyerhaeuser were directed to keep abreast of the situation and further advise the family.About $ 19,500,000 of the investments of Timber was in assets which were easily divisible and distributable pro rata to its stockholders. The remaining investments of approximately $ 15,500,000 were in assets which, for one reason or another, were not readily distributable. The legal adviser considered a number of plans for liquidating Timber, among them the use of a trust to handle the assets which were not readily divisible and distributable.Other family conferences were held in 1936, and in October of that year the decision was reached to transfer the approximately $ 15,500,000 of assets to another corporation, known as Bonners Ferry Lumber Co. (hereinafter called Bonners), in exchange for all the latter's stock, and then to liquidate Timber and distribute all its assets, including the Bonners stock, to the Timber stockholders. Bonners had been incorporated in Delaware on December 14, 1920, but had never engaged in business. Though it was dormant, the Weyerhaeuser family1948 U.S. Tax Ct. LEXIS 163">168 had kept the charter alive.This plan was adopted and formally approved at stockholders' and directors' meetings held on October 19 and October 26, 1936. On October 20 the assets above mentioned, constituting 43.779 per cent of Timber's total holdings and producing approximately 10 per cent of its income, were transferred to Bonners in exchange for all the latter's stock, 13,034 shares. Among the transferred assets there were, in round figures, $ 7,300,000 of past due notes of the Clearwater Timber Co.; $ 1,500,000 of debentures of Potlatch Forests, Inc., on which an extension was contemplated; $ 1,500,000 of accounts receivable and notes from Bonners Ferry Lumber Co., Ltd., then in liquidation; $ 994,000 in notes of Elise W. Hill, payable at her death; $ 440,000 in notes of the Northwest Paper Co., then in process of liquidation; and $ 200,000 in bonds of the Cowlitz County Diking District.On October 26 Timber was liquidated by the distribution of its remaining assets and the Bonners stock pro rata to its stockholders in exchange for their Timber stock, which was thereupon canceled. The stockholders took the Bonners stock into their accounts at approximately $ 730 a share. Bonners1948 U.S. Tax Ct. LEXIS 163">169 carried the assets acquired from Timber on its books at exactly the same figures at which those assets had been carried by Timber.After the transfer of assets to Bonners, that corporation became a personal holding company. Its board of directors was composed of the same members of the Weyerhaeuser family who were directors of Timber, R. M. Weyerhaeuser and F. E. Weyerhaeuser, president and secretary, respectively, of Timber, became president and secretary of Bonners.10 T.C. 1090">1093 Since it acquired the Timber assets Bonners has reported taxable income and paid dividends every year except in 1941, in which year it had a loss of $ 940,108.73. Its total net income for the years 1937 to 1946, inclusive, except for 1941, was $ 620,929.11. During that period it paid dividends of approximately $ 2,000,000, and its assets decreased in the amount of approximately $ 4,000,000.Timber, prior to its liquidation, had made substantial investments in stocks or securities of companies having to do with the timber business, such as timber-holding companies, logging companies, logging manufacturing companies, paper companies, and fabricating companies. Bonners has acquired and disposed of capital1948 U.S. Tax Ct. LEXIS 163">170 assets during all the years of its active corporate existence from 1936 to date. It has made some investments in timber properties, though not on so extensive a scale as Timber. Its heaviest investments in timber properties were made in 1946 through purchases from the estate of Elise W. Hill in order to liquidate notes approximating $ 1,000,000 payable at her death. It made one other large timber investment to preserve its equity in the Hill-Davis Co. Bonners' investment in government obligations has substantially increased, while its investment in corporation stocks has been decreasing. At the time of the trial of this case, Bonners was still an active personal holding company. During its first 10 years of operation it increased cash $ 849,000, acquired treasury stock $ 700,000, and increased government obligations $ 3,498,000. It reduced its notes receivable $ 6,539,000 and its domestic stocks and bonds $ 1,943,000.At the time of the liquidation of Timber, Elise W. Hill owned 50,000 shares of its capital stock, which had a basis for gain or loss to her of $ 42.50 a share. Her profit upon the liquidation of Timber was $ 202,365.97 which she reported as capital gain, including1948 U.S. Tax Ct. LEXIS 163">171 30 per cent thereof, or $ 60,709.79, as subject to tax. Timber had accumulated earnings and profits of $ 4,078,833.20, of which 43.779 per cent was allocable to Bonners, leaving $ 2,293,160.81 available earnings of Timber on 651,700 shares of its outstanding stock. Elise W. Hill's pro rata share of the earnings and profits was $ 175,936.85. In the deficiency notice the Commissioner determined that that amount was taxable as ordinary or dividend income and that only the balance of $ 26,429.12 was capital gain, 30 per cent of which, or $ 7,928.73, was subject to tax.The transfer of approximately 44 per cent of the assets of Timber to Bonners in exchange for all the latter's stock, and the liquidation of Timber and distribution of its assets, including the Bonners stock, were integrated steps of a unitary plan. The transfer of assets to Bonners was undertaken for reasons germane to the continuance of the corporate business. There was a business purpose in the transaction, and the plan which was adopted and carried out effected a reorganization 10 T.C. 1090">1094 of corporate business, with a continuity of the enterprise and continuity of interests therein in the same persons under a modified1948 U.S. Tax Ct. LEXIS 163">172 corporate structure. The distribution received by Elise W. Hill from Timber was made in pursuance of a plan of reorganization and, to the extent of her pro rata share of the accumulated earnings and profits of Timber, it had the effect of the distribution of a taxable dividend.The stipulation of facts is adopted by this reference.OPINION.Petitioners seek to have the distribution received by Elise W. Hill, the decedent, in 1936 taxed at capital gain rates, as a distribution in complete liquidation under section 115 (c) of the Revenue Act of 1936. 1 They contend, first, that the transfer of assets from Timber to Bonners was a separate transaction, not a part of the liquidation of Timber, and, second, that there was no business purpose sufficient to support a reorganization under section 112 (g). We find no merit in either contention. It is not open to question on this record that the transfer of assets to Bonners and the liquidation of Timber were parts of the same plan, which had been carefully thought out and decided upon in advance.1948 U.S. Tax Ct. LEXIS 163">173 In our opinion, what the parties did falls within not only the letter, but also the spirit, of section 112 (g) (1) (C), which defines a reorganization as "a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred." The transfer of approximately 44 per cent of the assets of Timber to Bonners in exchange for all the Bonners stock was certainly undertaken for reasons germane to the continuance of the corporate business, and Bonners ever since has been conducting business with the transferred assets or with reinvestments of proceeds therefrom. The same persons who had controlled and operated Timber control and operate Bonners. It is true that the investment policy of Bonners has been changed somewhat, in that more money has been invested in government obligations and less in corporate stocks and bonds, but there has been no disruption in the conduct of the business.Unlike the new companies in George D. Graham, 37 B. T. A. 623, 10 T.C. 1090">1095 and Standard Realization Co., 10 T.C. 708,1948 U.S. Tax Ct. LEXIS 163">174 Bonners was not availed of merely to complete the orderly liquidation of the assets transferred to it. It has continued to carry on a part of the business which Timber formerly conducted. It has acquired and disposed of new securities and made reinvestments. Under these circumstances, we think it may not be said that there was no business purpose in the transaction.Moreover, the transaction was brought about largely because of a change in the tax laws which adversely affected personal holding companies. The result of the plan which was adopted and carried out was that the readily divisible assets, which produced about 90 per cent of Timber's income, were taken out of the business and divided pro rata among the stockholders, thereby relieving the income produced by those assets from the burden of personal holding company surtax. It is difficult to find any lack of sound business prudence in such a transaction. As for the other assets which were not readily divisible, the parties in interest no doubt determined that the advantages to be derived from continued corporate management of those assets outweighed the disadvantage of personal holding company surtax on the income which1948 U.S. Tax Ct. LEXIS 163">175 such assets produced. In any event, however, the motive behind the transaction is not determinative, but the inquiry, rather, is as to whether what was done is the type of thing with which the reorganization provisions of the statute were concerned. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465; cf. Bazley v. Commissioner, 331 U.S. 737">331 U.S. 737.It does not matter that substantially the same result, as the petitioners contend, could have been produced by a partial liquidation of Timber or by some other method. The tax consequences must be determined by what was done, rather than by what might have been done. The statutory provisions relating to reorganizations were intended to permit of some flexibility in changing the mode of conducting corporate business, and we know of no rule that there can be a statutory reorganization only when there is no other possible way of accomplishing the particular end desired.Little need be added to what we have said in Estate of John B. Lewis, 10 T.C. 1080, decided this day, on the question as to whether there is a statutory reorganization in the type of situation1948 U.S. Tax Ct. LEXIS 163">176 here involved. The facts in that case are quite similar to those here. The fact that there the corporation was engaged in a manufacturing business, while here the corporation was engaged in an investment business, makes for no difference in result. We hold that the transaction which occurred in October 1936 constituted a statutory reorganization within the meaning of section 112 (g) (1) (C) of the Revenue Act of 1936, and that the distribution received by the decedent was made pursuant thereto.We do not understand petitioners seriously to contend that, if there 10 T.C. 1090">1096 was a reorganization, the distribution to the decedent, to the extent of her pro rata share in corporate earnings and profits, is not taxable as a dividend in accordance with the respondent's determination; but, in any event, we think there can be no question on that score. While the receipt of the Bonners stock by the decedent in exchange for her Timber stock is a type of transaction calling for no recognition of gain under section 112 (b) (3) of the act, she received considerable other property and money, which are not permitted to be received without recognition of gain. Therefore, under section 112 (c)1948 U.S. Tax Ct. LEXIS 163">177 (1) 2 her gain, to the extent of the other property or money received, is to be recognized; and under section 112 (c) (2), 2 if a distribution has the effect of the distribution of a taxable dividend, it is to be taxed as such to the extent of the distributee's ratable share of undistributed corporate earnings and profits. It is stipulated that the decedent's ratable share of such profits was $ 175,936.85. We hold that the decedent's gain to that extent shall be taxed as a dividend. Commissioner v. Bedford's Estate, 325 U.S. 283">325 U.S. 283.1948 U.S. Tax Ct. LEXIS 163">178 Decision will be entered for the respondent. Footnotes1. SEC. 115. DISTRIBUTIONS BY CORPORATIONS. * * (c) Distributions in Liquidation. -- Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117 (a), 100↩ per centum of the gain so recognized shall be taken into account in computing net income, except in the case of amounts distributed in complete liquidation of a corporation. * 2. SEC. 112. RECOGNITION OF GAIN OR LOSS. * * (c) Gain From Exchanges Not Solely in Kind. --(1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5) 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, but in an amount not in excess of the sum of such money and the fair market value of such other property.(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. * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619315/	APPEAL OF BLACK & YATES, INC.Black & Yates, Inc. v. CommissionerDocket No. 3442.United States Board of Tax Appeals2 B.T.A. 873; 1925 BTA LEXIS 2236; October 16, 1925, Decided Submitted July 6, 1925. 1925 BTA LEXIS 2236">2236 H. B. Lingle, C.P.A., for the taxpayer. Blount Ralls, Esq., for the Commissioner. 2 B.T.A. 873">873 Before STERNHAGEN, LANSDON, and LOVE. This appeal involves a deficiency in the sum of $2,544.55 for the calendar years 1919 and 1920, of which the taxpayer admits $1,055.88. There are three issues involved: (1) Inventories of 1920, (2) traveling expenses of officers disallowed in 1919, and (3) bad debts disallowed for 1920. FINDINGS OF FACT. 1. The taxpayer is a New Jersey corporation with its principal place of business in New York, N.Y., and is engaged in the wholesale business of buying and selling lumber, mostly hardwood. 2. In the conduct of its business it was the practice of two officers of the corporation, H. R. Black and H. L. Black, to travel about to solicit business and come in personal contact with its customers. In doing so they incurred expenses consisting of railway fares, hotel bills, meals, etc. These expenses were paid out of their personal funds, but at stated intervals, usually monthly, a detailed memorandum of the expenses was presented to the taxpayer, which reimbursed them for the expenses so incurred. During the year the expenses1925 BTA LEXIS 2236">2237 so incurred and paid by the taxpayer were as follows: 1919 - January, H. L. Black$76.50February, H. L. Black74.25March, H. L. Black66.02March, H. L. Black80.90April, H. L. Black117.25May, H. L. Black (western trip)352.65June, H. L. Black73.38June, H. L. Black76.501919 - July, H. L. Black$7.75July, H. L. Black48.50August, H. L. Black15.50August, H. L. Black78.50September, H. L. Black73.46October, H. L. Black92.50November, H. R. Black78.50November H. L. Black76.25December H. L. Black78.15December, H. R. Black77.20Other months, 1919, H. R. Black1,116,37Total2,660.132 B.T.A. 873">874 3. In the forepart of the year 1920 the taxpayer purchased 93,118 feet of teakwood consisting of 5 carloads for San Francisco, Calif., invoiced at $263 per thousand feet. During the year 1920 it sold 48,528 feet, leaving on hand at the end of the year 1920 44,590 feet. The taxpayer also purchased during this year one carload of gum wood, the quantity and value of which do not appear on record. The controversy exists between the taxpayer and the Commissioner as to the market or cost value of this teakwood at the1925 BTA LEXIS 2236">2238 close of the year 1920 for investory purposes. No evidence was presented to prove whether the market or cost value was lower at the end of said year. 4. The taxpayer had an account with the L.W.F. Engineering Co., Inc., for lumber sold. During the year 1920 it made frequent attempts to collect this account and did collect various amounts until it was reduced to $8,253.99. On December 7, 1920, the L.W.F. Engineering Co., Inc., went in the hands of a receiver as insolvent. The taxpayer thereupon considered the debt worthless and uncollectible, and so notified the Ocean Accident & Guaranty Co., Ltd., the insurer of this account, which company prior to December 31, 1920, also considered said debt worthless and in accordance with the terms of its policy paid the taxpayer $5,711.50 on January 3, 1921, leaving a balance of $2,542.49 which the taxpayer charged off its books as of December 31, 1920. No other payments were made on this account, except on February 24, 1923, at which time the insurance company paid the taxpayer $309.52. It is this amount of $2,542.49 which the taxpayer seeks to deduct as a bad debt for the year 1920, and which the Commissioner contends should be allowed1925 BTA LEXIS 2236">2239 in subsequent years. DECISION. The determination of the Commissioner as to the inventories is approved. The deficiency determined by the Commissioner resulting from the disallowance by the Commissioner of $2,660.13 as 2 B.T.A. 873">*875 traveling expenses for the year 1919 and the sum of $2,542.49 as a bad debt for 1920 is disallowed. Final determination will be settled on consent or on 15 days' notice, as provided by Rule 50. ARUNDELL not participating.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619316/	PEYTONA LUMBER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Peytona Lumber Co. v. CommissionerDocket No. 32330.United States Board of Tax Appeals21 B.T.A. 354; 1930 BTA LEXIS 1861; November 18, 1930, Promulgated 1930 BTA LEXIS 1861">1861 1. The 50 per cent stock interest of D.E. and A. M. Hewitt in the Elk Creek Lumber Co. was not owned or controlled, during the period January 1 to November 12, 1920, by the same interests which owned or controlled the other 50 per cent stock interest in that company and all, or substantially all, of the stock of the petitioner. Accordingly, the petitioner and the Elk Creek Lumber Co. were not affiliated for the period mentioned. 2. Special assessment denied. F. M. Livezey, Esq., for the petitioner. J. L. Bockstrom, Esq., for the respondent. LOVE 21 B.T.A. 354">354 This proceeding is for the redetermination of a deficiency in income and excess-profits taxes for the calendar year 1920, in the amount of $31,330.18. By amended petition, it is alleged that the respondent has erroneously denied the petitioner the right to file a consolidated return with the Elk Creek Lumber Co. for the entire year 1920, although such a return was permitted for the period November 12 to December 31, 1920. Alternatively to its claim of affiliation for the entire year, the petitioner alleges that the respondent has erroneously denied its application for special assessment1930 BTA LEXIS 1861">1862 under the provisions of sections 327 and 328 of the Revenue Act of 1918. As relates to the issue of special assessment, the hearing has been limited by order dated April 7, 1930, in accordance with the provisions of Rule 62(a) and (b) of the Board's rules of practice. 21 B.T.A. 354">355 FINDINGS OF FACT. Petitioner is a West Virginia corporation, with its principal place of business at Huntington. It was organized in 1905, and during 1920 it was engaged in the manufacture and sale of hardwood lumber, operating a band mill, dry kilns, and a planing mill at Omar, Logan County, W. Va. In 1919, D. E. Hewitt, A. M. Hewitt, his son, and one Campbell, father-in-law of the younger Hewitt, owned, or were interested in a corporation or corporations which owned, a tract of timber in Logan County near Elk and Huff Creeks. The three men named attempted to interest E. K. Mahan in the purchase of the timber tract mentioned. Mahan was president and general manager of the petitioner. As a result of negotiations between the Hewitts and Campbell and Mahan, it was agreed to organize a corporation which would purchase the said timber. In accordance with the agreement above mentioned, D. E. and1930 BTA LEXIS 1861">1863 A. M. Hewitt, E. K. Mahan, Fred C. Prichard, and F. M. Livezey, as incorporators, organized a West Virginia corporation known as the Elk Creek Lumber Co., hereafter referred to as the Elk Creek Co. The authorized capital stock of the Elk Creek Co. was $500,000, divided into 2,000 shares of preferred stock with a par value of $100 per share, a total of $200,000, and 3,000 shares of common stock of the total par value of $300,000. D.E. and A. M. Hewitt, hereafter termed the Hewitt group, purchased one-half of the preferred stock and Prichard, Martin and Mahan, hereafter termed the Mahan group, purchased the other one-half, each group paying the par value of the preferred stock acquired. The common stock was divided equally between the two groups as "bonus" stock. The Elk Creek Co. then acquired the timber tract mentioned above. Prior to organization of the Elk Creek Co. the Hewitt and Mahan groups had agreed that management of the company's operations was to be left to the Mahan group, which comprised the same persons who managed the petitioner. The Hewitt group assured Mahan that he and his associates could later acquire the Hewitt group's stock at cost, plus interest for1930 BTA LEXIS 1861">1864 the time it carried its investment in the business. A statement of the stockholders of the petitioner and the Elk Creek Co. during the year 1920 follows: PetitionerElk Creek Co.StockholderDec. 31, 1919Dec. 31, 1920Dec. 31, 1919Dec. 31, 1920C. T. Anderson272720C. H. Baisden37105H. S. Black505037W. A. Darrah282820T. W. Elswick303022A. M. Hewitt750D. E. Hewitt750B. L. Kidd1938105F. M. Livezey11E. K. Mahan1,0591,0201,3992,014P. M. Martin171713W. B. Martin9113097A. H. McQueen232317L. W. Olson36R. C. Pahl10110176F. C. Prichard35335370350Jos. Schmitz232317J. B. Smith15C. H. Tomlinson707052G. R. Wallace232317A. L. Wilkinson30118D. M. Wilkinson1G. M. Williams141410R. H. Williams551519Total2,0002,0003,0003,00021 B.T.A. 354">356 Transfers of petitioner's stock during the year 1920 were as follows: 1920TransfersNumber Number of of sharessharesJan. 29L. W. Olson36to Nell W. Olson36Mar. 29A. L. Wilkinson19to B. L. Kidd19DoNell W. Olson36Dorothy W. Wilkinson1to C. H. Baisden37Apr. 12E. K. Mahan39to W. B. Martin391930 BTA LEXIS 1861">1865 Transfers of stock of the Elk Creek Co. during the year 1920 were as follows: 1920TransfersNumber of Number of sharessharesJan. 11J. B. Smith15to F. C. Prichard15Nov. 13D. E. Hewitt750A. M. Hewitt750to E. K. Mahan1,500DoE. K. Mahan735to C. T. Anderson20C. H. Basiden30H. S. Black37W. A. Darrah20T. W. Elswick22B. L. Kidd30P. M. Martin13W. B. Martin97A. H. McQueen17R. C. Pahl76F. C. Prichard265J. Schmitz17C. H. Tomlinson52G. R. Wallace17A. L. Wilkinson8Grace M. Williams10R. H. Williams4Dec. 17E. K. Mahan150to C. H. Baisden75B. L. Kidd7521 B.T.A. 354">357 The funds acquired by the Elk Creek Co. through its sale of preferred stock were not sufficient, after purchase of the timber, to build and equip the company's mills. The petitioner and members of the Mahan group, individually, endorsed paper upon which the Elk Creek Co. borrowed funds to complete its equipment and commence operations. The total of loans secured as described was more than $220,000. During1930 BTA LEXIS 1861">1866 the year 1920, petitioner made advancements to the Elk Creek Co. in amounts as follows: YearAmount1919Dec. 31$2,3001920Jan. 151,100Jan. 172,500Jan. 201,000Jan. 221,000Mar. 131,800Mar. 3017,0001920June 30$3,000July 124,500Aug. 115,50039,700Nov. 12, notes assumed27,000Nov. 15, notes assumed84,000150,700The directors of petitioner during 1920, were E. K. Mahan, F. C. Prichard, W. B. Martin, P. M. Martin and R. C. Pahl. The directors of the Elk Creek Co. were, for the period January 1 to November 12, 1920, E. K. Mahan, F. C. Prichard, W. B. Martin, and D.E. and A. M. Hewitt. The Hewitts were not directors of the Elk Creek Co. for the period November 13 to December 31, 1920. The Mahan group directed the operations of the Elk Creek Co. E. K. Mahan was general manager of petitioner and the Elk Creek Co. Logging and manufacturing superintendents of either company were sometimes used to direct the operations of the other. The sales, cost accounting and collections of the Elk Creek Co. were conducted through the petitioner's offices. The stock of the Elk Creek Co. held during the period January 1 to1930 BTA LEXIS 1861">1867 November 12, 1920, by E. K. Mahan, F. C. Prichard, F. M. Livezey, J. B. Smith, and R. H. Williams, aggregating 1,500 shares, was held by these persons for the benefit of all the petition's stockholders. Smith and Williams were employees of Prichard. Livezey held one share to qualify as aw director, actual ownership of his stock being in Mahan. The common stock of the Elk Creek Co. was, during 1920, the only stock of that company having voting rights. On November 12, 1920, E. K. Mahan purchased the entire stock interests of D.E. and A. M. Hewitt in the Elk Creek Co., consisting of 1,000 shares of preferred and 1,500 shares of common stock. Mahan made this purchase on behalf of all the stockholders of petitioner, 21 B.T.A. 354">358 and on November 13, 1920, some of it was transferred to each such stockholder. Petitioner and the Elk Creek Co. filed an affiliated return for the entire year 1920, upon the basis of which income and excess-profits taxes were shown due, and were paid, in the amount of $15,310.89. Petitioner's invested capital and net income for the years 1914 to 1919, inclusive, and for two periods during 1920, are shown as follows: YearInvested Net income.Capital.1914$235,228.18$13,153.871915223,382.0515,987.601916214,369.6542,013.151917248,565.3253,338.451918$264,501.25$47,808.821919321,736.7981,530.441920 (a) Jan. 1 to Nov. 12294,768.01130,685.45(b) Nov. 12 to Dec. 3184,980.7214,592.131930 BTA LEXIS 1861">1868 The invested capital shown above for the period November 12 to December 31, 1920, is the consolidated invested capital of petitioner and the Elk Creek Co. In some manner not detailed by the record, petitioner took over the business of the Elk Creek Co. as of January 1, 1922. The consolidated net income of petitioner and the Elk Creek Co. for the year 1921, and the net income of petitioner for the years 1922 to 1925, inclusive, are shown as follows: YearNet income1921 (consolidated) (loss)$ (60,777.82)192220,729.85 19238,684.71 1924 (loss)(29,075.35)192512,862.21 The net income indicated for 1925 is that shown before the application of the 1924 loss against income for the year 1925. Money borrowed by petitioner during the year 1920, is shown as follows: Prior to date of affiliation as determined by respondent: 1920DebitCreditBalanceJan. 1$29,500.00Jan. 2$6,250.0023,250.00Apr. 16,250.0017,000.00Apr. 20$7,000.0024,000.00Apr. 201,000.0023,000.00May 31,000.0022,000.00May 51,000.0021,000.00May 102,500.0018,500.00June 41,000.0017,500.00July 16,250.0011,250.00July 3$1,000.00$10,250.00July 102,000.008,250.00July 24$2,500.0010,750.00July 242,500.0013,250.00July 242,500.0015,750.00Aug. 41,000.0014,750.00Sept. 141,000.0013,750.00Oct. 26,250.007,500.00Nov. 525,000.0032,500.001930 BTA LEXIS 1861">1869 Subsequent to date of affiliation as determined by respondent: Nov. 13$70,000.00$102,500.00Nov. 1584,000.00186,500.00Nov. 23$30,000.00$216,500.00Dec. 1820,000.00236,500.0021 B.T.A. 354">359 A certificate of inventory attached to the consolidated return filed by petitioner and the Elk Creek Co. for the year 1920 indicated that the inventory was taken at "cost or market," whichever was lower. The petitioner now contends that its inventory was taken upon the basis of the average cost of timber cut and manufactured, with the result that the value of all manufactured timber was indicated to be the same regardless of species or grade, although the selling price would vary with these factors. During 1920 high labor charges, freight rates, and costs of kiln drying caused many purchasers to buy only the best grades of lumber, upon the theory that it would be most economical to use good lumber because it would last longer. Due to this the petitioner sold during that year a considerably greater percentage of high priced lumber than was usual, with the result that its closing inventory contained a great amount of the poorer grades of lumber, 1930 BTA LEXIS 1861">1870 which, under the average cost inventory system, reflected an improper value of the inventory. The petitioner terms this an "over-realization" of income. The petitioner's records indicate the amount of each species and grade of lumber shipped during the year 1920 and the amount of each species and grade on hand at the beginning and end of that year. They also indicate the amount by which the proportion of high priced lumber shipped in the taxable year exceeded the usual proportions of such shipments in relation to shipments of the poorer grades. As indicated on the consolidated return, the inventories of manufactured lumber were, at January 1, 1920, $61,799.05, and at December 31, 1920, $181,662.89. The business and operations of the petitioner are fairly comparable to the business and operations of the following named concerns, all of whom are engaged in hardwood lumbering operations at the places indicated: Raine Lumber Co., Cloverlick, W. Va. Guyan Lumber Co., Herndon, W. Va. C. L. Ritter Lumber Co., Huntington, W. Va.Norwood Lumber Co., Forney, N.C.OPINION. LOVE: The petitioner contends that it was affiliated with the Elk Creek Co. for the entire year1930 BTA LEXIS 1861">1871 1920, or, alternatively, that it is entitled to special assessment under the provisions of section 328 of the Revenue Act of 1918. The provision of section 240 of the Revenue Act of 1918, upon which rests the petitioner's claim for affiliation, is as follows: (b) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated * * (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests. 21 B.T.A. 354">360 The respondent has determined that the two corporations mentioned were affiliated for the period November 13 to December 31, 1920, inclusive. The petitioner urges us to determine that such affiliation existed for the entire year 1920. On December 31, 1919, total outstanding common stock of the petitioner in the amount of 2,000 shares was held by nineteen persons. Three of these persons, namely, E. K. Mahan, F. C. Prichard, and R. H. Williams, holding 1,417 shares (70.85 per cent) of the petitioner's stock, also held (in their own names and through Livezey and Smith) 1,500 shares (50 per cent) of the common stock of the Elk Creek Co. The evidence indicates that this 50 per cent interest in1930 BTA LEXIS 1861">1872 the Elk Creek Co. was held by the persons mentioned for the benefit of all the stockholders of the petitioner. The petitioner's witnesses have so testified and the respondent did not challenge or controvert them. Upon this basis the owners of 100 per cent of the petitioner's common stock owned or controlled 50 per cent of the common stock of the Elk Creek Co. There were no substantial changes in the stock ownerships recited during the period January 1 to November 12, 1920. The remaining 50 per cent of common stock of the Elk Creek Co. was held by D.E. and A. M. Hewitt, who held no stock of the petitioner. The petitioner concedes that the "control" prescribed by statute refers to control of the voting stock. . It contends that the same interests which owned or controlled all, or substantially all, of its stock, and which owned 50 per cent of the stock of the Elk Creek Co., also controlled the 50 per cent interest of the Hewitts in the Elk Creek Co., and, therefore, that such "interests" owned or controlled all, or substantially all, of the stock of the two companies. To establish such control the petitioner relies upon several1930 BTA LEXIS 1861">1873 factors. First, is the promise given Mahan by the Hewitts, that Mahan and his associates could buy the Hewitts' stock upon payment of its cost plus interest for the time that they carried their investment in the business. Other alleged evidences of control of the Hewitt's stock are the agreement by which the Mahan group managed the business of the Elk Creek Co., the fact that three of the five directors were members of the Mahan group, the loans and endorsements extended by the petitioner, and the fact that petitioner handled the sales, cost accounting, and collections of the Elk Creek Co. We are not persuaded, however, that any or all of the factors above mentioned warrant our finding that the 50 per cent stock interest of the Hewitts was controlled by the same interests which owned or controlled the other 50 per cent of the stock of the Elk Creek Co. 21 B.T.A. 354">361 The Board has had occasion in similar proceedings to consider the effect of each of the factors relied upon by the petitioner as evidence of asserted control of the minority stockholdings. The principal reliance of the petitioner is upon the Hewitts' agreement to sell their stock as detailed in our findings. Referring1930 BTA LEXIS 1861">1874 to this agreement, which was not in writing, petitioner's counsel stated: * * There was an understanding between Mr. Mahan and Mr. Hewitt, - I say while not legally enforceable, yet there was an understanding * * * and at any time during the year that those interested in the Peytona Lumber Company wanted to acquire that outstanding stock that they might do so. On brief, counsel refers to this agreement as an "option." In , the Board considered the effect of an option to buy stock, saying: * * * A contract to buy which is binding on the seller does not itself give the buyer a control of the stock. * * * Until the contract had been executed and the stock bought, the control remained in the owner. We held to the same effect in , and in . The courts and the Board have frequently held that management or control of the business is not the control required by statute. In 1930 BTA LEXIS 1861">1875 , the court said: The management of the business of the corporation is not the control required by the statute. It refers to stock control. The fact that the minority is acquiescent and permits the majority to manage the business does not prove actual control over the minority interests. * * The control of the stock owned by the same interests refers to beneficial interest. We said in , that "control of the stock means more than control of the management." See also ; ;; ; ; , and long list of cases there cited. In , we said: The record does show that Heller Brothers Co. controlled the board of directors and consequently they were in1930 BTA LEXIS 1861">1876 a position to control the activities of the Tool Company, so long as there was no interference with the rights of the minority stockholder. But this is far from a control of his stock and stock control is the test laid down by the statute. The fact that one corporation managed the affairs of another and loaned it money from time to time does not alone warrant affiliation. . 21 B.T.A. 354">362 And in , we said: It must be admitted that the Howes Brothers dominated the company, directed its policies, and managed its business, but the test of the statute makes no mention of these factors in laying down the rule governing affiliation. Considering the arguments advanced by the petitioner, singly and collectively, we find nothing in the record to indicate that the stock held by the Hewitts was controlled by the interests whom the petitioner contends controlled it. So far as we are advised the Hewitts were free to vote their stock as they saw fit, and presumably they did so. The fact that they worked harmoniously with Mahan and his associates does not establish that the1930 BTA LEXIS 1861">1877 latter had control of their stock. . We approve the respondent's determination denying affiliation to the petitioner and the Elk Creek Co. for the period January 1 to November 12, 1920. Alternatively, the petitioner seeks special assessment under the provisions of section 328 of the Revenue Act of 1918. Under the provisions of section 327 of the same act, a taxpayer is not entitled to have its profits tax computed under section 328 until it has established by competent evidence that there exist abnormal conditions affecting its capital or income for the taxable year involved. ; . So far as is material herein the said section 327 provides: SEC. 327. That in the following cases the tax shall be determined as provided in section 328: * * (d) Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional1930 BTA LEXIS 1861">1878 hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328. This subdivision shall not apply to any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital, * * The petitioner's brief states that: * * * It is entitled to the benefit of special assessment because of abnormality of income during the calendar year 1920 and that such abnormality normality is apparent from a comparison of its income for that year with previous and succeeding years and because of the conditions prevailing in the lumber market during that year such as brought about the purchase of a larger percentage of higher grades of lumber than in other years. Without the benefit of special assessment petitioner's excess profits tax for the period from January 1, 1920, to November 12, 1920, will be 26.9% of its net income for such period. 21 B.T.A. 354">363 Consideration of the above-quoted statement of its claim reveals that the petitioner is relying1930 BTA LEXIS 1861">1879 upon two points; namely, its asserted "over-realization" of income due to the sale of an unusually large proportion of high-priced lumber with the consequent accumulation of the poorer grades, which, nevertheless, were included in its closing inventory at the average cost of all grades, and, second, that a comparison of its income for prior and succeeding years indicates that its profits in the taxable years were abnormally high. The second point is a resultant of the first. The petitioner's records, according to the testimony of its president, would reveal in detail the amount of each species and grade of lumber on hand at the beginning and end of the taxable year, together with the amount of each shipped during that year. They would also reveal the extent by which shipments of high priced lumber during the taxable year exceeded the usual proportion of such shipments in relation to shipments of the poorer grades of lumber. But no such detail has been offered us. We are asked to accept conclusions of the witness upon the factual issue and this we will not do. If an abnormality resulted from the conditions alleged by the petitioner, clearly it is susceptible of definite proof. 1930 BTA LEXIS 1861">1880 We have no such proof and we find no merit in this claim. Nor can we afford the petitioner relief because its net income during the taxable year exceeded that of prior and succeeding taxable years. The petitioner offers no proof that its prosperity during the taxable year resulted from an abnormality. There is nothing to indicate that the petitioner's capital was other than normal for the business in which it engaged. The mere fact that a corporation earns large profits in an especially favorable year does not create an abnormality in its income such as to entitle it to special assessment. ; ; ; and . And the fact that the taxpayer considers its tax too high is not sufficient to warrant special assessment. . As a further ground for special assessment the petition alleges use of a large amount of borrowed capital in the petitioner's business. This point requires very little discussion. 1930 BTA LEXIS 1861">1881 The use of borrowed capital in large or small amounts can justify special assessment only when its use creates an abnormality. We have no evidence of such a result. As we said in : It may well be that the use of as much money as was borrowed by the petitioner * * * was the usual, normal and ordinary course of business dealings by corporations engaged in the same or similar enterprises. 21 B.T.A. 354">*364 See also , and . We hold that the petitioner has failed to establish an abnormality affecting its capital or income for the period January 1 to November 12, 1920, or for the year 1920, and, consequently, we approve the respondent's denial of special assessment for each of such periods. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619317/	MICHAEL M. TODARO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentTodaro v. CommissionerDocket No. 14142-92.United States Tax CourtT.C. Memo 1995-398; 1995 Tax Ct. Memo LEXIS 398; 70 T.C.M. 451; August 17, 1995, Filed 1995 Tax Ct. Memo LEXIS 398">398 Decision will be entered for respondent. Michael M. Todaro, pro se. Thomas A. Dombrowski, for respondent. GOLDBERG, Special Trial Judge GOLDBERGMEMORANDUM OPINION GOLDBERG, Special Trial Judge: This case was heard pursuant to section 7443A(b)(3) and Rules 180, 181, and 182. 1 Respondent determined additions to tax for petitioner's 1983 taxable year under section 6651(a)(1) in the amount of $ 2,821, under section 6653(a)(1) and (2) in the respective amounts of $ 564.20 and 50 percent of the interest due on the entire understatement, and under section 6661 in the amount of $ 2,821. After a concession, 2 the issues for decision are: (1) Whether petitioner is liable for additions to tax under section 6653(a)(1) and (2) for negligence in claiming a partnership loss; and (2) whether petitioner is liable for an addition to tax under section 6661 for substantially understating his tax liability. 1995 Tax Ct. Memo LEXIS 398">399 Some of the facts in this case have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time his petition was filed, petitioner resided in Houston, Texas. Petitioner received a bachelor of arts degree from California State University in Long Beach, California, in 1974. Although his major was English, petitioner successfully completed several business courses including economics. He then worked as a real estate broker, and, several years later, attended Stanford Law School. Petitioner received his law degree in 1982. During the year at issue, petitioner was a licensed real estate broker in California, Texas, and Florida. This case arises out of an investment made by petitioner in 1983 in a tax shelter known as 1983 Western Reserve Oil and Gas Company, Ltd. (1983 WROG or the partnership). The partnership was a limited partnership created by Trevor Phillips (Phillips) and Terry Mabile (Mabile) and designed to be marketed as an oil and gas tax shelter. A corporation called Magna, primarily owned by Mabile, acquired rights to some potential oil and gas properties, which were then subleased to 1983 WROG1995 Tax Ct. Memo LEXIS 398">400 for alleged minimum annual royalties. The subleases were secured by alleged recourse promissory notes. The promissory notes were assumed by the limited partners in order to have sufficient bases against which deductions for the royalties and other drilling expenses could be passed through by 1983 WROG, an accrual basis partnership, and taken as deductions by the cash basis limited partners. The partnership was marketed to potential investors as a tax shelter, promising tax write-offs of 4 times the cash investment. However, the structure of the deal was such that the promoters received most of the cash investment, little drilling was done, and there was no realistic potential for recovery of the cash investment by the investor, much less any potential for profits. 31995 Tax Ct. Memo LEXIS 398">401 Petitioner was first informed of 1983 WROG by his sister, Diane Todaro Vorsheck, a travel agent. Petitioner then consulted with Tom Brown (Mr. Brown), an accountant that did some financial work for petitioner's parents and a promoter of 1983 WROG, and Michael Christianson (Mr. Christianson), a tax attorney that provided legal counsel to Phillips and Mabile. In making his decision to invest in 1983 WROG, petitioner relied solely on the advice of these individuals. In a letter dated February 10, 1984, 1983 WROG informed its investors that the Internal Revenue Service (IRS) was in the process of examining the partnership. On or about March 22, 1984, the IRS notified 1983 WROG that the partnership would be in violation of Federal tax laws if it claimed tax benefits that the promoters claimed would be available to the investors. In a letter dated May 9, 1984, 1983 WROG informed investors that the IRS was likely to disallow the partnership deductions claimed on its 1983 partnership return (Form 1065). From May 1984 through May 1985, 1983 WROG sent its investors numerous letters regarding the ongoing IRS audit. On May 20, 1985, petitioner filed his 1983 Federal income tax return on which1995 Tax Ct. Memo LEXIS 398">402 he claimed a partnership loss attributable to 1983 WROG in the amount of $ 40,118. A Notice of Final Partnership Administrative Adjustment (FPAA) for the 1983 taxable year was issued to 1983 WROG on March 10, 1987. The notice partner and partners other than the tax matters partner filed a petition with this Court at docket No. 17441-87, and, on June 19, 1991, in accordance with Rule 248(b), a decision was entered in the case sustaining respondent's adjustment of partnership items in the FPAA. Following the entry of the decision, computational adjustments were made by respondent to petitioner's 1983 tax return; in particular, respondent disallowed petitioner's 1983 WROG partnership loss of $ 40,118 in its entirety. Respondent then issued a notice of deficiency to petitioner for the affected items at issue herein. We first consider the question of whether petitioner is liable for additions to tax for negligence in claiming a partnership loss. Section 6653(a)(1) and (2) provide for additions to tax if any part of an underpayment of tax is due to negligence or intentional disregard of the rules or regulations. Negligence is defined as a lack of due care or failure to do what a reasonable1995 Tax Ct. Memo LEXIS 398">403 and ordinarily prudent person would do under the circumstances. Rybak v. Commissioner, 91 T.C. 524">91 T.C. 524, 91 T.C. 524">565 (1988); Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">937 (1985). Despite petitioner's lack of experience with the gas and oil industry prior to investing in 1983 WROG, petitioner did not research the drilling activities or investigate the financial status of the partnership. Nevertheless, petitioner contends that he acted prudently in making his investment in 1983 WROG and claiming the losses on his 1983 tax return because he relied upon the advice of an accountant and tax attorney. Good faith reliance on a competent accountant's advice may insulate a taxpayer from the section 6653(a) addition to tax. Jackson v. Commissioner, 86 T.C. 492">86 T.C. 492, 86 T.C. 492">539 (1986), affd. on other issues 864 F.2d 1521">864 F.2d 1521 (10th Cir. 1989); see also United States v. Boyle, 469 U.S. 241">469 U.S. 241, 469 U.S. 241">250-251 (1985). The taxpayer must establish that the person upon whom he or she relied is qualified to give the advice and that such reliance was reasonable. Freytag v. Commissioner, 89 T.C. 849">89 T.C. 849, 89 T.C. 849">888 (1987),1995 Tax Ct. Memo LEXIS 398">404 affd. 904 F.2d 1011">904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868">501 U.S. 868 (1991). Mr. Brown and Mr. Christianson were involved with the promotion and representation of 1983 WROG, and, therefore, were incapable of giving competent and unbiased advice regarding the investment. Considering the size of petitioner's investment and the proportionately large tax write-offs, further investigation was mandated. Saviano v. Commissioner, 765 F.2d 643">765 F.2d 643, 765 F.2d 643">654 (7th Cir. 1985), affg. 80 T.C. 955">80 T.C. 955 (1983). In light of petitioner's failure to seek independent counsel and research his investment, petitioner has not established that his reliance on Messrs. Brown and Christianson amounts to reasonable and prudent conduct. Moreover, petitioner has not shown that it would be reasonable for a person with his educational background to have expected an investment in 1983 WROG to be profitable. In spite of the bells and whistles regarding the IRS audit and the too good to be true tax advantages, petitioner claimed the partnership loss, and, in doing so, was negligent in preparing and filing his 1983 Federal tax return. 1995 Tax Ct. Memo LEXIS 398">405 4 Petitioner is liable for additions to tax under section 6653(a)(1) and (2). We next consider whether petitioner is liable for an addition to tax under section 6661. This section provides for an addition to tax in an amount equal to 10 percent of the underpayment attributable to a substantial understatement of tax. Sec. 6661(a). An understatement is substantial if it exceeds the greater of 10 percent of the correct tax or $ 5,000. In general, if a taxpayer has substantial authority for his tax treatment of the item in question, or if the taxpayer adequately disclosed the tax treatment of the item on his return, then the taxpayer may escape liability for an addition to tax with respect to that item. Sec. 6661(b)(2)(B). However, if the item in question is attributable to a tax shelter, the disclosure exception will not apply, and the substantial authority1995 Tax Ct. Memo LEXIS 398">406 exception will apply only if, in addition to substantial authority, the taxpayer reasonably believed that his treatment of the item is more likely than not the proper treatment. Sec. 6661(b)(2)(C)(i); sec. 1.6661-5, Income Tax Regs.Based on the FPAA and decision entered by this Court on June 19, 1991, respondent assessed a deficiency in petitioner's 1983 Federal income tax in the amount of $ 11,284. Petitioner does not dispute that he is liable for this deficiency, and, as such, there exists a substantial understatement in this case. Because 1983 WROG was found to be a tax shelter with the principal purpose to avoid or evade Federal income tax, petitioner must prove that there was substantial authority for his treatment of the loss, and that he reasonably believed in such treatment. Petitioner has failed to establish that there is substantial authority for his position or, as noted above, that he reasonably believed that such treatment was more likely than not the proper treatment. He was to receive tax benefits from his investment in 1983 WROG equal to 400 percent of his cash outlay. Despite this fact, petitioner proceeded to invest in 1983 WROG without any meaningful investigation1995 Tax Ct. Memo LEXIS 398">407 of the partnership. Based on the record in this case, we find that petitioner did not undertake the kind of independent factual analysis of 1983 WROG that would enable him to formulate a reasonable belief as to the tax treatment of the loss and to determine whether such treatment was more likely than not the proper treatment. Accordingly, we hold that he is liable for the section 6661 addition to tax for the taxable year 1983. To reflect the foregoing, Decision will be entered for respondent. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Petitioner conceded at trial that he filed his 1983 Federal income tax return late, and, as such, is liable for the addition to tax under sec. 6651(a)(1) as determined by respondent.↩3. Ferrell v. Commissioner, 90 T.C. 1154">90 T.C. 1154 (1988), involved Western Reserve Oil and Gas Co., Ltd., a limited and identically structured tax shelter promoted by the same individuals involved in 1983 WROG. In Ferrell↩, we held that the partnership was not engaged in a trade or business within the meaning of sec. 162(a), and that the whole partnership arrangement lacked economic substance. Most of the deductions claimed by the partnership, as well as the partnership loss deductions passed through the partnership to the partner-investors, were not, therefore, allowable.4. See Starrett v. Commissioner, T.C. Memo. 1990-183; Crittenden v. Commissioner, T.C. Memo. 1990-156↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619319/	MARTIN G. and MARILYN H. KLEIN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentKlein v. CommissionerDocket No. 21472-88.United States Tax CourtT.C. Memo 1989-283; 1989 Tax Ct. Memo LEXIS 283; 57 T.C.M. 686; T.C.M. (RIA) 89283; June 13, 1989. Sidney Eagle, for petitioners. Wilton A. Baker, for respondent. POWELLMEMORANDUM FINDINGS OF FACT AND OPINION POWELL, Special Trial Judge: This case was assigned pursuant to the provisions of section 7456(d) (redesignated as section 7443A by the Tax Reform Act of 1986, Pub. L. 99-514, section 1556, 100 Stat. 2755) and Rule 180 et seq. This case is before the Court on petitioners' motion to dismiss. The1989 Tax Ct. Memo LEXIS 283">284 gravamen of that motion is that the statutory notice for the 1980 taxable year is invalid. The facts are as follows. Martin G. Klein (petitioner) 1 was a partner in Agina Company during 1980. Agina, in turn, was a partner in Cambridge Financial Group. Cambridge was a partnership promoted by Edward A. Markowitz and others. Markowitz ultimately was convicted of charges involving various tax programs that he promoted. Respondent examined the Schedule K-1 submitted by Cambridge. That K-1 led to Agina. Agina's 1980 partnership return (Form 1065) only showed a loss in the amount of $ 185,000. This amount is the same as the amount shown on the Cambridge K-1 to Agina. From the K-1 of Agina, respondent determined that petitioner was a partner of Agina, disallowed the proportionate loss flowing from Cambridge through Agina to petitioner shown on petitioner's return, and issued a notice of deficiency to petitioner. Petitioner filed a petition with this Court. Petitioner resided in Connecticut when the petition was filed. The heart of petitioner's1989 Tax Ct. Memo LEXIS 283">285 arguments is that the notice of deficiency is invalid because "Agina's 1980 tax return has never been audited, nor has there been a determination disallowing any of Agina's losses." Petitioner relies on , and section 6212. 2Initially, we note that the year involved is prior to the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, 96 Stat. 324. Accordingly, the provisions relating to TEFRA partnerships (sections 6221 et seq.) do not apply. Thus, petitioner's argument must be predicated on the premise that there must be some type of formal examination of the partnership return by contacting a representative of the partnership. While it is unclear if there was any contact between respondent and a representative of Agina, we are willing to assume that there was no such contact. Section 6212(a) provides that "If the Secretary determines that there is a1989 Tax Ct. Memo LEXIS 283">286 deficiency * * he is authorized to send notice of such deficiency * * ." The language of section 6212 simply requires that respondent make a determination of a deficiency. Petitioner contends, however, that to make such a determination there must be an examination of a return, citing In Scar, respondent received erroneous information that the taxpayers claimed deductions from "Nevada Mining" partnership. The notice of deficiency stated, in part, "In order to protect the government's interest and since your original income tax return is unavailable at this time, the income tax is being assessed [sic] at the maximum tax rate of 70%. The tax assessment [sic] will be corrected when we receive the original return or when you send a copy of the return to us." 81 T.C. 857. The taxpayers, in fact, had no interest in " Nevada Mining." This Court held that the notice of deficiency was sufficient to establish the Court's jurisdiction. On appeal, the Ninth Circuit held on these particular facts that respondent had not made a "determination" required by section 6212(a). In this case, however, Cambridge, along with other1989 Tax Ct. Memo LEXIS 283">287 Markowitz programs, was the subject of intense investigation culminating in a criminal prosecution of the promoter. The paper trail of K-1s and partnership and individual returns then led to the issuance of the notice of deficiency. While it may be that the partners of Agina were never contacted, the K-1 from Cambridge and the partnership return made this unnecessary. In short, there clearly was a determination by respondent. This is a totally different situation from that that existed in Scar.To the extent that petitioner contends that respondent must contact a representative of Agina or petitioner in order for there to be a "determination" under section 6212(a), we reject that contention. This is not a situation where, as in Scar, respondent appeared in the wrong ball park. Rather, he was in the correct ball park, was at bat and knew both the game and the ball park well. 3 Petitioners' motion to dismiss will be denied. An appropriate order will be issued.Footnotes1. Marilyn H. Klein is a party because she filed a joint return with Martin. The disputed transactions involved Martin Klein.↩2. All statutory references are to the Internal Revenue Code of 1954, as amended, and as in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, except as otherwise provided.↩3. Compare fn. * (1975) (Blackmun, J. concurring).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619320/	Joseph Kane, Petitioner, v. Commissioner of Internal Revenue, Respondent. Rose Kane, Petitioner, v. Commissioner of Internal Revenue, RespondentKane v. CommissionerDocket Nos. 50587, 52755, 52756United States Tax Court25 T.C. 1112; 1956 U.S. Tax Ct. LEXIS 258; February 29, 1956, Filed 1956 U.S. Tax Ct. LEXIS 258">258 In Docket Nos. 50587 and 52755 decisions will be entered for the respondent.In Docket No. 52756 decision will be entered for the petitioner. An option to purchase stock during periods of the husband's employment was given to the wife by the chief stockholder and chairman of the board of directors of the corporation which employed her husband. When the option was exercised in three instances, the market prices of the stock exceeded the option price. Upon the entire evidence, held, that the option to purchase the stock was intended as additional compensation for the husband's services to the corporation. Held, further, that the excess of the market value of the stock over the option price in each year in which stock was purchased under the option is taxable to the husband under section 22 (a) of the 1939 Code as additional compensation for services. Sidney Gelfand, for the petitioners.S. Jarvin Levison, Esq., for the respondent. Harron, Judge. HARRON 25 T.C. 1112">1113 The Commissioner determined deficiencies in the income tax liability of Joseph Kane for the years 1945, 1946, and 1947 in the amounts set forth below; and he determined a deficiency in the income tax liability of Rose Kane for 1947, in the amount set forth below:Docket No.PetitionerYearDeficiency50587Joseph Kane1945$ 8,346.4852755Joseph Kane194614,069.33194710,187.0252756Rose Kane19473,745.58The chief question is whether gain realized upon the exercise of options to purchase stock in 1945, 1946, and 1947 is taxable to the petitioner Joseph Kane under the provisions of section 22 (a) of the 1939 Code, as the Commissioner has determined. In the event these determinations of the Commissioner are not sustained, it is necessary to decide whether gain realized in 1947, upon the exercise of an option to purchase stock, is taxable to the petitioner Rose Kane.FINDINGS OF FACT.The stipulated facts are found as facts according to the stipulation. 1956 U.S. Tax Ct. LEXIS 258">260 The stipulation and the attached exhibits are incorporated herein by this reference.The petitioners, husband and wife, are residents of New York City, New York. They filed individual returns with the collector of internal revenue for the third district of New York.The petitioners were married before 1935. They have two children. Joseph Kane is referred to hereinafter as Joseph, and Rose Kane is referred to hereinafter as Rose.Prior to 1935, the petitioners lived in New York City. Joseph Kane had lived there for about 30 years before 1935. In 1935, petitioners moved to Cincinnati, Ohio, where Joseph Kane accepted employment by Gruen Watch Company. The petitioners lived in a suburb of Cincinnati in a 6-room house which they rented.At all times since her marriage, Rose Kane had been a homemaker and she has not been employed in any other way.Lou Kane, hereinafter called Lou, is a brother of Joseph. In 1944, he maintained his residence in Saybrook, Connecticut, and he was a salesman for Bulova Watch Company in charge of its New England sales territory. He had been employed by Bulova Company for a period of 10 years up to 1944.25 T.C. 1112">1114 Joseph was a vice president of Gruen1956 U.S. Tax Ct. LEXIS 258">261 Watch Company, in charge of production, in 1943 and 1944. He received a salary and a "voluntary bonus" in the years 1940-1943, inclusive, in the amounts set forth below:YearSalaryBonusTotal1940$ 15,000$ 5,000$ 20,000194118,62510,00028,625194222,5007,50030,000194324,00010,00034,000Bulova Watch Company, hereinafter referred to as Bulova Company, has its principal office in New York City. In 1944, and thereafter, Arde Bulova was chairman of the board of directors; John Ballard was president; and Harry Henshel was vice president; and all three constituted the board of directors.Joseph, Rose, and Lou Kane were well acquainted with John Ballard and Arde Bulova. Joseph had known Ballard since 1930, and he had known Bulova for several years prior to 1944. Rose became acquainted with Bulova in connection with philanthropic work.In March of 1944, Joseph Kane issued a public notice that he intended terminating his employment with Gruen Watch Company. A few days after the issuance of the public notice, Lou, from New York, telephoned to Joseph in Cincinnati, and told Joseph that Ballard, president of Bulova Company, would like to talk to Joseph, 1956 U.S. Tax Ct. LEXIS 258">262 and that Ballard wished that Joseph would not make any definite commitment about his future employment until Ballard had the opportunity of talking to Joseph.In April of 1944, Joseph went to New York City to see Ballard. There were discussions with both Ballard and Arde Bulova about the possibility of Joseph's becoming associated with Bulova Company. Joseph, Ballard, and Arde Bulova arrived at some understanding about the possibility of Joseph's entering into the employment of Bulova Company. Joseph understood that he would have to move from Cincinnati to New York City. It was understood, also, that an interval of time would be required during which the Kanes could find a place to live in New York City. Also, Joseph wanted to have a vacation before he undertook new employment. Joseph returned to Cincinnati and discussed the entire matter with his wife, Rose.Shortly after Joseph returned to Cincinnati, Rose went to New York City. Arde Bulova talked to her about the possibility of her husband's becoming employed by Bulova Company. Arde Bulova told Rose that Bulova Company had been seeking to employ her husband and he proposed that in order to get her husband to work for Bulova1956 U.S. Tax Ct. LEXIS 258">263 Company he would give Rose an option to buy some of his, 25 T.C. 1112">1115 Arde Bulova's, shares of stock at $ 37 per share under the following conditions: If her husband, Joseph, was employed by Bulova Company for 1 year, she could buy 300 shares during the first year of his employment. If he was employed by Bulova Company a second year, she could buy 300 shares during the second year. If he was employed by Bulova Company a third year, she could buy 400 shares during the third year of his employment. Rose told Arde Bulova that she would accept the option under the terms which he had specified.Rose was able to purchase Bulova stock because she had assets of her own consisting of securities in various corporations which had been acquired during several years before 1944. A good part of Rose's assets represented gifts from her husband. The extent of her holdings in securities is reflected in her income tax returns for 1945, 1946, and 1947. In those 3 years she sold securities for, roughly, the total sum of $ 91,000.After Rose's discussion with Arde Bulova, the Kanes proceeded with arrangements to leave Cincinnati. In May of 1944, they gave up their rented house in Cincinnati; they1956 U.S. Tax Ct. LEXIS 258">264 stored some of their household equipment including china and silverware; and they sold at auction various articles of household furnishings, for about $ 2,555, because they preferred to refurnish a new home or apartment in New York City. The Kanes then went to visit Lou Kane in Saybrook, Connecticut, where they stayed until they rented an apartment in New York City in the early part of August of 1944.On August 17, 1944, Joseph and Rose executed separate agreements. Joseph executed an agreement with Bulova Watch Company under which he was employed as assistant to the president commencing August 21, 1944. Rose signed an agreement with Arde Bulova under which he gave her an option to buy up to 1,000 shares out of his own Bulova stock during the first, second, and third years of Joseph's employment by Bulova Company. The agreements are as follows:Bulova Watch CompanyExecutive Offices630 Fifth Avenue, New York 20, N. Y.August 17, 1944Mr. Joseph Kane,240 Central Park South,New York City, N. Y.Dear Sir:In accordance with conversation which you had with Mr. Arde Bulova and the undersigned, we make the following arrangement with you:You are hereby hired by our company1956 U.S. Tax Ct. LEXIS 258">265 and you agree to work for us as Assistant to the President, commencing August 21, 1944 and up to August 31, 1945 at a salary of $ 400 per week. If you are still in our employ beginning with 25 T.C. 1112">1116 September 1, 1945, your salary shall be $ 500 per week and if you are in our employ after September 1, 1946, your salary will be $ 600 per week. On and after September 1, 1945, the arrangement provided for herein may be cancelled by either party upon four months' written notice to the other party by registered mail to the addresses given herein.In addition to the above, if you are in our employ on August 31st of each of the years mentioned in this paragraph, you are to receive an amount equal to 1/2% of the net profit after taxes realized by our company as shown by our annual statement for the period ending March 31st, 1945, 1946 and 1947 and for no other years, payable on or before September 1, 1945, September 1, 1946 and September 1, 1947 respectively. If your employment ends during any year, then you are to receive one-twelfth of the yearly share of the profits above provided for each month of your employment during the year in which you have not been paid the said share of net1956 U.S. Tax Ct. LEXIS 258">266 profits.You are to devote all of your time, effort and energy to the performance of your duties as Assistant to the President or to such duties as you may be assigned by the President or other officer of our company, subject to our direction, and shall in all respects serve us diligently and to the best of your ability and shall not represent or in any way be connected, either directly or indirectly, with any other business during your employment with us.Bulova Watch Company, Inc.I agree to and accept the above: By [S] John H. BallardPresident[S] Joseph KaneJoseph KaneArde Bulova630 Fifth Ave.New York CityAugust 17, 1944Mrs. Rose Kane,240 Central Park South,New York, New YorkDear Mrs. Kane:As you know, we have been seeking to employ your husband Joseph Kane, but he is hesitating in accepting employment in our Company because you do not desire to move your home to New York from Cincinnati, where you now reside.In consideration of the sum of One ($ 1.00) Dollar, receipt of which is hereby acknowledged, and in consideration of your agreeing to give up your Cincinnati residence and making New York your home so that your husband will work for us, I, 1956 U.S. Tax Ct. LEXIS 258">267 by this letter, give you the option to buy from me 1000 shares of Bulova Watch Company, Inc. stock at the price of $ 37.00 per share. You are to exercise this option as follows: 300 shares within the first year of his employment, 300 shares within the second year of his employment and 400 shares within the third year of his employment.Upon your exercising this option, I agree to deliver certificates for the shares you elect to take under this option in proper form for transfer upon the payment to me of the price provided to be paid in this option.Very truly yours,[S] A. BulovaA. Bulova.I agree to the above:[S] Mrs. Rose Kane25 T.C. 1112">1117 Under the agreement with Bulova Watch Company, Joseph was employed as assistant to the president for 1 year from August 21, 1944, up to September 1, 1945, at which time the arrangements provided for by the agreement could be canceled by either party upon 4 months' written notice to the other party. If neither party canceled the agreement on or after September 1, 1945, Joseph's employment would be continued. The period of employment under the agreement with Bulova Watch Company was indefinite on and after September 1, 1945.In 1944, at the 1956 U.S. Tax Ct. LEXIS 258">268 time of Ballard's discussions with Joseph, and up to March 31, 1945, the authorized capital stock and the outstanding stock of Bulova Company amounted to 500,000 shares and 324,881 shares, respectively. Arde Bulova owned between 16 and 19 per cent of the outstanding stock. The number of shares which Bulova owned in 1944 did not exceed 61,727 shares. After Arde Bulova, the shareholder who owned the next largest block of Bulova stock, owned 3.16 per cent of the outstanding stock.The parties have stipulated that $ 37 per share, the option price, was in excess of the market price of stock of Bulova Company on August 17, 1944.Prior to March 31, 1947 (and also prior to August 17, 1944), no stock options had been given to any employee of Bulova Company by either Bulova Company or Arde Bulova.On July 24, 1945, before the exercise of any part of the option under the agreement of August 17, 1944, there was a split of the stock of Bulova Company on the basis of 2 new shares for 1 old share. Thereafter, the authorized and the outstanding stock of Bulova Company was twice the amount before July 24, 1945, namely, 1,000,000 and 649,762 shares, respectively. After the stock split, the number1956 U.S. Tax Ct. LEXIS 258">269 of shares of Bulova stock owned by Arde Bulova did not exceed 123,454 shares.As a result of the stock split, the option agreement of August 17, 1944, gave Rose the right to purchase a maximum amount of 2,000 shares at $ 18.50 per share, 600 shares during the first and second years of Joseph's employment, and 800 shares during the third year.The options to purchase Bulova stock from Arde Bulova were exercised on December 27, 1945, August 6, 1946, and July 21, 1947. On, or as of, each of the above dates, certificates of stock were issued to Rose Kane for 600 shares, 600 shares, and 800 shares, respectively. Rose used the proceeds from sales of stock in 1945, 1946, and 1947, for the purchase of Bulova stock in each of those years.Joseph Kane was in the employ of Bulova Company during the years in which the stock options were exercised.25 T.C. 1112">1118 The market prices per share of stock of Bulova Company on December 27, 1945, August 6, 1946, and July 21, 1947, were $ 37.16, 1 $ 51.25, and $ 33.75, respectively. The total cost, the total market prices, and the excess of the market prices above costs of the blocks of Bulova stock acquired under the stock option were as follows:Number ofExcess ofDate option exercisedsharesCostMarket valuemarket valueacquiredover costDec. 27, 1945600$ 11,100n1 $ 22,300$ 11,200Aug. 6, 194660011,10030,75019,650July 21, 194780014,80027,00012,200$ 37,000$ 80,050$ 43,0501956 U.S. Tax Ct. LEXIS 258">270 In each instance of the purchase of stock under the option agreement, Rose drew a check on her own checking account in the total amount of the purchase price of each purchase.During the years of their marriage, Rose received gifts from Joseph.In each of the years 1945, 1946, and 1947, securities were sold and Rose reported the sales in her individual income tax returns. The proceeds from the sales of securities which Rose reported in her individual income tax returns for 1945, 1946, and 1947 exceeded the cost of Bulova stock purchased 1956 U.S. Tax Ct. LEXIS 258">271 under the option in 1945, 1946, and 1947. For example, in her returns for 1945, 1946, and 1947, Rose reported sales of securities, in each year, for the total amounts of $ 24,980.11, $ 44,381.52, and $ 22,498.13, respectively.During all times material, Rose has had her own safety-deposit box. She has kept all of the Bulova stock in question in her own safety-deposit box.Rose still possesses all of the Bulova stock involved in these proceedings. All of the dividends thereon have been paid to her, and she reported the dividends in her individual income tax returns.Joseph has not used any of the Bulova stock in question as collateral for loans or in any other way.Arde Bulova reported the stock which he sold under the stock option agreement as capital transactions. He did not claim any deduction for the excess of market price over sales price.Joseph Kane received salary and bonus payments from Bulova Company in 1945, 1946, and 1947, in the total amounts of $ 34,740.35, $ 44,940.35, and $ 55,742.51, respectively.25 T.C. 1112">1119 In determining the deficiencies in the income tax liability of Joseph Kane (Docket Nos. 50587 and 52755) for 1945, 1946, and 1947, the Commissioner determined1956 U.S. Tax Ct. LEXIS 258">272 that Joseph Kane realized income from the exercise of a stock option in each of the taxable years in the amounts of $ 11,100, 2 $ 19,650, and $ 12,200, respectively. The explanation given by the Commissioner in the statements attached to the notices of deficiencies, in each instance, is as follows.It is held that the exercise of a stock option by Rose Kane, your wife, resulted in income taxable to you under the provisions of section 22 (a) of the Internal Revenue Code [1939], to the extent of the difference between the option price and the market price, * * on the date the option was exercised * * 1956 U.S. Tax Ct. LEXIS 258">273 In her income tax return for 1945, Rose Kane reported gain from the exercise of a stock option in the amount of $ 11,100, as ordinary income. She did not report any gain from the exercise of a stock option in her income tax return for 1946, or 1947.In determining the deficiency in the income tax liability of Rose Kane for the year 1947 (Docket No. 52756), the Commissioner determined that Rose had realized income in the amount of $ 12,200 upon the exercise of an option to buy 800 shares of stock of Bulova Co. in 1947. The explanation given in the statement attached to the deficiency notice is as follows:On July 23, 1947, Mrs. Kane executed an option to buy 800 shares of stock in the Bulova Watch Company. The excess of fair market value over cost is held to be taxable income to you.Fair market value (800 shares)$ 27,000.00Cost paid14,800.00Income realized$ 12,200.00The Commissioner agrees that if this Court holds that taxable gain was realized in 1947 upon the exercise of an option to purchase Bulova stock, and that such gain is taxable to Joseph Kane, then the above determination relating to Rose Kane is incorrect and should be set aside.The Bulova Watch 1956 U.S. Tax Ct. LEXIS 258">274 Company was controlled by the father of Arde Bulova up to the time of his death. Originally, the Bulova Company was a closely held corporation. Upon the death of Arde Bulova's father, Arde Bulova made John Ballard the president of the Bulova Company. In 1944, Arde Bulova exercised a dominant 25 T.C. 1112">1120 influence in the management of the Bulova Company and he was the largest stockholder.Arde Bulova offered Rose Kane the option to purchase some of his Bulova stock as an inducement to Joseph Kane to accept the position of assistant to the president of the Bulova Company in 1944 and to continue in the employ of the company; the option was intended to provide additional compensation to Joseph Kane in each year in which the option was exercised. The option was not intended to provide Rose Kane with a proprietary interest in the Bulova Company. In each of the years 1945, 1946, and 1947, Joseph Kane realized additional compensation for his services in the amount of the excess of the market value of the Bulova stock over the option price paid for the acquisition of stock in each year.Rose would have moved to New York City even if Bulova had not given her the option to buy Bulova stock. 1956 U.S. Tax Ct. LEXIS 258">275 OPINION.The chief question is whether the option granted by Arde Bulova, the chairman of the board of directors of Bulova Watch Company, was given for the purpose of enabling Rose Kane to acquire a proprietary interest in that company, or was given as additional compensation to Joseph Kane for his services to Bulova Company, to be received in each year in which the option was exercised. The petitioners contend that the option was granted for the purpose of giving Rose a proprietary interest in the Bulova Company, and that, therefore, no taxable income, under section 22 (a) of the 1939 Code, was realized in the years in which Rose exercised the option by either Rose or Joseph Kane.In the event the Court should sustain the contention of Joseph Kane that he did not receive taxable income under section 22 (a) in the years when Rose exercised the option, the respondent contends that Rose received taxable income, under section 22 (a) of the Code, in 1947, which is the only year before this Court involving Rose, because the option was intended as compensation to her for the trouble and inconvenience of moving from Cincinnati to New York and so that Bulova Company would have the services1956 U.S. Tax Ct. LEXIS 258">276 of Joseph Kane in New York.All of the questions arise under section 22 (a) of the 1939 Code. 325 T.C. 1112">1121 The questions to be decided are questions of fact. Abraham Rosenberg, 20 T.C. 5, 8, and 9.The petitioners rely upon Abraham Rosenberg, supra,1956 U.S. Tax Ct. LEXIS 258">277 and Commissioner v. Straus, 208 F.2d 325.It is pointed out that the respondent does not contend that his amendment to Regulations 111, section 29.22(a)-1, contained in T. D. 5507, dated April 12, 1946, 1946-1 C. B. 18, and elaborated upon in I. T. 3795, 1946-1 C. B. 15, apply to the stock option which is involved in these proceedings. The respondent recognizes that the stock option granted by Arde Bulova was given on August 17, 1944, and, accordingly, it is a stock option granted before February 26, 1945, to which the provisions of his regulations as they stood before his amendment apply. See Abraham Rosenberg, supra, pp. 9 and 10. The respondent relies upon the old regulations, the pertinent part of which is quoted in the margin. 41956 U.S. Tax Ct. LEXIS 258">278 We shall consider first the question presented in the proceedings of Joseph Kane. The respondent argues that the evidence supports a finding that the option was compensatory in nature. He argues that the evidence establishes that Arde Bulova granted the option, orally, at the time when employment of Joseph by Bulova Company first was being discussed; that the stock option was granted, orally, prior to the execution of the final employment agreement; that when the agreements were reduced to writing, the stock option agreement was tied to the agreement setting forth the terms of Joseph's employment; that the option was to be exercised during the period of Joseph's employment; and that the dominant motive underlying Arde Bulova's granting the stock option was to provide the "clincher" in obtaining Joseph's services for Bulova Company.The respondent relies upon the rule that an employee is taxable upon the economic benefits realized upon the exercise of a stock option which was granted as compensation for services rendered, or to be rendered, by the employee. Commissioner v. Smith, 324 U.S. 177">324 U.S. 177; Dean Babbitt, 23 T.C. 850.1956 U.S. Tax Ct. LEXIS 258">279 The respondent cites the foregoing cases and, also, Charles E. Sorensen, 22 T.C. 321. The respondent also contends that the petitioner, Joseph Kane, cannot avoid the tax consequences under section 22 (a), if the economic benefits of the stock option constitute additional compensation for his services to Bulova Company, merely because the option was given by Arde Bulova rather than by Joseph's employer, Bulova Company. On this point, he relies on Wanda V. Van Dusen, 8 T.C. 388, affd. 166 F.2d 647.25 T.C. 1112">1122 The issue to be decided places upon the Court the difficult task, in view of the record before us, of determining whether it was the intention of the parties that the option to purchase stock from Arde Bulova was to provide additional compensation to Joseph for his services, or was to give a proprietary interest in the Bulova Company to a member of Joseph's family, namely, his wife. The determination of such intent, which is a question of fact, is dependent upon the evidence in the case to be decided. "Each case must be decided upon its own peculiar facts, and facts which have been deemed1956 U.S. Tax Ct. LEXIS 258">280 significant under some circumstances may serve as guides, but are not necessarily controlling." Abraham Rosenberg, supra, p. 10.In their testimony, both Arde Bulova and Joseph Kane have denied emphatically that it was intended that any economic benefit which might be derived from exercise of the option was intended to be compensation for Joseph's services to Bulova Company. Joseph denies that he had any discussion with Arde Bulova about the terms of his employment by the company, and Arde Bulova denies having had any discussions with Joseph about his employment by the company, or about the stock option. Joseph, Rose, and Arde testified that the discussions about the stock option were between Rose and Arde exclusively and solely. Rose and Arde testified that the stock option was suggested by Arde and that neither Joseph nor Rose asked for the stock option. Arde testified that he had given friends and relatives opportunities to buy Bulova stock, and that he wanted Rose to have an opportunity to make an investment in the Bulova Company because it was his belief that such investments served to establish good "family" relations with the company. Also, 1956 U.S. Tax Ct. LEXIS 258">281 there is testimony that Rose was not happy about moving from Cincinnati back to New York City, that she expressed dissatisfaction, and that Arde Bulova voluntarily offered her the option to make her satisfied.All of the testimony of all of the witnesses has been carefully considered. There are inconsistencies in Arde Bulova's testimony. We are not impressed by Rose's professed dissatisfaction and alleged unhappiness about leaving Cincinnati, at least as a serious factor in the granting of the stock option. Rose finally testified that she would have gone to New York with her husband even if Arde Bulova had not granted her the stock option. There are statements appearing in the written agreements of August 17, 1944, which are in conflict with testimony of Joseph Kane and Arde Bulova. It is stated in the employment agreement of Bulova Company that Joseph Kane had had conversation with both Arde Bulova and John Ballard about his employment. It is stated in the option agreement that one of the purposes of that agreement was to get Joseph Kane to work for Bulova Company, and that he had been hesitating to accept employment in 25 T.C. 1112">1123 the company. All of these facets of the record1956 U.S. Tax Ct. LEXIS 258">282 have been taken into account.The limited question to be decided is whether the option was given with the intention that any economic benefits which might be derived were to constitute additional compensation to Joseph for services rendered or to be rendered.The petitioner Joseph Kane has testified that the only agreement relating to and fixing his compensation is the agreement which he made with the Bulova Company by which his compensation is stated to be a weekly salary, starting at $ 400 in the first year, increasing to $ 500 in the second year, and increasing to $ 600 in the third year, plus, in each year, one-half of one per cent of net profits after taxes, that he was entirely satisfied with the compensation so stated in the agreement, and that the agreement gave him better compensation than he had received from Gruen. The evidence shows that although Joseph had been receiving a "voluntary bonus" from his former employer, Gruen, the share of profits which he actually received from Bulova Company in 1945, 1946, and 1947 exceeded the amounts of the annual bonus which he had received from Gruen. For example, the amounts of Joseph's share of the net profits of Bulova Company 1956 U.S. Tax Ct. LEXIS 258">283 in 1945, 1946, and 1947 amounted to $ 13,940, $ 18,940, and $ 24,542, respectively, which amounts exceeded the voluntary bonus received from Gruen in any of the years 1940 through 1943. Also, the basic salary paid by Bulova Company to Joseph in 1946 and 1947, namely, $ 26,000 and $ 31,200, exceeded his highest basic salary from Gruen in 1943. Thus, the evidence lends support to Joseph's testimony that the employment agreement with Bulova Company was a better one than the contract with Gruen.After giving careful consideration to the testimony presented by the petitioners, there remain, nevertheless, obvious considerations which cannot be ignored. There is some background which is part of the entire situation which impresses us as having as much importance as the explanations given by the petitioners and Arde Bulova. The business of the Bulova Watch Company was directed by the father of Arde Bulova, if not developed by Arde Bulova's father. Arde Bulova testified that originally the stock of Bulova Watch Company was closely held, and from his testimony we understand that he meant, by the members of the family of Arde Bulova's father. It is established here that in 1944 Arde Bulova1956 U.S. Tax Ct. LEXIS 258">284 was the largest single stockholder of the company. It also is clear from Arde Bulova's testimony that he was the leading director of the company. He testified that after his father died he made Ballard the president of the company. It must be concluded that in 1944 Arde Bulova exercised the dominant position in the management of Bulova Company.25 T.C. 1112">1124 In less than a year after Arde Bulova gave Rose Kane the option to purchase some of his shares of stock, there was a 2-for-1 split in Bulova stock. We cannot, in view of Arde Bulova's position in the company, regard the happening of the stock split as an event which was wholly unthought of by Arde Bulova when he gave the option to Rose. In fact, he testified that he told Rose that if she took the option it would make her "rich." After the stock split, the option enabled Rose to purchase up to 2,000 shares of stock of Bulova Company at $ 18.50 per share in a rising market. A matter involving a stock split is one which is peculiarly within the knowledge of the highest officials of a corporation.All of the contentions of the petitioners invite the taking of a very naive view about all of the circumstances to which we are unable1956 U.S. Tax Ct. LEXIS 258">285 to subscribe. One aspect of these proceedings comes within the oft-repeated pattern of action by the wife of a taxpayer who is directly concerned in a business transaction in which the wife would have no interest other than the benefits to her husband and to her family. Where a wife has assets in her own name, it is an easy matter for her, for her husband's convenience, to use her assets in the same way that her husband could use his own assets, and where some tax consequence to the husband may be involved, the husband's convenience is served if the wife enters into a transaction. Many instances have come before the courts where the Commissioner has applied the broad provisions of section 22 (a) to protect the fisc, and where substance rather than form has been held to be determinative. In these proceedings the petitioners have the burden of proof which is, specifically, to prove that there was no vital causal connection between the employment of Joseph Kane and his rendition of services and the purchase of the stock at favorable prices, taking into account all of the circumstances. See Wanda V. Van Dusen, supra.We are left with a conviction that1956 U.S. Tax Ct. LEXIS 258">286 the explanations of the petitioners and of Arde Bulova do not serve to discharge the petitioners of their duty under their burden of proof. There are patent weaknesses in the explanations which have been given.In the first place, we must reject wholly the emphasis upon Rose's alleged unhappiness about moving from Cincinnati to New York City. Her professed objections to a change in the location of her home may have existed, but in deciding the issue presented, they are entirely immaterial and irrelevant.Also, the alleged desire of Arde Bulova, a generous one, simply to give Rose an opportunity to purchase Bulova Company stock is also irrelevant and immaterial even though he may be a person of magnanimous impulses. Since the market price of Bulova Company stock on August 17, 1944, was less than $ 37 per share, which was the 25 T.C. 1112">1125 option price, and since Rose had a portfolio of securities which had a value of around $ 90,000, Arde Bulova's willingness to sell her some of his stock could have been satisfied by simply offering to sell stock to Rose without giving Rose a favorable option price at which she could purchase stock over a period of 3 years, provided Joseph, her husband, 1956 U.S. Tax Ct. LEXIS 258">287 was employed by Bulova Company. The crux of the matter is that Arde Bulova gave Joseph's wife a favorable option price which was conditioned upon Joseph's employment. He has not testified that he ever gave any other friend, or relative, an option price when he offered them the opportunity to purchase any of his Bulova stock. This is the factor which raises the big doubt about the entire theory of the petitioners. To be perfectly clear about the point, it must be remembered that not only did Arde Bulova give Rose an option price but also he offered the option at exactly the same time that the employment of Joseph Kane was under consideration and before Joseph Kane entered into an employment contract with Bulova Company; and that there was a stock split in less than 1 year after the agreements were executed; and that the exercise of the option was put on a year to year basis and was made dependent upon whether Joseph Kane was employed by Bulova Company; and that the stock split occurred before the end of the first year within which the stock option could be exercised.After careful consideration of the respective arguments of both parties, it must be concluded that the situation1956 U.S. Tax Ct. LEXIS 258">288 in this case is not essentially different from the situation in the case of Wanda V. Van Dusen, supra. It is concluded that there existed a vital causal connection between Joseph's employment by and his rendition of services to Bulova Company, and the purchases of the Bulova stock at a favorable option price, and the compensation to be "realized" by Joseph for his services to the company, and the granting by Arde Bulova of the highly advantageous option to Rose before or at precisely the same time that Joseph Kane agreed to become the assistant to the president of Bulova Company. We agree with the respondent that, in truth, the stock option was the "clincher" of the employment agreement. We think there is no doubt that Arde Bulova intended that his option would be the final inducement which would bring about Joseph Kane's acceptance and continuation of employment by Bulova Company, and that there was present the intention that the economic benefit to be derived from the exercises of the option would constitute additional compensation for Joseph's services to Bulova Company. The Van Dusen case is strong authority in support of the respondent's 1956 U.S. Tax Ct. LEXIS 258">289 determination.A taxpayer cannot avoid tax upon his "realization" of income, such as compensation for his personal services, by anticipatory arrangements. 25 T.C. 1112">1126 Lucas v. Earl, 281 U.S. 111">281 U.S. 111; Burnet v. Leininger, 285 U.S. 136">285 U.S. 136; and Helvering v. Horst, 311 U.S. 112">311 U.S. 112. Even though Rose exercised the option and acquired the stock, the difference between market value and the option price at the time blocks of shares of Bulova stock were purchased constituted additional compensation to Joseph for services which he had rendered during the year in which each stock option was exercised, and he cannot escape the reach of section 22 (a) merely because his wife exercised the option and made the purchase of the stock. He rendered the personal services. The Commissioner's determination under section 22 (a) is fully supported by the doctrine of Corliss v. Bowers, 281 U.S. 376">281 U.S. 376; 281 U.S. 111">Lucas v. Earl, supra, and many other decisions which had followed the principle of those leading authorities.The rule established by 324 U.S. 177">Commissioner v. Smith, supra,1956 U.S. Tax Ct. LEXIS 258">290 cannot be avoided by the convenient arrangement of having the taxpayer's wife exercise a stock option which is part and parcel of an arrangement for the employment and compensation of the taxpayer. In the proceedings of Joseph Kane, the respondent's determinations are sustained.The conclusion in the main issue requires that the respondent's determination for the year 1947 in the proceeding of Rose Kane be reversed and set aside. It is so held.In Docket Nos. 50587 and 52755 decisions will be entered for the respondent.In Docket No. 52756 decision will be entered for the petitioner. Footnotes1. The parties have stipulated that the market value of 600 shares of Bulova stock on December 27, 1945, was $ 22,300, which amounts to about $ 37.16 per share. It is possible that the parties have made an error in their stipulation and that the market value was $ 22,200 or $ 37 per share, which is in accordance with the respondent's determination in his deficiency notice in which he determined that the excess of the market value over cost was $ 11,100. See footnote 2, infra↩.2. According to a stipulation of the parties, the excess of the market value of 600 shares of Bulova stock above the purchase price paid on December 27, 1945, amounted to $ 11,200. The Commissioner has included gain in the amount of $ 11,100 in the taxable income of Joseph Kane. There appears to be a discrepancy of $ 100 in the taxpayer's favor. However, the respondent, in Docket No. 50587, has not asked for an increase in the deficiency, in his answer, based upon realization of income by Joseph Kane to the extent of $ 100 more than the Commissioner determined in his notice of deficiency.↩3. SEC. 22. GROSS INCOME.(a) General Definition. -- "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service (including personal service as an officer or employee of a State, or any political subdivision thereof, or any agency or instrumentality of any one or more of the foregoing), of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains, or profits and income derived from any source whatever. * * ↩4. Regs. 111, Sec. 29.22(a)-1. What Included in Gross Income. -- * If property is transferred by a corporation to a shareholder, or by an employer to an employee, for an amount substantially less than its fair market value, regardless of whether the transfer is in the guise of a sale or exchange, such shareholder or employee shall include in gross income the difference between the amount paid for the property and the amount of its fair market value to the extent that such difference is in the nature of (1) compensation for services rendered or to be rendered * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619321/	CHARLES C. AND IRMA F. FIFER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentFifer v. CommissionerDocket No. 11706-91United States Tax CourtT.C. Memo 1993-44; 1993 Tax Ct. Memo LEXIS 43; 65 T.C.M. 1865; February 2, 1993, Filed 1993 Tax Ct. Memo LEXIS 43">43 An appropriate order will be issued, and decision will be entered under Rule 155. For Respondent: James F. Prothro. BEGHEBEGHEMEMORANDUM OPINION BEGHE, Judge: This case is before us on respondent's motion to dismiss for failure properly to prosecute under Rules 123(b) and 149(a). 1 Respondent determined deficiencies in petitioners' Federal income tax and additions to tax as follows: Additions to TaxYearDeficiencySec. 6653(b) 1Sec. 6661 21993 Tax Ct. Memo LEXIS 43">44 1981$ 10,437$ 5,219--- 19828,7853 4,393$ 2,19619832,3464 1,173--- Petitioners' deficiencies in income tax and their liability for additions to tax for fraud and substantial understatement of tax under sections 6653(b) and 6661, as determined by respondent, are attributable to their failure to report, on their 1981-83 Federal income tax returns, income earned by Mrs. Fifer as a private duty nurse's aide. Although respondent also determined that Mrs. Fifer was an independent contractor during the years at issue and that the income she earned as a private duty nurse's aide was therefore subject to self-employment tax, respondent has conceded that Mrs. Fifer was not working as an independent contractor during the years at issue. Petitioners resided in Terrell, Texas, when they filed the petition in this case. On November 27, 1991, we sent the parties a notice setting petitioners' case for trial at our Dallas, Texas, trial session beginning April 27, 1992. Our notice also informed the parties that their failure 1993 Tax Ct. Memo LEXIS 43">45 to appear at trial could "RESULT IN DISMISSAL OF THE CASE AND ENTRY OF DECISION AGAINST YOU." On February 18, 1992, respondent filed with this Court a request for admissions under Rule 90 that respondent had served on petitioners on February 12, 1992. The pertinent requested admissions were: 2. Admit that during each of the taxable years 1981, 1982, and 1983, petitioner Irma F. Fifer was * * employed as a private duty nurse's aide for Mrs. W.H. Hall. 3. Admit that during each of the taxable years 1981, 1982, and 1983, petitioners omitted from the petitioners' joint federal income tax returns 100% of the income earned by petitioner Irma F. Fifer from * * * employment as a nurse's aide. 4. Admit that during the taxable years 1981, 1982, and 1983, petitioner Irma F. Fifer earned, respectively, gross receipts of $ 24,074.53, $ 24,316.87, and $ 10,352.90 from * * * employment as a nurse's aide * * , which amounts were not reported on the petitioners' joint federal income tax returns for said years. 5 Admit that attached hereto as Exhibit D are true copies of twenty-nine (29) checks paid to Irma F. Fifer by Mrs. W.H. Hall for private duty nursing aide care during the tax years1993 Tax Ct. Memo LEXIS 43">46 at issue in this case. 6. Admit that the petitioners, prior to their being contacted by respondent's examining agent, never made any inquiry of Irma F. Fifer's payor in an effort to determine how much money she was paid by Mrs. W.H. Hall during each of the years 1981, 1982, and 1983. 7. Admit that, during the taxable years at issue in this case, petitioner Irma F. Fifer maintained a checking and savings account for her own use at the First Bank of Balch Springs, Texas, and that she wrote approximately twenty-five (25) checks each month during 1981, 1982, and 1983. 8. Admit that petitioners failed to produce records or other information to show * * * [Irma F. Fifer's] income [from employment as a private duty nurse's aide] to respondent's examining agents in connection with the examination by respondent of their income tax returns for 1981, 1982, and 1983. 9. Admit that during the tax years at issue in this case, petitioner Irma F. Fifer was reimbursed by Mrs. W.H. Hall for the full amount of the cost of all food, medicine, and supplies which she purchased for Mrs. W.H. Hall. 10. Admit that petitioners incorrectly stated on their joint income tax returns for the taxable years1993 Tax Ct. Memo LEXIS 43">47 1981 and 1982, that Irma F. Fifer's occupation was "housewife." 11. Admit that during taxable years 1981 and 1982, Irma F. Fifer's occupation was that of "private duty nurse's aide." 12. Admit that petitioners knew during the taxable years at issue in this case that they would owe more federal income tax if Irma F. Fifer's income earned from * * employment as a private duty nurse's aide were included on their federal income tax returns for the taxable years 1981, 1982, and 1983. 13. Admit that Charles C. Fifer prepared each of the petitioners' tax returns for the taxable years 1981, 1982, and 1983. 14. Admit that the petitioners knew during the taxable years at issue in this case that it was their responsibility to report on their federal income tax returns all of their income earned in each of the taxable years 1981, 1982, and 1983. 15. Admit that Irma F. Fifer instructed the First Bank of Balch Springs, Texas, that she would pick up her bank statements at the bank, and that she directed the bank not to mail her the bank statements. 16. Admit that when they signed and filed their joint federal tax returns for the tax years at issue in this case, the petitioners knew1993 Tax Ct. Memo LEXIS 43">48 that the said tax returns were false and that the said tax returns failed to report all of their taxable income for the taxable years at issue in this case. 17. Admit that during the taxable years at issue in this case, Irma F. Fifer knew that the payments she received from Mrs. W.H. Hall at the rate of $ 4 per hour, or $ 64 per day for a 16 hour day, were her salary. On March 5, 1992, respondent filed with this Court a motion to show cause why proposed facts in evidence should not be accepted as established under Rule 91(f). The pertinent facts that respondent sought to have accepted as established were: 2. The petitioners agree that they signed and filed the Form 1040A Federal Income Tax Returns for taxable years 1981, 1982, and 1983, true copies [of] which are attached hereto as Joint Exhibits 1-A, 2-B, and 3-C. Each of the said tax returns was prepared by petitioner Charles C. Fifer. * * 4. During each of the taxable years 1981, 1982, and 1983, petitioner Irma F. Fifer was * * * employed as a private duty nurse's aide for Mrs. W.H. Hall. 5. Mrs. W. H. Hall hired Irma F. Fifer in late 1980, and Irma F. Fifer worked for Mrs. W. H. Hall as a * * * private duty nurse's1993 Tax Ct. Memo LEXIS 43">49 aide until Mrs. Hall's death in May 1983. 6. During her employment as a private duty nurse's aide for Mrs. W.H. Hall, petitioner Irma F. Fifer was paid, via checks at the rate of $ 4.00 per hour or $ 64.00 per day, for a 16 hour work day. Petitioner Irma F. Fifer worked 16 hours per day, seven days a week, in Mrs. W.H. Hall's home during her employment by Mrs. W.H. Hall. 7. Petitioner Irma F. Fifer was fully reimbursed by Mrs. W.H. Hall for the full amount of the cost of any food, medicine and supplies which she purchased for Mrs. W.H. Hall during the taxable years at issue in this case. 8. During the taxable years 1981, 1982, and 1983, petitioner Irma F. Fifer earned, respectively, gross receipts of $ 23,360.00, $ 23,360.00 and $ 9,664.00 from * * employment as a nurse's aide, * * * which amounts were not reported on the petitioners' joint income tax returns for said years. 9. Petitioners Irma F. Fifer and Charles C. Fifer, for the taxable years 1981, 1982, and 1983, filed income tax returns for said years that omitted 100% of the Irma F. Fifer's income earned from * * * employment as a nurse's aide. 10. The petitioners failed to report income for taxable year 1981 from1993 Tax Ct. Memo LEXIS 43">50 Irma F. Fifer's * * employment as a nurse's aide in the amount of $ 23,360.00. True copies of pay checks received by Irma F. Fifer in the said amount are attached hereto as Joint Exhibit 5-E. 11. The petitioners failed to report income from taxable year 1982 from Irma F. Fifer's * * * employment as a nurse's aide in the amount of $ 23,360.00. True copies of checks received by Irma F. Fifer in the said amount are attached hereto as Joint Exhibit 6-F. 12. The petitioners failed to report income for taxable year 1983 from Irma F. Fifer's * * * employment as a nurse's aide in the amount of $ 9,664.00. True copies of checks received by Irma F. Fifer in the said amount are attached hereto as Joint Exhibit 7-G. 13. The petitioners' omission of * * * employment income from Irma F. Fifer's nursing aide activities constituted a substantial portion of the petitioners' income for each of the taxable years at issue in this case, as is shown by the following table:TaxIncomeIncomeYearReportedOmitted% Omitted1981$ 21,735.20$ 23,360.0052%198217,925.1523,360.0057%19837,018.799,664.0058%14. Petitioners Irma F. Fifer's and Charles C. Fifer's omission1993 Tax Ct. Memo LEXIS 43">51 of specific items of income on their joint federal income tax returns filed for taxable years 1981, 1982, and 1983 is a part of a three [year] pattern of omitting income. 15. Petitioners on their joint income tax returns for taxable years 1981 and 1982 incorrectly stated that Mrs. Irma F. Fifer's occupation as "housewife." In fact, Mrs. Irma F. Fifer['s] occupation during taxable years 1981 and 1982 was that of * * private duty nurse's aide. * * * 17. During the taxable years at issue the petitioners maintained two bank accounts; a joint account in both of their names at the Grove State Bank, or Interfirst Bank, and the personal checking and savings account of Irma F. Fifer at the First Bank of Balch Springs, Balch Springs, Texas. 18. Petitioner Irma F. Fifer, with the knowledge of Charles C. Fifer, opened and maintained a separate bank account at the First Bank of Balch Springs, in Balch Springs, Texas[,] in the sole name of Irma F. Fifer, into which account all of Irma F. Fifer's * * * employment income was deposited. None of the income deposited in this separate bank account was reported on their joint federal income tax returns for the taxable years at issue. 19. 1993 Tax Ct. Memo LEXIS 43">52 Irma F. Fifer instructed the First Bank of Balch Springs that she would pick up her bank statements at the bank, and she directed the bank not to mail her the statements. 20. When confronted at an interview by respondent's Special Agent, Irma F. Fifer denied signing the joint tax returns of the petitioners for 1981, 1982, and 1983. In reality, Irma F. Fifer signed each return. She later admitted that she recognized her signature on each joint tax return. 21. When confronted at an interview by respondent's Special Agent, Irma F. Fifer stated that she had made an effort to determine how much she was paid by Mrs. W.H. Hall during the taxable years 1981, 1982, and 1983, by asking for a Form W-2 or a Form 1099. In reality, Irma F. Fifer never made any inquiry of her payor for income information prior to filing the petitioners' joint income tax return for the taxable years at issue in this case. 22. When confronted at an interview by the respondent's Special Agent, Irma F. Fifer stated that she was unable to handle financial matters, and that she could not even write checks. In reality, Irma F. Fifer maintained a checking and savings account for her own use, and she wrote approximately1993 Tax Ct. Memo LEXIS 43">53 twenty-five (25) checks each month during taxable years 1981, 1982, and 1983. 23. The petitioners failed to produce records or other information as to * * * [Irma F. Fifer's] income [from employment as a private duty nurse's aide] to respondent in connection with the examination by respondent of their income tax returns for 1981, 1982, and 1983, [sic] 24. The petitioners understated their income tax liabilities on their joint federal income tax returns for the taxable years 1981, 1982, and 1983 in the respective amounts of $ 10,437.00, $ 8,785.00, and $ 2,346.00. 25. The petitioners have agreed with the respondent's determination of unreported income in this case. 26. Petitioner Charles C. Fifer has admitted that both he and Petitioner Irma F. Fifer knew during the taxable years at issue in this case that they would owe more federal income tax if Irma F. Fifer's income earned by * * * employment as a private duty nurse's aide were included on their tax returns for the taxable years 1981, 1982 and 1983. 27. During the taxable years at issue in this case, the petitioners reported, on their joint federal income tax returns only income received from employers who they knew had1993 Tax Ct. Memo LEXIS 43">54 the custom of providing information documents concerning such income to the Internal Revenue Service. The petitioners did not report income on their joint federal income tax returns received by petitioners from employers who they knew did not have the custom of providing information documents concerning the income to the Internal Revenue Service. 28. Petitioner Irma F. Fifer, during the years at issue in this case[,] was * * employed as a private duty nurse's aide and was not an employee of Mrs. W. H. Hall or of Mrs. W. H. Hall's nephew, Mr. Jean Rowe Jones. 29. Charles C. Fifer has admitted that neither he nor Irma F. Fifer made any inquiry of Mrs. W. H. Hall or Mr. Jean Rowe Jones as to the amount of income Irma F. Fifer earned from her nursing aide activities, for purposes of filing the federal income tax returns for the taxable years at issue. Charles C. Fifer has admitted during each of the taxable years at issue, the petitioners knew that reporting all of their income was the petitioners' responsibility. 30. Relative to each of the taxable years at issue in this case, neither Mrs. W. H. Hall nor Mr. Jean Rowe Jones provided Irma F. Fifer with any documents reflecting1993 Tax Ct. Memo LEXIS 43">55 the total amount of income paid by Mrs. Hall to Irma F. Fifer for each of the taxable years at issue in this case. 31. Charles C. Fifer has admitted that the petitioners signed and filed the joint federal income tax returns for the taxable years at issue, even though they both knew at the time that the returns were false and did not report all of their taxable income for the taxable years at issue in this case. 32. At no time did Irma F. Fifer or Charles C. Fifer inquire of Mrs. W. H. Hall or Mr. Jean Rowe Jones for the total amounts of income earned by Irma F. Fifer from her nursing aide activities during each year at issue in this case. 33. Irma F. Fifer knew that the amounts paid to her by Mrs. W. H. Hall, at the rate of $ 64.00 per day were her salary. Neither Mrs. W. H. Hall nor Mr. Jean Rowe Jones told her[,] Irma F. Fifer[,] that they would withhold federal income taxes or pay such taxes for her. 34. Income taxes on the amounts earned by Irma F. Fifer from * * employment as a nurse's aide during each year at issue in this case were not required to be withheld at the source by Mrs. W.H. Hall. * * On March 11, 1992, we granted respondent's motion and ordered petitioners1993 Tax Ct. Memo LEXIS 43">56 to file a response, in compliance with Rule 91(f)(2), with this Court on or before April 3, 1992. By letter dated March 27, 1992, petitioners informed the Court that they would not be prosecuting their case further because they lacked the funds to do so. On April 8, 1992, we wrote petitioners, stating that By law, the Court cannot close a case that was properly begun without entering a decision in the amount of tax, if any, due from the taxpayer. The Court's record in your case shows that your case is calendared for trial at a session in Dallas, Texas[,] commencing on April 27, 1992, and that a response was due from you by April 3, 1992, showing cause why the facts and evidence contained in respondent's proposed Stipulation of Facts should not be deemed stipulated. If you do not file a response with the Court and do not appear at the April 27, 1992, trial session, respondent's attorney will ask the Court to dismiss your case for lack of prosecution. In that event, the Court will have no choice but to grant respondent's request and dismiss your case. * * Neither petitioners nor counsel for petitioners appeared at the Court's April 27, 1992, Dallas calendar call. At the 1993 Tax Ct. Memo LEXIS 43">57 calendar call, respondent's counsel informed the Court that he had spoken to Mr. Fifer "one day last week", and that Mr. Fifer had told him that petitioners would neither appear in court nor otherwise pursue the case. Respondent thereupon filed a motion to dismiss for failure properly to prosecute. On December 2, 1992, the Court's order to show cause was made absolute, and, under Rule 91(f)(3), the facts and evidence set forth in respondent's proposed stipulation of facts were deemed stipulated for purposes of this case. The sanction of dismissal is exercised at the discretion of the trial court, Levy v. Commissioner, 87 T.C. 794">87 T.C. 794, 87 T.C. 794">803 (1986), and a case may be dismissed for failure properly to prosecute when the taxpayer fails to appear at trial and does not otherwise participate in the resolution of his claim. Rules 123(b), 149(a); Rollercade, Inc. v. Commissioner, 97 T.C. 113">97 T.C. 113, 97 T.C. 113">116-117 (1991); Basic Bible Church v. Commissioner, 86 T.C. 110">86 T.C. 110, 86 T.C. 110">112 (1986). Where dismissal for failure properly to prosecute is appropriate, the Court will enter a decision against the taxpayer as to any issue1993 Tax Ct. Memo LEXIS 43">58 for which he has the burden of proof. Rules 123(b), 149(a); Forbes v. Commissioner, T.C. Memo. 1991-214. However, where the Commissioner has alleged fraud and the taxpayer's case is to be dismissed for failure properly to prosecute, the Commissioner must come forward, either in the pleadings or at trial, with sufficient facts to sustain a finding of fraud before a decision including an addition to tax for fraud is entered against the taxpayer by reason of his failure to appear at trial. Pierce v. Commissioner, T.C. Memo. 1992-365; see also Smith v. Commissioner, 91 T.C. 1049">91 T.C. 1049, 91 T.C. 1049">1058 (1988), affd. 926 F.2d 1470">926 F.2d 1470 (6th Cir. 1991). In the case at hand, petitioners have the burden of proving that respondent incorrectly determined deficiencies in income tax for 1981-83 and an addition to tax for substantially understating their tax for 1982. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 290 U.S. 111">115 (1933). Petitioners not only failed to appear at trial, but also informed the Court, by letter dated March 27, 1992, that they would not prosecute1993 Tax Ct. Memo LEXIS 43">59 their case further. Despite our warnings that a case properly commenced in this Court cannot be closed without entering a decision and that petitioners' failure to prosecute would cause the Court to dismiss their case and enter decision against them, petitioners did not prosecute their case. Dismissal is therefore appropriate and we will grant respondent's motion with respect to petitioners' deficiencies in tax and the section 6661 addition to tax for 1982, as modified by respondent's concession that Mrs. Fifer was not an independent contractor during the years at issue. Respondent also determined that the deficiencies in petitioners' Federal income tax for the years at issue were due to fraud. Respondent accordingly seeks additions to tax for fraud under section 6653(b). For purposes of section 6653(b), fraud is the intentional underpayment of taxes motivated by the taxpayer's specific intent to evade a tax known or believed to be owing. Hebrank v. Commissioner, 81 T.C. 640">81 T.C. 640, 81 T.C. 640">642 (1983); Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111, 80 T.C. 1111">1123 (1983). Whether fraud exists is a factual question that we decide after reviewing the1993 Tax Ct. Memo LEXIS 43">60 entire record, and respondent has the burden of proving fraud by clear and convincing evidence. King's Court Mobile Home Park, Inc. v. Commissioner, 98 T.C. 511">98 T.C. 511, 98 T.C. 511">515-516 (1992). To meet this burden, respondent is entitled to rely on facts deemed admitted under Rule 90(c) or deemed stipulated under Rule 91(f)(3). Marshall v. Commissioner, 85 T.C. 267">85 T.C. 267, 85 T.C. 267">272 (1985); Soulard v. Commissioner, T.C. Memo. 1989-608. By failing to reply to respondent's request for admissions within the 30 days prescribed by Rule 90(c), petitioners are deemed to have admitted the facts contained therein. Rule 90(c); 85 T.C. 267">Marshall v. Commissioner, supra at 272; Freedson v. Commissioner, 65 T.C. 333">65 T.C. 333, 65 T.C. 333">335-336 (1975), affd. 565 F.2d 954">565 F.2d 954 (5th Cir. 1978). For purposes of this case, petitioners also are deemed to have stipulated the facts and evidence set forth in respondent's proposed stipulation of facts. See Rule 91(f)(3); Soulard v. Commissioner, supra.Through the deemed admissions and stipulations, 1993 Tax Ct. Memo LEXIS 43">61 respondent has established that petitioners did not report, as gross income on their 1981-83 income tax returns, wages that Mrs. Fifer earned as a nurse's aide. See Respondent's Request for Admissions, pars. 2-5, supra p. 3; Respondent's Proposed Stipulation of Facts, pars. 8-12, supra pp. 5-6. This is not the exceptional case where respondent has the burden of coming forward with evidence to show that petitioners were not entitled to deductions, credits, or exclusions not already claimed or allowed. See Rivera v. Commissioner, T.C. Memo. 1979-343. Accordingly, respondent has proved, by clear and convincing evidence, that petitioners underpaid their income taxes for the years at issue. The deemed admissions and stipulations are replete with the necessary indications of fraudulent intent. The "badges of fraud" respondent has established through the deemed admissions and stipulations include: (1) Petitioners' pattern of substantially understating income during the years at issue, see Respondent's Request for Admissions, pars. 3-4, supra p. 3; Respondent's Proposed Stipulation of Facts, pars. 8-14, supra pp. 5-6; (2) petitioners' attempts1993 Tax Ct. Memo LEXIS 43">62 to conceal Mrs. Fifer's wages in a undisclosed bank account, see Respondent's Proposed Stipulation of Facts, pars. 18-19, supra p. 7; (3) petitioners' attempts to conceal Mrs. Fifer's income by incorrectly stating that her occupation was "housewife" on their joint income tax returns for 1981 and 1982, see Respondent's Request for Admissions, pars. 10-11, supra p. 4; Respondent's Proposed Stipulation of Facts, par. 15, supra p. 6; (4) petitioners' practice of reporting only income received from employers who customarily provide respondent with employee information documents, see Respondent's Proposed Stipulation of Facts, par. 27, supra p. 8; and (5) petitioners' failure to cooperate with respondent's agents, see Respondent's Request for Admissions, par. 8, supra pp. 3-4; Respondent's Proposed Stipulation of Facts, pars. 20-23, supra p. 7. 2 On this record, we hold that respondent has proved, by clear and convincing evidence, petitioners' specific intent to evade taxes known or believed to be owing. We accordingly hold petitioners liable for additions to tax for fraud under section 6653(b). 1993 Tax Ct. Memo LEXIS 43">63 To reflect the foregoing and respondent's concession, An appropriate order will be issued, and decision will be entered under Rule 155. Footnotes1. 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 years at issue.↩1. Sec. 6653(b) was redesignated sec. 6653(b)(1)↩ by the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, sec. 325, 96 Stat. 324, 616, for taxes the last day for payment of which is after Sept. 3, 1982.2. Sec. 6661↩ was added to the Internal Revenue Code by the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, sec. 323, 96 Stat. 324, 613, and it applies to tax returns for which the due date for filing is after Dec. 31, 1982.3. Plus 50 percent of the interest due on $ 8,785 under sec. 6653(b)(2)↩.4. Plus 50 percent of the interest due on $ 2,346 under sec. 6653(b)(2)↩.2. See Niedringhaus v. Commissioner, 99 T.C. , (1992) (slip. op. at 14), and Wheadon v. Commissioner, T.C. Memo. 1992-633↩, for a nonexclusive list of the various kinds of circumstantial evidence that may support a finding of fraudulent intent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619325/	HARLAND W. FRENCH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentFrench v. CommissionerDocket No. 7485-78.United States Tax CourtT.C. Memo 1981-9; 1981 Tax Ct. Memo LEXIS 736; 41 T.C.M. 699; T.C.M. (RIA) 81009; January 6, 1981Harland W. French, pro se. Robert Fowler, for the respondent. HALL MEMORANDUM OPINION HALL, Judge: This case is before the Court on petitioner's and respondent's motions for summary judgment filed pursuant to Rule 121, Tax Court Rules of Practice and Procedure.Respondent, in his notice of deficiency issued to petitioner and his wife, determined deficiencies and an addition to tax for negligence as follows: Addition to TaxYearDeficiencyunder sec. 6653(a) 11972$ 187.51 2$ 0197422,499.281,124.96Petitioner resided in Moville, Iowa, at the time he filed his petition in this case. Petitioner and his wife, Darlene M. French, 3 filed joint Federal income tax returns in 1972 and 1974. 1981 Tax Ct. Memo LEXIS 736">738 Respondent's deficiency is based primarily upon petitioner's failure to substantiate expenses, deductions, cost bases and credits, and on the assessment of a self-employment tax. Petitioner in his petition raises a plethora of constitutional and statutory arguments and affirmative defenses, a claim for a $ 5,000,000 judgment against respondent and his agents under section 7214, 4 and a claim that the statute of limitations bars respondent from making the assessment proposed in the statutory notice. In his motion for summary judgment and accompanying memorandum, petitioner requests that we dismiss this case with prejudice against respondent. Petitioner relies on constitutional and other arguments. Respondent's motion for summary1981 Tax Ct. Memo LEXIS 736">739 judgment and accompanying memorandum alleges that the petition does not contain assignments of error directed to specific items in the deficiency notice and does not contain allegations of fact which establish that petitioner is entitled to items disallowed in the notice of deficiency, that this Court lacks jurisdiction to award petitioner damages under section 7214, and that the statute of limitations does not bar respondent's assessment contained in his statutory notice. Rule 121, Tax Court Rules of Practice and Procedure, provides that summary judgment shall "be rendered if the pleadings, answers to interrogatories, depositions, admissions, and any 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." In light of the entire record, including a transcript of a hearing on the summary judgment motions held on September 30, 1980, in Des Moines, we grant respondent's motion for summary judgment had deny petitioner's motion for summary judgment. The multitude of constitutional and statutory arguments and affirmative defenses advanced by petitioner are1981 Tax Ct. Memo LEXIS 736">740 frivolous and without merit. All such contentions have been fully considered by this and other courts, and decided adversely to the taxpayers. 5This Court lacks jurisdiction to award punitive damages to petitioner of $ 5,000,000 under section 7214. Sec. 7442. Petitioner's assertion that the statute of limitations bars assessment of either the 1972 proposed deficiency or the 1974 proposed deficiency and addition to tax for negligence is without merit. Section 6501(a) provides generally for a three-year statute of limitations for the assessment of any tax, which period commences with the filing of the return. For purposes of section 6501, a return filed prior to the last day prescribed for the filing thereof is considered filed on such last day. Petitioner's 1974 return was due on or before April 15, 1975. Sec. 6072. Respondent mailed his deficiency notice on April 3, 1978, within the period of limitations provided1981 Tax Ct. Memo LEXIS 736">741 by section 6501(a) for 1974. The issuance of the statutory notice suspends the running of the period of limitations. Sec. 6503. In addition, since the 1972 deficiency is attributable to an investment credit carryback from 1974 and respondent is within the statute of limitations for assessing the proposed deficiency for 1974, and 1972 proposed deficiency is not barred by the statute of limitations. Secs. 6501(j) and (m). Petitioner has not assigned any errors with respect to the substantive adjustments or the addition to tax for negligence, 6 nor has petitioner alleged any facts to show that respondent erred in making the adjustments. Hence respondent has established that there is no genuine issue as to any material fact. Respondent's motion for summary judgment is granted and petitioner's motion for summary judgment is denied.An appropriate1981 Tax Ct. Memo LEXIS 736">*742 order and decision 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 1972 deficiency is attributable to a claimed investment credit carryback of $ 187.51 from 1974.↩3. Darlene M. French, although named as a taxpayer on respondent's statutory notice, is not a party in this action.↩4. Section 7214 provides that any officer or employee of the United States convicted of certain criminal acts in connection with any revenue law of the United States may be dismissed from office or discharged from his employment and fined not more than $ 10,000, or imprisoned not more than 5 years, or both. Section 7214 also provides for damages against such officer or employee in favor of the party injured by such officer's or employee's actions.↩5. See the exhaustive list of cases cited in Bowser v. Commissioner, T.C. Memo. 1980-483 (1980); Hergott v. Commissioner, T.C. Memo. 1980-283 (1980); Brobeck v. Commissioner, T.C. Memo. 1980-239↩ (1980).6. The burden of proof is on petitioner to show that no part of the underpayment for 1974 was due to negligence. Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 58 T.C. 757">791 (1972). None of petitioner's arguments relieve him of liability for the negligence penalty. Hatfield v. Commissioner, 68 T.C. 895">68 T.C. 895, 68 T.C. 895">898↩ (1977).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619326/	KENNETH RALPH BARGER AND EVELYNE LUCILLE BARGER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBarger v. CommissionerDocket No. 1375-89United States Tax CourtT.C. Memo 1990-238; 1990 Tax Ct. Memo LEXIS 245; 59 T.C.M. 584; T.C.M. (RIA) 90238; May 16, 1990, Filed Kenneth Ralph Barger, pro se. Richard V. Vermazen, for the respondent. DINAN, Judge. DINAN821 MEMORANDUM1990 Tax Ct. Memo LEXIS 245">246 FINDINGS OF FACT AND OPINION This case was heard pursuant to the provisions of section 7443A(b) of the Internal Revenue Code of 1986 and Rules 180, 181 and 182. 1Respondent determined a deficiency of $ 1,154.00 in petitioners' Federal income tax for the taxable year 1985. Respondent having conceded that petitioners are entitled to a Schedule M deduction for a married couple when both work, the only issue for decision is whether a loss petitioners realized on the foreclosure of rental property they owned is a deductible business loss or nondeductible personal loss under section 165(c). Some of the facts have been stipulated. The stipulations of fact and accompanying exhibits are incorporated by this reference. Petitioners resided in Cedar1990 Tax Ct. Memo LEXIS 245">247 Rapids, Iowa, at the time they filed their petition herein. FINDINGS OF FACT In 1983, petitioner Kenneth Barger (hereinafter petitioner) sought to help his son and his family find living accommodations nearer to his son's place of employment. His son worked as a truck driver for a trucking company in Council Bluffs, Iowa, but lived in Cedar Rapids, Iowa. Cedar Rapids is 249 miles from Council Bluffs. Petitioner located a house in Griswold, Iowa, which is only 40 miles from Council Bluffs. Petitioner purchased the house in October, 1983. The purchase price was $ 27,000. He financed the purchase price with a mortgage of $ 17,000 from the Griswold State Bank, a loan from his credit union of $ 8,000, and $ 2,000 of his own money. The monthly mortgage payment on the house was $ 208.00. Petitioner's son and his family moved into the rental house towards the end of 1983. Petitioner charged his son $ 210.00 per month in rent. The son paid the rent directly to the bank. Petitioner paid off the credit union loan with his own funds. Petitioner also paid the insurance on the property and the property taxes. Petitioner's son separated from his wife in September, 1984. The son1990 Tax Ct. Memo LEXIS 245">248 moved out of the house but the wife continued to live there. Prior to the time of the separation the son had paid the rent every month. However, after he moved out of the house neither he nor his wife paid the rent. August 1984 was the last month in which rent was paid. Petitioner himself did not make the mortgage payments for those months that his son or daughter-in-law did not pay rent. In February 1985, the mortgagee moved to foreclose on the property. Petitioner tried to avoid foreclosure by getting another loan from 822 another bank to pay off the mortgagee. He was unsuccessful. At the time petitioner was under considerable stress. Because he had run out of options petitioner decided not to contest the foreclosure. The principal amount of the debt outstanding at the time he executed the quit claim deed was $ 16,831.49. Because the forced sales price was less than petitioner's basis in the property, petitioner incurred a loss. On his return for the taxable year 1985, petitioner reported the forced sale as follows. A gross sales price of $ 16,831.49, depreciation of $ 2,708.35 and a cost of $ 27,410.45 resulting in a loss of $ 7,870.61. Petitioner later filed1990 Tax Ct. Memo LEXIS 245">249 an amended return on which he reported the sales price as $ 14,000 which resulted in a loss of $ 10,702. OPINION Respondent, in his statutory notice of deficiency, determined that petitioner did not hold the property with a profit objective and accordingly disallowed the loss. The determination of respondent is presumed to be correct. Petitioners bear the burden of proving that respondent erred in his determination. Rule 142(a). Section 165(a) allows as a deduction any loss sustained by the taxpayer during the taxable year not compensated for by insurance or otherwise. However, section 165(c) limits deductions for losses of individuals to those incurred in a trade or business, incurred in a transaction for profit, or as a result of a casualty or theft. The standard used to determine if the loss was incurred in a trade or business or in a transaction entered into for profit is whether the taxpayer had an "actual and honest objective of making a profit." Horn v. Commissioner, 90 T.C. 908">90 T.C. 908, 90 T.C. 908">932-933 (1988); Dreicer v. Commissioner, 78 T.C. 642">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). While a reasonable1990 Tax Ct. Memo LEXIS 245">250 expectation of profit is not required, the taxpayer's profit objective must be bona fide. Allen v. Commissioner, 72 T.C. 28">72 T.C. 28, 72 T.C. 28">33 (1979). Whether petitioner had an actual and honest profit objective is a question of fact to be resolved from all the relevant facts and circumstances. Golanty v. Commissioner, 72 T.C. 411">72 T.C. 411, 72 T.C. 411">426 (1979), affd. in an unpublished opinion 647 F.2d 170">647 F.2d 170 (9th Cir. 1981). Section 1.183-2(b), Income Tax Regs., provides a nonexclusive list of relevant factors, which is a synthesis of prior case law, to be considered in determining whether an activity is engaged in for profit. Benz v. Commissioner, 63 T.C. 375">63 T.C. 375, 63 T.C. 375">382-383 (1974). These factors include: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that the 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 loss with respect to the activity; 1990 Tax Ct. Memo LEXIS 245">251 (7) the amount of occasional profit, if any, which is earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved. No single factor is controlling, but rather it is an evaluation of all the facts and circumstances in the case, taken as a whole, which is determinative. Section 1.183-2(b), Income Tax Regs.; Abramson v. Commissioner, 86 T.C. 360">86 T.C. 360, 86 T.C. 360">371 (1986). Petitioner argues that he thought that the property would appreciate in value and that if he could have paid the expenses he would have earned a profit in the long run. However, he offered no evidence that the property would ever appreciate substantially in value. Furthermore, given the rent he charged his son, he could never break even on the expenses associated with owning the property. The rent his son paid was enough to cover the mortgage payment. However, the remaining out of pocket expenses were paid by petitioner. These included paying off the credit union loan and paying the insurance and real estate taxes. There was also a depreciation expense on the property. Given these facts one might wonder why petitioner1990 Tax Ct. Memo LEXIS 245">*252 purchased the property. Certainly it appears that he could never earn a profit on it. The answer to this question is clear. Petitioner's purchase was purely altruistic; he purchased the property to provide for a home for his son and his family. While it is unfortunate that petitioner's good deed turned into a financial debacle, we hold that he may not deduct the loss under section 165(a) because he did not have the requisite profit objective. Because of a concession by respondent, Decision will be entered under Rule 155. Footnotes1. All subsequent section references are to the Internal Revenue Code of 1954, as amended and in effect for the taxable year in issue, unless otherwise indicated. 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/4619353/	DAVID BYRON WILBER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWilber v. CommissionerDocket No. 8163-86.United States Tax CourtT.C. Memo 1987-439; 1987 Tax Ct. Memo LEXIS 436; 54 T.C.M. (CCH) 380; T.C.M. (RIA) 87439; August 31, 1987. Robert J. Burbank, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined deficiencies in and additions to petitioner's Federal income tax as follows: ADDITIONS TO TAXSectionSectionYearDeficiency6654 16653(b)1977$ 16,546$ 195$ 8,273197821,26069210,630The sole issue is whether437 respondent's determination of section 6653(b) additions to tax should be sustained. FINDINGS OF FACT Some of the facts have been deemed stipulated and are found accordingly. The stipulation of facts and the exhibits attached thereto are incorporated herein by reference. Petitioner resided in St. Louis, Missouri, at the time his petition herein was filed. Petitioner filed no returns for the years in issue. Petitioner is married, but his wife is not a party to this case. Petitioner, though having only a tenth-grade education, is an intelligent sophisticated businessman. From approximately 1964 to 1970, petitioner worked as a real estate agent. In 1970, after passing the appropriate test, petitioner became a real estate broker licensed by the State of Missouri. As of the time of trial, petitioner continued to be a licensed real estate broker. From 1970 to 1978, petitioner operated his real estate brokerage business through a wholly owned corporation, Dave Wilber Realty, Inc. ("Realty"). Realty's corporate charter expired at the end of 1977, and since then petitioner has operated his real estate brokerage business as a sole proprietorship. Petitioner filed valid438 income tax returns for the 1973 through 1976 calendar years. Realty filed valid income tax returns for the 1975 and 1976 calendar years. Realty filed a 1977 tax return valid in all respects except that the following statement was made on the return: The numbers shown herein are nothing but numbers and in no way does filer of return acknowledge any income nor assets nor receipts in dollars of gold or silver coin as per Art. 1, Sec. 10, U.S. Constitution and Coinage Acts, 1792-1900. This statement reflects petitioner's misconception, acquired some time around 1976, that "dollar" is an indefinable term and that he cannot measure his income, file returns, or pay tax until "dollar" is defined. As a result of his misconception, petitioner failed to file returns during the years at issue, though he had taxable income in each of such years in excess of $ 30,000. In October of 1978, the Internal Revenue Service ("IRS") began an audit of petitioner's 1977 and 1978 taxable years. Petitioner maintained throughout the audit his frivolous position with respect to the indefinable "dollar." In a letter sent to respondent's agent, and later published in the South County News newspaper as439 an open letter to the IRS, petitioner denied a request by the agent to examine petitioner's and Realty's books and a request for a meeting stating: I am sorry * * but there is no useful purpose in your viewing my records. * * * the records are meaningless. There are no records that I paid or received any dollar quantities of the money of account of the United States unless you want to inform me that monetized debt units * * * are by law, the money of account of the United States * * .Petitioner never did provide respondent access to his or Realty's books. In reaction to the IRS's issuance of summonses to third parties or petitioner's belief that the IRS would issue summonses to third parties, petitioner sent such third parties "warnings" threatening a civil suit should they provide the IRS with information before requiring the IRS to define "dollar." In a letter sent to a financial institution with regard to a summons issued by respondent to such financial institution, petitioner again threatened a law suit should the financial institution provide the IRS with information without regard to the "fact" that the dollar is indefinable. Prior to and during the years at issue, 440 petitioner and his wife maintained a joint checking account. In 1977, petitioner opened a checking account using his middle and last names, Byron Wilber. Petitioner informed his tenants to begin making rental payments checks payable to Byron Wilber. In 1981, petitioner authorized a newsletter espousing his views on the indefinable dollar, attached to which was a pamphlet which advocated the use of cash to avoid detection by the IRS of individuals' money transfers. Petitioner practiced what he preached in that he, to an extent, dealt in cash and avoided banks and checking accounts. The IRS's audit of petitioner's 1977 and 1978 taxable years ultimately led to a grand jury indictment and a jury-trial conviction of petitioner for violating section 7203, specifically for willfully failing to file returns for the years at issue. Petitioner spent seven months in jail after his conviction was affirmed. See United States v. Wilber,696 F.2d 79">696 F.2d 79 (8th Cir. 1982). Petitioner was not represented by counsel and did not represent himself. Petitioner's presence at trial was solely in his capacity as a subpoenaed witness. OPINION At trial the Court dismissed petitioner's441 case as to all issues for which petitioner bore the burden of proof. Accordingly, the only issue before the Court is whether respondent's determination of the section 6653(b) addition to tax should be sustained. During the years in issue, section 6653(b) provided for an addition to tax equal to 50 percent of an underpayment, where any portion of such underpayment was due to fraud. Fraud is an intentional wrongdoing motivated by a specific purpose to evade a tax known or believed to be owing. Akland v. Commissioner,767 F.2d 618">767 F.2d 618, 621 (9th Cir. 1985), affg. a Memorandum Opinion of this Court; Hebrank v. Commissioner,81 T.C. 640">81 T.C. 640, 642 (1983). Respondent bears the burden of proving fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b); Akland v. Commissioner, supra;Kotmair v. Commissioner,86 T.C. 1253">86 T.C. 1253, 1259-1260 (1986). The presence of a fraud is a factual question to be determined by an examination of the entire record. Kotmair v. Commissioner, supra at 1259. As a result of petitioner's conviction pursuant to section 7203, he is collaterally estopped from denying that he willfully failed442 to file returns for the years in issue. Castillo v. Commissioner,84 T.C. 405">84 T.C. 405 (1985). In fact, petitioner admits that he failed to file returns during the years in issue. However, willful failure to file returns, without more, is not sufficient to prove fraud. Kotmair v. Commissioner, supra at 1260. Failure to file may, however, be considered in connection with other facts in determining whether an underpayment is due to fraud. Beaver v. Commissioner,55 T.C. 85">55 T.C. 85, 93 (1970). Respondent has proven that petitioner failed to file returns for the years in issue; had substantial income for the years in issue; threatened civil suits against third parties should they comply with summonses issued by respondent; utilized a checking account in a name he normally did not use; began utilizing cash to conceal transfer of money; and refused to cooperate with respondent's agents. Petitioner had filed returns for years prior to the years at issue and was thus aware of his Federal income tax obligations. On these facts, we hold that respondent has met his burden of proving fraud by clear and convincing evidence for each of the years at issue. 443 Respondent's determination of additions to tax for fraud is sustained. 2Decision will be entered for the respondent.444 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.↩2. A different result is not compelled by Raley v. Commissioner,676 F.2d 980">676 F.2d 980 (3d Cir. 1982), revg. a Memorandum Opinion of this Court; or Zell v. Commissioner,763 F.2d 1139">763 F.2d 1139 (10th Cir. 1985), affg. a Memorandum Opinion of this Court. Cf. Granado v. Commissioner,792 F.2d 91">792 F.2d 91 (7th Cir. 1986), affg. a Memorandum Opinion of this Court. During the years at issue in Raley, the taxpayer sent to the Internal Revenue Service and the Secretary of the Treasury numerous letters which informed them that he would never voluntarily pay an income tax and he had filed false Forms W-4E. The Third Circuit held that the Commissioner had not proved fraud because the taxpayer "went out of his way to inform every person involved in the collection process that he was not going to pay any income taxes." In the present case, petitioner's letter to respondent's agent falls far short of the standard established in Raley.↩Indeed the letter was sent by petitioner only after the Internal Revenue Service had contacted him.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619355/	Merriman H. Holtz and Helene Tyroll Holtz v. Commissioner.Holtz v. CommissionerDocket No. 58455.United States Tax CourtT.C. Memo 1957-106; 1957 Tax Ct. Memo LEXIS 148; 16 T.C.M. (CCH) 439; T.C.M. (RIA) 57106; June 26, 1957148 Moe M. Tonkon, Esq., Public Service Building, Portland, Ore., for the petitioners. John D. Picco, Esq., for the respondent. WITHEYMemorandum Opinion WITHEY, Judge: The respondent determined deficiencies in petitioners' income tax for the years and in the amounts as follows: YearAmount1949$958.301950671.66The sole issue presented for our determination is the correctness of the respondent's action in determining that losses sustained by petitioners during 1950 as the result of discharging a guaranty on bank loans made to a corporation controlled by them are not deductible as business bad debts under section 23(k)(1) of the Internal Revenue Code of 1939, but are deductible only as nonbusiness bad debts pursuant to section 23(k)(4) of the 1939 Code. [Findings of Fact] All of the facts have been stipulated and are found accordingly. Petitioners, husband and wife, residing in Portland, Oregon, filed their joint income tax returns for 1949 and 1950 with the collector for the district of Oregon at Portland, Oregon. Inasmuch as the activities of Merriman H. Holtz are those with which we are here primarily concerned, "petitioner" or "Holtz" 149 as hereinafter used has reference to him. Petitioner has been engaged since 1930 in the business of selling and distributing 16 millimeter film, audio visual equipment, supplies and accessories. In 1930, petitioner organized Pictures, Inc., under the laws of the State of Oregon. Pictures, Inc., was inactive until 1949 when it began the sale and distribution of 16 millimeter films in the Territory of Alaska. The corporation has continued in operation since 1949. Holtz was the manager of Pictures, Inc., and advanced to it the funds required for its operation. During 1949 and 1950, petitioners owned 99 of the 100 outstanding shares of capital stock of the aforementioned corporation. During 1932, petitioner organized Screen Adettes, Inc., pursuant to the laws of the State of Oregon. Since the time of its organization, Screen Adettes, Inc., has been engaged in the sale and distribution of 16 millimeter films in Oregon. During 1949 and 1950, petitioners owned 91 of the 100 shares of outstanding capital stock of Screen Adettes, Inc. Petitioner occasionally made advances to this corporation for working capital. In addition, Screen Adettes, Inc., on several occasions borrowed money from150 the United States National Bank of Portland, Oregon. All such loans were personally guaranteed by Holtz, who was president and managing officer of Screen Adettes, Inc., and was actively engaged in its affairs. In 1945, petitioner organized Screen Adette Equipment Corporation under the laws of Oregon for the purpose of engaging in the sale and distribution of motion picture equipment and accessories on the Pacific coast. Petitioners were the owners of 500 of 503 shares of its outstanding stock. Holtz was president and general manager of the corporation and was actively engaged in conducting its operations. In addition to the original capital invested by petitioners, Screen Adette Equipment Corporation obtained working capital from the United States National Bank of Portland, Oregon. The amounts so obtained were in the form of loans which were personally guaranteed by Holtz who pledged as collateral certain shares of listed common stock owned by petitioners. At the time they were pledged by petitioner, the foregoing shares had a market value substantially in excess of the value of the loans. In October 1949, Screen Adette Equipment Corporation filed a voluntary petition in bankruptcy151 with the United States District Court for the District of Oregon. The corporation thereafter ceased its operations and was dissolved by proclamation of the Governor of the State of Oregon on December 29, 1950. Pursuant to the bankruptcy proceeding, creditors of Screen Adette Equipment Corporation received only 0.038 per cent upon the claims filed by them. In January and March of 1950, the United States National Bank of Portland sold the collateral securities pledged by the petitioner as guarantor for the indebtedness of Screen Adette Equipment Corporation. The bank realized $83,316.29 from the sale of the securities which was applied against the indebtedness of the corporation. Consequently, petitioner was indebted to the bank in the amount of $64,119.34 upon his guaranty. Holtz was engaged as sole proprietor in the sale and distribution of audio visual equipment during part of 1950. In addition, during 1950, petitioner was employed on a part-time basis to sell 16 millimeter films for Audio Film Center, an association which operated a film rental library in Portland, Oregon. Petitioners were the owners of 90 per cent of the outstanding capital stock of Helene's, Inc., for many152 years prior to 1949. Helene's, Inc., was a corporation engaged in the operation of a ladies' retail apparel store in Portland, Oregon. Petitioner was president and was active in the management of Helene's, Inc. After moving to a new location in 1947, Helene's, Inc., experienced substantial losses and in 1949 all of its assets were sold. Creditors of Helene's, Inc., received approximately 50 per cent of their claims in full settlement. During the years of its operation prior to 1949, Helene's, Inc., had borrowed various amounts from the United States National Bank of Portland for use as working capital. Such loans were guaranteed by Holtz who pledged as collateral certain listed common stocks and life insurance policies owned by petitioners. Petitioners claimed a deduction in the amount of $83,316.29 on their joint income tax return for 1950 as "Bad debts arising from sales or services." This deduction was explained in Schedule C-2 of petitioners' 1950 return as "Payments made to U.S. National Bank as guarantor of business debt." The foregoing deduction represented payments made by petitioner in January and March of 1950 as guarantor on the notes of Screen Adette Equipment Corporation. 153 [Opinion] The respondent does not question the worthlessness of the indebtedness in issue or the year in which it is deducted as worthless, but has determined that petitioners are not entitled to the aforementioned bad debt deduction because the debt was not incurred in the conduct of petitioner's trade or business. The respondent therefore contends that petitioner's loss resulting from his guaranty on the notes of Screen Adette Equipment Corporation must be treated as a nonbusiness bad debt pursuant to the limitations of section 23(k)(4) of the 1939 Code. The petitioners contend that Holtz was engaged in the business of promoting, organizing, financing and managing corporations during the years in issue and that the guaranty obligation on behalf of Screen Adette Equipment Corporation was incurred in the conduct of that business. They accordingly take the position that the loss in the amount of $83,316.29 is deductible in full as a business bad debt under section 23(k)(1) of the 1939 Code. The issue here presented depends for its resolution on the determination as to whether or not petitioner was engaged in a trade or business of his own during 1949 and 1950 to which the154 indebtedness in question was proximately related. Robert Cluett, III, 8 T.C. 1178">8 T.C. 1178; Charles G. Berwind, 20 T.C. 808">20 T.C. 808, affd. 211 Fed. (2d) 575; Jan G. Boissevain, 17 T.C. 325">17 T.C. 325. If the indebtedness in question was not proximately related to petitioner's trade or business at the time it became worthless, it is deductible only as a nonbusiness bad debt under section 23(k)(4) of the 1939 Code. It is settled law that the business of a corporation is not the business of its officers. Burnet v. Clark, 287 U.S. 410">287 U.S. 410; Jan G. Boissevain, supra. However, a worthless debt, resulting from a loan by a stockholder to his corporation, may qualify as a business bad debt if the stockholder was engaged in promoting, organizing, financing and managing business enterprises. Henry E. Sage, 15 T.C. 299">15 T.C. 299; Vincent C. Campbell, 11 T.C. 510">11 T.C. 510; Langdon L. Skarda, 27 T.C. 137">27 T.C. 137; Giblin v. Commissioner, 227 Fed. (2d) 692, reversing a Memorandum Opinion of this Court, decided October 29, 1954 [13 TCM 1009,; T.C. Memo 1954-186">T.C. Memo. 1954-186]. The authority of the foregoing155 line of decisions is applicable only in the exceptional situations in which the taxpayer's activities in promoting, managing and making loans or contributions to a variety of businesses may be regarded as so extensive as to constitute a business separate and distinct from the business carried on by the enterprises themselves. Charles G. Berwind, supra. In Vincent C. Campbell, supra, for example, in which we held that the taxpayers were in the business of organizing and operating corporations engaged in the retail coal business, it was shown that from 1929 through 1944 the taxpayer had organized, managed and financed 12 corporations. In Giblin v. Commissioner, supra, the taxpayer, a practicing attorney, on 11 or 12 occasions between 1926 and 1945, contributed his time and money to the development of various enterprises and business ventures. The United States Court of Appeals for the Fifth Circuit there held that the taxpayer was engaged in the business of promoting or dealing in business enterprises. Petitioner has been engaged in the sale and distribution of motion picture films and equipment since 1930. During this period he carried on his156 activities through 4 separate business units: (1) Screen Adettes, Inc., a corporation engaged in the sale and distribution of 16 millimeter films in the State of Oregon; (2) Pictures, Inc., engaged in the sale and distribution of 16 millimeter films in the Territory of Alaska; (3) Screen Adette Equipment Corporation engaged in the sale and distribution of motion picture equipment and accessories; and (4) an individual proprietorship business conducted by petitioner for the purpose of selling audio visual equipment and accessories. In addition, the petitioners owned 90 per cent of the stock of Helene's, Inc., a ladies' retail apparel store. Holtz frequently advanced funds to the aforementioned corporations, endorsed corporate notes or guaranteed bank loans to provide them with working capital, and was active in the management of their operations. Early in 1950, the United States National Bank of Portland sold the securities pledged by petitioner as guarantor on loans made to the Screen Adette Equipment Corporation and realized $83,316.29 from their sale. The proceeds were applied to the indebtedness of the corporation, resulting in losses to petitioner in the amount of $83,316.29. 157 Consequently, it is apparent that the losses in question were not incurred in or proximately related to the individual proprietorship business operated by petitioner during 1950. Moreover, insofar as we are able to determine from the record herein, the advances made by petitioner to the Screen Adette Equipment Corporation and the bank loans guaranteed by him were for the purpose of assisting that corporation in its business of selling motion picture equipment and accessories. The history of petitioner's business in connection with the foregoing 3 corporations discloses no more than the customary activity of an individual who has devoted himself to carrying on a business enterprise by means of wholly-owned corporations. We do not think that the activities outlined herein are sufficiently extensive to establish the existence of a separate business of promoting, organizing, financing and managing businesses during 1950. Cf. Dominick J. Salomone, 27 T.C. 663">27 T.C. 663; Commissioner v. Smith, 203 Fed. (2d) 310, reversing 17 T.C. 135">17 T.C. 135; Hickerson v. Commissioner, 229 Fed. (2d) 631, affirming a Memorandum Opinion of this Court, decided December 29, 1954 [13 TCM 1180,; *158 T.C. Memo 1954-237">T.C. Memo. 1954-237]. Accordingly, on the evidence presented, we are unable to find that the indebtedness in question bore a proximate relationship to the petitioner's trade or business either at the time the loan was made or at the time it became worthless. The losses in issue must therefore be treated as nonbusiness bad debts under section 23(k)(4) of the 1939 Code. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619359/	BARBARA (NEWBURGER) NEWMAN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentNewman v. CommissionerDocket No. 3434-71.United States Tax CourtT.C. Memo 1974-45; 1974 Tax Ct. Memo LEXIS 274; 33 T.C.M. (CCH) 219; T.C.M. (RIA) 74045; February 21, 1974, Filed. Barbara (Newburger) Newman, pro se. Ronald A. Wagenheim, for the respondent. QUEALYMEMORANDUM FINDINGS OF FACT AND OPINION QUEALY, Judge: Respondent has determined the following deficiencies and additions to the Federal income tax of petitioner: YearDeficiency1 Section 6654(a) 1965$1,152.40$32.2719661,152.4032.2719671,152.4036.8819681,238.8338.61275 The questions before the Court are as follows: (1) Whether certain payments received by petitioner from her former husband pursuant to a decree of annulment are includable in her gross income under section 71(a) (1) for each of the years in question. (2) If such payments are includable, whether respondent properly imposed additions to tax pursuant to section 6654 for each of the years in question. FINDINGS OF FACT Some of the facts have been stipulated by the parties. Such facts and the exhibits attached thereto are incorporated herein by this reference.The legal residence of Barbara (Newburger) Newman (hereinafter referred to as "Barbara" or "petitioner") at the time of the filing of the petition herein was New York, New York. Petitioner did not file any Federal income tax returns for each of the taxable years 1965 through 1968. Barbara was first married in 1950 at the age of 18 years. She had a child by this marriage in 1952, but separated from her husband a month after the baby was born. Her husband subsequently obtained an ex parte Nevada divorce.276 On December 30, 1955, she married Andrew M. Newburger (hereinafter referred to as "Andrew"). On April 2, 1958, Barbara, as plaintiff, instituted an action for separation against Andrew, as defendant, in the Supreme Court of the State of New York, County of Westchester, and thereupon applied for and obtained an order for temporary alimony in the sum of $200 per week. In fixing such sum, the court assumed that any amount paid to Barbara would be subject to Federal and state income taxes. Andrew responded to such action by interposing a counterclaim for annulment based on the invalidity of the divorce obtained by her first husband. The counterclaim was tried and a judgment and decree of the Supreme Court of the State of New York dated October 25, 1960, and duly entered in the office of the Clerk of Westchester County on October 31, 1960, was issued in Andrew's favor, granting the requested annulment. The counter-judgment decreed that "the marriage heretofore existing between the plaintiff and the defendant was at the inception and is, null and void * * ." It also directed a hearing to be held to determine the amount of permanent alimony which Barbara was entitled to receive under277 the provisions of section 1140-a of the New York Civil Practice Act (now section 236 of the New York Domestic Relations Law). In the interim, she was to continue to receive $200 per week. The hearing on the issue of permanent support was held and a decision was entered on December 11, 1961. Pursuant to this decision, an order was made on January 18, 1962, amending the decree of annulment and directing Andrew to pay Barbara $150 per week for her support. This reduction in weekly payments was granted partially on the basis that such payments, now being made pursuant to an annulment order, would no longer fall within the scope of section 71 and thus would not be taxable to Barbara. She claimed otherwise, but Andrew's position which was based on Special Ruling, December 8, 1944, 454 CCH § 6092, and Rev. Rul. 59-130, 1 C.B. 61">1959-1 C.B. 61, prevailed. After Andrew and Barbara separated, she and her son moved to a rural area in Connecticut where the rent was low and where she could provide a good home life for her child. In 1962, her income tax return for 1960 was audited by the Internal Revenue Service in Bridgeport, Connecticut, as a result of a refund claim filed for278 such year on February 8, 1962. During the audit, a question arose as to the proper treatment of the support payments received from Andrew in 1960, although this was not the basis of the refund claim. During 1960, she received a total of $10,400 from Andrew, $8,500 of which was received prior to the annulment order on October 25, 1960. She showed the Bridgeport office copies of the memorandums which she and Andrew had submitted to the New York Supreme Court prior to its decision on December 11, 1961, to reduce Barbara's support payments. The Bridgeport office sent all the papers with respect to this issue to the district director in Hartford for his determination on the matter. On July 30, 1962, Barbara received a letter from the district director at Hartford attached to which was a report of the audit changes on her 1960 return and the proposed adjustments thereto. There was a written statement on the back of the audit report which explained the proposed adjustment in the following manner: Ann Barbara Newburger received during the year 1960 the sum of $200.00 a week ($10,400.00) from Andrew Newburger. The monies received prior to Oct. 25, 1960 were made pursuant to an order279 (alimony pendente lite entered June 1958), $8,500.00 - monies received after Oct. 25, 1960 were paid pursuant to an annulment order. It was determined that monies received pendente lite is alimony under Sec. 71(a) (3) of the 1954 Internal Revenue Code.The balance of money received during 1960 is not alimony under Sec. 71(a) (3) of the above Code. Therefore is not taxable to Ann Barbara Newburger. Pursuant to the amended annulment decree, Barbara received the sum of $7,800 in each of the years 1965 through 1968. She did not, however, file Federal income tax returns nor pay any estimated tax for any of these years in reliance on the letter from the district director which indicated that the government did not view the payments she received pursuant to an annulment order as income to her under section 71. It was her honest belief that she had no obligation to file any returns for such years since, except for these annulment payments, she had no other source of income. She never thought to question a written determination of the Internal Revenue Service. Barbara did not hear from the Internal Revenue Service again until March 3, 1969, when an agent called asking if she had filed280 a return for 1965. The agent expressed surprise when she responded in the negative since Andrew had told the agent that his support payments were based on a separation agreement and thus were deductible to him and taxable to her. In 1971, the respondent acquiesced to our decision in George F. Reisman, 49 T.C. 570">49 T.C. 570 (1968), acq. 1971-2, C.B. 3, which held that support payments received under circumstances similar to those presently before us were taxable to the wife under section 71(a) (1). On March 5, 1971, the respondent sent a notice of deficiency to petitioner asserting deficiencies for the taxable years 1965 through 1968. OPINION On October 25, 1960, Andrew Newburger, petitioner's second husband, obtained an annulment decree from the Supreme Court of New York on the grounds that under New York law, petitioner was still married to her first husband at the time she purported to marry him. The decree declared the marriage void ab initio and directed that petitioner receive $200 per week in temporary alimony. Such sum was intended to cover any income tax petitioner would owe on the receipt of the award. 281 Subsequently, on January 18, 1962, after a hearing was held on the issue of permanent support, the court amended its annulment decree and pursuant to section 1140-a of the New York Civil Practice Act, directed that Andrew pay Barbara $150 per week in permanent support. This reduction in weekly payments was granted to Andrew after the court concluded that on the basis of Special Ruling, December 8, 1944, supra, and Rev. Rul. 59-130, supra, Barbara would no longer be required to pay income tax on her award. In Special Ruling, December 8, 1944, supra, the plaintiff wife was granted a decree of annulment based on the fact that her husband had a wife living at the time he purported to marry her. It held that periodic payments made pursuant to a decree of annulment, where the marriage was void ab initio, were not alimony under section 22(k) of the 1939 Code, the predecessor to the present section 71. In Rev. Rul. 59-130, supra, the husband obtained a decree of annulment based on the wife's incurable insanity, a condition which arose subsequent to the marriage. The effect of the decree was prospective only. The ruling held that periodic payments made pursuant282 to such annulment decree were alimony within section 71(a) (1) since under state law, the annulment action was considered to be comparable to an action for divorce. The ruling, however, distinguished this situation from one involving a decree of annulment, where the marriage was void or voidable at its inception. In 1962, Barbara's income tax return for 1960 was audited as a result of a refund claim filed for such year which was based on a matter unrelated to the issue now before us. During the audit, the question of her support payments arose. Barbara took the position that these payments were not includable in her income under section 71(a) (1), citing Special Ruling, December 8, 1944, supra, and Rev. Rul. 59-130, supra, as her authority. On July 30, 1962, she received a letter from the district director at Hartford reflecting certain audit changes on her 1960 return and proposed adjustments thereto. On the back of the audit report there was a written statement declaring that the support payments made to her pursuant to the annulment were not taxable to her. In reliance on such advice she filed no income tax returns from that time forward. 2 In 1971, respondent283 asserted deficiencies against her for the taxable years 1965 to 1968 on the basis that the support payments were taxable to her. As a matter of law, the support payments paid to petitioner in each of the years in issue are taxable to her under section 71(a) (1). In our decision in Andrew M. Newburger, 61 T.C. (January 14, 1974), which involved the same facts as this case, we held that the payments in question were deductible by the husband. 3Whether the respondent should in good conscience be permitted retroactively to assess deficiencies against the petitioner presents a more difficult question. The Court recognizes that the Commissioner cannot, except as provided by statute, be estopped from altering its position on mistakes of law in the interpretation and administration of the income tax laws. 284 Knapp-Monarch Co. v. Commissioner, 139 F.2d 863">139 F.2d 863 (C.A. 8, 1944). We also recognize that different rules are applied to the Commissioner's actions in reaching a particular result. For instance, the government cannot be precluded - as might a private party - from taking advantage of a situation created by his own mistake. Automobile Club v. Commissioner, 353 U.S. 180">353 U.S. 180 (1957). In enforcing our income tax laws, however, there is an obligation on the part of the government, regardless of the legalities of the situation, to treat all its citizens alike. This is of particular concern in the assessment of the income tax. Cf. Sirbo Holdings, 476 F.2d 981">476 F.2d 981 (C.A. 2, 1973), vacating and remanding 57 T.C. 530">57 T.C. 530 (1972). In Automobile Club, supra, the Commissioner had issued rulings in 1934 and 1938 declaring that the petitioner was exempt from income tax as a "club" under the predecessor to section 101(9) of the 1939 Code. In 1945, he retroactively revoked his rulings to the year 1943. He could have assessed deficiencies for years earlier than 1943 since petitioner, in reliance on the Commissioner's rulings, had not filed a return285 dating back to 1933. He refrained from doing so, however, since it was in 1943 that he first changed his position with respect to the exempt status of petitioner. Recently, the Internal Revenue Service issued several advance revenue rulings dealing with the taxability of political organizations, including the national committees. 4 One such ruling indicated that political organizations would be taxable on the gain from the sale of appreciated property received as contributions. See Advance Rev. Rul. 74-21, I.R.B. 1974-2. In view of its prior practice, however, the Internal Revenue Service ruled that it would not assess deficiencies with respect to such sales occurring before October 3, 1972. Prior to such announcement, the Internal Revenue Service had tacitly accepted the claim that such organizations were exempt from the tax. It is thus clear that, prior to his acquiescence in 286 George F. Reisman, supra, the respondent held to the position that support payments made pursuant to a decree of annulment, the grounds for which arose prior to the marriage, did not fall within the ambit of section 71(a) (1). Petitioner had been so advised in 1962 and in reliance thereon, did not file returns in subsequent years. It is equally clear that the respondent has the power within his discretion to determine when and to what extent a change in his rulings should be applied retroactively. Section 7805. While generally speaking the courts will refrain from challenging the exercise, or nonexercise, by the respondent of this discretionary authority, this does not mean that his discretion is absolute. See Dixon v. United States, 381 U.S. 68">381 U.S. 68 (1965). We believe that this is a case with respect to which the respondent should have exercised such discretion in favor of the taxpayer. Acting in good faith, and upon the basis of the position then being maintained by the respondent, in the annulment proceedings the petitioner settled for a monthly payment predicated on respondent's ruling that she would not be subject to tax. She received less than she287 would otherwise have received on that assumption. There is thus more involved in this case than the naked question whether the respondent should be permitted to apply retroactively a change in position which resulted from the unsuccessful litigation of other cases. The respondent's position, which petitioner accepted as the law, resulted in a monetary loss to the petitioner. At this late date, she cannot be made whole. On these facts it would be grossly inequitable to permit the Government retroactively to assess deificiencies in the years before us. Petitioner should be accorded the same consideration and treatment from the Government as the Automobile Club of Michigan and the national committees. The result reached here is wholly in accord with the respondent's policy of encouraging taxpayers to rely on its published rulings. Section 601-201(1) (9), Proced. and Admin. Regs., provides, in pertinent part, as follows: (9) Taxpayers generally may rely upon Revenue Rulings published in the Internal Revenue Bulletin in determining the tax treatment of their own transactions and need not request specific rulings applying the principles of a published Revenue Ruling to the facts288 of their particular cases. However, since each Revenue Ruling represents the conclusion of the Service as to the application of the law to the entire state of facts involved, taxpayers * * are cautioned against reaching the same conclusion in other cases unless the facts and circumstances are substantially the same. * * * There is no question of justifiable reliance in our case where the petitioner's interpretation of Rev. Rul. 59-130, supra, as applied to her facts, was reaffirmed by the district director at Hartford. The nature of our income tax system is one of self-assessment. Its very foundations rest upon the continued goodwill and cooperation of our citizens in voluntarily disclosing their taxable income. Such cooperation will not long be forthcoming if the tax laws are not administered in an equitable and evenhanded manner. The respondent can ill-afford to violate the people's trust by applying one standard to the large taxpayer and another to the small taxpayer. As Justice Douglas said in his Concurring Opinion in 289 Commissioner v. Lester, 366 U.S. 299">366 U.S. 299, 306 (1961): * * In an early income tax case, Mr. Justice Holmes said "Men must turn square corners when they deal with the Government." Rock Island, A. & L.R. Co. v. United States, 254 U.S. 141">254 U.S. 141, 143. The revenue laws have become so complicated and intricate that I think the Government in moving against the citizen should also turn square corners. In accordance with the above, Decision will be entered for the petitioner. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. ↩2. Aside from the support payments, petitioner had no other income which would have required her to file tax returns for the years in question. ↩3. This was a situation in which respondent, facing litigation with respect to prior rulings, chose to litigate both sides of the question in the guise of a stakeholder. ↩4. The Internal Revenue Service has indicated that these rulings are designed to provide a clear understanding of the rules that will be applicable if Congress does not choose to enact statutory provisions requiring different results. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619360/	Overton Machine Company v. Commissioner.Overton Mach. Co. v. CommissionerDocket No. 24515.United States Tax Court1951 Tax Ct. Memo LEXIS 118; 10 T.C.M. (CCH) 810; T.C.M. (RIA) 51258; August 29, 1951James H. Larva, Esq., for the petitioner. Philip J. Wolf, Esq., for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion Respondent has determined deficiencies in petitioner's 1944 income tax, declared value excess profits tax, and excess profits tax liabilities in the amounts of $37.37, $11,538.81, and $63,187.59, respectively. Petitioner contests the deficiencies resulting from respondent's determination that only $40,000 of the $127,272.55 claimed as a deduction for compensation paid to its president represented reasonable compensation. Respondent has disallowed the excess. Findings of Fact The petitioner is a Michigan corporation incorporated in 1926 under the name of "American Machine Company", which name was changed to Overton Machine Company in 1944. 119 The petitioner filed its returns for 1944 with the Collector of Internal Revenue for the District of Michigan at Detroit, Michigan. It maintained its books of account and prepared its returns on the accrual basis of accounting. Petitioner is engaged in the business of manufacturing, assembling and selling drum drying machines used by the dairy industry for dehydrating milk and by the distillery industry for dehydrating distillers' slop. At all times petitioner's preferred stock was issued in the name of its president, Glen Overton, hereinafter referred to as Overton. At different times, some of the common stock was issued as qualifying shares to sons of Overton and to others unrelated to him. The balance of the common stock was issued to Overton. During the year 1944, Overton held approximately 90 per cent of the common stock. Overton was born in 1884. He studied agricultural engineering at an agricultural college in Michigan. Upon leaving college, he was employed in various dairy plants until 1910. From 1910 to 1926, he owned and operated creameries and milk products businesses. During the years 1926 to 1929, he perfected a drying cylinder to be used in a milk dehydrating120 machine and obtained a patent in 1929. He paid the experimental and developing costs incurred in perfecting this cylinder. The petitioner was organized to construct and sell these machines. It enjoyed moderate success until 1930 when the price of milk was reduced. Overton experimented with the use of the machine in other industries but experienced no success until about 1937 when the machine was adapted to the drying of brewers' yeast. In 1937 or 1938, Overton purchased a small plant, hired mechanics, and experimented with the milk drying machine for the purpose of adapting it to dehydrating distillers' slop. He perfected modifications of the machine which rendered it adaptable to this new use. These modifications were patented by Overton. In 1941 and 1942 during the experiment, several of the drum drying machines were manufactured and sold to distillers. More machines were manufactured and sold in 1943 and 1944. During 1944, petitioners' gross sales of machines and parts to both the dairy and distillery industries totaled $892,225.48, of which $845,925.59 represented machine sales and the balance parts sales. Petitioner employed 60 persons in 1944. Overton was the dominant121 personality in the petitioner's business. In addition to contacting customers and making sales, he made purchases, employed and trained personnel, engineered the construction of the machines according to specifications, and engineered the installation of machines in the purchasers' plants. During 1944, he had several conferences with all purchasers of the machines. Some of the sales in 1944 had their source in contacts Overton had made with distillery companies in 1942 and 1943. Manufacture and sale of the machines were delayed because of priority regulations. In 1926, the petitioner appointed a well-known manufacturer and seller of dairy equipment as the sole sales agent for its milk drying machines at a commission of 25 per cent of the selling price. On the same day, this agent contracted to pay Overton 15 per cent commission on all of petitioner's milk drying machines they sold in Wisconsin and Michigan, regardless of whether the sales were made by Overton personally or by a representative of the agent, and 10 per cent commission on petitioner's milk drying machines sold through his personal efforts anywhere outside of Wisconsin and Michigan. The agent also agreed to pay Overton122 a commission of 10 per cent on all products manufactured by them and sold by him, and 40 per cent commission on all other products he sold for them, without territorial restrictions. Both contracts were to remain in effect 25 years. The agent was appointed by the petitioner because of the reputation and contacts it had with the dairy industry. Overton objected to the manner in which the contract between petitioner and agent was being fulfilled. He alone had made about 74 per cent of the agent's sales and, as to another 14 per cent, he had gone with the agent's representative to complete the sale. Modifications of the contract between Overton and the agent occurred on June 25, 1930. On December 31, 1931, a new contract was entered into between petitioner and the agent, and at the same time the prior contracts between the agent and petitioner and between the agent and Overton were cancelled. Under the terms of the contract, the exclusive agency theretofore granted was withdrawn and the agent was permitted to purchase the machines on a 10 per cent discount basis, except in some instances where the rate was 5 per cent. The agent was given the right to sell the milk drying machines123 and "any drying equipment developed by the American Machine Company, Inc., or by Glen Overton, to be used outside of the Dairy industry". The contract was to remain in effect "from year to year from the date hereof subject to a notice of cancellation by any of the parties hereto given in writing to the others on the first day of October of any year." This contract remained in effect from the time it was entered into through the year in question. Overton was a party to the contract. A small percentage of petitioner's business was conducted through brokers who received the machines at 10 per cent below list price. They either assumed responsibility for the collection of the accounts or gave petitioner satisfactory paper in those instances where there was no credit risk. By a resolution of its board of directors dated January 2, 1931, petitioner approved as compensation to Overton "10 per cent on sales with a minimum salary of $5,000.00," provided, however, that any compensation in excess of $5,000 was not to be paid unless "the company has earned not less than 10 per cent on its capital stock and surplus". This method of compensation appeared to have been followed in the years 1931124 through 1933 but because of losses sustained during the depression years was abandoned in 1934 and 1935. Petitioner thereafter, in or about the year 1935, agreed to pay Overton a sum equal to 15 per cent of the selling price of all drum drying machines sold by him. This sum represented compensation for his services as president, sales manager, and salesman. The 15 per cent commission Overton received on his sales was the only remuneration he received for allowing petitioner to use his patents. Overton paid all sales and traveling expenses incurred by him in selling the machines. The agreement was not reduced to writing or evidenced by written minutes or resolution of the petitioner corporation. The agreement remained operative from the time it was put into effect through 1944. On December 2, 1946, Overton informed petitioner's board of directors that although he had not received compensation as an officer of the corporation for the past several years, he had instead received during those years a commission of 15 per cent on sales of drying machines and that from such commission he had paid all sales, traveling and other expenses incurred by him in connection with such sales. On125 that date the board of directors formally approved the method of compensating Overton for his services during those years. Overton did not always receive by actual payment the entire 15 per cent due him. He drew what he needed for living expenses and at times left the remainder as a credit in his account. In 1944, petitioner claimed as a deduction $127,272.55 as compensation paid to Overton for services rendered in that year. This sum is equal to 15 per cent of the selling price of drum drying machines sold by Overton in that year. Petitioner paid $85,658.03 of this sum in 1944 to Overton in cash and in 1945 issued to him a note for $41,614.52, dated January 31, 1945, due July 31, 1945, with interest at 5 per cent. Overton did not report the $41,614.52 as income on his individual income tax return for the taxable year 1944. In 1945 petitioner paid the note. During 1944 it was customary for manufacturers of drum drying equipment to pay a commission of at least 15 per cent of the sales price to its selling agents who rendered similar sales and engineering services to those rendered by Overton. Petitioner paid no dividends from the date of its organization through the year 1944. 126 Pursuant to an agreement entered into in 1944, Overton sold to a third party his patents for $200,000 cash, plus an additional sum based on a percentage of sales and limited to $20,000. In addition, the third party agreed to employ Overton, at his option, either under a half-time employment arrangement or in an advisory or consultative capacity. The agreement further provided that upon the termination of Overton's employment (whether by death or otherwise) he or his legal representatives or assigns would receive a sum equal to 2 1/2 per cent of the third party's sales of drum drying machinery with a $5,000 yearly minimum until all patent rights acquired from Overton under the agreement expired. The third party was not obligated to pay the 2 1/2 per cent in the event its gross sales from the drum drying machinery were less than a specified minimum. The petitioner was also a party under this agreement. It sold to the third party patterns, designs, plans, the American Machine Company name, and files of the business of the manufacture and sale of drum drying machinery except those applicable to the milk drying machines, for $20,000 cash. Pursuant to the agreement, the third party allowed127 petitioner to manufacture and sell for a specified period of time the patented drum drying machines in fulfillment of certain outstanding orders and proposals and for certain specified uses and purposes without payment of a royalty. In the year 1944, petitioner's milk drying machines sold for a price of approximately $11,400 to $12,000 each. In the same year, petitioner's machines, adapted to the drying of distillers' slop, sold for a price of approximately $13,000 to $14,000. The prices varied depending upon the accessories ordered by the purchasers. During the years 1941 through 1944, petitioner's sales (less returns and allowances), gross profit from sales, other income, deductions taken for Glen Overton's compensation, and net income, were as follows: Sales (LessDeductions forReturns andGross ProfitOtherGlen Overton'sNetAllowances)from SalesIncomeCompensationIncome1941$105,244.14$ 32,485.25$ 91.62$ 6,327.59$ 3,791.061942285,201.5470,335.741,146.7914,061.7911,856.521943307,947.7198,812.489,820.4321,036.6114,856.961944888,945.92271,867.748,072.09127,272.5552,493.16Opinion128 ARUNDELL, Judge: The factual question before us is whether the sum of $127,272.55 paid to Overton as compensation for his services in 1944 was reasonable. 1 Overton received no salary as such but instead was paid a commission of 15 per cent of the sales price on the drum drying machines he sold. The commissions earned in 1944 totaled $127,272.55. Although the sum is larger than the amount paid in prior years, it is none-the-less a sum paid pursuant to a commission rate which had been established for a long period of time. Furthermore, the sum includes commissions on a backlog of sales that had their source in contacts Overton had made as far back as 1942. Because of priority regulations, the manufacture and sale of the machines had been delayed. We think petitioner129 has submitted sufficient evidence to establish that a commission at the rate of 15 per cent was reasonable. It was customary for manufacturers and sellers of this type of machinery to pay a commission of at least 15 per cent to selling agents, who performed selling and engineering services similar to those performed by Overton. The sale of these machines was highly specialized and required considerable skill and effort. Before reaching the closing stages of a sale, it was necessary to work with the prospective customer's engineering staff, make engineering drawings, and do a considerable amount of costly plant layout work in order to make a presentation. It then took weeks and sometimes months before the sale was completed. The reasonableness of the commission paid to Overton is further indicated by the fact that it represented compensation for his services as president and manager as well as a commission for his selling efforts. The responsibilities and duties of Overton did not end with the completion of the sale. In addition to his administrative duties as president, he procured the materials, supervised building of the machines to see that they met specifications, and trained130 engineers and mechanics to install and operate them. We think it is also noteworthy that Overton's only remuneration for the patents he allowed petitioner to use was the 15 per cent commission he received on his sales. No specified royalty was paid despite the fact that the patents were of considerable value, as is indicated by their sale in 1946 for a substantial sum of money. Under these circumstances, it is our view that the sum of $127,272.55 paid to Overton pursuant to the 15 per cent commission rate was reasonable compensation for his services in 1944 and deductible in full. Section 23(a), Internal Revenue Code. Decision will be entered under Rule 50. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: (a) Expenses. - (1) Trade or Business Expenses. - (A) In General. - All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered * * *.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619361/	Calcasieu Paper Company, Inc. v. Commissioner.Calcasieu Paper Co. v. CommissionerDocket No. 33392.United States Tax Court1953 Tax Ct. Memo LEXIS 392; 12 T.C.M. (CCH) 74; T.C.M. (RIA) 53028; January 30, 1953392 In 1947, petitioner received a 10-year lease of a townsite with an option to buy during the seventh and eighth years of the lease. If the option were exercised, payments made after the sixth year of the lease were to be applied to the purchase price. Petitioner, in its 1947 income tax return, deducted the amount paid in that year under the lease as rent. Respondent disallowed the deduction on the ground that the agreement was not a lease but a sale. Held, the agreement was a lease, and the deduction as rent is allowed. Held, further, the useful life of a power plant purchased by petitioner determined. William T. Rogers, Esq., 801 Florida Nat'l Bank Bldg., Jacksonville, Fla., for the petitioner. Thomas C. Cravens, Esq., for the respondent. RICEMemorandum Findings of Fact and Opinion This case involves a deficiency in corporate income tax for the year 1947 in the sum of $8,606.52. The two issues presented for decision are: (1) was the sum of $22,500, paid by petitioner in 1947 under a lease containing an option to buy, a rental payment or did it represent a part of the purchase price of the property covered by the lease; and (2) what was the useful life of393 a power plant purchased by petitioner in 1947. Other issues presented by the pleadings were abandoned at the hearing. Findings of Fact Petitioner is a Louisiana corporation with its principal place of business in Elizabeth, Louisiana. It is engaged in the manufacture of kraft paper. It filed its original and amended income tax returns for the taxable year 1947 with the collector of internal revenue for the district of Louisiana. Prior to June 1946, the controlling interest in the capital stock of petitioner was owned by four separate estates. In June 1946, 67 per cent of the capital stock was acquired by the Jacksonville Paper Company. Jacksonville Paper Company (hereinafter called Jacksonville) is a Florida corporation with its principal place of business in Jacksonville, Florida. Industrial Lumber Company (hereinafter called Industrial) is a Louisiana corporation with offices in Elizabeth, Louisiana. On or about May 1, 1946, Jacksonville entered into negotiations for the purchase of a controlling stock interest in petitioner. On May 4, 1946, the following memorandum of agreement between Jacksonville and William S. Bedal and George W. Lane, trustees under the will of Sarah394 L. G. Wilson, was executed: "Alexandria, La., May 4, 1946. "This memorandum of agreement between Jacksonville Paper Co., a Florida Corp. as 1st Party (Corporation) and Wm. S. Bedal & Geo. W. Lane, Trustees u/w of Sarah L. G. Wilson as 2d parties (Trustees) is based upon the following facts: - "Corporation desires to obtain control of in excess of 66 2/3% of the outstanding capital stock of Calcasieu Paper Co. a Louisiana Corp. of Elizabeth, La. at a price which will be on the basis of $30 a share net after payment of Federal & State capital gains taxes. Trustees are willing to sell to first party all their shares of stock in Calcasieu Co. at said price but own only slightly in excess of 25,000 shares or less than 40% of said stock. To obtain the additional shares necessary Trustees will have to assemble said stock. "Corporation has delivered to Trustees its check drawn on the Barnett National Bank of Jacksonville, Fla. for $500,000 payable to the order of Miss. Valley Trust Co. of St. Louis as evidencing its good faith. Said check is to be used as follows: - "1. The check shall be deposited to the joint account of Corporation and Trustees in said Trust Co. Checks against395 the said account shall be signed by an authorized agent of Corporation and countersigned by either one of Trustees. "2. If sale is consummated sd. sum shall be applied as part purchase price of said stock owned by Trustees. "3. If sale is not consummated said sum shall be returned to Corporation. "4. Trustees shall tender from 66 2/3% plus 1 share of said outstanding stock up to 75% on or before July 1, 1946. "5. It is understood in connection with said tender, contracts must be made covering the power house, the town site and the forests of Industrial Lumber Co. the terms of which must be agreed upon by Calc. Paper Co. & Industrial Lbr. Co. "6. It is also understood that contracts must be made between Paper Co. and C. L. Glasgow & Wm. S. Bedal for their services. "7. The terms of all contracts above mentioned must be satisfactory to Corporation otherwise it shall not be obligated to accept said tender. "8. The stock to be tendered to Corporation shall be delivered to Miss. Valley Trust Co. indorsed in blank and delivered by Trust Co. against payment of full purchase price in cash. "9. The resources of Calc. Paper Co. are substantially as reflected in its balance sheet396 of March 31, 1946 copy of which will be furnished Corporation. "JACKSONVILLE PAPER CO. "By C. G. McGehee President. "Wm. S. Bedal, Trustee "u/w Sarah L. G. Wilson" Industrial owned large acreages of timber land adjacent to the Townsite of Elizabeth, Louisiana. It also owned the Townsite (variously referred to in the instruments quoted herein as "town site", "town properties", and "Town Site") and a power plant which provided the power necessary to operate the machinery of Calcasieu Paper Company, Inc., and to supply the Townsite with power. The offer of Jacksonville to buy a controlling interest in petitioner was conditioned upon petitioner being given, among other things, a 25-year cutting-right contract on 30,000 acres of land owned by Industrial that had been planted in timber. The offer was also conditioned upon petitioner procuring a lease from Industrial on the Townsite of Elizabeth and on the old power plant located there. Elizabeth had a population of approximately 1,400 all of whom worked either for Industrial or for petitioner. In June 1946, the transfer of stock to Jacksonville was consummated, Jacksonville paying in excess of $500,000 for it. During the taxable397 year in controversy, Jacksonville owned approximately 75 per cent of the capital stock of petitioner. No agreement was reached at the time of the transfer of the stock to Jacksonville with respect to the Townsite, the power plant, or the cutting rights on the timber land; but it was understood that details relating thereto would be the subject of further negotiation and agreement. On December 12, 1946, William S. Bedal, in his capacity as president of Industrial, wrote petitioner a letter stating that its offer to purchase the power plant was rejected and enclosing a memorandum setting forth the terms on which Industrial was willing to lease the power plant and the Townsite as follows: "MEMORANDUM OF TERMS ON WHICH INDUSTRIAL LUMBER COMPANY IS WILLING TO LEASE THE POWER PLANT AND TOWN PROPERTIES TO CALCASIEU PAPER COMPANY "POWER PLANT "PROPERTY INCLUDED: If lease is effected for both the power plant and town properties then all property at present included in the current lease is to be included in the proposed lease. This includes right-of-way for present transmission and supply lines. If power plant lease only is accepted then power plant lease will cover only the land, buildings398 and machinery used for the generation and distribution of electricity and the supplying of water together with the necessary rights-of-way for transmission and supply lines. All other land, buildings and machinery will be excluded. "TERM: Four years, commencing January 1, 1947. "RENTAL: Same as at present, that is $39,600 a year payable in monthly installments of $3,300 in advance. "OTHER TERMS: Calcasieu shall on demand reimburse Industrial for insurance premiums paid for insurance, the coverage to be the same as at present. Calcasieu shall on demand reimburse Industrial for taxes paid on leased property. Calcasieu shall, at its own expense, maintain the leased property in operating condition and surrender the same at the termination of the lease in as good condition as received, wear and tear alone excepted. The cost of all turbine replacements must be absorbed by Calcasieu. Industrial shall be put to no expense whatever in connection with the power plant. "Calcasieu shall furnish electric service and water to all residents of Elizabeth, likewise for all commercial properties. It must furnish free electric service for the street lights and free electricity and water for Industrial's399 main office, the hospital, the pavilion and the two negro churches. "Calcasieu shall also furnish gas to all premises where same is now being furnished. "Industrial shall be represented on the Board of Directors of Calcasieu by one director named by Industrial Lumber Company. The making of a lease on the power plant is contingent on the Calcasieu Paper Company reimbursing Industrial for insurance premiums advanced by Industrial and on the payment of which Calcasieu Paper Company is now in default and likewise on condition that Calcasieu acknowledges Industrial has in all respects complied with the current power plant lease and that Calcasieu has no claim of any kind against Industrial on account of the current power plant lease. "TOWN PROPERTIES "PROPERTY COVERED: Residences and commercial properties south of the Santa Fe railroad track and two residences and a beer parlor north thereof as under present lease, excepting therefrom the residences now occupied by Messrs. Glasgow, Ben F. Smith and Hollingsworth, also excepting the main office of Industrial Lumber Company and Elizabeth Hospital. If Industrial should need a dwelling for any employee in addition to Mr. Hollingsworth400 Industrial is to have the right to select a suitable dwelling for such employee and except the dwelling from the lease, the rental of Calcasieu being reduced proportionately. "TERM: Two years, commencing January 1, 1947. "RENTAL: $40,000 a year payable in monthly installments of $3,333.33 in advance. Out of this rental so paid Industrial will reimburse Calcasieu to the extent of $20,000 a year for all repairs made by Calcasieu to keep the houses and commercial properties in Elizabeth as a whole in habitable and usable condition, all repairs to be made by Calcasieu. Reimbursement to the extent of $20,000 is to be made by Industrial upon presentation of itemized statement showing expenditures. In addition, Industrial will match up to $5,000 every dollar in addition to $20,000 expended by Calcasieu in the above maintenance or in making additions, alternations and structural changes agreed to by both parties. "OTHER TERMS: Calcasieu shall on demand reimburse Industrial for insurance premiums paid for the same insurance coverage as at present; also reimburse Industrial on demand for taxes paid on the town properties. Calcasieu must continue the same services for the town as it does401 at present at its own expense, that is keeping drains open, oiling streets, watering streets, cutting weeds, maintaining the street electric lines and maintaining the streets and sewer system as well as the scavenger service. "If the power plant lease is not effected such buildings as are now on power plant site used in connection with the town will be included in the town lease without additional compensation. "In considering what are repairs those matters simply will be considered as repairs which are necessary to keep the leased property as a whole in habitable and usable condition. It will not be considered a repair where a building needs alternations, additions, structural changes and complete rehabilitation to put it in usable condition. For such purpose Calcasieu will have to expend its own funds except to the extent of the $5,000 matching as above provided. It is the intent that at least $20,000 a year be spent by Calcasieu on the leased properties as a whole and no substantial sum be spent on any one building except by agreement of the parties and under the $5,000 matching provision. "Calcasieu shall at the request of Industrial make repairs on the reserved dwellings402 at cost to Calcasieu. It shall also keep the hospital in a good condition of repair. "Industrial, as a condition of the lease, must be represented on the Board of Directors of the Calcasieu Paper Company by one director named by Industrial Lumber Company. "The lease will be subject to all servitudes, restrictions, encumbrances of any kind now existing on the lands, whether of record or not. "It will be a condition of the lease that Calcasieu agrees it has no claim of any kind against Industrial on the present lease of the town properties. "It will be understood in the lease of the power plant or of the town properties, or both, or either, that all property of Industrial not covered by lease to Calcasieu Paper Company is to remain in place with right of ingress and egress to Industrial, its employees and others; that Industrial shall have the right of access to the rented properties; that the books and records of Calcasieu relating to any matter connected with the leases or either of them or relating thereto be open to inspection by Industrial. "In making this offer for the lease of the town properties the Directors have considered that present rentals should be raised a minimum403 of 30 per cent; that a charge should be made for water and that the scavenging charge at present included in rent is far too low." On January 4, 1947, petitioner's attorney sent the following letter to Industrial: "Industrial Lumber Company, Inc., Elizabeth, Louisiana. "Attention: Mr. William S. Bedal, President "Gentlemen: - "On behalf of my client, Jacksonville Paper Company, Jacksonville, Florida, I am writing you in reference to your contract with the Jacksonville Paper Company, dated May 4, 1946, further evidenced by Memorandum dated May 18, 1946, and oral discussions attendant thereto. "In accordance with said contract, my client, Jacksonville Paper Company, hereby avails itself of its following agreements: "1. To purchase the Power Plant at Elizabeth, Louisiana, servicing Paper Company and the Town of Elizabeth, at a fair appraisal value, which you have been advised amounts to $89,985.00; "2. The purchase of cutting rights on the reforested areas of Industrial Lumber Company, estimated at 30,000 acres, both natural and hand-planted, at the rate of 10" an acre, annually in advance; and "3. The lease and operation of the Town Site of Elizabeth. "For the lease404 and operation of the Town Site, my client, Jacksonville Paper Company, has already paid you on a basis of $1,000.00 per month, the last payment covering the period through January 31, 1947. "Incidentally, my client has complied with its agreement to pay Mr. William S. Bedal, your President, his annual retainer of $5,000.00, and to Mr. C. L. Glasgow, Past President of Calcasieu Paper Company, $500.00 per month. "Having complied with all of its obligations under the contract and being ready and willing to proceed with the phases thereof, which have not been closed to date, my client hereby tenders to you in payment of the Power Plant and in payment of the cutting rights for 1947, a Cashier's Check drawn on The Calcasieu-Marine National Bank, Oakdale Branch, in the sum of $92,985.00, and requests that the proper deeds and instruments be executed to it within a reasonable time covering the sale of the Power Plant, the cutting rights and the rental of the Town Site. "Mr. C. G. McGehee is in my office at the time of the dictation of this letter to evidence my authority in the premises. "Your very truly, "/S/ LeDoux R. Provosty "/S/ C. G. McGehee C. G. McGehee LRP:m" On405 January 23, 1947, Jacksonville brought suit in the United States District Court for the Western District of Louisiana against Industrial seeking specific performance of the memorandum of agreement of May 4, 1946. Specifically, Jacksonville demanded judgment requiring Industrial to sell the power plant to Jacksonville for the sum of $89,985 and to rent to Jacksonville the Townsite of Elizabeth at a rental of $1,000 per month. The case went to trial and, after about three days of trial, it was settled. As a result of the settlement, petitioner purchased the power plant for the sum of $199,784.72 and obtained a 10-year lease on the Townsite, reading, in part, as follows: "ELIZABETH TOWN SITE CONTRACT "STATE OF LOUISIANA"PARISH OF RAPIDES "BE IT KNOWN, That on this 18 day of April, 1947, before me Richard B. Sadler, Jr., a Notary Public, duly commissioned and qualified in and for the Parish and State aforesaid, and in the presence of the hereinafter named and undersigned competent witnesses came and appeared INDUSTRIAL LUMBER COMPANY, INC., (hereinafter sometimes referred to as 'Industrial') a Louisiana Corporation domiciled in Allen Parish, Louisiana, herein represented by Wm. 406 S. Bedal, its President, duly authorized by resolution of the Board of Directors of said corporation dated April 18, 1947, and CALCASIEU PAPER COMPANY, INC., (hereinafter sometimes referred to as 'Calcasieu') a Louisiana Corporation, domiciled in Allen Parish, Louisiana, herein represented by C. G. McGehee, its President, duly authorized by resolution of the Board of Directors of said corporation, each of which declared and acknowledged unto me, Notary, through its respective representative that: "For the considerations and rentals and upon the terms and conditions hereinafter set out, 'Industrial' and 'Calcasieu' have and do by these presents enter into the following agreement and contract of lease and hiring, the 'Industrial' hereby does lease, let and hire unto 'Calcasieu' and 'Calcasieu' agrees to rent and take, to have and to hold the same for a period of ten (10) years from April 15, 1947, the same property herein leased being more fully described as follows, to-wit: * [Description of the property.] "LESS FOLLOWING DESIGNATED PROPERTY which is excluded from this lease: * [Description of the property.] "I. This lease and contract also includes all407 rights and servitudes the Industrial Lumber Company, Inc., owns on, over and across the right of way of the Jasper and Eastern Railroad, and any buildings, water lines, gas lines and electric lines owned by the Industrial Lumber Company, Inc., which are located on or across said right of way of Jasper and Eastern Railroad and which are included within the lines marked "Blue" shown on said attached plat and which railroad property and rights of way, it is understood and agreed are not owned or controlled by the Industrial Lumber Company, Inc."II. The said 'Calcasieu', in consideration of the lease of said property agrees to rent and lease said property and to pay the said 'Industrial' an annual rental of Thirty Thousand and No/100 ($30,000.00) Dollars each year during the term of this lease, which rentals are payable in equal quarterly installments of Seven Thousand Five Hundred and No/100 ($7,500.00) Dollars each in advance, the first quarterly annual installment to be paid on the execution of this lease and a like sum to be paid on the first day of each succeeding three (3) months period thereafter; said rentals are to be payable at the office of the 'Industrial' in Elizabeth, 408 Louisiana, or at such place as may, from time to time, be designated by written notice to 'Lessee'. "III. Any and all unpaid installments or rentals for this lease shall bear interest at the rate of five (5%) per cent per annum from maturity until paid; and also five (5%) per cent attorneys' fees on the amount to be collected in the event of default by said 'Lessee' and the placing of the claim in the hands of an attorney for collection; it is further agreed that if the 'Lessee' fails to pay any quarterly installment rentals, when due, or defaults in the performance of any other covenant or condition of this lease, at the option of the 'Lessor', or its successors or assigns, all unmatured rent shall become due and exigible, if the 'Lessee' fails to liquidate the amount delinquent or to perform such other covenants within ten (10) days after written demand therefor, and that on the happening of any of those events, 'Lessor' shall, 'ipsofacto', have the right to re-enter and repossess the leased premises. "IV. 'Lessee' further agrees and obligates itself to furnish or have furnished all utilities, including gas, water, electricity, sewers, scavenger service, street lighting and other409 similar public service, now or formerly furnished to or used for the benefits of the 'Town Site' of Elizabeth, Louisiana, and of the general public in or on the lease 'Town Site' premises, and likewise agrees to maintain the streets, walks, sewers, water mains and gas mains, electric power, and other service facilities in suitable condition for the purposes for which they were constituted. 'Calcasieu's' obligations under this paragraph shall cease if and when 'Calcasieu' discontinues the operation of utilities. "V. It is further agreed and understood that 'Lessee' shall, during the term of this lease, and beginning with the year 1947, pay all taxes, assessments, and levies assessed or levied against and on the leased property. "VI. It is further agreed that 'Lessee' shall carry all insurance and pay all insurance premiums on said property, and that 'Lessor' may require that 'Lessee' during the term of this lease take out fire, tornado and extended coverage insurance policies to protect 'Lessor' against loss by fire, windstorm and other hazards usually covered by such policies, in the sum equivalent to ninety (90%) per cent of its sound insurabel [insurance] value provided that410 'Lessee' is to be required to pay premiums on such insurance of not more than $425,000.00; and that in the event of loss due to such hazards such insurance monies is to be payable to 'Lessor' and 'Lessee' to be used to repair the damaged premises, and to be applied only to the payment of actual bills if and when incurred in that connection. "It is further agreed that the said 'Lessee' shall carry plate glass insurance against loss by breakage and other hazards to any plate glass now a part of any buildings on said town site. "VII. 'Lessee' shall also take out an insurance policy indemnifying 'Lessor' against its liability under the law to tenants and to the public by reason of 'Lessor's' ownership of the leased property with not less than $50,000.00 and $100,000.00 limits to be so carried. "VIII. It is further agreed that the 'Lessee' assumes all liability imposed by law upon or against the 'Lessor' for any claims which may be made against 'Lessor' by tenants, sub-tenants or other persons, by reason of the ownership of said property by 'Lessor', and to save 'Lessor' harmless from liability and damage against all such claims, including claims for damages or injuries resulting411 from vices or latent and apparent defects in or on the buildings and improvements located in said town sites. "IX. 'Lessor' hereby sells and transfers to 'Lessee' the right and option to purchase the property, both immovable and movable, herein leased, at any time between April 15, 1953 and April 15, 1955, for the sum of One Hundred and Twenty Thousand and No/100 ($120,000.00) Dollars cash. All rentals paid by 'Lessee' for rent accruing between April 15, 1953 and the date of consummation of the sale shall be credited on the purchase price. 'Lessee' shall give 'Lessor' sixty (60) days notice in writing of its intention to exercise this option. On receipt of said notice 'Lessor', within Thirty (30) days thereafter, shall deliver to 'Lessee' any abstracts of title for the leased premises in its possession and said abstracts shall be continued or brought up to date at 'Lessee's' expense. Said sale shall be closed, promptly after the abstracts have been completed, at the office of 'Lessor' at Elizabeth, Louisiana, and on payment to 'Lessor' of the purchase price 'Lessor' shall deliver to 'Lessee' a warranty deed to said property free from encumbrances, but excepting from said warranty412 all taxes, all servitudes affecting said property subsequent to April 15, 1947, which were granted with the consent of 'Lessee', and also excepting any servitudes obtained by public user which may have existed at the date of this lease or have arisen subsequently; provided this option shall not be enforceable if 'Lessee' is in default in any rental payment. "'Industrial' agrees not to grant any oil or gas mineral leases on town site while this lease is effective. "X. As a part of the consideration of this lease, 'Lessee' agrees to furnish to the improved premises owned by 'Lessor' and not leased hereunder, as well as to the occupants thereof, all public utility and other services which 'Lessee' may furnish or cause to be furnished to the leased premises and the occupants thereof, and on the same terms and conditions, not only during the term of this lease but after the termination thereof, so long as 'Lessee' or its assigns continue to operate said utilities in Allen Parish, Louisiana. 'Lessee' also agrees to likewise furnish said services to any properties which 'Lessor' may hereafter improve, provided the cost of connecting said property or properties into then existing service413 lines, mains, pipes, or otherwise of 'Lessee' is paid for by 'Lessor', and 'Lessee' is able to furnish said additional service without making additions to its present or then existing facilities therefor, 'Lessor' to pay for all material necessary for such connection. "XI. As a further consideration for this lease, 'Lessee' agrees to make the necessary repairs to busildings and improvements and the furniture and fixtures and movable contents in the hotel and other leased buildings, and to keep fire apparatus and all other movable and immovable property described in this lease, in reasonably good repair as a prudent owner administrator would do with similar property in his possession. Likewise, 'Lessee' agrees to return said leased property to the 'Lessor' in such reasonably good repair at the termination of this lease, and to replace any movable property, including furnishings contained in said buildings at the time of the execution of this lease, which may be lost or destroyed due to carelessness, negligence or improper use on the part of 'Lessee' or its agents and employees, to the end that said buildings and contents thereof may be returned to 'Lessor' in reasonably good repair414 and usable condition on the termination of this lease, ordinary wear and tear excepted. "XII. This contract is made subsequent to and supersedes a tentative agreement of March 20, 1947, by and between C. G. McGehee, Tillman Cavert, Arend V. Dubee, and Donald W. Cragin, individually and as Directors and/or stockholders of Calcasieu Paper Company, Inc., on the one part, and Wm. S. Bedal, George W. Lane, Arend V. Dubee, Donald W. Cragin, H. Bascom Funchess, Jr., and C. L. Glasgow, individually and as Directors and/or stockholders of Industrial Lumber Company, Inc., on the other part. This contract embodies the entire agreement on the subject matter herein contained between the parties, having been prepared after full discussion shall be construed neither for or against 'Calcasieu' or 'Industrial'. "This contract is binding on the successors and assigns of both parties hereto. "This done, read and signed by me at my Notarial Office in Alexandria, Louisiana, in the presence of Richard A. Anderson and Donald W. Cragin lawful witnesses, who hereunto sign with said parties and me, Notary Public, on this 18 day of April, 1947. "ATTEST: (signed) Richard A. Anderson (signed) Donald415 Wilson Cragin "INDUSTRIAL LUMBER COMPANY, INC."By: Wm. S. Bedal President "CALCASIEU PAPER COMPANY, INC. "By: C. G. McGehee President "BEFORE ME Richard B. Sadler, Jr. Notary Public "(SEAL)" The option to purchase, contained in the lease, was inserted at the request of the petitioner because it wanted to control the Townsite without further negotiations with Industrial, if petitioner later decided to expand the paper mill. The $30,000-a-year rental under the lease was considered by the president of petitioner to be excessive. Prior to the settlement of the suit for specific performance, petitioner had been paying an annual rental on the Townsite not in excess of $12,000 a year. Petitioner's president anticipated that the annual income to petitioner from the rental of the individual units in the Townsite to the employees of petitioner would be from $5,000 to $7,000 per year less than the annual outlay by petitioner in connection with the property. This estimate has proven to be approximately correct. The total value of the Townsite in 1947 did not exceed $120,000. In its income tax return for 1947, the petitioner claimed the payments made under the aforementioned416 lease as rental deductions. The respondent determined that the lease agreement was, in effect, a purchase and sale agreement, and disallowed the rental deductions. The power plant purchased by petitioner as a result of the settlement of the suit for specific performance was 40 years old in 1947. After Jacksonville bought a controlling interest in petitioner, its capacity was increased substantially. The old power plant was not capable of carrying the increased load and petitioner had to build a new power plant, costing $600,000, which was completed and put in operation in August or September 1950. Since that time the old plant has been used by petitioner as an emergency source of power and was still so used at the time this proceeding was heard in 1952. When it was necessary to inspect or repair the turbines in the new power plant, the turbines in the old power plant were used as a source of power. At times the new turbines were out of operation for as long as two weeks and this occurred from three to five times a year. Such emergency use of the old power plant was not satisfactory and petitioner had plans to spend an additional $250,000 for increased power. In its income tax return417 for 1947, petitioner claimed depreciation on the old power plant computed on an estimated useful life of four years. The respondent determined that it had a useful life of 10 years. The useful life of the old power plant in 1947 was 10 years. Opinion RICE, Judge: The first issue presents the now familiar problem whether a lease with an option to buy real property, under an arrangement where a part of the lease payments may be applied to the purchase price when the option is exercised, is a lease in fact or a sale. If a lease, the amounts paid are rental payments and are deductible in full in the year paid. 1 If a sale, the amounts paid must be capitalized and recovered through depreciation. 2418 Respondent argues that the so-called rental payment was not a proper deduction since, under the agreement in controversy, petitioner acquired title to or was acquiring title or an equity in the Townsite, and that it clearly appears from the record that the so-called lease was nothing more than a sales agreement and payments thereunder were, therefore, not deductible. In support thereof, he cites Chicago Stoker Corporation, 14 T.C. 441">14 T.C. 441 (1950); Truman Bowen, 12 T.C. 446">12 T.C. 446 (1949); Judson Mills, 11 T.C. 25">11 T.C. 25 (1948); Robert A. Taft, 27 B.T.A. 808">27 B.T.A. 808 (1933); Holeproof Hosiery Co., 11 B.T.A. 547">11 B.T.A. 547 (1928). He argues further that under the holding in Helser Machine & Marine Works, Inc., 39 B.T.A. 644">39 B.T.A. 644 (1939), petitioner is precluded from claiming the deduction because, under the agreement, it had a right to take title. The record shows that it was necessary for petitioner to have the use of the Townsite to house its employees because there were no other housing facilities in the neighborhood. Petitioner's president testified that the offer to buy control of petitioner was conditioned, among other things, upon petitioner419 getting a lease on the Townsite. He also testified that no offer at any time was made to buy the Townsite, nor was any offer ever made to sell it. His attorney, who attended some of the meetings during which the negotiations were held, also testified to the same effect. The suit for specific performance corroborates the testimony on this point because one of the specific demands for relief in that suit was for a lease of the Townsite at a rental of $1,000 per month. When the suit was settled, petitioner received the lease, in controversy here, at a rental of $30,000 a year for 10 years. Petitioner insisted it be given an option to buy the Townsite in order to protect itself at a later date if the capacity of the paper mill were expanded. The option which was granted could be exercised only during the two-year period commencing April 15, 1953, and ending April 15, 1955; and, if it were exercised, only the rentals paid after April 15, 1953 to the date of the consummation of the sale could be credited to the agreed purchase price of $120,000. We have found as a fact that the property was not worth more than $120,000, the option price, and the rental payments for the last four years420 of the lease amounted to exactly that figure. It cannot, therefore, be said that the payments in 1947 created an equity in the property in petitioner's favor. There is some evidence in the record that the value of the Townsite was considerably less than $120,000, but we do not need to set a precise valuation on the property because, if the value of the property does not equal or is less than the option price, the payments in 1947, which are not to be credited on the purchase price under any circumstances, could create no equityin the property. See Estate of Clarence B. Eaton, 10 T.C. 869">10 T.C. 869 (1948); and Gilken Corporation, 10 T.C. 445">10 T.C. 445 (1948), affd. 176 Fed. (2d) 141 (C.A. 6, 1949); and cf. Chicago Stoker Corporation, supra. The cases cited by respondent, except Helser Machine & Marine Works, Inc., supra, are cases holding that the agreements in controversy were not leases but sales agreements and that the payments created an equity in the payer. They are, therefore, distinguishable from this case. In Helser Machine & Marine Works, Inc., the taxpayer agreed to pay "rent" for 10 years and the lessors gave it an option421 to purchase the premises at any time during the term of the lease, the rental payments to apply as payments on the purchase price. The lessors also agreed that whenever the lessee had paid the full sum of $19,200 prior to May 1, 1945, they would deed the property to the lessee. We held in that case that since the taxpayer had a right to take title to the property at any time during the term of the lease when the total sum due for the 10-year lease had been paid, that the monthly payments made in 1935 were not deductible as rental. That case also is distinguishable from this one. It seems sufficient to point out that here there was no right in petitioner to exercise the option during the taxable year in question. By way of summary, this record shows that (1) the value of the Townsite was not in excess of $120,000, the option price; (2) only payments made after April 15, 1953, were to be applied to the purchase price under the option; (3) the amount required to be paid upon exercise of the option ($120,000) amounted to 40 per cent of the total payments to be made under the lease ($300,000); (4) the option could not be exercised at any time, but only after a period of six years; (5) 422 the term of the lease was 10 years, not a few months or a few years; and (6) the intent of the parties was to make a lease. We, therefore, decide this issue for the petitioner. With respect to the second issue, the record leaves something to be desired. The power plant was 40 years old when purchased by the petitioner in 1947. The capacity of petitioner to manufacture paper was increased substantially, and the old power plant was unable to carry the increased load. Petitioner built a new power plant which was completed and put in operation in August or September 1950 and, at the time of the hearing, had plans to expand it because the emergency use of the old plant had not been satisfactory. If the old power plant had been dismantled or abandoned at that time, petitioner's rate of depreciation could probably be sustained. However, the old plant was still in use as a source of emergency power at the time this proceeding was heard in 1952, a period of approximately five years after its purchase. Petitioner's president testified that plans had been made to spend an additional $250,000 for power, so we must assume some continued use of the old plant until such plans were executed. On423 the basis of the entire record, we conclude that petitioner has failed to sustain its burden of proof that the 10-year life determined by the respondent was erroneous, and, on this issue, we hold for respondent. Decision will be entered under Rule 50. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. (a) Expenses. - (1) Trade or Business Expenses. - (A) In General. - * * * rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpaper has not taken or is not taking title or in which he has no equity. * * ↩2. (1) Depreciation. - A reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) - (1) of property used in the trade or business, * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4669049/	FILE COPY BILL OF COSTS TEXAS COURT OF APPEALS, EIGHTH DISTRICT, AT EL PASO No. 08-19-00123-CV Joseph O. Lopez v. The City of El Paso (No. 2018DCV1047 IN COUNTY COURT AT LAW NO 6 OF EL PASO COUNTY) Type of Fee Charges Paid By MOTION FEE $10.00 E-PAID ISBELL MACHUCA MOTION FEE $10.00 E-PAID ISBELL MACHUCA MOTION FEE $10.00 E-PAID ISBELL MACHUCA FILING $205.00 PAID JOSHUA C. SPENCER CLERK'S RECORD $31.00 UNKNOWN Balance of costs owing to the Eighth Court of Appeals, El Paso, Texas: 0.00 Court costs in this cause shall be paid as per the Judgment issued by this Court. I, ELIZABETH G. FLORES, CLERK OF THE EIGHTH COURT OF APPEALS OF THE STATE OF TEXAS, do hereby certify that the above and foregoing is a true and correct copy of the cost bill of THE COURT OF APPEALS FOR THE EIGHTH DISTRICT OF TEXAS, showing the charges and payments, in the above numbered and styled cause, as the same appears of record in this office. IN TESTIMONY WHEREOF, witness my hand and the Seal of the COURT OF APPEALS for the Eighth District of Texas, this March 12, 2021. Elizabeth G. Flores, Clerk	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4619362/	KENNETH A. CATHCART and JOAN A. CATHCART, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCathcart v. CommissionerDocket No. 7033-76.United States Tax CourtT.C. Memo 1977-328; 1977 Tax Ct. Memo LEXIS 113; 36 T.C.M. (CCH) 1321; T.C.M. (RIA) 770328; September 22, 1977, Filed 113 Petitioners obtained a mortgage loan. Withheld from the proceeds of the loan were points representing additional interest. Held, petitioners are not entitled to deduct the entire amount of the points in the year they received the mortgage proceeds. Steven F. Gadon and George M. Britts, for the petitioners. Jan S. Neiman, for the respondent. WILESMEMORANDUM FINDINGS OF FACT AND OPINION WILES, Judge: Respondent114 determined a deficiency of $644.84 in petitioners' 1973 income tax. Because of concessions by the parties, the only issue we must decide is whether points withheld from a mortgage are deductible in the year petitioners obtained the mortgage proceeds. FINDINGS OF FACT This case was fully stipulated by the parties. Their stipulation and the exhibits attached thereto are incorporated herein by this reference. Petitioners Kenneth A. Cathcart and his wife Joan A. Cathcart timely filed their joint 1973 Federal income tax return, and were residents of Coral Springs, Florida, when they filed their petition herein. On January 15, 1973, petitioners obtained a mortgage from Southern Federal Savings and Loan Association of Broward County (hereinafter Southern Federal). The amount of this mortgage was $57,600, had an interest rate of 7 percent per year, and a duration of 29 years. Although the amount of the mortgage was $57,600, petitioners received a total disbursement of $55,039.92. In making the loan, Southern Federal withheld from the loan proceeds the following amounts: Recording Mortgage$ 10.00Documentary Stamps86.40Intangible Tax115.20Association Costs429.80Points1,086.60Preliminary Abstract40.00Final Abstract12.50Tax Escrow (3 months)216.48Insurance Escrow(1 month)28.67Prepaid Interest1/15/73-1/31/73190.43First Year InsurancePremium344.00Total Amount WithheldFrom Loan Proceeds$2,560.08115 On their 1973 Federal income tax return, petitioners, who are cash method taxpayers, claimed a $6,759.52 interest expense deduction. Of this amount, $1,631.60 was attributable to "mortgage refinancing cost" consisting of the intangible tax, association costs, and points, listed above. Respondent, in his notice of deficiency, disallowed the interest expense deduction for mortgage refinancing costs to the extent of $1,597.28. Petitioners now concede they are not entitled to deduct the intangible tax or the association costs, but maintain the entire amount of the points, $1,086.60, is deductible in 1973. The parties agree that the $1,086.60 charged for points represents an interest charge, and not a service charge. OPINION The only issue we must resolve is whether petitioners are entitled to deduct points withheld from mortgage proceeds in the year petitioners obtained their mortgage. On January 15, 1973, petitioners obtained a net proceeds mortgage loan from Southern Federal. The face amount of the mortgage was $57,600, bearing a 7 percent interest rate and having a duration of 29 years. As is common practice in net proceeds mortgage loans, the amount ultimately disbursed116 to petitioners, $55,039.92, was less than the face amount of the mortgage. The difference withheld by Southern Federal, $2,560.08, was used to pay various services and to pay points totalling $1,086.60. Although points frequently represent a hidden service charge, in the case before us the parties agree that the points represent an interest charge. As such, their deductibility is governed by section 163. 1Petitioners contend the entire $1,086.60 charged for points is fully deductible in 1973. In contrast, respondent contends the amount charged for points was not fully paid by petitioners in 1973, but rather payment is included in petitioners' monthly mortgage payments over the 29-year term. As such, respondent contends petitioners must pro rate the points over the life of the loan. This method of pro rating the charge over the life of the loan would entitle petitioners to an interest deduction of $34.34 for 1973. 2117 Section 163(a) provides that "There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness." Despite the language of section 163(a), cash method taxpayers may not take interest expense deductions for prepaid interest if such deductions materially distort their income. Sandor v. Commissioner,62 T.C. 469">62 T.C. 469 (1974), affd. 536 F. 2d 874 (9th Cir. 1976); Cole v. Commissioner,64 T.C. 1091">64 T.C. 1091 (1975); Resnik v. Commissioner,66 T.C. 74">66 T.C. 74 (1976), on appeal (7th Cir., June 30, 1976). The Internal Revenue Service, and subsequently Congress, recognized an administrative exception to the material distortion of income argument when dealing with taxpayers who prepay interest or points on a home mortgage. See Rev. Rul. 69-582, 2 C.B. 29">1969-2 C.B. 29; sec. 461(g)(2), added by sec. 208(a), Tax Reform Act of 1976, 90 Stat. 1541. Consequently, cash method taxpayers who prepay points on their home mortgages with funds not obtained from the lender are entitled to deduct the entire amount in the year paid. This rule, however, does not settle the case before us. Although we have cash method118 taxpayers who obtained a mortgage loan secured by their personal residence, the points required in order to obtain the loan were withheld from the mortgage proceeds. Because the points were withheld from the loan proceeds, rather than paid by petitioners to Southern Federal, we conclude petitioners are not entitled to deduct the entire $1,086.60 in 1973. Our decision in this matter is controlled by Rubnitz v. Commissioner,67 T.C. 621">67 T.C. 621 (1977). In Rubnitz, taxpayer owned an interest in Branham Associates (hereinafter Branham). In order to construct an apartment complex Branham, in 1970, obtained a $1,650,000 construction loan from a savings and loan association. Withheld from the proceeds of this loan was a "loan fee" of $57,750, which the parties agreed constituted interest under section 163(a). We concluded that the deduction or withholding of the loan fee from the loan proceeds did not constitute a "payment" of interest within the meaning of section 163(a), and therefore Branham was not entitled to deduct the full $57,750 as interest paid in 1970. Consequently, taxpayer was not entitled to the entire interest deduction he had claimed. In reaching119 this conclusion, we noted at 628, Branham received $1,592,220 from the bank but it promised to repay $1,650,000 plus interest at a specified rate. Of the difference between these figures, $57,750 might well have represented additional interest charges. However, it is plain that Branham did not pay that interest in 1970. Instead, by signing a promissory note, it specifically chose to postpone paying that amount until sometime in the future. The entire $57,780 was to be paid ratably by the borrower over the life of the loan as one component of the monthly installments * * which would ultimately result in the payment of the full $1,650,000.Therefore, Branham may not deduct the $57,750 as "interest paid" during 1970. Similarly, we conclude that petitioners are not entitled to deduct their points, totalling $1,086.60, as "interest paid" during 1973. Rather, petitioners may only deduct $34.34, that pro rata portion of the points attributable to 1973. To reflect the foregoing, Decision will be entered under Rule 155. Footnotes1. Statutory references are to the Internal Revenue Code of 1954 as amended and in effect during 1973.↩2. $1,086.60 X 11 monthly payments / 12 months X 1 / 29-year term = $34.34 Respondent erroneously contends that petitioners are entitled to deduct $34.32, rather than $34.34, in 1973. Respondent arrived at this figure by inserting $1,086.00 in the above formula.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619363/	Buena Vista Farms, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentBuena Vista Farms, Inc. v. CommissionerDocket No. 7173-74United States Tax Court68 T.C. 405; 1977 U.S. Tax Ct. LEXIS 93; June 20, 1977, Filed 93 Decision will be entered for the respondent. Held: B, a corporate farmer, held water primarily for sale in the ordinary course of its trade or business. Accordingly, the sale of 10 percent of its contractual right to receive payment in kind for water sold does not qualify as a sale or exchange of a capital asset under sec. 1221, I.R.C. 1954, and the gain attributable thereto is taxable as ordinary income. George H. Koster, for the petitioner.Peter D. Bakutes, for the respondent. Fay, Judge. FAY406 Respondent determined a deficiency in petitioner's Federal income tax for the calendar year 1971 in the amount of $ 18,951.Due to concessions, the sole issue remaining is whether 94 the gain realized by petitioner on the sale of a portion of its contractual right to receive certain water was capital gain or ordinary income.FINDINGS OF FACTCertain facts were stipulated and are so found.Petitioner Buena Vista Farms, Inc., was incorporated in the State of Delaware in 1965. At the time of filing the petition herein, its principal place of business was located in San Francisco, Calif. Petitioner timely filed a Federal corporate income tax return for the calendar year 1971 with the Director, Internal Revenue Service Center, Fresno, Calif.In 1966 petitioner merged with Buena Vista Associates, Inc., a California corporation primarily engaged in the business of farming. Petitioner is the successor corporation to Associates and as such acquired all the assets and assumed all the liabilities of Associates. During all relevant periods both corporations conducted the same businesses and were engaged in the same day-to-day activities. Consequently, the term "petitioner" will hereinafter refer to both Buena Vista Farms, Inc., and Buena Vista Associates, Inc.The farming activities of petitioner consisted of leasing farmland to tenants for a specified rental in cash 95 or crops. In addition, petitioner derived substantial income from the sales of water to tenants and other purchasers for irrigation purposes.The assets of petitioner included 1,847 acres of land known as the Paloma Ranch and approximately 23,000 acres of farmland referred to herein as the lake property. These properties are located in the southwestern part of the San Joaquin Valley in Kern County, Calif. Paloma Ranch was crisscrossed by extensive pipelines installed by oil companies, and only minimal farming activities were conducted on the property.407 The lake property was suitable for farming and was leased, solely for that purpose, by petitioner to the J. G. Boswell Co. (Boswell) from 1962 through 1970 under a long-term crop-sharing lease. The crops which were grown on this property consisted of cotton, different types of grain, and some specialty crops. Petitioner leased the lake property to five partnerships in 1971 for a cash rental. Petitioner's farming activities conducted in this manner were most successful, as the following chart demonstrates:TotalFarmingFarming incomeYearincome1 incomeas percent of total1961$ 739,765$ 652,03188.11962985,051884,88189.81963948,306829,55887.519641,105,8111,040,64194.119661,832,2031,017,68455.519671,553,558819,51352.819681,116,947789,59170.719691,233,283872,03970.719701,294,392891,33668.919712,960,4142,135,36772.196 The southern portion of the San Joaquin Valley receives only approximately 5 inches of rainfall per year. Thus, water for agricultural purposes in the area was supplied by irrigation. As part of its farming activities, petitioner sold water to tenants for irrigation purposes. In addition, petitioner sold water for irrigation to other purchasers, though it did not maintain a sales force or solicit sales of water. Petitioner obtained this water from three principal sources: water underlying the property and brought to the surface by wells located on the property, water diverted from the Kern River pursuant to a water right equal to 4 percent of the measured flow of the river at a certain point, and water purchased from other suppliers when the first two sources were inadequate. Delivery was effectuated through an elaborate system97 of ditches, pipelines, drains, pumps, and wells maintained by petitioner. Petitioner derived substantial income from water which it sold to tenants (as needed, from day-to-day) pursuant 408 to various written leases and to other purchasers as reflected by the following chart:1960$ 7,49819610196222,996196341,184196417,948196501966177,0161967399,1751968256,0121969295,0901970308,0121971708,437Petitioner consistently reported amounts received from water sales as ordinary income and claimed corresponding deductions for expenses incurred in delivering water, maintaining and repairing water delivery facilities, and purchasing water, on its Federal income tax returns. In addition, petitioner maintained a separate income account in its general ledger entitled "Water Income" for recording receipts from sales of water, and listed "inventory-water" and "water-inventory" as an asset on its balance sheets from 1963 through 1967.In 1964 the State of California (hereinafter referred to as the State) embarked upon the construction of the California Aqueduct. The purpose of the aqueduct was to transport water from northern to central and southern98 California.Due to its extremely dry condition, soil in portions of the San Joaquin Valley is subject to severe settling when water soaks the soil. This problem is generally known as shallow subsidence. To alleviate this problem, the State decided to preconsolidate or soak the soil in certain portions of the aqueduct's pathway prior to the construction of the aqueduct.In conjunction with this project, negotiations ensued between the California Department of Water Resources and petitioner concerning the furnishing of water by petitioner to the State for a portion of its preconsolidation requirements. During the course of the negotiations, there was no threat or discussion of condemnation of petitioner's water supplies. These negotiations culminated in an agreement entitled "Preconsolidation Water Agreement" (agreement) and dated June 1, 1964, which provided inter alia:A. As part of the facilities of the State Water Resources Development System being constructed by State pursuant to the California Water Resources Development Bond Act, State proposes to construct an aqueduct 409 with appurtenant pumps, structures and equipment running generally in a southeasterly direction99 through the southern portion of Kern County;B. State desires to acquire during the period of construction of said aqueduct a supply of water, ranging in quantity from a minimum of 47,000 acre-feet to a maximum of 76,400 acre-feet, to be used for preconsolidation of soils in the construction of said aqueduct; * Now, Therefore, Associates hereby agrees to sell, exchange, deliver and transport water to State and State hereby agrees to purchase and exchange water with Associates and to compensate it in accordance with the following provisions, to each and all of which the parties hereby mutually agree:1. Quantity: Associates shall deliver and State shall take hereunder not less than 23,500 acre-feet nor more than 38,200 acre-feet of water together with the transportation loss water hereinafter described. * 4. Transportation Losses: The maximum and minimum quantities of water to be supplied to State by Associates * * are quantities measured at Terminal Point as above identified. It is recognized that there may be channel losses between various Delivery Points and Terminal Point, and Associates agrees to supply all such losses, but shall be compensated for the same 100 by State in manner hereinafter provided in subparagraphs 9(b) and 9(c)(3). * 9. Compensation and Price: State shall compensate Associates for water supplied and services rendered hereunder as follows: * (b) In accordance with the provisions of paragraph 10, State shall deliver to Associates 131,600 acre-feet of water in exchange for the first 23,500 acre-feet of Associates' water delivered to and measured at the Terminal Point, and in exchange for an agreed transportation loss of 9,400 acre-feet to be incurred in transporting the first 47,000 acre-feet or any part thereof of water under both this contract and the contract of State with Kernco.(c) State shall compensate Associates for the remaining quantities of water required to be delivered by Associates pursuant to this contract as follows: * (2) Within ninety (90) days after the end of each calendar month during which water is delivered hereunder, State shall pay Associates the sum of $ 8.50 per acre-foot for each acre-foot of Associates' water in excess of 23,500 acre-feet delivered to and measured at the Terminal Point. * 10. Exchange Water: * (b) State shall, after completion of State aqueduct deliver101 to Associates, or its designees, at aqueduct's side, all quantities of water to which Associates is entitled pursuant to subparagraph 9(b) herein. Such water shall be delivered by State as requested by Associates, or its designee, prior to the year 1985, at such times as State determines it has capability to deliver surplus water * * * in excess of the annual entitlements of water 410 supply contractors * * provided, however, that no water shall be delivered in any year in which a shortage occurs * * . Requests for water pursuant to this paragraph shall be made in writing three months prior to the year * * in which water deliveries are desired. 2With regard to payment, petitioner agreed to receive water from the aqueduct when completed (hereinafter referred to as exchange water) as payment for the initial 32,900 acre-feet of water delivered to the State due to the scarcity102 of the commodity in the area. 3In 1965 and 1966, 23,499 acre-feet of water was delivered to the State under the agreement. Payments received by petitioner in money for water sold to the State pursuant to the agreement were reported as ordinary income for the year in which such payments were received.By March 10, 1968, all of the water to be furnished the State under the agreement had been delivered. 4103 Petitioner claimed deductions from ordinary income on its Federal income tax returns for expenses of delivering water to the State pursuant to the agreement.In 1971 prior to requesting or receiving any portion of the 131,600 acre-feet of exchange water from the State, as provided by paragraphs 9(b) and 10(b) of the agreement, petitioner sold 10 percent of its right to such water to a certain individual for $ 105,279. 5On its 1971 Federal income tax return, petitioner reported the $ 105,279 received as long-term capital gain from "water rights." 6 In his notice of deficiency, respondent determined that such amount constituted ordinary income.411 OPINIONThe 104 parties have framed the issue before us very narrowly, and we will confine our opinion to that issue. Specifically, we are to decide whether the gain realized by petitioner in 1971 from the assignment and sale of a portion of a contract interest or right, to receive certain exchange water, represents capital gain or ordinary income.Petitioner's position is predicated on its assertion that what it sold was an interest in an executory contract with a right thereunder to acquire certain property. Petitioner argues that as such, the contract represents "property" which does not fall within the exclusionary provisions of section 1221, 7 and thus constitutes a capital asset in its hands. Petitioner therefore concludes that the gain realized from such sale represents capital gain. We find petitioner's argument unpersuasive as it fails to distinguish between the conversion of a capital investment and the sale of a right to earned income.105 As the Supreme Court stated in Commissioner v. Gillette Motor Co., 364 U.S. 130">364 U.S. 130, 134 (1960):While a capital asset is defined * * as "property held by the taxpayer," it is evident that not everything which can be property in the ordinary sense and which is outside the statutory exclusions qualifies as a capital asset. * * * Thus the Court has held that an unexpired lease, * * * corn futures, * * * and oil payment rights * * * are not capital assets even though they are concededly "property" interests in the ordinary sense. * * Thus, the mere fact that what was sold by petitioner was a "contract right" does not establish that what was sold was a capital asset. See Commissioner v. P. G. Lake, Inc., 356 U.S. 260">356 U.S. 260 (1958); United States v. Woolsey, 326 F.2d 287">326 F.2d 287, 291 (5th Cir. 1963); United States v. Eidson, 310 F.2d 111">310 F.2d 111, 113-114 (5th Cir. 1962); Holt v. Commissioner, 35 T.C. 588 (1961), affd. 303 F.2d 687">303 F.2d 687 (9th Cir. 1962).Rather, it must be determined from an examination of the nature of the underlying106 sale of water to the State which gave rise to petitioner's right under the contract, whether such "contract right" represents a capital investment or an income right for Federal income tax purposes. Commissioner v. P. G. 412 ;Commissioner v. Ferrer, 304 F.2d 125">304 F.2d 125 (2d Cir. 1962), revg. in part 35 T.C. 617">35 T.C. 617 (1961); Norton v. United States, 551 F.2d 821 ( Ct. Cl. 1977, 39 AFTR 2d 77-1000, 77-1 USTC par. 9296); Holt v. Commissioner, supra.Such a determination requires that we initially ascertain whether the water petitioner sold to the State constituted a capital asset in petitioner's hands. 8Section 1221(1) provides that "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business" is excluded from the definition of a capital asset. Thus, proceeds from the sale of such "property" represent ordinary income.107 In the present case, the record clearly indicates that petitioner held its water primarily for sale to customers in the ordinary course of its business. Throughout the period from 1962 to 1971, petitioner's sales of water to lessees and other purchasers were continuous and substantial. Petitioner reported proceeds from water sales as ordinary income and claimed deductions for expenses attributable to the delivery of water, maintaining water delivery facilities, and purchasing water. In addition, an elaborate system of ditches, pipelines, drains, pumps, and wells was maintained by petitioner for the transport of water. Furthermore, water was listed as inventory in petitioner's financial statements from 1963 through 1967.The record indicates no reason to distinguish water sales by petitioner to the State from sales to other customers. Indeed, petitioner not only purchased approximately 46 percent of the quantity of such water specifically for resale to the State, but reported cash payments from the State as ordinary income. 9108 413 In view of the foregoing, the conclusion is inescapable that had petitioner received cash as payment for the entire amount of water it furnished the State under the contract, such amount would have been taxable as ordinary income. Westchester Development Co. v. Commissioner, 63 T.C. 198 (1974); cf. Arrowsmith v. Commissioner, 344 U.S. 6">344 U.S. 6 (1952). Furthermore, it is evident that petitioner's contractual right to receive exchange water from the State represents, in substance, a right to receive income from the sale of a noncapital asset. Commissioner v. P. G. Lake, Inc., 356 U.S. 260">356 U.S. 260 (1958); Hort v. Commissioner, 313 U.S. 28 (1941); cf. Kingsbury v. Commissioner, 65 T.C. 1068">65 T.C. 1068 (1976).While no issue is presented in this case regarding the taxable year in which the exchange water was properly reportable by petitioner as ordinary income, it is clear that payment in kind does not serve to transmute ordinary income into capital gain. See sec. 1.61-1(a), Income Tax Regs.Accordingly, we hold that upon the sale of 10 percent of*109 its contractual right, petitioner merely received a substitute for what would otherwise constitute ordinary income, and is taxable as such.Having so concluded, we need not consider whether the Corn Products doctrine exception to section 1221 is applicable in this case. See Corn Products Co. v. Commissioner, 350 U.S. 46 (1955); Hollywood Baseball Association v. Commissioner, 423 F.2d 494">423 F.2d 494 (9th Cir. 1970), affg. 49 T.C. 338">49 T.C. 338 (1968); Norton v. United States, supra.Decision will be entered for the respondent. Footnotes1. In 1971, the only year in which petitioner actually tilled the soil, less than 20 percent of petitioner's farm acreage was actually farmed by it. There are no figures available for 1965.↩2. The record indicates that 1 acre-foot of water is the amount of water necessary to cover 1 acre of land with 12 inches of water.↩3. The 131,600 acre-feet of water represents 32,900 acre-feet multiplied by 4. Pursuant to the 1966 merger, Buena Vista Farms, Inc., succeeded to all of Buena Vista Associates, Inc.'s rights and obligations under the Preconsolidation Water Agreement.↩4. The parties have stipulated that 54 percent of the water furnished in 1965 and 1966 by petitioner to the State pursuant to the agreement, came from petitioner's wells, and the remaining 46 percent came from water purchased by petitioner for purposes of delivery to the State. Seventy-nine percent of the water furnished in 1967 and 1968 by petitioner to the State pursuant to the agreement came from petitioner's wells, and the remaining 21 percent came from water purchased by petitioner for purpose of delivery to the State.↩5. This amount represents approximately $ 8 per acre-foot.↩6. Petitioner reported all $ 105,279 received as gain in accordance with his acknowledged basis of zero in the exchange water.↩7. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended.↩8. If water was a capital asset in petitioner's hands, a contractual right to acquire water would appear to also represent a capital asset. See Dorman v. United States, 296 F.2d 27">296 F.2d 27 (9th Cir. 1961). If the contractual right in issue represents the gain from the sale of a capital asset, the matter becomes largely theoretical. The proceeds would represent capital gain whether viewed as derived from the sale of a capital asset (the contract right) or the assignment by petitioner of its right to receive such capital gain. See Arrowsmith v. Commissioner, 344 U.S. 6">344 U.S. 6↩ (1952).9. We find petitioner's emphasis on its lack of a sales force and solicitations to refute the strong inference suggested by the foregoing pattern of conduct to be unpersuasive. While we are mindful of the significance sometimes attached to this factor, in view of the fact that petitioner's water resources were well known, the arid nature of the climate, and petitioner's lease provisions requiring tenants to purchase water from petitioner, we believe such sales efforts on the part of petitioner were unnecessary in this instance.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619365/	Multnomah Operating Co. v. Commissioner.Multnomah Operating Co. v. CommissionerDocket No. 52071.United States Tax CourtT.C. Memo 1956-42; 1956 Tax Ct. Memo LEXIS 256; 15 T.C.M. (CCH) 185; T.C.M. (RIA) 56042; February 23, 1956256 Harry Henke, Jr., Esq., and Harold L. Scott, C.P.A., Dexter Horton Building, Seattle, Wash., for the petitioner. Joseph G. White, Jr., Esq., for the respondent. WITHEYMemorandum Findings of Fact and Opinion WITHEY, Judge: The Commissioner has determined a deficiency against the petitioner, Multnomah Operating Co., in the amount of $11,805.43 for the year 1948 and $11,530.56 for the year 1949. The sole issue for our determination is whether or not certain payments made in each year by petitioner constituted deductible business expenses under section 23(a)(1)(A) of the Internal Revenue Code of 1939. Findings of Fact Stipulated facts are so found. Petitioner, Multnomah Operating Co., hereinafter referred to at times as Multnomah, is a corporation with its principal office and place of business in Seattle, Washington. It filed income tax returns for the calendar years 1948 and 1949 with the collector for the district of Washington. Petitioner was incorporated in 1931 with a paid-in capital of $1,000 which was represented by 250 shares of common stock. On the following dates, these shares were held as listed: July 1JanuaryJanuaryJanuaryShareholder1931194419481949A. P. Bassett15151515A. D. Belanger15F. A. Dupar & Peoples Natl. Bank Coexecutorsunder Will of A. P. Bassett5Frank A. Dupar171/21/210 1/2H. E. Dupar15H. E. Dupar and F. A. Dupar, Trustees1515Eric V. Hauser1F. M. Kenney - qualifying share Pacific CoastInvestment Co.111John R. Latourette1Maltby-Thurston Hotels, Inc.123Peter G. Schmidt, Trustee62S. W. Thurston - qualifying share Maltby-Thurston Hotels, Inc.1111Voting Trust - in existence from May 1, 1940to April 30, 1950217 1/2217 1/2217 1/2Total250250250250257 During the period 1944 through 1949 voting control of petitioner rested in the members of a voting trust, the identity and stock contributions to the trust of such members being as follows: MULTNOMAH OPERATING CO.Members of Voting Trust fromMay 1, 1940, to May 1, 1950194419481949F. A. Dupar171717H. E. Dupar15Maltby-Thurston Hotels, Inc.124124124Pacific Coast Investment Co.61 1/261 1/261 1/2Seattle First National Bank,Trustee under Will of H. E.Dupar, deceased1515Total217 1/2217 1/2217 1/2The total outstanding stock of the Maltby-Thurston Hotels, Inc., hereinafter referred to as Maltby, was as shown below in the following tabulations. These shares were held as follows on the following dates: MALTBY-THURSTON HOTELS, INC.July 1, 1931PrincipalCommonClass APreferredStockholdersStockStockStockTroy E. Himmelman1,991 2/33279 1/2F. M. Kenney1Harold Emery Maltby6,5691,260196 1/4Pacific Coast Investment Company1 1/4S. W. Thurston10,153 1/4120188 1/2Subtotal18,714 11/121,412465 1/2Frank D. or Blanche Bruce1,45915029H. E. Lutz2,04270175Earl McInnes1,566 2/33589Hy D. Miller150Total23,782 7/121,667908 1/2Stock outstanding on dates indicated above31,298 3/44,186 1/24,756258 Jan. 1, 1944Jan. 1, 1948Jan. 1, 1949CommonCommonCommonStockStockStockFrank A. Dupar08561,178T. E. Himmelman775797836F. M. Kenney457070Harold Emery Maltby100525525Dewey W. Metzdorf172172Pacific Coast Investment Co.511 1/4511 1/4511 1/4S. W. Thurston26 1/4184 3/4300 3/4Voting Trust15,995 1/215,11215,112Subtotal17,45318,22818,705Frank D. or Blanche Bruce1,569 1/41,569 1/41,569 1/4H. E. Lutz1,689 1/41,689 1/41,689 1/4Earl McInnes668 2/3668 2/3668 2/3Hy D. Miller344Total21,724 1/622,155 1/622,632 1/6Stock outstanding on dates indicated above27,52830,32330,401MALTBY-THURSTON HOTELS, INC.Stock in Voting TrustJan. 1,1944Jan. 1948Jan. 1949Frank A. Dupar267267267T. E. Himmelman1,7371,7371,737F. M. Kenney108108108H. E. Maltby5,725 1/45,0005,000Adeline G. Metzdorf1,0001,000Dewey W. Metzdorf828828S. W. Thurston8,158 1/46,1726,172Total15,995 1/215,11215,112Western Hotels, Inc., hereinafter referred to as Western, was incorporated259 about 1930 as a hotel service organization rendering general services to all hotels for a consideration. It represented an effort on the part of Maltby, Pacific Coast Investment Co., hereinafter referred to for convenience as PCI, and Frank A. Dupar who had previously been competitors to thereafter cease competition and act in concert to their mutual benefit in the hotel business. Western's total capital stock during 1931 consisted of 5,630 shares which was reduced to 100 shares in 1934. Its stock was held as follows on the indicated pertinent dates: WESTERN HOTELS, INC.Janu-Janu-Janu-July 1,aryaryaryShareholders1931194419481949A. D. Belanger1Byron Hotel Co.519Capital Hotel Co.558H. W. Casson1Chas. T. Donworth1Frank A. Dupar1252525Elman Hotel Co.299Exchange Invest-ment Co.179F. M. Kenney1H. E. Maltby1Maltby-ThurstonHotels Inc.2,886505050Hy D. Miller1Carl E. Morck1Morck Hotel Co.299John C. Pierce1Thad S. Pierce1Adolph D. Schmidt1Peter G. Schmidt1S. W. Thurston1Washington HotelCo.499West Coast HotelCo.378Pacific Coast Invest-ment Co.252525Total5,630100100100260 The total outstanding stock of PCI was at all times 600,000 shares which were held on July 1, 1931, as follows: PACIFIC COAST INVESTMENT CO.July 1, 1931Number ofStockholdersShares HeldJ. Duttenhoefer1,008W. J. Foster540W. B. Gaffney, Estate2,400A.C.C. Gamer220Henry Schupp5,040Larabie Stock Co.78,246Julia W. Larabie9,601C. Ted Larabie2,400Mary Ann Larabie2,400Lucien Larabie2,400Elizabeth Larabie2,400Sue M. Larabie2,400Fred Stocking1,231P. M. Troy1,231Sams V. Peters270Schmidt Estate, Inc.348,506Peter G. Schmidt14,401Mrs. Peter G. Schmidt500Frank T. Schmidt7,200Frederick W. Schmidt905Joe R. Speckart37,472J. H. Rohrbeck1F. M. Kenney6,001Toba Harris6,000N. P. Faris135Emma M. Foreman12,906Lena R. Gamer25,812C. E. Larabie1,200Mrs. R. D. Larabie3,600Emmy Mailand5,334U.S.National Bank of Portland,Trustee5,334Dorothy L. Gamer6,453Leland S. Gamer6,453Total number of shares issued600,000 on January 1, 1944, as follows: PACIFIC COAST INVESTMENT CO.January 1, 1944Number ofStockholdersShares HeldDr. Marie D. Equi5,334Blanche Gaffney1,200F. M. Kenney92,371Frank J. Kenney2,500Janet Lee2,500Helen Malloy2,500Grace Mallory2,500Emma M. Foreman25,812W. J. Foster540Olive B. Gaffney1,200A.C.C. Gamer12,906Dorothy L. Gamer6,573Leland L. Gamer6,553Irene Hannah6,000F. M. Kenney, Peter G. Schmidt,Trustees for Paula Speckart37,472Mrs. R. D. Larabie3,600Caroline Schmidt Maury4,000J. C. Sams270Phillipine S. Rettenmeyer62,175Adolph Schmidt42,175Clara M. Schmidt, Trustee20,000Clara M. Schmidt, Personal500Louise W. Schmidt62,179Peter G. Schmidt, Frank T. Schmidt,J. B. Peyton, Trustees for ElsaSchmidt63,080Peter G. Schmidt, Personal42,175Frank T. Schmidt, Trustee70,383Adolph Schmidt, Jr.4,000Robert A. Schmidt4,000Truman L. Schmidt4,000Philip H. Schmidt4,000Katherine Schupp5,040Alma Stocking1,231Smith Troy1,231Total number of shares issued600,000261 on January 1, 1948, as follows: PACIFIC COAST INVESTMENT CO.January 1, 1948Number ofStockholdersShares HeldMaltby-Thurston Hotels, Inc.471,983F. M. Kenney82,271Frank J. Kenney4,500Irene Kenney2,000Janet Lee4,500Dr. Marie D. Equi5,334Helen A. Malloy4,600Grace Mallory4,500New Washington Hotel Co.19,112Olive B. Gaffney1,200Total number of shares issued600,000 and on January 1, 1949, as follows: PACIFIC COAST INVESTMENT CO.January 1, 1949Number ofStockholdersShares HeldMaltby-Thurston Hotels, Inc.433,522New Washington Hotel Co.58,773Dr. Marie Equi5,334F. M. Kenney81,371Frank J. Kenney4,500Janet Lee4,500Irene Kenney2,000Helen A. Malloy4,600Mark A. Malloy900Grace Mallory4,500Total stock issued600,000The officers and directors of Maltby during the period 1944 through 1949 were as follows: 1944, 1945DirectorsOfficersS. W. ThurstonS. W. Thurston, Pres.F. A. DuparF. A. Dupar, Vice Pres.T. E. HimmelmanT. E. Himmelman, ViceH. E. MaltbyPres.H. W. CassonH. E. Maltby, Sec.-Treas.Chas. T. DonworthH. W. Casson, Asst. Sec.-F. M. KenneyTreas.1946, 1947, 1948S. W. ThurstonS. W. Thurston, Pres.F. A. DuparF. A. Dupar, Vice Pres.T. E. HimmelmanT. E. Himmelman, ViceH. E. MaltbyPres.Chas. T. DonworthH. E. Maltby, Sec.-Treas.F. M. Kenney, Asst. Sec.-Treas.1949S. W. ThurstonS. W. Thurston, Pres.F. A. DuparF. A. Dupar, Vice Pres.T. E. Himmelmanand Asst. Treas.H. E. MaltbyT. E. Himmelman, ViceChas. T. DonworthPres.Dewey W. MetzdorfH. E. Maltby, Sec.-Treas.F. A. Weston, Asst. Sec.-Treas.262 The officers and directors of the petitioner, Multnomah, for the years 1931 and 1944 through 1949, inclusive, were as follows: 1931DirectorsOfficersS. W. ThurstonS. W. Thurston, Pres.Earl V. HauserE. V. Hauser, Vice Pres.F. A. DuparF. A. Dupar, Sec.Peter G. SchmidtPeter G. Schmidt, Treas.H. E. MaltbyH. E. Maltby, Asst. Sec.John R. Latourette1944, 1945, 1946S. W. ThurstonS. W. Thurston, Pres.F. M. KenneyF. M. Kenney, Vice Pres.F. A. DuparEarl McInnis, Vice Pres.F. A. Dupar, Sec.H. E. Maltby, Treas.H. W. Casson, Asst. Treas.1947S. W. ThurstonS. W. Thurston, Pres.F. M. KenneyF. M. Kenney, Vice Pres.F. A. DuparEarl McInnis, Vice Pres.F. A. Dupar, Sec.H. E. Maltby, Treas.F. A. Weston, Asst. Sec.-Treas.1948, 1949S. W. ThurstonS. W. Thurston, Pres.F. M. KenneyF. M. Kenney, Vice Pres.F. A. DuparGordon Bass, Vice Pres.F. A. Dupar, Sec.H. E. Maltby, Treas.F. A. Weston, Asst. Treas.The officers and directors of Western for the years 1944 through 1949, inclusive, were as follows: 1944, 1945, 1946DirectorsOfficersS. W. ThurstonS. W. Thurston, Pres.F. M. KenneyF. M. Kenney, Vice Pres.F. A. DuparT. E. Himmelman, VicePres.F. A. Dupar, Sec.H. E. Maltby, Treas.H. W. Casson, Asst. Sec.-Treas.1947S. W. ThurstonS. W. Thurston, Pres.F. M. KenneyF. M. Kenney, Vice Pres.F. A. DuparT. E. Himmelman, VicePres.E. E. Carlson, Vice Pres.C. W. Hunlock, Vice Pres.F. A. Dupar, Sec.H. E. Maltby, Treas.1948S. W. ThurstonS. W. Thurston, Pres.F. M. KenneyF. M. Kenney, Vice Pres.F. A. DuparT. E. Himmelman, VicePres.Dewey W. Metzdorf, VicePres.C. W. Hunlock, Vice Pres.E. E. Carlson, Vice Pres.F. A. Dupar, Sec.H. E. Maltby, Treas.F. A. Weston, Asst. Sec.-Treas.1949S. W. ThurstonS. W. Thurston, Pres.F. M. KenneyF. M. Kenney, Vice Pres.F. A. DuparT. H. [T. E.] Himmelman,Vice Pres.Dewey W. Metzdorf, VicePres.C. W. Hunlock, Vice Pres.E. E. Carlson, Vice Pres.F. A. Dupar, Sec.H. E. Maltby, Treas.263 The officers and directors for PCI from 1944 through 1949, inclusive, were as follows: 1944, 1945, 1946DirectorsOfficersF. M. KenneyF. M. Kenney, Pres.Peter G. SchmidtA.C.C. Gamer, Vice Pres.A.C.C. GamerF. W. Schmidt, Sec.A. D. SchmidtF. W. Schmidt1947F. M. KenneyF. M. Kenney, Pres.Peter G. SchmidtA.C.C. Gamer, Vice Pres.A.C.C. GamerF. W. SchmidtA. D. Schmidt, Jr.F. W. Schmidt1948, 1949F. M. KenneyF. M. Kenney, Pres.F. A. DuparF. A. Dupar, Vice Pres.S. W. ThurstonS. W. Thurston, Sec.-Treas.F. A. Weston, Asst. Sec.-Treas.The Multnomah voting trust stock was votable by S. W. Thurston, Frank Dupar and F. M. Kenney on behalf of PCI in that order conditioned upon whether he who had the primary right so to do died, became incapacitated, unwilling or unable to vote the stock. The Maltby voting trustees in 1948 and 1949 were H. E. Maltby, S. W. Thurston, T. E. Himmelman, Frank A. Dupar and F. M. Kenney. By a lease, dated June 17, 1931, negotiated at arm's length, Hauser Securities Company leased the Multnomah Hotel in Portland, Oregon, to Maltby for a term of 15 years commencing July 1, 1931, and264 ending July 1, 1946. The lease rental consisted of a minimum fixed monthly rental of $7,000 per month and a designated percentage of gross revenue. No bonus or consideration other than this rental was paid to the lessor. The lease, inter alia, provided: "This lease to a large extent is based upon the personnel of the present officers of said Lessee and their ability to conduct and operate a first-class hotel and by reason thereof Lessee covenants and agrees not to assign this lease nor sublet nor underlet nor permit any other person or persons to occupy said premises other than the employees and patrons of said Lessee without the consent of said Lessor being first obtained in writing. * * (Provided further that it is understood and agreed that the within Lessee contemplates the forming of an Oregon corporation to whom the within lease may be assigned by it, the majority of the personnel of which will be the same as that of the within named Lessee and/or Western Hotels Inc. and Lessor consents to the within named Lessee assigning the within lease to said corporation to be duly formed providing that said assignment shall be subject to all of the terms, covenants and conditions265 of the within lease and with the consent that the demised premises are only to be used for the purposes herein stated and that the within consent shall in nowise alter, change or modify any term, covenant, provision or condition hereof nor shall this consent be continuing or extended to any other person, firm or corporation; provided further that said assignee shall in a form entirely satisfactory to the within named Lessor accept said assignment and agree to be bound by all the terms, covenants and conditions of the within lease; that this consent of assignment is limited to the one assignment herein stated, and after such assignment all liability of the within Lessee shall be at an end.)" The lessor required the deposit of security for the performance by petitioner of the lease provisions. To that end Maltby issued to petitioner $75,000 of its preferred stock which petitioner agreed to purchase. Petitioner in turn deposited the stock as security with the lessor. PCI, through its trustee, Peter G. Schmidt, and Frank Dupar each guaranteed to Maltby in writing that petitioner would pay the par value of 25 per cent of such stock. Each was required at an undisclosed time to pay the266 amount so guaranteed for which payment each was subsequently reimbursed by petitioner. On June 30, 1931, Maltby assigned its interest as lessee to petitioner, said assignment being assented to by the lessor. The assignment was therein stated to be "For One Dollar ($1.00) and other good and valuable consideration." The lease had been in negotiation for a period of approximately 10 months prior to its execution. The negotiators had been Dupar, Peter Schmidt and S. W. Thurston, who met with Hauser for negotiation approximately twenty times. At the time of assignment of the lease to petitioner, Dupar insisted upon compensation for his services rendered in the negotiations for the lease, for his guarantee of payment of par value of 25 per cent of the Maltby stock placed with the lessor as security by petitioner, and for what he alleged was his interest in the lease. It was agreed between Maltby, PCI and Dupar that petitioner would pay to them for the assignment of the lease of the hotel premises the amount of $2,500 per month after payment of the fixed and percentage rentals required by the lease terms. Of this amount, Dupar insisted that he receive $625 per month as such compensation. 267 The remainder, it was agreed, would be divided between PCI and Maltby in proportion to their respective stock holdings in petitioner. These payments were provided for by a separate written agreement between petitioner and Maltby entered into simultaneously with the assignment of the lease. Except for an undisclosed but short period of time immediately following inception, these payments have been made throughout the term of the lease and the extension thereof. At the time the lease was executed the Multnomah Hotel was in bad repair, and it was apparent that large expenditures would be required in order to make it a profitable business asset. To that end, the lease required the expenditure by petitioner of $21,600 per year over and above all other amounts or that such portion of that amount not so spent be paid to the lessor. The original lease terminated by its provisions July 1, 1946, but an extension was sought by petitioner as early as 1940 when it became apparent that negotiations by others were in progress in Portland looking toward the construction of a new hotel. Without the expenditure of about $400,000 for reequipment, remodeling and redecorating, petitioner's hotel could268 not withstand the competition of a new hotel. Before making such an investment, therefore, petitioner desired an extension of its lease. Negotiations for the lease extension were carried on by S. W. Thurston and Dupar, Schmidt having taken no part therein. Ultimately an extension agreement was executed directly between petitioner and the owner of the hotel property. This agreement, dated February 4, 1944, extended the term of the original lease to July 1, 1961, and provided for an increase of the minimum fixed rental to $8,500 per year. All of the terms and conditions of the original lease remained in full force and effect under the extension agreement, including the provision that the officers and personnel of petitioner were to be the same as Maltby or Western. Simultaneously petitioner and Hauser entered into a separate written agreement whereby provision was made for replacement of the original security of $75,000 of Maltby preferred stock with a like amount of the common stock of that corporation which was to be forfeited to Hauser as liquidated damages in case of petitioner's default in the lease terms. This was stock purchased and owned by petitioner. By an agreement between269 Maltby and Western, as first parties, and petitioner, as second party, dated February 3, 1944, petitioner agreed to continue the payments to Dupar, Maltby and PCI at the rate of $625, $1,250 and $625, respectively, throughout the extended term of petitioner's lease. The consideration therein stated for such extension of the payments is the agreement of said payees to accede to the lease extension at a higher minimum rental before the expiration of the original lease, the agreement of Maltby that its officers and personnel or that of Western would continue to operate the Multnomah Hotel, and the services of Maltby, Western and Frank Dupar in securing through negotiation the lease extention agreement. Peter G. Schmidt, as trustee of PCI, did not in fact aid in the procurement of the extension agreement. However, he and Dupar each approved the last mentioned agreement by their signatures. Opinion In its petition, its opening argument and on brief, petitioner has sought to limit the issue before us to the sole question of whether or not under section 23(a)(1)(A) of the 1939 Code 1 the amounts in controversy are properly deductible for the years 1948 and 1949 as rentals or other amounts270 necessary for petitioner's use and occupancy of the Multnomah Hotel property. Respondent, on the other hand, takes the view that such amounts are in reality nothing more nor less than distributions in the nature of guaranteed dividends to stockholders of petitioner and generally has determined that they are not deductible as ordinary and necessary business expense. 271 That the amounts involved, which were paid on either a monthly or a quarterly basis, totaling $2,500 per month, to Maltby, PCI and Dupar, hereinafter collectively referred to as payees, were not rentals, even though so designated in written contracts between the three payees and petitioner, we think is fairly obvious. In the light of the testimony of Dupar and S. W. Thurston who represented Maltby in all the transactions here involved, it is clear that the basis for the payments was services rendered by the three payees prior to the execution of the original lease in 1931 and also prior to the execution of the renewal agreement in 1944 and for services to be rendered thereafter during the term of the lease and its renewal. Petitioner, in contending that such payments were rentals and in attempting to show adequate consideration, therefore, urges that they were actually compensation for such services rendered in the past and to be rendered throughout the term of the lease. That being true, we can not conclude otherwise than that such payments were not rentals. We conclude from the facts as found that all the transactions referred to in such findings, with the exception of the lease272 and the renewal thereof negotiated with Hauser, were not arrived at on an arm's length basis. We must therefore scrutinize such transactions closely with respect to whether or not the controversial payments are "other payments required to be made as a condition to the continued use" of the hotel premises. The test, of course, lies in the answer to the question as to the likelihood or probability of an interruption in petitioner's use of such property in case it should default in such payments. The facts show clearly a close relationship between the three payees here involved and petitioner. Through a voting trust arrangement, they controlled petitioner. They were the parents responsible for its birth. As to the date of renewal of the lease, through their efforts, petitioner had become an increasingly valuable asset with bright prospects for its future. We do not think it is realistic to conclude that the three payees would have refused longer to render the services required of them in petitioner's operation under the lease in the event of default in the payment of the amounts in controversy, although concededly such default otherwise could have resulted in violation of the terms of*273 the lease through the payees' refusal to longer render the operational services therein required. We are impressed however that this record fully substantiates the conclusion that whatever the petitioner has named the amounts sought to be deducted, they were compensation for services rendered in the ordinary course of petitioner's business within the meaning of section 23(a)(1)(A). While respondent does contend that the $2,500 monthly payments are in excess of the true rental value of the hotel premises, he makes no contention that they are excessive or unreasonable as compensation. We think that, in the light of the long experience of all three payees in the hotel business and in view of their efforts in the negotiating of the original lease and the efforts of Dupar and Maltby in the negotiating of the renewal thereof, together with other services required of one or the other of them under the lease and its extension and agreements in pursuance thereof, such compensation is not unreasonable. Accordingly, we hold that the payments in question were deductible by petitioner. Decision will be entered under Rule 50. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: (a) Expenses. - (1) Trade or business expenses. - (A) In general. - All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619367/	DAVID G. and DELORES H. SATTERFIELD, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSatterfield v. CommissionerDocket No. 3418-73.United States Tax CourtT.C. Memo 1975-203; 1975 Tax Ct. Memo LEXIS 170; 34 T.C.M. (CCH) 872; T.C.M. (RIA) 750203; June 25, 1975, Filed Paul E. Castelloe and Lacy H. Reaves, for the petitioners. Eric B. Jorgensen, for the respondent. IRWINMEMORANDUM FINDINGS OF FACT AND OPINION IRWIN, Judge: Respondent determined a deficiency of $1,395.43 in the income tax of petitioners for the taxable year 1970. The sole issue for our determination is whether $5,985.88 of the amount petitioners reported as rental income is to be treated as a reimbursement for expenditures incurred by them on behalf of their lessee for improvements to the leasehold property and thus excludable171 from gross income. FINDINGS OF FACT Some of the facts have been stipulated and these stipulations are adopted as a part of our findings. The pertinent facts are summarized below. Petitioners, 1 David G. and Delores H. Satterfield, are husband and wife and resided in Clayton, N.C., during the year in issue and at the time of the filing of their petition with this Court. For the taxable year 1970 their joint Federal income tax return was timely filed with the Southeast Service Center, Chamblee, Ga. Petitioners employ the cash receipts and disbursements method of accounting. During the taxable year 1970 David G. Satterfield was engaged as a dealer of petroleum products. In addition to the petroleum dealership, petitioners owned and leased to commercial tenants certain warehouses located in Clayton, N.C. The above-mentioned warehouse property was purchased by petitioners in February 1968 from Central Oil and Milling Company of Clayton, N.C. At the date of purchase the property was subject to two leases which were assigned to petitioners. The lessee in both leases was Norwich Mills, 172 Inc. (Norwich), of Norwich, N.Y. One lease, dated September 1, 1965, covered warehouse number eight; the other, dated December 28, 1967, covered warehouse number one. There was also a third lease between petitioners and Norwich covering additional warehouse space. On March 14, 1969, Champion Products, Inc. (Champion) acquired Norwich through a merger and Norwich became a wholly-owned subsidiary. Norwich later was liquidated and became an operating division of Champion. In the early fall of 1969 Wayne K. Bright (Bright), Vice President of Finance of Champion, visited and inspected the warehouse facilities. He subsequently instructed William C. Dillon, Sr. (Dillon), Comptroller of Norwich, to negotiate a consolidation of the leases. In addition Dillon was directed to cause petitioners to reduce the fire hazard in warehouse number one resulting from its wooden flooring and to construct a cyclone fence around the loading ramps for additional safety. Aside from the fire hazard, Bright was also of the opinion that the flooring was in need of general repair. Dillon then conferred with petitioner and George Kloster, the plant manager of a manufacturing plant owned by Norwich in Clayton. 173 As a result of this conference, petitioner agreed to consolidate the leases into one lease to commence on January 1, 1970. Petitioner also agreed to install a concrete floor in warehouse number one and to construct a cyclone fence around the loading ramps. The new lease and supplemental agreement, set forth in the margin, 2 were drawn up by petitioners' attorneys. 174 On November 24, 1969, petitioner borrowed $6,000 from the Southern National Bank of North Carolina to pay for the improvements. The promissory note required petitioners to make 12 monthly payments of $533.10 beginning January 8, 1970, for a total of $6,397.20. In December 1969 petitioners installed the concrete floor in warehouse number one at a cost of $5,183 and constructed the cyclone fence at a cost of $802.88 for a total cost of $5,985.88. Norwich agreed to reimburse petitioners for the cost of the improvements through increased rental payments. To accommodate the repayment of petitioners' loan, Norwich further agreed to pay a higher rent during the first year of the lease rather than spreading the increase over the three-year term of the lease. For the first year the rental payments were to be $1,935 per month; for the last two years they were to be $1,400 per month. (See lease, footnote 2, supra.) During 1970 Norwich paid petitioners $23,220, all of which petitioners reported as rental income. 3 Petitioners, on their 1970 return, took depreciation deductions for the concrete floor and cyclone fence. 175 ULTIMATE FINDING OF FACT The $5,985.88 reimbursement for the improvements made by petitioners is additional rental income includable in petitioners' gross income for 1970. OPINION Section 61(a)(5)4 provides that gross income includes any rental payments received or accrued during the taxable year. In our judgment the additional rental payments herein must be included in petitioners' gross income. Section 1.61-8, Income Tax Regs.5 See and compare FrankT. B. Martin,11 B.T.A. 850">11 B.T.A. 850 (1928), with Beecham, Inc. v. United States, an unreported case ( E.D. Tenn. 1973, 32 AFTR 2d 73-5916, 73-2U.S.T.C. par. 9719). 176 Petitioners submit that the $5,985.88 expended for improvements should be excludable from their gross income by reason of section 1096 and M. E. Blatt Co. v. United States,305 U.S. 267">305 U.S. 267 (1938). This argument hinges upon their contention that the improvements were in fact lessee improvements. We cannot agree. It is our opinion that the facts clearly reflect that the improvements were those of petitioners (the lessor) and not those of their lessee. The fact that the lessee agreed to reimburse petitioners for the cost of the improvements through higher rental payments does not render the improvements lessee improvements. Furthermore, petitioners' reliance on clause 3(c) of the lease (see footnote 2, supra) is misplaced. That provision of the lease refers only to alterations177 and does not provide that the lessee is to make all improvements. It is our opinion that the installation of the cement floor and the construction of the cyclone fence were permanent improvements not encompassed by the term "alterations" as that term is used in the lease. We believe that the term "alterations" as used therein refers only to changes made to accommodate the particular needs of the lessee and does not include changes that are improvements of a permanent and general nature. Our view is buttressed by the fact that the lease further requires that any alterations shall be made at the expense of the lessee and shall also be restored at his expense at the termination of the lease except upon the written consent of the owner. We do not believe the cement floor and cyclone fence were intended to be "restored" in the sense used in the lease. Even assuming arguendo that the improvements were covered by clause 3(c), it still does not follow that improvements made at the expense of the lessee are the same as improvements made by the lessee. In short, petitioners have failed to overcome their burden of proving that in substance the improvements were lessee improvements, not lessor178 improvements. Because of the above finding, section 109, by its very terms, is not in point. See also section 1.109-1(a), Income Tax Regs.7Similarly, M. E. Blatt Co. v. United States,supra, is not in point as that case also involves lessee improvements, not lessor improvements. The other cases relied upon by petitioner 8 are also clearly distinguishable from the instant situation. 179 As it is our finding that the improvements were lessor improvements, not lessee improvements, even though the lessor was reimbursed, respondent must be sustained on the issue. To reflect other adjustments, Decision will be entered under Rule 155.Footnotes1. When the term "petitioner" is used in the singular, it refers to David G. Satterfield.↩2. LEASETHIS LEASE, made and entered into this the 14th day of October, 1969, by and between D. G. SATTERFIELD and wife DOLORES H. SATTERFIELD, parties of the first part (hereinafter called OWNER); and NORWICH MILLS, INC., a New York corporation with its principal place of business in Norwich, New York, part of the second part, (hereinafter called LESSEE): WITNESSETH: That the Owner has hereby leased to the Lessee, and the Lessee has hereby hired and taken from the Owner the following described property: Warehouse #1 and Warehouse #8 and Rooms 2, 3, 4, 6, and 7, all under the same roof, located at 306 Main Street, in Clayton, North Carolina, formerly known as Central Oil and Milling Company property. The terms and conditions of this Lease are agreed to be as follows: 1. The term of this lease shall be three (3) years, beginning January 1, 1970 and terminating December 31, 1972; provided, however, that on or before November 1, 1972 Lessee shall have the option for renewal for another two-year term provided such option is exercised by written notification to the Owner on or before said date of November 1, 1972, upon the same terms and conditions as provided for in the original term of this lease EXCEPT as to monthly rental, which shall be $1400.00 per month for the years 1973 and 1974. 2. As rental for said premises, said party of the second part shall pay to the parties of the first part for the first twelve (12) months of this lease, the sum of $1,935.00 per month, payable in advance on or before the first day of each month, beginning with the month of January 1970; and for the remaining period of said lease, the sum of $1,400.00 per month, beginning January 1, 1971, payable monthly in advance on or before the first day of each month, beginning with the month of January 1971. 3. It is also mutually agreed as follows: (a) The Owner shall be responsible for and shall pay all taxes and assessments imposed on the demised premises by any lawful authority. (b) The Owner shall carry insurance on the building but not on the contents thereof, and shall maintain the sprinkler system and the roof, walls and structural parts of the building in proper condition for use by Lessee. (c) Electrical service will be separately metered at the expense of and for the account of the Lessee. Any alterations to the building shall be at the expense of the Lessee and shall be restored by the Lessee at its own expense at the termination of the Lease except upon written consent of the Owner. 4. The Lessee covenants and agrees that it will take good care of the premises and upon the termination of this Lease, will surrender the premises in as good order and condition as they are in the beginning of this Lease, ordinary wear and tear excepted; and that it will make no unlawful or offensive use of the premises. If the Lessee shall fail and neglect to make any payment of rent when due or within fifteen (15) days after written notice thereof, or shall violate any of the provisions of this Lease, the Owner, without any other notice or demand, may at their option, terminate this lease and require the Lessee to vacate the premises hereby demised, or may enter the premises and expel the Lessee therefrom, or the Owner may in lieu of the above or in conjunction therewith, pursue any other lawful right or remedy incident to the relationship created by this Lease. AGREEMENTTHIS CONTRACT AND AGREEMENT, Made and entered into this 14th day of October, 1969, by and between D. G. SATTERFIELD and wife DOLORES H. SATTERFIELD, Parties of the first part; and NORWICH MILLS, INC., a New York corporation, with its principal place of business in Norwich, New York, party of the second part; WITNESSETH: WHEREAS, said parties of the first part have entered into a lease with the party of the second part for certain warehouse property in the Town of Clayton, North Carolina, said lease to begin on the first day of January, 1970, and have agreed to make certain repairs and additions to said property prior to the effective date of said lease. NOW, THEREFORE, it is agreed between the parties hereto that the parties of the first part will: (1) Remove the wooden floors that are now in existence in Warehouse #1 and will replace said floors with a concrete floor; (2) That they will install 215 feet of 4-foot cyclone fence and 68 feet of 6-foot cyclone fence around the loading ramps parallel to the Southern Railroad Spur Track, with three gates, the location of which is to be specified by the party of the second part.↩3. We note in passing that petitioners' return reflects a total gross rental income from the warehouse of $23,320.↩4. (a) General Definition.--Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items: * * * (5) Rents; ↩5. Rents and royalties. (a) In general. Gross income includes rentals received or accrued for the occupancy of real estate or the use of personal property. * * (b) Advance rentals; cancellation payments. Gross income includes advance rentals, which must be included in income for the year of receipt regardless of the period covered or the method of accounting employed by the taxpayer. * * * (c) Expenditures by lessee. As a general rule, if a lessee pays any of the expenses of his lessor such payments are additional rental income of the lessor. If a lessee places improvements on real estate which constitute, in whole or in part, a substitute for rent, such improvements constitute rental income to the lessor. Whether or not improvements made by a lessee result in rental income to the lessor in a particular case depends upon the intention of the parties, which may be indicated either by the terms of the lease or by the surrounding circumstances. For the exclusion from gross income of income (other than rent) derived by a lessor of real property on the termination of a lease, representing the value of such property attributable to buildings erected or other improvements made by a lessee, see section 109↩ and the regulations thereunder. * * 6. SEC. 109. IMPROVEMENTS BY LESSEE ON LESSOR'S PROPERTY. Gross income does not include income (other than rent) derived by a lessor of real property on the termination of a lease, representing the value of such property attributable to buildings erected or other improvements made by the lessee.↩7. In section 1.109-1(a), Income Tax Regs., note particularly the following: The exclusion applies only with respect to the income realized by the lessor upon the termination of the lease and has no application to income, if any, in the form of rent, which may be derived by a lessor during the period of the lease and attributable to buildings erected or other improvements made by the lessee. * *↩8. See Charles M. Howell, Administrator,21 B.T.A. 757">21 B.T.A. 757 (1930); Hilldun Corp.,T.C. Memo. 1967-210; and Estate of William F. Markham,↩ a Memorandum Opinion of this Court dated June 9, 1943.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619368/	Maggio Bros. Co. Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentMaggio Bros. Co. v. CommissionerDocket Nos. 111268, 1664, 5125United States Tax Court6 T.C. 999; 1946 U.S. Tax Ct. LEXIS 200; May 8, 1946, Promulgated 200 Decision will be entered for the respondent in Docket Nos. 111268 and 1664. In Docket No. 5125 decision will be entered under Rule 50. Under the facts, held, amounts withdrawn by petitioner's stockholder-employees in the taxable years and falsely charged to merchandise purchases, and checks issued to them in 1938 and 1939 charged to salaries which were not paid but were redeposited to petitioner's account, are not deductible as salaries paid; respondent did not err in disallowing deduction from 1938 income as a bad debt or as a business expense of an expenditure made in 1937; petitioner was engaged in 1940 in a joint venture with an individual and half the profits thereof are includible in petitioner's income; and at least part of the deficiencies in the taxable years was due to fraud with intent to evade tax. George201 Bouchard, Esq., for the petitioner.E. C. Crouter, Esq., for the respondent. Arnold, Judge. ARNOLD 999 These consolidated proceedings involve deficiencies and penalties determined by respondent as follows:Income taxDeclaredExcessvalue excessDocket No.profits taxprofits taxPenaltyYearDeficiencyPenaltydeficiencydeficiency1112681938$ 1,935.50$ 967.75$ 1,651.46$ 825.73166419391,607.46803.73$ 1,338.82669.41512519401,099.96549.981,072.31536.161000 Petitioner alleges that respondent erred (1) in disallowing deductions from gross income taken in petitioner's returns for the years 1938, 1939, and 1940 as merchandise purchases, (2) in disallowing as deductions for 1938 and 1939 amounts paid to stockholders as bonuses for services rendered during such years, (3) in disallowing a deduction taken in the 1938 return for a bad debt, (4) in adding to income for 1940 gross sales of a separate business operated by a partnership, and (5) in determining that the deficiencies for the years 1938, 1939, and 1940 were due to fraud with intent to evade tax.FINDINGS OF FACT.The petitioner202 during the calendar years 1938, 1939, and 1940, involved herein, was a California corporation, engaged in the wholesale fruit, produce, beer, and wine business, with its principal place of business at El Centro, California, and another place of business at Los Angeles, California. Six Maggio brothers, Frank, Sam, Pasquale, Paul, Salvatore, and Tony, and their brother-in-law, Anthony Fiore, owned all the stock of petitioner in equal shares and devoted their full time to the business of petitioner. All were directors. Sam Maggio was president of petitioner. The petitioner distributed fruit and vegetables to about six or seven towns and cities in Southern California and Arizona, and sometimes in Mexico. Petitioner owned about fourteen trucks, trailers, and automobiles, and had about eighteen employees, including the stockholders. At El Centro the petitioner owned a six-room building, including refrigeration and warehouse rooms and an office.The petitioner filed timely income and excess profits tax returns for 1938 and 1939, and an income, declared value excess profits, and defense tax return for 1940, with the collector of internal revenue at Los Angeles, reporting gross income, 203 deductions, and net income or losses, as follows:193819391940Gross income:Gross sales$ 405,482.97 $ 442,795.67 $ 481,135.38Cost of goods sold338,803.86 363,333.97 402,738.00 * * Total income70,342.99 84,000.68 84,023.26Deductions:Compensation of officers8,727.04 8,145.00Salaries and wages35,767.04 36,566.28 29,771.95 * Bad debts2,685.21 Total deductions70,746.25 84,333.47 81,215.81Loss(403.26)(332.79)Net income2,807.45The petitioner did not separately list or itemize any compensation of officers in its 1938 return. In its 1939 and 1940 returns the petitioner reported compensation of officers as follows: 1001 19391940Sam Maggio, president$ 3,320.00$ 3,020.00Paul Maggio, treasurer3,320.003,020.00Gary Matteson, secretary2,087.042,105.00Total8,727.048,145.00The 1938 return was signed by Gary Matteson, alone, as secretary and as the person who prepared such return. The 1939 return was signed by Sam Maggio, as president, and Gary Matteson, as treasurer, assistant treasurer, or accounting officer. The 1940 return was signed by Sam Maggio204 as president and Paul Maggio as treasurer, and stated that it was prepared by Hampton Foreman, secretary. It also contained a notation that it was compiled from figures of the former secretary and bookkeeper, Gary Matteson. The petitioner's returns were filed on the basis of cash receipts and disbursements.The board of directors of petitioner, under date of December 26, 1937, authorized salaries for each of the seven stockholders in the amount of $ 35 per week, and voted to allow each $ 10 per week to cover his expenses in the line of duty.At the annual meeting of the stockholders of petitioner on January 25, 1938, the salary of the officers and directors actively employed was fixed at $ 2,320 each for the year 1938; each to have a drawing account of $ 35 per week and a $ 10 per week expense allowance, and the balance to be paid or credited to their respective accounts as the condition of the business might permit.At the stockholders' annual meeting on January 28, 1939, the salaries of the officers and directors actively employed were fixed at $ 3,320 for the year 1939; each to have a drawing account of $ 35 per week and a $ 15 per week expense allowance. The same provision 205 was made at the annual meeting of stockholders on January 13, 1940.At a meeting of the board of directors held on July 29, 1940, the salary drawing account of the directors was increased to $ 40 per week and each was allowed an expense account of not more than $ 30 per week, effective August 5, 1940.On December 20, 1938, the directors voted:* * * that the corporation give a Christmas Bonus of $ 500.00 (Five Hundred Dollars) to each of the Directors of record, January 30, 1938.Inasmuch as funds are not available at this time, it is agreed that each will loan the corporation $ 500 (Five Hundred Dollars) without interest until such time as it may be agreed by them that payment can be made without financial inconvenience to the corporation.Pursuant to this resolution, seven checks for $ 500 each were issued to the seven stockholders under date of December 20, 1938. These were endorsed by the payees and deposited in petitioner's bank account on December 23, 1938. Similar bonus checks in the amount of $ 1,500 1002 each were issued for 1939 on December 5, 1939. These were deposited in petitioner's bank account on January 22, 1940. The books showed a record of loans from stockholders206 as a credit until July 17, 1940, when the balance of $ 21,000 was transferred to surplus. The amounts of $ 3,500 in 1938 and $ 10,500 in 1939 were not ordinary and necessary expenses paid during the taxable years in carrying on the business of petitioner.In petitioner's return for 1938 it claimed a deduction for bad debts, including an item of $ 1,572.11 listed as due from Knickerbocker Hotel and as having been charged off on June 8, 1938, as uncollectible. In the summer of 1937 the petitioner's stockholders gave an afternoon party at the Knickerbocker Hotel in Hollywood. They invited people to whom they sold or from whom they bought. They were interested in selling champagne to the hotel. The petitioner issued a check for $ 1,572.11 dated September 15, 1937, payable to Hollywood Knickerbocker, labeled "Maggio Party," and charged it to expense. The amount of $ 1,572.11 deducted on the petitioner's return for 1938 did not represent a bad debt, nor was it a business expense paid in 1938.Prior to February 28, 1940, Goebel F. Yates owned a truck and with it operated a wholesale fruit and produce business in El Centro, Brawley, and Holtville, California. On that date he sold his207 truck and business to Jack Rudy for $ 3,000. Rudy operated the business for about a year thereafter. Petitioner issued a check on February 28, 1940, to Imperial Valley Produce Co., which check was endorsed by Rudy, to pay for a 50 percent interest in the business purchased by Rudy. A separate set of books was kept in petitioner's Los Angeles office concerning this business. The books showed gross sales of this business in 1940 amounting to $ 33,641.52 and expenses of $ 26,662.11. The business operated by Rudy under the name Imperial Valley Produce Co. was a separate business from that of petitioner and was operated by a separate business entity. The receipts and expenses of that business were not receipts and expenses of petitioner. Half the net profit of that business in 1940 was income to petitioner for 1940.The respondent determined that petitioner's returns overstated the cost of merchandise purchased for resale by $ 12,001.48 in the 1938 return, $ 3,570 in the 1939 return, and $ 8,345.74 in the 1940 return. In 1938 the stockholders withdrew cash from the funds of petitioner by making fictitious entries purporting to show the purchase of specific merchandise for cash 208 and by issuing checks charged to merchandise purchased where no such merchandise was actually purchased. For example, a memorandum dated February 28, 1938, purported to show the payment of $ 155 for potatoes; also, a check dated May 23, 1938, purported to cover the payment of $ 70 for potatoes, but the potatoes were not in fact purchased in either instance. Numerous other such 1003 entries were made or checks were issued in 1938. Some four or five checks issued in 1939, and at least seventeen checks in 1940, likewise were charged to merchandise purchased, when in fact no such purchases were made. These entries and checks were known by the officers, directors, and stockholders of petitioner to be fictitious. As a result of this practice the petitioner's books and returns overstated the cost of goods sold or merchandise purchased for sale and showed a lesser taxable net income than in fact was realized. No part of the amounts determined by respondent as overstatements of cost of merchandise purchased was expended by petitioner in payment of compensation for personal services or other ordinary and necessary expenses incurred during the taxable years in carrying on the business209 of petitioner.Petitioner's action in charging to merchandise purchased amounts which were not so used and to labor and services amounts which were not so applied was done with intent to evade tax.The returns of petitioner for 1938, 1939, and 1940 were false and at least part of the deficiency in tax for each of such years was due to fraud with intent to evade tax.OPINION.Petitioner concedes that the returns for all the years involved overstated the amount of merchandise purchases, but contends that the amounts of the overstatements are properly deductible on the returns as representing additional salaries of the stockholders. The petitioner's stock was owned equally by seven individuals, six brothers and a brother-in-law. Each of the stockholders was a director and an employee of petitioner, devoted all his time to the business, and received the same salary as the other stockholders. Sam Maggio testified that in 1937 the stockholders were receiving salaries of $ 35 per week each, but found that they needed more money for living expenses, and that their bookkeeper devised the method of drawing cash for additional salaries and charging the amounts to merchandise purchases through210 the making of fictitious voucher entries showing the purchase of merchandise for cash or by issuing checks in payment of fictitious purchases of merchandise. The amounts paid each stockholder through this procedure are said to have been about $ 35 per week and were in addition to the regular salaries of $ 35 per week drawn by each and the annual bonuses. Petitioner contends that, as the stockholders often worked twelve to fourteen hours a day and the success of the business depended upon their efforts, the entire amounts taken by the stockholders were reasonable salaries for the services they rendered and were deductible expenses in determining the net income of petitioner. Petitioner's counsel argues that had the stockholders voted themselves salaries of $ 70 per week there 1004 could be no question that such amounts were reasonable, when they paid approximately that much to employees who worked only eight hours a day as compared with their twelve hours or more. He states that the stockholders were foreign-born Italians, with little formal education, and explains that the false entries in the petitioner's books were the idea of their bookkeeper upon whom they had depended211 since 1926 for the keeping of their records.While respondent argues that the regulations 1 prohibit the deduction under one provision of law of amounts deducted under another provision, that is not what is attempted here. Petitioner is seeking not a double deduction, but an alternative deduction. If it is established that the amounts or any part of them were in fact paid as compensation for the services performed by the stockholders, and their total compensation was reasonable in amount, the deduction may be allowed as a business expense. The burden is upon petitioner to show this. However, since the stockholders are also employees, amounts distributed may, as respondent contends, represent division of the profits rather than payment of compensation for services.As sole and equal owners the stockholders were at liberty to vote themselves any salaries they might choose, so long as the amounts were reasonable. Minutes of a stockholders' 212 meeting in January 1938 show that they fixed their salaries at $ 2,320 each for the year, with a $ 35 per week authorized drawing account for 52 weeks or $ 1,820, plus $ 500 more to be paid as they should later, as directors, determine. They withdrew in cash another $ 12,000, which was charged to merchandise purchases, but $ 3,500 drawn in December as a bonus was immediately returned to the corporation. In 1939 they voted to increase their salaries to $ 3,320 each. The authorized weekly drawing account of $ 35 each remained the same. They drew $ 3,500 in November, which was charged to merchandise purchases, but bonus checks amounting to $ 10,500 issued in December were returned to the corporation in January following. In 1940 they increased their salaries to $ 40 per week, effective August 5. They drew no bonuses, but drew $ 1,500 in February to invest in a business venture with Jack Rudy and drew $ 6,845.74 in the latter part of the year, at least part of which was used to finance the venture with Rudy. The bookkeeper who initiated the practice of false entries was discharged before July 1938, yet the stockholders continued the use of this method of procuring cash thereafter, 213 although the succeeding bookkeeper, Matteson, advised against it. The practice was carried to such an extent that Sam Maggio testified he could not now distinguish the purchase records which represented actual purchases from those which were false entries made to procure cash for distribution among the stockholders. While it is 1005 alleged that the amounts thus drawn were distributed equally among the stockholders and amounted to about $ 35 per week for each, this is not borne out by the record. The amounts determined by the respondent to be fictitious payments vary considerably from month to month in 1938, as in January only $ 10 was taken thus, in February $ 406, in March $ 2,093, and thereafter the amount ranged from $ 918 to $ 1,200 per month. In 1939 the use of fictitious cash vouchers for this purpose was evidently discontinued and the use of checks was not resorted to until November, when the amount of $ 3,500 was drawn through four checks. In 1940 there was one check for $ 1,500 issued on February 28 and admitted by Sam Maggio to be a false entry, and 24 checks drawn between August 6 and December 17, amounting to $ 6,845.74, were found by the respondent to be false214 entries. The petitioner does not question the amounts determined by the respondent.The petitioner's argument is that the stockholders needed more money for living expenses for their growing families and took these additional amounts as salaries for this purpose, the use of false entries being a device for which their bookkeeper was responsible. The respondent says the withdrawals were a means of distributing profits. The petitioner apparently paid no dividends, as such, in the taxable year, but paid regular salaries in amounts voted by the stockholders. While the comparative regularity of the withdrawals made in 1938 lends some credence to petitioner's argument that they were taken as additional compensation to meet current needs, it is to be noted that the practice stopped at the end of the year and was not again resorted to until November of 1939. If the money was needed for current expenses of the stockholders, as petitioner claims, it was not consistent that the practice was stopped at the end of the year. The need must have been as great in 1939 and 1940, yet lesser amounts were withdrawn in those years and, at least in 1940, were certainly used for other purposes than215 living expenses. It is more in accordance with the established facts to conclude that petitioner was distributing profits in 1938 and that, having succeeded in showing a book loss for the year and thereby escaping income tax, it was not necessary to continue the distribution in 1939 until the profits were ascertainable. The withdrawals in November of 1939 were made when a profit could be foreseen, and very evidently they constitute a distribution of profits. In 1940 the withdrawals were used, at least in part, to finance the venture with Rudy, rather than to meet the current living expenses of the stockholders. This money was used for investment and not for salaries. We conclude, therefore, that the amounts by which merchandise purchases were overstated in the taxable years before us were not payments of salaries, deductible under section 23 (a) of the Revenue Act of 1938 or section 23 (a) of the Internal Revenue Code.1006 The respondent disallowed $ 3,500 taken as a deduction on the 1938 return and $ 10,500 taken as a deduction on the 1939 return as bonuses paid to the stockholders of petitioner for services rendered. Respondent states that these were excessive deductions216 and that, since the checks issued to the stockholders were deposited in petitioner's bank account, the amounts were not actually expended by petitioner and are not deductible as salaries or compensation for services.It is clear from the resolution of the directors on December 20, 1938, authorizing the bonuses of $ 500 for that year and requiring that the same amounts be loaned back to the corporation, that the payment of the amounts was an empty gesture. The checks were issued and redeposited to petitioner's account. The amounts were never received by the stockholders. Checks issued in December 1939 in the amount of $ 1,500 to each stockholder were deposited to the petitioner's account in January 1940. While minutes of the directors' meeting at which the issuance of 1939 bonus checks was authorized were not found, it seems that the same result was intended. The effect of the procedure was to show an expenditure for salaries diminishing the book profits and an equivalent receipt in the form of loans from the stockholders. No actual expenditure resulted and the stockholders remained in the same position as before, in so far as their ownership of the petitioner was concerned. 217 In Harrington Co., 6 T. C. 720, we concluded that compensation voted to corporate officers contingent upon contribution of the same amounts to corporate surplus was not an expense incurred in the taxable year, since the amounts were not at any time available to the officers and therefore were not constructively received by them. In Royal Mfg. Co. v. Commissioner, 139 Fed. (2d) 958, affirming B. T. A. memorandum opinion, it was held that where dividend checks were endorsed and redeposited to the corporation's account, the corporation might not have a dividends paid credit, since the control of the proceeds never passed irrevocably to the stockholders.In this case the stockholders had no intention of receiving the proceeds of the bonus checks as salary payments in the respective taxable years, and, therefore, the issuance of the checks was not in fact a payment of a business expense in those years. The respondent did not err in disallowing deduction of the bonus payments.On the 1938 return petitioner deducted several items as bad debts, one of which was an amount of $ 1,572.11 shown as due from Knickerbocker Hotel, 218 with the explanation, "Unable to Collect." Petitioner paid this amount by check dated September 15, 1937, to Hollywood Knickerbocker. The check was marked "Maggio Party." It appears that in the summer of 1937 the Maggios had an afternoon party at the Knickerbocker Hotel in Hollywood. Petitioner now admits that the item was not a bad debt, but contends that the expense of the party 1007 was a business expense and is deductible as such, since the party was for the benefit of customers with whom the petitioner had business dealings and since it was given at the hotel in an effort to procure business from the hotel as a prospective purchaser of champagne. It is stated that the deduction of the item was taken in the 1938 return because it had not been taken in the 1937 return. It is obvious that the expense of such a party held in 1937 and paid for in that year may not be taken as a deduction on petitioner's 1938 return, whether or not it was a legitimate business expense. Respondent properly disallowed this deduction.With respect to the year 1940, the respondent added $ 33,641.52 to the gross income of petitioner from merchandise sales as representing income shown on the books219 of Imperial Valley Produce Co. The internal revenue agent testified as follows concerning an interview with Sam Maggio in May 1941:I asked him specifically about one check for $ 1,500 made payable to the Imperial Valley Produce Company.Mr. Maggio stated that that check was to purchase the business of a Mr. Goebel Yates.I asked him further if that business was owned by the corporation, and he said yes. I then asked him why the sales and purchases and other items of income and deductions of the Imperial Valley Produce Company were not incorporated into the records and income tax returns of the Maggio Bros. Co. Inc.He stated that he didn't want the bookkeeper, Mr. Hampton Foreman, who prepared the 1940 income tax return of the corporation to know, or any other person to know that the Maggio Bros. Co. Inc., owned and operated the Imperial Valley Produce Company.* * * ** * * I recall Mr. Maggio stated that $ 1,500 was used as a part payment to purchase the business of Mr. Yates. I asked him specifically if the items which are noted on the check were actually delivered to the Maggio Bros. Co. Inc. He said, "No." He said that all he knew was that he bought Yates out and got a truck. 220 Petitioner now contends that Imperial Valley Produce Co. was the name of a business owned by the Maggios and one Jack Rudy in partnership, the Maggios having a 50 percent interest and Jack Rudy 50 percent. It appears that the business was formerly operated by Yates, who testified that he owned a Ford tractor and semitrailer and operated in El Centro, Brawley, and Holtville, California, taking orders and buying and selling produce. He had no dealings with the Maggios, but sold his truck and route to Rudy in February 1940 for $ 3,000 and Rudy thereafter operated the business as Valley Produce. Sam Maggio testified that a partnership agreement was drawn up and signed; that the business was operated about a year; that the Maggios put about $ 8,000 in it; that a loss was sustained; and that Rudy gave petitioner a note dated June 1, 1944, for $ 2,646.33 to cover his half of the loss. The agreement, he said, named Jack Rudy and Calegaro 1008 Vitale as the partners. Vitale was the father-in-law of Paul Maggio and performed no services; the Maggios merely used his name. The funds invested by the Maggios were procured from petitioner by making false entries in the books of petitioner. 221 Matteson testified that Sam Maggio told him they were buying Yates' business and that Rudy was to operate it for them and with them and that the purchase included a truck.While the evidence is conflicting, we are of the opinion that it is sufficiently shown that the Imperial Valley Produce Co. was a separate business entity from petitioner, and that Rudy was a partner or joint adventurer with the petitioner. This is shown by the fact that Rudy paid $ 3,000 for the business, of which only half appears to have been contributed from petitioner's funds, that Rudy made the purchase without disclosing the participation of the others, and that a separate set of books was kept, and it appears that Rudy ultimately gave a note payable to the petitioner for his share of the loss, for which he would not be liable if he had been merely an employee and not a partner. The inclusion in full of the income and expenses of the Imperial Valley Produce Co. as income and expenses of petitioner in 1940 was error. However, since the funds invested in the business operated by Rudy were petitioner's funds and the note given by Rudy was payable to petitioner, we conclude that the business was operated 222 by petitioner and Rudy as a partnership or joint venture. Half the profits of this business derived in 1940 are includible in petitioner's income for that year. While petitioner contends that a loss was sustained, the respondent's figures indicate that as far as 1940 is concerned a profit resulted. Certainly petitioner has not shown that a loss was sustained in 1940 from this venture.The respondent determined penalties of 50 percent of the deficiencies, on the ground that the deficiencies were due to fraud with intent to evade tax, and that liability for the penalties was incurred under section 293 (b) of the Revenue Act of 1938 and section 293 (b) of the Internal Revenue Code. The burden is upon the respondent to establish fraud with intent to evade tax. T. G. Nicholson, 38 B. T. A. 190.Petitioner conceded that some of the book entries were false, but contends that the purpose of the falsification was not to evade tax and that no fraud upon the United States resulted, since the amounts taken by the stockholders through the false entries were actually taken as salaries.The stockholders were not deceiving themselves by the falsification of the 223 books and could not intend to deceive their bankers by showing a losing business. The only possible conclusion is that they intended to deceive the tax agencies of the State and Federal Governments as to the petitioner's profits. The stockholders followed a 1009 course of action obviously directed to the diminution of their income tax liability. While legitimate actions in this direction, or tax avoidance, may not be penalized, any fraudulent or illegal actions or concealment of true profits through false bookkeeping constitutes attempts at tax evasion and affords grounds for the assertion of penalties. In this case the profits realized by petitioner were concealed through manipulations and false bookkeeping. In 1938, by charging amounts to merchandise purchases, $ 12,001.48 of profits were distributed to the stockholders. In December the book profits were reduced further by $ 3,500 through the issuance of bonus checks charged to salaries, which were never paid. In filing the return for 1938 petitioner took a bad debt deduction of $ 1,572.11 for an item which was not a debt nor a business expense of that year. As a result of these actions a loss of $ 403.26 was shown *224 on petitioner's return instead of a profit. In 1939 the actual profits were reduced by $ 3,570 by distributing profits to the stockholders and charging the amount through false entries to merchandise purchases, and by $ 10,500 more through the issuance of bonus checks which were never paid. For 1939 the petitioner was thus able to show a loss of $ 332.79 instead of a profit on its books and tax return. In 1940 the false entries of money withdrawn, at least in part, to finance the venture with Rudy reduced profits by $ 8,345.74, so that the net profit shown on the books and returns was untrue. The returns were filed with the knowledge that they were based upon false book entries. We conclude that the petitioner's returns for 1938, 1939, and 1940 were false and were filed with intent to evade tax, and that at least a part of the deficiency for each of these years was due to fraud with intent to evade tax.Decision will be entered for the respondent in Docket Nos. 111268 and 1664. In Docket No. 5125 decision will be entered under Rule 50. Footnotes1. Art. 23 (a)-1, Regulations 101, and sec. 19.23 (a)-1 of Regulations 103.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619370/	J. S. J. LYELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Lyell v. CommissionerDocket No. 43540.United States Board of Tax Appeals29 B.T.A. 133; 1933 BTA LEXIS 991; October 20, 1933. Promulgated 991 W. Leo Austin, Esq., L. E. Cahill, Esq., and George H. Abbott, C.P.A., for the petitioner. W. R. Lansford, Esq., and E. G. Sievers, Esq., for the respondent. MATTHEWS 133 This proceeding arises upon the determination by respondent of a deficiency in petitioner's income tax for the calendar year 1924 in the amount of $12,204.84. Four assignments of error are made by the petitioner, as follows: (1) That respondent failed to allow adequate depletion in respect of the Lyell royalty; (2) that respondent failed to allow adequate depletion in respect of the Lyell fee land; (3) that respondent refused to allow as a deduction a bonus received by petitioner for granting an oil and gas lease, in so far as such bonus represented a return of capital; and (4) that respondent failed to allow depreciation on the cost of drilling oil wells. At the hearing the respondent amended his answer to allege that he was in error in allowing depletion on the bonus received. This allegation was made in order to safeguard the Government's interest in the event the Supreme Court, in the Murphy Oil Co. case then pending, should hold no depletion allowable on a bonus. 992 All the facts, save the discovery value of the one-eighth royalty interest on the 60-acre tract, were stipulated by the parties as set out 134 in our findings of fact. Evidence as to the discovery value of the royalty interest was introduced. FINDINGS OF FACT. 1. In 1919, before the discovery of oil on the tract herein in controversy, taxpayer purchased 80 acres of land in fee, described as the E 1/2 of the NW 1/4 of Section 3, T. 16 S.,R. 15 W., Union County, Arkansas, for $600.00. In 1923, the North 60 acres of this tract was leased for oil and gas purposes. 2. During the years 1923, 1924, 1925 and up to February 6, 1926, the taxpayer developed the South 20 acres of the above-mentioned tract by drilling twelve (12) oil and/or gas wells thereon. During this period, taxpayer operated this property for the production of crude petroleum and natural gas. 3. The tract herein styled the Lyell fee is described as the So. 20 acres of the E 1/2 of NW 1/4 of Sec. 3, T. 16 S., R. 15 W., Union County, Arkansas. 4. All costs of drilling, developing and equipping the Lyell fee for oil and gas purposes were capitalized by the petitioner for each of the years herein993 mentioned. 5. In the regular course of petitioner's business, he expended for lease equipment on the Lyell fee in 1923, $1,539.57, and in 1924, $31,232.87, and in 1924 for well equipment, $12,625.60; for earthen storage $1,050.66. 6. In the ordinary course of petitioner's business, he expended in 1924 for connection with the installation of equipment relating to the production of oil and gas from the property, and for the drilling of oil and gas wells on the Lyell fee prior to production from the well for which the costs were made: Teaming$1,543.50Automobile expense171.60Drilling permits250.00Development labor2,132.31Contract drilling35,874.40Total$39,971.817. During the year 1924 petitioner paid adverse claimants of interests in the mineral rights on the Lyell fee the sum of $16,194.20. 8. The factors necessary for the computation of depletion sustained on discovery value of the Lyell fee are enumerated as follows: a. Underground reserves of crude oil at the date of discovery were 405,521 bbls. b. The property produced during the year 1924, 186,956.11 bbls. c. The taxpayer is entitled to deduction for depletion, based994 on discovery value. d. The fair market or discovery value of mineral in the Lyell fee at the date of discovery was $133,821.93. 9. The factors necessary for determining the statutory limit of the depletion deduction on the Lyell fee not elsewhere enumerated herein in this statement of facts are as follows: a. The gross receipts from the sale of crude oil and/or gas from the Lyell fee in 1924 were $163,094.86. b. The ordinary business expense in connection with the operation of the Lyell fee amounted to $26,759.86. c. Depreciation of furniture and automobiles amounted to $421.75; overhead expense amounted to $250.00, and interest paid amounted to $904.90. 135 10. The underground reserves of crude oil and the amount of such oil produced in 1924, as stated above, will be used in the computation of the deduction for depreciation of the lease and well equipment on the Lyell fee. 11. The following factors, together with such other factors as are mentioned herein, or as may be proved in the hearing before the Board of Tax Appeals, will be used in the determination of the deduction for depletion applicable to the North 60 acres of the above mentioned 80-acre995 tract known as, and herein styled, the Lyell royalty: a. The capital sum will be the fair market or discovery value of this 1/8 royalty interest on June 25, 1923, the date of discovery of oil thereon for the reserves for this interest as set forth in paragraph b immediately following. b. The underground reserves of crude oil as of the date of discovery was 130,000 bbls., representing this taxpayer's 1/8th royalty. c. Oil produced from this property to the taxpayer's 1/8th interest amounted in 1923 to 42,994.61 bbls. and in 1924, 64,845.11 bbls. d. In 1924 taxpayer received as the proceeds of the sale of royalty oil and/or gas the sum of $43,000.07. e. In 1924 the only expense of this taxpayer applicable to the Lyell royalty was severance tax paid the State of Arkansas in the amount of $1,074.89. f. Under the terms of the lease executed by the taxpayer and covering the south 20 acres of the North 60 acres comprising the Lyell royalty, taxpayer received as bonus out of the proceeds of the sale of 7/16ths of the oil and/or gas produced from the working interest or lessees production from said 20 acres: In 1923$14,348.42In 192420,651.58Total$35,000.00996 At the time petitioner purchased the 80-acre tract in 1919 there was no crude oil producing well within five miles of his land. The 60-acre tract in which petitioner owned a one-eighth royalty interest lay directly between two producing wells, one about two miles to the southeast and the other three miles to the northwest. There was also a gas well two miles to the north. The fair market or discovery value of petitioner's one-eighth royalty interest in this tract on the date of discovery, June 25, 1923, was not more than $32,500. OPINION. MATTHEWS: 1. The relevant sections of the 1924 Revenue Act are set out in the margin. 1 The first question is whether respondent 136 allowed an adequate amount of depletion in 1924 in respect of the one-eighth royalty interest owned by petitioner in a 60-acre tract of oil and gas lands in Union County, Arkansas; and this depends, all other facts and factors having been stipulated by the parties, on the discovery value of the petitioner's interest in the tract when oil was found there on June 25, 1923. Petitioner claims a discovery value of $80,000, but respondent has allowed only $32,500. 1997 The evidence showed that petitioner's 60-acre tract lay directly between two producing wells, one about two miles to the southeast and the other three miles to the northwest. There was also a gas well two miles to the north. On the basic, or discovery, date in 1923, the only known oil sand in the field was the first, or Smackover, sand. The petitioner testified that on the eve of discovery, between June 15 and 20, 1923, he had received an offer of $6,000 for a one sixty-fourth interest in 40 of the 60 acres over which his royalty extended. Petitioner declined this offer because he thought the interest was worth $10,000. Evidence was also put in to show that there had been a sale, between June 10 and 20, 1923, of a one sixty-fourth royalty interest in another tract of 40 acres, belonging to one Laney, about two miles a little west of north of petitioner's tract, for $16,000. There was a producing well on the farm adjoining the Laney tract about one half mile west of Laney's property. Both the offer and the sale were for all the minerals which might be in the land and not merely for the oil in the first sand. Upon such slender evidence petitioner seeks to sustain his claim998 to a discovery value of $80,000. It will be observed that both the offer to buy a portion of the petitioner's royalty interest and the sale of the Laney royalty interest were made a few days before petitioner's discovery date, although the regulations require that fair market value be determined "at the date of discovery or within thirty days thereafter." Treasury Regulations 65, art. 221. More-over, it was clearly demonstrated here that the only productive sand discovered on petitioner's tract was the first, or Smackover, sand, and the discovery value to be ascertained, of course, is the value of that sand. Ibid, art. 222. The offer received by petitioner, even if 137 accorded the full evidential value which a mere offer, as opposed to a sale, seldom obtains, was for a royalty interest in all the minerals, in the tract. Likewise, the sale by Laney was of all the minerals, not merely those in a particular sand. An offer to buy, or a purchase of an interest in, oil that has been discovered in a particular sand and all oil which may be later discovered in other sands in the area is obviously not data which can be of use in determining the discovery value of a single999 oil sand. The evidence submitted fails to show that the discovery value of petitioner's royalty interest in the 60-acre tract was any greater than the amount of $32,500 allowed by the respondent. 2, The second issue involves the depletion allowable on the 20-acre tract of oil and gas land owned by the petitioner in fee, but this issue is disposed of by the stipulation, supra, wherein the parties agreed upon all the facts and factors necessary to calculate such depletion. Depletion will be allowed accordingly. 3. The third issue and the affirmative issue raised by respondent, being closely related, may be considered together: (a) Whether the bonus received by petitioner for granting an oil and gas lease constituted income or a return of capital; and (b) whether the bonus was subject to depletion. The petitioner had an 80-acre tract, the south 20 acres of which he retained in fee throughout the taxable year and developed himself. The north 60 acres he leased, retaining a one-eighth royalty interest on the whole. Of the 60 acres so leased, there was a south 20-acre tract upon which petitioner received as a bonus, out of the proceeds of the sale of seven sixteenths of1000 the oil and gas produced from the working interest, $35,000, which was made up of payments aggregating $14,348.42 in 1923 and $20,651.58 in 1924. It is this bonus which is in question here. Depletion of the bonus, as calculated under T.D. 3938, had already been allowed by respondent. Whether the bouns was depletable, a question raised by the respondent by an affirmative plea in his answer to safeguard the Government's interest, he now waives in his brief, since it is disposed of by the Supreme Court's decision in Murphy Oil Co. v. Burnet,287 U.S. 299">287 U.S. 299, allowing depletion. This leaves the question of whether the bonus was capital and how depletion is to be calculated. The relevant provision of the statute is set out in the margin, ante.The question has been settled by the Supreme Court's decision in Burnet v. Harmel,287 U.S. 103">287 U.S. 103, and the Murphy Oil Co. case, supra. A mining or oil lease bonus, the court said, represents income and is to be taxed as such, but because of the peculiar nature of the business, it also represents in part a return of capital in the same way as a lease royalty, and to the extent of1001 such capital investment is subject to depletion. In the Murphy case, the court reviewed and 138 approved the method employed by the Commissioner. (See Treasury Regulations 45, art. 215, and the corresponding provision, Regulations 65, and T.D. 3938, V-2 C.B. 117, Nov. 13, 1926, amending the regulations.) This method differs from former practice only in the situation where the Commissioner properly finds that the sum of the bonus and expected royalties exceeds the lessor's capital investment in the oil in the ground. In such case, the allowable depletion is to be apportioned ratably between bonus and estimated royalties. If bonus and expected royalties do not exceed petitioner's capital investment, the whole bonus received in advance of royalties will be treated, as hitherto, as a return of capital and depletion allowed accordingly. Here the Commissioner determined depletion in accordance with the method described in T.D. 3938. This method having been upheld by the court and the amount so determined not having been questioned by petitioner, the depletion allowed by respondent in his notice of deficiency is approved. 1002 4. We now pass to the last issue, touching certain incidental expenditures made by petitioner in connection with his operations on his oil land held in fee, including lease equipment and drilling, of $39,971.81. All these expenditures were capitalized by the petitioner for the respective years. The question is whether they should be returnable, as petitioner contends, through depreciation, or as respondent urges, following article 225, Treasury Regulations 65, through depletion. This question has now been put at rest by the Supreme Court's decision in United States v. Dakota-Montana Oil Co.,288 U.S. 459">288 U.S. 459. Cf. Burnet v. Jergins Trust,288 U.S. 508">288 U.S. 508, and Petroleum Exploration Co. v. Burnet,288 U.S. 467">288 U.S. 467. The legislative history of depletion and depreciation allowed on oil production was reviewed by the Supreme Court in the Dakota-Montana case, and the following conclusion reached: Thus the Acts of 1918, 1921 and 1924 were consistently construed by the regulations to permit a depletion, but not a depreciation allowance for the costs of development work and drilling, which were treated for this purpose either as1003 a part of the cost or an addition to the discovery value of the oil in the ground. The administrative construction must be deemed to have received legislative approval by the reenactment of the statutory provision, without material change. No. 80, Murphy Oil Co v. Burnet, decided December 5, 1932; Brewster v. Gage,280 U.S. 327">280 U.S. 327, 337. These expenditures for nonphysical improvements will accordingly be returned through depletion. Judgment will be entered under Rule 50.Footnotes1. Sec. 204. (c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property, except that in the case of mines, oil and gas wells, discovered by the taxpayer after February 28, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the basis for depletion shall be the fair market value of the property at the date of discivery or within thirty days thereafter; but such depletion allowance based on discovery value shall not exceed 50 per centum of the net income (computed without allowance for depletion) from the property upon which the discovery was made, except that in no case shall the depletion allowance be less than it would be if computed without reference to discovery value. Sec. 214. (a) In computing net income there shall be allowed as deductions: * * (9) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvememts, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In the case of leases the deduction allowed by this paragraph shall be equitably apportioned between the lessor and lessee. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4669052/	In The Court of Appeals Seventh District of Texas at Amarillo No. 07-20-00001-CR VERNON BUSBY, JR., APPELLANT V. THE STATE OF TEXAS, APPELLEE On Appeal from the 100th District Court Hall County, Texas Trial Court No. 3879, Honorable Stuart Messer, Presiding March 11, 2021 MEMORANDUM OPINION Before QUINN, C.J., and PIRTLE and PARKER, JJ. Appellant Vernon Busby, Jr., appeals from the trial court’s order revoking his deferred adjudication community supervision, adjudicating him guilty of the third-degree felony offense of resisting arrest with a deadly weapon,1 and sentencing him to serve ten 1 TEX. PENAL CODE ANN. § 38.03(d) (West 2016). years in prison.2 Appellant challenges the trial court’s revocation through three issues. We will affirm. Background In May of 2018, appellant pled guilty to the felony offense of resisting arrest with a deadly weapon. Pursuant to a plea bargain, the trial court deferred adjudication of appellant’s guilt and placed him on three years’ community supervision. As part of his community supervision, appellant was required to pay a $1,500 fine, complete two hundred hours of community service, and attend substance abuse counseling. In February of 2019, the State filed a motion to adjudicate the guilt of appellant. In its motion, the State alleged that appellant had violated seven conditions of his community supervision. At a hearing on the State’s motion, appellant appeared with counsel and entered a plea of not true to all allegations. Carol McKay, appellant’s community supervision officer, testified that she and appellant reviewed the terms and conditions of appellant’s community supervision shortly after appellant’s original guilty plea to the charges. McKay testified that appellant committed multiple violations while he was on supervision including failure to submit to a substance abuse evaluation before June 15, 2018, failure to attend substance abuse counseling, failure to complete his community service hours, failure to pay supervision fees, and failure to report in November and December of 2018 and 2 A third-degree felony is punishable by imprisonment for any term of not more than ten years or less than two years and a fine not to exceed $10,000. TEX. PENAL CODE ANN. § 12.34 (West 2019). 2 January of 2019. McKay further testified that when appellant reported in February, appellant admitted having used methamphetamine at a Super Bowl party. The State introduced a form signed by both appellant and McKay in which appellant admitted having used methamphetamine on February 3.3 After the State rested, appellant testified. Appellant claimed he was joking, and he denied using methamphetamine during the Super Bowl party, but he acknowledged, “I was around people that were indulging in it.” In response to the allegations that he failed to report, appellant stated that he was prescribed medication for vertigo and he cannot remember phone numbers and dates. Appellant admitted that he was not making payments like he was supposed to but that he was financially unable to do so. At the time of trial in December of 2019, appellant claimed that he had adjusted to his medication and that he can “own up” to the responsibilities of his community supervision. On cross- examination, the State explored appellant’s explanations and reviewed with appellant his criminal history. At the conclusion of the hearing, the trial court stated that it found McKay’s testimony credible and that appellant had violated the terms of his community supervision by using methamphetamine. The trial court also found that appellant failed to report as directed; failed to pay court-ordered fees; failed to complete a financial statement for the months of June, July, August, September, November, and December of 2018 and 3 The form provided that “an admission to the use of illicit substances and/or alcohol, or the detection of illicit substances and/or alcohol through testing, may result in sanctions or other actions being taken, including the revocation of my probation.” The form, dated February 5, 2019, was witnessed by Mark White, a community supervision officer. 3 January 2019; failed to complete his community service; failed to submit to a substance abuse assessment on June 15; and failed to attend and complete substance abuse counseling. As such, the trial court adjudicated appellant guilty of the offense of resisting arrest with a deadly weapon and sentenced him to ten years’ incarceration in the Institutional Division of the Texas Department of Criminal Justice. Appellant timely appealed the resulting judgment. By his appeal, appellant presents three issues. His first two issues challenge the sufficiency of the evidence supporting the trial court’s determination that he failed to pay fines and fees and that he consumed methamphetamine. In his third issue, appellant contends that his sentence is disproportionate to the gravity of the offense. Law and Analysis A trial court’s order revoking community supervision is reviewed for an abuse of discretion. Rickels v. State, 202 S.W.3d 759, 763 (Tex. Crim. App. 2006) (citing Cardona v. State, 665 S.W.2d 492, 493 (Tex. Crim. App. 1984) (en banc)). In a revocation hearing, the State bears the burden of proving, by a preponderance of the evidence, that the defendant violated the terms and conditions of his community supervision. Id. at 763-64; Cobb v. State, 851 S.W.2d 871, 874 (Tex. Crim. App. 1993) (en banc). The State satisfies this burden when the greater weight of credible evidence presented to the trial court creates a reasonable belief that it is more probable than not that the defendant has violated a condition of his community supervision. Rickels, 202 S.W.3d at 763-64. An appellate court reviews the evidence presented in a revocation proceeding in the light 4 most favorable to the trial court’s ruling. Garrett v. State, 619 S.W.2d 172, 174 (Tex. Crim. App. 1981). The trial court is the sole trier of fact and determines issues of credibility and the weight to be given to testimony at a revocation hearing. Mattias v. State, 731 S.W.2d 936, 940 (Tex. Crim. App. 1987) (en banc). The trial court can accept or reject any or all of the testimony presented by the State or the defendant. Id. Proof of any one violation of the terms and conditions of community supervision is sufficient to support a revocation. McDonald v. State, 608 S.W.2d 192, 200 (Tex. Crim. App. 1980) (op. on reh’g); Taylor v. State, 604 S.W.2d 175, 180 (Tex. Crim. App. 1980). A probationer’s oral admission of a violation of a term or condition of community supervision made to a probation officer is, by itself, sufficient to support a revocation of community supervision. Hampton v. State, No. 07-00-00078-CR, 2000 Tex. App. LEXIS 4721, at 4-5 (Tex. App.—Amarillo July 18, 2000, no pet.) (citing Cunningham v. State, 488 S.W.2d 117, 119-21 (Tex. Crim. App. 1972)). Methamphetamine Use In the present case, one of the terms and conditions of appellant’s community supervision required him to totally abstain from purchasing, using, possessing, or consuming controlled substances, harmful drugs, or any chemical which might cause intoxication unless prescribed by a physician. When appellant reported to his supervision officer, McKay, on February 5, 2019, he admitted to McKay that he had used methamphetamine at a Super Bowl party two days prior. Appellant also signed an acknowledgement of his methamphetamine use on February 3, and it was witnessed by 5 McKay and another supervision officer. This use of methamphetamine occurred during appellant’s period of community supervision and constitutes a violation of the terms and conditions of appellant’s community supervision. Because an oral admission of a violation of a term or condition of community supervision made to a probationer’s probation officer is, by itself, sufficient evidence to support a revocation of community supervision, we must conclude that the evidence is sufficient to support the trial court’s determination that appellant violated the terms and conditions of his community supervision. See Hampton, 2000 Tex. App. LEXIS 4721, at 4-5. Because proof of only one violation is necessary to support a revocation, we conclude that the trial court did not abuse its discretion in adjudicating appellant guilty of the offense of resisting arrest with a deadly weapon. See McDonald, 608 S.W.2d at 200. We acknowledge that appellant testified he did not use methamphetamine on February 3, he was around others that were using at the party, and he did not understand that the acknowledgement form he signed was “self-incriminating.” Importantly, the trial court heard the testimony of McKay and appellant and resolved the credibility issue in favor of McKay. See Mattias, 731 S.W.2d at 940. We conclude the evidence is sufficient to support the trial court’s determination that appellant violated the terms and conditions of his community supervision by using methamphetamine, a controlled substance, and this evidence is also sufficient to support the trial court’s adjudication of appellant’s guilt. Keelin v. State, No. 07-13-00420-CR, 2014 Tex. App. LEXIS 8936, at 6-7 (Tex. App.—Amarillo Aug. 13, 2014, pet. ref’d) (mem. op., not designated for publication) (in-person admission to supervision officer and signed 6 admission of methamphetamine use sufficient evidence to revoke community supervision). Because sufficient evidence of a single violation supports the revocation of community supervision, we need not address appellant’s first issue challenging the sufficiency of the evidence to support the violation of failure to pay court-ordered fines and fees. Id. at 7; see TEX. R. APP. P. 47.1. Disproportionate Sentence By his third issue, appellant contends his sentence is disproportionate to the gravity of the offense.4 We begin a review of a challenge to the sentence imposed by comparing the gravity of the offense with the severity of the sentence when all the applicable circumstances are considered. Noyes v. State, No. 07-16-00229-CR, 2018 Tex. App. LEXIS 3572, at 6 (Tex. App.—Amarillo May 21, 2018, no pet.) (mem. op., not designated for publication) (citing Graham v. Florida, 560 U.S. 48, 60, 130 S. Ct. 2011, 176 L. Ed. 2d 825 (2010)). In making this assessment, we consider the harm caused or threatened to the victim, the offender’s culpability, and the offender’s prior adjudicated and unadjudicated offenses. State v. Simpson, 488 S.W.3d 318, 323 (Tex. Crim. App. 2016) (citing Graham, 560 U.S. at 60). Only if we can infer that the sentence is grossly disproportionate to the offense will we compare the sentence appellant received with the sentence others received for similar crimes in this jurisdiction or in other jurisdictions. 4 Error may be preserved for a disproportionate sentencing allegation by filing and presenting a motion for new trial raising the issue. See Richardson v. State, 328 S.W.3d 61, 72 (Tex. App.—Fort Worth 2010, pet. ref’d) (per curiam). 7 Noyes, 2018 Tex. App. LEXIS 3572, at 6; Winchester v. State, 246 S.W.3d 386, 389 (Tex. App.—Amarillo 2008, pet. ref’d). Texas courts have traditionally held that, so long as the punishment imposed lies within the range prescribed by the Legislature in a valid statute, that punishment is not excessive, cruel, or unusual. See, e.g., Duran v. State, 363 S.W.3d 719, 724 (Tex. App.—Houston [1st Dist.] 2011, pet. ref’d). “[T]he sentencer’s discretion to impose any punishment within the prescribed range [is] essentially ‘unfettered.’” Ex parte Chavez, 213 S.W.3d 320, 323 (Tex. Crim. App. 2006). Except for grossly disproportionate sentences, which are “exceedingly rare, . . . a punishment that falls within the legislatively prescribed range, and that is based upon the sentencer’s informed normative judgment, is unassailable on appeal.” Id. at 323-24. The offense of resisting arrest with a deadly weapon is a third-degree felony. TEX. PENAL CODE ANN. § 38.03. As such, the applicable range of punishment is a term of not more than ten years or less than two years and a fine not to exceed $10,000. Id. § 12.34. Appellant’s sentence is the maximum sentence in the statutory range—a range determined by the Legislature to constitute appropriate punishment for this type of crime. Appellant pleaded guilty to the underlying offense of resisting arrest with a deadly weapon. In that case, the indictment alleged that appellant used a razor boxcutter to “resist, prevent, or obstruct” his arrest. Appellant admitted that during the first nine months that he was on community supervision, he failed to submit to a substance abuse evaluation, failed to report in November, December, and January, failed to pay court- ordered fines and fees, and failed to file a financial statement for five months. Appellant also signed an admission of use form that stated that he used methamphetamine in 8 February of 2019. Appellant’s community supervision officer testified that appellant was not a good candidate for continued probation because he disregarded the conditions of his supervision. The trial court can consider appellant’s failure to comply with the terms and conditions of his community supervision in assessing his sentence. Vega v. State, No. 07-19-00111-CR, 2020 Tex. App. LEXIS 4038, at 6 (Tex. App.—Amarillo May 21, 2020, no pet.) (mem. op., not designated for publication); see TEX. CODE CRIM. PROC. ANN. art. 37.07, § 3(a)(1) (West Supp. 2020). Nothing in the record demonstrates that this sentence was grossly disproportionate to this offense. Finding no inference of gross disproportionality, we need not and do not reach the considerations regarding sentences for similar crimes in the same jurisdiction and in other jurisdictions, as appellant has provided nothing to consider in those regards. Noyes, 2018 Tex. App. LEXIS 3572, at 6. We overrule appellant’s third issue. Conclusion Having overruled the three issues that appellant has presented to us on appeal, we affirm the trial court’s judgment. Judy C. Parker Justice Do not publish. 9	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4619328/	Murl W. Garrett v. Commissioner. Marilyn M. Garrett v. Commissioner.Garrett v. CommissionerDocket Nos. 1944-66 and 4345-66.United States Tax CourtT.C. Memo 1968-51; 1968 Tax Ct. Memo LEXIS 249; 27 T.C.M. 271; T.C.M. (RIA) 68051; March 27, 1968. Filed 1968 Tax Ct. Memo LEXIS 249">249 Murl W. Garrett, pro se, 2537 Avenel Dr., Farmer's Branch, Tex. W. H. Cathey, for petitioner Marilyn M. Garrett. Marvin G. Kramer, for the respondent. SCOTT Memorandum Findings of Fact and Opinion SCOTT, Judge: Respondent determined deficiencies in the income taxes of petitioner Murl W. Garrett for the calendar years 1963 and 1964 in the amounts of $119.40 and $120.83, respectively, and determined deficiencies in the income taxes of petitioner Marilyn M. Garrett for the calendar years 1963 and 1964 in the respective amounts of $262.78 and $245.41. The only issue for decision is whether petitioner Murl W. Garrett or petitioner Marilyn M. Garrett is entitled to the dependency exemption for Melinda Frances Garrett for each of the calendar years 1963 and 1964. Findings of Fact Some of the facts have been stipulated and are found accordingly. Murl W. Garrett (hereinafter referred to as Murl) resided at the time of the filing of his petition in these cases in Dallas County, Texas. He filed his individual Federal income tax returns for the calendar years 1963 and 1964 with the district director of internal revenue at Dallas, Texas. Marilyn M. Garrett (hereinafter1968 Tax Ct. Memo LEXIS 249">250 referred to as Marilyn) resided at the time of the filing of her petition in these cases in Dallas County, Texas. Marilyn filed her individual Federal income tax returns for the calendar years 1963 and 1964 with the district director of internal revenue at Dallas, Texas. Prior to July 31, 1962, Marilyn and Murl were married. Their daughter, Melinda Frances Garrett (hereinafter referred to as Melinda) was born on December 23, 1959. Murl and Marilyn were divorced on July 31, 1962, and under the divorce decree Marilyn was awarded custody of Melinda. During the years 1963 and 1964 Melinda lived with Marilyn in an apartment which adjoined the apartment of Marilyn's mother, Mary Frances Moore (hereinafter referred to as Mary). During the years 1963 and 1964 Murl paid through the Registry of the Dallas County Support Department the total sums of $725 and $828, respectively, for the support of Melinda. The apartment in which Marilyn and Melinda lived was owned by Mary. Mary was confined to a wheelchair and Marilyn felt that it was necessary that Mary have some adult with her at all times. Marilyn also felt that while she was away at work it was necessary to have someone other than1968 Tax Ct. Memo LEXIS 249">251 Mary to assist in the care of Melinda. There was a connecting door between Mary's apartment and the apartment in which Marilyn and Melinda lived. This door could be left open so that one person could care for both Mary and Melinda while doing general housework in either apartment. Marilyn's apartment consisted of a living room, another room that was used for a dining room as well as a general purpose room, a kitchen, a den, a bedroom, and a bath. Mary's apartment consisted of two rooms and a bath. Marilyn and Mary had an agreement that Marilyn would not pay rent in cash for her apartment, but instead would pay for groceries for Mary as well as for herself and Melinda and would also pay for the utilities for both her own and Mary's apartments and the cost of a domestic worker to assist Mary, look after Melinda, do the housework in both apartments, and do the washing and ironing and cook the noonday meal for Mary, Marilyn, and Melinda. Included in the utilities bills to be paid by Marilyn were the cost of gas, electricity, 272 water, and a telephone which was in Mary's apartment. Marilyn had no telephone in her own apartment but at times she did use the telephone in Mary's1968 Tax Ct. Memo LEXIS 249">252 apartment. For the year 1963 Marilyn paid $1,032.73 for groceries for herself, Melinda, Mary, and the domestic worker's noonday meal. Also included in the amount Marilyn paid for groceries were such items as household cleaning supplies and similar household items. She paid $1,883.70 as wages and social security for a domestic worker and $315.32 for utilities. During the year 1963, Marilyn paid $2.74 as church contributions for Melinda, $27.14 for medical expenses and $55.08 for hospitalization insurance for Melinda, $134.31 for clothing for Melinda, and $20 for Melinda's entertainment. For the year 1964 Marilyn spent $1,147.25 for groceries for three meals a day for herself, Melinda, and Mary, the noon meal for the domestic worker, and household items, $1,883.70 for wages and social security for the domestic worker, and $324.92 for utilities for the two apartments. In 1964 Marilyn paid $2.62 for church contributions for Melinda, $30.70 for medical expenses and $55.08 for hospitalization insurance for Melinda, and $156.12 for clothing for Melinda. Marilyn came home and ate her noonday meal with Mary and Melinda. The domestic worker had her noonday meal in Marilyn's apartment. 1968 Tax Ct. Memo LEXIS 249">253 The domestic worker arrived at Marilyn's apartment at about 8 o'clock in the morning after Marilyn, Melinda, and Mary had eaten breakfast. She left at about 5 o'clock in the afternoon when Marilyn returned from work. Marilyn prepared a light evening meal for herself, Mary, and Melinda. The major meal of all three of them was the noonday meal. Generally Melinda would have the same breakfast as Marilyn and Mary, but at the other meals she ate only about half as much as Marilyn and Mary. There was only one water meter for the two apartments. There were separate meters for electricity and gas in the apartments. However, Marilyn did not keep separate records of the amount paid as utilities for each of the apartments. Generally, the domestic worker would spend most of the morning in Marilyn's apartment cleaning the apartment and fixing the noonday meal and would spend most of the afternoon in Mary's apartment cleaning that apartment. The domestic worker, in addition, would do washing and ironing, supervise Melinda, and wait on Mary. While it was necessary to have someone with Mary all the time, Mary did not need constant attention. The fair rental value of the apartment occupied by1968 Tax Ct. Memo LEXIS 249">254 Marilyn and Melinda was $75 a month during the years 1963 and 1964. Ultimate Fact Marilyn contributed over one-half of Melinda's support for the calendar year 1963, and Murl contributed over one-half of Melinda's support for the calendar year 1964. Opinion Marilyn kept excellent records of her total expenditures for groceries, cost of domestic worker, total utilities bills for her apartment and Mary's apartment, as well as complete records of amounts expended specifically for Melinda. She kept no detail of the actual activities of the domestic worker, the amounts spent for various types of foods such as coffee compared to milk, or the utility charges for each utility in each apartment. This type of information would make the problem of determining the portion of the total expenses applicable to Melinda less difficult. Marilyn was an honest and sincere witness. She freely admitted that she had to have a domestic worker to stay with her mother while she worked and that the domestic worker spent time looking after Mary, cleaning Mary's apartment and washing and ironing for Mary, as well as looking after Melinda and cooking for the three of them. She stated that in her own opinion1968 Tax Ct. Memo LEXIS 249">255 one-third of the domestic worker's time should be allocated to Melinda. A schedule which she produced allocated one-half of the domestic worker's time to Melinda. Marilyn stated that this allocation was made for her by an employee of the Internal Revenue Service, and that in her opinion he allocated too high a portion of the domestic worker's time to Melinda. Respondent, in his brief, argues that onethird of the domestic worker's time should be allocated to Melinda, one-third to Mary, and the other third to housework, and that one-third of the portion allocated to housework should be allocated to Melinda. Marilyn's testimony is that while the domestic worker spent approximately one-half of her time in the apartment which she and Melinda occupied and one-half in the 273 apartment which Mary occupied, she did the cooking of the noonday meal in the morning in the apartment occupied by Marilyn and Melinda. For this reason we cannot agree with respondent's allocation but have taken Marilyn's estimate that one-third of the total amount paid for domestic help should be allocated to Melinda. Respondent allocated one-sixth of the grocery bills to Melinda and this allocation has some1968 Tax Ct. Memo LEXIS 249">256 basis in the testimony of Marilyn that Melinda ate, except for breakfast, about one-half of the amount which she, Mary, and the domestic worker had for their meals. We have, therefore, accepted this suggested allocation of respondent's as the best available from this record. Respondent allocated one-third of the utility bills to Melinda. However, Marilyn's testimony was that the utility payments included the cost of a telephone which was in Mary's apartment and other utilities for both apartments. Marilyn stated that she "didn't have a phone." Considering Marilyn's testimony, in our opinion a more reasonable allocation of the utility costs is that one-fourth of the total amount paid by Marilyn is part of Melinda's support. In accordance with the allocation suggested by respondent, we have considered one-half of the $75 per month fair rental value of Marilyn's apartment to be part of Melinda's support. The result of the allocations we have made is that the total amount of Melinda's support in 1963 was $1,568.12 including the $239.27 which Marilyn spent specifically for Melinda. The $725 paid by Murl is less than one-half of Melinda's support for the calendar year 1963, and therefore1968 Tax Ct. Memo LEXIS 249">257 Marilyn is entitled to a deduction for the dependency exemption for Melinda for 1963. The addition of the amounts which Marilyn spent specifically for Melinda during the calendar year 1964 totaling $244.52 to the amounts of the household expenses which we have allocated to Melinda's support for that year results in the total cost of Melinda's support for the year 1964 being $1,594.85. The $828 contributed by Murl for Melinda's support for the year 1964 is over one-half of Melinda's total support for that year. Therefore, Murl is entitled to the dependency exemption for Melinda for the calendar year 1964. The evidence here does not permit a determination with exactitude of the total cost of Melinda's support for either 1963 or 1964. If either one of the two parties before us in these consolidated cases was the only petitioner, we would decide the case against that petitioner for failure to carry the necessary burden of proof to show the total amount of Melinda's support. However, since we have before us as petitioners the two persons who together paid the total amount of Melinda's support, we have felt impelled to use our best judgment in coming to a conclusion of the total cost1968 Tax Ct. Memo LEXIS 249">258 of Melinda's support in each year. In arriving at our conclusion, we have considered all the evidence and evaluated the evidence with due regard to the honesty of Marilyn's testimony, as well as to the vagueness of some portions of her testimony and the inconsistencies in her testimony. Decisions will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619329/	SANTA FE PACIFIC GOLD COMPANY AND SUBSIDIARIES, BY AND THROUGH ITS SUCCESSOR IN INTEREST, NEWMONT USA LIMITED, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSanta Fe Pac. Gold Co. v. Comm'rNo. 22956-06United States Tax Court130 T.C. 299; 2008 U.S. Tax Ct. LEXIS 17; 130 T.C. No. 17; June 25, 2008, Filed2008 U.S. Tax Ct. LEXIS 17">17 P used the percentage depletion method to calculate depletion deductions for its mine, M, which was placed in service on or before Dec. 31, 1989. P was subject to the alternative minimum tax but did not make adjusted current earnings (ACE) adjustments under sec. 56(g)(4)(C)(i) or (F)(ii), I.R.C, for depletion for M even though M's adjusted basis had been fully depleted for cost depletion purposes. When calculating the sec. 57(a)(1), I.R.C., preference for M, P included development costs capitalized under sec. 56(a)(2), I.R.C., in M's adjusted basis.Held: Sec. 56(g)(4)(F)(i), I.R.C., does not preclude the sec. 56(g)(4)(C)(i), I.R.C., ACE adjustment from applying to depletion.Held, further, unamortized sec. 56(a)(2), I.R.C., costs are not included in M's adjusted basis for purposes of calculating sec. 56(g)(4)(C)(i), I.R.C., ACE adjustments for depletion.Held, further, because of R's concession, unamortized sec. 56(a)(2), I.R.C., costs may be included in M's adjusted basis for purposes of calculating sec. 57(a)(1), I.R.C., preferences for the years at issue.Held, further, to the extent that the same amounts are not also treated as sec. 57(a)(1), I.R.C., preferences, P is required to 2008 U.S. Tax Ct. LEXIS 17">18 make a sec. 56(g)(4)(C)(i), I.R.C., ACE adjustment for depletion for M.David D. Aughtry, Arnold B. Sidman, and William O. Grimsinger, for petitioner.Curt M. Rubin and Jennifer S. McGinty, for respondent.Goeke, Joseph RobertJOSEPH ROBERT GOEKE130 T.C. 299">300 GOEKE, Judge: This case is before the Court on the parties' cross-motions for partial summary judgment. After concessions, 1 the primary issue for decision, for purposes of adjusting petitioner's alternative minimum taxable income (AMTI) under the alternative minimum tax (AMT), is whether section 56(g)(4)(C)(i)2 limits the depletion deduction for a mine placed in service on or before December 31, 1989, specifically petitioner's Mesquite Mine, to depletion deductions allowed in computing earnings and profits, or whether section 56(g)(4)(F) alone governs all adjusted current earnings (ACE) adjustments relating to depletion regardless of when the property is placed in service. We must also decide whether unamortized mine development costs that must be capitalized and amortized under section 56(a)(2) (unamortized section 56(a)(2) costs) are included in the adjusted basis of depletable property, specifically the Mesquite Mine, for purposes of determining 2008 U.S. Tax Ct. LEXIS 17">19 (1) the amount of section 57(a)(1) preferences, and/or (2) the amount of section 56(g)(4)(C)(i) ACE adjustments for depletion. We hold that unamortized section 56(a)(2) costs are not included in the adjusted basis of depletable property for purposes of determining the amount of section 56(g)(4)(C)(i) ACE adjustments for depletion. In addition, because respondent conceded that unamortized section 56(a)(2) costs may be included in the adjusted basis of depletable property for purposes of determining section 57(a)(1) preferences, petitioner is not liable for any increases in its AMT liability that might otherwise arise 2008 U.S. Tax Ct. LEXIS 17">20 from our holding on this issue. We hold further that section 56(g)(4)(C)(i) applies to depletion of the Mesquite Mine to the extent that the amount by which the depletion deductions attributable to the Mesquite Mine exceeded the mine's adjusted basis during the years at issue is not also treated as a section 57(a)(1) preference.130 T.C. 299">301 BackgroundThe record establishes or the parties do not dispute the following facts.Petitioner is the successor in interest to the Santa Fe Pacific Gold Corp. and an alternate agent for the Santa Fe Pacific Gold Corp. & Subs. Consolidated Group. At the time it filed its petition, petitioner's principal place of business was Denver, Colorado.Petitioner owned several gold mines during the taxable years ending December 31, 1994, 1995, and 1996, and May 5, 1997 (the years at issue), that were placed in service on or before December 31, 1989. Petitioner's Mesquite Mine was placed in service in September 1981, and petitioner's two Twin Creeks Mines were placed in service in December 1987 and March 1989.Petitioner calculated its depletion deductions using the percentage depletion method under section 613, as opposed to the cost depletion method under section 612, for 2008 U.S. Tax Ct. LEXIS 17">21 regular tax purposes for all of its mines during the years at issue. Petitioner was subject to the AMT during the years at issue, and it included section 57(a)(1) preferences for depletion when calculating its AMTI. When calculating its ACE adjustment, petitioner did not make any adjustments under section 56(g)(4)(C)(i) for mines that were placed in service on or before December 31, 1989. Petitioner incurred development costs under section 616(a) for its mines, which it capitalized and amortized over a 10-year period as required by section 56(a)(2).On November 13, 2006, respondent issued a notice of deficiency to petitioner for the years at issue. Respondent made the following changes to petitioner's ACE adjustments for depletion: 3YearReported ACEAdjusted ACE1994$ 6,119,535$ 12,676,873199518,517,20842,115,8801996 3,004,14444,790,6871997 2,378,50013,738,815130 T.C. 299">302 Petitioner timely petitioned the Court to review respondent's determinations. The parties filed cross-motions for partial summary judgment on the issue of whether section 56(g)(4)(C)(i) requires ACE adjustments for 2008 U.S. Tax Ct. LEXIS 17">22 depletion for mines placed in service on or before December 31, 1989. Because one of petitioner's arguments is that section 57(a)(1) precludes the application of section 56(g)(4)(C)(i) to depletion, we must also determine whether sections 57(a)(1) and 56(g)(4)(C)(i) perfectly overlap when applied to depletion. This in turn depends on whether unamortized section 56(a)(2) costs are included in the adjusted basis of depletable property for purposes of determining section 57(a)(1) preferences and/or section 56(g)(4)(C)(i) ACE adjustments. Respondent concedes that petitioner correctly reported the portions of the ACE adjustments attributable to the Twin Creeks Mines. The Twin Creeks Mines were not subject to the section 56(g)(4)(C)(i) ACE adjustment because their adjusted bases were greater than the depletion deductions attributable to them. See infra pp. 8-9. The parties filed memoranda in support of their respective motions and in opposition to the opposing party's motion, and the Court held a hearing on these issues in Washington, D.C.DiscussionI. Summary JudgmentSummary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678">90 T.C. 678, 90 T.C. 678">681 (1988). 2008 U.S. Tax Ct. LEXIS 17">23 The Court may grant summary judgment when there is no genuine issue of any material fact and a decision may be rendered as a matter of law. Rule 121(b); Sundstrand v. Commissioner, 98 T.C. 518">98 T.C. 518, 98 T.C. 518">520 (1992), affd. 17 F.3d 965">17 F.3d 965 (7th Cir. 1994). The parties agree that there are no questions regarding any material facts related to the issue before the Court and that the issue is a pure question of law that should be resolved by summary judgment.II. Statutory BackgroundCongress enacted the AMT as a part of the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, 100 Stat. 2085, in order to prevent 130 T.C. 299">303 taxpayers with substantial economic income from avoiding significant tax liability by using exclusions, deductions, and credits. See Snap-Drape, Inc. v Commissioner, 105 T.C. 16">105 T.C. 16, 105 T.C. 16">21 (1995), affd. 98 F.3d 194">98 F.3d 194 (5th Cir. 1996). The AMT equals the excess of the tentative minimum tax over the regular tax for the year. Sec. 55(a). For corporations, the tentative minimum tax is 20 percent of so much of AMTI as exceeds the exemption amount, reduced by the AMT foreign tax credit for the year. Sec. 55(b)(1)(B). AMTI is the taxable income of the taxpayer for the year determined with the adjustments provided in sections 562008 U.S. Tax Ct. LEXIS 17">24 and 58 and increased by the amount of items of tax preference in section 57. Sec. 55(b)(2).Section 56(g)(1) provides that the AMTI of any corporation for the taxable year shall be increased by 75 percent of the excess of the corporation's ACE over the corporation's preadjustment AMTI, which is the taxpayer's AMTI determined without regard to section 56(g) or the alternative tax net operating loss deduction.A. Section 56(g)(4)(C)(i)Section 56(g)(4)(C)(i) provides that in determining ACE, no deduction is allowed for any item that would not be deductible for any taxable year for purposes of computing earnings and profits. Section 56(g)(5)(A) provides that the term "earnings and profits" means earnings and profits computed for purposes of subchapter C. Section 1.312-6(c)(1), Income Tax Regs., provides:In computing the earnings and profits for any period beginning after February 28, 1913, the only depletion or depreciation deductions to be considered are those based on (i) cost or other basis, if the depletable or depreciable asset was acquired subsequent to February 28, 1913 * * . Thus, discovery or percentage depletion under all revenue acts for mines and oil and gas wells is not to 2008 U.S. Tax Ct. LEXIS 17">25 be taken into consideration in computing the earnings and profits of a corporation. [Emphasis added.]Sections 611 through 614 govern deductions allowable for depletion of natural resources. Section 613 allows taxpayers deductions for depletion that are based on a percentage of gross income, regardless of the adjusted basis of the property, if the deductions are larger than they would be under the cost depletion method. Section 612 governs cost depletion, 130 T.C. 299">304 an alternate method of calculating depletion deductions using the adjusted basis of the property provided in section 1011. See also sec. 1.611-2(b)(2), Income Tax Regs.When the AMT applies, section 56(g)(4)(C)(i) offsets the permanent benefit of the percentage depletion method by requiring an ACE adjustment if a taxpayer's depletion deduction exceeds the adjusted basis of the property. The section 56(g)(4)(C)(i) ACE adjustment equals the excess, if any, of the taxpayer's current depletion deduction for the property for regular tax purposes over the aggregate of the deductions allowable for the current year and for future years when calculating earnings and profits. Section 1.56(g)-1(d)(1), Income Tax Regs., provides:no deduction is 2008 U.S. Tax Ct. LEXIS 17">26 allowed in computing adjusted current earnings for any items that are not taken into account in determining earnings and profits for any taxable year * * . Thus, to the extent an item is, has been, or will be deducted for purposes of determining earnings and profits, it does not increase adjusted current earnings in the taxable year in which it is deducted for purposes of determining pre-adjustment alternative minimum taxable income. * * [Emphasis added.]Because a taxpayer is never allowed depletion deductions in excess of the adjusted basis of the property under the cost depletion method, section 56(g)(4)(C)(i) requires an ACE adjustment of the amount by which the depletion deduction for the property exceeds the adjusted basis of the property. However, to the extent that the taxpayer has an adjusted basis in its property, section 56(g)(4)(C)(i) does not require an ACE adjustment even if the taxpayer deducts an amount for depletion that exceeds what it would be allowed under the cost depletion method because the excess deduction will be allowed as a deduction under the cost depletion method in a future year.B. Section 56(g)(4)(F)(i)For a taxpayer subject to the AMT owning mines 2008 U.S. Tax Ct. LEXIS 17">27 placed in service after December 31, 1989, section 56(g)(4)(F)(i) offsets both the temporary and the permanent benefits of the percentage depletion method:130 T.C. 299">305 (F) Depletion. --(i) In general. -- The allowance for depletion with respect to any property placed in service in a taxable year beginning after December 31, 1989, shall be cost depletion under section 611.This requires an ACE adjustment for the difference between a taxpayer's depletion deduction and the amount that would be allowed if the taxpayer calculated its depletion deduction using the cost depletion method.To the extent that both section 56(g)(4)(C)(i) and (F)(i) would otherwise require ACE adjustments (as would be the case if a mine was placed in service after December 31, 1989, and its adjusted basis is less than the depletion deduction), the taxpayer must make an upward ACE adjustment only under section 56(g)(4)(F)(i). See infra pp. 18-19. When a mine's adjusted basis is fully depleted, the ACE adjustments under section 56(g)(4)(C)(i) and (F)(i) will both equal the deduction allowed under the percentage depletion method. Because the adjustment under section 56(g)(4)(F)(i) will offset the benefit of deducting an amount 2008 U.S. Tax Ct. LEXIS 17">28 that would not be deductible for purposes of computing earnings and profits, section 56(g)(4)(C)(i) does not apply. 4C. Section 57(a)(1)Section 57(a)(1) is also designed to offset the permanent benefit of the percentage depletion method. It includes as a tax preference item that must be added to AMTI under section 55(b)(2)(B):(1) Depletion. -- With respect to each property (as defined in section 614), the excess of the deduction for depletion allowable under section 611 for the taxable year over the adjusted basis of the property at the end of the taxable year (determined without regard to the depletion deduction for the taxable year). * Section 614(a) defines "property" as "each separate interest owned by the taxpayer in each mineral deposit in each separate tract or parcel of land."Section 1.57-1(h)(3), Income Tax Regs., which further explains section 57(a)(1), provides:130 T.C. 299">306 (3) Adjusted basis. For the determination of the adjusted basis of the property at the end of the taxable year 2008 U.S. Tax Ct. LEXIS 17">29 see section 1016 and the regulations thereunder.Therefore, to the extent that a taxpayer's depletion deduction exceeds the adjusted basis of the property determined under section 1016, the taxpayer has a preference item under section 57(a)(1) that will be added to its AMTI under section 55(b)(2).D. Unamortized Section 56(a)(2) CostsSection 616(a) allows a taxpayer to currently deduct mine development costs. A taxpayer's election under section 616(b) to deduct those costs ratably according to units of ore sold may defer a portion of the deduction. However, section 291(b) provides that, for corporations, the amount that would otherwise be deductible under section 616(a) must be reduced by 30 percent, but that the amount not allowable as a current deduction may be amortized and deducted ratably over a 60-month period. As an alternative, section 59(e) provides that a taxpayer may elect for regular tax purposes to amortize the expenditures that would otherwise be allowed as a deduction under section 616(a) over 10 years without regard to section 291.Section 56(a)(2) provides that if a taxpayer is subject to the AMT, when calculating AMTI the taxpayer must amortize over 10 years any mine 2008 U.S. Tax Ct. LEXIS 17">30 development costs that it would otherwise have deducted currently under section 616(a), without regard to section 291. However, if a taxpayer makes an election under section 59(e), section 56(a)(2) does not apply.A key issue in this case is whether unamortized section 56(a)(2) costs are included in the adjusted basis of depletable property when calculating section 56(g)(4)(C)(i) ACE adjustments and section 57(a)(1) preferences.III. The Positions of the PartiesPetitioner argues that section 56(g)(4)(C)(i) does not apply to depletion because ACE adjustments for depletion may be made only under section 56(g)(4)(F)(i). Because section 56(g)(4)(F)(i) does not apply to mines placed in service on or before December 31, 1989, petitioner argues that no ACE adjustment should be made for depletion for mines placed in 130 T.C. 299">307 service on or before December 31, 1989. In support of this argument, petitioner asserts that: (1) Congress created a "grace period" to protect mines placed in service on or before December 31, 1989, from all ACE adjustments for depletion; (2) the rules of statutory construction show that section 56(g)(4)(C)(i) does not apply to depletion; (3) the legislative history of section 56(g)(4)2008 U.S. Tax Ct. LEXIS 17">31 confirms that section 56(g)(4)(C)(i) does not apply to depletion; (4) the statutory scheme of section 56 makes sense only if section 56(g)(4)(C)(i) does not apply to depletion; and (5) applying section 56(g)(4)(C)(i) to depletion would duplicate the adjustment for tax preferences under sections 55(b)(2) and 57(a)(1).Respondent argues that on its face section 56(g)(4)(C)(i) applies to both depletable and other property regardless of when it is placed in service, while section 56(g)(4)(F)(i) applies only to depletable property placed in service after December 31, 1989. While subparagraphs (C)(i) and (F)(i) overlap in some cases, they are not in conflict or ambiguous. Therefore, respondent argues that there is no need to resort to rules of statutory construction or legislative history; but even if we were to use these tools, they would not alter the plain meaning of the statute.Respondent further argues that section 56(g)(4)(C)(i) does not merely duplicate the adjustment for tax preferences in sections 55(b)(2) and 57(a)(1) because sections 56(g)(4)(C)(i) and 57(a)(1) treat unamortized section 56(a)(2) costs differently.IV. The "Grace Period" ArgumentPetitioner first argues that when 2008 U.S. Tax Ct. LEXIS 17">32 Congress enacted the AMT, it included a grace period that protects mines placed in service on or before December 31, 1989, from any ACE adjustments resulting from depletion deductions. Petitioner claims that this intention is found in section 56(g)(4)(F)(i), quoted above. Petitioner argues that because the limitation "after December 31, 1989," also applies to six other specifically identified items in section 56(g)(4), Congress must have intended for this "grace period" to be an integral part of the AMT scheme as a whole. Therefore, petitioner believes that section 56(g)(4)(C)(i) does not apply to depletable property placed in service on or before December 31, 1989, either. 130 T.C. 299">308 Petitioner argues that if we do not extend the "grace period" to section 56(g)(4)(C)(i), we will negate the protection for depletable property placed in service on or before December 31, 1989, that Congress intended when it limited the application of section 56(g)(4)(F)(i) to property placed in service after that date.We agree that by limiting the reach of section 56(g)(4)(F)(i)Congress provided some protection for taxpayers owning depletable property placed in service on or before December 31, 1989. Section 613(a)2008 U.S. Tax Ct. LEXIS 17">33 allows a taxpayer to calculate depletion deductions using the percentage depletion method for regular tax purposes if that method results in a greater deduction than a deduction calculated under the cost depletion method. However, for property placed in service after December 31, 1989, section 56(g)(4)(F)(i) offsets the benefit of the percentage depletion method when the AMT applies. Unlike section 56(g)(4)(C)(i), section 56(g)(4)(F)(i) requires an ACE adjustment in any year for which the taxpayer's percentage depletion deduction exceeds the depletion deduction calculated under the cost depletion method, even if the percentage depletion deduction is less than the adjusted basis of the property. Therefore, section 56(g)(4)(F)(i) may require an ACE adjustment in situations where section 56(g)(4)(C)(i) would not apply. Because the limitation in section 56(g)(4)(F)(i) protects property placed in service on or before December 31, 1989, from the ACE adjustment under section 56(g)(4)(F)(i), taxpayers owning such property do not need to make ACE adjustments for depletion unless they have already fully depleted the adjusted basis of the property.While section 56(g)(4)(F)(i) allows a taxpayer 2008 U.S. Tax Ct. LEXIS 17">34 to enjoy the temporary benefits of the percentage depletion method if it owns property placed in service on or before December 31, 1989, we do not see any indication that Congress intended this protection to extend to the permanent benefits of the percentage depletion method once the taxpayer has fully depleted the adjusted basis of the property. Congress included in section 56(g)(4) both subparagraph (C)(i) and subparagraph (G), which was redesignated in 1990 but is materially the same as current subparagraph (F), in TRA. 52008 U.S. Tax Ct. LEXIS 17">35 If 130 T.C. 299">309 Congress had wished to limit the application of section 56(g)(4)(C)(i) to property placed in service after December 31, 1989, it could have included a limitation similar to the one found in section 56(g)(4)(F)(i). In the absence of clear evidence that Congress intended to protect depletable property placed in service on or before December 31, 1989, from all ACE adjustments related to depletion, we will not restrict the application of section 56(g)(4)(C)(i) to property placed in service after December 31, 1989. V. Statutory ConstructionPetitioner also argues that the rules of statutory construction show that section 56(g)(4)(C)(i) does not apply to depletion. Petitioner supports its argument with three theories, which we address in turn.A. No Provision Should Be SuperfluousFirst, petitioner argues that courts must attempt to interpret statutory provisions so as not to render any other provisions in the same enactment superfluous. See Freytag v. Commissioner, 501 U.S. 868">501 U.S. 868, 501 U.S. 868">877, 111 S. Ct. 2631">111 S. Ct. 2631, 115 L. Ed. 2d 764">115 L. Ed. 2d 764 (1991). Petitioner argues that applying section 56(g)(4)(C)(i) to depletion renders the limitation of section 56(g)(4)(F)(i) to mines placed in service after December 31, 1989, superfluous.As discussed above, subparagraphs (C)(i) and (F)(i) do serve different functions. While applying section 56(g)(4)(C)(i) to depletion renders the protection in section 56(g)(4)(F)(i)2008 U.S. Tax Ct. LEXIS 17">36 superfluous for the owner of property that has fully depleted the adjusted basis of the property for cost depletion purposes, the limitation on the application of section 56(g)(4)(F)(i) is of significant benefit for taxpayers with property placed in service on or before December 31, 1989, that have not fully depleted the property's adjusted basis. Petitioner enjoyed this benefit with respect to its Twin Creeks Mines. See supra note 1. Therefore, applying section 56(g)(4)(C)(i) to depletable property placed in service on or before December 31, 1989, 130 T.C. 299">310 does not render the limitation in section 56(g)(4)(F)(i) superfluous.B. The Particular Is Not Included in the GeneralPetitioner next argues that section 56(g)(4)(C)(i) does not apply to depletion because it is a general provision that includes what is already included in a more particular provision, section 56(g)(4)(F)(i). In United States v. Chase, 135 U.S. 255">135 U.S. 255, 135 U.S. 255">260, 10 S. Ct. 756">10 S. Ct. 756, 34 L. Ed. 117">34 L. Ed. 117 (1890), the Supreme Court stated:where there is, in the same statute, a particular enactment, and also a general one, which, in its most comprehensive sense, would include what is embraced in the former, the particular enactment must be operative, and the general enactment must 2008 U.S. Tax Ct. LEXIS 17">37 be taken to affect only such cases within its general language as are not within the provisions of the particular enactment. * While respondent agrees with this theory, he disagrees that it applies in this case. Section 56(g)(4)(F)(i) is the "particular enactment" that deals specifically with depletion, but it applies only to property placed in service after December 31, 1989. In the case of a taxpayer with property placed in service after December 31, 1989, whose depletion deduction exceeds the adjusted basis of the property for cost depletion purposes, petitioner is correct that subparagraphs (C)(i) and (F)(i) would both require the taxpayer to make the same ACE adjustment to the extent that the depletion deduction exceeds the adjusted basis of the property. Respondent concedes that in such situations only the particular provision, section 56(g)(4)(F)(i), applies. However, section 56(g)(4)(F)(i) does not apply to property placed in service on or before December 31, 1989. Therefore, only the general provision, section 56(g)(4)(C)(i), applies to such property, and there is no overlap between the particular and the general. Because the Mesquite Mine was placed in service on or before 2008 U.S. Tax Ct. LEXIS 17">38 December 31, 1989, it is subject only to the adjustment in section 56(g)(4)(C)(i).C. Ambiguities Must Be Resolved Against the DrafterPetitioner next argues that ambiguous statutes must be resolved against the drafter, in this case the Government. However, this canon of statutory construction applies only where statutes are ambiguous. Chickasaw Nation v. United 130 T.C. 299">311 States, 208 F.3d 871">208 F.3d 871, 208 F.3d 871">880 (10th Cir. 2000), affd. 534 U.S. 84">534 U.S. 84, 122 S. Ct. 528">122 S. Ct. 528, 151 L. Ed. 2d 474">151 L. Ed. 2d 474 (2001); see also White v. United States, 305 U.S. 281">305 U.S. 281, 305 U.S. 281">292, 59 S. Ct. 179">59 S. Ct. 179, 83 L. Ed. 172">83 L. Ed. 172, 87 Ct. Cl. 749">87 Ct. Cl. 749, 1938-2 C.B. 238 (1938). As discussed above, section 56(g)(4)(C)(i) applies to all property regardless of when it was placed in service, and it offsets the permanent benefit of the percentage depletion method and other deductions that are not allowed when calculating earnings and profits. Section 56(g)(4)(F)(i) applies only to depletable property that is placed in service after December 31, 1989, and it offsets the temporary and permanent benefits of the percentage depletion method. We decline to read ambiguity into a statute that has only one meaning on its face.VI. Legislative HistoryPetitioner also argues that the legislative history of section 56(g)(4) clarifies any remaining ambiguities and confirms that section 56(g)(4)(C)(i)2008 U.S. Tax Ct. LEXIS 17">39 does not apply to depletion. Generally, the Court looks to legislative history only if the statute is unclear. Blum v. Stenson, 465 U.S. 886">465 U.S. 886, 465 U.S. 886">896, 104 S. Ct. 1541">104 S. Ct. 1541, 79 L. Ed. 2d 891">79 L. Ed. 2d 891 (1984); Woodral v. Commissioner, 112 T.C. 19">112 T.C. 19, 112 T.C. 19">22 (1999). However, we do not find section 56(g)(4) unclear.Furthermore, the legislative history of section 56(g)(4) does not alter our understanding of the statute. The House conference report for TRA explains that some adjustments will be made to ACE according to how those items are treated when calculating earnings and profits, and then goes on to say: "Additionally, adjusted current earnings requires different treatment of certain specifically listed items." H. Conf. Rept. 99-841 (Vol. II), at II-275 (1986), 1986-3 C.B. (Vol. 4), 1, 275.We agree that depletion is specifically listed in section 56(g)(4)(F)(i) and is therefore entitled to "different treatment". However, it does not necessarily follow that the general provisions in section 56(g)(4)(C)(i) do not apply to depletable property that is outside the scope of section 56(g)(4)(F)(i).VII. The Statutory Scheme of Section 56Petitioner next argues that applying section 56(g)(4)(C)(i) to depletion conflicts with the statutory scheme of section 562008 U.S. Tax Ct. LEXIS 17">40 because it: (1) Requires section 56(g)(4)(C)(i) to be read in 130 T.C. 299">312 isolation; (2) conflicts with the regulations; (3) is inconsistent with section 56(g)(4)(F)(i); and (4) is inconsistent with respondent's ACE worksheets.Petitioner argues that respondent's position, that section 56(g)(4)(C)(i) applies to depletion, is plausible only if section 56(g)(4)(C)(i) is read in isolation; and if we are to read individual paragraphs in isolation, then section 56(g)(5)(B) eliminates all section 56(g)(4) adjustments.We agree that phrases must be construed in the light of the overall purpose and structure of the whole statutory scheme. Dole v. United Steelworkers of Am., 494 U.S. 26">494 U.S. 26, 494 U.S. 26">35, 110 S. Ct. 929">110 S. Ct. 929, 108 L. Ed. 2d 23">108 L. Ed. 2d 23 (1990); 112 T.C. 19">Woodral v. Commissioner, supra at 22. However, we disagree that respondent's position is plausible only if section 56(g)(4)(C)(i) is read in isolation. Read by itself, section 56(g)(4)(C)(i) applies to all property regardless of when it is placed in service and offsets the permanent benefit of the percentage depletion method and other deductions that are not allowed in any year when computing earnings and profits. Read in the context of section 56 as a whole, it applies only to depletion if a taxpayer owns depletable 2008 U.S. Tax Ct. LEXIS 17">41 property with an adjusted basis smaller than the amount of the taxpayer's depletion deduction and the property is not subject to section 56(g)(4)(F)(i); i.e., was placed in service on or before December 31, 1989. While section 56(g)(4)(F)(i) may limit its application, section 56(g)(4)(C)(i) does not conflict with the rest of section 56 unless we adopt petitioner's position that section 56(g)(4)(F)(i) is the only section that governs ACE adjustments for depletion. We decline to create a conflict where there is none on the face of the statute.Furthermore, contrary to petitioner's argument, section 56(g)(5)(B) does not eliminate all section 56(g)(4) adjustments. Section 56(g)(5)(B) provides:(5) Other definitions. -- For purposes of paragraph (4) -- * * (B) Treatment of alternative minimum taxable income. -- The treatment of any item for purposes of computing alternative minimum taxable income shall be determined without regard to this subsection.While we agree that section 56(g)(5)(B) cannot be read in isolation without causing some confusion, it is clear from the statute as a whole that paragraph (5)(B) simply means that 130 T.C. 299">313 items used in making ACE adjustments should not be included in 2008 U.S. Tax Ct. LEXIS 17">42 preadjustment AMTI as well. Otherwise, ACE would always equal preadjustment AMTI, and section 56(g)(1) would be meaningless.Petitioner also argues that the structure of the regulations indicates that depletion is treated separately from other adjustments that are based on earnings and profits. Section 1.56(g)-1(d)(3), Income Tax Regs., contains a partial list of items not deductible in computing earnings and profits that does not mention depletion, and section 1.56(g)-1(j), Income Tax Regs., separately addresses depletion. Petitioner argues that this means that depletion is never subject to the general earnings and profits rule. However, the list in section 1.56(g)-1(d)(3), Income Tax Regs., is clearly a "partial list". Section 1.56(g)-1(d)(3), Income Tax Regs., provides:Items described in paragraph (d)(1) of this section [referring to items not deductible in computing earnings and profits] are not taken into account in computing earnings and profits (and thus are not deductible in computing adjusted current earnings) even if they are not identified in this paragraph (d)(3). * Therefore, it does not prove that there cannot be an ACE adjustment related to depletion under the general 2008 U.S. Tax Ct. LEXIS 17">43 earnings and profits rule, particularly because the regulations under section 312 specifically include deductions under the percentage depletion method as an item that is not allowable as a deduction when calculating earnings and profits. Sec. 1.312-6(c)(1), Income Tax Regs. Furthermore, the specific regulation that governs depletion, section 1.56(g)-1(j), Income Tax Regs., applies only to property placed in service after December 31, 1989.While noting that implications drawn from subsequent legislation provide a hazardous basis for divining the intent of an earlier Congress, petitioner next argues that the parenthetical in section 56(g)(4)(F)(ii), which was added in 1992 by the Energy Policy Act of 1992, Pub. L. 102-486, sec. 1915(a)(1)-(2), 106 Stat. 3022, confirms that section 56(g)(4)(C)(i) does not apply to depletion. Section 56(g)(4)(F)(ii) provides:(ii) Exception for independent oil and gas producers and royalty owners. -- In the case of any taxable year beginning after December 31, 1992, clause (i) (and subparagraph (C)(i)) shall not apply to any deduction 130 T.C. 299">314 for depletion computed in accordance with section 613A(c). [Emphasis added.]Petitioner argues that the use of the parenthetical 2008 U.S. Tax Ct. LEXIS 17">44 "(and subparagraph (C)(i))" indicates that the information inside the parentheses is redundant. Therefore, the fact that Congress chose to state in parentheses that section 56(g)(4)(C)(i) does not apply to independent oil and gas producers means that section 56(g)(4)(C)(i) would not have applied to those taxpayers in any event because section 56(g)(4)(C)(i) does not apply to depletion. Respondent, by contrast, argues that if Congress had believed that the clause regarding section 56(g)(4)(C)(i) was redundant, it would not have included the clause.Respondent's argument is more persuasive. It is a cardinal rule of statutory construction to give effect to every clause in a statute if possible, and this does not change simply because the clause is in parentheses. Market Co. v. Hoffman, 101 U.S. 112">101 U.S. 112, 101 U.S. 112">115-116, 25 L. Ed. 782">25 L. Ed. 782 (1879). While it is inappropriate to give a parenthetical such weight that it contradicts the plain meaning of the rest of the statute, see, e.g., Chickasaw Nation v. United States, 534 U.S. 84">534 U.S. at 89, respondent's argument is consistent with our interpretation of section 56(g)(4)(C)(i). Therefore, given the limited utility of using the views of a subsequent Congress to make inferences 2008 U.S. Tax Ct. LEXIS 17">45 as to the intent of an earlier Congress, we will not interpret section 56(g)(4)(F)(ii) as meaning that section 56(g)(4)(C)(i) does not apply to depletion.Petitioner also argues that the Commissioner's corporate AMT instructions for the last 20 years confirm that section 56(g)(4)(C)(i) does not apply to depletion. Petitioner points out that the Commissioner's "Adjusted Current Earnings Worksheet" does not list depletion among the ACE adjustments for items not deductible from earnings and profits.Even if we were to find Commissioner's worksheets to be misleading, these informal publications are not law. Zimmerman v. Commissioner, 71 T.C. 367">71 T.C. 367, 71 T.C. 367">371 (1978), affd. without published opinion 614 F.2d 1294">614 F.2d 1294 (2d Cir. 1979); Green v. Commissioner, 59 T.C. 456">59 T.C. 456, 59 T.C. 456">458 (1972). However, we do not find the worksheets to be misleading because they have a place for "Other items" and point to the partial list 130 T.C. 299">315 in section 1.56(g)-1(d)(3), Income Tax Regs., indicating that the worksheets are not comprehensive.In addition, the Commissioner published a technical advice memorandum in 1999 addressing another taxpayer's argument similar to petitioner's current argument that section 56(g)(4)(C)(i) does not apply 2008 U.S. Tax Ct. LEXIS 17">46 to depletion for property placed in service on or before December 31, 1989. Tech. Adv. Mem. 199910045 (Mar. 12, 1999). The taxpayer's arguments were rejected for the same reasons respondent gives in this case. Id. Therefore, petitioner's argument that respondent is now changing his position after 20 years is without merit.VIII. Development CostsPetitioner's final argument is that if section 56(g)(4)(C)(i) applies to depletion, then section 57(a)(1) is superfluous or at least duplicative. Both section 56(g)(4)(C)(i) ACE adjustments and section 57(a)(1) preferences appear to require adjustments for the same amount: the excess of the depletion deduction allowed under the percentage depletion method over the adjusted basis of the property.Respondent concedes that there may be some overlap between the two sections and agrees with petitioner that under section 1.56(g)-1(a)(6)(ii), Income Tax Regs., the amount of the ACE adjustment is reduced by the amount taken into account under section 57(a)(1) to prevent duplication. However, respondent argues that sections 56(g)(4)(C)(i) and 57(a)(1) do not perfectly overlap. Respondent concedes that unamortized section 56(a)(2) costs are added to the 2008 U.S. Tax Ct. LEXIS 17">47 adjusted basis of property when calculating section 57(a)(1) preferences but argues that they are not added to the adjusted basis of property when calculating sections 56(g)(4)(C)(i) ACE adjustments. Therefore, the section 57(a)(1) preference will generally be less than the excess of the depletion deduction over the property's adjusted basis as calculated for purposes of sections 56(g)(4)(C)(i), and the ACE adjustment will be the difference between this excess and the amount of the section 57(a)(1) preference.Petitioner argues that if section 56(g)(4)(C)(i) applies to depletion, sections 56(g)(4)(C)(i) and 57(a)(1) perfectly overlap because unamortized section 56(a)(2) costs are included in the adjusted basis of depletable property for purposes of calculating 130 T.C. 299">316 both section 57(a)(1) preferences and sections 56(g)(4)(C)(i) ACE adjustments. 6To decide this issue, we must consider whether sections 56(g)(4)(C)(i) and 57(a)(1) share the same definitions of "property" and "adjusted basis". Our analysis shows that they do and that 2008 U.S. Tax Ct. LEXIS 17">48 section 56(a)(2) costs should not be included in the adjusted basis of property for purposes of calculating the adjustments under either section 56(g)(4)(C)(i) or 57(a)(1). However, because respondent conceded in this case that section 56(a)(2) costs may be included in the adjusted basis of property for purposes of calculating the section 57(a)(1) preference, we will allow petitioner to include section 56(a)(2) costs in the adjusted basis of the Mesquite Mine for the years at issue.A. Section 56(g)(4)(C)(i)The ACE adjustment in section 56(g)(4)(C)(i) is the excess of the amount of the depletion deduction allowable under the percentage depletion method over the adjusted basis of the property. See secs. 1.312-6(c)(1), 1.611-2(b)(2), Income Tax Regs.Section 614(a) provides the definition of "property" for purposes of determining depletion deductions:SEC. 614 (a). General Rule. -- For the purpose of computing the depletion allowance in the case of mines, wells, and other natural deposits, the term "property" means each separate interest owned by the taxpayer in each mineral deposit in each separate tract or parcel of land. [Emphasis added.]Section 1.611-1(d), Income Tax Regs., further 2008 U.S. Tax Ct. LEXIS 17">49 explains the difference between "property" and the entire "mineral enterprise":(1) "Property" means. (i) in the case of minerals, each separate economic interest owned in each mineral deposit in each separate tract or parcel of land or an aggregation or combination of such mineral interests permitted under section 614(b), (c), (d), or (e); * ** * * (3) "Mineral enterprise" is the mineral deposit or deposits and improvements, if any, used in mining or in the production of oil and gas and only so much of the surface of the land as is necessary for purposes of mineral 130 T.C. 299">317 extraction. The value of the mineral enterprise is the combined value of its component parts.(4) "Mineral deposit" refers to minerals in place. When a mineral enterprise is acquired as a unit, the cost of any interest in the mineral deposit or deposits is that proportion of the total cost of the mineral enterprise which the value of the interest in the deposit or deposits bears to the value of the entire enterprise at the time of its acquisition.(5) "Minerals" includes ores of the metals, coal, oil, gas, and all other natural metallic and nonmetallic deposits, except minerals derived from sea water, the air, or from similar 2008 U.S. Tax Ct. LEXIS 17">50 inexhaustible sources. It includes but is not limited to all of the minerals and other natural deposits subject to depletion based upon a percentage of gross income from the property under section 613 and the regulations thereunder.[Emphasis added.]These definitions make it clear that for purposes of determining depletion deductions, "property" includes only the actual minerals, not improvements or the surface land that are part of the entire "mineral enterprise". While the definition of "minerals" is not limited to property eligible for the depletion deduction under section 613 but also includes oil and gas, it is limited to natural deposits that are exhaustible; i.e., subject to depletion. Sec. 1.611-1(d)(5), Income Tax Regs. Therefore, "property" for purposes of determining the allowable deduction for cost depletion purposes does not include unamortized section 56(a)(2) costs because those are not costs paid for exhaustible minerals.Neither the Code nor the regulations specifically state whether unamortized section 56(a)(2) costs are included in the adjusted basis used for cost depletion purposes. However, consistent with the definition of "property", the definition of "adjusted 2008 U.S. Tax Ct. LEXIS 17">51 basis" for cost depletion purposes does not include unamortized section 56(a)(2) costs. Under section 612 the adjusted basis for purposes of determining depletion deductions is the adjusted basis provided in section 1011. Section 1.612-1, Income Tax Regs., provides:(b) Special rules. (1) The basis for cost depletion of mineral or timber property does not include:(i) Amounts recoverable through depreciation deductions, through deferred expenses, and through deductions other than depletion, * * Because unamortized section 56(a)(2) costs are not recovered through depletion deductions but are amortized under section 56(a)(2), they are not part of the adjusted basis for cost depletion purposes.130 T.C. 299">318 This is consistent with the treatment of development costs that are deferred under section 616(b) (section 616(b) costs) or disallowed and amortized under section 291(b) (section 291(b) costs). Like section 56(a)(2) costs, section 616(b) costs and section 291(b) costs are associated with depletable property but are deducted or amortized separately from the depletion deductions. Under section 616(c), section 616(b) costs are included in the adjusted basis of the mine under section 1016(a)(9) for most 2008 U.S. Tax Ct. LEXIS 17">52 purposes but are disregarded for purposes of computing depletion deductions under section 611. Similarly, under section 291(b)(5) the portion of the adjusted basis of property attributable to section 291(b) costs is not taken into account for purposes of determining depletion deductions under section 611.Petitioner argues that unamortized section 56(a)(2) costs should be included in the adjusted basis of depletable property for purposes of both sections 57(a)(1) and 56(g)(4)(C)(i) because section 56(a)(7)7 specifically provides that unamortized section property. As in effect for the years at issue, section 56(a)(7) provides:(7) Adjusted basis. -- The adjusted basis of any property to which paragraph (1) or (5) applies (or with respect to which there are any expenditures to which paragraph (2) or subsection (b)(2) applies) shall be determined on the basis of the treatment prescribed in paragraph (1), (2), or (5), or subsection (b)(2), whichever applies. [Emphasis added.]Because section 56(a)(2) provides that the section 56(a)(2) costs shall be capitalized and amortized ratably over a 10-year period, petitioner argues that section 56(a)(7) requires section 56(a)(2) costs to be included 2008 U.S. Tax Ct. LEXIS 17">53 in the adjusted basis of depletable property for all AMT purposes. Section 56(a)(7) does provide that development costs should be included in the basis of the property to which section 56(a)(2) applies. However, development costs are incurred to improve the entire mineral enterprise, not to acquire the actual minerals in place. See sec. 616(a). Therefore, unamortized section 56(a)(2) costs are added to the adjusted basis of the mineral enterprise, but they are excluded from the adjusted basis of the mineral deposits for the purpose of 130 T.C. 299">319 determining depletion deductions. See sec. 1.611-1(d)(3) through (5), Income Tax Regs.On the basis of the foregoing discussion, we conclude that unamortized section 56(a)(2) costs are not included in the adjusted basis of property for purposes of calculating ACE adjustments under section 56(g)(4)(C)(i) for depletion.B. Section 57(a)(1)Section 57(a)(1) includes as a tax preference item:(1) Depletion. -- With respect to each property (as defined in section 614), the excess of the deduction for depletion allowable under section 611 2008 U.S. Tax Ct. LEXIS 17">54 for the taxable year over the adjusted basis of the property at the end of the taxable year (determined without regard to the depletion deduction for the taxable year). * * * [Emphasis added.]Section 614(a) defines "property" as "each separate interest owned by the taxpayer in each mineral deposit in each separate tract or parcel of land." (Emphasis added.) This is the definition of "property" that is used for purposes of cost depletion, which does not include unamortized section 56(a)(2) costs. Therefore, unamortized section 56(a)(2) costs are not part of the property used in determining the amount of the section 57(a)(1) preference. However, both petitioner and respondent take the position that, notwithstanding the narrow definition of "property" in section 614(a), unamortized section 56(a)(2) costs are included in the definition of "adjusted basis" for purposes of section 57(a)(1).The regulations under section 57(a)(1) reference section 1016 for determination of the adjusted basis. Sec. 1.57-1(h)(3), Income Tax Regs.Section 1016(a)(9) requires adjustments to basis for deferred section 616(b) costs, and section 1016(a)(20) requires adjustments to basis for unamortized development 2008 U.S. Tax Ct. LEXIS 17">55 costs deferred under section 59(e). While section 1016 does not specifically refer to unamortized section 56(a)(2) costs, it does require adjustments for items properly chargeable to capital account and for depletion. Sec. 1016(a)(1) and (2).The Commissioner has historically argued that deferred section 616 development costs are part of the adjusted basis used in calculating the section 57(a)(1) preference on the basis of the reference to section 1016 in section 1.57-1(h)(3), Income Tax Regs., and the references to deferred section 616130 T.C. 299">320 development costs in section 1016(a)(9) and (20). See Tech. Adv. Mem. 83-14-011 (Dec. 22, 1982); Tech. Adv. Mem. 97-47-002 (Nov. 21, 1997); Field Serv. Adv. Mem. 200021006 (May 25, 2000); cf. Field Serv. Adv. Mem. 0614, 1993 FSA LEXIS 72 (June 30, 1993). While the pattern in section 1016 is to adjust basis for deferred section 616 development costs, respondent's argument ignores the fact that the definition of "property" in section 614(a), which is the definition of property used by section 57(a)(1), does not include the entire mineral enterprise but includes only minerals in place. Therefore, section 1016 may require unamortized section 56(a)(2) costs to be added to the 2008 U.S. Tax Ct. LEXIS 17">56 basis of the mineral enterprise, but it is only the adjusted basis of the minerals in place that is used to calculate the section 57(a)(1) preference.While not directly on point, the Supreme Court's reasoning in United States v. Hill, 506 U.S. 546">506 U.S. 546, 113 S. Ct. 941">113 S. Ct. 941, 122 L. Ed. 2d 330">122 L. Ed. 2d 330 (1993), persuades us that unamortized section 56(a)(2) costs are not included in the adjusted basis of depletable property for purposes of calculating section 57(a)(1) preferences. The issue in Hill was whether unrecovered costs of depreciable tangible items used to exploit the taxpayers' mines (unrecovered depreciation costs) should be added to the adjusted basis for purposes of section 57(a)(8), which was redesignated section 57(a)(1) in 1986 by TRA sec. 701(a), 100 Stat. 2320. 506 U.S. 546">Id. at 548. The Supreme Court reasoned that because taxpayers do not deduct unrecovered depreciation costs through depletion but instead deduct them through depreciation, the unrecovered depreciation costs are separate assets from the mineral deposits. 506 U.S. 546">Id. at 558-559. This is similar to the way that land is treated as a separate asset from a building that sits on it for purposes of calculating depreciation, but the land and the building have a combined adjusted basis 2008 U.S. Tax Ct. LEXIS 17">57 for purposes of determining gain or loss when they are sold together. Id. The Supreme Court relied on the definitions of "property", "mineral deposit", "minerals in place", and "mineral enterprise" found in section 614(a) and section 1.611-1(d), Income Tax Regs., to decide that the term "property" used in section 57(a)(8) includes only minerals in place and excludes improvements. 506 U.S. 546">Id. at 553-560. While noting the taxpayers' argument that section 1016 governs adjustments to basis, the Supreme Court concluded that "the computation of adjusted basis under section 1016 is wholly predicated on, rather than 130 T.C. 299">321 independent of, an understanding of 'mineral deposit' as distinct from 'improvements' within the meaning of the regulations under section 611." 506 U.S. 546">Id. at 554.The Supreme Court declined to extend its reasoning to costs deferred under section 616, particularly section 616(b) costs, because section 616(c) sets up a different system for section 616(b) costs. 506 U.S. 546">Id. at 564 n.12. However, the Supreme Court's findings, that (1) the term "property" as used in section 614(a) includes only minerals in place and (2) the definition of "property" is critical to defining the adjusted basis of the property, 2008 U.S. Tax Ct. LEXIS 17">58 apply in the case before us. 506 U.S. 546">Id. at 553-554. Because unamortized section 56(a)(2) costs are not directly incurred to acquire minerals in place, they are not included in the definition of depletable property in section 614(a). Under the reasoning in506 U.S. 546">Hill, this means that they cannot be included in the adjusted basis of depletable property for purposes of calculating section 57(a)(1) preferences.This interpretation is also supported by the legislative history of the revisions to the AMT in 1986. The House conference report states: "The excess over the adjusted basis of the depletable property is a preference." H. Conf. Rept. 99-841 (Vol. II), supra at II-268, 1986-3 C.B. (Vol. 4) at 268 (emphasis added). Because unamortized section 56(a)(2) costs are not depletable but are amortized over a 10-year period, this statement indicates that they should not be added to the adjusted basis of the property for purposes of section 57(a)(1).Petitioner again argues that section 56(a)(7) defines "adjusted basis" for all AMT purposes and that that section provides that unamortized section 56(a)(2) costs are included in the basis of property. However, section 1.57-1(h)(3), Income Tax Regs., references 2008 U.S. Tax Ct. LEXIS 17">59 section 1016, not section 56(a)(7), for the definition of "adjusted basis" for purposes of calculating section 57(a)(1) preferences. In any event, our analysis shows that the property referred to in section 56(a)(7) is the mineral enterprise, and only the adjusted basis of the mineral deposit is relevant for determining section 57(a)(1) preferences.Our analysis is inconsistent with the Commissioner's historical and current position that unamortized section 56(a)(2) costs may be included in the adjusted basis of depletable property for purposes of calculating section 57(a)(1) preferences. However, because respondent has conceded this 130 T.C. 299">322 issue as it relates to the Mesquite Mine, the parties should nevertheless apply respondent's concession in the Rule 155 computation that the parties agree will be necessary after the remaining issue has been resolved.IX. ConclusionOn the basis of our analysis, unamortized section 56(a)(2) costs are not included in the adjusted basis of depletable property when calculating the amount of 56(g)(4)(C)(i) ACE adjustments or section 57(a)(1) preferences. However, because respondent conceded that unamortized section 56(a)(2) costs may be included in the 2008 U.S. Tax Ct. LEXIS 17">60 adjusted basis of the Mesquite Mine for purposes of calculating section 57(a)(1) preferences, petitioner may include such costs. Therefore, petitioner is not required to make adjustments to its calculation of section 57(a)(1) preferences for the Mesquite Mine for the years at issue and should compute its AMT consistent with our holding that section 56(g)(4)(C)(i) applies to depletion to the extent that amounts treated as section 56(g)(4)(C)(i) ACE adjustments are not also treated as section 57(a)(1) preferences.To reflect the foregoing,An appropriate order will be issued.APPENDIXExample 1: The Operation of Section 56(g)(4)(C)(i) and (F)(i)Taxpayer owns a mine that was placed in service after December 31, 1989. The mine has an adjusted basis of $ 100. The deduction allowed under the percentage depletion method is $ 25, and the deduction allowed under the cost depletion method is $ 20. Taxpayer did not incur any development costs under section 616(a) that it is required to capitalize and amortize under section 56(a)(2). In order to demonstrate the difference between section 56(g)(4)(C)(i) and (F)(i), in Examples 1-4 we assume that section 57(a)(1) does not apply.Under section 56(g)(4)(F)(i), 2008 U.S. Tax Ct. LEXIS 17">61 Taxpayer must make an ACE adjustment of $ 5, which is the difference between the deduction allowed under the percentage depletion method ($ 25) and the deduction allowed under the cost depletion method ($ 20).Taxpayer does not make an ACE adjustment under section 56(g)(4)(C)(i) because Taxpayer's deduction for depletion ($ 25) is less than the mine's 130 T.C. 299">323 adjusted basis ($ 100), so it does not exceed the amount allowable as a deduction in any tax year. Taxpayer will eventually be allowed to deduct $ 25 under the cost depletion method.Example 2:Same as Example 1, except that Taxpayer's mine was placed in service on or before December 31, 1989.Taxpayer is not required to make any ACE adjustments for depletion. Section 56(g)(4)(F)(i) does not apply to property placed in service on or before December 31, 1989, and as discussed in Example 1, Taxpayer is not required to make an adjustment under section 56(g)(4)(C)(i).Example 3:Same as Example 1, except that Taxpayer's mine has an adjusted basis of zero. Therefore, no deduction is allowed under the cost depletion method.Taxpayer must make an ACE adjustment under section 56(g)(4)(F)(i) of $ 25, which is the difference between the deduction allowed 2008 U.S. Tax Ct. LEXIS 17">62 under the percentage depletion method ($ 25) and the deduction allowed under the cost depletion method (zero).Taxpayer is not required to make an ACE adjustment under section 56(g)(4)(C)(i). Because Taxpayer is required to take into account the excess of the deduction allowed under the percentage depletion method over the amount allowed in any year ($ 25) in calculating its ACE, Taxpayer is no longer claiming a deduction for an item that would not be deductible for purposes of computing earnings and profits.Example 4:Same as Example 3, except that Taxpayer's mine was placed in service on or before December 31, 1989.Taxpayer is not required to make an ACE adjustment under section 56(g)(4)(F)(i) because that section does not apply to property placed in service on or before December 31, 1989.Petitioner argues that section 56(g)(4)(C)(i) does not require Taxpayer to make an ACE adjustment for depletion because only section 56(g)(4)(F)(i) applies to depletion.Respondent argues that Taxpayer is required to make an adjustment under section 56(g)(4)(C)(i) of $ 25, which is the difference between the deduction taken under the percentage depletion method ($ 25) and the amount that would be allowable 2008 U.S. Tax Ct. LEXIS 17">63 in any year under the cost depletion method (zero). Because Taxpayer did not make an ACE adjustment for this amount under section 56(g)(4)(F)(i), nothing prevents section 56(g)(4)(C)(i) from applying.We agree with respondent that section 56(g)(4)(F)(i) does not prevent section 56(g)(4)(C)(i) from applying to depletion.However, as discussed in the Opinion, the $ 25 difference between the amount allowable under the percentage depletion method and the adjusted 130 T.C. 299">324 basis of the mine will be taken into account under section 57(a)(1). Therefore, section 56(g)(4)(C)(i) will be preempted by section 57(a)(1) just as it was preempted by section 56(g)(4)(C)(i) in Example 3.Example 5: The Treatment of Section 56(a)(2) Costs Under Sections 57(a)(1) and 56(g)(4)(C)(i)Taxpayer owns property that was placed in service on or before December 31, 1989. The property has an adjusted basis for cost depletion purposes(cost basis) of zero, excluding unamortized section 56(a)(2) costs. Taxpayer has unamortized section 56(a)(2) costs of $ 20. Taxpayer is allowed a deduction of $ 25 under the percentage depletion method.Respondent and petitioner both argue that Taxpayer's section 57(a)(1) preference equals $ 5:$ 25(depletion deduction)- 0(cost basis)- 20(unamortized section 57(a)(2) costs)-----------------------------------------5(section 57(a)(1) preference)Respondent 2008 U.S. Tax Ct. LEXIS 17">64 argues that Taxpayer's section 56(g)(4)(C)(i) ACE adjustment equals $ 20:$ 25(depletion deduction)- 0(cost basis)- 5(amount taken into account under section 57(a)(1))-------------------------------------------------------20(section 56(g)(4)(C)(i) ACE adjustment)Respondent argues that the unamortized section 56(a)(2) costs are not included in basis for purposes of section 56(g)(4)(C)(i).Petitioner argues that Taxpayer's section 56(g)(4)(C)(i) ACE adjustment, if it applies to depletion, would equal zero because unamortized section 56(a)(2) costs are taken into account:$ 25(depletion deduction)- 0(cost basis)- 20(unamortized section 56(a)(2) costs)- 5(amount taken into account under section 57(a)(1))-------------------------------------------------------0(section 56(g)(4)(C)(i) ACE adjustment)Under the Court's analysis, Taxpayer's section 57(a)(1) preference should equal $ 25 because unamortized section 56(a)(2) costs are not taken into account in either calculation:$ 25(depletion deduction)- 0(cost basis)---------------------------------25(section 57(a)(1) preference)130 T.C. 299">325 Therefore, Taxpayer's section 56(g)(4)(C)(i) ACE adjustment would equal zero:$ 25(depletion deduction)- 0(cost basis)- 25(amount taken into account under section 57(a)(1))-------------------------------------------------------0(section 56(g)(4)(C)(i) ACE adjustment)However, 2008 U.S. Tax Ct. LEXIS 17">*65 because respondent conceded that petitioner may include section 56(a)(2) costs in the Mesquite Mine's adjusted basis for purposes of determining the section 57(a)(1) preferences attributable to that mine, in their Rule 155 computations the parties should follow respondent's position (the section 57(a)(1) preference would be $ 5 and the section 56(g)(4)(C)(i) ACE adjustment would be $ 20 in this example).Footnotes1. Respondent concedes the portions of the adjusted current earnings (ACE) adjustments set forth in the notice of deficiency attributable to petitioner's Twin Creeks Mines made pursuant to sec. 56(g)(4)↩ in the amounts of $ 3,659,182, $ 12,676,115, $ 22,655,817, and $ 6,574,253 for the years ending Dec. 31, 1994, Dec. 31, 1995, Dec. 31, 1996, and May 5, 1997, respectively.2. Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩3. Respondent also made other adjustments in the notices of deficiency that the Court will address in a separate opinion.↩4. Examples 1-4 in the appendix to this Opinion illustrate the operation of sec. 56(g)(4)(C)(i) and (F)(i) and the views of the parties and the Court on whether sec. 56(g)(4)(C)(i)↩ applies to depletion.5. Tax Reform Act of 1986, Pub. L. 99-514, sec. 701(a), 100 Stat. 2320; Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-508, sec. 11301(b), 104 Stat. 1388-449. The original sec. 56(g)(4)(G) provided:(G) Depletion. -- The allowances for depletion with respect to any property placed in service in a taxable year beginning after 1989, shall be determined under whichever of the following methods yields deductions with a smaller present value:(i) cost depletion determined under section 611,or(ii) the method used for book purposes.↩6. Example 5 in the appendix to this Opinion illustrates the operation of secs. 56(a)(2), 57(a)(1), and 56(g)(4)(C)(i)↩, and the positions of the parties and the Court.7. Sec. 56(a)(7) was redesignated sec. 56(a)(6) in 1997. Taxpayer Relief Act of 1997, Pub. L. 105-34, sec. 403(a), 111 Stat. 844↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619330/	F. W. Graham v. Commissioner.Graham v. CommissionerDocket No. 108313.United States Tax Court1943 Tax Ct. Memo LEXIS 379; 1 T.C.M. 834; T.C.M. (RIA) 43149; March 30, 19431943 Tax Ct. Memo LEXIS 379">379 Burns Poe, Esq., 1210 Puget Sount Nat'l Bank Bldg., Tacoma, Wash., for the petitioner. Arthur L. Murray, Esq., for the respondent. HARRON Memorandum Opinion HARRON, Judge: The Commissioner determined a deficiency of $901.92 for the year 1939. The deficiency is contested in part, petitioner assailing only the inclusion of $13,621.99 in income. Respondent added that amount to income as "profit on cancellation of indebtedness." Petitioner resides in Shelton, Washington. He filed his return for 1939 with the collector for the district of Washington. He keeps his books and makes his returns on the accrual basis. The facts stipulated by the parties are adopted as our findings of fact. On December 27, 1939, petitioner was indebted to Frank J. Walsh on a note in the total amount of $25,525.14, the principal of the note, $15,823.82, plus accrued interest in the amount of $9,701.32. 1 The interest had been accrued on the books of petitioner and regularly deducted in his returns filed during the period 1929 to 1939, inclusive. On December 27, 1939, Walsh accepted cash and property having a total value of $11,903.15 in full satisfaction of the above indebtedness, thereby cancelling $13,621.991943 Tax Ct. Memo LEXIS 379">380 of the debt. The note was given, originally, to a contracting company to cover the unpaid balance due to the company for the construction of a building. (Later, Walsh acquired the note from the contracting company). Petitioner contends that the compromise and settlement of the debt did not result in his acquisition of gain, but that, rather, it resulted in a rearrangement of the cost price of the building, in part payment of costs of which the note was given. Petitioner relies on Hirsch v. Commissioner, 115 Fed. (2d) 656; Helvering v. A. L. Killian Co., 128 Fed. (2d) 433. The facts show that the partial forgiveness of the debt was gratuitous. There is nothing in the record to indicate that the creditor received any consideration for the partial forgiveness of the debt. On the contrary it was without consideration and for the benefit of the debtor, petitioner. It is held that the gratuitous forgiveness of indebtedness constituted1943 Tax Ct. Memo LEXIS 379">*381 a gift within the meaning of Section 22 (b) (3) of the Internal Revenue Code, and, accordingly, the amount of the debt which was cancelled was not taxable income. This question is controlled by Helvering v. American Dental Co., 318 U.S. 322">318 U.S. 322. Respondent does not raise any separate question relative to the cancellation by the creditor in 1939 of interest which petitioner accrued in earlier years and deducted in his returns for earlier years. However, the holding in the American Dental Co. case disposes of such question in petitioner's favor. The issue is determined in petitioner's favor, but because one of respondent's adjustments is conceded there must be a recomputation of the deficiency under Rule 50. Decision will be entered under Rule 50. Footnotes1. There is an error in the amount of one of the items stipulated. It appears to be in the amount of the accumulated interest which was said to be $9,702.32, and which probably is $9,701.32.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619331/	Joseph and Anastasia Marcello, et al. 1 v. Commissioner. Marcello v. CommissionerDocket Nos. 89004-89007.United States Tax CourtT.C. Memo 1963-66; 1963 Tax Ct. Memo LEXIS 280; 22 T.C.M. 270; T.C.M. (RIA) 63066; March 5, 1963deQuincy V. Sutton, Esq., for the petitioners. Robert S. Leigh, Esq., for the respondent. WITHEYMemorandum Opinion WITHEY, Judge: A deficiency in the income tax of each of the respective petitioners for 1957 has been determined by respondent as follows: Docket1957No.PetitionersDeficiency89004Joseph and Anastasia Mar-cello$418.0089005Anthony and Maria Carollo225.8189006John J. and Marie Pecoraro369.8089007Joseph A. and Sletia Poretto455.80The only issue presented is whether, by virtue of the disallowance of certain claimed deductions of a partnership in which the respective husband petitioners were partners, the taxable reported income of each of the petitioners has been1963 Tax Ct. Memo LEXIS 280">281 understated. All of the facts have been stipulated and we adopt the stipulation as our findings of fact as follows: Petitioners, Joseph and Anastasia Marcello are husband and wife, with their address as c/o Nola Printing Company, 530 Iris Street, New Orleans, Louisiana. These petitioners filed their joint United States income tax return for the calendar year 1957 with the district director of internal revenue at New Orleans, Louisiana. Anthony and Maria Carollo are husband and wife residing at 5500 Vermillion Boulevard, New Orleans, Louisiana. These petitioners filed their joint United States income tax return for the calendar year 1957 with the district director of internal revenue at New Orleans, Louisiana. Petitioners John J. and Marie Pecoraro are husband and wife residing at 3631 Elysian Field Avenue, New Orleans 22, Louisiana. These petitioners filed their joint United States income tax return for the calendar year 1957 with the district director of internal revenue at New Orleans, Louisiana. Petitioners Joseph A. and Sletia Poretto are husband and wife residing at 26 Sonia Place, New Orleans 21, Louisiana. These petitioners filed their joint United States income tax1963 Tax Ct. Memo LEXIS 280">282 return for the calendar year 1957 with the district director of internal revenue at New Orleans, Louisiana. At all times material petitioners Joseph Marcello, Jr., Anthony Carollo, John J. Pecoraro, and Joseph A. Poretto, were members of Nola News, a partnership engaged in the business of printing and furmishing racehorse wire services to subscribers. An additional member of the partnership not involved in this proceeding was Ralph Emery of Chicago, Illinois. Under the agreement of the partnership, the five partners were to share in the net profits and losses equally after salaries were paid to the partners Joseph A. Poretto and Joseph Marcello, Jr. At all times material the address of Nola News was 530 Iris Street, New Orleans, Louisiana. Nola News timely filed a United States partnership return of income on Form 1065, for the fiscal year ended February 28, 1957, with the district director of internal revenue, New Orleans, Louisiana. On December 29, 1956, Nola News issued check number 338 in the amount of $100 on its bank account, payable to the order of Frank Ryan. On December 29, 1956, Nola News issued check number 337 in the amount of $500 on its bank account, payable1963 Tax Ct. Memo LEXIS 280">283 to the order of the American Committee on Italian Mitigation. This check represented a contribution to such committee. On June 7, 1956, Nola News issued a check number 1449 in the amount of $3,500 on its bank account, payable to the order of Ernest M. Loeb and Co., investment brokers, New Orleans, Louisiana. No oral testimony or documentary evidence other than the income tax returns of petitioners has been offered or introduced into the record herein. There is, therefore, no proof whatsoever that the three checks stipulated to have been issued by the partnership were ever delivered or cashed. Except for the check drawn to the American Committee on Italian Mitigation there is also no evidence concerning the nature of such payments on the assumption that the checks had been delivered and cashed by the payees thereof. With respect to the exception there is no proof as to whether the American Committee on Italian Mitigation is a charitable institution within the meaning of section 170(c) of the Internal Revenue Code of 1954. For virtually complete lack of any proof to show error in respondent's determination of the deficiencies herein, his determination of1963 Tax Ct. Memo LEXIS 280">284 deficiency in each case is sustained. Decision will be entered for the respondent. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Anthony and Maria Carollo. Docket No. 89005; John J. and Marie Pecoraro, Docket No. 89006; and Joseph A. and Sletia Poretto, Docket No. 89007.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619332/	Big "D" Development Corporation v. Commissioner.Big "D" Development Corp. v. CommissionerDocket No. 4758-68.United States Tax CourtT.C. Memo 1971-148; 1971 Tax Ct. Memo LEXIS 183; 30 T.C.M. 646; T.C.M. (RIA) 71148; June 21, 1971, Filed Fritz Lyne, 1400 Adolphus Tower, Dallas, Tex., and Ira Lee Allen, for the petitioner Richard K. Seltzer, for the respondent. STERRETTMemorandum Findings of Fact and Opinion STERRETT, Judge: Respondent determined a deficiency of $143,701.35 in petitioner's income tax for the fiscal year ending October 31, 1964. The question before the Court is whether a sale of land by petitioner in 1964 qualifies for installment method of reporting income under section 453(b). 1Findings of Fact All of the facts were stipulated. The stipulation and exhibits attached thereto are incorporated herein by this reference. The Big "D" Corporation (hereinafter referred to as petitioner) 1971 Tax Ct. Memo LEXIS 183">184 is a Texas corporation presently having its principal place of business in Houston, Texas. At the time of filing its petition herein, petitioner's principal place of business was located in Dallas, Texas. Petitioner was incorporated in 1955 and has kept its books and reported its income on a cash basis, utilizing a fiscal year ended October 31. Petitioner timely filed its Federal corporation income tax return for the 1964 fiscal year with the district director of internal revenue, Dallas, Texas. During 1964, petitioner's president was D. A. Childre who, together with his brother H. Thad Childre, owned sufficient units of a voting trust so as to control the election of petitioner's directors. Also D. A. Childre owned 24.5 percent and H. Thad Childre owned 34.6 percent of petitioner's stock in 1964. Petitioner, in turn, controlled a voting trust and owned sufficient shares of common stock in Great Southwest Life Insurance Company (hereinafter referred to as Great Southwest), also a Texas corporation, to give it voting control of Great Southwest. During times relevant hereto, all, or almost all, of petitioner's directors and shareholders were directors of Great Southwest. H. Thad1971 Tax Ct. Memo LEXIS 183">185 Childre was chairman of the board and C. A. Childre was president of Great Southwest during 1964. Prior to 1964 petitioner had acquired land along the North Central Expressway near its intersection with Blackburn and Haskell Streets in the city of Dallas. The property was referred to as the Block 4/975 land, and had an adjusted tax basis to petitioner of $414,631.02 on October 23, 1964. By general warranty deed dated October 23, 1964, and delivered at a closing on October 29, 1964, petitioner conveyed the Block 4/975 land to Great Southwest for a total price of $967,518 resulting in a net long term capital gain to petitioner of $552,886.98. The transaction was approved in a corporate resolution, dated October 29, 1964, passed by the board of directors of petitioner and in a corporate resolution, also dated October 29, 1964, passed by the board of directors of Great Southwest at their respective meetings held on that day. By 647 those resolutions, each board of directors agreed that the total value of the Block 4/975 land was $967,518, based upon an appraisal, and that the effective date of the sale was October 23, 1964. Great Southwest purchased the Block 4/975 land subject1971 Tax Ct. Memo LEXIS 183">186 to a first lien note the principal amount of which on October 1, 1964, was $374,213.95 and upon which, as of October 23, 1964, there was accrued interest in the amount of $1,434.51. A check for $3,145.15 was issued by Great Southwest to Southwest Title and Abstract Company in payment of the full amount of the closing costs. In exchange for the Block 4/975 land, Great Southwest executed a bond payable to the petitioner and dated October 23, 1964. The bond (hereinafter referred to as the Great Southwest bond) was in the face amount of $591,175.55 which was determined by subtracting from the agreed purchase price of $967,518, the closing costs paid by Great Southwest and chargeable to the petitioner in the amount of $2,128.50, and the first lien on the property in the amount of $374,213.95. The terms of the Great Southwest bond provided it was payable on or before 5 years from its effective date, and that it would bear interest at the rate of 5 1/2 percent per year. Amounts not exceeding a total of $150,000, out of specified percentages of premium income from various types of policies written by Great Southwest were to be placed in a sinking fund. Principal and interest were to be paid1971 Tax Ct. Memo LEXIS 183">187 from the sinking fund. However no payments were to be made into the sinking fund if the capital and unrestricted surplus of Great Southwest would thereby be reduced below $687,900. Neither the unpaid principal nor the interest due under the bond would be a liability of Great Southwest or a claim against any of its assets except the sinking fund. Finally the bond retained for Great Southwest the right at its option, to make a payment of all or any part of the principal or interest at any time out of any funds of the company without penalty or loss rights under the bond. The Great Southwest bond was non-negotiable, completely conditional and practically worthless. The total capital and surplus amount fixed under the Great Southwest bond was subject to adjustment in case of merger of Great Southwest. Effective December 31, 1964, Great Southwest and Texas Reserve Life Insurance Company merged and Great Southwest was the surviving corporation. In accord with the terms of the bond, the minimum total capital and surplus amount fixed under the bond before payments could be made into the sinking fund was adjusted upward from $687,900.00 to $1,497,699.33. At no time during the periods ended1971 Tax Ct. Memo LEXIS 183">188 December 31, 1964, through December 31, 1968, was the combined capital and surplus of Great Southwest as much as $1,497,699.33. At the conclusion of its fiscal year ending September 30, 1964, Great Southwest held a general obligation bond of the petitioner (hereinafter referred to as the Big "D" bond). The Big "D" bond was in the principal amount of $700,000 all of which was outstanding on September 30, 1964. The bond was due June 1, 1969, and it provided for interest at the rate of 5 1/2 percent per year. Payment of the Great Southwest bond was effected by entries on the books of petitioner reducing the principal and interest owing on the Big "D" bond held by Great Southwest as follows: DateTotal PaymentInterestPrincipalJune 1, 1965$ 89,416.58$ 8,908.12$ 80,508.46June 1, 196691,951.7338,776.4453,175.29June 1, 196738,500.0025,162.0513,337.95June 23, 196758,002.0058,002.00June 1, 196893,500.0024,317.2569,182.75July 12, 1968 318,954.561,985.46316,969.10 $690,324.87$99,149.32$591,175.55In its Federal corporate income tax return for fiscal year ending October 31, 1964, petitioner made a timely1971 Tax Ct. Memo LEXIS 183">189 election to report the gain realized from the sale of the Block 4/975 property on the installment method. Respondent, in a statutory notice dated July 9, 1968, included the entire amount of the gain in petitioner's fiscal year 1964 income for the stated reason "* * * that this gain is not reportable using the installment method of reporting." 648 Opinion We are to determine whether the transfer on October 23, 1964, by petitioner, Big "D" Development Corporation, of real estate in Dallas, Texas, known as the Block 4/975 property, to the Great Southwest Life Insurance Company qualifies under section 4532 for reporting under the installment method. Respondent contends that the entire gain realized on the transaction must be included in petitioner's income for its fiscal year ended October 31, 1964, because, it is alleged, petitioner transferred the land in return for immediate part cancellation of a substantial portion of its indebtedness to Great Southwest. 1971 Tax Ct. Memo LEXIS 183">190 Prior to dealing with the issue thus framed, a preliminary matter must be disposed of. Petitioner in its reply brief contends that respondent in his opening statement before this Court and in his brief has raised a new issue which, not having been pleaded, cannot be entertained by this Court, or which, at least, shifts the burden of proof to the respondent. We cannot agree. Respondent in the statutory notice said: (b) It is determined that you realized additional income of $550,903.47 from the sale of Block 4/975 of Middleton Brothers Oak Grove Addition to the City of Dallas, Dallas County, Texas, computed as follows: * * It is further determined that this gain is not reportable using the installment method of reporting. As can be seen the determination made by respondent is very broadly based. At the hearing where this case was submitted to the Court, respondent, in his opening statement, adduced several alternative theories supporting the determination in the statutory notice. In his opening brief respondent discarded all theories but the one set out above; that the transaction resulted in the immediate cancellation of a substantial indebtedness owing to the vendee, and1971 Tax Ct. Memo LEXIS 183">191 petitioner thus received all that was owing it under the agreement of sale. It is readily apparent that respondnet merely narrowed the issue after taking a broad position in the statutory notice. The specific reason for the purported deficiency, as finally asserted in respondent's opening brief and in his remarks before the Court, is consistent with and inherent in the determination set out in the notice of deficiency. 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 of deficiency and shift the burden of proof to the respondent, much less bar his contentions from consideration. Compare, C. D. Spangler, 32 T.C. 782">32 T.C. 782, 32 T.C. 782">793 (1959); and Raoul H. Fleischmann, 40 B.T.A. 672">40 B.T.A. 672, 40 B.T.A. 672">682 (1939) with Rozelle McSpadden, 50 T.C. 478">50 T.C. 478, 50 T.C. 478">493 (1968). It would be otherwise where respondent's determination in a statutory notice is narrowly drawn and, after the matter has been petitioned to this Court, respondent advances new grounds not directly or implicitly within the ambit of the determination made in the notice. Arthur Sorin, 29 T.C. 959">29 T.C. 959, 29 T.C. 959">969 (1958);1971 Tax Ct. Memo LEXIS 183">192 W. H. Weaver, 25 T.C. 1067">25 T.C. 1067, 25 T.C. 1067">1085 (1956). Since respondent has not raised a new issue, we hold the respondent's determination remains presumptively correct, and the burden of proof continues to be on petitioner. We now turn to the substantive issue of whether gain on the transaction in question can be reported by the installment method. The installment method of reporting provided by section 453(b) is a relief measure and an exception to the general rule requiring a cash basis taxpayer to report an item of income in the year received. This being so, the provision must be strictly construed. Cappel House Furnishing Co. v. United States, 244 F.2d 525, 529 (C.A. 6, 1957), affirming, 140 F. Supp. 92">140 F. Supp. 92 (S. D.Ohio, 1956). Substance and not form will determine whether a transaction is an installment sale, and an arrangement lacking reality will not be given effect. Griffiths v. Commissioner, 308 U.S. 355">308 U.S. 355 (1939); Hindes v. United States, 326 F.2d 150 (C.A. 5, 1964), reversing in part and affirming in part 214 F. Supp. 583">214 F. Supp. 5831971 Tax Ct. Memo LEXIS 183">193 (W.D. Tex., 1963), on remand 246 F. Supp. 147">246 F. Supp. 147 (W.D. Tex., 1965), reversed in part and affirmed in part 371 F.2d 650 (C.A. 5, 1967), Williams v. United States, 219 F.2d 523, 527 (C.A. 5, 1955); Everett Pozzi, 49 T.C. 119">49 T.C. 119, 49 T.C. 119">127 (1967). On October 23, 1964, petitioner conveyed the Block 4/975 land to Great Southwest, and received in return the assumption of a first lien on the land in the amount of $374,213.95, payment of its $2,128.50 share of closing costs, and a bond in the face amount of $591,175.55. The total purchase price was $967,518. Petitioner had a basis of $414,631.02 in the property, and thus realized a gain of $552,886.98. The Great Southwest bond was specifically payable to petitioner, bore interest of 5 1/2 percent per annum, was non-negotiable, and was payable five years from its effective date of October 23, 1964. At the time of the conveyance, Great Southwest held a general obligation bond issued to it by the petitioner. The Big "D" bond was in the principal amount of $700,000, and nothing in the evidence indicates that any payments on the principal had been made prior to October 23, 1964. The due date for1971 Tax Ct. Memo LEXIS 183">194 the Big "D" bond was June 1, 1969, and interest was payable on the bond at the rate of 5 1/2 percent per year. The amounts due petitioner under the Great Southwest bond were satisfied by a series of entries on the books of petitioner from 1965 through 1968 whereby its obligation for principal and interest to Great Southwest under the Big "D" bond was reduced to zero. Petitioner had voting control of Great Southwest, and was in turn controlled by H. Thad Childre and D. A. Childre who were, respectively, chairman of the board and president of Great Southwest. Under the circumstances here present petitioner must show that the Big "D" bond was independent from the transaction conveying the Block 4/975 land. United States v. Williams, 395 F.2d 508, 511 (C.A. 5, 1968); Blue Flame Gas Co., 54 T.C. 584">54 T.C. 584, 54 T.C. 584">595 (1970). Careful scrutiny of the transaction and the obligations petitioner and Great Southwest owed each other is required because of the close interrelationship of the two corporations. Petitioner was in control of Great Southwest. Under the terms of the bond it gave in return for the Block 4/975 property, Great Southwest could pay the entire amount due1971 Tax Ct. Memo LEXIS 183">195 at any time. Thus the inference can fairly be drawn that petitioner was in a position to effect an immediate $591,175.55 reduction of its $700,000 indebtedness to Great Southwest, and no evidence presently before this Court serves to negate this inference. Petitioner in its reply brief argues there is no evidence showing that the Big "D" bond in the amount of $700,000, due June 1, 1969, and held by Great Southwest was precisely the indebtedness of petitioner to Great Southwest reduced by the book entries reflecting payment of the Great Southwest bond. In the stipulation of facts the parties jointly agreed that: "The following payments of principal and interest by Great Southwest Life Insurance Company to Big "D" Development Corporation were made by entries on the books of Big "D" Development Corporation reducing the principal and/or interest of the general obligation bond due June 1, 1969, of Big "D" held by Great Southwest Life Insurance Company. * " The evidence for the existence of the Big "D" bond was an abstract from a proxy statement, dated November 30, 1964, published in connection with the "Proposed Merger of Great Southwest Life Insurance Company, Dallas, Texas and Texas1971 Tax Ct. Memo LEXIS 183">196 Reserve Life Insurance Company, Houston, Texas." The abstract was a joint exhibit attached to the stipulation which the parties lodged with the Court. Petitioner has made no effort to show by evidence the existence of any other general obligation bond of Big "D" held by Great Southwest, due June 1, 1969. The interrelatedness of the Big "D" bond with the sale of Block 4/975 is the heart of respondent's case. It is significant that petitioner, nonetheless, merely argues about the sufficiency of the evidence, and does not in fact deny that it was the Big "D" bond in the principal amount of $700,000, and due June 1, 1969, which was reduced 650 by offsetting amounts owed under the Great Southwest bond. The play upon the evidence attempted by petitioner's counsel, who must surely have more than some knowledge of petitioner's affairs, is inappropriate. The amount considered received in the year of a transaction by a taxpayer making an installment sale is computed by taking into account amounts constructively as well as actually received. Williams v. United States, supra; Stephen A. Cisler, Jr., 39 T.C. 458">39 T.C. 458, 39 T.C. 458">466 (1962);1971 Tax Ct. Memo LEXIS 183">197 J. L. McInerney, 29 B.T.A. 1">29 B.T.A. 1, 29 B.T.A. 1">6 (1933), affirmed 82 F.2d 665 (C.A. 6, 1936). Any outstanding indebtedness of a seller to a purchaser cancelled in consideration for the transfer of property in an installment sale will be considered a payment received in the year of sale. Riss v. Commissioner, 368 F.2d 965, 968 (C.A. 10, 1966), affirming a Memorandum Opinion of this Court; W.H. Batcheller, 19 B.T.A. 1050">19 B.T.A. 1050, 19 B.T.A. 1050">1053-1054 (1930). The transfer of appreciated property in satisfaction of an indebtedness is a sale or exchange resulting in recognizable gain to the extent the cancelled debt exceeds the taxpayer's basis in the transferred property. Harry L. Bialock, 35 T.C. 649">35 T.C. 649, 35 T.C. 649">660 (1961); Peninsula Properties Co., Ltd., 47 B.T.A. 84">47 B.T.A. 84, 47 B.T.A. 84">91 (1942). Thus we have concluded that petitioner, at the time of the sale, was in receipt of $591,175.55 since its indebtedness to Great Southwest could, at its sole discretion, be reduced by that amount. The present situation appears analogous to cases where taxpayers have set up elaborate1971 Tax Ct. Memo LEXIS 183">198 escrow schemes, Williams v. United States, supra; Rhodes v. United States, 243 F. Supp. 894">243 F. Supp. 894 (W.D.S.C. 1965); 49 T.C. 119">Everett Pozzi, supra, or shell corporations; Hindes v. United States, supra, in an effort to establish a qualifying installment sale. In those cases the courts were able to see through the arrangements and observe that full receipt of the total consideration merely awaited the command of the seller, and that any cross indebtedness was lacking in reality. See also Newmark v. Commissioner, 311 F.2d 913 (C.A. 2, 1962), affirming a Memorandum Opinion of this Court. There it was held that a taxpayer had received salary from his controlled corporation because demand notes issued in lieu of salary by the corporation could be offset against taxpayer's debt to the corporation. The interrelatedness of the Big "D" bond, the Great Southwest bond, and the conveyance of the Block 4/975 property is further emphasized by the fact that both bonds bore interest at the rate of 5 1/2 percent per year. 54 T.C. 584">Blue Flame Gas Co., supra. The process of reducing the Great Southwest indebtedness by a series of entries1971 Tax Ct. Memo LEXIS 183">199 on petitioner's books, decreasing its obligation to Great Southwest by equivalent amounts, will not serve to qualify the transaction in issue as an installment sale. The purpose for this method of payment is not clear from the record before us. We can only infer, as does respondent, that it was selected to accommodate petitioner's desire to qualify for installment reporting However, mere bookkeeping formalisms engaged in solely for the purpose of permitting a taxpayer to report gain on the installment basis will not be given effect. John H. Rickey, 54 T.C. 680">54 T.C. 680, 54 T.C. 680">694 (1970). Our decision here is not altered by the opinion in Estate of Lipman v. United States, 376 F.2d 455 (C.A. 6, 1967), affirming 245 F. Supp. 393">245 F. Supp. 393 (E.D. Tenn., 1965). There stock was purchased from the taxpayer-wife by a corporation which agreed, inter alia, to cancellation of the taxpayer-husband's indebtedness according to a set schedule in years subsequent to the year of sale. It was held that this provision did not constitute a payment in the year of sale. The Court of Appeals1971 Tax Ct. Memo LEXIS 183">200 noted that the taxpayer-husband had covenanted not to compete with the corporation, and that while a violation of the covenant would cause the taxpayer-husband's indebtedness to become immediately due, the corporation would nonetheless be liable to continue payments to the taxpayer-wife for the stock. The present case clearly lacks this particular tripartite aspect. An additional reason the Court of Appeals affirmed the District Court in Lipman was because bankruptcy of the purchaser would leave the taxpayer-husband liable to the purchaser's creditors. We do not have in evidence the terms of the Big "D" bond and cannot say that bankruptcy of Great Southwest would leave petitioner liable to Great Southwest's creditors. Lacking evidence, we are not at liberty to assume facts favorable to the petitioner on whose shoulders the burden of proof rests. 651 The present case has presented a close factual question. The record in some respects is incomplete. The extent to which this Court is left uninformed as to the details of the transaction must weigh against the petitioner on whom the burden of proof rests. Based upon the whole record and for the reasons set forth above, we decide1971 Tax Ct. Memo LEXIS 183">201 petitioner's gain on the sale of the Block 4/975 land in 1964 cannot be reported by the installment method but rather is fully taxable in its fiscal year ended October 31, 1964. Accordingly: Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated.↩2. SEC. 453. INSTALLMENT METHOD. (a) Dealers in Personal Property. - (1) In general. - Under regulations prescribed by the Secretary or his delegate, 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. (b) Sales of Realty and Casual Sales of Personalty - (1) General rule. - Income from. - (A) a sale or other disposition of real property, or * * 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) In the case of a sale or other disposition during a taxable year beginning after December 31, 1953 * * * 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.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619334/	Max M. Axelrod, Petitioner, v. Commissioner of Internal Revenue, RespondentAxelrod v. CommissionerDocket No. 87288United States Tax Court37 T.C. 1053; 1962 U.S. Tax Ct. LEXIS 178; March 8, 1962, Filed 1962 U.S. Tax Ct. LEXIS 178">178 Decision will be entered for the respondent. Petitioner and Cammer were partners in a cafe. Petitioner notified Cammer that unless Cammer purchased his interest he would bring an action for an accounting and dissolution of the partnership. Cammer borrowed funds from a finance company to purchase petitioner's interest in the partnership. Petitioner agreed to guarantee the loan with the finance company. Cammer defaulted on the loan and petitioner was required to pay the finance company the balance due on the loan. Petitioner deducted the amount paid as a bad debt under section 166(f), I.R.C. 1954. Held, the proceeds of the loan were not used in the trade or business of the borrower within the meaning of section 166(f) and petitioner is not entitled to a bad debt deduction under that section. Morton M. Stotter, Esq., for the petitioner.Thomas J. Moroney, Jr., Esq., for the respondent. Drennen, Judge. Mulroney, J., dissenting. Forrester and Fay, JJ., agree with this dissent. Fay, J., dissenting. Forrester, J., agrees with this dissent. DRENNEN37 T.C. 1053">1053 OPINION.Respondent determined a deficiency in petitioner's income tax for the taxable year 1957 in the amount of $ 2,417.33. The only issue for decision is whether petitioner is entitled to a deduction under section 166(f) of the Internal Revenue Code of 1954 as the result of a loss sustained1962 U.S. Tax Ct. LEXIS 178">180 by petitioner as guarantor of a noncorporate obligation.All of the facts have been stipulated, are so found and are incorporated herein by reference. Those necessary to an understanding of our inquiry are recited below.Petitioner lived in Ohio in 1957 and filed his income tax return for the calendar year 1957 on the cash basis of accounting with the district director of internal revenue at Cleveland, Ohio.37 T.C. 1053">1054 In 1948 petitioner and Stanford S. Cammer formed a partnership for the purpose of operating a cafe in Santa Barbara, California. Cammer was the active partner and operated the business. Petitioner, living in Ohio, did not actively participate in the operation of the cafe.Due to differences which arose between petitioner and Cammer, petitioner notified the latter that unless he would agree to purchase petitioner's interest in the partnership, petitioner would institute an action for an accounting and for dissolution of the partnership. Cammer decided to purchase petitioner's interest in the partnership and borrowed the sum of $ 7,500 from the Lake Shore Finance Corporation, an Ohio corporation, hereinafter referred to as the finance company. Cammer delivered to1962 U.S. Tax Ct. LEXIS 178">181 the finance company his promissory note in the amount of $ 7,500. The funds received from the finance company were used by Cammer to purchase petitioner's interest in the partnership.Petitioner, who owned approximately 10 percent of the nonvoting stock of the finance company, executed a separate instrument wherein petitioner became a guarantor for the payment of Cammer's note to the finance company.By September 1957 Cammer had reduced the principal balance of the loan to $ 6,088.50. However, shortly thereafter, Cammer defaulted in payment of the note, and the finance company demanded payment of the balance by petitioner as guarantor of the loan. Petitioner paid the finance company the sum of $ 6,088.50 in 1957. On his 1957 tax return, petitioner claimed a bad debt deduction under section 166(f), I.R.C. 1954, in the amount of $ 6,088.50. Respondent determined that the loss was not deductible under section 166(f) and disallowed the claimed deduction.Section 166(f) provides: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 in1962 U.S. Tax Ct. LEXIS 178">182 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 * * * at the time of such payment.Respondent concedes that petitioner paid the sum of $ 6,088.50 in discharge of his obligation as a guarantor, that the debt was a noncorporate obligation, and that the obligation of Cammer to the finance company was worthless at the time of payment. But respondent contends that inasmuch as the proceeds of the loan were used by Cammer to acquire an additional capital interest, they were not used in the borrower's trade or business within the meaning of section 166(f). Petitioner argues conversely that the borrowed funds were 37 T.C. 1053">1055 utilized in the borrower's trade or business since the proceeds of the loan were used to acquire petitioner's interest in the partnership, which acquisition was undertaken in order to prevent a dissolution of the business. The issue to be decided is thus reduced to whether or not the proceeds of the loan were used in Cammer's trade or1962 U.S. Tax Ct. LEXIS 178">183 business within the meaning of section 166(f).The provision contained in section 166(f) was first written into the law as part of the Internal Revenue Code of 1954; 1 and appears to have originated in the Senate Finance Committee. 2 The phrase "used in trade or business of the borrower" is not explained in either section 166(f) of the Code or the regulations relating thereto ( sec. 1.166-8, Income Tax Regs.); nor is any real light shed on the meaning of the phrase or the purpose of the provision by the Senate Finance Committee in its report. 31962 U.S. Tax Ct. LEXIS 178">185 And it would be of little help in deciding this issue whether the purpose of Congress in enacting section 166(f) was to confirm the administrative and judicial construction of the internal revenue laws that treated guarantors' losses as bad debt losses, as suggested by the majority opinion of the Supreme Court in Putnam v. Commissioner, 352 U.S. 82">352 U.S. 82 (1956), or was simply to permit deduction of certain guaranty payments that were not deductible at all under the 1939 Code, as suggested by the dissenting opinion in the Putnam case. 4 So we must approach the problem unaided by any clearly defined legislative1962 U.S. Tax Ct. LEXIS 178">184 intent or any prior judicial construction.5 Under such circumstances, we assume the statutory words were used in their ordinary and usual sense with the meaning 37 T.C. 1053">1056 commonly attributable to them. DeGanay v. Lederer, 250 U.S. 376">250 U.S. 376, 250 U.S. 376">381 (1919).In our opinion, the phrase "used in the trade or business of the borrower" (emphasis supplied) in section 166(f) of the 1954 Code requires that the borrowed funds be directly employed in carrying on the borrower's trade or business, and that the use of the borrowed funds by Cammer to purchase petitioner's partnership interest does not meet that requirement. The borrowed funds were never available for use in the operation of the cafe nor to acquire assets for use in the business. They were used to acquire a capital asset, an interest in the partnership, for the borrower, not in the conduct or operation of his cafe business, and we do not think the stipulated facts support a conclusion that Cammer was in the business of dealing in business interests. 1962 U.S. Tax Ct. LEXIS 178">186 Furthermore, even if we could agree with petitioner that the borrowed funds could be said to have been used to prevent dissolution of the borrower's business, we do not think such a purpose under these circumstances could be considered a use in the business within the meaning of the statute. Rather than being a debt "incurred because of business relationships," as mentioned in the committee report (footnote 3), this was a debt incurred to sever a business relationship, and the guarantor, rather than the business, received the proceeds of the loan.We believe our conclusion is the more logical application of the section to the facts in this case. The Supreme Court decided in 352 U.S. 82">Putnam v. Commissioner, supra, that a guarantor's loss is deductible, if at all, as a bad debt. Section 166 of the 1954 Code provides for the deduction of bad debts, and under section 166(d) this debt, not having been created or acquired in connection with a trade or business of the taxpayer nor incurred in his trade or business, would be a nonbusiness bad debt and the loss would be considered a short-term capital loss, unless recognized as a bad debt deductible to 1962 U.S. Tax Ct. LEXIS 178">187 the full extent thereof under section 166(a) by reason of section 166(f). If, by enacting the exception to section 166(d) contained in section 166(f) in the case of the guaranty by a noncorporate taxpayer of a noncorporate obligation, Congress intended to encourage small businesses by making it easier for them to borrow money, it would seem that the limit of its inducement to the guarantor of small business borrowings would be to place the guarantor in the same position taxwise with respect to the deductibility of his loss as would be the borrower himself. If the borrower used the borrowed money directly in the operation of his trade or business and lost it, his loss would be deductible in full. But Cammer did not use the borrowed money directly in the operation of his trade or business; he used it to acquire for himself petitioner's interest in the partnership. Cammer's acquisition of petitioner's 37 T.C. 1053">1057 partnership interest was an investment in a capital asset, Peter P. Risko, 26 T.C. 485">26 T.C. 485 (1956), Frank L. Newburger, Jr., 13 T.C. 232">13 T.C. 232 (1949), and we assume his loss on the sale or other disposition thereof would have1962 U.S. Tax Ct. LEXIS 178">188 been a capital loss. Sec. 741, I.R.C. 1954; compare Rev. Rul. 55-68, 1955-1 C.B. 372. To apply section 166(f) of the 1954 Code to give this petitioner, the guarantor, a full deduction for a bad debt would seem to extend that section beyond reason.Decision will be entered for the respondent. MULRONEY; FAYMulroney, J., dissenting: Under section 166(f), I.R.C. 1954, the guarantor has the burden of showing the borrower "used" the proceeds of the loan in his "trade or business." I think he would satisfy his burden if he showed the proceeds of the loan were the funds used by the borrower to start up in the cafe business, acquire an existing cafe business, or, as here, buy out the business interest of his remaining partner in the cafe. The statute requires the guarantor to do no more than trace the loan proceeds to the borrower's cafe business. The majority holds that before the statute applies the guarantor must show that the loan proceeds were "directly employed in carrying on the borrower's trade or business." I see no reason for such a construction, but if it is warranted it would seem to me the borrowed funds, which were used to1962 U.S. Tax Ct. LEXIS 178">189 buy the interest of the borrower's partner in the assets of the cafe business, were directly employed in carrying on the borrower's sole proprietorship.Admittedly, if the funds were used by the borrower to purchase merchandise and fixtures for use in his cafe, the borrowed funds would be "used in the trade or business of the borrower." I see no difference when the funds are used to buy out another's one-half interest in the merchandise and fixtures that are to be used in the borrower's cafe business. I would hold for the petitioner.Fay, J., dissenting: I respectfully disagree with the majority opinion of the Court that the proceeds of the loan were not used in the trade or business of Cammer within the meaning of section 166(f). The prerequisite to the deduction under section 166(f) that the borrower use the proceeds of the loan in his trade or business was, I believe, intended to prohibit a deduction where the borrower uses the funds for a purpose unrelated to his business. In the instant case the borrower was faced not only with the threat of a suit for an accounting but with the possible disruption or collapse of the business. In an effort to forestall such a chain of1962 U.S. Tax Ct. LEXIS 178">190 events, he borrowed funds which he used to purchase petitioner's interest in the partnership. 37 T.C. 1053">1058 Under these circumstances I believe that the proceeds were used in the trade or business of the borrower in the ordinary and usual sense of the term. Footnotes1. H.R. 8300, 83d Cong., 2d Sess. (1954).↩2. While there was a section 166(f) in the House bill, it pertained to mortgage foreclosures and was eliminated by the Senate Finance Committee, which substituted the provision contained in the present section 166(f)↩.3. S. Rept. No. 1622, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. (1954), on section 166(f) simply states (pp. 24-25):"Your committee also provided that business bad debt treatment will be available where a noncorporate taxpayer, who was the endorser (or guarantor or indemnitor) of the obligation of another, is required to pay the other's debt (and cannot collect it from the debtor). However, this treatment is to be available only where the debt represents money used in the other person's trade or business. Your committee believes that this treatment should be available in such cases since in most cases debts of this type usually are incurred because of business relationships." and (p. 200):"This subsection will allow a deduction from gross income for a loss suffered by a noncorporate taxpayer through payment during the taxable year of part or all of his obligation as a guarantor, endorser, or indemnitor of a noncorporate obligation. In order to obtain an ordinary loss, the taxpayer must establish that the proceeds of the loan were used in the trade or business of the borrower and that the obligation of the borrower, to the person to whom the taxpayer made payment in discharge of his guarantor's obligation, was worthless at the time of such payment (without regard to the guaranty, endorsement, or indemnity). * * *"↩4. Or was merely an ad hoc amendment designed to meet the problem of a father who had made advances to his son's business, as suggested in a footnote to an article in 70 Harv. L. Rev. 1145, 1149↩ (1957).5. We have neither found nor been cited any cases directly concerned with the scope of section 166(f), I.R.C. 1954↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619338/	Almy Gilford v. Commissioner.Gilford v. CommissionerDocket No. 29641.United States Tax Court1952 Tax Ct. Memo LEXIS 311; 11 T.C.M. 175; T.C.M. (RIA) 52049; February 27, 19521952 Tax Ct. Memo LEXIS 311">311 Petitioner inherited a fractional interest in improved real estate as tenant in common with her sisters. The property was rented through a management agent and was sold in 1944 at a loss. Held, petitioner and her sisters were not partners in operation of the property and petitioner's loss was an ordinary loss. Harry Friedman, Esq., 540 Munsey Bldg., Washington, D.C., for the petitioner. Charles M. Greenspan, Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: Respondent determined a deficiency in income tax for 1945 in the amount of $6,295.02, arising out of the disallowance of a claimed long-term capital loss carry-over from 1944. The loss arose from a sale of real property in 1944. The amount is not in dispute. The sole issue is whether the loss was capital or ordinary. [The Facts] Petitioner is an individual residing at 316 Lexington Avenue, New York, New York. Her returns for the calendar years 1944 and 1945 were filed with the collector of internal revenue for the second district of New York. John P. Gilford, the petitioner's father, at the time of his death on December 7, 1928, owned in fee a property1952 Tax Ct. Memo LEXIS 311">312 located at 724 Third Avenue, New York, New York, and a one-third interest as a tenant in common of properties located at 720-722 Third Avenue, New York, New York. The petitioner in 1928 acquired, under the will of her father, a one-eighth interest in the estates owned by her father in such properties and on June 26, 1943, acquired an additional one-eighth interest in such estates in the properties as remainderman of a testamentary trust established by the will. The petitioner's uncle, Thomas B. Gilford, at the time of his death on January 23, 1931, owned in fee properties known as 730, 732, and 734 Third Avenue, New York, New York, and a one-third interest as a tenant in common of the properties located at 720-722 Third Avenue, New York, New York. The petitioner, as of September 8, 1933, as remainderman of a testamentary trust established by the will of her uncle, Thomas B. Gilford, acquired a one-fourth interest in the estates owned by her uncle in the properties at the time of his death. Each of petitioner's sisters, Lentilhon Gilford Fluegge and Marion Gilford Kunhardt, and Winthrop Gilford Slade, acquired similar interests in such properties and estates at the same times1952 Tax Ct. Memo LEXIS 311">313 as petitioner. The several owners agreed upon a sale of the properties as a unit and on January 27, 1944, entered into an agreement of sale with the General Realty & Utilities Corporation, for conveyance of all the right, title, and interest of the sellers in the properties, the interest of the sellers being therein stated to be owners of the fee as to two parcels and two-thirds interest in the fee as to a third parcel. Upon her original federal income tax return for the year 1944, the petitioner reported a net loss of $126,458.52, as an ordinary loss deductible in full, as a result of the sale, using a basis of $153,159.26. The petitioner filed an amended federal income tax return for the year 1944 treating her loss on the above sale as a capital loss, using a basis of $157,979.29, reporting a long-term capital loss of $130,358.36. Petitioner's application of this claimed capital loss carry-over in the return for the year 1945 led to the assertion of the deficiency in question. The fractional interests of petitioner and all the other owners of fractional interests were by agreement of the owners placed in the hands of a real estate firm for management of the entire block as1952 Tax Ct. Memo LEXIS 311">314 a unit, each of the owners executing identical written authority to the real estate agent. The real estate agent rented the properties, kept accounts for each parcel on which was shown the location of the property, the rents received, the expenses applicable thereto, the net rents, and the division of such net balance to the owners of the fractional interests in accordance with their ownership. Petitioner's total income from this Third Avenue property was $703.27 in 1944. She also owned an interest in a South Street property. The properties were improved. There were eight separate buildings on eight pieces of land. The ground floors were occupied by stores, and the upper floors of seven of the buildings were rented as apartments. One was closed above the ground floor as not complying with the multiple dwelling ordinance. [Opinion] The rule is well settled that improved real property rented for the production of income is "property used in the trade or business" of the taxpayer, regardless of whether the taxpayer is engaged in any other trade or business and whether more than one piece of property is involved. Such property, therefore, is not a capital asset of the taxpayer1952 Tax Ct. Memo LEXIS 311">315 within the meaning of section 117 (a) (1) of the Internal Revenue Code. Fackler v. Commissioner, 133 Fed. (2d) 509, affirming 45 B.T.A. 708">45 B.T.A. 708; Leland Hazard, 7 T.C. 372">7 T.C. 372. The case of Susan P. Emery, 17 T.C. 308">17 T.C. 308, cited by petitioner to the contrary, is not in point. There the property was not improved and the owners permitted its sale for delinquent taxes. We concluded that it was not used in the trade or business of the owners. Petitioner contends, however, that the joint ownership and operation of the fractional interests in the Third Avenue block front constituted a partnership or joint venture, within the definition in section 3797 (a), Internal Revenue Code; that the partnership property was sold at a loss and that the loss to petitioner, being a loss on the sale of an interest in a partnership, was a capital loss. Petitioner says that she and her sisters consulted together many times with reference to the management and use of the buildings, considered razing the buildings to make a parking lot, discussed various offers by prospective purchasers, and finally agreed upon acceptance of the offer of the General1952 Tax Ct. Memo LEXIS 311">316 Realty & Utilities Corporation.There was no written agreement between the sisters. They did not file partnership returns showing the income of this alleged partnership. They are not partners solely by their tenancy in common of the property. Tenants in common may by agreement contribute their interests to a partnership or joint venture, but the agreement here between the sisters is nothing more than to appoint an agent for management and collection of rents and for effecting a sale at a satisfactory price. The sisters did only what was essential to derive income from the properties as co-owners. This does not amount to a partnership agreement. In Estate of Edgar S. Appleby, 41 B.T.A. 18">41 B.T.A. 18, affirmed 123 Fed. (2d) 700, it was held that two brothers who owned property as tenants in common and leased it to tenants were not partners. In N. Stuart Campbell, 5 T.C. 272">5 T.C. 272, we held a loss on the sale of a building by two co-owners who inherited the property and placed it with an agent for sale or rental, as in the present case, was an ordinary loss. The idea that there could have existed a partnership between the co-owners was not suggested. We conclude1952 Tax Ct. Memo LEXIS 311">*317 that there was no partnership between petitioner and her sisters with respect to the property. The loss was an ordinary loss, deductible in full in 1944. Hence, petitioner had no capital loss carryover to 1945 and the respondent's determination was correct. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619339/	George J. Kolowich v. Commissioner.Kolowich v. CommissionerDocket No. 109351.United States Tax Court1943 Tax Ct. Memo LEXIS 520; 1 T.C.M. 416; T.C.M. (RIA) 43026; January 9, 19431943 Tax Ct. Memo LEXIS 520">520 William C. Allee, Esq., and Lyall F. Martz, Esq., 1820 Union Guardian Bldg., Detroit, Mich., for the petitioner. Melvin S. Huffaker, Esq., for the respondent. MELLOTTMemorandum Findings of Fact and Opinion MELLOTT, Judge: The Commissioner made several adjustments to the net income shown by petitioner's return for the calendar year 1939 and determined a deficiency in income tax in the amount of $2,528.48. The petition alleges that he erred in making the several adjustments and also that petitioner should be allowed an additional deduction of $3,600 not claimed in his return. At the hearing petitioner waived three assignments of error. The issues requiring determination are whether respondent erred: (1) in increasing income for personal services by $10,822.75; (2) in disallowing an alleged long-term capital loss of $1,902; (3) in disallowing an alleged ordinary loss of $6,891.46 resulting from the foreclosure of a mortgage upon real estate; and (4) "in not considering sales expense in the amount of $3,600 which the petitioner asserts as an affirmative issue." Issue I Findings of Fact Petitioner, a resident of Wayne County, Michigan, filed his income tax returns for 1938 and1943 Tax Ct. Memo LEXIS 520">521 1939 with the collector of internal revenue for the district of Michigan. They were made on the cash basis. In the return for 1938 petitioner reported the receipt of salaries and other compensation for personal services aggregating $25,000. This was comprised of a drawing account of $3,000 actually paid to him in cash in monthly installments and $22,000 representing the amount agreed to be paid to him by the Detroit Housing Corporation in connection with the "supervision and sales management" of 44 houses at the rate of $500 per house. He reported a loss of $622.28 from the sale of an 8 room house and boat house, a loss of $34,020 from the sale of St. Clair Shore bonds (50 percent or $17,010 as a capital loss), and deductions aggregating $8,236.50. The return showed no net income but instead a loss of $868.78 and no tax due. In the return for 1939 petitioner reported salaries and other compensation for personal services rendered to the Detroit Housing Corporation aggregating $17,000. This was comprised of a drawing account of $3,000 paid to him monthly in cash and $14,000 representing the amount agreed to be paid to him by the corporation in connection with 28 houses under the same1943 Tax Ct. Memo LEXIS 520">522 circumstances as set out in the preceding paragraph. He reported a loss of $158.50 from the sale of a boat house, a loss of $668.20 from the sale of stocks, a loss of $3,650 (50 percent or $1,825 as a capital loss) from the sale of St. Clair Shore bonds, a loss of $3,804 (50 percent or $1,902 as a capital loss) in connection with the foreclosure of a mortgage on "New Baltimore house" and an additional ordinary loss in connection with the foreclosure of a mortgage on the same property in the amount of $6,891.46. The total income was further reduced by allowable deductions, exemptions and credits for dependents and petitioner paid a tax of $10.05. The Detroit Housing Corporation (hereinafter sometimes referred to as the corporation) has been organized at some undisclosed time prior to January 1, 1938. It owned some land suitable for development through the construction of small homes. The total amount of its authorized stock is not shown. Petitioner's wife owned a substantial block of its preferred and common stock. She was its secretary, John C. Finan was its president and they, together with petitioner, constituted the executive committee of the board of directors. The other directors1943 Tax Ct. Memo LEXIS 520">523 were A. Lark and John Hopkins. Hopkins was comptroller. At a special meeting of the board of directors of the corporation held on February 8, 1938, and attended by Finan, petitioner and his wife it was stated that the corporation had set up a building program to build approximately 100 homes on the property being developed by it. It was resolved: In addition to their regular salaries, the corporation shall pay to George J. Kolowich the sum of Five Hundred Dollars ($500.00) per house for supervision and sales management, to John C. Finan the sum of One Hundred Twenty-five Dollars ($125.00) per house for overseeing purchases and assisting in building and financial supervision; and to Irene G. Kolowich the sum of Forty Dollars ($40.00) per house for general work relative to applications, inspections and finance and closing sales. The above amount is to be paid in December of each year or at any other time that it may be mutually agreed. During the year 1938 the corporation constructed and petitioner sold 44 homes financed by the F.H.A. In general the building program was carried out substantially as follows: A commitment to make a loan would be secured from a prospective mortgagee1943 Tax Ct. Memo LEXIS 520">524 and the construction of a house would then be started. While it was being constructed the F.H.A. made various inspections and, upon completion and final inspection, agreed to insure the loan. A down payment would be secured from the purchaser and a mortgage would be placed upon the property in an amount usually more than sufficient to take care of the total expense of building the house. The gross profit to the corporation on the houses built and sold during 1938 averaged, exclusive of supervision and sales management, approximately $1,000 per house, the total profit from the sales made during that year aggregating $41,656.64. The $300 per house specified to be paid to petitioner for supervision and sales management was not paid. He had no power to sign checks and the funds of the corporation could be paid out only upon checks signed by two of the following, i.e., Finan, Mrs. Kolowich and John Hopkins. The financial statement of the corporation as of December 31, 1938, is as follows: ASSETSCash on Hand, in Bank & Sinking Fund$ 20,330.36Investments (Stock & Bonds - Market)38,651.00Buildings under Construction - Net69,483.66Notes Receivable2,970.95Accounts Receivable601.65Mortgages Receivable - 2nd Mortgages$ 5,824.79Less Reserve4,719.551,105.24Lend Contracts Receivable202,668.46 72,223.59* 130,444.87Real Estate Owned & Held for Resale$610,623.86Less Reserve116,528.84494,095.02Depreciation* 43,095.39* 450,999.63Furniture & Fixtures$ 5,422.60Less Depreciation5,104.93317.67$830,224.02LIABILITIESNotes Payable - Bank$ 11,850.00Accounts PayableFranchise & Personal Taxes - General Taxes, etc4,326.91Trust Funds & Deposits942.50Interest Payable5,595.02Construction Supervision Payable on bldge. as completed4,045.40Land Contracts Payable39,427.92Mortgages & Bonds Payable$426,324.04Payable to Officers & Directors77,537.35Capital Stock - Preferred 45,248.30 shs. at $1 Par * 39 1/2%Common 49,293.33 shs. at.10 Par * 40%50,177.63Reserve & Unrealized Profits on Land Contracts72,233.59Surplus & Additional Reserve137,773.66$830,234.02* 72,223.59* 758,000.43* 43,095.39* 714,905.04Surplus Red* 769.14* 714,135.901943 Tax Ct. Memo LEXIS 520">525 On December 20, 1938, the corporation caused a journal entry to be prepared crediting to petitioner the sum of $22,000 "for services covering properties listed below". (Listing the 44 pieces of property.) St. Clair Shores Municipal bonds, having a cost basis to petitioner according to his income tax return of $71,820, had been sold by him to the corporation for $37,800; but no part of the agreed purchase price had been paid to him. (The details of this transaction are not shown.) Petitioner's account with the corporation at the end of the calendar year 1938 showed two credit entries, one under date of November 15 in the amount of $37,800 and one under date of December 20 in the amount of $22,000. The aggregate of these two amounts ($59,800) was transferred to the general ledger of the corporation on December 31, 1938. The journal entry of December 20, 1938, was made pursuant to the action taken by the executive committee on February 8, 1938, set out in the findings above and no subsequent meeting of the board of directors was held at which instructions1943 Tax Ct. Memo LEXIS 520">526 were given with reference to making any particular entries. Petitioner told the comptroller of the company how he "wanted to dispose of the thing" and "that he was to credit my (petitioner's) account, accounts payable." Petitioner did not anticipate drawing the money out immediately, and none of it was withdrawn during 1938. During the year 1939 the following withdrawals were made by petitioner: July 31$ 9,000.00August 3110,600.00September 3010,000.00November 3023,022.75December 3110,000.00$62,622.75During the same period the following credits were made to his account on the books of the corporation: August 31$ 1,122.75November 305,000.00December 316,000.00December 3114,000.00 The withdrawals were in cash. The credit of $14,000 on December 31 represented commissions of $500 each in connection with the supervision and sales management of 28 houses. The details of the other credit entries are not shown. The corporation had a line of credit at a local bank of $20,000, and notes or other indebtedness of the corporation aggregating that amount could be signed by two of the following: Finan, Hopkins and Irene G. Kolowich. The record does1943 Tax Ct. Memo LEXIS 520">527 not indicate whether the bank loans outstanding at the end of the year 1938 ($11,850) were, or were not owing to the same bank which had extended the $20,000 line of credit. The $10,822.75 additional income included by respondent in petitioner's 1939 return was determined as follows: 1938 Commissions credit$22,000.001938 Bonds sold37,800.00Due December 31, 1938$59,800.001939 Commissions credited14,000.00Total credits$73,800.00Amount paid to petitioner in 1939$62,622.75Amount applicable to bonds37,800.00Taxable 1939 commissions$24,822.75Reported 1939 commissions14,000.00Additional 1939 income$10,822.75Opinion Upon brief the parties discuss at length what has sometimes been referred to as the doctrine or "fiction" of constructive receipt. In essence it is that one is deemed to be in receipt of income when, under the facts, the actual reducing of it to possession is contingent only upon his own will. The regulations 1 recognize as a prerequisite that the "income must be credited or set apart to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and1943 Tax Ct. Memo LEXIS 520">528 must be made available to him so that it may be drawn at any time * * ." Substantially the same language has been used by the courts and the Board of Tax Appeals in numerous cases, some of which are cited by the parties. John A. Brander, 3 B.T.A. 231">3 B.T.A. 231; Ella C. Loose, Executrix, 15 B.T.A. 169">15 B.T.A. 169; Burns et al. v. Commissioner, 31 Fed. (2d) 399; Hadley v. Commissioner, 36 Fed. (2d) 543. But the doctrine of constructive receipt is to be sparingly applied, Cox Motor Sales Co., 42 B.T.A. 192">42 B.T.A. 192, and the mere posting of a credit to the taxpayer's account or even the issuance of notes for an unpaid liability is not sufficient to justify its application. It has been suggested that perhaps it should never be "applied to the recipient's advantage because to do so would be contrary to the purpose of the rule" ( Sanford Corporation, 38 B.T.A. 139">38 B.T.A. 139, affd., 106 Fed. (2d) 882, certiorari denied, 309 U.S. 659">309 U.S. 659): but decision in this case will not be rested on that 1943 Tax Ct. Memo LEXIS 520">529 theory.The facts need not be reviewed at length. Petitioner insists that the corporation's assets "were more than sufficient to satisfy the petitioner's account in event that he desired to withdraw the funds subsequent to December 20, 1938, and prior to the close of the year." He points to the balance sheet showing "cash on hand, in Bank & Sinking Fund 20,330.26 , investments in stocks and bonds with a market value of $38,631 and other substantial assets and a bank credit of $25,000," which, he says, were more than sufficient to satisfy his account. This argument, under the circumstances here present, is not persuasive. A portion of the cash in the sinking fund - the amount is not shown - was no doubt placed there for the purpose of retiring the corporation's bonds. According to the financial statement the corporation's mortgages and bonds payable amounted to $426,324.04. Its investment in stocks and bonds was not necessarily worth the amount carried on its books. Most of them had been purchased from petitioner in 1938, as a result of which he had been enabled to take a $34,000 loss representing 48 percent of their cost to him. In this1943 Tax Ct. Memo LEXIS 520">530 connection it is noted that during the year 1939 he sold some of the same bonds to the corporation, taking a loss equivalent to 55 percent of his cost basis. Likewise questionable is the value of the bank credit of $25,000, which petitioner says the corporation had though which other evidence indicates was only $20,000. In this connection it is noted that the corporation was already indebted to banks in the amount of $11,850 and in addition was indebted to its officers and directors in the amount of $77,537.35. Under the circumstances, therefore, it cannot be found as a fact that merely because the amount was credited to petitioner's account upon the corporation's books, he, keeping such records as he kept and making his returns on the cash basis, should report it in his income for 1938. Passing the abstract question of the possible solvency of the corporation and dealing with other phases of the case, it seems to be obvious that the "intimacy of the family relationship" would have been, and was, a substantial deterrent to the withdrawal of such a substantial sum by petitioner between December 20th and December 31st, 1938. In this connection it may be pointed out that petitioner's1943 Tax Ct. Memo LEXIS 520">531 wife owned a large portion of the corporation's common and preferred stock. The record is not clear as to how much she actually owned. Petitioner stated that she owned approximately 39 percent. It is possible this may have referred to the total issued stock and that she - as is somewhat suggested by pencil notations appearing upon the financial statement - may have owned practically all of the outstanding stock. If so, probably she would have been reluctant to permit him to withdraw all that the corporation could have scraped together, especially since, as he stated, he "did not need it." But however that may be the affirmative action of at least two of the officers of the company was required to make any portion of the money actually available to petitioner and none of it was made available to him. Under the circumstances, therefore, he cannot be said to have been in constructive receipt of the $22,000 in 1938. Respondent's computation seems to be eminently fair to the taxpayer. Petitioner, by his own statements, has shown that he was entitled to receive in 1939 commissions in the aggregate amount of $36,000. He actually received $62,623.75, $37,800 of which respondent has allocated1943 Tax Ct. Memo LEXIS 520">532 to the indebtedness for the bonds, which had been sold to the corporation. This left $24,822.75 which respondent credited to commissions, though he might have argued that the whole $36,000 of commissions had actually been paid. Petitioner concedes that he actually received $62,622.75 during 1939 and that he was on the cash basis. Under the circumstances we think that the commissioner did not err in including the $10,822.75 in issue in petitioner's return for 1939. We have deliberately refrained from making some of the findings requested by petitioner. Testifying as a witness he stated that he had the right to withdraw the money at any time, that he used the corporation merely as a bank, that he had discussed the whole matter with his wife and Finan about December 1, 1938, and that they understood he could withdraw the money at any time. Both Finan and petitioner's wife testified briefly but neither substantiated his statements in this particular nor were they asked any questions bearing on the subject. His statement that they understood he could withdraw the money at any time was a mere conclusion. His contention that he "used the corporation merely as a bank" is unsupported by the1943 Tax Ct. Memo LEXIS 520">533 evidence. So far as the record shows he withdrew nothing during 1938 except his salary of $3,000 and $600 as automobile expense. Then, too, there are certain inaccuracies in his testimony which are wholly unexplained. Thus at one juncture (R. 89) he stated that he was the president of the corporation in 1938. Exhibits introduced in evidence show, however, that Finan was its president on February 28, 1938, and no subsequent meeting of the board of directors, at which officers were elected, is shown. The corporation records contain numerous erasures and respondent, upon brief, makes much of the fact that the minutes of the corporation of February 8, 1938 (Ex. 1), set out in the findings, may contain a sentence added after they were written up. In this connection he points out that the entire paragraph, except the last sentence, appears within quotation marks, whereas the last line, upon which petitioner places substantial reliance, is not embraced within the quotation marks. We need not find, nor do we find, that the erasures were aught than corrections of mistakes; nor is there any evidence - other than that referred to - indicating that the corporation's records were changed. But1943 Tax Ct. Memo LEXIS 520">534 giving full effect to them, we are not convinced that respondent erred in determining that petitioner's income from commissions was $24,822.75 rather than $14,000 as reported by him. This issue is therefore decided against petitioner. Issues II and III Findings of Fact In 1927 petitioner purchased a piece of property at New Baltimore (23 miles from Detroit) having a lake frontage of 150 feet and a depth of 350 feet with an old building on it. The building had no value and was torn down shortly thereafter. Petitioner then erected a new home at a cost of $8,000. In 1928 he expended an additional $6,400 on the house for a new basement, a heating refrigerator plant, built a sea wall, dock and garage and made other improvements to the property at a total cost of $1,400. In 1934 petitioner concluded that he could not afford to keep that type of property for himself and placed a "For Rent" sign on it. He had moved out of the property in 1933. The property was rented once for a week and at a later date for a period of two weeks. Petitioner received a total of $50 net from rental of the property, an additional $50 having been paid to a real estate agent as a commission for securing1943 Tax Ct. Memo LEXIS 520">535 a tenant who never paid any additional amount and who moved out after occupying the property for only a brief time. In 1932 there was an unpaid mortgage on the property amounting to "approximately $6,000 or $7,000." Petitioner had been declared a bankrupt and had also been indicted for a violation of the criminal laws of the state at some undisclosed time, apparently between 1930 and 1932. In the schedules filed by him in the bankruptcy proceeding the lake front property was not listed as an asset. Petitioner contended that it was exempt as a homestead. After being examined at length by creditors and other interested parties in the bankruptcy court, his claim for exemption of the property as a homestead was denied. The trustee did not take possession of the real estate or attempt to sell it but (in the language of petitioner) "abandoned" it. Thereafter petitioner made an effort to refinance the property with an H.O.L.C. loan. A tentative commitment was granted for an amount equivalent to the outstanding loan, less $1,500; but local counsel refused to approve the making of a loan to petitioner, since he was, at that time, under indictment in the state courts and a bankrupt. Petitioner, 1943 Tax Ct. Memo LEXIS 520">536 however, conveyed the property to his wife, paid $1,500 toward the reduction of the indebtedness, the H.O.L.C. placed a mortgage upon the property for the balance, and the wife reconveyed the property to petitioner. In 1938 the H.O.L.C. instituted proceedings to foreclose its mortgage, the principal sum then due being $6,174.48. Inferentially it appears (5 E-4, petition) that the expiration date in connection with the mortgage foreclosure sale was October 24, 1939; but no redemption was made. In petitioner's income tax return for the year 1939 he claimed a capital loss of $3,804 and that 50 percent of the amount, or $1,902, was deductible as a long term loss. He also claimed an ordinary loss in the amount of $6,891.46, computing the losses as follows: LOT - New Baltimore House - Acquired 1927H.O.L.C. foreclosed - redemption date Oct. 24, 1939. Lotvalued at date acquired $13,000.00.Lot revalued in 1934 for rental purpose$6,000.00Less.356% of mtg. prin. balance due to H.O.L.C. of $6,174.482,196.00Loss$ 3,804.0050% allowable$1,902.00HOUSE & IMPROVEMENTS - On above lot acquired 1927$2,000.00, plus improvements in 1928 - $6,400.00Garage, fence, docks, etc., in 1930 - $1,400.00With lot (as shown above) $13,000.00 total cost to 1930 -$28,800.00Re-Valued in Sept. 1934(Lot as shown above $6,000.00)Buildings$10,000.00Improvements2,500.00$12,500.00Less depreciation taken in 1937 - $400.00Less depreciation taken in 1938 - $400.00Less windstorm loss in 1938 - notcovered by insurance - deductedin 1938631.20Depreciation already taken1,431.20Total net cost as of 193910,869.80Less principal amount due on H.O.L.C. mtg. which was foreclosed and notredeemed in Oct. 1939 of $6,174.48 -.644% of $6,174.483,978.34Total net loss from foreclosed property other than capital asset$6,891.461943 Tax Ct. Memo LEXIS 520">537 The Commissioner determined that the evidence did not substantiate the fair market value of the former residence property allocated to the lot and to the improvements at the time the property was converted to business purposes and that it did not appear that the property was used in a trade or business. He therefore disallowed both deductions. The correctness of his action is placed in issue by assignments of error 4 (c) and 4 (e) in the petition. The total value of the real estate in 1934 was $9,000, 35 percentum of which was attributable to the land the remainder to the improvements. The property was appropriated to income producing purposes in 1934. Opinion Section 23 of the Internal Revenue Code authorizes the deduction of losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business or in any transaction entered into for profit, though not connected with the trade or business. Section 117 defines capital assets as property held by the taxpayer, but not including property used in the trade or business of a character which is subject to allowance for depreciation. It was settled by Heiner v. Tindle & Union Tr. Co. of Pittsburgh, 276 U.S. 582">276 U.S. 582,1943 Tax Ct. Memo LEXIS 520">538 that an individual taxpayer sustains a deductible loss through the sale, for less than his cost basis, of property originally acquired as a residence but later converted into business property. The regulations implement the rule of the cited case, Article 23 (e) - 1 of Regulations 101 providing that if property purchased or constructed for use as a residence is, prior to its sale, "rented or otherwise appropriated to income-producing purposes and is used for such purposes up to the time of its sale, a loss * * computed as provided in section III, is, subject to the limitations provided in section 117, an allowable deduction in an amount not to exceed the excess of the value of the property at the time it was appropriated to income-producing purposes (with proper adjustments for depreciation) over the amount realized from the sale." The Treasury Department has ruled (I.T. 3217, C.B. 1938-2, p. 94; I.T. 3246, C.B. 1939-1, p. 137), and the rulings appear to be in accordance with the law and decisions of ( George S. Jephson, 37 B.T.A. 1117">37 B.T.A. 1117; John D. Fackler, 45 B.T.A. 708">45 B.T.A. 708, on appeal 6 C.C.A. * ; Report of Committee1943 Tax Ct. Memo LEXIS 520">539 on Ways and Means No. 1860, 75th Congress, Third Session), that "the gain derived or the loss sustained upon the sale of improved property used in trade or business constitutes a capital gain or loss in so far as such gain or loss is allocable to the land and an ordinary gain or loss in so far as allocable to the depreciable improvements." (I.T. 3217, supra.) Also that "in applying section 117 * * to a sale or other disposition of real estate consisting of land and improvements, the net proceeds of sale should be apportioned on the basis of the value of the land, and the value of the depreciable improvements on the date of the sale." (I.T. 3246, supra.) It is apparent petitioner endeavored to compute his capital and ordinary loss in accordance with the above rulings. It also inferentially appears - the records were not introduced in evidence but no controversy upon this point seemed to exist at the hearing - that the foreclosure and sale occurred in 1938 and the period of redemption expired in 1939. The loss, if any, was therefore, deductible in the latter year. Derby Realty Corporation, 35 B.T.A. 335">35 B.T.A. 335,1943 Tax Ct. Memo LEXIS 520">540 appeal 6 C.C.A. dismissed; Shelden Land Co., 42 B.T.A. 498">42 B.T.A. 498; G.C.M. 19367, C.B. 1937-2, p. 115. But while the present issues are to be resolved in favor of the petitioner the facts do not justify approval of the computations used by him in his return. Petitioner, testifying as a witness, expressed the opinion that in 1934 the land was worth $6,000 and the buildings and other improvements were worth $12,500, a total of $18,500. This was the only evidence adduced upon the subject. In the opening statement his counsel stated: * * Now, in 1930, the market had fallen off from real estate. Offers to sell this property and other properties were made. The trustee in bankruptcy finds himself in a position where there are no bids. The trustee in bankruptcy must close his trust business. Where there is no equity in the real estate in question, either for the bankrupt estate or for the bankrupt, practice in this district is to abandon the property, and this property was so abandoned by order of the court. Now, that the judgment of the trustee in bankruptcy was correct is manifest by the history of the property. I expect to show1943 Tax Ct. Memo LEXIS 520">541 that subsequent to the bankruptcy, in 1934, I believe, the mortgage was refinanced with the Home Owners Loan Corporation. Now, that there was no equity in there is apparent by the fact that you couldn't get any tenant, and that the property was finally foreclosed and there was no equity salvaged out of it by the petitioner here, the there bankrupt, so that if the history of the impact of the bankruptcy and this petition upon the property * . Statement of counsel, of course, does not constitute evidence; nor has the portion set out above been accepted as such. It emphasizes the difficulty that triers of the facts experience, however, in attempting to determine the fair market value of real estate which they have never seen. Notwithstanding petitioner's testimony, we are reluctant to accept his appraisal; for there are too many circumstances indicating that he was too sanguine. Thus, we think it may be assumed that a trustee in bankruptcy would not have "abandoned" a piece of property having a value of $18,500 merely because it was encumbered with a mortgage of "between $6,000 and $7,000." It may also fairly be assumed that appraisers representing the H.O.L.C. would not have required1943 Tax Ct. Memo LEXIS 520">542 the payment by petitioner of $1,600 before agreeing to make a loan sufficient to liquidate the indebtedness secured by the mortgage if the property had an actual fair market value of $18,500 - the principal amount of the mortgage taken by the H.O.L.C. was not shown but was apparently between $6,000 and $7,000 - and we take judicial notice of the fact that the H.O.L.C., which was organized for the purpose of benefiting distressed home owners (12 U.S.C.A. 1461, et seq.) adopted a liberal policy toward them. The act by its terms limited the face value of the bonds and the cash to be advanced by the H.O.L.C. to an individual to $14,000 "or 80 percentum of the value of the real estate as determined by an appraisal made by the corporation, whichever is the smaller." If the loan was, say $6,500, that would indicate that the appraisers valued the property at approximately $8,000. The evidence of value is far from satisfactory but we are of the opinion that it was not in excess of $9,000 in 1934 and we have so held. The portion of the total allocable to the land was, in our judgment, 35 percentum and to the buildings 65 percentum. We therefore compute1943 Tax Ct. Memo LEXIS 520">543 petitioner's capital and ordinary loss, as outlined in I.T. 3246, supra, as follows: Value of land$3,150.00Less 35% of mortgage2,161.17Loss988.9350% allowable as a capitalloss. Sec. 117$494.46Value of improvements5,850.00Less depreciation at3% for 1934, 1935,1936, 1937 and1938$877.50Windstorm loss in1938. Not cov-ered by insur-ance. Deductedand allowed(see Ex. A)831.201,708.70$4,141.30Less 65% of mortgage4,013.41Ordinary loss allowable$127.89Issue IV In petitioner's return for the year 1939 he included the sum of $600 paid to him by the corporation for "car and travel expense", and deducted the same amount as an expense. Similar entries were made in the 1938 return. In the petition it is alleged that: Petitioner incurred sales promotion and selling expenses in the sum of $3,600. These expenses, which were omitted as deductions in the 1939 income tax return were ordinary and necessary in the course of business for which there was no additional reimbursement. This allegation is denied in the respondent's answer. In lieu of findings of fact we set out at this juncture the evidence pertaining to this1943 Tax Ct. Memo LEXIS 520">544 issue. Petitioner testified that he had certain expenses in connection with making the sales which were not reimbursed to him by the company. He stated: The expenses of a man that has charge of supervision and sales consists of a large amount of automobile expenses, telephone calls, entertainment; also I maintain men on the houses to display the houses and put up "for sale" signs, electric lights, different types of inducements to attract sales. When asked to estimate the expenses which he had during the year 1939 he said: A. Around $3,600, between $3,600 and $4,000. Q. How did you arrive at that figure? A. I arrived at it on the basis of approximately $300 a month. Q. Have you got any receipts or checks to justify that figure? A. No, I have not. I dealt in cash. The men that I have working for me I would pay them the $2 or $3 a day that they would be getting for display purposes, and entertainment on the same basis. It was all on a cash basis. Under cross-examination petitioner was asked whether he had anything of any nature to show with respect to the sales expenses, to which he responded - No, I did not, except that the income, in addition to the unit income that I was1943 Tax Ct. Memo LEXIS 520">545 receiving from the Detroit Housing Corporation, was more than absorbed each month in my expenses and that's how I arrived at my expenses. In other words, the compensation that I received from the Detroit Housing Corporation was used up for the incidental expenses and you just - if there's a question in your mind, just estimate a sale of about $300,000, 44 houses, supervising them, hiring and firing help and hiring salesmen and - I feel that you will agree with me that the expense of $300 a month is very small. (Parenthetically it may be observed that 28 houses were sold by petitioner during 1939 rather than 44 houses.) Opinion Section 23 of the Internal Revenue Code permits the deduction from gross income of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * ." This term has been defined in numerous decisions. See Kornhauser v. United States, 276 U.S. 145">276 U.S. 145; Deputy v. du Pont, 308 U.S. 488">308 U.S. 488; Textile Mills Securities Corp. v. Commissioner, 314 U.S. 326">314 U.S. 326. Petitioner relies upon the language used in Cohan v. Commissioner, 39 Fed. (2d) 540:1943 Tax Ct. Memo LEXIS 520">546 Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close o should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making. It is not fatal that the result will inevitably be speculative. The quoted language has been applied in many cases and should now be followed. So far as automobile expense is concerned we think it may be assumed that the $600 paid by the corporation to petitioner was ample. In this connection it is also noted that the corporation appears to have expanded $475 for "auto Equipment" during the year 1938 and $1,649.20 for auto expense in the year 1939. Assuming that this includes the $600 paid to petitioner it would seem that the corporation expended an additional $1,049.20. During the same time it paid an average of approximately $25 per month for electric lights, telephone and telegraph bills aggregating $368.49, and advertising amounting to $1,082.24. It is reasonable to conclude, as we do, that the corporation paid all of the expenses for automobiles, electric lights, telephones, telegraph and advertising in connection with the sales1943 Tax Ct. Memo LEXIS 520">547 made in 1939. We can only speculate as to the amount expended by petitioner for entertainment and for "maintaining men on the houses to display the houses and put up 'For Sale' signs, etc." The aggregate probably did not exceed $25 per month or a total of $300. This amount is therefore allowed as an additional deduction from 1939 gross income. Decision will be entered under Rule 50. Footnotes. The figures shown in pen and ink are shown in pencil on the exhibit received in evidence, (Ex. 5) but are not otherwise explained.↩1. Art. 42-2, 42-3, Regulations 101.↩*. BTA decision affirmed by CCA-6, 133 Fed. (2d) 509↩,	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619340/	G. W. Onthank Company v. Commissioner.G. W. Onthank Co. v. CommissionerDocket No. 42593.United States Tax Court1954 Tax Ct. Memo LEXIS 250; 13 T.C.M. 300; T.C.M. (RIA) 54098; March 31, 19541954 Tax Ct. Memo LEXIS 250">250 Deductions: Interest. - Investment Certificates issued by petitioner to shareholders and others held to be an indebtedness and interest payments thereon were deductible. Richard E. Williams, Esq., 306 Fifteenth Street, Des Moines, Ia., for the petitioner. Mark Townsend, Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: Respondent determined deficiencies in income tax of petitioner in the amounts of $8,581.34 for 1947 and $8,917.75 for 1948. Several adjustments are uncontested and can be reflected in a Rule 50 computation. The sole issue for decision is whether certain amounts accrued by petitioner as interest on investment certificates were properly deductible as interest under section 23(b), or whether such amounts were in the1954 Tax Ct. Memo LEXIS 250">251 nature of dividends. Findings of Fact The stipulated facts are so found and the stipulation is incorporated herein by reference. Petitioner is an Iowa corporation having its principal place of business at Des Moines, Iowa. Its income tax returns for 1947 and 1948 reported income on an accrual basis and were filed with the collector of internal revenue at Des Moines, Iowa. Petitioner was incorporated on December 26, 1941, with the authorized capital stock consisting of 900 shares of Class A stock with a par value of $100 per share and $10,000 shares of Class B stock with a par value of $1 per share. Additional capital stock was authorized and issued, and prior to March 1, 1947, petitioner had issued and outstanding 20,000 shares of Class B (common) stock with a par value of $1 per share and 1,800 shares of Class A (preferred) stock with a par value of $100 per share. Class A stock was non-voting preferred stock on which a dividend not exceeding $6 per share per annum was to be paid out of the net profits of petitioner for each calendar year. The stock was non-voting and subject to retirement out of surplus as authorized by the directors. The directors of petitioner decided1954 Tax Ct. Memo LEXIS 250">252 additional operating capital was needed and means of raising it were discussed. Some holders of Class A stock evidenced a desire for some type of absolute obligation in place of their preferred stock. On February 3, 1947, a special meeting of petitioner's directors was held and means of raising additional operating capital were considered. Effective March 1, 1947, pursuant to a plan of recapitalization approved by the directors and stockholders, petitioner issued "Investment Certificates" (hereinafter called Certificates) totaling $270,000 face value. Petitioner exchanged Certificates having a face value of $180,000 for the entire issue of Class A stock outstanding. The remaining $90,000 face amount of Certificates was first offered to holders of Class A stock. Some of these holders purchased Certificates for cash in the amount of $65,500. Certificates were also sold for cash to other individuals and companies who had not been Class A stockholders. The recapitalization did not change voting control of petitioner. It did result in a $90,000 increase in working capital. The Certificates were in the following form: "INVESTMENT CERTIFICATE, "TWENTY YEAR 6% INVESTMENT CERTIFICATE1954 Tax Ct. Memo LEXIS 250">253 OF "G. W. ONTHANK COMPANY, AN IOWA CORPORATION "NO. AMOUNT $ "The G. W. Onthank Company, an Iowa Corporation for value received, promises to pay to the bearer on the 1st day of March 1967 the sum of $ in lawful money of the United States of America at the office of the Company in Des Moines, Iowa, and to pay interest thereon in legal lawful money out of the net income of the said company at the rate of six percent (6%) per annum, payable annually on the 31st day of December of each year, at the office of the Company in Des Moines, Iowa, on presentation of this certificate for endorsement of payment thereon, conditioned, however, upon the net income of the company being sufficient during any interest period to pay the amount due as interest in accord with the terms and provisions hereof. If the net income of the company is insufficient to pay interest at the rate of 6% (six per cent) per annum during any interest period, the Company will pay interest on all outstanding certificates of this issue to the extent of its net income for that interest period and pro rata among the holders of such certificates. The interest on this certificate shall not be cumulative. "This certificate, 1954 Tax Ct. Memo LEXIS 250">254 or any portion of the sum represented hereby, may be assigned in multiples of One Hundred Dollars ($100.00) by endorsement as provided on the back hereof. Notice of assignment must be given in writing to the G. W. Onthank Company and the original certificate returned to the Company in order that the assignee's name may be registered on the books of the corporation as the holder thereof and new certificates issued as the interests of the owners shall appear. "This certificate is one of a duly authorized issue of Investment Certificates of the corporation, fully registered and serially numbered of like date, tenor and effect, in the aggregate sum of Two Hundred Seventy Thousand Dollars ($270,000.00). The obligation evidenced hereby is severable and may be enforced without regard to other registered holders. "This certificate and all certificates of this issue are subject in all respects and subordinate, both as to principal and interest, to the claims of all creditors of the corporation, and upon dissolution or liquidation of the corporation, no payment shall be due or payable upon this certificate unless and until all creditors of the corporation shall have been paid in full. All1954 Tax Ct. Memo LEXIS 250">255 holders of this issue of Investment Certificates shall rank pari passu with each other and superior to the stockholders of the corporation with respect to their capital stock. "The corporation reserves the right to pay and redeem this certificate or any part thereof on any interest payment date and in the following manner: After determination by the Board of Directors of the Company as to the principal amount of these certificates that it desires to retire, the Company shall first invite all certificate holders to offer their certificates to the Company at not less than par and at not more than One Hundred Two Dollars ($102.00) for each One Hundred Dollars ($100.00) of face amount, plus in each case, accrued and unpaid interest. If the amount offered by holders of these certificates is more than the amount established to be retired the certificates offered will be taken up and redeemed by the Company in the order of the lowest offering prices until the full amount established to be retired has been taken up. If the amount offered as above, is less than the amount to be retired, those certificates offered will be taken up, and the balance of the established amount to be retired will1954 Tax Ct. Memo LEXIS 250">256 be selected by lot in units of One Hundred Dollars ($100.00) face amount and will be redeemed at One Hundred Two Dollars ($102.00) for each One Hundred Dollars ($100.00) of face amount. In event of a partial retirement of the amount represented by this certificate, the registered holder hereof agrees to present this certificate to the corporation for reissue of the amount of the principal sum not retired. "Provision for retirement sinking fund reserve and other terms and conditions of this obligation are set forth in a resolution of the Board of Directors of the corporation duly adopted at a meeting held on February 3, 1947, which resolution is spread upon the minutes of the corporation and is hereby made a part hereof. "If one or more of the following events of default should occur, viz: (a) If default be made in the punctual payment of any instalment of interest on any outstanding Investment Certificate or Certificates or (b) if default be made in the observance or performance of any of the terms of these certificates or of the provisions of the resolution of the Board of Directors of the Company authorizing this issue, and if any such default shall continue for a period of two1954 Tax Ct. Memo LEXIS 250">257 (2) years after written notice thereof shall have been given to the Company by the holder, then the entire principal amount of this certificate shall become due and payable immediately. In event suit is brought by the holder to enforce the obligations of the Company hereunder and if it shall be determined in such suit that the Company is in default, the Company will pay to the holder the cost and expenses of collection, including reasonable attorney fees. "IN WITNESS WHEREOF, G. W. Onthank Company has caused this certificate to be duly executed by its proper officers this day of 1947. ATTEST: Secretary President" Petitioner accrued the sums of $13,123 and $16,200 on its books in 1947 and 1948, respectively, as interest on its outstanding Certificates and claimed these amounts as deductions. Respondent disallowed the claimed deductions. The Investment Certificates on which the above sums were accrued as interest were bona fide obligations of petitioner and the accrued sums were interest on those obligations. Opinion The question here is essentially a fact question. Tribune Publishing Co., 17 T.C. 1228">17 T.C. 1228. If the Investment Certificates issued by petitioner represented1954 Tax Ct. Memo LEXIS 250">*258 a bona fide indebtedness the amounts accrued as interest thereon were properly claimed as deductions. The Certificates were cast in the form of interest bearing obligations. A business purpose for the issuance of interest bearing securities was present, i.e. the need for additional capital and the reluctance of holders of the old preferred stock to invest further unless an absolute obligation were offered. The recapitalization succeeded in raising additional capital as planned. There is some suggestion in respondent's argument that the only purpose was to gain a tax advantage, but that suggestion rests merely on the presence at the directors' meeting of petitioner's tax advisor and the fact that he prepared the form of the Certificates. We do not think this suggestion in the argument is convincing as to the purpose of the recapitalization. Our ultimate finding of fact decides the issue in favor of petitioner. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619342/	M. M. Argo, Petitioner, v. Commissioner of Internal Revenue, RespondentArgo v. CommissionerDocket Nos. 109996, 112248United States Tax Court3 T.C. 1120; 1944 U.S. Tax Ct. LEXIS 83; July 20, 1944, Promulgated 1944 U.S. Tax Ct. LEXIS 83">83 Decision will be entered under Rule 50. 1. The judgment of a Federal District Court in an action between petitioner and a collector of internal revenue for recovery of income tax paid by petitioner for 1937 involved the same question as is here involved for 1938 and 1939, but the parties to the two proceedings were not identical. Held, that the judgment of the Federal District Court does not preclude this Court from further considering that question as to 1938 and 1939.2. The judgment of a Federal District Court in an action between petitioner and a collector of internal revenue for recovery of income tax paid by petitioner for 1937 involved the same question as that here involved for 1940. None of the facts upon which the adjudication of the District Court was based is shown in the record. Held, that this Court is not precluded by the District Court judgment from further considering that question as to the latter year.3. On an issue of whether a business which is asserted by the taxpayer to be a partnership composed of himself, his wife, and minor children is to be recognized as a partnership for income tax purposes -- where the evidence does not support a positive1944 U.S. Tax Ct. LEXIS 83">84 finding that the activities and services of the taxpayer were the main factors in the production of the income, but points strongly in that direction, the taxpayer must, in order to establish what he asserts, prove that his activities and services were not the main factors in the production of the income. Thomas H. Fox, Esq., and Victor H. Smith, Esq., for the petitioner.Charles P. Bagley, Esq., for the respondent. Tyson, Judge. Murdock, Sternhagen, Van Fossan, Leech, Mellott, and Disney, JJ., concur only in the result. TYSON3 T.C. 1120">1121 Respondent determined deficiencies in income tax against petitioner as follows: For 1938, $ 680.24; for 1939, $ 460.05; and for 1940, $ 550.23.These deficiencies are chiefly the result of respondent's determination that petitioner is taxable, as the sole owner thereof, on all the net income of an unincorporated business operated during the taxable years under the style of Birmingham Electric & Manufacturing Co. No other adjustment is in controversy. Petitioner contests this determination on the ground that the business was owned and operated as a partnership during the taxable years. He also pleads res judicata, based on a1944 U.S. Tax Ct. LEXIS 83">85 judgment of the United States District Court for the Southern Division of the Northern District of Alabama in an action by this petitioner against the collector of internal revenue for the district of Alabama to recover income taxes paid for the year 1937, wherein the issue was whether the Birmingham Electric & Manufacturing Co. was, during that year, a partnership among petitioner, his wife, and his three children. The proceedings have been consolidated.Petitioner concedes on brief that an item of $ 4,600 earned by him as commissions in 1939 independently of the business activities of the Birmingham Electric & Manufacturing Co., which item was entered on the books of that company as received by it, embraced in its partnership returns for that year, and included by respondent in his computation of deficiencies against petitioner for that year, is taxable to him, irrespective of the finding of this Court as to whether or not a bona fide partnership existed during 1939.It was stipulated at the hearing that if we should find there was a valid partnership during 1938 and 1939, for income tax purposes, the petitioner is not entitled to credit in those years for the dependency of Sarah1944 U.S. Tax Ct. LEXIS 83">86 Ellen Argo, as was allowed by respondent. Effect to the concession and stipulation will be given under Rule 50.FINDINGS OF FACT.Petitioner is a resident of Birmingham, Alabama. He filed his income tax returns with the office of the collector for the State of Alabama.During 1936 petitioner owned all the capital stock of the Birmingham Electric & Manufacturing Co., a corporation organized under the laws of Alabama, and engaged in the business of repairing and rebuilding electrical machinery and equipment. The business, both while operated as a corporation and as an unincorporated concern, was of a type requiring technical knowledge. Petitioner is a graduate electrical engineer and he has been engaged in that profession since 1912. He was president of the corporation and received a salary for the year 1936 of $ 12,000.3 T.C. 1120">1122 During 1936 petitioner discussed with an attorney, an auditor, and a certified public accountant the question of dissolving the corporation and forming a partnership consisting of himself, his wife, and his three minor children. The possibility of a saving in income taxes was also discussed. Petitioner's attorney advised him to form the partnership1944 U.S. Tax Ct. LEXIS 83">87 and stated it could be accomplished legally without the execution of a written agreement. The proposed partnership was also discussed by petitioner during the latter part of 1936 with his wife, Esther B. Argo, and his children, Malcolm M. Argo, Jr., then of the age of 18, Ann A., then of the age of 16, and Sarah Ellen, then of the age of 7. Malcolm M. Argo, Jr., became of age on July 9, 1939, and Ann A. Argo in January 1941. As a final result of these discussions petitioner told his wife and children that he was going to dissolve the corporation and was going to make an outright gift to each of them of a one-fifth interest in the partnership and that they would be partners with him and be responsible for any debts of the partnership. It was understood that petitioner was to receive $ 6,000 a year from the profits and would manage the business, with the right to operate it as he saw fit. The profits after deducting the petitioner's $ 6,000 per annum were to be distributed equally between the other four members of the family.At that time petitioner's wife owned no property except the family home, which was encumbered by a mortgage on which petitioner was liable. Her occupation1944 U.S. Tax Ct. LEXIS 83">88 was that of a housewife, and she was without any income other than a small amount derived from writing. The occupation of the children was that of attending school and they had no property or income.During the time that the business was operated as a corporation petitioner's wife frequently helped with the office work, his son worked for the business during his school vacations, and his oldest daughter also worked for the business during her school vacations.On December 31, 1936, the Birmingham Electric & Manufacturing Co., the corporation, was dissolved, and petitioner, as its sole stockholder, received all its assets and assumed its liabilities. These assets were immediately credited to an unincorporated business which thereafter conducted the same character of business as had the corporation and under the same name as that of the corporation. This unincorporated business will be sometimes referred to hereinafter as the company.Petitioner instructed his bookkeeper to make entries on the company's books dividing interests in the company equally among the five members of the family, and he told her that he was making a gift to his wife and children of those interests. She was1944 U.S. Tax Ct. LEXIS 83">89 also told that petitioner was to be distributed $ 6,000 annually from the profits and the remaining profits were to be distributed four ways among the other members of the family. In January 1937 capital accounts were opened 3 T.C. 1120">1123 on the books crediting each member of the family with a total of $ 4,317.58.Petitioner did not execute any deed, bill of sales, or other written form of conveyance transferring any interest in the business to his wife or children. After January 1937 the everyday operations of the company continued in the same manner and under the same name as during incorporation, except for capital accounts, and for accounts of withdrawals by each of the members of the family in the case of the company. Petitioner continued to handle and control the affairs of the company as he had in the case of the corporation.The balance sheet of the company, as shown on its return made as a partnership, contained as of January 1, 1937, the same assets and liabilities as the balance sheets of the corporation of December 31, 1936, as shown on its return, and that balance sheet is as follows:ASSETSCash$ 2,586.49Accounts receivable6,801.17Inventories5,382.15Other assets:Service deposits55.00Capital assets:Building$ 4,500.00Machinery and equipment5,500.00Furniture and fixtures337.72Delivery equipment3,458.9313,796.65Less: Allowance for depreciation 1,337.5012,459.15Land4,000.0016,459.15Deferred charges440.65Total 31,724.61LIABILITIESNotes payableAccounts payable11,605.16Accrued accounts:Interest$ 1,046.07Taxes206.131,252.20Income taxes341.70Mortgages2,900.00Capital accounts15,625.55Total 31,724.611944 U.S. Tax Ct. LEXIS 83">90 During the taxable years petitioner's wife assisted in the business of the company when it was convenient for her to do so at night, as 3 T.C. 1120">1124 she was attending to her household affairs during the day, or on Saturday afternoons. She did clerical work, filing, and typing letters. She received no salary.Petitioner's son Malcolm, Jr., attended college throughout 1937, except for the summer vacation period, during most of which period he assisted in the business of the company during afternoons in the shop and on night emergency calls when pumps or motors in coal mines were damaged by electrical storms. He also assisted his father during that year in managing the business. During the first half of 1938 he was away at college and during the remainder of the year, except while on a vacation in Cuba, he attended a local college during the morning and worked in the company warehouse in the afternoon, repairing and reconditioning motors. He attended college throughout 1939 and until graduating as an electrical engineer in June 1940, when he began working for the company on a full time basis, continuing to do so until he enlisted in the Army in October 1940. He received no salary. 1944 U.S. Tax Ct. LEXIS 83">91 Petitioner's daughter Ann was away at college during 1937, except for a summer vacation, during half of which she attended a local college in the mornings. In the afternoons when not in school she helped in the business with filing and stenographic work. She did no work in 1938, being away at school during both the regular and summer terms. She did no work in 1939. In 1940 she did no work until October, after graduation. The balance of that year she worked regularly in the office or in the plant, operating machines and helping make carbon brushes. She received no salary. Petitioner's daughter, Sarah Ellen, did no work for the company at any time.The amount and character of the company's assets for various periods, as shown by the balance sheets attached to partnership returns filed by it, are as follows:December 31, 1937December 31, 1938Cash$ 3,374.61$ 3,731.48Accounts receivable10,852.9014,878.63Inventories10,932.1010,473.84Other assets:Service deposits55.0055.00Capital assets:Building$ 4,500.00$ 4,500.00Machinery and equipment5,687.005,687.00Furniture and fixtures337.72337.72Delivery equipment3,399.563,441.6913,924.2813,966.41Less: Allowance fordepreciation 3,981.985,829.499,942.308,136.92Land4,000.0013,942.304,000.0012,136.92Deferred charges:Insurance premiums403.71512.71Other44.00447.71512.71Total 39,604.6241,788.581944 U.S. Tax Ct. LEXIS 83">92 3 T.C. 1120">1125 December 31, 1939December 31, 1940Cash$ 6,342.85$ 4,687.59Accounts receivable12,186.1816,125.34Inventories8,944.009,889.47Service deposits55.0055.00Fixed:Land4,000.004,000.00Buildings$ 4,500.00$ 4,500.00Machinery and equipment5,687.006,037.00Furniture and fixtures538.78849.63Delivery equipment3,312.264,197.2114,038.0415,583.84Less reserve for depreciation8,164.595,873.4510,632.234,951.61Prepaid insurance premiums, etc561.98545.44Total 37,963.4640,254.45For the years 1937, 1938, 1939, and 1940 the company books in the various capital accounts of petitioner, his wife, and his three children, the partnership returns of income filed by petitioner, and the individual income tax returns filed by the members of the family show net distributable profits as follows:1937193819391940M. M. Argo$ 6,000.00$ 6,000.00$ 6,000.00$ 6,000.00Esther B. Argo2,496.721,988.471,164.21826.47Malcolm M. Argo, Jr2,496.721,988.481,164.21826.47Ann A. Argo2,496.721,988.481,164.21826.47Sarah Ellen Argo2,496.721,988.481,164.20826.47Total 15,986.8813,953.9110,656.839,305.881944 U.S. Tax Ct. LEXIS 83">93 The above listed profits of $ 10,656.83 in 1939 include $ 4,600 in personal commissions now conceded by petitioner to be his individual income, taxable to him as such.There were no drawing accounts on the books for petitioner's wife and children during 1937. All withdrawals by or for them during that year, totaling $ 7,650, were charged to petitioner on the books. Neither petitioner's wife nor his children had authority at any time to draw checks on the company's bank account.Drawing accounts on the books of the company reflect withdrawals for the years 1938, 1939, and 1940 as follows:193819391940M. M. Argo$ 6,000.22$ 4,934.39$ 2,481.55Esther B. Argo1,240.101,364.662,983.67Malcolm M. Argo, Jr1,117.331,432.621,324.20Ann A. Argo688.971,551.121,219.17Sarah Ellen Argo65.101,155.621,243.67Total 9,111.7210,438.419,252.26The withdrawals totaling $ 10,438.41 for 1939 include erroneous charges for withdrawals not in fact made, in the amount of $ 4,600, charged to the extent of $ 600 against petitioner's account and $ 1,000 against each of the remaining accounts. The foregoing drawing accounts 3 T.C. 1120">1126 of petitioner's wife1944 U.S. Tax Ct. LEXIS 83">94 and children, and the amount of withdrawals listed as above therein, also include a number of items based on checks drawn to the order of petitioner and deposited in his individual bank account, as follows:193819391940Number ofNumber ofNumber ofchecksAmountchecksAmountchecksAmountEsther B. Argo2$ 300.00Malcolm M. Argo, Jr6750.002$ 125.00Ann A. Argo2$ 247.40Sarah Ellen Argo1625.00Total 81,050.002125.003872.40Petitioner's wife had an allowance for running the house and would obtain what money she needed from the bookkeeper for household and personal expenses. Her withdrawals represented these amounts, except those represented by the checks deposited as above shown to petitioner's individual bank account.There were no "dollars and cents" restrictions on Malcolm Jr.'s withdrawals. When he needed money he would ask the bookkeeper for it and she would let him have it. Ann made her withdrawals by asking her father or the office for them. She did not have to consult her father, but she was not allowed to make promiscuous withdrawals in large amounts. The moneys received by 1944 U.S. Tax Ct. LEXIS 83">95 each of the children through their withdrawals were used for school allowances, clothing, doctors and hospital bills, and for the other needs of each, except for those withdrawals represented by checks deposited in the petitioner's individual bank account as above shown.The 1936 income and excess profits tax return of the corporation, Birmingham Electric & Manufacturing Co., was subscribed and sworn to by petitioner as president on March 12, 1937, and filed with the collector of internal revenue for the district of Alabama on March 15, 1937. On a schedule attached thereto appears the following statement:Comment Relative to DissolutionThis corporation was dissolved on December 31, 1936, and the net assets were distributed to the stockholder in complete liquidation and cancellation of the capital stock as of that date. The business will be conducted henceforth without interruption by M. M. Argo, as a proprietorship.Under date of February 23, 1937, petitioner addressed the following letter to the "Secretary of Treasury, Att: Commissioner of Internal Revenue":As provided in Article 308 of Regulation 90 relating to excise tax on employers under Title 9 of Social Security Act, I1944 U.S. Tax Ct. LEXIS 83">96 am hereby giving notice that the Corporation known as Birmingham Electric & Mfg. Company was dissolved December 31, 1936 and that henceforth the business will be conducted under the same name by M. M. Argo as proprietor.3 T.C. 1120">1127 Annual returns of excise tax under Title IX of the Social Security Act for the years 1937 and 1938 were filed with the same collector on behalf of the company by petitioner, who executed the affidavit thereto as "M. M. Argo, Owner."Employer's summary information returns under Title VIII of the Social Security Act for the periods January 1 through June 30, 1937, and July 1 through December 31, 1937, were filed with the same collector on behalf of the company by petitioner, who executed the affidavit thereto as "M. M. Argo, Owner."Seven employer's tax returns under the same title and act were filed with the same collector quarterly on behalf of the company for the period ended March 31, 1938, through the period ended September 30, 1939, by petitioner, who executed the affidavit to each as "M. M. Argo, Owner."Petitioner filed personal property tax list returns with the tax assessor of Jefferson County, Alabama, covering the personal property of the company, 1944 U.S. Tax Ct. LEXIS 83">97 and executed affidavits thereto on December 8, 1937, and October 6, 1938, respectively, wherein he stated that he was the "owner" of such property.Petitioner, on or about June 10, 1937, filed a financial statement and balance sheet of the company with the First National Bank of Birmingham for credit purposes. The heading, "Corporation," on the printed form was stricken out and the word, "Individual," substituted. The statement showed "Condition at close of business April 30th 1937." The statement was signed in the name of the company, "By M. M. Argo, Title of Officer, Owner." On or about March 24, 1939, a balance sheet of the business as of February 28, 1939, was filed by petitioner with the same bank. It was signed, "M. M. Argo, Owner."On December 16, 1940, petitioner filed a complaint against Henry J. Willingham, the collector of internal revenue for the district of Alabama, in the District Court of the United States for the Southern Division of the Northern District of Alabama, for the recovery of income taxes for the year 1937 alleged to have been paid April 19, 1940, in the amount of $ 876.14, plus interest, in response to a notice of deficiency determined on the ground 1944 U.S. Tax Ct. LEXIS 83">98 that, "there was no bona fide partnership (referring to the Birmingham Electric & Manufacturing Company) and that the net income reported on form 1065 actually represented net income to Mr. M. M. Argo from his individually conducted business under the name of Birmingham Electric & Manufacturing Company." The complaint further alleged that the business was a partnership during 1937 and that the Commissioner erred in taxing petitioner with all the income of the business. A general denial to this complaint was filed.3 T.C. 1120">1128 On February 24, 1941, the judge of the District Court entered an "Order on Pre-Trial Hearing" wherein it was stated that:It was agreed by all of the parties that the following are all of the issues in controversy in this cause:Plaintiff claims refund of income taxes for the year 1937, under the revenue laws of the United States because The Birmingham Electric and Manufacturing Company was a partnership throughout the entire calendar year 1937 and the plaintiff was taxable only on partnership income accruing to him.Defendant pleads: (1) The general issue; and(2) In the taxable year, plaintiff was the individual owner of the said business and was taxable 1944 U.S. Tax Ct. LEXIS 83">99 on the entire income therefrom and there was no partnership.On October 16, 1942, an order of the court was entered as follows:This cause coming on to be heard, prior to the submission of the cause to the jury, the parties stipulated by their respective counsel, in open Court, that if the jury found from the evidence that there was a partnership between the plaintiff and his wife, and three children during the calendar year 1937 that judgment should be rendered upon such verdict in favor of the plaintiff for the sum of $ 985.31, plus interest thereon at six per cent per annum from and after April 19, 1940, until paid as provided by law, and that on the other hand, if the jury found from the evidence that no such partnership existed during the calendar year 1937, then judgment should be rendered upon such verdict in favor of the defendant, and the case thereupon being submitted to the jury, the jury reported a verdict as follows:"We, the jury, find that there was a partnership during the year 1937."C. L. Collins,"Foreman"it is accordingly by the CourtOrdered, Adjudged and Decreed that the plaintiff herein have and recover of and from the defendant herein the sum of Nine1944 U.S. Tax Ct. LEXIS 83">100 Hundred Eighty-five and 31/100 ($ 985.31) Dollars * * .An appeal from this judgment of the district court was taken by Henry J. Willingham, collector, defendant in the suit, to the United States Court of Appeals for the Fifth Circuit, and on motion filed by the appellant the appeal was dismissed. It is that judgment which petitioner pleads here as res judicata.The petition in Docket No. 109996, covering the years 1938 and 1939, was filed February 21, 1942. The petition in Docket No. 112248, covering the year 1940, was filed on August 24, 1942.OPINION.The main issue in both dockets is whether, for Federal income tax purposes, there was a valid partnership existing in the taxable years, with petitioner, his wife, and his children as partners therein. Incidental to that issue there is the further issue of whether the judgment of the United States District Court constitutes res judicata, 3 T.C. 1120">1129 or, as more properly stated with reference to the situation here, estoppel by judgment as to the main issue.We shall consider first the incidental issue.That the principle of estoppel by judgment does not apply with respect to the disposition of the issue we have here as to the years1944 U.S. Tax Ct. LEXIS 83">101 1938 and 1939 is clear, because the suit in the United States District Court involving the year 1937, although brought by petitioner, as is the proceeding here, was against the collector of internal revenue, whereas, the proceeding in Docket No. 109996 herein, involving 1938 and 1939, is against the Commissioner of Internal Revenue. The parties to the two suits were not identical and that prime requisite for the application of the doctrine of estoppel by judgment is lacking as to the proceeding in Docket No. 109996. We are therefore not precluded by the judgment of the District Court from considering the question presented in that docket on its merits. Sage v. United States, 250 U.S. 33">250 U.S. 33; Bankers Pocahontas Coal Co. v. Burnet, 287 U.S. 308">287 U.S. 308; and United States v. Nunnally Investment Co., 316 U.S. 258">316 U.S. 258. Cf. Tait v. Western Md. Ry. Co., 289 U.S. 620">289 U.S. 620; and Sunshine Coal Co. v. Adkins, 310 U.S. 381">310 U.S. 381. The proceeding in Docket No. 109996 having been instituted prior to June 15, 1942, section 3772 (d) of the Internal Revenue1944 U.S. Tax Ct. LEXIS 83">102 Code, as added by section 503 of the Revenue Act of 1942, 1 does not apply.The proceeding in Docket No. 112248 herein, involving the year 1940, was, 1944 U.S. Tax Ct. LEXIS 83">103 however, instituted after June 15, 1942; so that the fact that petitioner's suit in the District Court was against the collector, while here his proceeding is against the Commissioner, does not of itself operate to prevent the application of the principle of estoppel by judgment as to 1940. Respondent, on brief, concedes this. Does the judgment of the District Court nevertheless constitute estoppel by judgment as to the issue presented in Docket No. 112248?The rule of estoppel by judgment, so far as it relates to the requirement that the question in the two cases must be the same, is stated in Southern Pacific Railroad v. United States, 168 U.S. 1">168 U.S. 1, 168 U.S. 1">48, as follows:The general principle announced in numerous cases is that a right, question or fact distinctly put in issue and directly determined by a court of competent jurisdiction, as a ground of recovery, cannot be disputed in a subsequent suit between the same parties or their privies; and even if the second suit is for a different cause of action, the right, question or fact once so determined must, as between the same parties or their privies, be taken as conclusively established * .3 T.C. 1120">1130 1944 U.S. Tax Ct. LEXIS 83">104 See also Cromwell v. County of Sac, 94 U.S. 351">94 U.S. 351, 94 U.S. 351">353; New Orleans v. Citizens' Bank, 167 U.S. 371">167 U.S. 371, 167 U.S. 371">397; United States v. Moser, 266 U.S. 236">266 U.S. 236; and 289 U.S. 620">Tait v. Western Md. Ry. Co., supra. This rule applies to tax cases, and if the conditions for its operation exist, it governs where, as here, taxes for different years are involved and the action in the later case is upon a different claim or demand from that involved in the earlier one and the parties are the same in both cases. 289 U.S. 620">Tait v. Western Md. Ry. Co., supra;Leininger v. Commissioner, 86 Fed. (2d) 791; The Evergreens, 47 B. T. A. 815; affd., 141 Fed. (2d) 927; and Alice G. K. Kleberg, 2 T.C. 1024, 1032.The pleadings and judgment in the suit in the District Court show that the point in controversy and the thing adjudged was whether the petitioner here (plaintiff there) and his wife and children were partners during 1937 in the business operated1944 U.S. Tax Ct. LEXIS 83">105 under the name of Birmingham Electric & Manufacturing Co., or whether that business was owned by the petitioner as an individual proprietor. As that suit was one to recover income taxes paid by the petitioner in response to a determination by the Commissioner that there was not a bona fide partnership and that the business was owned by, and the net income was taxable to, the petitioner, and as the parties stipulated therein that, if the jury found there was a partnership during 1937, judgment should be rendered on such verdict in favor of the petitioner for the taxes paid, it is obvious that the verdict of the jury and the judgment entered thereon involved a determination that there was a partnership for Federal income tax purposes in 1937. The question presented here in Docket No. 112248 is the same, except for different years, such question requiring a determination of whether there was a partnership for Federal income tax purposes between the same persons in the same business during the year 1940.In 167 U.S. 371">New Orleans v. Citizens' Bank, supra, at pp. 396, 398, the Supreme Court said:* * * The estoppel resulting from the thing adjudged does not depend1944 U.S. Tax Ct. LEXIS 83">106 upon whether there is the same demand in both cases, but exists, even although there be different demands, when the question upon which the recovery of the second demand depends has under identical circumstances and conditions been previously concluded by a judgment between the parties or their privies. This is the elemental rule, stated in the text books and enforced by many decisions of this court. * It follows, then, that the mere fact that the demand in this case is for a tax for one year and the demands in the adjudged cases were for taxes for other years, does not prevent the operation of the thing adjudged, if, in the prior cases, the question of exemption was necessarily presented and determined upon identically the same facts upon which the right of exemption is now claimed. [Italics supplied.]See also 289 U.S. 620">Tait v. Western Md. Ry. Co., supra, p. 626.The record herein does not show what evidence was presented to the jury in the District Court suit. All that we know is that the 3 T.C. 1120">1131 question of whether a partnership existed in 1937 among the petitioner and his wife and children was presented in that suit for determination. 1944 U.S. Tax Ct. LEXIS 83">107 Whether that question was solved by evidence of the same facts and circumstances as are shown in the present case or by evidence of a different set of facts and circumstances does not appear, and hence it is impossible to determine that the question presented here has, "under identical circumstances and conditions," been previously concluded by the judgment of the District Court. In order to work an estoppel by judgment the facts, as well as the question, in both cases must be the same, and if it is not known what the facts in both cases are the rule does not apply. Campana Corporation v. Harrison, 135 Fed. (2d) 334, 336.In cases where the rule of estoppel by judgment has been invoked the facts in the former proceedings were clearly determinable from the record before the court. See 289 U.S. 620">Tait v. Western Md. Ry. Co., supra;United Shoe Mach. Co. v. United States, 258 U.S. 451">258 U.S. 451, 258 U.S. 451">459; Oklahoma v. Texas, 256 U.S. 70">256 U.S. 70, 256 U.S. 70">86; Vicksburg v. Henson, 231 U.S. 259">231 U.S. 259; 167 U.S. 371">New Orleans v. Citizens' Bank, supra;1944 U.S. Tax Ct. LEXIS 83">108 Washington Gas Co. v. District of Columbia, 161 U.S. 316">161 U.S. 316; The Evergreens v. Nunan, 141 Fed. (2d) 927; Leininger v. Commissioner, supra;Paine & Williams Co. v. Baldwin Rubber Co., 113 Fed. (2d) 840; Libbie Rice Farish, 2 T.C. 949; Pryor & Lockhart Development Co., 34 B. T. A. 687; Arthur Curtiss James, 31 B. T. A. 712.Since none of the facts upon which the adjudication of the District Court was based is shown in this record, we are unable to say that they were the same, or substantially the same, as those presented here upon the same question, and, consequently, we hold that the judgment of that court does not operate as an estoppel by judgment in this proceeding for the year 1940, and that we are not precluded from considering the question presented as to that year on its merits.Having decided that the principle of estoppel by judgment does not apply to the proceeding in either of the two dockets here involved, we shall now consider the main issue presented1944 U.S. Tax Ct. LEXIS 83">109 in both of those proceedings.As to this main issue, respondent contends that there was no bona fide partnership, for Federal income tax purposes, among petitioner, his wife, and his children and that consequently petitioner is taxable with their alleged distributable shares in the profits of the company's business as determined by the respondent; while petitioner contends that there was such a bona fide partnership and that he is not so taxable.Although the partnership between the petitioner and his wife and children may be a valid partnership under the law of Alabama, and although it be assumed that the facts found herein support the conclusion 3 T.C. 1120">1132 that the petitioner made a bona fide gift to his wife and children of an interest in the business, we are nevertheless of the opinion that the arrangement between the petitioner and his wife and children should not be recognized as a partnership during either of the taxable years, for the purposes of the income tax law, and that the respondent correctly taxed the petitioner on the whole of the income of the business for those years.The business was that of repairing and rebuilding electrical machinery and equipment. The services1944 U.S. Tax Ct. LEXIS 83">110 rendered by the petitioner's wife and his daughter, Ann, and his son, Malcolm, were obviously of negligible importance as an income producing factor. We are not informed as to whether other persons were employed and as to the nature and extent of their services, if any. The business required the application of technical knowledge and the petitioner, in managing the business, supplied that knowledge. He is a graduate electrical engineer. The company owned physical assets, such as land, building, machinery, and equipment, furniture and fixtures, delivery equipment, and inventories. Those assets were carried in the balance sheets attached to its returns at the following values:Jan. 1 1937$ 21,841.30Dec. 31, 193724,874.40Dec. 31, 193822,610.76Dec. 31, 193918,817.45Dec. 31, 194018,841.08If the earnings of the business were due mainly, though not entirely, to the personal activities and abilities of the petitioner as an electrical engineer, under the principle applied in Earp v. Jones, 131 Fed. (2d) 292; certiorari denied, 318 U.S. 764">318 U.S. 764; Mead v. Commissioner, 131 Fed. (2d) 323;1944 U.S. Tax Ct. LEXIS 83">111 certiorari denied, 318 U.S. 777">318 U.S. 777; and Schroder v. Commissioner, 134 Fed. (2d) 346, we would be required to disregard the arrangement between the petitioner and the members of his family and to tax the income to him as the real earner thereof, Lucas v. Earl, 281 U.S. 111">281 U.S. 111. On the other hand, if the earnings of the business were not due mainly to the personal services rendered by petitioner, but mainly flowed from the capital interests of the several partners, the rule of the Earp, Mead, and Schroder cases would not apply and the petitioner would be taxable only on his distributive share of the income. J. D. Johnston, Jr., 3 T.C. 799, and M. W. Smith, Jr., 3 T.C. 894.As we have indicated above, the evidence shows that the personal activities and abilities of the petitioner contributed in a large measure to the production of the income and that, in the operation of the business, the company used physical assets of the value of approximately $ 20,000 during five years. The books and partnership returns show that during1944 U.S. Tax Ct. LEXIS 83">112 the years 1937 to 1940, inclusive, the annual net earnings 3 T.C. 1120">1133 ranged from $ 15,986.88 in 1937 to $ 9,305.88 in 1940. Such annual earnings are 50 percent and more in excess of the capital investment in physical assets. The personal services of the petitioner were worth $ 12,000 per year, if measured by the amount of salary paid him for identical services by the predecessor corporation in 1936. It would seem, therefore, that the physical assets, or capital interests, were not responsible for the production of the income to such a degree as would place the present case without the rule of the Earp, Mead, and Schroder cases and bring it within the rule of the Johnston and Smith cases. While the evidence affords no basis for a positive finding that the activities and services of the petitioner were the main factors in the production of the income, it points quite strongly in that direction. In this situation, if the petitioner would escape the tax on the distributive shares of his partners, we think that he should have shown that his activities and services were not the main factors in the production of the income of the company. This he has not done, and 1944 U.S. Tax Ct. LEXIS 83">*113 we consequently are unable to say that the respondent erred in taxing to petitioner the whole of the income of the company for the taxable years involved. The determination of the respondent is therefore approved.Decision will be entered under Rule 50. Footnotes1. SEC. 503. SUIT AGAINST COLLECTOR BAR IN OTHER SUITS.Section 3772 (relating to suits) is amended by inserting at the end thereof the following new subsection:"(d) Suits Against Collector a Bar. -- A suit against a collector (or former collector) or his personal representative for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected, or of any penalty claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully collected shall be treated as if the United States had been a party to such suit in applying the doctrine of res judicata in all suits instituted after June 15, 1942, in respect of any internal revenue tax, and in all proceedings in the Board and on review of decisions of the Board where the petition to the Board was filed after such date."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619343/	BOSTON SAFE DEPOSIT & TRUST CO. AND CORNELIA G. PFAFF, EXECUTORS OF THE WILL OF CHARLES PFAFF, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Boston Safe Deposit & Trust Co. v. CommissionerDocket No. 31537.United States Board of Tax Appeals21 B.T.A. 394; 1930 BTA LEXIS 1856; November 20, 1930, Promulgated 1930 BTA LEXIS 1856">1856 The decedent left certain property in trust to pay the income thereof to his widow for life, and with power in the trustee to invade the principal if necessary for the comfort and support of the widow, and thereafter to pay the remainder to certain admitted charities. Held that the possibility of the principal being invaded was so remote that the stipulated present worth of the gifts to charities had there been no such provision in the trust agreement may be deducted from the gross estate as the amount of the gifts to charity. Charles M. Rogerson, Esq., for the petitioners. Lewis S. Pendleton, Esq., for the respondent. MURDOCK 21 B.T.A. 394">394 The Commissioner determined a deficiency in estate tax of $7,114.89. The only issue is whether or not the Commissioner erred in failing to allow a deduction to represent the value of certain gifts to charities. FINDINGS OF FACT. The petitioners are the executors of the estate of Charles Pfaff. The decedent died on July 23, 1925, a resident of Boston, Mass.On July 19, 1921, Charles Pfaff created a trust of which the Boston Safe Deposit & Trust Co. was named trustee. At later dates he altered this1930 BTA LEXIS 1856">1857 trust and added to the trust property. The income was to be paid to him during his life and after his death to his wife, Cornelia H. Pfaff, for her life. The trust agreement at the time of his death provided in part as follows: (2) * * If in the opinion of the Trustee for the time being hereunder said net income [the entire net income from the trust property] shall be insufficient for her comfort and support, such Trustee may pay from time to time to her or for her benefit such sums out of the principal of the trust property as such Trustee may deem necessary for her comfort and support. If for any reason said Cornelia H. Pfaff shall desire to have paid to her or for her benefit any sum or sums out of the principal of the trust property and shall in writing request the Trustee for the time being hereunder to pay to her or for her benefit any sum or sums not exceeding in the aggregate One Hundred Thousand Dollars ($100,000) out of the principal of the trust fund, such Trustee shall pay to her, or for her benefit out of the principal of the trust fund such sum or sums not in excess, in the aggregate, of One Hundred Thousand Dollars ($100,000) which she shall request. The1930 BTA LEXIS 1856">1858 trust agreement contained other provisions which need not be set forth here in detail but which gave certain remainders after life estates to admitted charities. 21 B.T.A. 394">395 The parties have stipulated that the value of the trust property at the date of the decedent's death was $475,539.76 and "that the amount which would be deductible for charitable, public, and similar bequests if the Trust Indenture had contained no provision authorizing the trustee to pay to Cornelia H. Pfaff 'such sums out of the principal of the trust property as such trustee may deem necessary for her comfort and support' is $176,229.14 which is the sum the petitioners contend should be deducted." The value of the gross estate as determined by the Commissioner was $574,094.23. The income from the trust property for the years shown was as follows: 1922$18,565.74192321,579.58192429,444.52192529,864.091926$28,992.93192734,268.85192824,562.67The decedent had been a brewer but retired from business in 1922. He and his wife had no children. They were people who lived simply. The income from the trust was their principal means of support for several years prior1930 BTA LEXIS 1856">1859 to the death of the decedent and had proven ample for this purpose. Cornelia H. Pfaff was 55 years of age at the time her husband died. She then had some income from her separate property. Her manner of living was much the same after her husband's death as it had been before. The income from the trust was more than ample for her needs. From the income which she received after her husband's death she gave away at least $3,000 annually and still had excess income which she added to her substantial principal. She expended for her own use and pleasure $14,460 and $15,403.17 in 1927 and 1928, respectively. She never withdrew any of the $100,000 provided in the trust instrument except $12,000 to compensate the Trust Co. for settling the decedent's estate. The petitioners deducted $171,105.29 in the estate-tax return representing the value of the charitable gifts. The Commissioner disallowed this deduction, claiming that the right to invade the principal for the benefit of the life beneficiary rendered the value of the charitable gifts unascertainable. OPINION. MURDOCK: The petitioners concede that inasmuch as the wife was given the right to withdraw $100,000 out of the principal1930 BTA LEXIS 1856">1860 of the trust fund, this $100,000 must be deducted in computing the value of the gifts to charity. But they contend that the stipulated amount of $176,229.14 should be deducted as the value of the gifts to charity, because the contingency that the trustees might be required to invade the principal for the comfort and support of the widow is so remote 21 B.T.A. 394">396 that it should not be considered to defeat or even reduce the gifts to charity. In support of this contention they first point out that under Massachusetts law the discretionary power of a trustee under such circumstances may be exercised only as sound judgment may indicate in the light of all attendant conditions, with due regard for the rights of those whose interests are injuriously affected by its exercise. ; ; ; ; . Inasmuch as the decedent and his wife had both been living on the income from the trust property for several years prior to his decease, it is only reasonable to believe that after the decedent's death his1930 BTA LEXIS 1856">1861 widow would be able to live on the income from that same trust property. Furthermore, she had some independent property of her own which was substantial in amount, and which gave her considerable additional income. Under all the circumstances of the case, there was at the time of the decedent's death, only a remote possibility that in the discretion of the trustees it would be necessary to invade the principal beyond the $100,000 above mentioned for the comfort and support of the widow. This conclusion is supported by the opinion testimony of one of the officers of the Trust Co., and subsequent events show that his opinion was correct. There are a number of cases in which the principles herein involved have been fully discussed and which make further comment in this case unnecessary. These cases fully support the petitioners' contention. See ; ; ; 1930 BTA LEXIS 1856">*1862 ; ; affd., ; ; . Cf. . Judgment will be entered for the petitioners under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619345/	WINN-DIXIE STORES, INC. AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWinn-Dixie Stores v. Comm'rNo. 5382-97United States Tax Court113 T.C. 254; 1999 U.S. Tax Ct. LEXIS 47; 113 T.C. No. 21; October 19, 1999, Filed 1999 U.S. Tax Ct. LEXIS 47">47 Decision will be entered under Rule 155. P entered into a leveraged corporate-owned life insurance (COLI) program in which it purchased life insurance on approximately 36,000 of its employees and systematically borrowed against the cash value of the policies to fund the premiums. The COLI program was designed so that annual premiums, fees, and policy loan interest would exceed the projected annual death benefits and net cash value of the policies. The program was designed to generate large amounts of interest on petitioner's policy loans that petitioner intended to deduct for income tax purposes. The income tax savings from the deductions for interest and fees were projected to be substantially in excess of the projected net costs of maintaining the COLI program. In each year of operation, the COLI program projected a pretax loss and an after-tax gain.Held: P's broad-based leveraged COLI program lacked economic substance and business purpose (other than tax reduction) and is therefore a sham for tax purposes. As a result, interest on P's COLI policy loans is not deductible interest on indebtedness within the meaning of sec. 163, I.R.C. The administrative fees associated with the COLI 1999 U.S. Tax Ct. LEXIS 47">48 program are not deductible because they were incurred in furtherance of a sham. Michael J. Henke, Tegan M. Flynn, Cary D. Pugh, Thomas Crichton IV, Robert H. Cox, and Thomas P. Marinis, Jr., for petitioner.Nancy B. Herbert, Jeffrey L. Bassin, James D. Hill, and Michelle A. Missry, for respondent. Ruwe, Robert P.RUWE113 T.C. 254">254 RUWE, JUDGE: Respondent determined a deficiency of $ 1,599,176 in petitioner's Federal income tax for its tax year ending June 30, 1993. After concessions, the issue is whether deductions petitioner claimed for policy loan interest and administrative fees associated with certain of petitioner's corporate-owned life insurance (COLI) policies are deductible.113 T.C. 254">255 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulations of facts are incorporated herein by this reference. At the time the petition was filed, petitioner was a Florida corporation with its principal office in Jacksonville, Florida.Petitioner was founded in the 1920's, and its stock is publicly 1999 U.S. Tax Ct. LEXIS 47">49 traded on the New York Stock Exchange. Petitioner is a major food retailer made up of self-service food stores which sell groceries, meats, seafood, fresh produce, deli/bakery, pharmaceuticals, and general merchandise items. As of June 30, 1993, petitioner had 1,165 stores in 14 States and the Bahama Islands.Petitioner is an accrual basis taxpayer, which has adopted a 52- 53 week fiscal year ending on the last Wednesday in June. Petitioner filed a consolidated corporate Federal income tax return for its fiscal year ending June 30, 1993.As of June 30, 1993, petitioner employed approximately 36,000 full-time and 69,000 part-time employees. Since 1988, all full-time employees who completed 3 months of continuous service have been eligible for a flexible benefits program called "Winn- Flex". Under Winn-Flex, employees were furnished certain benefits that they received automatically and certain optional benefits among which they could choose. Employees automatically received life insurance and accident and sickness coverage. The optional benefits included a medical plan, dental coverage, vision coverage, supplemental associate life insurance, long-term disability and two flexible spending 1999 U.S. Tax Ct. LEXIS 47">50 accounts for health care and dependent care. Petitioner self-insured the medical and life insurance benefits under Winn-Flex while the remaining benefits were insured through third parties. The life insurance coverage provided by the company under the core Winn-Flex benefit program was in effect only while a worker was a full-time employee. Petitioner provided no postretirement benefits to its employees under Winn-Flex. 113 T.C. 254">256 Early retirees covered by the Winn-Flex plan had the option of continued coverage under a separate insurance pool not paid for by petitioner.Since 1980, petitioner has also maintained a program to provide death, disability, and retirement benefits to a limited number of full-time management level employees. This program was known as the "Management Security Program" (MSP). During the fiscal year ending in 1993, 615 of petitioner's employees were covered under the MSP. In order to provide funds for specific benefits for each manager, petitioner purchased flexible premium adjustable life insurance policies on each manager (MSP policies) from American Heritage Life Insurance Co. (AHL). The MSP policies are individual policies and not group contracts. The death benefits 1999 U.S. Tax Ct. LEXIS 47">51 under the individual MSP policies were tailored to cover petitioner's costs for preretirement deaths of the covered individual and to cover costs of postretirement benefits. Petitioner's practice of purchasing MSP policies on the lives of its managers began long before 1993.During 1992 and early 1993, Wiedemann & Johnson (WJ) and The Coventry Group (Coventry) formed a joint venture (WJ/Coventry) and approached petitioner with a proposal for the purchase by petitioner of individual excess interest life insurance policies on the lives of petitioner's employees. AIG Life Insurance Company (AIG) was to be the underwriter for the proposed policies. In a letter dated January 12, 1993, Mr. Alan Buerger, chairman of Coventry, confirmed a meeting on January 14, 1993, with Mr. Richard D. McCook, petitioner's financial vice president. Included with the letter was a memorandum from Mr. Buerger and Mr. Bruce Hlavacek, chairman and chief executive officer of WJ, proposing that petitioner purchase a "broad-based COLI pool".The memorandum provided an overview section which generally described a broad-based COLI pool as consisting of a group of corporate-owned life insurance (COLI) policies covering 1999 U.S. Tax Ct. LEXIS 47">52 a wide cross-section of a corporation's employees. Petitioner was the proposed beneficiary of the COLI policies to be written on the lives of petitioner's employees. WJ/Coventry's proposal focused on two issues raised by petitioner in a prior meeting. These two issues were described as "(i) achieving positive earnings in every year; and (ii) providing an exit if 113 T.C. 254">257 the tax laws change or Winn-Dixie's appetite for interest deductions declines."The memorandum summarized the tax aspects of leveraged COLI with the following captioned diagram:[diagram omitted]1 - Winn-Dixie makes deposits and pays loan interest to insurance carrier.2 - Winn-Dixie receives withdrawals, loans and death proceeds from the insurance carrier.3 - Winn-Dixie receives a tax deduction for loan interest paid.The memorandum next explained the difference between the proposed broad-based COLI pool and petitioner's then existing leveraged COLI program being used to fund the MSP. The memorandum stated:Winn-Dixie is familiar with leveraged COLI and particularly with the tax arbitrage created when deductible policy loan interest is paid to finance non-taxable policy gains. Winn-Dixie's existing leveraged COLI policies provide 1999 U.S. Tax Ct. LEXIS 47">53 this arbitrage and, having been purchased before passage of the 1986 Tax Reform Act, provide it beyond the $ 50,000 cap applicable to newer policies.A broad-based COLI Pool applies the same principle in ways that are effective under current law. But, where each of the existing policies was designed to fund a specific executive's benefit under the MSP, the Pool that we have illustrated would cover 38,000 employees at all levels of Winn-Dixie's workforce.With respect to obtaining the employees' consent to purchase the COLI policies on their lives, the memorandum stated:We usually recommend that a company adopt or expand employee death benefits when installing a COLI Pool. This provides an immediate and meaningful benefit for employees, and it helps to provide a logic and incentive for obtaining employees' consent to being insured. The benefit may 113 T.C. 254">258 depend on the size of the pool and the amount of the insurance purchased on each employee. A death benefit in the range of $ 5,000 to $ 15,000 is typical for the Pools presented here. After an employee leaves the company, the benefit is normally reduced or discontinued. With normal rates of retirement and attrition, only a small proportion 1999 U.S. Tax Ct. LEXIS 47">54 of the participants will receive a benefit. As a result, the cost of providing the benefit is insignificant.The memorandum also expressed an opinion on the tax issues raised by the proposed COLI pool, the legislative status of leveraged COLI, and exit strategies available to petitioner in the event that the tax laws change:What tax issues are raised by the COLI Pool?Deductibility of Interest. Because the COLI Pool involves systematic borrowing of increases in the policies' cash value, a deduction for interest to carry policy loans is allowed only if at least four of the first seven annual premiums are paid in cash. In addition, a deduction is allowed for interest on only the first $ 50,000 debt to carry policies on any one employee. The COLI Pool proposed here is designed to satisfy the 4-out-of-7 rule, and the financial illustrations take into account the $ 50,000 cap on loans for which interest deductions are allowed. * * What is the legislative status of leveraged COLI?In the past few years, Rep. Barbara Kennelly (D-Conn.) and Senator David Pryor (D-Ark.) have introduced bills that would impose new restrictions on the deductibility of interest paid on loans from COLI policies. 1999 U.S. Tax Ct. LEXIS 47">55 No bill is now pending, but it is possible that one will be introduced in the future. Kennelly/Pryor, as the last such bill was generally known, was written with the participation and support of the National Association of Life Underwriters, and, if a similar bill does become law, we do not believe the financial advantages of Winn-Dixie's COLI Pool would be seriously compromised. History suggests that specific changes in the law that would address leveraged COLI would also allow grandfathering of existing policies. Past changes, for example, imposition of the $ 50,000 loan cap, have grandfathered existing policies, and the large number of major corporations that have created COLI pools is a significant political constituency. Of course, grandfathering cannot be assumed, and we have, therefore, kept the consequences of exit very much in mind in developing strategies for Winn-Dixie.What exit strategies are available if the tax laws or Winn-Dixie's tax position changes?A COLI Pool can become a financial burden if the tax arbitrage in the program loses its attractiveness. This can occur, for example, if Winn-Dixie's marginal tax rate on interest deductions becomes low and remains low, 1999 U.S. Tax Ct. LEXIS 47">56 if Winn-Dixie becomes an alternative minimum taxpayer, or if the intended premium payment strategy becomes invalid through regulation. 113 T.C. 254">259 Likewise, Winn-Dixie's appetite for interest expense may be satisfied for reasons unrelated to deductibility. * * If it becomes necessary or useful to terminate the COLI Pool, or to discontinue further borrowing, Winn-Dixie will be able to do so without significant adverse effect. The policies can be put on a "paid-up" basis, either with the original carrier or with another carrier via a "1035" exchange, without incurring a tax liability, a negative effect on earnings, or a significant cash payment.The memorandum outlined two proposed financial strategies for structuring the purchase by petitioner of the pool of COLI policies. The first strategy was labeled "cash management". The second strategy was labeled the "zero-cash strategy" and was described as follows:Under Strategy 2, Winn-Dixie would maximize its tax arbitrage by borrowing the first three premiums and would minimize its cash investment by withdrawing accumulated policy values to pay the next four premiums. The policies used in this zero cash strategy are specially designed to minimize cash 1999 U.S. Tax Ct. LEXIS 47">57 outflows and to maximize the rate of return on investment. Thus, loads are minimal, the interest rate is high, and the loan spread is limited to 40 basis points. Because little cash is required, a higher premium can be used. We have illustrated an average premium of $ 3,000 per employee.Petitioner elected strategy 2, the zero-cash strategy.On January 25 and 27, 1993, Mr. Buerger sent revised copies 1 of the 1993 COLI proposal materials to Mr. McCook and Mr. Hlavacek. The revised 1993 COLI proposals outlined two scenarios for the amount of interest petitioner was to be charged for policy loans. Both interest scenarios were based upon the zero-cash strategy. 2 The two scenarios for the zero-cash strategy were outlined as follows:Scenario 1 - Constant Loan Interest Scenario. In this scenario, it is assumed that Winn-Dixie's appetite for interest deductions remains large, and policy interest is charged at 11.06% throughout the life of the COLI Pool. This scenario results in the largest amount of earnings possible.Scenario 2 - Reducing Loan Interest Scenario. In this scenario, Winn-Dixie's appetite for interest deductions is assumed to reduce over time. To adjust to the change in circumstances, 1999 U.S. Tax Ct. LEXIS 47">58 the interest rate under the COLI Pool policies is reduced to 8% after the fifteenth year. This scenario generates 113 T.C. 254">260 a somewhat smaller tax arbitrage, but the resulting earnings are nevertheless significant.Included in the revised proposal memorandum dated January 27, 1993, were projections of petitioner's profit and loss, cash-flow, and balance sheet balances under scenario 1, the constant loan interest rate scenario, for the years 1993 through 2052. The projections were based on the assumption that premiums paid by petitioner would be financed by policy loans in all years except years 4 through 7. In the years 4 through 7, inclusive, premiums were to be paid using funds from policy withdrawals. The constant loan interest rate (scenario 1) projections included in the January 27, 1993, memorandum are attached as appendix A.Under the constant loan interest rate scenario, the projections assumed that the interest rate paid by petitioner on policy 1999 U.S. Tax Ct. LEXIS 47">59 loans remained constant at 11.06 percent 3 for the life of the pool. Amounts to be credited to petitioner on borrowed cash value were set at 40 basis points below the 11.06 percent being charged to petitioner. 41999 U.S. Tax Ct. LEXIS 47">60 Thus, the borrowed cash value would be credited at 10.66 percent. The remaining cash value was credited at 4 percent. The January 27, 1993, memorandum explains that "A COLI Pool generally works best when the interest rate on policy loans is highest." 5 The projections under the constant loan interest rate scenario were also based on the following assumptions:Corporate tax bracket38%Population (number of insured employees)38,000Premium$ 3,000 per lifeMortality assumption100% of 1983 GAM 1Fee$ 8 per participant annuallyBased upon the above assumptions, Coventry projected that the "pretax earnings effect" of the COLI plan for the first 113 T.C. 254">261 policy year (1993) would be a loss of $ 4,605,000, 6 before adjusting for the related reduction in income taxes. This pretax loss was based on the following projected figures for the end of the first policy year: Cash surrender value (CSV) of the COLI policies of $ 119,586,000 increased by death benefits of $ 2,016,000 and reduced by annual premiums of $ 114 million, 7 accrued loan interest of $ 11,902,000, 81999 U.S. Tax Ct. LEXIS 47">61 and administration fees of $ 304,000. 9 Similar projections for the years 1994 through 2052 produced pretax losses in each year.With respect to the estimated 1993 premiums of $ 114 million, the projection indicated that petitioner would, in part, satisfy the premiums by borrowing $ 107,684,000 against cash surrender value. For 1994, the projection indicated that petitioner would partially satisfy its premium and interest payment 10 obligation by borrowing $ 113,929,000 and withdrawing $ 1,649,000 from the net cash value of the policy. For 1995, the projection indicated that a loan of $ 110,318,000 and a policy withdrawal of $ 14,731,000 would be used to pay a large portion of the premiums of $ 113,852,000 and interest payment of $ 24,486,000. Except for the next 4 years, 1996 through 1999, the projection indicated petitioner would finance a large portion of its premium and interest payments with policy loans. For years 1996 through 1999, petitioner would generally 1999 U.S. Tax Ct. LEXIS 47">62 finance its premium and interest payments through policy withdrawals. The policies' premiums were to be completely paid by 2007; therefore, no premium payments were projected for the years 2008 through 2052. However, for years 2008 through 2052, policy loans continued to be projected in amounts that were approximately between 90 percent and 95 percent of the amount of the annual loan interest payments.113 T.C. 254">262 The projection indicated that petitioner would sustain a negative "pretax earnings effect" on the COLI plan for every year the plan remained in effect. Thus, the projection for the years 1993 through 2052 indicated petitioner would incur net pretax out-of- pocket losses as follows:YearPretax loss effectYearPretax loss effectYearPretax loss effect1993$ 4,605,0002013$ 16,390,0002033$ 15,238,00019948,403,000201417,839,000203414,769,000199511,282,000201518,071,000203514,320,000199610,399,000201618,285,000203613,828,00019979,997,000201718,492,000203713,281,00019989,559,000201818,546,000203812,674,00019999,381,000201918,446,000203912,013,00020009,756,000202018,342,000204011,312,00020019,959,000202118,228,000204110,583,000200210,310,000202218,103,00020427,675,000200310,725,000202317,968,00020435,867,000200411,358,000202417,817,00020448,374,000200512,215,000202517,645,00020457,782,000200613,151,000202617,446,00020467,214,000200714,178,000202717,215,00020476,650,000200810,134,000202816,946,00020486,110,000200911,269,000202916,643,00020495,583,000201012,420,000203016,193,00020505,070,000201113,653,000203115,086,00020514,586,000201214,973,000203216,545,00020524,742,000Total pretax loss755,644,000The 1999 U.S. Tax Ct. LEXIS 47">63 projection of profit and loss also included an analysis of the effect of the COLI plan on petitioner's income tax liability in each of the years 1993 through 2052. Assuming a 38- percent corporate tax bracket, 111999 U.S. Tax Ct. LEXIS 47">64 the projected $ 11,902,000 loan interest accrued and deducted by petitioner in the first policy year (1993) resulted in a projected tax saving of $ 4,524,000. 12 A projected deduction for estimated administration fees of $ 304,000 resulted in a projected tax saving in 1993 of $ 116,000. 13 Thus, the total projected tax benefits from deductions generated by the proposed COLI plan during the first policy year was $ 4,640,000. 14 The projection compared the estimated tax benefit of $ 4,640,000 to the estimated pretax loss effect of $ 4,605,000 resulting in a positive 113 T.C. 254">263 "after-tax earnings effect" of $ 35,000. 15 The after-tax earnings effect (the excess of tax savings over net pretax costs) was projected to increase substantially in subsequent years. Coventry's projected after- tax earnings effect was as follows:YearAfter-tax earnings effectYearAfter-tax earnings effectYearAfter-tax earnings effect1993$ 35,0002013$ 60,796,0002033$ 44,780,00019941,021,000201459,009,000203443,361,00019952,770,000201558,409,000203541,789,00019963,642,000201657,797,000203640,124,00019974,033,000201757,161,000203738,369,00019984,458,000201856,647,000203836,529,00019994,624,000201956,250,000203934,601,00020009,997,000202055,819,000204032,582,000200116,143,000202155,353,000204130,479,000200222,799,000202254,846,000204230,466,000200330,108,000202354,291,000204329,291,000200437,980,000202453,683,000204423,772,000200546,477,000202553,017,000204521,361,000200655,822,000202652,289,000204618,971,000200764,479,000202751,492,000204716,655,000200868,339,000202850,620,000204814,423,000200966,998,000202949,664,000204912,313,000201065,616,000203048,730,000205010,347,000201164,127,000203148,327,00020518,529,000201262,524,000203245,233,00020526,264,000Total after-tax earnings2,246,431,000The projected total after-tax earnings of more than $ 2.2 billion were the result of total projected income tax savings of more than $ 3 billion less projected pretax net losses. The projected tax savings were attributable to the anticipated tax deductions for policy loan interest and fees. 161999 U.S. Tax Ct. LEXIS 47">65 The effect on Winn-Dixie's after- tax earnings and cash-flow was projected to be positive in each year only because of tax benefits from interest and fee deductions. Absent such tax benefits, the effect on Winn-Dixie's earnings and cash-flow would be negative in every year. 17In February 1993, Mr. McCook decided to have petitioner engage in the proposed broad-based COLI plan. On March 25, 1993, Mr. Hlavacek sent Mr. McCook another projection 113 T.C. 254">264 under the constant loan interest rate scenario estimating the effect of the proposed COLI plan. The projection estimated, among other things, the effect over 60 years beginning in 1993 of the proposed COLI purchase on petitioner's effective tax rate. The projection assumed an effective tax rate of 40 percent and predicted that the proposed COLI purchase would reduce petitioner's effective tax rate each year, reaching its lowest point of 26.54 percent in 2007.AIG participated in the development of information for projections regarding petitioner's proposed COLI plan. A preliminary census reflecting the ages of the approximately 36,000 employees to be insured was prepared 1999 U.S. Tax Ct. LEXIS 47">66 on May 28, 1993. 18 Mr. Buerger sent two more sets of revised projections to Mr. McCook. The first set of revised projections was sent on May 28, 1993, and the second was sent on June 4, 1993. Both projections were based on issuance of the proposed policies effective as of March 1993. The first set of revised projections assumed that petitioner's taxes were paid at a rate of 40 percent 19 for purposes of predicting the tax effect of the COLI purchase on petitioner's financial ratios. The second set of revised projections used a tax rate of 39 percent 20 and assumed just over 36,000 of petitioner's employees would be insured. This projection also assumed that maximum loans would be made in most years but that cash withdrawals would be made in policy years 4 through 7 and policy years 16 through 21. The June 4, 1993, projections are attached as appendix B.Using the same basic analysis that had been used in the January projections, the June 4, 1993, projections again indicated that petitioner would sustain a pretax loss and a posttax 1999 U.S. Tax Ct. LEXIS 47">67 profit on the COLI policies for every year the plan remained in effect. See appendix B. Thus, for the years 1993 through 2052, the June 4, 1993, projections indicated the broad- based COLI plan would affect petitioner's profit and loss as follows: 113 T.C. 254">265 Policy year 11999 U.S. Tax Ct. LEXIS 47">68 Pretax earnings effectTax benefit from interest deductionTax benefit from admin. fee deductionAfter-tax earnings effect 219933 ($ 4,188,000)$ 4,368,000$ 113,000=$ 292,0001994($7,885,000)8,988,000113,000=1,217,0001995(10,869,000)13,887,000113,000=3,130,0001996(9,972,000)13,856,000112,000=3,996,0001997(9,669,000)13,823,000112,000=4,266,0001998(9,366,000)13,788,000112,000=4,533,0001999(9,063,000)13,750,000111,000=4,799,0002000(9,243,000)19,159,000111,000=10,027,0002001(9,736,000)25,088,000111,000=15,462,0002002(10,013,000)31,595,000110,000=21,692,0002003(10,345,000)38,733,000110,000=28,498,0002004(10,879,000)46,551,000110,000=35,782,0002005(11,619,000)55,104,000109,000=43,595,0002006(12,428,000)64,456,000109,000=52,136,0002007(13,208,000)73,436,000108,000=60,336,0002008(9,182,000)73,039,000107,000=63,965,0002009(9,409,000)72,612,000107,000=63,310,0002010(9,651,000)72,153,000106,000=62,608,0002011(9,888,000)71,661,000105,000=61,878,0002012(10,104,000)71,134,000105,000=61,134,0002013(10,056,000)70,569,000104,000=60,616,0002014(11,085,000)70,497,000103,000=59,515,0002015(11,875,000)69,905,000102,000=58,132,0002016(12,704,000)69,181,000101,000=56,579,0002017(13,584,000)68,405,000100,000=54,921,0002018(14,384,000)67,581,00099,000=53,296,0002019(15,112,000)66,710,00098,000=51,696,0002020(15,905,000)65,789,00096,000=49,980,0002021(16,447,000)64,818,00095,000=48,467,0002022(16,336,000)63,797,00094,000=47,554,0002023(16,124,000)62,724,00092,000=46,692,0002024(15,898,000)61,599,00091,000=45,791,0002025(15,662,000)60,421,00089,000=44,848,0002026(15,417,000)59,191,00087,000=43,862,0002027(15,163,000)57,908,00085,000=42,831,0002028(14,901,000)56,573,00084,000=41,756,0002029(14,632,000)55,187,00082,000=40,637,0002030(14,352,000)53,750,00080,000=39,478,0002031(14,063,000)52,264,00078,000=38,279,0002032(13,765,000)50,732,00075,000=37,043,0002033(13,457,000)49,155,00073,000=35,771,0002034(13,141,000)47,535,00071,000=34,465,0002035(12,816,000)45,873,00069,000=33,126,0002036(12,483,000)44,172,00066,000=31,755,0002037(12,139,000)42,435,00064,000=30,360,0002038(11,784,000)40,665,00061,000=28,942,0002039(11,417,000)38,865,00059,000=27,507,0002040(11,035,000)37,040,00056,000=26,060,0002041(10,638,000)35,194,00053,000=24,609,0002042(10,223,000)33,332,00051,000=23,160,0002043(9,794,000)31,460,00048,000=21,714,0002044(9,344,000)29,583,00045,000=20,284,0002045(8,902,000)27,707,00043,000=18,847,0002046(8,455,000)25,840,00040,000=17,425,0002047(8,006,000)23,990,00037,000=16,022,0002048(7,563,000)22,167,00034,000=14,638,0002049(7,153,000)20,378,00032,000=13,256,0002050(6,739,000)18,630,00029,000=11,921,0002051(6,407,000)16,932,00027,000=10,552,0002052(6,244,000)15,292,00024,000=9,072,000(681,922,000)????=??113 T.C. 254">266 The June 4 projections indicate that without tax savings from policy loan interest and administration fee deductions, the earnings effect over 60 years would have been a negative $ 681,922,000. The tax savings over 60 years for interest and fee deductions were projected to be $ 2,696,038,000. After these tax benefits are taken into consideration, the projection indicated that petitioner would realize an after-tax profit of $ 2,014,115,000. These after-tax financial benefits were dependent on the tax savings flowing from the interest and fee deductions being generated by the broad-based COLI plan.Petitioner prepared a list of "Company Expense Reduction Opportunities" for fiscal year 1993 that listed 23 items of savings that totaled $ 329,093,000. The largest item of expense reduction on the list is "Proposed Corporate Life Insurance (COLI)". The list shows that 1999 U.S. Tax Ct. LEXIS 47">69 this item (COLI) was estimated to be implemented on June 30, 1993, and that petitioner's estimated savings from COLI was $ 300 million. Mr. McCook testified that he thought this figure was derived from the "After-Tax Earnings Effect" shown in column J of appendix A. 21AIG is a major underwriter of COLI policies. AIG had been working with WJ/Coventry in preparing the COLI plan. Mr. Qureshi of AIG was the actuary who designed and priced the COLI policies purchased by petitioner. On June 4, 1993, Mr. Larry Walters of AIG, sent a Letter of Understanding regarding the COLI policies to Mr. McCook. The Letter of Understanding provided that petitioner would remit, as consideration for the policies, a net payment of $ 7,245,000, the difference between a total premium of $ 108,573,000 and an estimated first year policy loan of $ 101,328,000. In the Letter of Understanding, AIG agreed to provide life insurance coverage in accordance with the Policy 1999 U.S. Tax Ct. LEXIS 47">70 Terms Overview. The Letter of Understanding required that the following conditions be met:1. * * [Petitioner] reviews and verifies the accuracy of the information contained on the Client Master Information Form, attached as Exhibit A. [22] * * 113 T.C. 254">267 2. * * * [Petitioner] completes and certifies the information contained on the Certification of Employee Census form, attached as Exhibit B,[231999 U.S. Tax Ct. LEXIS 47">73 ] * 3. * * [Petitioner] completes at least one Individual Life Insurance Application for each defined class of covered employees.4. The aggregate number of employees within each defined class of covered employees, on the effective date of coverage, totals at least 2,000 lives.5. The minimum annual premium for each covered employee is $ 3,000 and the maximum annual premium for each covered employee is $ 16,667.6. AIG Life determines that each defined class of covered employees identified on the attached Client Master Information Form and each employee identified on the Certification of Employee Census are acceptable for underwriting purposes and that the amounts of coverage applied for are acceptable.In addition, the Letter of Understanding required that petitioner acknowledge and agree with the 1999 U.S. Tax Ct. LEXIS 47">71 following:1. This Letter of Understanding and attached Exhibits A and B contain the entire agreement between the parties and supersedes all previous agreements entered into between Client and AIG Life, or promises made with regard to the subject matter of this letter.2. * * [Petitioner] has reviewed with its own legal and tax advisors all present and future implications of its ownership of the Policies, including, but not limited to, the tax consequences of loans and/or withdrawals from the Policies and the deductibility thereof, and that it has not relied upon any representations of AIG Life or any employee, broker, or agent of AIG Life in that regard.3. The premiums specified in the Policies are intended to meet the requirements of Section 7702 and Section 7702A of the Internal Revenue Code as in effect on the date of this letter so that the Policies will qualify as life insurance and will not be treated as modified endowment contracts. AIG Life does not warrant or represent that the Policies will not be treated as modified endowment contracts.4. The statements contained in the attached Exhibits A and B shall be considered as binding representations by the * * * [petitioner] and 1999 U.S. Tax Ct. LEXIS 47">72 that such Exhibits shall be deemed attached to and made a part of the Policies.The Letter of Understanding provided that if, within 90 days of June 4, 1993, all the above conditions had been met and 113 T.C. 254">268 AIG received the total first-year premium, then AIG would agree to issue to petitioner, in the State of Florida, the life insurance policies effective as of March 1, 1993.By invoice dated June 9, 1993, Coventry requested payment of a balance due on the 1993 COLI policies of $ 7,245,000 from petitioner. The invoice reflected a total premium of $ 108,573,000, covering 36,191 total lives at $ 3,000 of premium each, less a policy loan of $ 101,328,000 to arrive at the net amount due.On June 15, 1993, in accordance with the Letter of Understanding, AIG sent the "Policy Terms Overview" (PTO) to petitioner. The PTO provided for an effective date of March 1, 1993, and required that AIG and petitioner agree to several provisions under the insurance policies relating to the following: Claim Stabilization Reserve, Cost of Insurance Rates, Expense Caps, Surrender Fee, Interest Rate on Unborrowed Funds, and the Loan Interest Spread.The PTO generally provided that AIG would establish on behalf of petitioner a claims stabilization reserve (CSR) for the policies. Petitioner could not withdraw or borrow against the amounts credited to the CSR. The maximum level of the CSR at the end of each year was generally determined to 1999 U.S. Tax Ct. LEXIS 47">74 be the higher of the annualized "cost of insurance" 24 (COI) charges actually collected in any one of 3 preceding policy years or the highest amount of death benefits actually incurred in any one of 3 policy years. COI charges were deducted from the premium that was paid and used to fund the CSR. The CSR was generally held available by AIG to pay death claims under the COLI policies.On each policy anniversary, the PTO required AIG to compute an "Experience Cost", defined as COI charges collected from petitioner during the preceding year, less a 2-percent AIG retention fee, less the net amount for which AIG was at risk for claims during the preceding policy year. The negotiated 2- percent retention fee limited AIG's mortality-related 113 T.C. 254">269 profit. If the experience 1999 U.S. Tax Ct. LEXIS 47">75 cost as of a policy anniversary was positive, it was added to the CSR's value as of the policy anniversary. If the experience cost was negative, it was subtracted from the CSR's value. AIG credited interest to the CSR at an annual rate of 4 percent. If, on a policy anniversary, the CSR balance exceeded its maximum permissible level, the excess was credited to the unrestricted policy account value. The PTO provided that the CSR would be held by AIG on behalf of petitioner for as long as the policies remained in force plus 1 year. At the end of the 1 year, a final accounting would be made by AIG and the balance of any remaining reserve would be refunded to petitioner.Petitioner was to be charged 11.06 percent interest on amounts that it borrowed against the cash value of the policies. Pursuant to the PTO, the portion of the policy account value that was borrowed would earn interest at a rate not to exceed 40 basis points 25 or four-tenths of 1 percent below the amount charged on policy loans. Thus, the interest rate credited on the portion of the account value that had been borrowed was 10.66 percent. 26 The balance of the policy account values would earn interest at a rate guaranteed 1999 U.S. Tax Ct. LEXIS 47">76 to be no less than 4 percent.The policies provided for expense charges which would not exceed 23 percent of the premiums paid. The expense charges were comprised of premium expense charges of 17.8 percent and annual expense charges of 5.2 percent. The negotiated PTO reduced maximum expense charges from 23 percent to 8.934 percent of premiums paid.Mr. McCook approved the purchase of the 1993 COLI policies, and on June 17, 1993, Mr. McCook, on behalf of petitioner, executed the June 4, 1993, Letter of Understanding. On the same day, petitioner remitted the net amount of $ 7,245,000 to AIG as payment for the policies.The 1993 COLI policy forms were registered and approved in form and for sale by the insurance commissioner of the State of Florida. Initially, the total number of lives included, subject to eligibility, under the 1993 COLI policies was 36,191 as of June 17, 1993.113 T.C. 254">270 On June 17, 1993, petitioner paid WJ/Coventry $ 300,000 pursuant to an invoice dated 1999 U.S. Tax Ct. LEXIS 47">77 June 11, 1993. The payment was for services to be performed in year 1 of an administration agreement for the 1993 COLI policies. Also on June 17, 1993, Mr. McCook signed a Notification Certificate as a condition precedent to the sale of the COLI policies in which petitioner certified that it would notify the employees of the purchase of the COLI policies and give them an opportunity to refuse the coverage.On July 19, 1993, Mr. McCook executed the PTO. 27 Also on July 19, 1993, Mr. McCook accepted receipt of the COLI policy contract documents from AIG and authorized Coventry to retain possession of the policies on petitioner's behalf. 28 The type of coverage provided was listed as "excess interest life". The person whose life was insured under each policy was one of petitioner's employees. Petitioner was listed as the owner and beneficiary of each policy. The rights and liabilities of AIG and petitioner were governed by insurance policy forms (Policy Form), riders to the policies, the Letter of Understanding, and the PTO. The Letter 1999 U.S. Tax Ct. LEXIS 47">78 of Understanding and the PTO set forth essential elements of the agreement between petitioner and AIG and amended and tailored the COLI policies to petitioner.Policy face amounts varied with the age of each insured. Generally, petitioner's death benefits were governed by policy Option A, which provided for benefits based on the larger of the face amount plus the account value on the date of death, or the account value on the date of death multiplied by a specified percentage based on the age of the insured. 29 The applicable mortality table was the 1980 Commissioners Standard Ordinary Mortality Table B, Age Last Birthday, referred to as the CSO-B table. Under the terms of the policies, death benefits from a policy would first be used to reduce any outstanding loan.Under the terms of the policies, petitioner could withdraw part of the cash value of each COLI policy. However, a withdrawal 1999 U.S. Tax Ct. LEXIS 47">79 113 T.C. 254">271 could not exceed the "net cash value" 30 of the policy.The policies also permitted petitioner to borrow an amount that, with interest to the next policy anniversary, would not exceed the net cash value of the policy. The policies provided that at the insured's death, any policy debt will be deducted from the proceeds of that policy. The policies were the sole security for any loans. Interest on petitioner's loans was due on each policy anniversary date. The policies provided for both a fixed and variable loan interest rate.The policies were modified by a Renewable Level Term Insurance Rider. The rider provided death benefits equal to the amount of death benefits lost as a result of a withdrawal from the account value. Under the provisions of the rider, petitioner had the option on any policy anniversary date to elect to change from the 11.06-percent 1999 U.S. Tax Ct. LEXIS 47">80 policy loan interest rate to a fixed rate of 10 percent in arrears or 9.1 percent in advance which would apply to both old and new policy loans. For the 1993 COLI policy year March 1, 1993 to 1994, petitioner elected the variable loan interest rate of 11.06 percent.The final provisions governing the COLI policies purchased by petitioner in June 1993 were devised to produce results in accord with those set forth in the June 4, 1993, projections contained in appendix B.On July 19, 1993, petitioner entered into an Administrative Services Agreement with Coventry in which petitioner appointed Coventry as the administrator of the COLI pool. Under the agreement, petitioner was to pay $ 300,000 31 in each of the first 2 years and $ 200,000 annually in all subsequent policy years, and Coventry was to perform the following services in connection with the COLI policies:(a) On the basis of census information supplied by petitioner(1) Identify which of the petitioner's employees may become insured;(2) Calculate the face amounts of the policies and the first year premiums for the covered employees;113 T.C. 254">272 (3) Determine and process new insureds and process any change in the status of any insured;(4) Make 1999 U.S. Tax Ct. LEXIS 47">81 the necessary calculations with respect to premiums, loans, withdrawals, loan interest, death claims and/or any other periodic payments;(b) Provide consolidated invoice and itemization to petitioner and AIG;(c) Receive and inspect the insurance policies from AIG and forward them to petitioner;(d) Search government databases and other sources for covered deceased employees and obtain death certificates for deceased insureds;(e) Provide petitioner with ongoing advice with respect to financial options and strategies related to 1993 COLI polices; and(f) Provide petitioner with various reports including insurance value reports, year-end summaries, accounting reports and custom-designed decision-support reports.For employees who died while in petitioner's employ, petitioner filed an Employer's Statement through its plan administrator, Coventry, who would then present the claim to AIG. Coventry, as plan administrator, was responsible for ascertaining employee deaths for those employees that died while no longer in petitioner's employ.Westport Management, an organization that 1999 U.S. Tax Ct. LEXIS 47">82 performs administrative services for life insurance companies, was engaged by AIG and WJ/Coventry to administer petitioner's COLI policies. In order to ascertain deaths of former employees, Coventry would ask Westport to perform "Social Security sweeps", by checking data base files to determine whether any covered former employee had died. After the purchase of the policies and input of the COLI policy data on its computer system, Westport began its administrative duties, regularly preparing performance and accounting reports, which were provided to Coventry and AIG. On every policy anniversary, Westport calculated all values on a monthly basis for all policies for the coming year. On petitioner's behalf, Coventry administered the COLI plan, acted as an intermediary with AIG, and checked reports and other information provided by AIG and Westport to ensure correctness. Every month and on request, Coventry received reports from Westport on past and expected performance of the policies and policy loans. 113 T.C. 254">273 From these reports, Coventry generated annual and periodic policy value and other reports and journal entries showing aggregate policy activity. The Coventry reports included information 1999 U.S. Tax Ct. LEXIS 47">83 about the CSR, experience rating, cash value calculations, claims, refunds and recisions. The Coventry reports also included information about the amount of tax savings the COLI program was generating for petitioner.From 1993 through 1996, petitioner kept the employee COLI policies in force. AIG billed petitioner for premiums and interest annually on a net basis, as set forth below:June 1993, Policy year beginning March 1, 1993Premium$ 108,573,000Loan(101,328,000)Net premium1 7,245,000Policy year beginning March 1, 1994Premium$ 107,862,000.00Loan(108,877,159.95)Interest11,136,375.63Balance due10,121,215.68Policy year beginning March 1, 1995Premium$ 107,685,000.00Loan(112,165,202.89)Withdrawal(4,080,660.74)Net premium due(8,560,863.63)Interest23,140,858.57Balance due11999 U.S. Tax Ct. LEXIS 47">84 113 T.C. 254">274 114,579,994.94Policy year beginning March 1, 1996Premium$ 107,553,000.00Withdrawal(129,934,414.41)Net premium due(22,381,414.41)Interest35,497,690.97Balance due13,116,276.56COI and policy expense charges (DAC tax, State premium tax, commission and loading charges) under petitioner's COLI policies were as follows:Policy yearCost of insuranceExpense chargesTotal1993$ 3,354,561$ 3,412,447$ 6,767,00819944,641,2494,721,1309,362,37919954,890,6498,516,81713,407,46619965,173,4148,990,64214,164,056The annual amounts of cash paid by petitioner to AIG for the COLI policies, compared with the total of COI and policy expense charges for corresponding years, were as follows:Policy yearCash paid by petitionerCOI plus expense charges1993$ 7,178,860$ 6,767,008199410,121,2169,362,379199514,578,92513,407,466199613,116,27714,164,056Total$ 44,995,278$ 43,700,909For the first 4 COLI policy years, beginning March 1, 1993, AIG billed petitioner $ 431,049,000 in gross premiums and $ 69,774,925 in interest charges. Gross premiums and 1999 U.S. Tax Ct. LEXIS 47">85 interest charges totaled $ 500,823,925. Of this total amount, 113 T.C. 254">275 petitioner remitted the above-calculated $ 44,995,278 32 in cash.Following the enactment of tax law changes in 1996, petitioner commenced discussions with AIG, Coventry, and WJ concerning the phaseout or discontinuance (unwind) of the COLI policies. These discussions concerned the approximately 36,000 policies purchased by petitioner in 1993 plus approximately 11,000 and 9,000 COLI policies purchased in 1994 and 1995, respectively. On October 22, 1996, Mr. McCook sent a letter to Mr. Qureshi, vice president of AIG, which stated:Winn-Dixie has used AIG policies on three corporate owned life insurance (COLI) programs over the last several years. Because of the recent tax law changes, we have been working with Alan Buerger of the Coventry Group and Bruce Hlavacek of Wiedemann and Johnson, to try to minimize the financial impact on Winn-Dixie for the phase out of COLI.Mr. Qureshi responded to Mr. McCook's October 22, 1996, letter and acknowledged the recent change in the law with respect to the COLI policies. Mr. Qureshi also indicated that AIG would be pleased to discuss various options 1999 U.S. Tax Ct. LEXIS 47">86 available to petitioner.Coventry prepared a draft booklet dated October 30, 1996, which contained, among other things, an overview of the current status of petitioner's COLI pool, an opinion of the financial effect of the 1996 tax law change, and explanations of several exit and unwind strategies. The draft booklet indicated that petitioner had three separate enrollments covering approximately 55,740 lives. The first enrollment "WD1" was in relation to the policies written in 1993 covering 35,810 employees. The second enrollment "WD2" was in relation to the policies written on November 30, 1994, covering 10,704 employees. The third enrollment "WD3" was written on June 30, 1995, and covered 9,226 employees. With respect to the effect of the 1996 tax law changes on petitioner's COLI policies, the booklet stated in pertinent part:In August of 1996, Congress amended the Internal Revenue Code was [sic] to deny deductions for any interest on policy loans on the lives of employees, officers, and persons financially interested in a trade or business maintained by the taxpayer. The disallowance was retroactive to January 1, 1996, except that deductions may be continued through 1998 on up to 1999 U.S. Tax Ct. LEXIS 47">87 20,000 policies. The deduction on those policies, however, must be based 113 T.C. 254">276 on an interest rate no higher than Moody's average corporate bond rate, and only 90% of such interest is deductible in 1997 and 80% thereof is deductible in 1998.* * * In the aggregate, the three enrollments cover 55,740 lives with aggregate outstanding loans of about $ 500 million at interest rates averaging 11%. At a 39% tax bracket, these policies would produce tax deductions worth $ 21,450,000 per year.Under the amended law, assuming aggregate indebtedness of $ 195 million on the "best" 20,000 policies and a Moody's rate of 8% per annum, the following savings will be available:Calendar 1996$ 6,084,000Calendar 19975,475,600Calendar 19984,867,200The booklet next identified three basic exit strategies for petitioner. The three strategies were listed as the policy surrender, policy unwind, and aggressive tax strategy. The policy surrender strategy generally entailed the cancellation or surrender of the policy and the receipt by petitioner of the net cash value of the policy. The booklet recommended under this strategy that petitioner maintain the policies on 20,000 lives in fiscal years 1996 and 1997.With respect 1999 U.S. Tax Ct. LEXIS 47">88 to the policy unwind strategy, in lieu of surrendering the policies, petitioner was informed that it could keep the policies in force and allow the unrealized gains related to the policies to be paid out eventually as tax-free death benefits. The booklet further stated that in order to unwind a policy, petitioner "would withdraw a portion of the cash value equal to premiums paid (i.e., Winn-Dixie's tax basis) and apply the withdrawal to repay an equal amount of loan." The booklet indicated that the result of such a withdrawal and repayment is a policy with a greatly reduced cash value, substantially all of it borrowed.The third strategy, the aggressive tax strategy, suggested that under the revised statute, deductions were disallowed only with respect to policies on the life of an individual who was an officer or employee or was financially interested in petitioner's trade or business. The booklet further indicated that counsel for Coventry believed that a strong argument could be made that the disallowance described by the statute did not apply where the insured was a former officer or employee or was not financially interested. Based on this 113 T.C. 254">277 argument, the booklet gave an example 1999 U.S. Tax Ct. LEXIS 47">89 which assumed an additional $ 200 million of aggregate indebtedness could be attributed to petitioner's former employees upon whom policies were still maintained. As a result of the additional $ 200 million of aggregate indebtedness, the booklet concluded that the tax savings in each year would be equal to 39 percent of 11 percent of $ 200 million or $ 8,580,000, for as long as the loans remained in force.In a letter to Mr. Qureshi dated September 8, 1997, Mr. McCook indicated that in light of the passage of the legislation pertaining to leveraged COLI, petitioner was working toward a more complete understanding of the COLI policies it purchased from AIG. Finally, in letters dated December 4, 1997, Mr. McCook notified Mr. Qureshi and Mr. Buerger of petitioner's intent to cancel all three blocks of leveraged COLI policies. Mr. McCook indicated in his notice to Mr. Qureshi that petitioner wished to surrender COLI blocks I, II, and III as of November 1, October 30, and June 30, 1997, respectively.OPINIONOn its return for the fiscal year ending June 30, 1993, petitioner claimed a deduction of $ 3,735,544 for accrued interest on loans from COLI policies that petitioner purchased in 1993. 1999 U.S. Tax Ct. LEXIS 47">90 33 Petitioner also claimed a $ 100,000 deduction for administrative fees related to these COLI policies. 34 Respondent disallowed the deductions after determining that the 1993 COLI Plan was tax motivated, unsupported by any independent business purpose, and lacked economic substance. Respondent argues that the arrangement was a sham.The starting point for determining whether the form of a particular transaction will be recognized for tax purposes is 113 T.C. 254">278 the Supreme 1999 U.S. Tax Ct. LEXIS 47">91 Court's decision in Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 293 U.S. 465">469, 79 L. Ed. 596">79 L. Ed. 596, 55 S. Ct. 266">55 S. Ct. 266 (1935), wherein the Court stated: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. * * * But the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended.In Gregory, the Court denied reorganization treatment with respect to a stock distribution even though the taxpayers had followed each step required by the Code for a reorganization. In deciding that the distribution was taxable as a dividend, the Court held that the structure of the transaction was a "mere device" for the "consummation of a preconceived plan" and not a reorganization within the intent of the Code as it then existed. Id. Because the transaction lacked economic substance, as opposed to formal reality, it was not "the thing which the statute intended." Id.; see Kirchman v. Commissioner, 862 F.2d 1486">862 F.2d 1486, 862 F.2d 1486">1490-1491 (11th Cir. 1989), affg. Glass v. Commissioner, 87 T.C. 1087">87 T.C. 1087 (1986).A transaction that lacks substance is not recognized for Federal tax purposes. 1999 U.S. Tax Ct. LEXIS 47">92 See ACM Partnership v. Commissioner, 157 F.3d 231">157 F.3d 231, 157 F.3d 231">247 (3d Cir. 1998), affg. in part and revg. in part T.C. Memo 1997-115; United States v. Wexler, 31 F.3d 117">31 F.3d 117, 31 F.3d 117">122 (3d Cir. 1994). Denial of recognition means that such a transaction cannot be the basis for a deductible expense. See 31 F.3d 117">United States v. Wexler, supra at 122. Citing the Supreme Court's decision in Gregory, the Court of Appeals for the Eleventh Circuit in 862 F.2d 1486">Kirchman v. Commissioner, supra, stated the doctrine as follows:The sham transaction doctrine requires courts and the Commissioner to look beyond the form of a transaction and to determine whether its substance is of such a nature that expenses or losses incurred in connection with it are deductible under an applicable section of the Internal Revenue Code. If a transaction's form complies with the Code's requirements for deductibility, but the transaction lacks the factual or economic substance that form represents, then expenses or losses incurred in connection with the transaction are not deductible. [Id. at 1490.]Because the transactional events at issue in this case actually occurred, we limit our inquiry to the question of whether 113 T.C. 254">279 the substance of the COLI transaction 1999 U.S. Tax Ct. LEXIS 47">93 corresponds with its form. 35Section 163(a) provides that "There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness." Court opinions have clearly established that a lack of economic substance may operate to bar interest deductions arising under section 163. See Knetsch v. United States, 364 U.S. 361">364 U.S. 361, 5 L. Ed. 2d 128">5 L. Ed. 2d 128, 81 S. Ct. 132">81 S. Ct. 132 (1960); 3631 F.3d 117">United States v. Wexler, supra; Goldstein v. Commissioner, 364 F.2d 734">364 F.2d 734 (2d Cir. 1966), affg. 44 T.C. 284">44 T.C. 284 (1965). Interest payments are not deductible if they arise from transactions "that can not with reason be said to have purpose, substance, or utility apart from their anticipated tax consequences." 364 F.2d 734">Goldstein v. Commissioner, supra at 740; 1999 U.S. Tax Ct. LEXIS 47">94 see also Sheldon v. Commissioner, 94 T.C. 738">94 T.C. 738 (1990). "Such transactions are said to lack 'economic substance.'" Lee v. Commissioner, 155 F.3d 584">155 F.3d 584, 155 F.3d 584">586 (2d Cir. 1998) (quoting Jacobson v. Commissioner, 915 F.2d 832">915 F.2d 832, 915 F.2d 832">837 (2d Cir. 1990), affg. in part and revg. in part T.C. Memo 1988-341), affg. in part and remanding in part on another ground T.C. Memo 1997-172. The fact that an enforceable debt exists between the borrower and lender is not dispositive of whether interest arising from that debt is deductible under section 163. Rather, the overall transaction, of which the debt is a part, must have economic substance before interest can be deducted. See 155 F.3d 584">Lee v. Commissioner, supra at 587; 31 F.3d 117">United States v. Wexler, supra at 125. If this were not the rule, every tax shelter, no matter how transparently sham, could qualify for an interest expense deduction as long as there was a real creditor in the 1999 U.S. Tax Ct. LEXIS 47">95 transaction that demanded repayment. Such a result would be "contrary to the longstanding jurisprudence of sham shelters from Knetsch on down." Lee v. Commissioner, supra 155 F.3d 584">155 F.3d at 587.In determining whether a transaction or series of related transactions constitute a substantive sham, both this Court 113 T.C. 254">280 and a majority of the Courts of Appeals have utilized a flexible analysis that focuses on two related factors, economic substance apart from tax consequences, and business purpose. See 157 F.3d 231">ACM Partnership v. Commissioner, supra; Karr v. Commissioner, 924 F.2d 1018">924 F.2d 1018, 924 F.2d 1018">1023 (11th Cir. 1991); accord Casebeer v. Commissioner, 909 F.2d 1360">909 F.2d 1360 (9th Cir. 1990), affg. in part and revg. in part on another ground Larsen v. Commissioner, 89 T.C. 1229">89 T.C. 1229 (1987); James v. Commissioner, 899 F.2d 905">899 F.2d 905, 899 F.2d 905">908-909 (10th Cir. 1990), affg. 87 T.C. 905">87 T.C. 905 (1986); Shriver v. Commissioner, 899 F.2d 724">899 F.2d 724, 899 F.2d 724">727 (8th Cir. 1990), affg. T.C. Memo. 1987-627; Rose v. Commissioner, 868 F.2d 851">868 F.2d 851, 868 F.2d 851">854 (6th Cir. 1989), affg. 88 T.C. 386">88 T.C. 386 (1987); 862 F.2d 1486">Kirchman v. Commissioner, supra; United Parcel Serv. of Am., Inc. v. Commissioner, T.C. Memo. 1999-268. 371999 U.S. Tax Ct. LEXIS 47">96 Economic substance, in this context, is determined by objective evaluation of changes in economic position of the taxpayer (economic effects) aside from tax benefits. See 862 F.2d 1486">Kirchman v. Commissioner, supra at 1492; accord 364 U.S. 361">Knetsch v. United States, supra at 366 ("nothing of substance to be realized * * from this transaction beyond a tax deduction"); 157 F.3d 231">ACM Partnership v. Commissioner, supra at 248; 94 T.C. 738">Sheldon v. Commissioner, supra. The inquiry into whether there was a legitimate business purpose involves a subjective analysis of the taxpayer's intent. See 157 F.3d 231">ACM Partnership v. Commissioner, supra at 247; 862 F.2d 1486">Kirchman v. Commissioner, supra at 1492.We will begin with an examination of the economic substance of petitioner's 1993 COLI plan. In doing so, we focus on the COLI transaction in its entirety rather than any single step. See Kirchman v. Commissioner, supra 862 F.2d 1486">862 F.2d at 1493-1494.Petitioner's 1993 purchase of COLI on the lives of approximately 36,000 1999 U.S. Tax Ct. LEXIS 47">97 of its employees was done pursuant to an overall plan that projected costs and benefits for each year over a 60-year period. See appendixes A and B. Petitioner also recognized that circumstances might well change during that period that would cause it to modify or terminate the plan. In fact, the COLI plan was impacted by legislation in 1996, and the COLI policies were terminated in 1997. However, 113 T.C. 254">281 for the first 2 years, the COLI plan was followed and it produced results that were consistent with plan projections. 38 We will, therefore, examine the economic substance of the COLI transactions by analyzing the projections that reflect the plan.Shortly after having been approached by WJ/Coventry regarding proposals for COLI to be purchased from AIG, petitioner decided that it was interested in what was described as a "zero-cash strategy". This strategy was based 1999 U.S. Tax Ct. LEXIS 47">98 on an elaborate plan involving the purchase of life insurance on the lives of over 36,000 of petitioner's then current employees. The plan was complex and depended upon relationships between many factors, including number of lives insured, premium levels, policy expenses, rates of interest to be charged and credited, policy loans, cash surrender values, withdrawals from cash surrender values, and death benefits. Petitioner was to be the owner and beneficiary of the policies. Detailed projections were prepared to demonstrate the financial impact of the plan. The projections assumed a high rate of interest (11.06 percent) would be charged to petitioner on its policy loans. This would be countered by a high rate of interest to be credited to petitioner on the portion of the gross cash surrender value that petitioner had borrowed against. The crediting rate was 40 basis points below the rate charged to petitioner on its policy loans (10.66 percent). The rate to be credited on the unborrowed portion of the gross cash surrender value was 4 percent. Policy loans by petitioner would be used to pay most of the premiums and interest with the result that petitioner's net equity in the policies 1999 U.S. Tax Ct. LEXIS 47">99 would remain relatively small. Death benefits would be applied to reduce outstanding policy loans.The profit and loss statements in the projections illustrate the pretax effect and the after-tax effect that the COLI plan would have on petitioner. The difference between pretax and after-tax effects was based on the income tax savings that would result from deducting policy loan interest and administrative fees. Policy loan interest was clearly the dominant element. All the various projections prepared 113 T.C. 254">282 before the actual purchase of the policies in June 1993 show that the pretax effect on petitioner for each policy year was a loss and that the after-tax effect was a significant profit.The projections submitted to petitioner on June 4, 1993, were prepared just before petitioner's purchase of the COLI policies in June 1993. These projections are attached as appendix B. We shall use figures from the projections in appendix B to illustrate the COLI plan's lack of economic substance.The elements of the COLI plan and their projected impact on petitioner at the completion of the first policy year were as follows. Petitioner would make a premium payment of $ 108,573,000 and simultaneously borrow 1999 U.S. Tax Ct. LEXIS 47">100 $ 101,328,000 against the policy. This required petitioner to pay the balance of $ 7,245,000 to AIG to satisfy the premium. At the end of the policy year, interest accrued on petitioner's policy loans would be $ 11,191,000, and petitioner would also have incurred administrative fees of $ 290,000. What benefit was petitioner to get for these costs? At the end of the first policy year, the COLI policies would have net cash surrender value of $ 11,287,000. In addition, based on actuarial determinations, petitioner expected death benefits from the COLI policies in the first year to be $ 3,250,000. 39 Based on the combination of these first-year costs and benefits, the net effect of the COLI plan was a first-year loss 40 of $ 4,188,000 computed as follows:Net premium payment$ 7,245,000Interest on policy loan11,191,000Administrative fees290,00018,726,000Less:Net cash surrender value11,287,000Death benefits3,250,00014,537,000Loss1 4,189,000113 T.C. 254">283 Following the same approach, the June 1993 projections show the COLI plan producing pretax losses in the next 2 policy years of $ 7,885,000 and $ 10,869,000, respectively. Thereafter, the pretax losses over the next 57 years range from $ 6,244,000 in 1999 U.S. Tax Ct. LEXIS 47">101 the last year to $ 16,447,000 in year 2021. The total of pretax losses for the projected 60 years was $ 681,922,000. In each and every year, the combined yearly pretax benefits from the policies; i.e., the expected death benefits from the 36,000 policies plus the year-end net equity value of the policies, were substantially less than petitioner's cost of maintaining the policies.The next part of the June 1993 profit and loss projections illustrates the "tax effect" of the COLI plan. The profit and loss statement contained in the June 1993 projections shows first-year income tax savings from the COLI plan of $ 4,480,000. This amount is composed of tax savings of $ 4,368,000 attributable to a deduction of accrued first-year interest on policy loans of $ 11,191,000 and tax savings of $ 113,000 attributable to a deduction of first-year administrative fees of $ 290,000. Based on this, the projected "after- tax earnings 1999 U.S. Tax Ct. LEXIS 47">102 effect" for the first policy year was $ 292,000. 41 Similar projections for each of the following 59 years show that while the "pretax earnings effect" of the plan resulted in losses, the "after-tax earnings effect" continued to be positive in each year reaching its peak in the year 2008 when the "after-tax earnings effect" would be $ 63,965,000. This amount was arrived at by subtracting the pretax loss of $ 9,182,000 from projected income tax savings of $ 73,146,000. 42 The projected income tax savings of $ 73,146,000 were attributable to tax deductions for interest of $ 187,279,000 and administrative fees of $ 276,000. The June 1993 projections indicate that had the 1993 COLI plan remained in effect through the year 2052, petitioner's total pretax loss over 60 years would have been $ 681,922,000 but that the total tax saved because of policy loan interest and fee deductions would have exceeded $ 3 billion, resulting in a total "after-tax earnings effect" of more than $ 2 billion.The June 1993 1999 U.S. Tax Ct. LEXIS 47">103 projections contain a cash-flow analysis for each policy year from 1993 to 2052. The structure of the zero-cash 113 T.C. 254">284 strategy was intended to produce a positive after-tax cash-flow for each policy year. Thus for the first year, the plan was to produce a positive cash-flow of $ 196,000 after factoring in tax savings from deducting policy loan interest and fees. 43 Without the savings from these deductions, there would have been a negative cash-flow of over $ 4 million. The projections show increasing positive after-tax cash-flows for each of the following 59 years. Projected after-tax cumulative cash-flow for the entire 60-year period was more than $ 2 billion. Cumulative net equity at the end of each year varied, rising in some years and falling in others but, because of the policy loans and withdrawals, remained relatively small in relationship to the numbers in the overall plan. For example, cumulative net equity after 15 years was projected to be $ 498,000, whereas cumulative positive cash-flow was projected to be $ 289,263,000. See appendix B, Cash Flow. Without the tax savings from tax deductions for policy loan interest and fees, there would have been a substantial negative cash- 1999 U.S. Tax Ct. LEXIS 47">104 flow in each year, and the costs of maintaining the COLI plan would have greatly exceeded benefits.We recognize that one of the normal benefits of life insurance is the death benefit to be received if the insured dies before the insured's actuarially determined life expectancy. Thus, the predictable cost of maintaining life insurance might be greater than predictable death benefits and still be justified by the financial protection that insurance provides against the financial consequences of the unexpected death of the insured. But as 1999 U.S. Tax Ct. LEXIS 47">105 we discuss later, petitioner had no such reason or purpose for engaging in the 1993 COLI program. Petitioner suggests that the policies could conceivably produce tax-independent benefits if some catastrophe were to occur that would produce large, unexpected death benefits. We are convinced that this was so improbable as to be unrealistic and therefore had no economic significance. Indeed, petitioner makes no pretense that it purchased these policies in anticipation of, or to protect itself against, a catastrophic 113 T.C. 254">285 event. The policies were on the lives of 36,000 individual employees of various ages who lived in diverse locations. The insured employees' lives were to remain insured even after their employment was terminated. The anticipated mortality of this large group was actuarially determined, and both AIG and petitioner engaged in the COLI transactions based on these actuarial expectations. While there would obviously be some variation in the actual mortality of the insured population, such variations were not expected to significantly affect the plan. And as explained later, the function of the claims stabilization reserve was to ameliorate fluctuations in actual mortality experience.Economic 1999 U.S. Tax Ct. LEXIS 47">106 substance depends on whether, from an objective standpoint, the transaction was likely to produce economic benefits aside from tax deductions. See Kirchman v. Commissioner, 862 F.2d 1486">862 F.2d at 1492; Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543">820 F.2d 1543, 820 F.2d 1543">1549 (9th Cir. 1987), affg. T.C. Memo. 1986-23. Viewing the COLI plan as a whole, we find that the only function of the plan was to produce tax deductions in order to reduce petitioner's income tax liabilities. Without the tax deductions, the plan as designed would produce a negative cash-flow and a negative earnings effect for petitioner in each and every year the plan was in effect. Consequently, the COLI transactions lacked economic substance apart from producing tax deductions.In determining whether a transaction should be respected for tax purposes, we also look to whether the taxpayer had a business purpose for engaging in the transaction other than tax avoidance. See Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 435 U.S. 561">583-584, 55 L. Ed. 2d 550">55 L. Ed. 2d 550, 98 S. Ct. 1291">98 S. Ct. 1291 (1978); 862 F.2d 1486">Kirchman v. Commissioner, supra at 1492; 820 F.2d 1543">Bail Bonds by Marvin Nelson, Inc. v. Commissioner, supra at 1549. Petitioner argues that it had an economic objective and 1999 U.S. Tax Ct. LEXIS 47">107 valid business purposes for entering into the COLI transaction other than tax avoidance. Petitioner alleges that before entering into the 1993 COLI transaction, it had become concerned with increasing costs associated with its Winn-Flex program and that it decided to implement the COLI program as a mechanism for obtaining funds to pay such costs.Before entering into the COLI transaction, there were numerous versions of profit and loss and cash-flow projections, which were consistently formatted so that petitioner 113 T.C. 254">286 could compare the pretax earnings effect to the post-tax earnings effect. Petitioner requested multiple versions of the projections at various estimated combined Federal and State marginal tax rates in order to see what effect a change in rates would have on the proposed COLI transaction. On the other hand, petitioner produced no contemporaneously prepared documents indicating that it purchased the 1993 COLI policies in order to provide a source for funding its Winn-Flex obligations. Unlike the policies used to fund petitioner's obligations under its Management Security Program, the individual 1993 COLI policies were not tailored to fund benefits due the insured employees 1999 U.S. Tax Ct. LEXIS 47">108 under Winn- Flex. Indeed, the policies were to remain in effect after the individual employees left petitioner's employ. In planning for and setting up the COLI plan, petitioner's financial vice president and principal financial officer, Mr. McCook, never told the individuals at WJ/Coventry, who were planing the COLI transactions, about any purpose or objective to use the COLI plan to fund benefits under Winn-Flex.On brief, petitioner argues that death benefits and policy loans and withdrawals from the net cash value of COLI policies could be used to help fund Winn-Flex. However, the projections, which embody petitioner's broad-based COLI plan, show that anticipated death benefits and net cash values were going to be exhausted in order to satisfy petitioner's premiums and policy loan interest obligations. According to petitioner's COLI plan, there would be no death benefits and cash value left over to provide the necessary funding for Winn-Flex. Indeed, the COLI plan anticipated that after using available death benefits, policy loan proceeds, and withdrawals, petitioner would still be required to make annual cash payments in order to satisfy its annual premium and policy loan interest 1999 U.S. Tax Ct. LEXIS 47">109 obligations. We do not believe that petitioner purchased the COLI policies to fund Winn-Flex.In his testimony, Mr. McCook made it clear that his focus was on the bottom line, after-tax earnings impact, of the COLI plan and the resulting positive cash-flow that the tax deductions were expected to generate. Referring to the January 27, 1993, projections of profit and loss prepared by Coventry (appendix A), Mr. McCook testified that he expected that by the 15th year the annual financial benefit of the COLI transaction would offset the annual costs of petitioner's Winn-Flex 113 T.C. 254">287 obligations. According to the January 27, 1993, projection of profit and loss (appendix A), there was a pretax loss in each year of the 60 years in the projection. The pretax loss for the 15th year (2007) was $ 14,178,000, and the cumulative pretax loss for the first 15 years was $ 148,483,000. The January 27, 1993, projection of profit and loss showed a profit for the year 2007 only after considering the tax savings from the policy loan interest and fee deductions. The projected after-tax profit from the COLI plan for 2007 was $ 64,479,000. When Mr. McCook identified the amount he believed would be available to fund 1999 U.S. Tax Ct. LEXIS 47">110 the annual costs of Winn-Flex, he referred to the $ 64,479,000 amount of projected after-tax earnings from the COLI program for the year 2007. This amount was produced by loan interest and fee deductions. A tax savings generated by the COLI plan was the only reason the plan produced positive earnings and cash-flow. Indeed, petitioner's internal records show that petitioner viewed the 1993 COLI plan as an "Expense Reduction Opportunity", that would produce estimated savings of $ 300 million. 44 The only "expense" that was reduced by the COLI plan was petitioner's income tax liability.Even if we were to accept Mr. McCook's testimony that he intended 1999 U.S. Tax Ct. LEXIS 47">111 to use tax savings to fund Winn-Flex, that would not cause the COLI plan to have economic substance. 45 If this were sufficient to breathe substance into a transaction whose only purpose was to reduce taxes, every sham tax-shelter device might succeed. Petitioner's benefit from the COLI plan was dependent on the projected interest and fee deductions that would offset income from petitioner's normal operations. The possibility that such tax benefits could have been used as a general source of funds for petitioner's Winn-Flex obligations (or any other business purpose) does not alter the fact that the COLI plan itself had only one function and that was to generate tax deductions which were to be used to offset 113 T.C. 254">288 income from its business and thereby reduce petitioner's income tax liabilities in each year.Petitioner also argues that the purchase of the COLI policies permitted it to increase group life benefits offered to Winn-Flex participants. It is true 1999 U.S. Tax Ct. LEXIS 47">112 that petitioner offered an additional $ 5,000 in life insurance benefits to employees who agreed to allow petitioner to purchase COLI policies on their lives. However, this was done at the suggestion of Coventry in order to obtain the employees' consent to have their lives insured. There was no relationship between death benefits under the COLI policies and the relatively small $ 5,000 employee death benefit. All policies bore a $ 3,000 annual premium, and death benefits under the policies were based on that premium amount and the age of the employee. Also, petitioner had a high turnover among its employees, and the $ 5,000 death benefit expired when the insured's employment with petitioner ended. As a result, Coventry advised petitioner that the additional $ 5,000 in coverage could be provided at an insignificant cost. Based on the record, we do not believe that the purpose of the COLI plan was to fund employee benefits.Petitioner's COLI plan required a relatively small amount of cash investment by petitioner and charged a high rate of interest on petitioner's policy loans based on the assumption that petitioner's "appetite for interest deductions remains large". The projections showed 1999 U.S. Tax Ct. LEXIS 47">113 that the COLI plan would generate positive cash- flows and earnings only because of the tax benefit associated with the interest and fee deductions. Tax considerations permeated the planning stages of petitioner's COLI. When the broad-based COLI plan was first explained to him, Mr. McCook recognized that it was a tax shelter. Mr. McCook's primary concern was to achieve a positive cash- flow. The only way a positive cash-flow could be achieved was through the deduction of interest on policy loans. This is why petitioner concentrated on its ability to deduct loan interest and the availability of "exit strategies" in the event new legal restrictions on deductions were enacted or petitioner's "appetite" for interest deductions diminished.Following the enactment of tax law changes in August 1996, which greatly restricted employers' deductions for interest on loans from company-owned life insurance policies 113 T.C. 254">289 on the lives of employees, petitioner terminated its COLI program. See Health Insurance Portability and Accountability Act of 1996, Pub. L. 104-191, sec. 501, 110 Stat. 2090. The 1996 change in the tax law caused petitioner's COLI program to become a financial burden because it specifically 1999 U.S. Tax Ct. LEXIS 47">114 prohibited the deduction of policy loan interest under petitioner's plan. After the 1996 tax law change, none of petitioner's purported business purposes affected petitioner's decision to terminate the COLI program.Petitioner cites Campbell v. Cen-Tex, Inc., 377 F.2d 688">377 F.2d 688 (5th Cir. 1967), as controlling precedent in this case. 461999 U.S. Tax Ct. LEXIS 47">115 Petitioner's reliance on this case is misplaced. Cen-Tex was a family-owned corporation that had entered into deferred compensation arrangements, which obligated it to provide payments to the surviving spouse or lineal descendants of employee stockholders and to purchase and redeem stock of deceased stockholders. Cen-Tex decided to meet these obligations by purchasing insurance on the lives of the employee stockholders. Cen-Tex paid the first annual premium on each policy and prepaid the next four annual premiums, discounted at 3 percent, and then borrowed against the value on each of the policies at a 4-percent rate. See 377 F.2d 688">id. at 689.The court allowed deductions for interest on the policy loans.Cen-Tex, Inc. is clearly distinguishable from petitioner's case. The parties in Cen-Tex, Inc. stipulated that the insurance policies at issue were procured to assist in meeting the obligations of the taxpayer under its deferred compensation plan and its obligations under the stock option and redemption agreement, as well as for the general objective of having insurance on its key employees and stockholders. Based on this concession, the court found there was a bona fide nontax business purpose and economic objective to be served by the insurance. See id. The court also found that the transaction produced benefits other than tax benefits. The court concluded that "The policies purchased provided for a beneficial interest. The transaction was not without economic value, economic significance, economic substance, or commercial 113 T.C. 254">290 substance." 377 F.2d 688">Campbell v. Cen-Tex, Inc., supra at 692 (fn. refs. omitted).In contrast to 377 F.2d 688">Campbell v. Cen-Tex, Inc., supra, we have found that no nontax purpose was served by the COLI transactions. The projections for the COLI policies 1999 U.S. Tax Ct. LEXIS 47">116 contemplated a substantial pretax loss in each year, even after considering the projected death benefits and net cash surrender value of the policies. Only by deducting the policy loan interest and fees and reducing its income tax could petitioner anticipate any benefit from its COLI transactions. Without the tax benefits of the policy loan interest and fee deductions being generated by the COLI plan, petitioner's plan would have generated a predictable negative cash-flow and pretax loss in each of the 60 years projected. This predictable result precludes any economic value, economic significance, economic substance, or commercial substance other than the tax benefit.Based upon all the aforementioned considerations, we find that petitioner purchased the COLI policies in 1993 pursuant to a plan the only function of which was to generate interest and fee deductions in order to offset income from other sources and thereby significantly reduce its income tax liability. We hold that petitioner's 1993 broad-based COLI program lacked substance and was a sham.Petitioner argues that lack of economic substance does not warrant disallowing the interest deduction in question because deductions 1999 U.S. Tax Ct. LEXIS 47">117 for interest on life insurance policy loans were condoned by Congress as indicated by the safe harbor test of section 264 and its legislative history. Petitioner argues that the legislative history shows that Congress clearly accepted the deductibility of interest on corporate-owned life insurance products that satisfy the safe harbor tests of section 264. Petitioner maintains that because its COLI policies were life insurance contracts within the meaning of section 7702 and its pattern of borrowing from the policies satisfied the "four-of-seven test" of section 264(c)(1), its loan interest is deductible under section 163. Petitioner also argues that because Congress, through legislation in 1996, further extended its denial of deductions associated with interest payments on COLI policy loans, petitioner was not barred from taking such deductions prior to 1996.113 T.C. 254">291 Section 264(a)(3) generally provides that no deduction is allowed for amounts paid or accrued on indebtedness incurred to purchase a life insurance contract if such debt was incurred pursuant to a plan of purchase which contemplates the systematic borrowing of increases in the cash value of the insurance contract. Section 264(c)(1)1999 U.S. Tax Ct. LEXIS 47">118 provides an exception to the general rule under section 264(a)(3). Section 264(c)(1) provides that if no part of any four annual premiums due in the first 7-year period of an insurance contract is financed by means of indebtedness, then the general rule of section 264(a)(3) will not apply. 471999 U.S. Tax Ct. LEXIS 47">119 1999 U.S. Tax Ct. LEXIS 47">120 The parties refer to this exception as the "four-of-seven test". The parties agree that petitioner's COLI policies meet the requirements of the four-of-seven test. 48 The parties disagree as to whether satisfaction of the requirements of section 264(a) and (c) authorizes a deduction of the interest expenses arising out of a transaction that otherwise is without substance.An argument similar to petitioner's was made in Knetsch v. United States, 364 U.S. 361">364 U.S. 361, 5 L. Ed. 2d 128">5 L. Ed. 2d 128, 81 S. Ct. 132">81 S. Ct. 132 (1960). In Knetsch, the Court found that the taxpayer's purchase of annuity contracts and simultaneous loans from an insurance company was a sham 113 T.C. 254">292 that did not give rise to deductible interest. Nevertheless, like petitioner, the taxpayer in Knetsch contended that by enacting section 264 as part of the 1954 Code, Congress "authorized" the interest deductions for transactions prior to the effective date of the 1954 Code. See 364 U.S. 361">id. at 367. Section 264(a)(2), as enacted in 1954, denied a deduction for amounts paid on indebtedness incurred to purchase or carry a single premium annuity contract, but only as to contracts purchased after March 1, 1954, the date of enactment. See id. From this the taxpayers reasoned that Congress intended to allow interest deductions for such transactions occurring prior to March 1, 1954, regardless of their substance. The Supreme Court disagreed, concluding that unless such meaning plainly appeared from 1999 U.S. Tax Ct. LEXIS 47">121 the statute and its legislative history, the Court would not attribute such an intent to Congress, for "'To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.'" Id. (quoting Gregory v. Helvering, 293 U.S. 465">293 U.S. at 470).A taxpayer's right to a deduction for interest on an insurance policy loan is based on section 163, not section 264. Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742, 54 T.C. 742">755 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). Section 264 does not confer the right to a deduction but simply denies, disallows, or prohibits deductions that might otherwise be allowable under some other provision. See 54 T.C. 742">54 T.C. 756. Thus, while the parties agree that petitioner's COLI plan meets the "four-of-seven test" of section 264(c)(1) and would be excepted from the general disallowance rule of section 264(a)(3), section 264 does not confer a right upon petitioner to take the deduction that would not otherwise be allowable under section 163.Petitioner cites the Senate Finance Committee's report discussing the scope of section 264 prior to the 1964 amendment. The report states that "under present law, no interest deductions are denied 1999 U.S. Tax Ct. LEXIS 47">122 where the taxpayer purchases an insurance contract with the intention of borrowing the maximum amount on the contract each year". S. Rept. 830, 88th Cong., 2d Sess. (1964), 1964-1 C.B. (Part 2) 505, 581. Based on this, petitioner argues that Congress did not view the Supreme Court's decision in Knetsch as foreclosing interest deductions based on the type of sham transactions involved in this case. A similar argument was advanced in McLane v. 113 T.C. 254">293 Commissioner, 46 T.C. 140">46 T.C. 140 (1966), affd. 377 F.2d 557">377 F.2d 557 (9th Cir. 1967), where the taxpayers had engaged in a series of transactions similar to those in the instant case. In the Revenue Act of 1964, Pub. L. 88-272, sec. 215(a), 78 Stat. 55, Congress added subsection (a)(3) of section 264 to address problems associated with amounts paid or accrued on indebtedness incurred with respect to several types of insurance contracts pursuant to a plan of systematic borrowing. In McLane v. Commissioner, supra 46 T.C. 140">46 T.C. 144-145, we considered the same passage from the Senate Finance Committee report that petitioner cites and stated: Based upon the foregoing, petitioner by a tour de force concludes that: (a) The 1958 transaction herein is the type of abuse 1999 U.S. Tax Ct. LEXIS 47">123 meant to be curbed by subsection (a)(3), but only prospectively; (b) the legislative history expressly confirms his assertion that the deduction flowing from this abuse was allowable under prior law; and (c) the 'interest' involved herein is therefore deductible.We agree with petitioners that the 1958 transaction in form fell within the class of transactions at which subsection (a)(3) was aimed. But we do not agree with his assertion that the legislative history should be turned into an open-ended license applicable without regard to the substance of the transaction. Nor do we agree with the assertion that, if Knetsch and Pierce, were controlling with respect to post-1958 multiple-premium annuities, there would have been no need for further legislation in 1964. Knetsch and Pierce involved transactions without substance. Congress, in enacting section 264(a)(3), struck at transactions with substance. It is a reductio ad absurdum to reason, as petitioner does, that Congress simultaneously struck down a warm body and breathed life into petitioner's cadaver.[Fn. ref. omitted.]Petitioner attempts to supplement its argument by citing additional legislative materials related to changes or 1999 U.S. Tax Ct. LEXIS 47">124 proposed changes to section 264 in 1984, 1986, 1987, 1988, 1990, 1991, and 1996. We need not address each of the changes and proposals regarding interest deductions on life insurance policy loans. It is clear that Congress and the Treasury Department were aware of the problems associated with interest deductions on life insurance loans. However, we are not persuaded that Congress, by enacting and amending section 264 or other related provisions that restrict the deductibility of interest, intended to allow interest deductions under section 163 based on transactions that lacked either economic substance or business purpose. In Knetsch, the Supreme 113 T.C. 254">294 Court noted that nothing in the legislative history of section 264 suggests that Congress intended to protect sham transactions. Similarly, we find nothing in the more recent legislative history of section 264 suggesting that Congress intended to allow deductions arising from sham transactions that lacked economic substance and business purpose.The transactions associated with petitioner's COLI program lacked economic substance and business purpose (other than tax reduction). As a result, the interest on petitioner's COLI loans was not deductible 1999 U.S. Tax Ct. LEXIS 47">125 interest on indebtedness within the meaning of section 163. The same reasoning applies to the administrative fees associated with the COLI plan. 49 They were incurred in connection with, and were an integral part of, a sham transaction and, as a result, are not deductible. See Karr v. Commissioner, 924 F.2d 1018">924 F.2d at 1022-1023; Kirchman v. Commissioner, 862 F.2d 1486">862 F.2d 1486; Lee v. Commissioner, 155 F.3d 584">155 F.3d 584 (2d Cir. 1998). We, therefore, uphold respondent's disallowance of these deductions.Decision will be entered under Rule 155. 113 T.C. 254">295 APPENDIX ASCENARIO 1 -- CONSTANT LOAN INTEREST RATEPROFIT AND LOSS STATEMENT(dollars in thousands except earnings per share)Pre-Tax Effect(A)(B)(C)(C1)(D)(E)YearNet Annual (Premium) Annual CSV Increase/(Decrease)Accrued Loan Interest (Payment)Deductible Loan Interest (Payment)Death BenefitsAdmin. FeePre-Tax Earnings Effect A+B+C+D+E1993(114,000)119,586(11,902)(11,902)2,016(304)(4,605)1994(112,280)126,513(24,486)(24,486)2,155(304)(8,403)1995(99,121)122,492(36,661)(36,661)2,312(304)(11,282)199623,952(29)(36,633)(36,633)2,614(303)(10,399)199724,182(30)(36,602)(36,602)2,756(303)(9,997)199824,411(32)(36,570)(36,570)2,934(303)(9,559)199924,340(35)(36,535)(36,535)3,152(303)(9,381)2000(113,380)152,293(51,654)(51,654)3,287(302)(9,756)2001(113,264)168,363(68,351)(68,351)3,595(302)(9,959)2002(113,137)185,941(86,771)(86,771)3,959(302)(10,310)2003(112,997)205,253(107,079)(107,079)4,399(301)(10,725)2004(112,841)226,309(129,436)(129,436)4,911(301)(11,358)2005(112,667)249,264(154,019)(154,019)5,508(300)(12,215)2006(112,472)274,461(181,034)(181,034)6,194(300)(13,151)2007(112,253)302,091(210,699)(206,693)6,983(299)(14,178)20080213,785(231,471)(206,209)7,851(299)(10,134)20090234,409(254,176)(205,666)8,796(298)(11,269)20100257,067(278,992)(205,060)9,803(297)(12,420)20110281,888(306,108)(204,387)10,864(296)(13,653)20120309,092(335,731)(203,644)11,961(295)(14,973)20130338,897(368,084)(202,828)13,091(294)(16,390)20140371,620(403,420)(201,938)14,253(293)(17,839)20150408,917(442,145)(200,971)15,448(291)(18,071)20160449,906(484,575)(199,926)16,673(290)(18,285)20170494,902(531,044)(198,799)17,938(288)(18,492)20180544,368(581,916)(197,588)19,289(287)(18,546)20190598,625(637,563)(196,285)20,777(285)(18,446)20200657,819(698,339)(194,878)22,461(283)(18,342)20210722,246(764,590)(193,354)24,397(281)(18,228)20220792,208(836,648)(191,694)26,615(279)(18,103)20230867,928(914,804)(189,879)29,184(276)(17,968)20240949,613(999,303)(187,885)32,146(273)(17,817)202501,037,393(1,090,314)(185,684)35,546(270)(17,645)202601,131,328(1,187,917)(183,247)39,410(267)(17,446)202701,231,384(1,292,076)(180,544)43,740(263)(17,215)202801,337,543(1,402,677)(177,547)48,446(259)(16,946)202901,449,715(1,519,519)(174,238)53,415(255)(16,643)203001,567,742(1,642,320)(170,601)58,634(250)(16,193)203101,691,227(1,770,698)(166,634)64,628(244)(15,086)203201,819,004(1,904,072)(162,337)68,762(238)(16,545)203301,953,020(2,041,845)(157,710)73,819(232)(15,238)203402,089,112(2,182,737)(152,749)79,081(225)(14,769)203502,226,401(2,325,080)(147,440)84,576(217)(14,320)203602,362,737(2,466,685)(141,768)90,329(209)(13,828)203702,495,443(2,604,815)(135,720)96,292(201)(13,281)203802,621,661(2,736,378)(129,288)102,236(192)(12,674)203902,738,347(2,858,051)(122,486)107,873(182)(12,013)204002,842,259(2,966,346)(115,340)112,947(172)(11,312)204102,930,135(3,057,756)(107,898)117,200(162)(10,583)204202,998,802(3,128,893)(100,220)122,567(151)(7,675)204303,033,490(3,175,595)(92,381)136,378(139)(5,867)204403,035,085(3,194,629)(84,469)151,298(128)(8,374)204503,010,969(3,184,372)(76,577)165,738(116)(7,782)204602,957,486(3,143,787)(68,803)179,192(105)(7,214)204702,873,589(3,071,784)(61,234)191,639(94)(6,650)204802,760,378(2,968,747)(53,949)202,343(83)(6,110)204902,619,159(2,835,702)(47,020)211,032(73)(5,583)205002,451,775(2,674,269)(40,506)217,487(63)(5,070)205102,261,733(2,487,427)(34,457)221,162(54)(4,586)205202,102,864(2,284,848)(28,917)177,288(46)(4,742)All 1999 U.S. Tax Ct. LEXIS 47">126 figures are estimates. Actual results will depend upon mortality, interest rates and dividends.[table continued]113 T.C. 254">296 Tax Effect(G)(H)(I)(J)(K)YearPolicy Loan Tax CreditAdmin. Fee Tax CreditTax Effect G+HAfter-Tax Earnings EffectAfter-Tax Earnings Per Share 119934,5241164,640350.0019949,3081159,4231,0210.01199513,93611514,0522,7700.04199613,92611514,0413,6420.05199713,91511514,0304,0330.05199813,90311514,0184,4580.06199913,89011514,0054,6240.06200019,63911519,7539,9970.13200125,98811526,10316,1430.21200232,99411533,10822,7990.30200340,71811540,83330,1080.39200449,22411449,33837,9800.50200558,57811458,69246,4770.61200668,86011468,97455,8220.73200778,54311478,65764,4790.84200878,35911378,47368,3390.89200978,15311378,26666,9980.87201077,92311378,03665,6160.86201177,66711377,78064,1270.84201277,38511277,49762,5240.82201377,07511277,18660,7960.79201476,73611176,84859,009201576,36911176,48058,409201675,97211076,08257,797201775,54411075,65357,1610.75201875,08410975,19256,6470.74201974,58810874,69656,2500.73202074,05410874,16155,8190.73202173,47410773,58155,3530.72202272,84410672,95054,8460.72202372,15410572,25954,2910.71202471,39610471,50053,6830.70202570,56010370,66253,0170.69202669,63410169,73552,2890.68202768,60710068,70751,4920.67202867,4689867,56750,6200.66202966,2109766,30749,6640.65203064,8299564,92348,7300.64203163,3219363,41448,3270.63203261,6889061,77845,2330.59203359,9308860,01844,7800.58203458,0448558,13043,3610.57203556,0278356,11041,7890.55203653,8728053,95240,1240.52203751,5747651,65038,3690.50203849,1307349,20336,5290.48203946,5456946,61434,6010.45204043,8296543,89532,5820.43204141,0016141,06330,4790.40204238,0845738,14130,4660.40204335,1055335,15829,291204432,0984932,14723,772204529,0994429,14321,361204626,1454026,18518,9710.25204723,2693623,30516,6550.22204820,5013220,53214,4230.19204917,8682817,89512,3130.16205015,3922415,41610,3470.14205113,0942113,1148,5290.11205210,9881711,0066,2640.08All 1999 U.S. Tax Ct. LEXIS 47">127 figures are estimates. Actual results will depend upon mortality, interest rates and dividends.113 T.C. 254">297 SCENARIO 1 -- CONSTANT LOAN INTEREST RATECASH FLOW DETAIL(dollars in thousands)Corporate Cash Outflow(A)(B)(C)YearPremiumLoan InterestAfter-Tax Admin. Fee1993(114,000)0(188)1994(113,929)(11,902)(188)1995(113,852)(24,486)(188)1996(113,771)(36,661)(188)1997(113,681)(36,633)(188)1998(113,588)(36,602)(188)1999(113,488)(36,570)(188)2000(113,380)(36,535)(187)2001(113,264)(51,654)(187)2002(113,137)(68,351)(187)2003(112,997)(86,771)(187)2004(112,841)(107,079)(187)2005(112,667)(129,436)(186)2006(112,472)(154,019)(186)2007(112,253)(181,034)(186)20080(210,699)(185)20090(231,471)(185)20100(254,176)(184)20110(278,992)(184)20120(306,108)(183)20130(335,731)(182)20140(368,084)(182)20150(403,420)(181)20160(442,145)(180)20170(484,575)(179)20180(531,044)(178)20190(581,916)(177)20200(637,563)(175)20210(698,339)(174)20220(764,590)(173)20230(836,648)(171)20240(914,804)(169)20250(999,303)(168)20260(1,090,314)(166)20270(1,187,917)(163)20280(1,292,076)(161)20290(1,402,677)(158)20300(1,519,519)(155)20310(1,642,320)(151)20320(1,770,698)(148)20330(1,904,072)(144)20340(2,041,845)(139)20350(2,182,737)(135)20360(2,325,080)(130)20370(2,466,685)(125)20380(2,604,815)(119)20390(2,736,378)(113)20400(2,858,051)(107)20410(2,966,346)(100)20420(3,057,756)(93)20430(3,128,893)(86)20440(3,175,595)(79)20450(3,194,629)(72)20460(3,184,372)(65)20470(3,143,787)(58)20480(3,071,784)(52)20490(2,968,747)(45)20500(2,835,702)(39)20510(2,674,269)(34)20520(2,487,427)(28)All 1999 U.S. Tax Ct. LEXIS 47">128 figures are estimates. Actual results will depend upon mortality, interest rates and dividends.[table continued]Corporate Cash Inflow(D)(E)(F)(G)YearPolicy Loan Tax SavingsPolicy LoanPolicy WithdrawalTax-Free Death Benefits19934,524107,68402,01619949,308113,9291,6492,155199513,936110,31814,7312,312199613,9260137,7222,614199713,9150137,8642,756199813,9030137,9992,934199913,8900137,8283,152200019,639137,17503,287200125,988151,66603,595200232,994167,52103,959200340,718184,94604,399200449,224203,95204,911200558,578224,68105,508200668,860247,44606,194200778,543272,42506,983200878,359193,01307,851200978,153211,70408,796201077,923232,25009,803201177,667254,772010,864201277,385279,469011,961201377,075306,543013,091201476,736336,285014,253201576,369370,192015,448201675,972407,477016,673201775,544448,433017,938201875,084493,496019,289201974,588542,978020,777202074,054597,043022,461202173,474655,995024,397202272,844720,151026,615202372,154789,772029,184202471,396865,114032,146202570,560946,382025,546202669,6341,033,725039,410202768,6071,127,225043,740202867,4681,226,943048,446202966,2101,332,873053,415203064,8291,444,941058,634203163,3211,562,850064,628203261,6881,685,629068,762203359,9301,815,248073,819203458,0441,948,220079,081203556,0272,084,057084,576203653,8722,221,133090,329203751,5742,357,313096,292203849,1302,490,0970102,236203946,5452,616,6740107,873204043,8292,733,9640112,947204141,0012,838,7250117,200204238,0842,927,6650122,567204335,1052,986,7880136,378204432,0983,016,0510151,298204529,0993,021,2260165,738204626,1452,998,0710179,192204723,2692,945,5920191,639204820,5012,863,4150202,343204917,8682,752,2050211,032205015,3922,613,2080217,487205113,0942,448,5750221,162205210,9882,305,4430177,288All 1999 U.S. Tax Ct. LEXIS 47">129 figures are estimates. Actual results will depend upon mortality, interest rates and dividends.[table continued]113 T.C. 254">298 Net Cash Flow (H, I, & J) & Surplus (K)(H)(I)(J)(K)YearNet Cash FlowCumulative Cash FlowCumulative Cash Flow at 4.35% Pre-Tax Cumulative Net Equity 119933535(53)7819941,0211,05683817819952,7703,8263,48523719963,6427,4687,09533719974,03311,50111,20133119984,45815,95915,85417519994,62420,58320,79913320009,99730,58031,316242200116,14346,72348,339266200222,79969,52272,556295200330,10899,630104,822327200437,980137,610145,922367200546,477184,087196,723414200655,822239,910258,345466200764,479304,388330,377524200868,339372,728408,310519200966,998439,725486,960575201065,616505,341566,303635201164,127569,468646,249700201262,524631,992726,695769201360,796692,788807,528201459,009751,797888,697201558,409810,205971,429201657,797868,0021,055,756920201757,161925,1631,141,696950201856,647981,8101,229,415978201956,2501,038,0601,319,0821,005202055,8191,093,8801,410,7131,035202155,3531,149,2331,504,3201,069202254,8461,204,0801,599,9121,107202354,2911,258,3711,697,4891,151202453,6831,312,0541,797,0471,201202553,0171,365,0711,898,5741,258202652,2891,417,3602,002,0541,322202751,4921,468,8512,107,4651,393202850,6201,519,4722,214,7781,469202949,6641,569,1352,323,9561,548203048,7301,617,8662,435,0711,508203148,3271,666,1932,548,711685203245,2331,711,4262,662,2081,729203344,7801,756,2072,778,2601,858203443,3611,799,5682,895,9411,933203541,7891,841,3573,015,1382,010203640,1241,881,4813,135,7942,089203738,3691,919,8503,257,8562,168203836,5291,956,3793,381,2772,243203934,6011,990,9803,506,0082,309204032,5822,023,5623,632,0012,362204130,4792,054,0413,759,2182,397204230,4662,084,5073,889,822169204329,2912,113,7994,022,599204423,7722,137,5714,153,131204521,3612,158,9324,284,556204618,9712,177,9034,416,931(4,341)204716,6552,194,5584,550,372(4,598)204814,4232,208,9804,685,016(4,796)204912,3132,221,2934,821,045(4,928)205010,3472,231,6394,958,675(4,991)20518,5292,240,1685,098,134(4,975)20526,2642,246,4325,239,658(4,941)All 1999 U.S. Tax Ct. LEXIS 47">130 figures are estimates. Actual results will depend upon mortality, interest rates and dividends.113 T.C. 254">299 SCENARIO 1 - CONSTANT LOAN INTEREST RATEBALANCE SHEET SUMMARY(dollars in thousands)(A)(B1)(B2)(B)YearCash AmountGross Cash Surrender ValueOutstanding (Loan)Insurance Net Cash Surrender Value199335119,596(107,616)11,98019941,056246,061(221,396)24,66519953,826368,374(331,476)36,89819967,468368,186(331,216)36,970199711,501367,876(330,943)36,933199815,959367,397(330,652)36,745199920,583367,008(330,339)36,669200030,580518,930(467,034)51,896200146,723686,622(618,005)68,618200269,522871,619(784,552)87,066200399,6301,075,569(968,163)107,4062004137,6101,300,113(1,170,310)129,8032005184,0871,547,013(1,392,580)154,4332006239,9101,818,331(1,636,831)181,4992007304,3882,116,279(1,905,056)211,2232008372,7282,324,858(2,092,868)231,9902009439,7252,552,907(2,298,156)254,7512010505,3412,802,162(2,522,535)279,6282011569,4683,074,513(2,767,705)306,8082012631,9923,372,040(3,035,541)336,5002013692,7883,696,994(3,328,067)368,9272014751,7974,051,835(3,647,555)404,2802015810,2054,440,729(3,997,694)443,0352016868,0024,866,820(4,381,326)485,4952017925,1635,333,474(4,801,480)531,9932018981,8105,844,342(5,261,448)582,89420191,038,0606,403,152(5,764,585)638,56820201,093,8807,013,474(6,314,100)699,37420211,149,2337,678,773(6,913,114)765,65920221,204,0808,402,381(7,564,627)837,75420231,258,3719,187,244(8,271,289)915,95520241,312,05410,035,794(9,035,290)1,000,50420251,365,07110,949,751(9,858,179)1,091,57220261,417,36011,929,899(10,740,660)1,189,23920271,468,85112,975,894(11,682,425)1,293,46920281,519,47214,086,579(12,682,433)1,404,14620291,569,13515,259,936(13,738,869)1,521,06720301,617,86616,493,017(14,849,189)1,643,82820311,666,19317,781,309(16,009,926)1,771,38220321,711,42619,121,648(17,215,847)1,905,80120331,756,20720,505,234(18,461,532)2,043,70320341,799,56821,920,085(19,735,415)2,184,67020351,841,35723,349,517(21,022,427)2,327,09120361,881,48124,771,530(22,302,756)2,468,77420371,919,85026,158,656(23,551,673)2,606,98320381,956,37927,479,838(24,741,217)2,738,62220391,990,98028,701,693(25,841,333)2,860,36020402,023,56229,789,198(26,820,490)2,968,70820412,054,04130,707,139(27,646,985)3,060,15420422,084,50731,419,234(28,290,172)3,129,06120432,113,79931,884,697(28,712,437)3,172,26020442,137,57132,075,465(28,884,537)3,190,92820452,158,93231,972,124(28,791,793)3,180,33120462,177,90331,564,289(28,424,843)3,139,44620472,194,55830,841,004(27,773,818)3,067,18620482,208,98029,806,151(26,842,200)2,963,95120492,221,29328,470,031(25,639,258)2,830,77320502,231,63926,848,924(24,179,646)2,669,27720512,240,16824,972,749(22,490,297)2,482,45120522,246,43222,930,156(20,650,250)2,279,906All 1999 U.S. Tax Ct. LEXIS 47">131 figures are estimates. Actual results will depend upon mortality, interest rates and dividends.113 T.C. 254">300 [table continued](C)(D)(E)YearAccrued Loan InterestRetained Earnings Gain/(Loss)Annual Impact on Earnings199311,902113113199424,4861,2341,121199536,6614,0632,828199636,6337,8053,743199736,60211,8314,026199836,57016,1344,303199936,53520,7174,582200051,65430,82210,106200168,35146,99016,168200286,77169,81722,8272003107,07999,95730,1402004129,436137,97738,0192005154,019184,50146,5242006181,034240,37555,8752007210,699304,91264,5372008231,471373,24768,3342009254,176440,30067,0542010278,992505,97765,6762011306,108570,168 64,1922012335,731632,76162,5932013368,084693,63160,8702014403,420752,65759,0262015442,145811,09658,4382016484,575868,92257,8262017531,044926,11357,1912018581,916982,78856,6752019637,5631,039,06556,2772020698,3391,094,91555,8492021764,5901,150,30255,3872022836,6481,205,18654,8852023914,8041,259,52254,3352024999,3031,313,25553,73320251,090,3141,366,32953,07420261,187,9171,418,68252,35320271,292,0761,470,24451,56320281,402,6771,520,94150,69620291,519,5191,570,68449,74320301,642,3201,619,37348,69020311,770,6981,666,87847,50420321,904,0721,713,15546,27720332,041,8451,758,06444,90920342,182,7371,801,50143,43720352,325,0801,843,36841,86720362,466,6851,883,57040,20220372,604,8151,922,01838,4482038 2,736,3781,958,62336,60420392,858,0511,993,28934,66720402,966,3462,025,92432,63520413,057,7562,056,43930,51420423,128,8932,084,67628,23820433,175,5952,110,46325,78720443,194,6292,133,87023,40620453,184,3722,154,89121,02220463,143,7872,173,56218,67120473,071,7842,189,95916,39820482,968,7472,204,18514,22520492,835,7022,216,36512,18020502,674,2692,226,64810,28420512,487,4272,235,1938,54520522,284,8482,241,4916,298All 1999 U.S. Tax Ct. LEXIS 47">132 figures are estimates. Actual results will depend upon mortality, interest rates and dividends.113 T.C. 254">301 APPENDIX BSCENARIO 1 - CONSTANT LOAN INTEREST RATE - MARCH ISSUE[see tables in original]Footnotes1. The above-quoted sections of the proposal remained substantially the same in each of the revised copies of the proposal.↩2. The Jan. 27, 1993, revised proposal assumed a pool covering 38,000 employees with an average premium of $ 3,000 per employee.↩3. The 11.06-percent rate was based on Moody's Baa rate from November 1992, which was 8.96 percent. Coventry converted it to an arrears rate and added 1 percent to reach 11.06 percent.↩4. This is referred to as "loan spread". The Jan. 27, 1993, memorandum explains: "An effective COLI Pool should have a small 'spread' between the interest rate charged on policy loans and the amounts credited to borrowed cash values."5. The rate in effect for the MSP policies was 8.41 percent.↩1. The mortality assumption "GAM" was not defined in the proposal. Ultimately, petitioner and AIG agreed upon using the 1980 Commissioners Standard Ordinary Mortality Table B to estimate mortality.↩6. See appendix A.↩7. This amount is arrived at using the assumed premium per employee of $ 3,000 times the assumed 38,000 employees for a total of $ 114 million.↩8. This amount is the interest due from petitioner as calculated by Coventry on a projected first-year policy loan taken by petitioner in the amount of $ 107,684,000. Annual interest of 11.06 percent on $ 107,684,000 is actually $ 11,909,850.9. Using these figures the calculation is: $ 119,586,000 + $ 2,016,000 + ($ 114,000,000) + ($ 11,902,000)+ ($ 304,000) = ($ 4,604,000). The $ 1,000 variance between this calculation and the pretax loss of $ 4,605,000 in appendix A appears to be attributable to rounding of the components of the calculation.↩10. The projection indicated that petitioner would actually pay the estimated $ 11,902,000 of interest due on the 1993 loan of $ 107,684,000 in 1994. Interest accumulated on policy loans was payable in arrears.↩11. The corporate tax rate on all projections was an estimated combined Federal and State marginal tax rates.12. A deduction of $ 11,902,000 times an assumed tax rate of 38 percent actually results in a tax benefit of $ 4,522,760. But see supra note 8.↩13. For instance, a deduction of $ 304,000 times an assumed tax rate of 38 percent results in a tax benefit of $ 115,520.↩14. Thus, $ 4,524,000 + $ 116,000 = $ 4,640,000.↩15. For instance, a reduction in earnings due to amounts paid of $ 4,605,000 can be offset by a reduction in taxes of $ 4,640,000 for an overall after-tax earnings increase of $ 35,000.↩16. Projected interest and fees over a 60-year period totaled $ 77,476,680,000 and $ 14,326,000, respectively.17. Similarly, the proposal memorandum projected the effect of the COLI purchase on petitioner's after-tax retained earnings balance on its balance sheet over 60 years. The proposal predicted that petitioner's retained earnings balance would increase by $ 2,241,491,000 over the 60 years.↩18. Before the preliminary census, the projections were based on estimates of the number of employees and their ages.↩19. See supra note 11.↩20. See supra note 11.↩1. Policy years are from Mar. 1 to the end of February.2. In some instances the figures in this column vary from the sum of their components by $ 1,000. This appears to be due to rounding off, and any variances appear to be insignificant.↩3. Based on the underlying figures from which this amount was computed, the figure should be $ 4,189,000.↩21. Three hundred million dollars is the approximate total of the annual "After-Tax Earnings" projected for the policy years 1993 through 2007. The total projected After-Tax Earnings for the years 1993 through 2052 is $ 2,246,431,000. See appendix A.↩22. Exhibit A, Client Master Information Form, listed petitioner's name as the name to appear on the policy and as the owner of the policy. Petitioner's main address was listed as the billing address, and Mr. McCook was named as the contact. The policy name was listed as "Excess Interest Life Ins.", and the effective date was listed as Mar. 1, 1993.↩23. Exhibit B, Certification of Employee Census, generally required that petitioner, as part of the application for coverage under the policies, certify that employee information on the census was correct. Among other things, petitioner certified that each individual on the census was a full-time (minimum 30 hours per week) employee, at least 18 years of age, no older than age 75, not absent from work for more than 10 consecutive business days within the 90 days preceding the date of certification, and that petitioner notify and obtain consent from each employee on the census that insurance is to be issued on his or her life.24. "Cost of Insurance" was defined in the policy document. The COI was calculated on each monthly processing date. Generally, the COI was calculated under the following formula:COI =(Proceeds - Account Value)x(Value from Table of Maximum Insurance Rates)1,000Proceeds were defined as the benefits due to petitioner as the beneficiary. Account Value on the policy date was defined as the initial net premium less an annual expense charge.↩25. Each basis point equals one one-hundredth of a percent (0.01 percent). Thus, 40 basis points is equivalent to 0.40 percent.↩26. The 10.66 percent figure is arrived at by reducing the loan interest rate of 11.06 percent by 0.40 percent.↩27. Mr. Walters of AIG signed the PTO on July 15, 1993.↩28. The contracts were listed on the delivery receipt as being policy Nos. 5003000001 through 5003035983.↩29. Some of the death benefits were paid under Option B, which was calculated to include the account value in the face amount, and the insurance proceeds were determined to be the larger of the face amount on the date of death, or the account value on the date of death multiplied by a specified percentage.↩30. The net cash value of the policy was defined as the cash value less any prior withdrawals and any policy debt. The cash value was defined as the greater of the Guaranteed Cash Value, or the Account Value less the surrender charge that applies. The Guaranteed Cash Value was determined by a Table of Guaranteed Values provided with the policy.↩31. Petitioner deducted $ 100,000 of the $ 300,000 on its income tax return for the fiscal period ending June 30, 1993.↩1. A revised invoice was sent on Sept. 21, 1993, which reflected a reduction in insureds from 36,191 to 35,983 due to a recision of 208 policies. Thus, the calculation was as follows:Premium$ 107,949,000.00Loan(100,770,140.06)Net premium7,178,859.94Less amount paid(7,245,000.00)↩Balance owed petitioner66,140.061. Policy year beginning Mar. 1, 1995, was revised at least twice. The final revision resulted in the following:Premium$ 107,685,000.00Loan(112,112,913.04)Withdrawal(4,134,020.12)Net premium due(8,561,933.16)Interest23,140,858.57Balance14,578,925.41Amount paid14,579,994.94↩Net refund due1,069.5332. See preceding table for cash total.↩33. This was approximately one-third of the total policy loan interest that would accrue during the first policy year that began Mar. 1, 1993, and ended Feb. 28, 1994. The $ 3,735,544 was interest attributable to the period Mar. 1 through June 30, 1993. We note that petitioner deducted interest on these "loans" for the period Mar. 1 through June 30, 1993, even though the COLI policies and policy loans were not finalized until mid-June 1993. Respondent argues that interest cannot accrue for a period prior to the time the loan was actually made. Because of our disposition, we need not address this issue.↩34. This was one-third of the $ 300,000 administrative fee for the first policy year that began Mar. 1, 1993, and ended Feb. 28, 1994.↩35. In Kirchman v. Commissioner, 862 F.2d 1486">862 F.2d 1486, 862 F.2d 1486">1492 (11th Cir. 1989), affg. Glass v. Commissioner, 87 T.C. 1087">87 T.C. 1087 (1986), the court observed:Courts have recognized two basic types of sham transactions. Shams in fact are transactions that never occur. In such shams, taxpayers claim deductions for transactions that have been created on paper but which never took place. Shams in substance are transactions that actually occurred but which lack the substance their form represents. * ↩36. In Knetsch v. United States, 364 U.S. 361">364 U.S. 361, 5 L. Ed. 2d 128">5 L. Ed. 2d 128, 81 S. Ct. 132">81 S. Ct. 132 (1960), the Court applied sec. 163(a) of the 1954 Code. The language of sec. 163(a) of the 1954 Code remained unchanged in the 1986 Code. See sec. 163(a); see also United States v. Wexler, 31 F.3d 117">31 F.3d 117, 31 F.3d 117">123↩ (3d Cir. 1994).37. In certain situations courts have held that a transaction that lacks economic substance, other than the production of a tax benefit, is a substantive sham regardless of the motive of the taxpayer. See 364 U.S. 361">Knetsch v. United States, supra at 365; Dewees v. Commissioner, 870 F.2d 21">870 F.2d 21, 870 F.2d 21">35 (1st Cir. 1989); 862 F.2d 1486">Kirchman v. Commissioner, supra at 1492↩.38. The instant case involves deductions for accrued interest and fees in the first plan year. The first year of the COLI insurance began on Mar. 1, 1993, and ended on Feb. 28, 1994. The deductions in issue were based on an allocation of the interest and fees that had accrued during petitioner's taxable year ended June 30, 1993.↩39. Under the terms of the policies, death benefits from a policy would first be used to reduce any outstanding loan.↩40. The projections refer to the loss as negative pretax earnings.↩1. The June 1993 projection shows $ 4,188,000. This is apparently due to rounding or a math error.↩41. The above figures were taken from the June 1993 projections reflected in appendix B. The totals vary by $ 1,000, apparently due to rounding off the last three digits.↩42. See supra note 41.↩43. In addition, the plan would result in petitioner's having a cumulative net equity in the COLI policies at the end of the first policy year of $ 96,000. Cumulative net equity was the gross surrender value of the policies minus outstanding policy loans and accrued policy loan interest. Gross cash surrender value of $ 112,471,000 minus the sum of the outstanding loan of $ 101,184,000 and accrued loan interest of $ 11,191,000 equals $ 96,000. See appendix B, Balance Sheet Summary. The combination of cumulative net equity and positive cash-flow equals the projected positive after-tax earnings effect of $ 292,000. $ 96,000 plus $ 196,000 equals $ 292,000.↩44. When Mr. McCook was asked how the $ 300 million was derived, he testified that he thought that it was the total of the "After-tax Savings" figures listed in the Jan. 27, 1993, projections. These Jan. 27, 1993, projections are contained in appendix A, Profit and Loss Statement. The after-tax earnings referred to by Mr. McCook are in column J. The total after-tax earnings for the policy years 1993 through 2007 are slightly more than $ 300 million. The total projected after-tax earnings for the years 1993 through 2052 are more than $ 2 billion.↩45. We note that none of these tax savings were earmarked for funding Winn-Flex. They were simply projected to reduce petitioner's tax liabilities and thereby increase petitioner's after-tax profits by more than $ 2 billion over 60 years.↩46. Petitioner's case is appealable to the Court of Appeals for the Eleventh Circuit. Decisions of the Court of Appeals for the Fifth Circuit that were handed down prior to Sept. 30, 1981, are generally binding as precedent in the Eleventh Circuit. Bonner v. City of Prichard, 661 F.2d 1206">661 F.2d 1206↩ (11th Cir. 1981).47. In pertinent part, sec. 264(a) provides:SEC. 264(a) General Rule. -- No deduction shall be allowed for -- * * (3) Except as provided in subsection (c), any amount paid or accrued on indebtedness incurred or continued to purchase or carry a life insurance, endowment, or annuity contract (other than a single premium contract or a contract treated as a single premium contract) pursuant to a plan of purchase which contemplates the systematic direct or indirect borrowing of part or all of the increases in the cash value of such contract (either from the insurer or otherwise).* * * (c) Exceptions. -- Subsection (a)(3) shall not apply to any amount paid or accrued by a person during a taxable year on indebtedness incurred or continued as part of a plan referred to in subsection (a)(3) --(1) if no part of 4 of the annual premiums due during the 7-year period (beginning with the date the first premium on the contract to which such plan relates was paid) is paid under such plan by means of indebtedness,(2) if the total of the amounts paid or accrued by such person during such taxable year for which (without regard to this paragraph) no deduction would be allowable by reason of subsection (a)(3) does not exceed $ 100,(3) if such amount was paid or accrued on indebtedness incurred because of an unforeseen substantial loss of income or unforeseen substantial increase in his financial obligations, or(4) if such indebtedness was incurred in connection with his trade or business.For purposes of applying paragraph (1), if there is a substantial increase in the premiums on a contract, a new 7-year period described in such paragraph with respect to such contract shall commence on the date the first such increased premium is paid.48. The parties also agree that petitioner's COLI policies meet the definition of a life insurance contract for purposes of sec. 7702↩.49. Respondent argues that the administrative fees should be disallowed pursuant to sec. 265. Because we have held that the administrative fees must be disallowed as the product of a sham, we have no need to consider disallowance under sec. 265↩.. Total annual premium less annual withdrawal.↩. Based on 76.6 million shares outstanding.↩1. Blank space indicates that there was no legible figure in underlying exhibit.↩. Assumes deaths occur midyear.↩1. Blank space indicates that there was no legible figure in underlying exhibit.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619347/	PAUL S. WALDEN and MARIE C. WALDEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWalden v. CommissionerDocket No. 46097-86.United States Tax CourtT.C. Memo 1988-98; 1988 Tax Ct. Memo LEXIS 130; 55 T.C.M. 332; T.C.M. (RIA) 88098; March 7, 1988. John H. Birkeland, for the petitioners. Linda J. Wise, for the respondent. COUVILLIONMEMORANDUM OPINION COUVILLION, Special Trial Judge: This case was considered pursuant to the provisions of section 7456(d) (redesignated as section 7443A(b) by section 1556 of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2755) and Rule 180 et seq. 1Respondent determined a deficiency of $ 45,917 in petitioners' Federal income tax1988 Tax Ct. Memo LEXIS 130">131 for the year 1980. Respondent has before the Court a motion for partial summary judgment under Rule 121 with respect to whether petitioners are entitled to deductions attributable to a minimum annual royalty by a partnership, Virginia Partners, Ltd. (VPL) in which petitioners had an interest. 2Petitioners were residents of Wheatridge, Colorado, at the time they filed their petition. VPL was organized as a limited partnership on December 4, 1978. Paul S. Walden (petitioner) was a limited partner in VPL. 3 Pursuant to a contract which had been entered into earlier, VPL, on April 20, 1979, entered into a sublease (lease) to mine and market, as sublessee, all of the mineable and merchantable coal underlying some 8,000 acres of land in Lee County, Virginia, and Harlan County, Kentucky. In addition, VPL purchased from the sublessors two corporations, the assets of which included coal mining equipment. The lease was for a primary term of 20 years, unless in the sole judgment of VPL the economically recoverable coal was exhausted sooner, in which event the lease was terminable. The1988 Tax Ct. Memo LEXIS 130">132 lease could be extended beyond 20 years, on a year-to-year basis, at VPL's election, until such time as all merchantable coal had been extracted from the properties; however, such extensions could not go beyond the primary terms of the underlying leases affecting the coal property, which terms were 40 years with renewal terms of 40 years. Under the lease, VPL was obligated to pay its lessors a production royalty of four percent (4%) of the gross sales price, f.o.b. mine, per 2,000 pounds of coal mined and sold from the coal properties. VPL was also obligated to pay additional production royalties due on the underlying leases of 75 cents ($ .75) per 2,000 pounds of coal mined and sold from the leased premises. 4 Irrespective of production, VPL was obligated to pay advanced royalties, annually, subject to credits from production. These advanced royalty obligations were payable in cash and promissory notes as follows: For the first1988 Tax Ct. Memo LEXIS 130">133 year (1979), cash of $ 240,000 and a recourse (personal liability) note of $ 8,100,200; for the second year (1980), cash of $ 120,000 payable at the rate of $ 10,000 per month during the year 1979, and a recourse (personal liability) note of $ 8,220,200 to be executed by VPL on or before the 1980 anniversary date of the lease; for the third year (1981), $ 120,000 cash, payable $ 10,000 per month beginning one month after the first annual anniversary date of the lease, and a nonrecourse note of $ 8,220,200; and for all subsequent years, a nonrecourse note of $ 8,340,200 to be executed before each annual anniversary date of the lease. 5All of the notes were payable 20 years after date, subject to prior production payments; however, each note could be extended, at the option of either the payee or the maker, for an additional 10 years. Other than the payments due from production, no other cash payments were required1988 Tax Ct. Memo LEXIS 130">134 on the notes prior to maturity. Each note provided that no principal payments were due until all earlier executed notes had been paid in full. The notes bore interest at six percent (6%) per annum, from maturity. All of the notes were secured by the coal reserves underlying the leased properties. As a condition of his admission as a limited partner in VPL, petitioner was required, as part of his capital contribution, (as were all limited partners) to assume personal liability for his ratable share of the two recourse notes of $ 8,100,200 and $ 8,220,200 executed by VPL, to its lessors under the lease for the first two advanced royalties. On its partnership information return for 1980, VPL deducted $ 8,340,200 as advanced minimum royalties for that year. Respondent disallowed the deduction, contending that the amount claimed did not constitute a deductible advanced royalty within the minimum royalty provision of section 1.612-3(b)(3), Income Tax Regs.6Under Rule1988 Tax Ct. Memo LEXIS 130">135 121, summary judgment may be granted "if the pleadings, answers to interrogatories, depositions, admissions, and any 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). Partial summary judgment may also be granted. Rule 121(b). The moving party bears the burden of proving there is no genuine issue of material fact. Jacklin v. Commissioner,79 T.C. 340">79 T.C. 340, 79 T.C. 340">344 (1982); Espinoza v. Commissioner,78 T.C. 412">78 T.C. 412, 78 T.C. 412">416 (1982). The party opposing a properly supported motion cannot rest upon the mere allegations or denials in his pleadings, but must "set forth specific facts showing that there is a genuine issue for trial." Rule 121(d). The standard for granting a motion for summary judgment requires that there be no genuine issue of material fact. A material fact is one that is both relevant to an element of a claim or defense and that might affect the outcome of a lawsuit. The substantive law governing a claim or defense determines the materiality of a fact. Entry of summary judgment is not precluded by disputes1988 Tax Ct. Memo LEXIS 130">136 over irrelevant or immaterial facts. Anderson v. Liberty Lobby, Inc.,477 U.S. 242">477 U.S. 242, 106 S. Ct. 2505, 2510 (1986); T.W. Elec. Service v. Pacific Elec. Contractors,809 F.2d 626">809 F.2d 626, 809 F.2d 626">630 (9th Cir. 1987). In determining if a genuine issue of material fact exists, all facts and inferences must be viewed in the light most favorable to the party opposing the motion. Anderson v. Liberty Lobby, Inc.,106 S.Ct. at 2513; 79 T.C. 340">Jacklin v. Commissioner, supra, at 344; 78 T.C. 412">Espinoza v. Commissioner, supra at 416. A genuine dispute over a material fact precluding the grant of summary judgment exists "if the evidence is such that a * * * [judge or] jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., supra at 2510. Summary judgment may be granted if the nonmoving party's evidence is "merely colorable * * * or is not significantly probative." Anderson v. Liberty Lobby, Inc., supra at 2511 (citations omitted). Section 1.612-3(b)(3), Income Tax Regs., sets forth the rules for deductibility of advance royalties. Generally, an advance royalty is deductible only1988 Tax Ct. Memo LEXIS 130">137 in the year the mineral product, for which the royalty is paid, is sold. Section 1.612-3(b)(3), Income Tax Regs. When the advance royalty is paid or accrued "as a result of a minimum royalty provision," an exception to the general rule is provided by the regulation and the advance royalty may be deducted in the year the royalty is paid or accrued even though no mineral product has been sold. Section 1.612-3(b)(3), Income Tax Regs.For purposes of the regulation, a minimum royalty provision requires that a substantially uniform amount of royalties be paid at least annually either over the life of the lease or for a period of at least 20 years, in the absence of mineral production requiring payment of aggregate royalties in a greater amount. * Section 1.612-3(b)(3), Income Tax Regs. The regulation is valid. Redhouse v. Commissioner,728 F.2d 1249">728 F.2d 1249 (9th Cir. 1984), affg. 79 T.C. 355">79 T.C. 355 (1982), cert. denied 469 U.S. 1034">469 U.S. 1034 (1984); Wing v. Commissioner,81 T.C. 17">81 T.C. 17 (1983). To the extent, therefore, that no coal was sold during the year in question, the royalty for such year is deductible only if the royalty was paid1988 Tax Ct. Memo LEXIS 130">138 pursuant to a minimum royalty provision within the meaning of section 1.612-3(b)(3), Income Tax Regs.7A valid minimum royalty provision must contain a requirement that a substantially uniform amount of royalties be paid at least annually over the term of the lease, or for a period of at least 20 years, to satisfy the regulation. Capek v. Commissioner,86 T.C. 14">86 T.C. 14, 86 T.C. 14">41 (1986); Vastola v. Commissioner,84 T.C. 969">84 T.C. 969 (1985); 81 T.C. 17">Wing v. Commissioner, supra. A minimum royalty provision does not satisfy the regulation if the provision permits the deferral of royalty payments. There must be an enforceable obligation to make a royalty payment1988 Tax Ct. Memo LEXIS 130">139 each year. Oneal v. Commissioner,84 T.C. 1235">84 T.C. 1235, 84 T.C. 1235">1241 (1985); 84 T.C. 969">Vastola v. Commissioner, supra at 975-976; 81 T.C. 17">Wing v. Commissioner, supra at 38 n.30. This Court has previously determined in several cases what constitutes a "minimum royalty provision" under section 1.612-3(b)(3), Income Tax Regs. See, e.g., 86 T.C. 14">Capek v. Commissioner, supra;81 T.C. 17">Wing v. Commissioner, supra. In Capek, it was held that in order to qualify as a minimum royalty under section 1.612-3(b)(3), Income Tax Regs., the lease must require the payment of a substantially uniform amount of royalties at least annually. 86 T.C. 14">86 T.C. 41. In other words, the lease cannot permit the deferral of payment of the minimum annual royalty or relegate its payment to production. There must be an enforceable obligation to make a substantially uniform payment each year. 81 T.C. 17">Oneal v. Commissioner, supra at 41. The fact that the value of the property securing payment of the royalty obligation is sufficient to assure the ultimate payment of the obligation is irrelevant under section 1.612-3(b)(3), Income Tax Regs.86 T.C. 14">Capek v. Commissioner, supra;1988 Tax Ct. Memo LEXIS 130">140 84 T.C. 969">Vastola v. Commissioner, supra;81 T.C. 17">Wing v. Commissioner, supra.In light of these pronouncements, two considerations stand out in the evaluation of respondent's motion: Were the advanced royalty obligations by VPL "substantially uniform" and, if so, were such obligations "paid at least annually?" Two of the notes (including the note for the year in question) were full recourse obligations, while the remaining notes were nonrecourse obligations. While this difference, standing alone, might not be sufficient to conclude that the advanced royalty obligations were not "substantially uniform," 8 this Court held in 81 T.C. 17">Wing v. Commissioner, supra at 41, that, where a lease allows payment of an advanced royalty which may include nonrecourse notes, the obligation is not an advanced minimum royalty, unless there is required annual payments in a substantially uniform amount. Additionally, this Court held in Wing that, in determining substantial uniformity, the terms of the entire agreement must be considered. Furthermore, when an advanced royalty includes a nonrecourse note, the payment of which is contingent on mineral production from1988 Tax Ct. Memo LEXIS 130">141 the property which is the subject of the lease, the nonrecourse note will not constitute a deductible advanced royalty payment. 84 T.C. 969">Vastola v. Commissioner, supra;Maddrix v. Commissioner,83 T.C. 613">83 T.C. 613 (1984), affd. 780 F.2d 946">780 F.2d 946 (11th Cir. 1986). The cash payments during the terms of the lease in this case differed: Cash was required only for the first three years and no cash was required thereafter. None of the notes required payments other than from production. Most significantly, for our purposes here, no payments were due on any note (even if there was production) unless all earlier executed notes were paid in full. From the above, the Court finds and concludes that the advanced royalty obligations of VPL were not "substantially uniform" and were not1988 Tax Ct. Memo LEXIS 130">142 "paid at least annually." In effect, payment of the notes was contingent and deferred to the production and sale of coal. Thus, in the absence of production, there was no retirement for an "annual" payment. 9 The regulations in question and the judicial interpretations thereof require that payments must not be contingent, but rather must be independent of sales of the mineral involved and, moreover, such payments must be made annually. 1988 Tax Ct. Memo LEXIS 130">*143 Therefore, with respect to the loss claimed by petitioners on their 180 return from VPL, such loss is not allowed to the extent such loss is attributable to an advanced mineral royalty obligation of VPL under section 1.612-3(b)(3), Income Tax Regs. We find no genuine issue of material fact on this question. Respondent's motion for partial summary judgment is granted. To the extent coal was mined and sold during 1980, petitioners may be entitled to their ratable share of the partnership's allowable deduction of royalties attributable to minerals (coal) actually sold. This opinion does not address that question as the same will be determined on trial of this case on its merits. This opinion is limited to the question whether the royalty obligation at issue qualified under a minimum royalty provision as envisioned by section 1.612-3(b)(3), Income Tax Regs., and, to that extent, it is the Court's finding and ruling that such obligation did not qualify. To reflect the foregoing, An appropriate order will be issued.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. All Rule references are to the Tax Court Rules of Practice and Procedure. ↩2. The only other adjustment to petitioners' 1980 return has been agreed to by the parties. ↩3. The date of his admission into VPL is not clear from the record; however, the date is immaterial for our purposes here, since petitioners, in their objection to respondent's motion, admitted petitioner was a partner in VPL for the year at issue. ↩4. A separate consideration was agreed to for the two corporations purchased by VPL. ↩5. For purposes of the motion for partial summary judgment, respondent agrees that, for the year in question, the cash was paid and the note for that year was in fact recourse. ↩6. On their 1980 income tax return, petitioners claimed $ 81,657 as their distributive share of the total loss reported by VPL for 1980. Respondent disallowed the entire $ 81,657 in the notice of deficiency. ↩7. For 1980, VPL reported gross sales of $ 1,472,655, which the Court assumes, for purposes of the motion, included sale of coal. The effect which such sales may have had on petitioners' entitlement to a deduction for 1980 is addressed in the latter part of this opinion. This opinion addresses solely the question whether the advanced royalty qualified as a deductible advance minimum royalty under section 1.612-3(b)(3), Income Tax Regs.↩, to the extent such royalty exceeded the amount of coal sold. 8. See Poster v. Commissioner,T.C. Memo. 1988-57↩, filed February 18, 1988, where the first two advanced royalty notes were recourse, and the six succeeding notes were nonrecourse. Under the facts of that case, the Court held the advanced royalties were not deductible pursuant to a minimum royalty provision, even for the year in which the recourse note was executed. 9. We note that, since the note for the year in question was "recourse" and, therefore, petitioner was personally liable for VPL's obligation on the note, this Court, in Heitzman v. Commissioner,T.C. Memo. 1987-109, rejected the argument that assumption of a personal liability or execution of a recourse note, payable after the end of the year in question, complied with the requirements of section 1.612-3(b)(3), Income Tax Regs.: In reaching our conclusion we have considered but cannot adopt petitioners' argument that since the Stonehurst partners were personally liable for the minimum royalties, the sublease in effect provided for guaranteed minimum royalties and thus satisfied the regulation. In support of this contention, petitioners point to Vastola, where we noted by way of dictum that an accrual basis taxpayer could make a strong argument that the regulation should be interpreted to include a provision requiring the payment of royalties with the execution of recourse promissory notes. 84 T.C. 969">84 T.C. 979. However, any weight attributable to this dictum was removed by our subsequent decision in Capek, where the provision at issue permitted the payment of the minimum royalty with a recourse note payable after the end of the taxable year. Applying the same principles discussed above, we concluded that "Even assuming that petitioners would eventually pay the notes, payment after the close of the taxable year does not satisfy the requirement of the regulation that the royalties be paid at least annually over the term of the lease." 86 T.C. 14">86 T.C. 47. [53 T.C.M. 241↩, 245, 56 P-H Memo T.C. par. 87, 109 at 87-566.]	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619348/	Joseph J. Vidmar v. Commissioner.Vidmar v. CommissionerDocket No. 35043.United States Tax Court1952 Tax Ct. Memo LEXIS 115; 11 T.C.M. 854; T.C.M. (RIA) 52248; August 5, 1952William A. Vidmar, Esq., 1005 Hippodrome Bldg., Cleveland, Ohio, for the petitioner. Charles Speed Gray, Esq., for the respondent. VAN FOSSAN Memorandum Opinion VAN FOSSAN, Judge: Respondent determined a deficiency of $157.14 in petitioner's income tax for 1947. Petitioner alleges error as to three items. In the first item, petitioner claims that in computing his opening inventory for a newly-established liquor business he is entitled to take up the sum1952 Tax Ct. Memo LEXIS 115">116 of $500 on account of 10 cases of "off brands" of liquor which he personally had on hand from a previous business venture. Such liquor was kept in his cellar at home and transferred to his new business as needed. He claims the liquor was reasonably worth $50 per case. Respondent refused to allow the $500 worth of liquor as part of petitioner's opening inventory. Although the proof is somewhat scanty, we are satisfied that respondent erred in such determination. The record reasonably establishes that the facts were as alleged by petitioner. Accordingly, on this item we reverse the respondent's action. Petitioner next claimed a loss of $462.50 incurred in connection with the acquisition of a new automobile. Petitioner had a 1938 Cadillac automobile, purchased in 1944 for $1,800. In 1947 he acquired a new Cadillac at a stated cost of $4,150. In negotiating the purchase and sale, petitioner turned in the old car and was allowed $275 on account thereof, paying the balance in cash. Petitioner claims that the purchase of a new automobile and the disposition of the old automobile were two separate transactions. The record does not support him. The old car was turned in as part payment on1952 Tax Ct. Memo LEXIS 115">117 the new car. It had a depreciated cost of $1,200. The difference between this figure and $275 allowed as credit is $925. Petitioner charged half of this sum to personal use and claimed the other half ($462.50) as a loss attributable to business. Under the provisions of Section 112 (b) (1), I.R.C. and Regulations 111, Sec. 29.112(b) (1)-1, no gain or loss is allowable on account of such an exchange. See National Outdoor Advertising Bureau, Inc., 32 B.T.A. 1025">32 B.T.A. 1025, at 32 B.T.A. 1025">1035, where the precise question is presented on comparable facts. Respondent is sustained. The third issue poses the question whether a taxpayer who filed a timely return for 1947 in which he elected to take the standard deduction provided by section 23 (aa), I.R.C., may revoke this election by an amended return filed after the due date and claim a specific deduction for interest paid. The statute, as amended by the Revenue Act of 1944, is specific and provides in section 23 (aa) (3) (C) "If the taxpayer does not signify, * * * his election to take the standard deduction, it shall not be allowed. If he does so signify, such election shall be irrevocable." In his1952 Tax Ct. Memo LEXIS 115">*118 return for 1947, filed March 15, 1948, petitioner elected to take the standard deduction. On January 17, 1949, petitioner filed an amended return claiming a specific deduction for interest paid. Respondent held that petitioner, having made the election of the standard deduction, could not change such election. Such was the law at that time. Petitioner argues that the law has since been changed by the Revenue Act of 1951 and that it is inequitable to apply the statute as it stood in 1947. The Act itself answers this argument by providing that the amendments shall apply only with respect to taxable years beginning after December 31, 1949. On this item respondent is sustained. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619349/	GIDEON-ANDERSON CO., SUCCESSOR TO GIDEON-ANDERSON LUMBER & MERCANTILE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Gideon-Anderson Co. v. CommissionerDocket No. 22365.United States Board of Tax Appeals18 B.T.A. 329; 1929 BTA LEXIS 2077; November 22, 1929, Promulgated 1929 BTA LEXIS 2077">2077 Chase Morsey, Esq., and Harry Friedman, Esq., for the petitioner. H. Leroy Jones, Esq., for the respondent. MURDOCK 18 B.T.A. 329">329 OPINION. MURDOCK: As the result of a motion filed on July 8, 1929, by the petitioner in the above entitled case, a hearing was held on July 24, 1929, on the question of whether or not the Board has jurisdiction in this case. Certain documents were offered in evidence as joint exhibits of both parties in this proceeding and thereafter briefs were filed. On November 9, 1926, the Commissioner mailed a deficiency notice to "Gideon-Anderson Lumber and Mercantile Company, Gideon, Mo.," notifying it of deficiencies in its income and profits taxes for the calendar years 1917 and 1918 and of an overassessment for the year 1919. Thereafter, a petition was filed under the heading "The Gideon-Anderson Company, Successor to the Gideon-Anderson Lumber and Mercantile Company, Petitioner." This petition is verified by W. P. Anderson, who states that he is the president of the Gideon-Anderson Co. and that the Gideon-Anderson Lumber & Mercantile Co. was merged into the Gideon-Anderson Co. on January 1, 1922. On December 31, 1921, the1929 BTA LEXIS 2077">2078 Gideon-Anderson Lumber & Mercantile Co., then a corporation of the State of Missouri, and three other corporations of the State of Missouri in a similar line of business, after proper action by their respective stockholders and boards of directors, entered into an agreement of "Amalgamation and Incorporation" for the consolidation of all four under the laws of Missouri, into a consolidated corporation to be called "The Gideon-Anderson Company." On January 24, 1922, the Secretary of State of the State of Missouri issued a certificate of consolidation stating that, whereas these four corporations had complied with the law governing the consolidation of manufacturing and business companies, the said corporations were duly consolidated under the name of Gideon-Anderson Co., located at Gideon, Mo., and entitled to all the rights and privileges granted to manufacturing and business corporations under the laws of the State for a term of 50 years from the date of the certificate. 18 B.T.A. 329">330 Our question is to determine whether under the provisions of section 283(a) and section 274(a) of the Revenue Act of 1926, we have any jurisdiction to entertain the proceeding which the petitioner1929 BTA LEXIS 2077">2079 has sought to institute by the filing of its petition. In any case before this Board it is incumbent upon the petitioner to allege sufficient facts to show that we have jurisdiction and, of course, if at any stage of the proceedings it appears that we do not have jurisdiction, an order of dismissal should be entered. The respondent ent can take such action to protect his interests as he may deem necessary. He has several courses open to him. For instance, in the present case, even if he did not know the details of the succession, he could have moved for dismissal or for more adequate pleading of jurisdictional facts. The petitioner has not alleged sufficient facts to show that we have jurisdiction and on this ground alone dismissal would be proper. But we will consider such facts as are now before us. If we have jurisdiction, it is because the petitioner comes within the meaning of the word "taxpayer" as used in section 274(a) which is in part as follows: If in the case of any taxpayer the Commissioner determines that there is a deficiency in respect of the tax imposed by this title, the Commissioner is authorized to send notice of such deficiency to the taxpayer by registered1929 BTA LEXIS 2077">2080 mail. Within 60 days after such notice is mailed * * * the taxpayer may file a petition with the Board of Tax Appeals for a redetermination of the deficiency. * * * We must look to the laws of Missouri for the effect of the consolidation. But corporations exist for specific purposes, and only by legislative act, so that if the life of the corporation is to continue even only for litigating purposes, it is necessary that there should be some statutory authority for the prolongation. The matter is really not procedural or controlled by the rules of the court in which the litigation pends. It concerns the fundamental law of the corporation enacted by the State which brought the corporation into being [Section 10165 of the Revised Statutes of Missouri, 1919, under which the four corporations were consolidated, provides as follows: Any two corporations now existing under general or special laws * * * whose objects and business are in general of the same nature, may amalgamate, unite and consolidate said corporations and form one consolidated corporation, hold and enjoy all the rights, privileges, powers, franchises1929 BTA LEXIS 2077">2081 and property belonging to each, and under such corporate name as they may adopt or agree upon; * . Provided that no such consolidation shall in any manner affect or impair the rights of any creditors of either of said corporations * . Our attention has not been called to any case decided in the court of last resort of the State of Missouri, which is directly in point on 18 B.T.A. 329">331 the question of whether or not the consolidating companies, under this act, are dissolved and a new consolidated company incorporated. We have been able to find no such case. Two lower court cases are cited, which are not very helpful, although the one, ; , contains the statement that where two or more business companies are consolidated under section 1334, the constituent corporations become dissolved or extinguished, and that the amalgamated corporation is a new corporation, but that touching the business of the old corporations, and as to their respective debtors and cerditors, the consolidated company is to be regarded as continuation of the old companies under a new name. In the other case, 1929 BTA LEXIS 2077">2082 ; , the court held that a proceeding instituted against one of the consolidating corporations before the consolidation, could be prosecuted without bringing in the new consolidated corporation. It is not clear in the statute itself whether the legislature intended that a new corporation was to come into being and the old corporations were to be dissolved. The Supreme Court of the United States has said that if a statute contains no words of grant of corporate powers to the consolidated corporations, then the old corporations must be continued in existence. See , and cases there cited. This Missouri statute, however, contains words of grant of power. It provides that the one consolidated corporation shall "hold and enjoy all the rights, privileges, powers, franchises and property belonging to each" of the old corporations. These words, although they do not set out in detail the powers of the consolidated corporation, constitute nevertheless, a very clear grant of corporate powers. If these words had been omitted from the act, then no one could1929 BTA LEXIS 2077">2083 have said what powers the consolidated corporation was to have and the rule laid down by the Supreme Court would apply. In our opinion, the consolidating corporations under this Missouri law are dissolved and a new corporation comes into being, which new corporation is not the same corporation as any one of the consolidating corporations. This is the general rule in case of a consolidation where the statute does not specifically provide what is to happen in this regard. Fletcher Cyclopedia Corporations, vol. 7, § 4700 et seq.; Cook on Corporations, 8th ed., vol. 5, § 897; Thompson on Corporations, 3rd ed., § 6012 et seq; Corpus Juris, vol. 14(a) p. 1067. Also cf. State ex rel. Houck v. Lesueur, 145 No. 322; ; ; affd. ; . 18 B.T.A. 329">332 We have heretofore fully considered the effect of the dissolution of a corporation in Missouri upon the right to institute proceedings before this Board. See 1929 BTA LEXIS 2077">2084 S. Hirsch Distilling co.,. The petitioner in this case is not the taxpayer, and, this being so, we have no jurisdiction to entertain the proceeding (cf. ; ; ; ; ; ; ; ). Reviewed by the Board. Order of dismissal will be entered accordingly.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619372/	Benedetto Romano, Petitioner v. Commissioner of Internal Revenue, RespondentRomano v. CommissionerDocket No. 621-85United States Tax Court101 T.C. 530; 1993 U.S. Tax Ct. LEXIS 78; 101 T.C. No. 35; December 13, 1993, Filed 78 An appropriate order will be issued. On Nov. 17, 1983, U.S. Customs agents seized $ 359,500 in cash from P as he and his wife were attempting to enter Canada from the United States. On the same day, R made a termination assessment against P under sec. 6851, I.R.C. On Oct. 11, 1984, after P failed to file an income tax return, R mailed P a notice of deficiency for P's 1983 taxable year, which P timely petitioned to this Court on Jan. 9, 1985. The proceedings in this Court were stayed pending a criminal tax evasion charge being prosecuted against P and a forfeiture proceeding against the seized funds. R brought suit in U.S. District Court to reduce the termination assessment to judgment, obtaining summary judgment against P. P appealed to the U.S. Court of Appeals for the Second Circuit, which affirmed the District Court. In the instant case, R contends that the District Court judgment is res judicata which prevents P from contesting his 1983 tax liability in the instant case. Held, the District Court judgment is not res judicata in the instant case. Murray Appleman, for petitioner.Catherine Chastanet, for respondent. Wells, Judge. WELLS531 OPINION79 WELLS, Judge: The instant case is before us on respondent's motion for summary judgment 1 and motion to impose damages under section 6673. Respondent determined a deficiency in petitioner's Federal income tax as follows:Additions to taxYearDeficiencySec. 6653(a)(1)Sec. 6653(a)(2)1983$ 191,895.19$ 9,594.761Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.At the time he filed the petition in the instant case, petitioner resided in New York, New York. On November 17, 1983, as petitioner 80 and his wife were attempting to enter Canada from the United States, U.S. Customs agents discovered and seized $ 359,500 in U.S. currency from petitioner.On the same day, upon being informed of the seizure, respondent issued a termination assessment against petitioner for $ 169,981. On October 11, 1984, after petitioner 532 failed to file a Federal income tax return for his 1983 taxable year, respondent issued petitioner a statutory notice of deficiency for petitioner's 1983 taxable year, encompassing the 1983 calendar year through December 31, 1983. Respondent's motion states that the statutory notice erroneously refers to a "jeopardy assessment" instead of a "termination assessment". Such assessment is hereinafter referred to as the termination assessment. The notice of deficiency included as income the amount calculated under the termination assessment and estimated amounts for wages and salary, interest income, and cost of living. Respondent's motion states that, if res judicata applies in the instant case, then respondent concedes that the estimated wages and salary, interest income, and cost of living items determined in the notice of deficiency are not includable81 in petitioner's gross income for his 1983 taxable year.On January 9, 1985, petitioner filed his petition in the instant case. Subsequently, proceedings were held in abeyance pending a criminal tax evasion charge that was being prosecuted against petitioner and the forfeiture proceeding described below, seeking forfeiture of the $ 359,500 in seized funds.Meanwhile, during November 1989, when the statute of limitations on assessment and collection of the 1983 termination assessment was about to expire, the United States filed a suit in the U.S. District Court for the Eastern District of New York seeking to reduce the termination assessment to judgment pursuant to section 7402(a). On December 19, 1990, the District Court granted summary judgment in favor of the United States in the amount of $ 169,981 plus statutory interest, as allowed by law, for taxes owed pursuant to the termination assessment.Petitioner appealed the District Court judgment to the U.S. Court of Appeals for the Second Circuit on the ground that the District Court lacked subject matter jurisdiction due to the pending Tax Court proceeding. On May 6, 1992, the Court of Appeals affirmed the judgment of the District82 Court, holding that the Tax Court and U.S. District Courts have concurrent jurisdiction to determine a taxpayer's income tax liability pursuant to section 7402(a). On October 5, 1992, the Supreme Court denied petitioner's petition for a writ of certiorari.533 Separately, a forfeiture case was proceeding in the U.S. District Court for the Western District of New York with respect to the $ 359,500 in cash seized from petitioner by the U.S. Customs agents on November 17, 1983. United States v. $ 359,500 in United States Currency, 638">645 F. Supp. 638 (W.D.N.Y. 1986), revd. and remanded 828 F.2d 930">828 F.2d 930 (2d Cir. 1987) (the forfeiture case). In the forfeiture case, the District Court held that a civil forfeiture, based on a failure to declare currency prior to transporting it out of the country, requires that the owner of the currency have actual knowledge of an obligation to report the currency. The District Court held that even if the statute does not require actual knowledge, some notice must be provided as a matter of due process, and because it was undisputed that no signs or other form of notice existed, the owner could83 not be deprived of the currency. The Court of Appeals reversed, holding that actual knowledge of an obligation to report the currency was not required. Additionally, the Court of Appeals remanded the forfeiture case for a decision as to whether the notice required by due process could be satisfied by charging petitioner with constructive knowledge of an obligation to report. Petitioner's response to the instant motion states that the District Court has not, as of filing his response, decided such issue.Rule 121(b) provides that summary judgment may be rendered if the pleadings and admissions show that no genuine issue exists as to any material fact and that a decision may be rendered as a matter of law. Naftel v. Commissioner, 85 T.C. 527">85 T.C. 527, 529 (1985). The moving party bears the burden of proving that no genuine issue of material fact exists. Marshall v. Commissioner, 85 T.C. 267">85 T.C. 267, 271 (1985). The facts are viewed in a light most favorable to the nonmoving party. Jacklin v. Commissioner, 79 T.C. 340">79 T.C. 340, 344 (1982).Respondent contends that the doctrine of res judicata prevents petitioner84 from contesting his Federal income tax liability for his 1983 taxable year. Respondent contends that res judicata applies in the instant case because the District Court decided, on the merits, that petitioner is liable for income taxes for taxable year 1983 in the amount of $ 169,981 plus statutory interest as allowed by law. Petitioner argues that the District Court decision is not res judicata because the Tax Court's jurisdiction to determine a deficiency 534 in the instant case would be usurped and that a decision prior to the conclusion of the forfeiture case would be a duplicative use of judicial resources.The doctrine of res judicata is founded in the public policy that litigation must end and that the result should bind those who have contested the issue. Shaheen v. Commissioner, 62 T.C. 359">62 T.C. 359, 363 (1974). Generally, res judicata applies to repetitious suits involving the same cause of action. Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 597 (1948). The rule of res judicata provides:that when a court of competent jurisdiction has entered a final judgment on the merits of a cause of action, the parties to85 the suit and their privies are thereafter bound "not only as to every matter which was offered and received to sustain or defeat the claim or demand, but as to any other admissible matter which might have been offered for that purpose." The judgment puts an end to the cause of action, which cannot again be brought into litigation between the parties upon any ground whatever, absent fraud or some other factor invalidating the judgment. [Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 597 (1948); citations omitted.]When a claim of liability relating to a particular tax year is litigated, "a judgment on the merits is res judicata as to any subsequent proceeding involving the same claim and the same tax year." Commissioner v. Sunnen, supra at 598.When a termination assessment is determined by the Secretary to be justified, the tax is assessed and becomes immediately due and payable. Sec. 6851(a)(1); sec. 1.6851-1(a), Income Tax Regs. The tax so assessed is tax for the period beginning on the first day of the current taxable year and ending on the date of the assessment. Sec. 6851(a)(2); sec. 1.6851-1(a)(2), Income Tax86 Regs. Consequently, the termination assessment terminates the taxable year for the purpose of computing the amount of tax to be assessed and collected under the expedited termination assessment procedure. In the instant case, that termination occurred on November 17, 1983. It, however, did not terminate the taxable year for all purposes, and it clearly did not cut short the taxable year for the purpose of issuing a notice of deficiency. The termination of the taxable year does not create 2 short taxable years; the taxpayer's taxable year remains the same. Ramirez v. Commissioner, 87 T.C. 643">87 T.C. 643, 647 (1986). Section 6851(b) requires that a notice of deficiency based on the taxpayer's "full taxable year (determined without regard to any 535 action taken under subsection (a))" be sent after the assessment under section 6851.The issue involved in the instant motion appears to be one of first impression. Although the Court of Appeals for the Second Circuit 2 held that the District Court had jurisdiction to reduce the termination assessment to judgment notwithstanding the pendency of the deficiency proceedings in this Court, nothing in the Second87 Circuit's order affirming the District Court indicates that the District Court undertook to determine petitioner's final liability for the entire year. Indeed, it is apparent that the District Court only exercised its jurisdiction over the termination assessment, which only covered the period January 1, 1983, through November 17, 1983.There is no indication that the District Court decided the merits of petitioner's tax liability for the entire 1983 taxable year when it rendered summary judgment for taxes and interest petitioner owed pursuant to the termination assessment. For example, if petitioner had a loss which he recognized on or after November 18, 1983, and before January 1, 1984, it could affect tax liability for the entire 1983 taxable year. Consequently, it is entirely possible that the amount collected as a result of the termination assessment, which must be treated as a payment of tax for 88 1983 under section 6851(a)(3), could result in an overpayment of tax for 1983. Cf. Ramirez v. Commissioner, 87 T.C. 643">87 T.C. 643, 647 (1986).Although respondent, for the purpose of the instant motion, conditionally concedes the additional income determined in the notice of deficiency in the event we should decide that res judicata applies, such items nonetheless affect petitioner's final tax liability for 1983. Also in issue are the additions to tax determined in the notice of deficiency. As one of the requirements for the application of res judicata is missing in the instant case, that is, a final judgment on the merits of petitioner's tax liability for his entire 1983 taxable year, the doctrine of res judicata does not apply to the instant case.Our conclusion is supported by the legislative history of section 6851, which was enacted as a part of the Tax Reform 536 Act of 1976, Pub. L. 94-455, 90 Stat. 1520. The legislative history shows that Congress was concerned about determining a taxpayer's tax liability based upon less than a full taxable year. The Joint Committee report states:Since the Act provides this special proceeding whereby the taxpayer89 can have both administrative and judicial review of the appropriateness of the jeopardy or termination assessment within as few as 40 days after the making of such assessment, Congress believed it is appropriate to provide that the making of a termination assessment does not terminate a taxable year, create a deficiency, or require the Service to give the taxpayer a notice of deficiency within 60 days of a termination assessment. The decision in the Laing [3] case interprets prior law to require such a notice within 60 days of the making of the termination assessment since it regards the amount assessed pursuant to such an assessment as a deficiency. This approach, however, would have the effect of requiring courts to make a determination of tax liability based upon less than a full taxable year. Such a determination appears to be inconsistent with the provisions of section 6851(b) (prior to its amendment) allowing the taxable year to be reopened after termination until its normal end if the taxpayer has income after the termination. The requirement of multiple short taxable years could not only create administrative problems for the Service, but also could result in detriment90 to the taxpayer whose income tax liability might be greater because of the multiple years.Therefore, the Act revises section 6851 to provide that a termination assessment does not end the taxable year for any purpose other than the computation of the amount of tax to be assessed and collected. Also, the language relating to reopening of a taxable year is eliminated. This has the general effect of treating amounts assessed and collected pursuant to termination assessments in a manner similar to the collection of estimated taxes. Such an enforced collection, however, is subject to the administrative and judicial review described above, but it does not have the effect of terminating the taxpayer's taxable year. Rather, such taxable year continues until its normal end.Congress believes it is appropriate to allow a taxpayer who has been subjected to a termination assessment to contest the ultimate issue of his tax liability in the Tax Court91 in the same manner as is provided with respect to a taxpayer who has been subjected to a jeopardy assessment. Consequently, the Act provides that within 60 days after the later of the due date of the taxpayer's return for the full taxable year or the date on which the return is actually filed, the Service must send the taxpayer a notice of deficiency.[Staff of Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1976, at 363 (J. Comm. Print 1976); fn. refs. omitted.]Consequently, we hold that petitioner is not foreclosed from his "day in court" in this Court to have his liability for *537 his entire 1983 taxable year decided. Accordingly, we deny respondent's motion. For the same reasons, we deny respondent's motion for damages under section 6673.To reflect the foregoing,An appropriate order will be issued. Footnotes1. 50 percent of the interest due on the portion of the deficiency due to negligence.↩1. Respondent filed a document entitled respondent's motion for an order to show cause why petitioner should not be bound by the District Court's determination of petitioner's 1983 Federal income tax liability, which the Court filed as a motion for summary judgment.↩2. Absent stipulation to the contrary, venue for any appeal of the instant case would lie in the Second Circuit.↩3. Laing v. United States, 423 U.S. 161">423 U.S. 161↩ (1976).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619373/	Richard E. Beck v. Commissioner. Charlotte S. Beck v. Commissioner.Beck v. CommissionerDocket Nos. 15285, 15286.United States Tax Court1949 Tax Ct. Memo LEXIS 268; 8 T.C.M. (CCH) 126; T.C.M. (RIA) 49031; February 9, 1949Allin H. Pierce, Esq., 135 So. LaSalle St., Chicago, Ill., for the petitioners. Charles D. Leist, Esq., for the respondent. DISNEYMemoradum Findings of Fact and Opinion DISNEY, Judge: These cases, duly consolidated, involve income taxes for the calendar year 1943. Deficiencies were determined as follows: Docket No. 15285, $5,446.87; Docket No. 15286, $5,499.19. The question for consideration is whether a loss taken upon depreciation of real estate is ordinary or capital, which in turn depends upon whether the real property was used in petitioners' 269 trade or business and therefore was not a capital asset within section 117 (a) (1) of the Internal Revenue Code; and whether it was sold, or abandoned. From evidence adduced, we make the following Findings of Fact The Federal income tax returns involved were filed with the collector for the first district of Illinois. The petitioner Richard E. Beck is the step-son of Charlotte S. Beck, the widow of his father C. E. Beck, who died November 11, 1937. From C. E. Beck the petitioners inherited, in equal parts, a one-fourth interest each in property located at 5526-5532 South Shore Drive, at 55th and Lake Streets, Chicago, Illinois, the property as to which the loss herein is claimed (hereinafter called the Lake property). C. E. Beck and John E. Kernott had each owned a half interest therein. Kernott died about 1928, his interest passing to City National Bank of Chicago (hereinafter referred to as trustee or bank) as trustee for Doris Kernott. The lot has at all times been vacant, unimproved real property, with a frontage of 134 feet, overlooking Lake Michigan and separated therefrom by a city park. The depth of the lot is 300 feet. It is in a block which is zoned270 against any commercial use except apartments or apartment hotels or hotels. At the time of trial, R. E. Beck had not been by the property in a year. The petitioners also inherited from C. E. Beck an income-producing property at Devon and Western Avenues, a ground lease on and building on a rental property in the Loop district, and a small piece of vacant undeveloped property at 89th and Halsted Streets, all of the above being in Chicago, Illinois; also some lots in St. Cloud, Florida, purchased for the purpose of building homes. The petitioners did not purchase or develop any of the above properties, except that in Florida, and did not, after C. E. Beck's death in 1937, develop any property in the Chicago area. C. E. Beck conducted his business under the name of C. E. Beck Enterprises, and for about a year after his death the petitioners used that name, but since have used the name R. E. Beck Enterprises. Richard E. Beck is manager, but both petitioners are equal owners. The business has principally been that of holding and managing real estate for rental and income purposes, the operation of some motion picture theatres, and a hog and cattle ranch in Florida, and some security271 transactions. The executive office of the business, and of the theatre business, was, in general, maintained in downtown Chicago. An assistant to R. E. Beck maintains the office. About six book accounts were kept, of which one was known as Beck Properties. There was a separate bank account, with separate printed checks, for the Beck Properties account. The books were audited regularly by a firm of accountants. The Beck Properties account contained three or four pieces of real estate, including the Lake property, the others being inclued in those hereinabove listed as inherited by the petitioners. R. E. Beck does not speculate in "appreciative securities." The Lake property had been held by C. E. Beck (and Kernott) since about 1918, when it was acquired as part of a larger trust, by exchange of a piece of improved and rented commercial property. The adjusted basis of petitioners' half interest in the Lake property is agreed, and we find, to be $30,000. Prior to the death of C. E. Beck in 1937 effort was made by the owners through real estate brokers to sell the Lake property for about $75,000. The property was listed with a number of agencies at different times and at different272 times different prices were asked. About November or December 1937 an offer of about $50,000 for the entire property was made and refused. The petitioners joined the trustee, immediately after inheriting their half interest in the property, in endeavoring to realize the highest available price for the property and authorized the trustee to represent them in such endeavors. The asking price was reduced to $60,000 in 1938. Thereafter the price was gradually reduced. It was at no time less than $30,000. The trustee and petitioners both tried to liquidate the property. The Lake property was never rented, or listed for rental. At one time the owners discovered that a part of the property was being used for a parking lot by a hotel. Continuation of such use was permitted, on condition that the user would look after the remaining portion, and keep up its appearance, but no consideration was received for the use. C. E. Beck had blue print plans made on two occasions for development of the Lake property after his death, and in 1938 R. E. Beck had plans drawn by an engineering firm for the purpose of an apartment project. He discussed the matter with a real estate firm, who proposed an apartment273 building, also with another real estate man who rendered an opinion on the real estate firm's project. He also discussed thematter of costs and financing with a friend, a contractor on a large scale. Effort was made to mortgage the property, for financing a project, to an insurance company, but without success. The real estate firm's apartment proposal was rejected by R. E. Beck. A proposition for building row houses on the property was also considered in 1939 but nothing was done. A drive-in restaurant was considered but zoning ordinances prevented that project. The bank-trustee for the Kernott interest took the position that it could not go into development of the property. R. E. Beck on January 10, 1939, obtained from the trustee an option to purchase the Kernott interest for $30,000 by May 10, 1939. As the trustee could not under its powers, and would not participate in the development of an apartment building as proposed, the option was necessary. It was not exercised. The insurance company approached for a mortgage considered the project economically unsound. The war in Europe in 1940 and the entry by the United States in 1941 restricted chance for development. The taxes were274 paid on the property up to and including 1939, by the petitioners and the trustee. Thereafter taxes for 1940, 1941 and 1942 were not paid, because of failure by petitioners to pay their part. They considered the taxes too high. R. E. Beck offered to sell his interest to the trustee for the amount of taxes, so that he could pay the taxes and take an income deduction, but the bank declined. He told the bank he would not continue to pay taxes. The petitioners' share of the taxes for 1940, 1941 and 1942 on the property was about $5,300. At one time, after R. E. Beck told the trustee that he was going to pay no more taxes, the trustee rejected a proposition to purchase the Beck interest for $11,000. The offer was reduced to $2,500, subject to taxes, and was later reduced to $1,500. Later R. E. Beck asked what the trustee would give for the property and was told a nominal consideration would be paid, that it would pay $100 for a deed. The trustee would have paid up to $500. On December 22, 1943, the bank-trustee, and the petitioners, entered into a written "Real Estate Sale Contract" providing, in pertinent part, that the trustee agreed to purchase and petitioners agreed to sell for275 $100 the undivided one-half interest of petitioners in the property, by quit-claim deed, subject to all taxes and any fees or charges incurred for tax reductions effected or attempted on the property, the petitioners agreeing to furnish good and merchantable title, and payment of the $100 to be made within five days thereafter. On December 24, 1943, in Florida, the petitioners executed a quit-claim deed to the property to the trustee, reciting a "consideration" of "$10.00 and other good and valuable considerations." Documentary stamps in the amount of fifty-five cents were attached. The deed was acknowledged by petitioners on December 28, 1943, and recorded in Cook County, Illinois, on December 30, 1943. On December 24, 1943, the petitioners also assigned to the trustee their rights in any tax refunds from the property. Some tax experts had been employed and were attempting to adjust the taxes on a contingent basis. The trustee agreed with petitioners to pay the tax experts their fees. The petitioners each received $50 for the conveyance. All instruments were drawn by the trustee in conjunction with petitioners' attorney who examined them and presented them to petitioners for signature. 276 R. E. Beck had decided to abandon the property. The trustee had suggested the quit-claim deed and that it would pass $50 to each of the petitioners. The trustee regarded the acquisition of the property as a sale because it paid $100 for it, but did not consider it was paying $100 as the price of the property. It considered it was a purchase and was buying the property. The trustee paid up the taxes on the property, amounting to about $5,300, and penalties, and about July 1, 1944, sold the property for about $28,500. The asking price was $30,000. In income tax returns for 1943 each petitioner reported under "Net gain (or loss) from sale or exchange of property other than capital assets" a loss of $14,950, or one-half of $29,900, on land sold, acquired in 1937 by devise, with a basis of $30,000 and "gross sales price (contract price)" of $100. It is listed in the return under "Property other than Capital Assets." A sworn protest filed as to the years 1943 and 1944 by petitioners with the Internal Revenue Agent in Charge at Chicago, dated November 12, 1946, protesting against treatment of the loss here involved, as long-term capital loss instead of ordinary loss, contains, in277 pertinent part, the following language: "When the taxpayers received their one-half interest in the land, they immediately joined with the City National Bank in endeavoring to realize the highest available amount, and authorized the bank to represent them in such endeavors. In 1938, the asking price of the total property was reduced to $60,000. In subsequent years, due to decline of the neighborhood, the asking price was further reduced from time to time. "The taxpayers determined in 1942, that due to the decline in the market value, and the expense involved, they would not pay any further real estate taxes on the property until such time as it was sold. The bank, in the meantime, continued to pay one-half of such taxes out of the funds of the Kernott Estate. By the end of 1943, the accumulated taxes and penalties and interest thereon was approximately $5,000. The bank was apprehensive about the back taxes which constituted a lien on their 1/2 interest as well as the taxpayers interest, and threatened to bring a partition suit. The taxpayers finally decided to sell out their one-half interest to the bank as Trustee of the Kernott Estate for the best price obtainable plus assumption278 of taxes. The bank offered $100them for a quitclaim deed, which offer was accepted, and sale was made on December 30, 1943. This sale was a bona fide arm's-length transaction. The bank subsequently paid off the back taxes and was successful in disposing of the whole property in 1944. "The taxpayers suffered a loss of $29,900 on the sale to the bank, each claiming a deduction of one-half, or $14,950, on his 1943 income tax return. "The taxpayers never made any personal use of the property and at no time had any other interest therein than to dispose of it at the best available price. The taxpayers claim that their loss is fully deductible under Section 23 (e) of the Internal Revenue Code as a loss resulting from a transaction entered into for profit." In the determination of deficiency the Commissioner disallowed, as to each of the petitioners, deduction of $14,950 as "loss on sale of property other than a capital asset" and allowed a capital loss of $7,475, with the explanation that the loss suffered on the sale of the land at 5526-5532 South Shore Drive, Chicago, Illinois, was a long-term capital loss; and referred to section 117 of the Internal Revenue Code279 . Opinion The petitioners' position is, in a word, that the property was not a capital asset because it was "real property used in the trade or business of the taxpayers" within the last clause of section 117 (a) (1) of the Internal Revenue Code, 1 and further that even if it was a capital asset, there was abandonment thereof, and no sale or exchange, therefore the loss taken was not limited by section 117 (b) which places a 50 per cent limitation upon loss or gain "recognized upon the sale or exchange of a capital asset," held for more than six months. The view includes the contention that section 117 (j) does not here apply, since the property here involved is "real property used in the trade or business held for more than six months which is not * " includible in inventory or held primarily for sale to customers in ordinary course of trade. 280 We will first consider the idea that there was abandonment and not sale; for, if there was, it would be immaterial whether the property was a capital asset. We hold that there was no abandonment. Though there was testimony from R. E. Beck and the representative of the bank attempting to establish abandonment, it can not prevail over the facts otherwise appearing. The petitioners' returns reported a sale for $100. That amount was received. The "Real Estate Sale Contract" describes a sale, the contract reciting that the bank agrees to purchase, and that the petitioners here agree to sell, the land involved; and in the quit-claim deed they convey it for a "consideration" recited as "Ten Dollars and other good and valuable considerations." In addition, the evidence is that R. E. Beck tried to obtain various prices for the land from the bank, from $11,000 down to $1,500, and later Beck asked what the bank would give. The protest sworn to by the petitioners on November 7, 1946, states that they finally decided to "sell" to the bank "for the best price obtainable plus assumption of the taxes." The bank offered them $100 for a quit-claim deed, which offer was accepted and sale was made on281 December 30, 1943. These statements are flatly opposed to the contention now made as to evidence of abandonment. It is difficult, moreover, to conceive of abandonment when $100 consideration was received. In Commonwealth, Inc., 36 B.T.A. 850">36 B.T.A. 850, $50 was paid and abandonment was found, but the $50 was for other property, recording fees and revenue stamps. The conveyance was to a mortgagee. We hold that there was here no abandonment, but sale. Was the property a capital asset? It is not if, within the latter part of section 117 (a) (1) of the Code, it is excepted from capital assets as "real property used in the trade or business of the taxpayer." It was within section 117 (g) held for more than six months, was not within section 117 (j) includible in inventory or held primarily for sale to customers in ordinary course of business, since the petitioners do not claim to have been, and were not, in the business of selling real estate. Our question, therefore, is, and is presented as: Was this real estate used in petitioners' business? It was not actually put to any use, in any ordinary sense, for it was vacant and unimproved. No rent was obtained from it at any time and a hotel282 was allowed to use it as a parking space in consideration of keeping it cleaned up. The petitioners argue, nevertheless, that within the meaning of section 117 (a) (1) it was used in business, the argument in effect being that it was so used because the petitioners were in the business of developing property for rental purposes, and tried, though vainly, to develop this property for that purpose. We have carefully examined each of the cases relied on by the petitioners. We need not discuss them in detail for each, in our view, fails to support the petitioners' thesis here. Some involve merely abandonment, which we have above declined to find. Others arose prior to the amendment of section 117 in 1942 and are not on the point urged here. None involves, as here, mere inheritance of vacant real estate, non-user thereof by actual use or leasing to others, and later sale. Carter-Colton Cigar Co., 9 T.C. 219">9 T.C. 219, comes nearest to the present situation, yet differs essentially from it, for there the petitioner, being in the tobacco distributing business, had use for and was leasing quarters for its warehouse and principal office, and acquired the property in question with the intent283 and purpose of erecting thereon its own warehouse and store building, for occupation as its principal place of business. Because of death of one manager that purpose was abandoned, after plans and specifications had been proposed for erection of the building, and later the unimproved property was sold. Some slight income was received from the property, by leasing it for advertising space. We think acquisition of real estate for actual use as principal place of business, the beginning, by drawing of plans, of such use, and use of property for advertising space differs greatly from the situation here. It would be more analogous had the petitioners acquired the property for their principal office building and had they been in a business in which they needed such office or principal building. Here, however, the petitioners acquired, by inheritance, vacant property. Though inheritance has been called a neutral factor, it indicates here that the acquisition of the property was not because of its necessity in the business, as in the Carter-Colton case, supra. The inherited vacant property was never actually used at all. Montell Davis, 11 T.C. 538">11 T.C. 538. Evidence indicates tentative284 efforts to improve it for rental purposes. That, the petitioners say, was their business. Yet not only had this property long been held, both by them and their predecessor, unimproved and unrented, but no other property was improved by them. They received the rents from leases on the property at Western and Devon Avenues, and one at 6 South State Street. Though owning a location at 89th & Halsted Streets, they did not develop it or show reason why it was not developed, and no development of some lots in Florida is shown. Under these circumstances there is in our opinion, strain in the effort to show development of rental property to be the business of the petitioners. They were, rather, merely holding inherited property, hoping to sell it. This conclusion is consistent with the sworn statement of both the petitioners in their protest, as late as November 17, 1946, wherein they affirmed that when they received the property they immediately tried to sell, and continued so to do; that they never made any personal use of the property; and that they "at no time had any other interest therein than to dispose of it at the best available price." We have, in weighing the evidence, compared285 these statements, made before the present contention was joined, with other evidence adduced, and they impress us more than the testimony, often equivocal, given to sustain an interested view. They are to be contrasted with the contention on brief that the "efforts of the petitioners from the beginning were to develop the property as one of the income-producing assets of the real estate rental business * ." They could not, in truth, develop the Lake property without acquiring the other half interest; yet they let their option thereon lapse. Their position is indeed that if they had title to the other half they might have improved the lot. The bank was never in the business of developing the property, and took the position that it could not join therein. The view that there was here business use of this property seems both belated and out of keeping with the facts involved. We conclude that the facts here do not disclose the use of property in the trade or business of the petitioners within the intendment of section 117 of the Internal Revenue Code. We, therefore, affirm the determination of the Commissioner that the loss was a capital loss, on sale of a capital286 asset. Decision will be entered for the respondent. Footnotes1. SEC. 117. CAPITAL GAINS AND LOSSES. (a) DEFINTIONS. - 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 * * * real property used in the trade or business of the taxpayer; * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619374/	Homer H. and Agnes Germain v. Commissioner.Homer H. & Germain v. CommissionerDocket No. 26319.United States Tax Court1952 Tax Ct. Memo LEXIS 296; 11 T.C.M. (CCH) 226; T.C.M. (RIA) 52063; March 11, 1952296 Malcolm E. Rosser, Esq., for the petitioners. W. B. Riley, Esq., for the respondent. HILL Memorandum Opinion HILL, Judge: Respondent has determined a deficiency in income tax of $136.50 against the petitioners for the year 1948. The petitioner filed sets forth two errors, as follows: 1. The disallowance of a deduction claimed as travel expenses in the amount of $954. 2. The determination of the deficiency against petitioners upon the basis of a joint return of the combined income of the marital community. [The Facts] The proceeding was heard at Muskogee, Oklahoma, on May 7, 1951, by Henry C. Stockell, who was designated as a Commissioner for that purpose pursuant to Rule 48 of the Rules of Practice of the Tax Court and section 1114 (b) of the Internal Revenue Code. The Commissioner has filed his report setting forth his findings of fact with respect to the proceeding. No exception has been taken by either party to the Commissioner's findings and, upon examination, we approve and hereby adopt such findings and include the same herein by reference as our findings of fact. The petitioners are husband and wife and residents of Muskogee, 297 Oklahoma. The return for the taxable year was filed with the collector of internal revenue for the district of Oklahoma. Upon the proceeding being called for hearing on May 7, 1951, at Muskogee, Oklahoma, the parties appeared by counsel and the petitioner Agnes Germain in person, and the petitioners announced, through counsel, that they were ready for trial. Thereupon the petitioner Agnes Germain took the witness stand and upon questioning by her counsel it developed that she had no personal knowledge of the expenditures by her husband for which claim is made; that her husband had merely told of the expenditures and their amounts. Thereupon counsel for the respondent objected to the testimony of this witness as hearsay, and the objection was sustained by the Commissioner. No exception to this ruling was taken by counsel for the petitioners, such counsel stating that he agreed that the evidence was not competent, but that he wished to move for a continuance of the hearing to give opportunity to secure the testimony of the petitioner, Homer H. Germain, who was somewhere on the West Coast working for a theatrical company. The motion for continuance was denied by the Commissioner, whose298 action is here assigned as error by the petitioners. [Opinion] It appears that the petition in this proceeding was filed more than 12 months prior to the hearing and that the petitioners had due notice of the time and place of the hearing and had ample opportunity prior to that time to obtain the testimony, the necessity for which bases the request for continuance. The action of the Commissioner in denying the motion for continuance was justified and is hereby approved. The hearing of the proceeding was thereupon closed without the introduction of additional evidence. The record does not contain a copy of the return filed or the schedule attached to the deficiency notice. The burden rests upon the petitioners to establish their right to the deduction of the amount claimed or that the determination by respondent was incorrect. Welch v. Helvering, 290 U.S. 111">290 U.S. 111; Burnet v. Houston, 283 U.S. 223">283 U.S. 223. There being absolutely no evidence in the record as to the amount of the expenditures claimed as travel expenses or their actual character, the respondent's action in his disallowance is sustained. As to the second assignment of error, upon the determination299 of the deficiency upon the basis of a joint return, it need only be said that we have no information as to the character of the return filed, whether joint or separate. The action of the respondent in his determination of the deficiency upon the joint basis is not shown to be in error and is approved. At the conclusion of the hearing of the proceeding, respondent's counsel moved for judgment and was advised by the Commissioner that the latter had no right to render judgment but would report the motion as made. This motion has been put in writing by counsel for respondent and filed in the record. The motion is well taken and is granted. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619375/	Pan American Eutectic Welding Alloys Co., Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentPan American Eutectic Welding Alloys Co. v. CommissionerDocket Nos. 72544, 74765United States Tax Court36 T.C. 284; 1961 U.S. Tax Ct. LEXIS 150; May 17, 1961, Filed 150 Decisions will be entered under Rule 50. The petitioner was organized as a wholly owned subsidiary of a United States corporation for the purpose of selling in Western Hemisphere countries goods produced by another company owned by the same interests and later by the parent. The petitioner bought such goods from such other company and later from the parent, and sold them to a distributor in a foreign Western Hemisphere country. The agreement between the petitioner and the distributor provided that the petitioner should retain title and risk of loss until the goods reached the foreign port of delivery. Held, that all of petitioner's income was derived from sources outside the United States and that it qualifies as a Western Hemisphere trade corporation under 109 of the Internal Revenue Code of 1939 and section 921 of the Internal Revenue Code of 1954. Morton L. Deitch, Esq., and Lewis G. Cole, Esq., for the petitioner.Charles M. Greenspan, Esq., and Warren S. Shine, Esq., for the respondent. Atkins, Judge. ATKINS284 The respondent determined deficiencies in income and excess profits taxes for the years and in the amounts as follows:DocketTaxable year ended Oct. 31 --Income taxExcess profitsNo.tax725441952$ 12,301.60$ 14,213.947254419531,591.99None 7254419544,907,43407.1619556,507.8774765195621,251.56The only issue is whether the petitioner qualifies as a Western Hemisphere trade corporation within the meaning of section 109 of the Internal152 Revenue Code of 1939 and section 921 of the Internal Revenue Code of 1954 and is therefore entitled to the credit provided by section 26(i) of the 1939 Code and the special deduction provided by section 922 of the 1954 Code.The respondent by stipulation concedes that there are no deficiencies in excess profits tax for the taxable years ended October 31, 1952, and October 31, 1954.FINDINGS OF FACT.Some of the facts are stipulated and are incorporated herein by this reference.The petitioner is a corporation organized on April 30, 1947, under the laws of the State of New York, with its principal place of business in the city of New York. It is engaged in the business of buying and selling welding rods and related materials. It keeps its books and prepares its income tax returns on the basis of a fiscal year ending 285 October 31, and employs an accrual method of accounting. Its Federal income tax returns for the taxable years ended October 31, 1952, through October 31, 1956, were filed with the director of internal revenue for the second New York district.The petitioner is, and during each of the years in controversy was, a wholly owned subsidiary of Eutectic Welding Alloys153 Corp., hereinafter referred to as EWAC, a corporation organized on January 15, 1946, under the laws of the State of New York. During the fiscal year ended October 31, 1952, the capitalization of the parent was represented entirely by common stock which was owned 55 percent by Rene D. Wasserman and 45 percent by his then wife, Marie Rose Wasserman. On November 1, 1952, the parent was recapitalized and thereafter the entire amount of common stock was owned by Wasserman and the preferred stock was owned by trustees of a trust created by his then wife, the trustees being Sigmund Wasserman and Jose Hassid. Rene D. Wasserman was and is president of both the petitioner and EWAC.Rene Wasserman emigrated to the United States from Switzerland in 1940 and organized a business for the purpose of manufacturing specialty welding rods, which are materials used for the purpose of welding breaks and cracks in metal. This organization and its successor, Alpine Metals Manufacturing Co., were sole proprietorships. The sole proprietorship was discontinued in October 1955, when its functions were assumed by EWAC.The petitioner was formed on the advice of counsel for the purpose of selling the specialty154 welding products manufactured by Alpine Metals Manufacturing Co., for ultimate consumption in Canada, Central America, and South America. During each of the years in controversy all of petitioner's business was done in North, Central, and South America and in the West Indies. It purchased the products from Alpine Metals Manufacturing Co. until that individual proprietorship discontinued business and thereafter from EWAC.EWAC also set up a corporation called Low Temperature Welding Alloys Corp. for the purpose of selling these products for consumption in countries outside the Western Hemisphere, and a corporation called American Eutectic Welding Sales Co. to sell such products for consumption in the United States.The petitioner, EWAC, and Alpine Metals Manufacturing Co. were all located at 40-40 172d Street, Flushing, New York, which property consisted of sizable factory and office buildings. Overhead service charges, such as bookkeeping and office rent, telephone and postage expense, and insurance on goods in transit, were paid by EWAC and allocated to the petitioner, to the sole proprietorship, and to EWAC's other wholly owned subsidiaries. Other expenses were paid directly155 by petitioner. The products purchased by the petitioner 286 and the other subsidiaries from EWAC and from Alpine Metals Manufacturing Co. were sold to them at 7 percent above cost.The petitioner made the following sales during the taxable years involved:Returns andGross salesallowancesNet salesper booksFiscal year ended Oct. 31, 1952Canadian -- regular$ 4,559,89$ 459.98$ 4,099.91 Canadian -- distributors112,674.383,213.17109,461.21 Export24,258.61866.2623,392.35 E.I.S.A. (M.I.S.A.)166,583.68166,583.68 EquipmentTotal308,076.564,539.41303,537.15 Fiscal year ended Oct. 31, 1953Canadian -- regular57,339.684,194.6953,144.99 Canadian -- distributors115,582.1632,000.2383,581.93 E.I.S.A. (M.I.S.A.)80,711.8580,711.85 Equipment223.07223.07 Export23,114.74560.3022,554.44 Total276,971.5036,755.22240,216.28 Fiscal year ended Oct. 31, 1954Canadian -- regular5,485.232,808.642,676.59 Canadian -- distributors70,198.26988.0069,210.26 Eutectic Welding Alloys Co. of Canada Ltd21,561.7121,561.71 Export38,906.4312,997.5325,908.90 E.I.S.A. (M.I.S.A.)160,531.18160,531.18 Equipment(8.28)(8.28)Total296,674.5316,794.17279,880.36 Fiscal year ended Oct. 31, 1955M.I.S.A.123.297.67123,297.67 Export27,313.042.4427,310.60 Canadian -- distributors103,087.764,697.0898,390.68 Canadian -- regular877.55199.91677.64 Total254,576.024,899.43249,676.59 Fiscal year ended Oct. 31, 1956M.I.S.A.138,338.48138,338.48 Export35,771.74186.4135,585.33 Canadian Weldrods Mfg. Co., Ltd249,019.37249.019.37 Canadian -- distributors73,506.0817,585.6455,920.44 Canadian -- regular48.7048.70 Total496,684.3717,772.05478,912.32 156 Eutectic International S.A. (E.I.S.A.), was a corporation organized under the laws of the Republic of Panama in 1947. It was dissolved on June 1, 1953, and a corporation known as Metallica International S.A. (M.I.S.A.), a corporation also organized under the laws of the Republic of Panama in 1953 by the same interests, continued the same activities in the same manner. These two corporations are sometimes hereinafter referred to collectively as MISA. MISA was owned 287 22 percent by Rene Wasserman's father and 78 percent by other Swiss interests.EWAC and the petitioner entered into contracts with MISA and its predecessor authorizing and licensing those two corporations to purchase the products in question and to sell them anywhere in the world other than in the United States, the Dominion of Canada, British Columbia, Newfoundland, the Hawaiian Islands, the Canal Zone, and the Republic of Panama, for use outside of those countries. Therein it was agreed:that the title to all merchandise sold shall remain in EUTECTIC and/or PAN-AMERICAN EUTECTIC, whichever is the seller, until delivery at destination; and by the same token risk of loss until arrival at destination shall157 remain in the seller.In a typical transaction between the petitioner and MISA, an order was first placed with MISA by one of its customers for certain specified products to be shipped to a port outside the United States, and requesting as terms of payment a 60-day sight draft on a bank in a Central American country.MISA by letter then confirmed the order and the terms, enclosing its invoice showing a "Value F.A.S. [free alongside ship] New York," and stating that the goods were to be sent by maritime freight and that insurance was covered "by our New York plant for your account." Copies of this letter and of the production invoice, together with shipping instructions and instructions as to handling of documents, were sent by MISA to petitioner. The instructions typewritten on the letter were in part as follows:NEW YORK:We enclose 6 copies of our production invoice. Please put goods immediately into production and apply for U.S. E/L. Once the goods have become ready, please effect shipment by ocean freight. Haras are to draw documentary draft at 60 days' sight through the Banco Hipotecario de El Salvador, San Salvador. Insurance is to be covered under your open policy158 for account of customers. * * The petitioner then filled the order in New York and turned the goods over to a freight forwarder, Haras & Company, international shipping specialists, and gave the freight forwarder the instructions as to shipping which petitioner had received from MISA. The freight forwarder was instructed to make the bill of lading in the name of petitioner. Petitioner also delivered a commercial invoice and insurance certificate, showing the petitioner as the insured, and requesting that the freight forwarder draw the sight draft. Petitioner also advised the freight forwarder to inform the bank that it was to follow MISA's instructions regarding collection and further handling of the goods.The freight forwarder then prepared shipping documents. These were sent under a covering letter to the bank in the country of destination. 288 Accompanying this letter were petitioner's draft, the bill of lading, insurance certificate, and commercial invoice to MISA's customer. The bill of lading was prepared by the freight forwarder to the order of petitioner. The freight forwarder had the power to, and did, endorse the bill of lading before forwarding it to the159 bank.At the same time that it prepared the invoice to MISA's customer, the petitioner invoiced MISA for the goods, stating that "charges follow."The petitioner later forwarded to MISA the freight forwarder's statement of charges and debited MISA's account accordingly.MISA later sent its formal purchase order to petitioner.The documents held by the bank were delivered to MISA's customer when the latter accepted the draft, and the bank in due course made collection of the draft, remitting the proceeds to MISA, and so advised the freight forwarder.Petitioner billed MISA on open account and MISA made payments in dollars in New York to petitioner, usually 30 days after arrival of the goods in the country of destination.The petitioner recorded sales in its books when it received the dock receipt from the freight forwarder showing that the goods had been delivered in New York to the carrier.Petitioner's books never showed any goods in transit as inventory or otherwise.All shipments to or for petitioner's customers were insured by petitioner under an open policy for at least the price paid by MISA's customer, which was greater than MISA's cost price. The cost of such insurance (as160 well as shipping and related charges) was itemized in the total paid by MISA to petitioner and in the total paid by MISA's customer to MISA. The petitioner's method of fixing export prices was to first establish a base price in order that it could be sure of making a profit. Transportation and insurance necessarily had to be listed separately because of varying costs resulting from the shipping destination and the manner of shipment.The above-mentioned insurance policy covered EWAC and all its subsidiaries, including the petitioner. Under the terms of the policy, insurance attached from the time the goods left petitioner's warehouse until the goods were delivered to the final warehouse at the destination named in the policy, certificate, or declaration. The insurance certificate issued with respect to an individual shipment named the petitioner as the shipper and consignee and showed the destination of the goods as the port of entry where the goods were to be delivered to the customer. It provided that any loss was to be paid to the order of the petitioner. In the case of an insurance claim, the petitioner would make application to have the loss paid to it. Such recoveries161 were 289 small and the recoveries would be placed in petitioner's bank account and would be credited to insurance recoveries. At the close of the year recoveries were netted off against insurance expense. In one instance an insurance loss check dated November 16, 1954, in the amount of $ 35.60, which was payable to the petitioner, was endorsed over by the petitioner to MISA.Sales invoices sent by the petitioner to MISA and to MISA's customers provided that title to all materials shipped should remain in the petitioner until arrival at the place of destination.The petitioner made every effort to assist its distributor MISA with respect to promotion, development, and sale of products. The petitioner's executives made several trips through Latin America and lectured. Literature was prepared in Spanish and Portuguese and this was furnished to MISA. MISA's salesmen were thoroughly trained and retrained in a school maintained by the petitioner in Flushing, New York. On several occasions specialists were sent by petitioner to South America to aid and assist MISA.For the purpose of this case, all sales made by petitioner to others than MISA during petitioner's taxable years162 ended October 31, 1950, to October 31, 1956, inclusive, were accomplished in the same form as sales made to MISA during such period.Petitioner did not pay any income taxes, or taxes in lieu thereof, to any country other than the United States during any of the taxable years involved herein.During each of the petitioner's taxable years ending October 31, 1950, and October 31, 1951, all the facts with respect to the source of petitioner's gross income and the method of operating its business were, for purposes of this case, the same as during petitioner's taxable year ended October 31, 1952.In its income tax returns for the fiscal years ended October 31, 1952, 1953, and 1954, the petitioner claimed as credits for Western Hemisphere trade corporations the respective amounts of $ 20,456.91, $ 2,306.63, and $ 8,402.68. In its returns for the fiscal years ended October 31, 1955 and 1956, the petitioner claimed special deductions for Western Hemisphere trade corporations in the respective amounts of $ 12,515.12 and $ 40,868.40.In the notice of deficiency the respondent held that the petitioner was not a Western Hemisphere trade corporation and, therefore, disallowed the credits and 163 special deductions claimed by the petitioner.Title to all the goods sold by the petitioner during the years in question passed in foreign countries in the Western Hemisphere, and all the income derived by the petitioner from such sales was from sources outside the United States.290 OPINION.In support of his determination that the petitioner does not, during the years in question, qualify as a Western Hemisphere trade corporation within the meaning of section 109 of the Internal Revenue Code of 1939 and section 921 of the Internal Revenue Code of 1954, 1 the respondent makes substantially the same contentions as were advanced by him in Barber-Greene Americas, Inc., 35 T.C. 365">35 T.C. 365, on appeal (C.A. 7). He does not question that all of petitioner's business was done in countries in the Western Hemisphere and that at least 90 percent of its gross income was from the active conduct of a trade or business. However, he does contend that 95 percent or more of petitioner's gross income was not derived from sources outside the United States, as required by the statutory provisions. It is argued that the petitioner retained bare legal title to the goods164 shipped to MISA until delivery in the foreign countries in the Western Hemisphere, that this was done primarily for tax avoidance purposes, and that such retention of bare legal title does not serve to prevent the equitable title or beneficial ownership and general property in the goods from passing to the buyer within the United States. It is also argued that within the intendment of the statute the petitioner would have to be present and conducting some business within the foreign countries of 291 the Western Hemisphere to establish that the source of its sales income was without the United States.165 In Barber-Greene Americas, Inc., supra, we thoroughly considered and rejected these various arguments and contentions of the respondent. We there held that the creation of a subsidiary for the purpose of making sales of goods in foreign Western Hemisphere areas in an attempt to qualify as a Western Hemisphere trade corporation does not constitute tax avoidance; that the statute does not require that a corporation, to qualify, must maintain a foreign warehouse or factory or pay foreign taxes; and that if the domestic corporation has agreed with its foreign buyers that title will be retained until the goods reach a foreign port, the agreement is controlling, and that the income thereunder is to be considered as being from sources without the United States, unless the retention of title is a mere sham. The same conclusions were reached by the Court of Claims in A. P. Green Export Co. v. United States, 284 F.2d 383">284 F. 2d 383. See also International Canadian Corp. v. Frank, F. Supp. (W.D. Wash.)(Mar. 29, 1961).In the instant case there can be no question that it was the intention of both the petitioner and its distributor166 that title to the goods should remain in the petitioner until delivery of such goods at the foreign ports. The basic contract, as well as each invoice, so provided, and the basic contract provided that risk of loss until arrival at destination should remain in the seller. The petitioner carried insurance against loss during transit. The fact that the petitioner charged MISA a basic price plus insurance and freight (c.i.f.) does not, under present circumstances, indicate that title passed in the United States. Barber-Greene Americas, Inc., supra, and A. P. Green Export Co., supra.Cf. United States v. Balanovski, 236 F. 2d 298 (C.A. 2). Here, as was true in Barber-Greene Americas, Inc., supra, the petitioner undertook real responsibilities, risks, and obligations in retaining title until delivery of the goods to the foreign port and its retention of title was real.We have found, and hold, that title to the goods sold by petitioner passed in foreign places and that the income from such sales was from sources outside the United States. Following Barber-Greene Americas, Inc., supra,167 we hold that the petitioner qualified as a Western Hemisphere trade corporation for each of the years in question. Cf. American Food Products Corporation, 28 T.C. 14">28 T.C. 14. It follows that the respondent erred in disallowing the credits claimed pursuant to section 26(i) of the 1939 Code and the special deductions claimed pursuant to section 922 of the 1954 Code.Decisions will be entered under Rule 50. Footnotes1. Section 109 of the 1939 Code provides:"For the purposes of this chapter, the term "western hemisphere trade corporation" means a domestic corporation all of whose business is done in any country or countries in North, Central, or South America, or in the West Indies, or in Newfoundland and which satisfies the following conditions:"(a) If 95 per centum or more of the gross income of such domestic corporation for the three-year period immediately preceding the close of the taxable year (or for such part of such period during which the corporation was in existence) was derived from sources other than sources within the United States; and"(b) If 90 per centum or more of its gross income for such period or such part thereof was derived from the active conduct of a trade or business."Section 921 of the 1954 Code is, insofar as here material, substantially identical.Section 26(i) of the 1939 Code provides:(i) Western Hemisphere Trade Corporations. -- In the case of a western hemisphere trade corporation (as defined in section 109) -- * * * *(2) Taxable years beginning after March 31, 1951, and before April 1, 1954. -- In the case of a taxable year beginning after March 31, 1951, and before April 1, 1954, an amount equal to 27 per centum of its normal-tax net income computed without regard to the credit provided in this subsection.(3) Taxable years beginning after March 31, 1954. -- In the case of a taxable year beginning after March 31, 1954, an amount equal to 30 per centum of its normal-tax net income computed without regard to the credit provided in this subsection.Section 922 of the 1954 Code provides:SEC. 922. SPECIAL DEDUCTION.In the case of a Western Hemisphere trade corporation there shall be allowed as a deduction in computing taxable income an amount computed as follows -- (1) First determine the taxable income of such corporation computed without regard to this section.(2) Then multiply the amount determined under paragraph (1) by the fraction -- (A) the numerator of which is 14 percent, and(B) the denominator of which is that percentage which equals the sum of the normal tax rate and the surtax rate for the taxable year prescribed by section 11.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619376/	GEORGE P. ROWELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Rowell v. CommissionerDocket No. 13648.United States Board of Tax Appeals12 B.T.A. 1197; 1928 BTA LEXIS 3391; July 6, 1928, Promulgated 3391 1. In the absence of evidence as to facts upon which debts were ascertained to be worthless, and as to the time of such ascertainment, held that no deduction is allowable in 1919 and 1920. 2. Alleged loss upon the sale in 1921 of a commercial law practice disallowed for lack of evidence as to the cost and the March 1, 1913, value thereof. 3. The March 1, 1913, value of the business not being shown, the inclusion by the respondent of the entire amount of the sales price in income for 1921, is approved. Harry B. Caton, Esq., for the petitioner. John F. Greaney, Esq., for the respondent. SIEFKIN1197 This is a proceeding for the redetermination of deficiencies in income taxes for the years 1919, 1920, and 1921, in the respective amounts of $617.07, $175.85, and $2,337.82. Three issues are involved: (1) Whether the respondent erred in disallowing as deductions from gross income for the year 1919 items aggregating $1,796.41, claimed as bad debts ascertained to be worthless and charged off in 1919; (2) whether the respondent erred in disallowing as deductions from gross income for the year 1920 items aggregating $153.27, representing3392 advances in behalf of clients, and items aggregating $617, representing personal loans made between 1917 and 1920, claimed as bad debts ascertained to be worthless and charged off during 1920, and (3) whether the respondent erred (a) in disallowing a deduction from gross income for 1921 of $7,100, claimed as a loss upon the sale in 1921 of a commercial law practice, and/or (b) in including in the petitioner's income the entire consideration of $2,900 received by him under the terms of said sale. FINDINGS OF FACT. The petitioner, for about 30 years, has been a practicing attorney in Stambord, Conn. Prior to 1921 a part of his practice was a commercial law business obtained from out-of-town clients through listing in certain law lists and publications. Included in petitioner's income-tax return for the year 1919, as a deduction as bad debts ascertained to be worthless and charged off during the year 1919, was an item of $1,794.36, composed of about 150 debts ranging in amount from about $1.25 to about $570. Most of these were on the petitioner's books on March 1, 1913. 1198 Included in this list were the following items: Herbert B. Lanyon, $571.35; A. B. Griswold3393 Co., $151.40; Samuel Mandelson, $112.12; Sarver & Ames, $56,46; Fred P. Wood, $45.65; Frederick Whitehouse, $44.60; Brown & Boles, $28; Wilber Mercantile Agency, $12.34; Credit Insurance Adjustment Co., $17,68; Carthienour Watson, $35, and Louis H. Porter, $1.34. Lanyon had the ability to pay, had some property and considerable earning capacity, and petitioner could have enforced payment of the amount owed at March 1, 1913, but Lanyon moved to New York and he could not be located by petitioner. Petitioner finally learned that Lanyon died about 1919. A. B. Griswold operated a large contracting concern and at the time the service was rendered by the petitioner was able to pay, but Griswold got into difficulties and absconded. Petitioner could not locate him. Samuel Mandelson was a man of known character for paying his bills and had some small property, but he died, leaving no estate, about the time petitioner charged this debt off. Sarver & Ames was a commercial agency in Philadelphia or some city outside of Connecticut which had no property in Connecticut subject to execution. Petitioner obtained a divorce for Fred P. Wood, who later got into difficulties and left Connecticut. 3394 Frederick Whitehouse was a contractor in Stamford and removed to California about the time the debt was charged off by petitioner. On March 1, 1913, Whitehouse could have paid this bill but petitioner was unable to locate him in California. Brown & Boles at one time kept a garage in Stamford and the debt was collectible, but they have not been in Stamford since 1917. Wilber Mercantile Agency was a large commercial agency having offices in several of the large cities. Petitioner made repeated efforts to collect this bill, and in 1919 determined the efforts were futile and charged off the debt. Credit Insurance Adjustment Co. was a collection agency, and the circumstances with regard to that debt were similar to those of the Wilber Mercantile Agency debt. Carthienour Watson resided in Stamford at the time the debt was incurred, but she removed to North Carolina, and petitioner determined in 1919 that the debt was worthless and that further attempts to collect the bill would be useless. Louis H. Porter was a New York attorney who never paid the amount due petitioner, and petitioner did not think the debt warranted effort of collection. 1199 The petitioner3395 seldom filed suit for collection of any debts immediately after they became due. He never considered it worth while to bring suit to collect attorney's fees for amounts from $25 to $75. There were on the books of the petitioner in 1920, 18 debts representing advances made to and expenses incurred for clients during the years 1917 to 1920, aggregating $153.27. This amount was included in petitioner's return for the year 1920 as a deduction, because the petitioner was convinced that there was no chance of collecting the debts. These amounts were not charged again as office expenses. The petitioner also included as a deduction on his return for the year 1920, the amount of $617 representing personal loans made by the petitioner as follows: August Steifel, loan made February and April, 1919$135.00Edgar Atkin, balance due on loans made126.50Emmett Owen, loan made October 15, 191779.95August W. Kelly, loan made December, 192075.00Bayard Cole, balance on loan200.00Total617.00August Steifel disappeared and the petitioner charged the amount of the debt off in 1920. Bayard Cole got to drinking and died in a hospital. Petitioner learned, 3396 about two months after the loan was made to Kelly, that Kelly filed a petition in bankruptcy either the month before or the month after the loan was made and the amount was uncollectible. Edgar Atkin was a drunkard and when petitioner charged the debt off in 1920, collection thereof was hopeless. Emmet Owen was an artist living in Stamford who moved away, and the debt was charged off in 1920. By a contract dated February 16, 1921, and effective April 1, 1921, the petitioner sold his commercial law business to Bartram & Meade of Stamford for a total consideration of $2,900. Included in the business at the time the transfer was made were pending claims of a fixed value of over $10,000 and numerous pending cases where litigation had been instituted, aggregating over $6,000. The contract of sale provided in part as follows: 9. The Party of the Second Part agrees to and does hereby sell and turn over to the Parties of the First Part, as of the date of this Agreement, his said commercial law practice and agrees to faithfully use his best influence and endeavor to have transferred to the Parties of the First Part, in such manner as they may elect, his said representation in3397 said law and mercantile lists, which said lists are (A) "Guaranteed Attorneys List," published by the United States Fidelity & Guaranty Co., Baltimore, Maryland; (B) "The National List," published by National Surety Company of New York; (C) "The Clearing 1200 House Quarterly," published by the Attorneys National Clearing House, Minneapolis, Minnesota; (D) "Directory of Attorneys," published by the Wilber Mercantile Agency, Chicago, Illinois. 10. The Party of the Second Part shall turn over to the Parties of the First Part all open and unfinished claims and cases incident to his said commercial law practice, and, for so long as they may reasonably require the same, all his office files, records and registers relative thereto. All claims and cases so turned over pursuant to this agreement shall be properly noted on the said registers and records of the party of the Second Part. * * 12. During the continuance of this working agreement, the Party of the Second Part will not engage in the practice of commercial law in said Stamford incident to the receipt of claims or causes of action forwarded through the medium of commercial and law lists, except at the request of3398 the Parties of the First Part. Nor in any event shall the Party of the Second Part engage in such commercial practice in said Stamford for the period of 18 months from the date of this agreement, nor will he within said time, nor at any time during the continuance of this working agreement, endeavor to directly or indirectly obtain representation, without the consent of said Parties of the First Part, in any law or mercantile list and especially those referred to in paragraph 9 hereof. * * 24. * * * and the Party of the Second Part to accept, therefor the sum of $2,900.00 payable in manner following: The said five years' lease of said Room #4 and all and every of said other rights and privileges to said Party of the Second Part in the said offices of the Parties of the First Part as hereinbefore referred to and provided for, and in addition thereto the joint and several promissory notes of said Parties of the First Part for the sum of $1,000 bearing equal date herewith and payable two years after date, with interest at the rate of 6% per annum, payable semi-annually. 25. Should said Party of the second Part by required for reasons of ill health or otherwise to move from3399 said Stamford and so entirely retire from the practice of law in said community, thereby rendering said lease of said Room #4 and said other rights and privileges of no further use or value to him, the Parties of the First Part will repay to said Party of the Second Part the sum of $31.67 a month, as representing the reasonable value of the monthly rent of said premises, as hereinbefore agreed, for the unexpired term of said lease, * . The petitioner succeeded in transferring to Bartram & Meade the representation of the lists referred to in the contract. For the 5 years preceding March 1, 1913, the annual gross receipts from the petitioner's commercial law practice were as follows: 1908$2,054.5219091,712.6619101,472.3619113,842.0419121,834.8910,916.471201 The petitioner built up his commercial law practice over a period of about 20 years. Until 1917, he did the commercial law work himself, with the assistance of one and sometimes two assistants. From 1917 to 1920, he was abroad on government business. The petitioner apportioned about $500 of the total office expenses to the commercial law practice. The petitioner kept3400 his accounts and filed his income-tax returns for all years upon the basis of cash receipts and disbursements. OPINION. SIEFKIN: The issues in this proceeding are: (1) Whether the respondent erred in disallowing as deductions from gross income for the year 1919, items aggregating $1,796.41 claimed as bad debts ascertained to be worthless and charged off in 1919; (2) Whether the respondent erred in disallowing deductions from gross income for the year 1920, items aggregating $153.27, representing advances on behalf of clients and items aggregating $617.00 representing personal loans made between 1917 and 1920, claimed as bad debts ascertained to be worthless and charged off during 1920; and (3) Whether the respondent erred (a) in disallowing a deduction from gross income for 1921 of $7,000 claimed as a loss upon the sale in 1921 of a commercial law practice, and/or (b) in including in the petitioner's income the entire consideration of $2,900 received by him under the terms of said sale. (1) Section 214(a)(7) of the Revenue Act of 1918 provides: That in computing net income there shall be allowed as deductions: * * (7) Debts ascertained to be worthless and charged3401 off within the year. In , we held that the fact that debts were charged off in a particular year raises no presumption that they were ascertained to the worthless in the same year. In , we stated: Section 234(a)(5) of the Revenue Act of 1918 contemplates that before a taxpayer can charge a debt off and deduct it from gross income it must be determined to be worthless. That determination must be based upon facts. We are of the opinion that the evidence is not sufficient to establish worthlessness. The debts appear to have been charged off because a lawyer thought that collection thereof was doubtful, but the facts to justify such opinion are not before us. In , we held that where nothing occurred during 1921 to indicate that a debt was more uncollectible in 1202 that year than in previous years, no deduction may be had for the year 1921, although the debt was charged off in that year. In 3402 , we stated at page 578: The burden then is upon the petitioner to establish that it did make certain during the taxable year that the debts claimed as deductions were without value. We take it for granted that when Congress authorizes this Board to decide the issues arising between a taxpayer and the Commissioner in such a case as this, such taxpayer has not established the correctness of his contention by his bald statement that he believed it to be worthless, or that he ascertained it to be worthless or that, on undisclosed information he came to the conclusion that it was worthless. To so hold would be to put the Government in the hands of the taxpayer and substitute his judgment as to the conclusion to be drawn from the facts for that of the body created to decide the issue. Nor is it a question whether the taxpayer believed the debt to be worthless. To so hold would be to grant an undue advantage to the pessimist or to the taxpayer who made no investigation. In our opinion the burden upon the petitioner is to show what steps he took to collect the debt, what information came to his knowledge and what other circumstances3403 existed which led him to his conclusion. It then becomes the duty of the Board to determine whether the debt was in fact ascertained to be worthless within the meaning of the law. . In the instant proceeding the petitioner testified as to eleven of the items claimed as worthless debts, but no evidence was submitted to show when the debts were ascertained to be worthless, nor were the facts upon which such ascertainment was based presented in each case. Most of the debts were outstanding as of March 1, 1913, and it is not shown that they were more uncollectible in 1919 than in prior years. We must uphold the action of the respondent in disallowing the deduction for bad debts for the year 1919. (2) The petitioner claims as a deduction on account of bad debts for the year 1920, the amount of $153.27, representing advances made on behalf of clients during the years 1917 to 1920. The petitioner testified that they were charged off in 1920 because he was convinced that there was no chance of collecting them and that they were not large enough to warrant the bringing of suits for collection. 3404 In , we stated: The question for us is whether in fact the debts were ascertained to be worthless in the year claimed. Presumably the taxpayer thought they were or it would not have charged them off; but the mere repetition of the taxpayer's opinion does not prove that the charge-off was well founded. See also We must hold that no deduction is allowable for this item. 1203 Likewise, with regard to personal loans totaling $617 which the petitioner made in the years 1917 to 1920, the petitioner failed to show that the debts were ascertained to be worthless in the year 1920. With regard to one of the debts, the petitioner testified that he learned about 2 months after the loan was made that the debtor had, either a month before or a month after the loan was made, filed a petition in bankruptcy. Clearly, in this case, since the loan was made in December, 1920, the debt was not ascertained to be worthless in 1920. No deduction is allowable for this item. (3) The petitioner claims as a loss upon the sale of his business in 1921, the amount of $7,100. 3405 This is based upon his estimate that the March 1, 1913, value of his business was $10,000. Section 202(a) and (b) of the Revenue Act of 1921 provides: That the basis for ascertaining the gain derived or loss sustained from a sale or other disposition of property, real, personal, or mixed, acquired after February 28, 1913, shall be the cost of such property; except that - * * (b) The basis for ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, acquired before March 1, 1913, shall be the same as that provided by subdivision (a); but - (1) If its fair market price or value as of March 1, 1913, is in excess of such basis, the gain to be included in the gross income shall be the excess of the amount realized therefor over such fair market price or value; (2) If its fair market price or value as of March 1, 1913, is lower than such basis, the deductible loss is the excess of the fair market price or value as of March 1, 1913, over the amount realized therefor; and (3) If the amount realized therefor is more than such basis but not more than its fair market price or value as of March 1, 1913, or less*3406 than such basis but not less than such fair market price or value, no gain shall be included in and no loss deducted from the gross income. The petitioner has offered no evidence as to the cost of the business, nor is there any satisfactory evidence as to the March 1, 1913, value thereof. The evidence introduced as tending to show a March 1, 1913, value consists of earnings prior to that date, meager in amount and uncertain as to source, i.e., to what extent the personality of the petitioner entered into such earnings. No basis for the determination of gain derived or loss sustained upon the sale having been shown, the disallowance of a loss by the respondent is approved. See . The March 1, 1913, value of the business not being shown, the inclusion by the respondent of the entire amount of the sales price in income for 1921 is approved. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619377/	Estate of Caroline C. Wells, Deceased, by Edward D. Stannard, Henry H. Wells, and Frank Wells McCabe, Executors v. Commissioner.Estate of Wells v. CommissionerDocket No. 110674.United States Tax Court1943 Tax Ct. Memo LEXIS 200; 2 T.C.M. (CCH) 446; T.C.M. (RIA) 43340; July 10, 1943200 Robert C. Poskanzer, Esq., for the petitioner. Walt Mandry, Esq., for the respondent. LEECH Memorandum Opinion LEECH, Judge: Respondent has determined a deficiency in gift tax of the decedent, Caroline C. Wells, for the year 1938 in the sum of $3,058.49. The issue is whether a transfer in trust by decedent in 1938 for the benefit of six grandchildren constituted gifts of future or present interests in property. [The Facts] We find the facts as stipulated. Briefly these are that the decedent died a resident of Brewster, New York. Her return for the year here involved was filed with the collector for the Fourteenth District of New York at Albany, New York. On April 2, 1938 the decedent executed an indenture of trust, conveying to trustees property of a value of $32,026.88. The provision of the trust instrument pertinent to the question here presented reads as follows: FIRST: To invest and reinvest the same, and from time to time change the investments of said principal sum, and to receive the rent, issues and profits, and income therefrom derived, and to pay therefrom the expenses of investments, taxes, assessments, insurance and all other necessary and proper charges and 201 expenses incurred during the lifetime of my two youngest grandchildren, VIRGINIA WELLS and FRANK WELLS or the survivor, or until the survivor of them shall have reached the age of twenty-seven years, and to apply such net income and such portion of the principal as my said trustees shall deem proper in their discretion for the education, support and maintenance during said education of the children of my son Henry H. Wells, to wit: TOMLINSON WELLS, ALFRED W. WELLS, HENRY H. WELLS. JR., HOWARD CROSBY WELLS, VIRGINIA WELLS and FRANK WELLS, such education to include School, College, Professional and Cultural education. In the event that my said two youngest grandchildren VIRGINIA WELLS and FRANK WELLS, or the survivor of them shall die before reaching the age of twenty-seven years I direct that any balance of said trust fund that may not have been applied as hereinabove provided, shall be paid by my said Trustees to my son HENRY H. WELLS if he be living at that time, and if my said son HENRY H. WELLS, shall not be living at that time, I direct that my said Trustees pay said balance to my daughter-in-law, CAROLINE W. WELLS, in the expectation that such balance or so much thereof as may202 be necessary shall be used for the education of the surviving children of my said son Henry H. Wells and his said wife. In the event that any of said fund shall remain at the time that the survivor of my two youngest grandchildren shall have reached the age of twenty-seven years, I direct that any such balance shall be distributed as follows: I direct my trustees to pay one-half of said balance to my said son Henry H. Wells. In the event that my said son, Henry H. Wells shall not be living at that time I direct that my said Trustees pay said one-half of said balance to my daughter-in-law, CAROLINE W. WELLS. In the event that both my said son, Henry H. Wells, and my daughter-in-law, Caroline W. Wells, shall not be living at the termination of this Trust, as hereinabove provided, I direct that said one-half of such balance be distributed equally among the surviving children, the issue of deceased child or children taking the share its or their parent would have received if living. I direct that the remaining one-half of said balance be distributed equally among my grandchildren, LOUISE CROSBY O'BRIEN, FRANK WELLS McCABE, AMBROSE CHURCH McCABE, and LYMAN SPALDING McCABE, the children203 of my deceased daughter, Pauline Wells McCabe, the issue of any deceased child or children taking the share its or their parent would have received if living. On the date this trust was created the eldest of the six beneficiary grandchildren, Tomlinson Wells, was 24 years of age, and the youngest, Frank Wells, was 8 years of age. The decedent filed a gift tax return for 1938 in which she reported the aforementioned gifts and also a gift to her son, Henry H. Wells, and took thereon seven exclusions of $5,000 each, six of these being upon the gifts in trust to her grandchildren. Respondent in determining the deficiency disallowed the aforesaid six exclusions upon the ground that these gifts in trust were of future interests in property with respect to which exclusions were not permitted by section 504(b) of the Revenue Act of 1932. In the 5 years from 1938 to 1942, inclusive, the income from the trust corpus amounted to $9,659.09. During those years the trustees expended all of the income together with $10,665.89 of the trust corpus, or a total of $20,324.98, for expenses of education of Alfred W. Wells, Henry H. Wells, Jr., Howard Crosby Wells and Virginia Wells. No expenditures 204 were made with respect to Tomlinson Wells or Frank Wells. [Opinion] Petitioner contends that the transfer in trust was of six present interests in property on which the decedent was entitled to six exclusions of $5,000 each. It is insisted that paragraph "FIRST" of the trust agreement reading " * * to apply such net income and such portion of the principal as my said trustees shall deem proper in their discretion, etc." should be construed as limiting the discretionary powers of the trustees to the question of whether or not corpus should be invaded. Upon this premise it is argued that as to the income of the trust fund the six beneficiaries had a right to immediate payment for their benefit and, consequently, present interests. Attention is called by petitioner's counsel to the decision of the Circuit Court of Appeals for the Eighth Circuit in , which is urged as a correct application of the law to the facts. In the Smith case, supra, we had held () conveyances to an education trust for the benefit of four of the settlor's grandchildren, under 205 conditions in some respects similar to those here involved, to be gifts of future interests. Our decision was reversed by the Eighth Circuit. With all due respect, however, to that court we do not admit error in our view of that case. In this connection we note that the Ninth Circuit in , has expressed its doubt as to the correctness of the Ninth Circuit's decision in the Smith case, supra, as resting "on an insecure foundation." Aside from this moreover, the conditions attached to the gifts here are, we think, radically different from those in the Smith case. In the later case the corpora of the two trusts were directed in each instance to be held by the trustees "in equal, undivided portions" for the designated beneficiaries and anything remaining of any such portion, after expenditures in the discretion of the trustees for the education of the beneficiary for which it was held, was to be paid over to such beneficiary on reaching a certain age. Under such facts there was at least ground for argument, that a certain definite sum having been given each beneficiary, which was available for immediate206 use for his or her benefit, it constituted in each case a present interest the value of which could then be computed. Here, however, we have a different situation. The fund transferred in trust is not to be held in equal portions for the several beneficiaries. It is merely provided that it may be spent in the discretion of the trustees for the education of the beneficiaries. There is no provision that the beneficiaries share equally in the disbursements. Any part of the fund remaining after the death of the survivor of the two younger of the beneficiaries or upon the younger of those two reaching 27 years of age was to go to the settlor's son. Both the fact and the aggregate value of the gift of all of the beneficiaries of the trust, including the remaindermen, were stipulated. Our problem is to determine whether the primary gifts to each of the six grandchildren were of present or future interests and, if present, to segregate the value of each for the purpose of applying the exclusion under section 502(b) of the Revenue Act of 1932. If the construction of the trust instrument advocated by counsel for petitioner were correct, the income would have to be applied in equal portions207 for each of the six beneficiaries. No one of them would be entitled to receive more than another. In fact, only if such were the case would it be possible to compute a separate value for the gift to each child. If the trustees in the exercise of their discretion might spend twice as much of the income on education of one child as on another or none of it at all on some of the beneficiaries, then it is evident that no basis exists upon which a value could be computed for the interest of a beneficiary, whether present or future, and no exclusion would be allowable. ; ; ; . That this is the construction placed by the parties on the instrument is unquestionable. In the 5 years following the gift in trust the trustees have expended all of the income in each year, together with a large amount of the corpus. All of these expenditures have been for the benefit of only four of the six beneficiaries and the expenditures for 208 these particular four beneficiaries vary greatly in amount. We conclude that none of the six beneficiaries took a present interest, determinable in amount, under the transfer in trust. Their enjoyment of either income or principal was dependent upon the exercise of the discretionary powers vested in the trustees. ; ; . Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619379/	APPEAL OF GEORGE E. CRANE CO., INC.George E. Crane Co. v. CommissionerDocket No. 142.United States Board of Tax Appeals2 B.T.A. 567; 1925 BTA LEXIS 2336; September 9, 1925, Decided Submitted June 9, 1925. 2336 Ernest L. Riley, C.P.A., for the taxpayer. Ward Loveless, Esq., for the Commissioner. 567 Before GRAUPNER, TRAMMELL, and PHILLIPS. The above-entitled appeal is from the determination of a deficiency in income and profits taxes for the calendar year 1918 in the amount of $1,965.55. The deficiency results from the denial by the Commissioner of personal service classification to the taxpayer. FINDINGS OF FACT. 1. The taxpayer is a California corporation organized in 1905 and doing business in the City of Stockton. 2. The taxpayer is engaged in the business of buying and selling real estate for clients, collecting rents, doing a general insurance brokerage business, acting as financial agent, and loaning money for clients. 3. George E. Crane and W. E. Washington were the owners in equal shares of all of the capital stock of the taxpayer during the year 1918, excepting two shares which were held in the name of a bookkeeper of the taxpayer for the purpose of qualifying him as a director. Crane and Washington devoted their full time to the business of the taxpayer and acted as managers and salesmen. There were three employees of the taxpayer. 2337 The earnings were distributed equally between Crane and Washington at the end of each year. 4. The balance sheet shows the following to be the assets, liabilities, and capital of the taxpayer as of December 31, 1917, and December 31, 1918: Dec. 31, 1917Dec. 31, 1918ASSETSCurrent:Cash on hand$87.51$20.04Cash in banks88,062.8218,379.16Accounts receivable (insurance premiums)1,296.775,291.07Notes receivable4,616.4638,698.40Notes receivable (W. A. Washington)5,000.0022,500.00Notes receivable (Geo. E. Crane)2,500.00Advances (Geo. E. Crane)8,153.72Advances (W. A. Washington)7,665.18Revenue Stamps15.232.64Inv. beans (taken in as commission)1,545.18Union Island Farm33,293.24Deposits (overdrawn)3,882.055,080.55Total137,799.26108,290.76Fixed assets:Furniture and fixtures$1,281.07$1,152.97Stocks11,477.8411,613.65Jones property344.41344.41Newell block279.89279.89Smith-Gould property539.53539.53Total13,922.7413.930.45Total assets151,722.00122,221.21LIABILITIES AND CAPITALCurrent liabilities:Suspense300.00Demand deposits and collections118,933.7972,421.21Notes payable27,000.00Notes payable (Geo. E. Crane)7,500.00Accounts payable (Geo, E. Crane)1,624.50Accounts payable (W. A. Washington)563.71Total128,922.0099,421.21Capital - capital stock 122,800.0022,800.00Total liabilities and capital151,722.00122,221.212338 568 5. In support of its contention that its principal income resulted from the personal service of the stockholders the taxpayer has tabulated its income for 1918, as follows: Amount.Percentage of income.Selling price of beans taken as commission over market value Dec. 31, 1917$247.171.04Commissions, attorneys' fees, etc11,702.1849.50Commission and profit, Brandt & Knomann deal9,793.1141.42Interest received$3,973.63Less interest paid2,695.381,278.255.41Dividends received621.502.63Total gross income23,642.21100.006. During 1918 taxpayer received authorization from Brandt & Knomann to purchase for them a ranch known as the Nichol ranch, it being agreed that Brandt & Knomann would pay $175 per acre and that the taxpayer was to make its commission from the seller. The taxpayer purchased the property for approximately $9,000 less than Brandt & Knomann had agreed to pay, representing its profit on the transaction. It held title to the property for some time, until the tenants on it were dispossessed. The transaction was financed by funds borrowed2339 by the taxpayer. DECISION. The determination of the Commissioner is approved. ARUNDELL not participating. Footnotes1. Includes stock dividend of $2,100 par value. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619380/	Yeast Products, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentYeast Products, Inc. v. CommissionerDocket No. 28926United States Tax Court21 T.C. 308; 1953 U.S. Tax Ct. LEXIS 16; November 30, 1953, Promulgated 16 Decision will be entered under Rule 50. 1. Excess Profits Tax -- Sec. 722 (b) (4) Relief -- Constructive Average Base Period Net Income. -- Petitioner filed timely applications and related claims for refund for the taxable years 1943 and 1944, seeking relief under section 722 (b) (4) by reason of having commenced business during the base period. Held, that petitioner's business commenced in 1938 did not reach, by the end of 1939, the earning level it would have reached had it commenced business 2 years earlier. The amount of petitioner's constructive average base period net income determined and relief granted.2. Excess Profits Tax Credit Carry-Over. -- Held, the so-called "variable credit rule" is applicable in computing an unused excess profits credit adjustment from the year 1941. Nielson Lithographing Co., 19 T.C. 605">19 T. C. 605, followed. Richard P. Jackson, Esq., Alex Schlaffer, Esq., and William B. Van Buren, Esq., for the petitioner.Maurice S. Bush, Esq., for the respondent. Hill, Judge. HILL 308 This proceeding involves the respondent's disallowance of the petitioner's applications for excess profits tax relief under section 722, Internal Revenue Code, and the related claims for 17 refund of excess profits tax in the amounts of $ 23,690.87 and $ 60,823.73 for the taxable years 1943 and 1944, respectively. The applications for relief, Form 991, for the taxable years 1943 and 1944, were duly filed by petitioner on June 15, 1944, and March 15, 1945, respectively. In his notice of disallowance, respondent also determined deficiencies in excess profits tax for the years 1943 and 1944 in the respective amounts of $ 11,668.64 and $ 4,992.24, the payment of which was deferred under Code section 710 (a) (5).The primary questions presented are, whether petitioner is entitled to excess profits tax relief for the taxable years under Code section 722 and more specifically whether petitioner is entitled, under 309 the push-back rule of section 722 (b) (4), to use a constructive average base period net income and, if so, the amount thereof in determining its excess profits tax credit for the taxable years. In the alternative petitioner claims general relief under section 722 (b) (5). There are also involved for the taxable years the questions of petitioner's unused excess profits credit adjustments for carry-overs and carry-backs.The proceeding was heard before Hugh G. Postles 18 as a commissioner designated for that purpose by the Court. Objections filed by the parties to the report of the commissioner have been carefully considered.A previous opinion in this proceeding was promulgated on September 10, 1953. That opinion was reconsidered in response to a motion of the petitioner herein and such opinion was vacated on October 9, 1953.FINDINGS OF FACT.The petitioner is a New Jersey corporation with principal office and place of business in Paterson, New Jersey. It was incorporated on January 14, 1938, and commenced business in May 1938.The petitioner's returns for the taxable years involved were filed with the collector of internal revenue for the fifth district of New Jersey. The petitioner filed timely applications for relief, Form 991, under Code section 722 and related claims for refund, Form 843, of excess profits tax for the years 1943 and 1944. In its applications for relief, petitioner claims qualifying factors for relief primarily under section 722 (b) (4) by virtue of having commenced business during the base period and also for general relief under section 722 (b) (5). Respondent disallowed the claims for relief and refund and determined that 19 petitioner's excess profits tax credit should be computed on the invested capital basis, amounting to $ 4,896 for each of the taxable years 1943 and 1944.The petitioner was organized by Raymond C. Foster and Francis G. Zick who became president and vice president, respectively, and directors of that company. The petitioner issued for cash 1,000 shares of preferred stock for $ 100 per share and 1,000 shares of common stock for $ 1 per share. Its stockholders, in addition to Foster and Zick, included among others a pharmaceutical company and some of its officers and employees, and certain officers of an eastern brewery company.The purpose of organizing petitioner, more particularly hereinafter stated, was the collection of waste yeast or beer "slurry," from breweries for the purpose of processing therefrom several brewers' yeast products.310 Brewers' yeast is a particular strain of yeast used to induce alcoholic fermentation in making beer. The yeast, an aggregate of minute unicell organisms, grows and multiplies so long as there is substance to feed on and in the course of the fermenting action the yeast originally put into the brewing vat triples in quantity. After the beer is siphoned 20 from the brewing vat the floor of the vat is covered with a residual, thick, muddy solution called "slurry," consisting principally of brewers' yeast but also containing hop particles and resins and other solids which make the yeast very bitter. During the 1930's most of the breweries in this country considered slurry to be a waste byproduct which was washed down the sewer. However, it was generally known that in several European countries, particularly Germany, slurry had been processed as dried brewers' yeast for human consumption because of its nutritional value.In the early 1930's Anheuser-Busch, Inc., a large midwestern brewery which sold certain grain and other byproducts to animal and poultry feed industries, instigated experimentation with dried slurry for feed purposes. The dried slurry, called feed yeast, was found to be such a potent fortifier in feeds, that a great demand was immediately created. Anheuser-Busch, Inc., had the Buffalo Foundry Company build and install drying machinery designed to dry the wet slurry so as not to leave any live yeast cells and yet not kill the vitamin potency of the product. Prior to 1936 Anheuser-Busch, Inc., was producing from 650 to 21 750 tons of dry feed yeast per annum which was only a fraction of the demand. It still had large quantities of waste slurry but found it uneconomical to install additional drying machinery. Up to and including 1939, Anheuser-Busch, Inc., made a sustained effort to interest other concerns in processing dried feed yeast for sale to it as the principal distributor of that product to the feed industry.During the early 1930's and after the beneficial effect of feed yeast in animal and poultry feed had been established, various laboratories conducted research to analyze brewers' yeast from slurry to identify the vitamins therein, and it was found that brewers' yeast was one of the richest natural sources of vitamin B complex in that it contained all of the then known B vitamins plus several unknown elements. Anheuser-Busch, Inc., and also the Pabst Brewing Company began processing slurry for recovery of the yeast and debittering and drying it for sale to pharmaceutical houses for use in products for human consumption.In 1934 Pabst Brewing Company employed Foster to direct sales of several products it was developing, including brewers' yeast. Foster, a graduate of Massachusetts Institute 22 of Technology, had theretofore had years of experience with the Borden Company in charge of 311 sales of specialty products, including malted milk and dry skim milk, throughout the United States. In 1934, in addition to drying slurry as feed yeast, Pabst had devised methods of recovering the yeast, free of hop particles and other impurities, and debittering it to a point where it was reasonably palatable. At the time Foster was employed Pabst was looking for sales outlets for debittered dried brewers' yeast, principally to pharmaceutical companies because of the growing interest in vitamin B complex. During 1935 and 1936 dried brewers' yeast was used for the production of yeast tablets generally sold throughout the country, but the vitamin potency per tablet was low and a large dosage was necessary. During those years several pharmaceutical companies, including Upjohn Company, were experimenting with processes to extract from debittered dried brewers' yeast a vitamin B complex concentrate as an ingredient in certain pharmaceutical preparations. By 1937 Pabst was making debittered brewers' yeast at both of its breweries at Milwaukee and Peoria and its entire production was being sold 23 to Upjohn for extraction of vitamin B complex concentrate. In 1936, due to lack of sufficient production facilities, Pabst refused an offer from certain Japanese interests to purchase annually about $ 85,000 worth of dried brewers' yeast. Foster discussed the problem with the Japanese who were concerned with the possibility of not getting a sufficient supply of dried brewers' yeast from Germany. In his work with Pabst, Foster became acquainted with employees in and the use of yeast by various pharmaceutical companies and, also, he became quite aware of the widespread and growing demand for dried brewers' yeast.In 1933 Upjohn Company employed Zick in its research department. Zick, a biological chemist, had several prior years' experience in laboratory and experimental work along various lines, including dried foods and irradiated substances. He was also experienced in making biological assays, that is, using rats or other animals in testing various substances. His first work for Upjohn was solving a problem of drying a syrupy maltose baby food, to meet competition and improve sales.In 1934 Upjohn had developed and was using in certain preparations a water extract concentrate from 24 yeast, but it had not proved wholly satisfactory in stability or potency. In addition Upjohn had on the market a capsule known as "A B D G Compound," in which the yeast concentrate component was bought from Anheuser-Busch, but the compound leaked through the capsule. At about that time Upjohn and other pharmaceutical companies were making considerable progress in isolating and synthetizing certain vitamins, but Upjohn needed a good concentrate of vitamin B complex from natural sources to meet certain requirements.312 Sometime in or about 1934 Upjohn placed Zick in charge of experimenting with the extraction of vitamin B complex concentrate. In the course of his study and testing of known data Zick found that a rice polish vitamin B complex on the market did not contain all of the B vitamins and was known to form a gas which exployed sealed containers; that certain clay absorbate vitamins on the market were wholly unsatisfactory because of the clay element; and that the water extract from yeast was not satisfactory because some B vitamins were not soluble in water and thus would not filter, also, it was unstable and when purified lost potency. Using Pabst's debittered dried brewers' 25 yeast, Zick ran a full B complex assay to determine its vitamin content and then tackled the problem of extracting a B complex concentrate from debittered dried brewers' yeast.Zick did considerable pioneer research work to develop the optimum point of solubility and filtration of all the then known vitamins in yeast, together with stability and maximum potency of the extraction. In 1936 Zick perfected a laboratory method of producing the desired B complex concentrate which showed good results, first in biological assays and then in certain hospital tests on humans. Thereupon Upjohn determined to go into the production of a vitamin B complex concentrate extracted from debittered dried brewers' yeast. Zick helped to design the necessary machinery ordered by Upjohn from the Buffalo Foundry Company, supervised the installation, and was in charge of the operation until it was running smoothly. Thereafter he went back to research and experimented with capsulating vitamin products. During the period 1936 to 1937 Upjohn sold vitamin B complex concentrate tablets and the demand was so great that Upjohn, through Foster, purchased all of Pabst's production of debittered dried brewers' yeast. 26 In 1937 Upjohn sent Zick to various parts of this country and Canada to try to obtain additional sources of supply of debittered dried brewers' yeast, but the breweries he visited were not interested in saving slurry and producing debittered yeast.In the latter part of 1937 and in view of the growing demand for dried brewers' yeast and B complex concentrates for human consumption, Foster became interested in starting a business to produce those products from slurry. He was also interested in producing feed yeast. His survey of the field indicated that the vicinity of New York constituted the best location. It was close to a supply of raw material because many breweries in that area were throwing away their slurry. In addition numerous pharmaceutical companies were located east of the Mississippi. Foster made arrangements to buy slurry from Ruppert Brewery and Ballantine Brewery. He then interested Zick in the enterprise as the technical man to manage production. Zick found a suitable plant site in Passaic, New Jersey, in an abandoned 313 paper mill which had sufficient floor space and was located near an ample supply of steam. The latter was vitally necessary in the production methods 27 to be used.The petitioner was organized in January 1938 primarily for the purpose of producing, from slurry, both debittered and non-debittered dried brewers' yeast and, both dry and liquid vitamin B complex concentrates, for sale to pharmaceutical companies. There was a then existing demand and a large potential market for such products. Petitioner's secondary purpose was to produce feed yeast (dried slurry) as a means of using up any excess supply of slurry and of keeping the employees busy when otherwise they might be idle. The demand for feed yeast greatly exceeded the then existing supply but the anticipated margin of profit thereon was small.Zick designed and ordered the necessary equipment from the Buffalo Foundry Company. He laid out and supervised the plant installations primarily for the production of debittered yeast and concentrates, those being the products with which he was most familiar. Based on his experience at Upjohn, Zick designed the plant equipment for an estimated production capacity per annum of approximately 1,400,000 pounds of debittered yeast with equipment located in one room and 110,000 pounds of dry concentrate with separate equipment in another room. 28 The debittered yeast required additional processing as compared with non-debittered yeast. The dry concentrate required a drying process applied to liquid concentrate. Zick's experience at Upjohn was that in extracting B complex vitamins from yeast, the yield in pounds of dry concentrate amounted to approximately 15 per cent of the quantity in pounds of dried brewers' yeast used as the basic ingredient. The estimated production capacity was on a basis of three 8-hour shifts a day for a 6-day week throughout the year. The production methods were such as to require 24-hours-a-day operations and each shutdown necessitated a thorough cleaning of the equipment. In planning the petitioner's plant capacity Zick and Foster took into consideration their knowledge that Upjohn was then paying Pabst 23 cents a pound for debittered yeast used as the raw material for making concentrates, and was charging itself $ 2.03 a pound for its concentrates over and above costs and various interdepartmental expenses, including assays. Throughout the periods involved Zick was in charge of production, assay, and experimentation work and Foster was the general manager and in charge of sales.The petitioner's 29 plant was sufficiently equipped to commence operation in May 1938 and with the purchase of centrifuges, mixers, and additional tanks in June 1938 the plant was fully equipped for all purposes for which it was designed. At all times material here the petitioner's machinery and equipment remained essentially the same except 314 that in August 1939 it purchased an additional filter press used in making concentrates. The petitioner had tank trucks for hauling slurry from the breweries and slurry-holding tanks for storage prior to processing. The plant had a drying and centrifuge room wherein debittered and non-debittered yeast (including feed yeast) were produced. The equipment in that room included, inter alia, one atmospheric dryer, a pulverizer, a vibrating screen, centrifuges, mixers, wooden and copper tanks, and various pumps. The atmospheric dryer was used for all products made in the drying and centrifuge room and thus was a controlling factor in the total production capacity of that room. The plant had a separate concentrating room for the production of liquid and dry concentrates and the equipment in that room included, inter alia, one 1,000-gallon copper cooker and condenser, 30 filter presses, one 200-gallon-an-hour vacuum pan and condenser with vacuum and centrifuge pumps and condensate tank, one alcohol recovery column with pumps and tanks, one agitator, a reciprocating vacuum pump, several closed copper tanks, and one single drum vacuum dryer and condenser. All the equipment in the concentrating room was used in producing both liquid and dry concentrate. The use of the single drum vacuum dryer was the most prolonged operation, the waiting period for complete dehydration in making dry concentrates, and thus that piece of equipment was a controlling factor in the total production capacity of the concentrate room.The petitioner's methods of production of its various yeast products were, briefly, as follows:Feed yeast was simply dried slurry. From the holding tank slurry was pumped directly to the preheater and then to the atmospheric dryer which evaporated the liquid. The end product was a flaky substance consisting of brewers' yeast and hop particles, bitter resins and beer solids. The dried slurry, called feed yeast, was packed in bags for shipment. It was the only product made for use in animal and poultry feeds. All of petitioner's other yeast products 31 were for human consumption.Non-debittered yeast was processed from slurry. The slurry from the holding tank was screened to remove hop particles, beer solids, etc. and then pumped to the preheater and atmospheric dryer. The end product was a very bitter dried brewers' yeast, either in flaky or pulverized form, which was packed for shipment.Washed or ironized yeast was processed from slurry. The slurry, from the holding tank, was screened to remove hop particles, beer solids, etc. and then washed so as to recover as nearly as possible a 100 per cent pure yeast solution which was then pumped to the preheater and the atmospheric dryer. The process removed only a little of the bitter taste. The end product was a non-debittered dried 315 brewers' yeast, either in flaky or pulverized form, which was packed for shipment. That product was also used by petitioner for processing a non-debittered concentrate.Debittered yeast was processed from slurry. The slurry, from the holding tank, was screened to remove hop particles, beer solids, etc. The yeast liquid was then pumped to a mixing tank where a certain alkaline was added and then pumped to a centrifuge which separated liquids from yeast solids. 32 That mixing and centrifuging process was repeated until the bitter taste was thoroughly removed. The debittered yeast liquid was pumped to storage tanks and then to the preheater and the atmospheric dryer. The end product was debittered dried brewers' yeast, either in flaky or pulverized form, which was packed for shipment. That product was also used by petitioner for processing debittered concentrates.Yeast concentrate was processed from dried brewers' yeast (either debittered or non-debittered) derived from slurry in petitioner's own plant, or, from dried primary brewers' yeast purchased from suppliers of that product. The primary yeast, which was cultured or grown, was free of any bitterness. The production unit was called a "C" batch, denoting the concentrate produced from a certain quantity of yeast used as the basic ingredient. Measured quantities of yeast and water were placed in a cooker and after cooking at a specified temperature the yeast was cooled in a storage tank. An alcohol solvent was then added and after standing for a period of time the yeast and alcohol solution was put through a filter press. The resulting filtrate, containing the extracted vitamins, went 33 into a holding tank. The filtrate was pumped into a heated vacuum pan causing evaporation of a portion of the alcohol solvent and producing a liquid concentrate. The evaporated solvent passed off to a distillate receiver for recovery of the alcohol. Depending upon a customer's specifications, the liquid concentrate was put through the vacuum dryer for additional evaporation and concentration in liquid form and/or was mixed as a syrup before packaging for shipment. To produce a dry concentrate the liquid concentrate from the vacuum pan was completely dehydrated in the vacuum dryer and the resulting flaky or powdered concentrate was packaged for shipment.Under actual operating conditions during the last quarter of 1939, the maximum production capacity of petitioner's plant was dependent upon factors involving the quantities of various products produced. The approximate maximum capacity of the drying and centrifuge room was controlled by the capacity of the atmospheric dryer which was either 1,440,000 pounds of non-debittered yeast (including feed yeast) or 1,350,000 pounds of debittered yeast. Accordingly, the use of the dryer had to be allocated between the production of non-bittered 34 and debittered yeast products. The approximate maximum capacity 316 of the concentrate room was either 110,500 pounds of dry concentrate or 37,500 gallons of liquid concentrate and the use of the equipment in that room had to be allocated between the production of liquid and dry products.At all times herein material the petitioner purchased slurry from breweries under agreements requiring it to take all the slurry contracted for, whether or not used in petitioner's production. The price paid by petitioner for slurry was on the basis of a unit price of 2.8 cents per pound of yeast solids contained therein. During 1938 Zick found that the Ruppert Brewery slurry could not be successfully debittered and an additional supply of slurry was obtained from other brewers. At all times material here petitioner had an ample supply of slurry to meet its needs and overall production capacity. Slurry obtained from Ballantine Brewery and Schaffer Brewery debittered satisfactorily, except that the different batches would not always debitter to a uniform degree. That factor was immaterial in the production of some concentrates, but presented a problem where thoroughly debittered dry concentrates were 35 ordered by customers. Some time during 1939 petitioner started making concentrates with primary brewers' yeast as the basic ingredient because it contained no bitters and resulted in a uniform product, which contained the same vitamin B complex as concentrates produced from brewers' yeast recovered from slurry. Furthermore, there was a loss of 25 per cent of the yeast content of slurry in the centrifuging process of thoroughly debittering yeast for use in concentrates, while there was no such loss in the use of primary yeast.From May to the end of 1938 and during most of 1939, petitioner was actually going through a stage of development of both its products and markets. Foster called on various pharmaceutical concerns which were very much interested in petitioner's yeast products, as a needed additional source of supply, or as a new product, or as a better substitute for a vitamin product then in use, such as rice polish. However, each concern made its own assay for potency, stability, etc. of petitioner's samples. Then each concern made its own specifications, particularly as to concentrates, depending on its ultimate use of the product in pharmaceutical preparations. That resulted 36 in time-consuming operations by petitioner in experimentation and assay work to produce acceptable tailormade sample products, because a complete assay, using rats, required a period of 6 to 8 weeks. In numerous instances there was a lapse of several months between the time Foster first approached a pharmaceutical company and the receipt of an order for a specialized yeast product. In the meantime rejected products represented a considerable waste in materials and costs. During 1938 Zick found that at the start of a "C" batch of concentrate he could not put more than 300 pounds of yeast in the cooker because of excessive 317 foaming and thus the end product of about 15 per cent of the basic ingredient was limited to about 45 pounds of dry concentrate. Prior to the end of 1939, through the use of de-foamers and other controls, Zick could start a "C" batch with 400 pounds of yeast in the cooker and produce therefrom about 60 pounds of dry concentrate. That speeded up production. Also, prior to the end of 1939 Zick developed a new chemical assay method for determining the vitamin content and potency of his concentrates within 5 or 6 hours, which saved waste and greatly speeded production 37 of samples according to specifications of customers and prospective customers. Furthermore, under the Federal Food and Drug Act, petitioner was required to accurately label the contents of its products for human consumption.The petitioner had a net operating loss of $ 21,356.23 for 1938 and of $ 44,539.81 for 1939. The petitioner's balance sheets at the end of those years were as follows:ASSETS19381939Cash$ 9,748.04 $ 1,511.43 Accounts receivable879.10 1,523.15 Inventories22,314.47 16,839.36 Depreciable assets51,806.38 57,978.16 Less reserve for depreciation(2,313.84)(9,145.06)Other assets:Organization expenses523.26 523.26 Prepaid expenses1,602.97 671.84 Security deposit50.00 50.00 Total assets$ 84,610.38 $ 69,952.14 LIABILITIESAccounts payable$ 888.40 $ 13,342.24 Notes payable3,248.68 300.00 Accrued expenses350.53 526.94 Capital stock:Preferred stock100,000.00 120,000.00 Common stock1,000.00 1,200.00 Surplus (deficit)(20,877.23)(65,417.04)Total liabilities$ 84,610.38 $ 69,952.14 The petitioner's total net sales during each month of 1938 and 1939 were as follows:19381939January$ 1,099.80February1,319.12March7,895.60April4,066.75May7,001.00June$ 246.008,620.41July561.005,868.00August$ 5,492.35September$ 88.806,447.25October182.683,541.25November418.808,135.37December186.006,799.00Totals$ 1,683.28$ 66,225.90318 38 During 1938 and 1939 petitioner's principal customers and its sales, in quantity and dollar amount as to each product, were as follows:19381939CustomerQuantityDollar amountQuantityDollar amountFeed YeastAnheuser-Busch, Inc., St.260,000 lbs.$ 19,200.00Louis, Mo.Non-Debittered YeastIronized Yeast1,350 lbs.$ 186.00180,000 lbs.$ 18,955.00Laboratories,Atlanta, Ga.Sundry customers150 lbs.30.884,655 lbs.523.351,500 lbs.$ 216.88184,655 lbs.$ 19,478.35Washed or Ironized Yeast (non-debittered)Chocolate Products,Chicago, Ill.10,475 lbs.$ 1,245.00Ironized Yeast500 lbs.70.00Laboratories,Atlanta, Ga.Sundry customers300 lbs.36.0011,275 lbs.$ 1,351.00Debittered YeastBakon Yeast, Inc., New1,005 lbs.$ 200.00York, N. Y.Purity Drug Co., Passaic,1,125 lbs.$ 315.004,050 lbs.1,149.75N. J.Upjohn Co., Kalamazoo,2,900 lbs.713.4050,850 lbs.11,700.30Mich.Sundry customers375 lbs.123.004,018 lbs.1,098.884,400 lbs.$ 1,151.4059,923 lbs.$ 14,148.93Non-Debittered Yeast ConcentrateGelatin Products Co.,Detroit, Mich.150 lbs.$ 377.001,500 lbs.$ 2,000.00Debittered Yeast Concentrate (#380)Burroughs Wellcome Co.,Tuckahoe, N. Y.2,526 lbs.$ 10,104.00Sundry customers25 lbs.103.002,551 lbs.$ 10,207.00Liquid Concentrate (S-100 Syrup)Sharp & Dohme, Inc.,Philadelphia, Pa3 1/2 gals.$ 70.00Sundry customers1/4 gal.6.253 3/4 gals.$ 76.25Liquid Concentrate (S-50 Syrup)Purity Drug Co., Passaic,N. J.98 1/2 gals.$ 723.75Miscellaneous ProductsSundry customers$ 61.00Gross sales of all products$ 1,745.28$ 67,246.28Less returns andallowances62.001,020.38Net sales$ 1,683.28$ 66,225.9039 319 The petitioner's sales prices were fixed on a basis of the existing market prices and a consideration of the amount of processing involved in each product. The liquid concentrates involved specified formulas and varying degrees of concentration. The petitioner's prices on its products varied to some extent during 1938 and 1939, but its basic prices on certain products to principal customers in 1939 were approximately as follows:Feed yeast7 1/2 cents per poundNon-debittered yeast10 1/2 cents per poundDebittered yeast23 cents per poundDebittered dry concentrate$ 4 per poundLiquid concentrates$ 6 and $ 20 per gallonDuring 1939, the first full year of operations, the petitioner's costs of materials used were approximately 2.8 cents per pound for non-debittered yeast including feed yeast; 4 cents per pound for debittered yeast; $ 2.05 per pound for dry concentrates; and $ 4.50 per gallon for liquid concentrates. During that year the petitioner's gross sales, material costs, factory costs, deductions, and net loss, in round figures, were as follows: 320 Gross sales$ 66,226 Material costs140 $ 43,215Factory costs:Trucking$ 5,251Labor11,537Power2,054Water1,046Steam6,293Insurance325Assay cost2,064Miscellaneous1,470Supplies2,445Total factory costs2 32,485Total cost of sales75,700 Gross profit or (loss)($ 9,474)Deductions:Compensation of officers$ 18,333Office salaries720Rent2,490Repairs2,015Bad debtsTaxes1,535Depreciation6,831Other deductions3 2,940Total deductions34,864 Net income or (loss)($ 44,338)In December 1939 Anheuser-Busch, Inc., offered to contract with petitioner to purchase 80 tons of feed yeast per month at the prevailing price of 7 1/2 cents per pound. In the same month petitioner agreed to supply as much feed yeast as it was able to produce but not in excess of 60 tons (120,000 pounds) per month which, on an annual basis, would equal the maximum drying capacity of its atmospheric dryer. At the end of 1939 petitioner had a market for all of the feed yeast it desired to produce and it had arrangements with seven brewers for an ample supply of slurry. However, petitioner's production of feed yeast was necessarily limited by the quantity of other non-debittered yeast and also debittered yeast produced.Prior to 1938 the Ironized Yeast Laboratories of Atlanta, Georgia, imported from England 41 non-debittered dried brewers' yeast used in processing an ironized yeast tablet which was coated so that the 321 bitterness of the yeast was immaterial. Those tablets had been on the market for several years. Petitioner contacted that company in 1938 and made deliveries of sample products. The Ironized Yeast Laboratories entered into a contract for a period of 12 months beginning May 1, 1939, for the purchase from petitioner of 200,000 to 400,000 pounds of non-debittered yeast at a price of 10 1/2 cents per pound. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of Ironized Yeast Laboratories' purchases of non-debittered yeast from petitioner would be 300,000 pounds during the year 1939.Prior to 1938 Upjohn Company of Kalamazoo, Michigan, had a large demand for a vitamin B complex concentrate tablet which it had on the market. The dry concentrate used in those tablets was extracted by Upjohn from debittered dried brewers' yeast, derived from slurry. Upjohn purchased Pabst Brewing Company's entire output of debittered yeast. During 1938 and 1939 Upjohn did not have a sufficient supply of debittered yeast to meet its 42 growing requirements for extracted concentrates and, after a testing period, began making purchases of debittered yeast from petitioner at a price of 23 cents per pound. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of Upjohn's purchases of debittered dried brewers' yeast from petitioner would be 130,000 pounds during the year 1939.In addition to producing non-debittered and debittered dried brewers' yeast for sale to customers, the petitioner also produced those products during 1938 and part of 1939 for use as the basic ingredient for its extraction of liquid and dry vitamin B complex concentrates. Prior to the end of 1939 petitioner was using primary yeast as the basic ingredient for most of its concentrates because that eliminated the process of thoroughly debittering yeast derived from slurry and resulted in more uniform batches of concentrates.During the period from 1932 to 1938 the Burroughs Wellcome Company of Tuckahoe, New York, was developing and producing certain yeast extracts for use in products for retail trade. During those years it purchased yeast spore (that is primary yeast) from Anheuser-Busch, 43 Inc. In 1938 Burroughs Wellcome was producing a dry yeast concentrate and marketing a compressed yeast tablet under the name of "Tabloid Yeast Concentrate" which was nationally advertised as a vitamin B complex product and for which there was a large demand. In 1938 the petitioner supplied Burroughs Wellcome with samples, as per specifications, of petitioner's dry vitamin B complex concentrate (#380) and Burroughs Wellcome, after testing, concluded it was the best product of its kind then available. Sometime in 1939 Burroughs Wellcome discontinued its own production 322 of dry yeast concentrate and began purchasing the petitioner's dry concentrate (#380) at $ 4 per pound for use in compressed tablets. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of Burroughs Wellcome's purchases of dry vitamin B complex concentrate (#380) from petitioner would be 15,000 pounds during the year 1939.During 1938 Sharp & Dohme, Inc., of Philadelphia, Pennsylvania, placed on the retail market a liquid B complex phosphate which contained a B complex extract made from rice polish. Under certain conditions the rice polish extract tended 44 to form a gas which exploded the containers. During 1939 Sharp & Dohme purchased, at $ 20 per gallon, small quantities of petitioner's liquid concentrate (S-100) and experimented therewith along with samples of concentrates of two other companies, for the purpose of finding a substitute for the rice polish extract. Toward the end of 1939 Sharp & Dohme definitely decided that petitioner's liquid concentrate (S-100) would be used as an ingredient for the vitamin content of its phosphate product, but a contract with petitioner had not been entered into at the end of the year 1939. Sharp & Dohme's 1939 volume of sales of its B complex phosphate would have required the purchase of 1,137 1/2 gallons of petitioner's product if it had been used as an ingredient during that year. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of Sharp & Dohme's purchases of liquid concentrate (S-100) from petitioner, at a price of $ 20 per gallon, would be at least 1,500 gallons during the year 1939.In 1939 the United Drug Company of Boston, Massachusetts, had several thousand agencies throughout the country for the retail sale of its 45 many pharmaceutical products, under the name of Rexall Drugs. During 1939 United experimented with samples of petitioner's liquid concentrate (S-50) for use as a vitamin ingredient for mixture in liquid tonics, etc. which United had produced and sold for several years. After assays and numerous tests in certain mixtures United determined, in December 1939, to use the petitioner's liquid concentrate in a new product to be offered to the public. In a letter to petitioner, dated December 15, 1939, United stated that an ultraconservative estimate of its initial requirement would be 500 gallons of petitioner's liquid concentrate and that it could not go far wrong on an estimate of using 1,000 gallons a year. The letter further stated that after the product was established on the retail market there was a possibility of using 5,000 gallons a year. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of United Drug's purchases of liquid 323 concentrate (S-50) from petitioner, at a price of $ 6 per gallon, would be at least 1,000 gallons during the year 1939. During 1939 the International Vitamin Corporation of New York City, 46 New York, negotiated with petitioner to experiment with and produce a particular liquid vitamin B complex concentrate to be sold under the trade name "Blexin" to meet a greatly expanding demand for such a product by certain pharmaceutical companies. Before the end of 1939 the petitioner had developed the desired liquid concentrate and International had printed labels and was making arrangements for the sale of Blexin. The petitioner's liquid concentrate, Blexin, was superior in vitamin content and stability to a slightly similar rice polish B complex extract then produced by a California company which sold its product to one pharmaceutical company at the rate of about 3,000 gallons per month during 1938. If the petitioner had started business 2 years before it actually did so, then the reasonable estimate of the amount of International's purchases of liquid concentrate (Blexin) from petitioner, at a price of $ 6 per gallon, would be 12,000 gallons during the year 1939.During the year 1939 the petitioner's atmospheric dryer in its drying and centrifuge room had an annual production capacity of either 1,440,000 pounds of non-debittered yeast or 1,350,000 pounds of debittered yeast 47 made from slurry. After allocating the use of the dryer to the production of the above estimated purchases of 300,000 pounds of non-debittered and 130,000 pounds of debittered yeast for human consumption, the petitioner had a production capacity of approximately 1 million pounds of feed yeast for animals and poultry. During the year 1939 the petitioner's concentrate room had an annual production capacity of either 110,500 pounds of dry concentrate or 37,500 gallons of liquid concentrate made from primary yeast as the basic ingredient. That capacity, allocated between the production of liquid and dry concentrates, was in excess of the above mentioned total estimated purchases of 14,500 gallons of liquid and 15,000 pounds of dry concentrates. During the year 1939, the petitioner had the plant capacity to produce the estimated purchases of products at certain prices by principal customers, as follows:ProductUnit priceQuantitySales priceDrying and centrifuge room:Feed yeast$ 0.0751,000,000 lbs$ 75,000Non-debittered yeast0.105300,000 lbs31,500Debittered yeast0.23 130,000 lbs29,900Concentrate room:Dry concentrate (#380)4.00 15,000 lbs60,000Liquid concentrate (S-100)20.00 1,500 gals30,000Liquid concentrate (S-50)6.00 1,000 gals6,000Liquid concentrate (Blexin)6.00 12,000 gals72,000Total gross sales$ 304,40048 324 Based on the 1939 costs of materials used in the petitioner's products during 1939, the costs of materials (on a quantum basis) for the estimated amount of products mentioned in the next preceding paragraph, would have totaled approximately $ 137,600. The petitioner's actual factory costs and deductions for 1939, projected to cover the increased production for gross sales amounting to approximately $ 300,000, would have amounted to approximately a total of $ 68,410 for factory costs and a total of $ 48,212 for deductions. Based on the foregoing estimated gross sales, costs, and deductions, if petitioner had started business 2 years before it actually did so, the petitioner would have realized for the year 1939, the following:Gross sales$ 304,400Materials costs$ 137,600Factory costs68,410206,010Gross profit$ 98,390Deductions48,212Net profit$ 50,178Per cent net profit16.4In the petitioner's line of business there was no material change in the costs of materials, labor, steam, etc. or in sales prices of comparable products during the base period years. If petitioner had started business 2 years before it actually did so, it would have attained during the base period years its proportionate 49 share of the then existing market for vitamin products.During the years 1936 to 1939 there was a rapid growth in the demand for and the production and sale of vitamin products, including, inter alia, certain isolated and synthetized B vitamins and the B complex vitamins from natural sources. The synthetic vitamins then produced did not cover the whole range of the then known B vitamins contained in brewers' yeast and while the separate synthetic vitamins could be combined and used by pharmaceutical companies in certain preparations, they were not in direct competition with natural B complex vitamins used in other preparations. The B complex from yeast contained all the then known vitamins plus unknown vitamins and being derived from a natural source, it constituted the preferable vitamin element in certain preparations.With respect to its various products the petitioner encountered little direct competition. Instead, during 1938 and 1939, petitioner had the problem of establishing with the prospective customers the purity, potency, stability, etc. of its products for human consumption, after which certain markets were more or less assured. The market for feed yeast was greatly 50 in excess of the total supply of all producers of that product. The petitioner's market with the Ironized Yeast Laboratories for non-debittered yeast had no domestic competition. The 325 petitioner's market with the Upjohn Company for debittered yeast filled that company's demand for the product in addition to the supply by two other producers. The petitioner's markets for concentrates were based principally on tailormade products to fill special needs of the customers or prospective customers and in certain respects were new products in the vitamin field. The liquid B complex extract from rice polish which had been on the market since prior to 1936 and was used in substantial quantities during 1938 and 1939, was not in direct competition with petitioner's specialized liquid concentrates because the rice polish extract did not contain all of the B vitamins found in yeast and was not as potent or stable as petitioner's products. Competition was not actually a material limitation upon the growth of petitioner's business and would not have been a limiting factor if petitioner had started business 2 years before it actually did so.According to the Biennial Census of Manufacturers published 51 by the Department of Commerce, in editions for the years as indicated, the sales of all types of vitamin products at the selling price at the factory (generally referred to as wholesale prices) and including vitamin products and special formulas sold to or prescribed by physicians and vitamin products packaged for sale to the general public, were as follows:1925$ 342,55419271,443,21119294,483,76919316,039,507193311935$ 16,111,802193727,098,510193941,862,480Statistical data published by the Department of Commerce discloses for the years indicated, the amounts in billions of dollars of "Disposable Personal Income" (which is income remaining to persons after deduction of personal tax and non-tax payments to general government) before any breakdown as to data on personal savings, personal consumption expenditures, etc.; and also similarly published but separate data discloses "Retail Drug Store Sales," as follows: (The separate data is combined in one schedule only for convenience.)DisposablepersonalRetail drugstoreincome insales inYearbillionsbillions1929$ 82.5$ 1.690193073.71.554193163.01.438193248.81.182193345.21.066193451.61.156193558.01.233193666.11.344193771.11.527193865.51.474193970.21.56352 326 As compiled by the Bureau of Internal Revenue and reported in its publication "Statistics of Income for 1940," the composite amount of gross sales and also of net profit less tax-exempt income plus interest paid, for the years indicated, in millions of dollars for all United States corporations filing Federal income tax returns, was as follows:Gross salesNet profitYearin millionsin millions1936$ 100,586$ 7,4511937108,3837,410193891,1954,4791939101,5767,306The petitioner's average base period net income is an inadequate standard of normal earnings because the petitioner commenced business during the base period and its business did not reach, by the end of the base period, the earning level which it would have reached if it had commenced business 2 years before it did so. The excess profits tax of petitioner computed under chapter 2, subchapter E, of the Code, without the benefit of section 722, is excessive and discriminatory. The sum of $ 36,760 would be a fair and just amount, representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon comparison of normal earnings and earnings during the excess 53 profits tax years 1943 and 1944 involved in this proceeding.The petitioner, pursuant to the provisions of section 710 (a) (5) of the Code, deferred payment of excess profits taxes for the years 1943 and 1944 in the respective amounts of $ 11,668.64 and $ 4,992.24.The petitioner's applications for relief under section 722 of the Code included claims for unused excess profits credit carry-overs, based on a constructive average base period net income, from the taxable years 1941 and 1942 to the taxable year 1943; and from the taxable years 1942 and 1943 to the taxable year 1944. These applications also included claims for unused excess profits credit carry-backs, based upon a constructive average base period net income, from the taxable years 1944 and 1945 to the taxable year 1943; and from the taxable years 1945 and 1946 to the taxable year 1944.At the end of 1939 the business of the petitioner, after application of the 2-year push-back rule, was still in a state of continued development and growth and had not reached a normal level of production, sales, and earnings during 1940 and 1941. In determining the unused excess profits credit carry-over from the year 1941, the sum of $ 29,000 54 fairly represents the constructive average base period net income for the year 1941.327 OPINION.In this proceeding petitioner seeks relief from excess profits taxes for the years 1943 and 1944, under the provisions of the Internal Revenue Code, section 722 (a) and section 722 (b) (4)155 and in the alternative under section 722 (b) (5). There is no question herein but that under section 712 the petitioner is entitled to have its excess profits credit 56 computed either under section 713 based on income or under section 714 based on invested capital, whichever amount results in the lesser tax under chapter 2, subchapter E, of the Code. Here the petitioner had no net income during its base period years 1938 and 1939 and respondent computed and allowed, for the taxable years involved, an excess profits credit based on petitioner's invested capital. There is no issue as to the amount so determined.The claimed relief may be granted only if petitioner meets the qualifying factors prescribed under the general rule provided in section 722 (a), namely, if it establishes (1) that the tax (computed without the benefit of section 722) is excessive and discriminatory, and (2) what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income; provided such amount gives rise to an excess profits credit which is greater than the credit otherwise available to petitioner.Under section 722 (b) (4) the petitioner's tax (computed without the benefit of section 722) "shall be considered to be excessive and discriminatory" if petitioner establishes the further qualifying factors that its average 57 base period net income is an inadequate standard of 328 normal earnings because it commenced business during the base period and its average base period net income does not reflect the normal operation for the entire base period of the business. The petitioner did commence business in May 1938 which was during the base period. The facts of record and the testimony of witnesses establish to our satisfaction that petitioner's operating losses, or zero average base period net income, do not reflect the normal operation for the entire base period of the business. This conclusion is supported by factual circumstances peculiar to petitioner's getting into production. At the time petitioner commenced business there was a demand for the basic yeast products it proposed to process for sale to pharmaceutical companies. However, it immediately became necessary to make certain modifications of its products, particularly the concentrates, according to each prospective customer's specifications, with the result that the entire 8 months of 1938 and most of 1939 were devoted to experimentation and development with attendant losses in materials and labor costs and in production for sale. Before the 58 end of 1939 petitioner's efforts began to bear fruit, that is, actual orders and substantial prospective orders. On the record, it is clear that petitioner's business did not reach, by the end of 1939, the earning level which it would have reached if petitioner had commenced business 2 years before it did so. We conclude and have found as an ultimate fact that petitioner's average base period net income is an inadequate standard of normal earnings. The petitioner has satisfied the requirements of section 722 (b) (4). Victory Glass, Inc., 17 T.C. 381">17 T. C. 381.We have further concluded and found as an ultimate fact that the petitioner's excess profits tax for the years involved, computed without the benefit of section 722, is excessive and discriminatory. This is based upon the petitioner's having met the requirements of section 722 (b) (4) and our finding that the sum of $ 36,760 would be a fair and just amount, representing normal earnings to be used as a constructive average base period net income, which amount would give rise to an excess profits credit greater than the credit computed and allowed on the basis of petitioner's invested capital.At the trial of this proceeding and with 59 respect to the amount of the constructive earnings, the petitioner took the position that if it had commenced business 2 years before it did so, its 1939 level of business would have resulted in gross sales and a net profit in excess of the amounts found in our findings of fact; that its constructive earnings would have been approximately the same amount for each of the years 1939, 1938, 1937, and 1936; and that petitioner is entitled to a constructive average base period net income in excess of the amount found in our findings of fact. The respondent contends that petitioner 329 has failed to prove the claimed amount of constructive earnings or any other amount.The petitioner's proposed reconstruction can not be accepted in toto for the reason that it is not fully supported by the facts and the credible testimony of witnesses. The petitioner's proposed gross sales for 1939 are excessive because some of the assumed sales included therein by certain witnesses are not based on reasonable estimates bearing a demonstrable relation to the existing and/or probable market for petitioner's products in that year. To the extent that the opinions of certain witnesses were not based upon the facts 60 of record or were given without revealing basic evidential material, they lack a proper foundation, Avey Drilling Machine Co., 16 T. C. 1281, 1299, and have been disregarded.However, we are satisfied that the record herein does establish a proper basis for reconstruction and upon our own appraisal of the facts and testimony herein we have proceeded to find the sum which, in our judgment, would be a fair and just amount representing normal earnings to be used as a constructive average base period net income. In this connection we have proceeded on the premise that in the application of section 722 (b) (4) the "purpose of the 2-year push-back rule is to establish a figure which is assumed to be the maximum amount which would have been earned by the taxpayer in its last base period year, if it had commenced business 2 years before it did" and that the "assumed figure is then used as a point of departure in reconstructing the taxpayer's average base period net income (using appropriate indices * ) in order to determine his excess profits credit." Del Mar Turf Club, 16 T.C. 749">16 T. C. 749, 766. Also see Suburban Transportation System, 14 T. C. 823, 829. Further, it is recognized that section 72261 of the Code does not prescribe an exact criteria for a reconstruction, see Danco Co., 14 T.C. 276">14 T. C. 276, 288, but instead "it calls for a prediction and an estimate of what earnings would have been under assumed circumstances, an approximation where an absolute is not available and not expected," Victory Glass, Inc., supra, at page 388. The Findings of Fact fully set forth the various factors establishing the assumed maximum amount of net profit of $ 50,178 which would have been earned by petitioner in its last base period year 1939, if it had commenced business 2 years before it did so. It would serve no useful purpose to review these factors here. We have used the reconstructed net profit for 1939 as the point of departure in backcasting those earnings over the prior base period years 1938, 1937, and 1936, taking into consideration the business statistics placed in the record. The statistics on business in general and on disposable personal income disclose the year 1938 as one of general business recession. On the other hand, the statistics on all types of vitamin sales disclose 330 a steadily expanding market for vitamin products throughout the base period years.Based upon a consideration 62 of the whole record, we conclude that the sum of $ 36,760 would be a fair and just amount, representing normal earnings to be used as a constructive average base period net income for purposes of an excess profits tax based upon comparison of normal earnings and earnings during the excess profits tax years 1943 and 1944 involved in this proceeding.In view of the above conclusion it is not necessary to discuss petitioner's alternative claim for relief under section 722 (b) (5).With respect to the question of unused excess profits credit carry-overs and carry-backs, which are matters for recomputation under Rule 50, the petition raised an issue only with regard to the correctness of respondent's method of computing an unused excess profits credit adjustment from the year 1941, wherein respondent applied the "variable credit rule" provided for in the Bureau of Internal Revenue Bulletin on Section 722 and Regulations 112, section 35.722-3 (d). That "rule" was approved in Nielson Lithographing Co., 19 T. C. 605, wherein we said:In other words, the variable credit "rule," as stated above, may be considered when the last year of the base period reflects substantially less than a full level 63 of normal operation, and after the application of the 2-year push-back rule the question arises whether earnings had reached a normal level during the first and second excess profits tax taxable years. The rule provides that earnings during these 2 years of growth should not be reduced by an excess profits credit based upon a normal earning capacity. Failure to apply the variable credit "rule" in a situation such as we have here would result in a double benefit to the petitioner, and such was not intended by section 722.Also, see Radio Shack Corporation, 19 T. C. 756, 762.In the instant case the record establishes and we have found that at the end of 1939 the business of petitioner, after application of the 2-year push-back rule, was still in a state of continued development and growth and had not reached a normal level of production, sales, and earnings during 1940 and 1941. On the facts of record we are satisfied that this is an appropriate case for the application of the variable credit rule and for the purpose of computing the unused excess profit credit adjustment, if any, under Rule 50, we have found petitioner's constructive average base period net income to be $ 29,000 for 64 1941.Reviewed by the Special Division.Decision will be entered under Rule 50. Footnotes1. Includes cost of brewers' slurry, primary yeast, alcohol, and other materials for products sold, and also for experimental, waste, and rejected products.2. Exclusive of payroll taxes and personal property taxes, which are included in "Taxes" listed under deductions.↩3. Includes cost of advertising, traveling expenses, communications, stationery, insurance other than plant, professional fees, etc.↩1. No comparable data published.↩1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.(a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, * * (b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because -- * * (4) the taxpayer, either during or immediately prior to the base period, commenced business or changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had commenced business or made the change in the character of the business two years before it did so, it shall be deemed to have commenced the business or made the change at such earlier time. * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619382/	Estate of Oscar H. Perrin, Fred Perrin and Edna M. Perrin, Executors v. Commissioner.Estate of Perrin v. CommissionerDocket No. 580.United States Tax Court1944 Tax Ct. Memo LEXIS 334; 3 T.C.M. (CCH) 225; T.C.M. (RIA) 44076; March 13, 1944334 1. The value of a trust, created in 1935, to pay so much of the income and principal as the settlor-trustee "may in his discretion deem necessary or proper for the comfort, support, and/or happiness" of his wife for life, and thereafter to others upon the same terms, held, includible in the estate of the settlor-trustee as a transfer, the enjoyment of which was subject to a change through the exercise by him of a power to alter, amend, or revoke. Section 811 (d) of the Internal Revenue Code. 2. The value of a trust, created in 1935, for the education of two grandchildren, providing for the payment of amounts of income and principal not exceeding a stipulated maximum during the course of the college career, or if they should not go to college, during four years, and then so much as necessary for their support and maintenance until they reach the age of thirty when the balance should be paid over to them, equality to be maintained between them, held, not includible in the estate of the settlor-trustee. 3. The value of a trust, created in 1937, for the education of a third grandchild, payments to be made as above, and upon her reaching the age of thirty the balance to be 335 paid to her, held, not includible in the estate of the settlor-trustee. Oliver A. Wyman, Esq., 31 Milk St., Boston, Mass., for the petitioners. M. L. Sears, Esq., for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion This proceeding is for the redetermination of a deficiency of $18,605.98 in estate tax determined by the Commissioner. The deficiency resulted, in the main, from the inclusion in the decedent's estate of the value of three trusts alleged to be subject to a retained power to alter, amend, or revoke within the meaning of section 811 (d) of the Internal Revenue Code, or subject to retention of the right to designate the persons who shall possess or enjoy the property within the meaning of section 811 (c) of the Internal Revenue Code. Other issues have either been settled by the parties or abandoned. Findings of Fact The case has been submitted upon a stipulation of facts which we hereby adopt as our findings of fact. Oscar H. Perrin died on November 24, 1939, domiciled in Medford, Massachusetts, and the estate tax return was duly filed by his executors with the Collector of Internal Revenue for the district of Massachusetts. On December 17, 1935 336 the decedent transferred property to himself as trustee for the benefit of his wife, Edna M. Perrin. The declaration of trust provided in part as follows: "FIRST: To pay to or for EDNA M. PERRIN, wife of said OSCAR H. PERRIN, such part of the income as the Trustee may in his discretion deem necessary or proper for the comfort, support and/or happiness of said EDNA M. PERRIN as long as she may live and also such amounts from principal as the Trustee in his discretion may deem necessary for the comfort, support and/or happiness of said EDNA M. PERRIN during her life. Said income may be paid quarterly or otherwise in the discretion of the Trustee and principal payments may be made at any time. "SECOND: Upon the death of said EDNA M. PERRIN, the fund then remaining shall be held for my son, FRED PERRIN of Rochester, New York, he to receive such part of the income and also such part of the principal as the Trustee in his discretion may deem necessary for his comfort, support and/or happiness during his life." Thereafter the remaining fund was to be held in equal shares upon the same terms for the support and maintenance of grandchildren until the time of distribution specified. The judgment337 of the trustee as to equality of income or principal in any case calling for equality was to be absolutely binding upon the beneficiaries. In the case the trustee should deem any beneficiary incompetent properly to handle the payments to be made to him, the trustee might, in his discretion, make payments in whole or in part as follows: (a) To the legal guardian or conservator of such person; (b) Expend the same for the comfort, support, education and/or happiness of such person or pay the same to some person or persons to be expended for such purposes; (c) Accumulate the same for his or her benefit, but not for a longer period than the lives of the Donor's wife and child and grandchildren now living and twenty-one (21) years thereafter, for distribution at such time or times as the Trustee may deem expedient; (d) Reimburse any persons who may have expended money for the comfort, support, education and/or happiness of any beneficiary hereunder, the same to be wholly within the discretion of the Trustee and his decision as to whether money was so spent to be final. On the same date, December 17, 1935, a trust was created for the benefit of decedent's grandchildren, Phyllis and338 Kenneth, with the settlor as trustee, providing as follows: "FIRST: To hold the property for the benefit of my grandchildren, PHYLLIS L. PERRIN and KENNETH F. PERRIN, of Rochester, New York, and, except as hereinafter provided in this section, to accumulate the net income thereof and add the same to the principal until one of said grandchildren shall go to college or enter training in school, college, institution or otherwise for a professional, technical, special or business career. The decision of the Trustee hereunder as to whether a grandchild has entered such school, etc. as to entitle him or her to receive benefits hereunder shall be binding. "As each of such grandchildren shall enter college, or other school, or institution as aforesaid, to pay to or for such grandchild from the accumulated income and from principal, if necessary, a sum or sums not to exceed two thousand dollars per year for such time, not to exceed four (4) years, as he or she may continue in any college or in any school or institution or in training as aforesaid. If any such grandchild shall not complete his course or training or shall have completed it within four (4) years, the Trustee shall pay 339 to or for such grandchild the difference between the total previously paid to such grandchild hereunder and eight thousand dollars ($8,000.00), such difference to be paid at the rate of two thousand ($2,000.00), per year, beginning when such grandchild shall reach the age of twenty-one, or at such time as such grandchild shall cease or complete his or her course or training, whichever may be later. "If any grandchild shall elect not to enter college or prepare for a professional, technical or business career, to pay to or for such grandchild the sum of two thousand dollars ($2,000.00) per year for four (4) years beginning at the time such grandchild shall reach the age of twenty-one (21) years. "If, in the judgment of the Trustee, it is more convenient, in order to maintain equality between the grandchildren, to establish separate funds for each grandchild, he shall have the right so to do, such separation to be made at or after the first payment shall be due under this instrument. It is the intent of the Donor that the grandchildren shall share equally in the fund, except as hereinafter set forth. "After a grandchild has received eight thousand dollars ($8,000.00) hereunder, the340 fund held for him or her (in the event the Trustee has separated the fund into two parts as above provided) or such part of the fund, if no separation has been made, as will, in the sole judgment of the Trustee, be necessary to hold, in order to maintain equality, shall be held for such grandchild, such part of the income thereof and also such part of the principal to be paid to him or her as may in the discretion of the Trustee be necessary for the support and maintenance of such grandchild until he or she shall reach the age of thirty (30) years, the fund or part thereof then held for him or her shall be turned over to him or her, free of all trusts." Disposition was provided for in case either grandchild should die before reaching the age of 30. A provision identical with that of the Edna M. Perrin trust in case of incompetence of any of the beneficiaries was incorporated. It was further provided: "In all cases, the Trustee shall in his sole discretion determine to whom and at what times payments shall be made hereunder and the discretion of the Trustee shall be binding upon all parties. "While the chief purpose of this Section is to provide an educational fund for said grandchildren, 341 the Trustee may in his discretion pay over such part of the income and also such part of the principal to or for either or both grandchildren at any time before they would otherwise be entitled to receive the same hereunder. Such payments may be made for the support, maintenance, education or happiness of said grandchildren or may be in the form of payments for specific purposes or occasions, such as birthdays, Christmas, and the like." A substantially similar trust was established on August 12, 1937, for the benefit of a grandchild, Betty Joan Perrin, born after the establishment of the aforementioned trusts. Opinion ARUNDELL, Judge: In the trust instrument for the benefit of Edna M. Perrin the settlor, as trustee, was given the right to determine, in his discretion, what part of the income and principal was to be paid to Edna for her "comfort, support and/or happiness," and upon her death to apply the same discretion for the benefit of Fred, and thereafter for the benefit of the grandchildren until the termination of the trust. The problem presented is whether such a discretionary right amounts to a power "to alter, amend, or revoke" within the meaning of section 811 (d) of 342 the Internal Revenue Code. 1It is now well-settled law that a power to reallocate the corpus or income of a trust, though strictly within a group of certain named beneficiaries, is comprehended by the phrase "power to alter, amend, or revoke." Porter v. Commissioner, 288 U.S. 436">288 U.S. 436; Commissioner v. Bridgeport City Trust Co., 124 Fed. (2d) 48. The principle applies even though the power is phrased in terms of disinheritance. Chickering v. Commissioner, 118 Fed. (2d) 254. The vital factor is that the settlor could choose by whom and in what proportion the property would be taken. As stated by the court: While the power retained by the decedent is phrased in terms of disinheritance, 343 we can see no difference between this and a more conventionally phrased special power of appointment. As a practical matter Mrs. Chickering could choose between two possible objects - her son or the William A. Russell Trust - and could apportion the income and principal between them in any proportion she chose to the extent of complete exclusion of either. Nor is it important that the power is exercisable by the donor in his capacity as trustee rather than as settlor. Welch v. Terhune, 126 Fed. (2d) 695. In that case one of the three trustees was donor and it was provided that the trust might be terminated or amended at any time by the trustees. In Union Trust Company of Pittsburgh v. Driscoll, 138 Fed. (2d) 152, the Third Circuit Court of Appeals followed Welch v. Terhune, supra, on this point and in answering the argument directed to the narrowness of the power reserved stated: Describing the power possessed by her as a fiduciary one, if that it be, does not mean that she could not have exercised it, although its exercise would be restricted by the terms of the deed of settlement, and344 the legal consequences of those terms as applied to the management of the trust estate. But she could still change the enjoyment of the beneficial interests. Thus she still had a string attached to her beneficence, albeit that string was weaker than if she held it in the sole capacity of settlor. * * Both courts were also of the opinion that the addition to subdivision 811 (d) made by section 805 of the Revenue Act of 1936, to the effect that it was not material in what capacity the power was subject to exercise by the decedent, is merely declaratory of the meaning of the subdivision prior to the addition of the phrase. Article 20, Treasury Regulations No. 80. The trust for the benefit of Edna M. Perrin falls within the principles laid down by the above authorities. The decedent was possessed during his lifetime of the right to determine the amounts of income and principal which would go to Edna, and consequentially, the amounts which would remain over to his son and grandchildren. Upon Edna he could confer all or little. He "still had a string attached to his beneficence." Although the instrument spoke in terms of a discretionary right, that right in effect is nothing different345 from a power "An existing right in property is not a power, but a power is the right, ability or faculty of doing something." Clifford v. Helvering, 105 Fed. (2d) 586, reversed on other grounds, 309 U.S. 331">309 U.S. 331. By virtue of this power to which the enjoyment of the property was subject, the value of the property is includible in his gross estate under section 811(d) of the Internal Revenue Code. The trust for the two grandchildren, Phyllis and Kenneth, stands upon a different footing. Under the terms of this instrument the grandchildren were to participate as equally as might be in the enjoyment of the fund, and this though the time of payments to each might vary. Upon their reaching the age of thirty the remaining fund was to be paid over to them in equal shares, free of all trusts. Thus, the amounts ultimately payable to the beneficiaries were fixed, and the trustee had no discretion to vary this ultimate right. The respondent finds difficulty in the clause giving the trustee the right to make payment to others, in case of incompetence of either beneficiary. Manifestly, payment may be made only for the benefit of the grandchild; 346 the manner alone, not the substance of enjoyment is altered. Likewise, the provision vesting in the trustee discretion to determine to whom, and at what time payments shall be made must be considered within the frame of the trust. Within that frame payments may be made only to the named beneficiaries, except in case of incompetence, and then for their benefit. The provision dealing with special payments for birthdays, Christmas, and the like is limited by the enjoinder of equality that pervades the instrument. This trust then allows of no power to change the enjoyment of the property transferred, and so may not be included in the gross estate under section 811(d), or any other section. The trust for the benefit of the third grandchild, Betty Jo&n is substantially the same, with the further limitation that payment may be made only for the benefit of the one grandchild. Therefore, it is held that the value of the property held in trust for Edna M. Perrin, stipulated to be $40,178.55 is includible in the estate of the decedent under the authority of section 811(d) of the Internal Revenue Code. The other two trust properties may not be included in his estate. Decision will be entered347 under Rule 50.Footnotes1. (d) Revocable Transfers. - * * * (2) Transfers on or prior to June 22, 1936. - To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person to alter, amend, or revoke * *.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619383/	WILLIAM C. SAMPSON AND LUCILLE A. SAMPSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSampson v. CommissionerDocket No. 14039-84.United States Tax CourtT.C. Memo 1988-202; 1988 Tax Ct. Memo LEXIS 227; 55 T.C.M. (CCH) 800; T.C.M. (RIA) 88202; May 5, 1988. 227 William C. Sampson and Lucille A. Sampson, pro se. Nancy B. Herbert, for the respondent. PARKERMEMORANDUM FINDINGS OF FACT AND OPINION PARKER, Judge: Respondent determined deficiencies in and additions to petitioners' Federal income tax as 228 follows: 1 Sec. 6653(a)(1) Sec. 6653(a)(2)YearDeficiencyAdditionAddition1980$ 19,064$ 953 - 0 -198126,449 1,322 50% of interestdue on $ 26,4419229 The issues for decision are: (1) Whether income from petitioner William C. Sampson's osteopathic practice and income from petitioner Lucille A. Sampson's sales of Shaklee products are properly taxable to the petitioners as the earners of the income or to the Lucille A. Sampson Pure Equity Trust; (2) Whether the trust is a grantor trust under sections 671-677; (3) Whether petitioners have substantiated deductions claimed for automobile expenses incurred in earning the Shaklee products sales income; 2(4) Whether petitioners are liable for additions to tax under section 6653(a) for negligence or intentional disregard of rules and regulations; and (5) Whether petitioners are liable for damages under section 6673 for instituting or maintaining this case primarily for delay or for maintaining a frivolous or groundless position in the Tax Court. 230 FINDINGS OF FACT A few of the facts have been stipulated and are so found. The stipulation of facts, supplemental stipulation of facts, and exhibits attached thereto are incorporated herein by this reference. Dr. William C. Sampson and Lucille A. Sampson (collectively petitioners) resided in Middletown, Ohio at the time they filed their petition in this case. Dr. Sampson is also known as W. Clifford Sampson and W. C. Sampson. For the taxable years 1980 and 1981, petitioners filed joint Federal income tax returns at the Cincinnati Service Center in Covington, Kentucky. On those returns, Dr. and Mrs. Sampson listed their occupations as osteopath and housewife, respectively. During 1980 and 1981, Dr. Sampson earned substantial income from his osteopathic practice, which he conducted through his professional corporation, Dr. W. Clifford Sampson, Inc., or W. Clifford Sampson, Inc. During 1980 and 1981, Mrs. Sampson earned income as a distributor of Shaklee Products. In an effort to shift the incidence of taxation, petitioners diverted their earned income through several entities as will be outlined in detail below. In 1975 petitioner formed W. Clifford Sampson, Inc., pursuant231 to the Ohio corporation law, a professional corporation which is still in existence. Petitioner owns all of the stock of his professional corporation. Petitioner and his wife were the only officers of the corporation and completely controlled the corporation. Dr. Sampson was the only person performing osteopathic services for his professional corporation. W. Clifford Sampson, Inc., filed Form 1120 corporate income tax returns for 1980 and 1981 taxable years, reporting gross receipts of $ 29,181 and $ 67,926, respectively. The corporation deducted cost of goods sold of $ 24,738 and $ 54,391 for 1980 and 1981, respectively. For 1980 the cost of goods sold included drugs in the amount of $ 1,393 and professional fees (for Dr. Sampson's services) of $ 23,345. For 1981 the cost of goods sold consisted solely of professional fees for Dr. Sampson's services of $ 54,391. On April 1, 1975, petitioners also formed the Lucille A. Sampson Pure Equity Trust. The trust agreement is a form with appropriate blanks to be filled in. Petitioners executed the document and entered into the family trust arrangement without consulting an attorney and without obtaining any legal advice as to the232 matter. Roger L. and Joan M. Whitesel, who had a similar family trust arrangement, witnessed the document. Lelah M. Truxal and W. Clifford Sampson were the first trustees. Mrs. Truxal resigned shortly after the formation of the trust. Mrs. Truxal and her husband also had a similar family trust arrangement. During 1980 and 1981, Bruce A. Sampson, Diane Sampson Spear, Lucille A. Sampson, and William C. Sampson were the trustees of the Lucille A. Sampson Pure Equity Trust. Bruce A. Sampson and Diane Sampson Spear are petitioners' children. In 1980 and 1981, the beneficial interests of the Lucille A. Sampson Pure Equity Trust were held as follows: 19801981Bruce A. Sampson1550Diane Sampson Spear1550Lucille A. Sampson300 William C. Sampson400 Petitioners transferred their residence and the surrounding four acres at 5911 W. Alexandria Road, Middletown, Ohio to the trust in 1975. Other than its use as an office for Mrs. Sampson's Shaklee products distribution business, this property did not produce income and continued to be used as petitioners' family residence as it had before 1975. 3 Thus, the sources of income of the trust were233 Dr. Sampson's osteopathic practice and Mrs. Sampson's sales of Shaklee products. On April 10, 1975, Dr. Sampson executed a professional service contract with the Lucille A. Sampson Pure Equity Trust. The contract provided: The TRUST and Dr. W. C. Sampson do covenant and agree as follows: 1. The TRUST agrees to furnish the following to Dr. W. C. Sampson for his services as an Osteopathic Physician to the TRUST. a) The use of the TRUST properties with paid utilities for living and working quarters for other uses than TRUST use. b) The use of a telephone listed in his name for other than TRUST business, and payment of the telephone bill. c) The use of a leased automobile for other than TRUST business. 2. Dr. W. C. Sampson agrees to give his professional services to the TRUST for the above listed benefits of paragraph 1.Petitioner signed in his own right and as trustee of the234 Lucille A. Sampson Pure Equity Trust. On September 16, 1975, W. Clifford Sampson, Inc., contracted with the Lucille A. Sampson Pure Equity Trust for petitioner's professional services. The contract provided: The COMPANY and the TRUST do covenant and agree as follows: 1. The TRUST agrees to furnish the expertise and knowledge of Dr. W. C. Sampson, D.O. to the COMPANY. The COMPANY accepts the expertise and knowledge of Dr. W. C. Sampson, D.O. The services to be provided shall be understood by both parties to consist of the skills denoted an Osteopathic Physician licensed by the State of Ohio. 2. The COMPANY cannot control or supervise the work or services to be performed by Dr. W. C. Sampson. The TRUST agrees that Dr. W. C. Sampson shall devote his time and effort to the business of the COMPANY and all remuneration earned belongs to the COMPANY. 3. The TRUST shall be compensated for the services of Dr. W. C. Sampson to the COMPANY, a fee equaling 82% per annum of the income earned for the COMPANY by Dr. W. C. Sampson. That fee, in part or in whole, shall be paid on demand of the TRUST. Any modification of this fee shall be in writing and agreed to by both parties. 235 Petitioner signed the contract as president of the corporation and as trustee of the trust. In 1980, pursuant to the above outlined contracts, W. Clifford Sampson, Inc., paid the Lucille A. Sampson Pure Equity Trust $ 23,345, the amount of the professional fees the corporation had deducted as part of its cost of goods sold. The corporation deducted this amount on its Form 1120 as a component of the cost of goods sold, deducted rent and various other items, and reported taxable income of $ 289 and paid tax of $ 49. The Lucille A. Sampson Pure Equity Trust reported $ 23,345 as imcome from the W. Clifford Sampson, Inc., professional corporation. The trust also reported income of $ 1,275, the net profit from Mrs. Sampson's sales of Shaklee products, on its 1980 Form 1041, fiduciary income tax return. After deductions, the trust purportedly distributed a total of $ 9,750 in various amounts to the following beneficiaries: W. Clifford Sampson$ 4,386Lucille Sampson2,438Diane Sampson Spears1,463Bruce A. Sampson1,463$ 9,750However, these amounts were in each instance reduced by claimed depreciation deductions so that the amounts actually received by236 the individuals and reported on their individual returns were as follows: W. Clifford Sampson$ 2,090Lucille Sampson1,163Diane Sampson Spears698Bruce A. Sampson698In addition, the Lucille A. Sampson Pure Equity Trust issued a Form 1099-NEC (nonemployee compensation) to Dr. Sampson in the amount of $ 1,960 which the trust deducted on its return as fiduciary fees and which Dr. Sampson reported on his return as income from wages, salaries, tips, etc. The trust issued another Form 1099-NEC to Dr. Sampson in the amount of $ 3,670 which does not appear to have been deducted by the trust but was reported as rental income from two unidentified properties on petitioners' return, reduced by depreciation, and a net amount of $ 1,928 reported as income for the year. After various deductions for housing, trustee medical expenses, insurance, auto expenses, utilities, telephone, bank charges, dues and subscriptions, and trust educations [sic] expenses totaling $ 9,9l0, the Lucille A. Sampson Pure Equity Trust reported no taxable income and no tax due for 1980. Of the $ 23,345 income earned by Dr. Sampson in the performance of osteopathic services in 1980 and237 after funneling that money through the Dr. W. Clifford Sampson, Inc., professional corporation and the Lucille A. Sampson Pure Equity Trust and of the net profit of $ 1,275 for the Shaklee Products business, only the following amounts were reported on petitioners' individual tax return for that year: $ 1,960 as fiduciary feespaid by trustto Dr. Sampson1,928 as net income fromrental properties Aand B on petitioner'sSchedule E2,090 as Dr. Sampson's net dis-tribution from the trust1,163 as Mrs. Sampson's net dis-tribution from the trustTotal$ 7,141 In other words, only 29 percent of that total income of $ 24,620 earned by Dr. and Mrs. Sampson was reported by petitioners, and many of their nondeductible personal and family expenses had been deducted as purported business expenses of the trust. None of Mrs. Sampson's income from sales of Shaklee products was reported as such on their personal return, that activity being reported solely by the trust and included in the above figures. Respondent determined a deficiency in the amount of $ 19,064 in petitioners' tax for the 1980 taxable238 year. 4 The deficiency was based on including in their income the $ 23,345 income from Dr. Sampson's osteopathic practice and the gross receipts of $ 25,256 for the Shaklee products business, less the net trust income distributes to petitioners ($ 2,090 for Dr. Sampson and $ 1,163 for Mrs. Sampson). 5 Respondent now agrees that the cost of goods sold and most of the expenses of the Shaklee products business have now been substantiated. See n.2, supra.The contracts outlined above terminated on December 30, 1980. On December 31, 1980, Dr. Sampson formed the Sampson Business Trust. The trust agreement was a printed form published by the Sentinel Educational Services. Mrs. Sampson239 and petitioners' son were the trustees of the Sampson Business Trust, whose principal place of business was listed as 5911 W. Alexandria Road, Middletown, Ohio. See n.3, supra. The purpose of the trust was: The purport of this instrument is to convey certain properties and other considerations of value to the Trustees, to constitute a Trust for the benefit of the beneficiary's [sic], held by the Trustees, in Trust, and for the duration hereof; AND to provide for a prudent and economical administration of This Trust's properties and assets, including the effective management of Trust business affairs. The Trustees shall conserve, maintain, manage, invest and re-invest, and improve the financial rating of This Trust' AND, the Trustees, other than the Grantor, in accordance with the restrictions contained herein, shall make distributions of income, or accumulate for later distributions, or distribute corpus as permitted herein, to the beneficiary's [sic] on a pro rata basis, in accordance with the number of Units held, in amounts determined in the Trustee's sole discretion.The trust instrument did not identify any beneficiaries and the printed form recited that "The Grantor240 [Dr. Sampson] shall receive, as part consideration for his conveyance, all the beneficial interest in the income and corpus of this Trust" and that "The Beneficiaries shall hold their beneficial interests upon the terms and conditions contained herein." Among such terms and conditions was a provision that the certificates of interest were "non-assessable, non-negotiable, and, non-transferrable." By another Sentinel Education Services printed form, the trustees issued all 100 units (certificates of interest) to the Lucille A. Sampson Pure Equity Trust as the sole beneficiary of the Sampson Business Trust. On January 1, 1981, Dr. Sampson and the Sampson Business Trust executed a professional services contract whereby petitioner would provide services as an osteopath to the trust. The contract stated: NOW THEREFORE, in consideration of the above premises and the mutual covenants and conditions hereinafter contained, IT IS AGREED: 1. Service: DOCTOR hereby agrees to furnish his skills and expertise to the TRUST, and the TRUST does hereby agree to accept the services of DOCTOR upon the terms and conditions set forth herein. The services to be provided shall be understood by241 both parties to consist of the skills denoted an Osteopathic Physician licensed by the State of Ohio. 2. Performance: The DOCTOR hereby agrees that all services hereinabove listed shall be performed in a good professional manner and that DOCTOR will at all times faithfully, industriously, and to the best of his ability, experience, and talents, perform all duties that may be required of and from him pursuant to the express and implicit terms hereof, to the reasonable satisfaction of the TRUST. 3. Term of Service: The term of this agreement shall be for a period of one year, commencing as of the above date, terminating on the 1st day of January 1982, OR, until the specific performances agreed to be performed have been completed, subject, however, to prior termination as hereinafter provided. At the expiration date hereof, this agreement shall be considered renewed for regular periods of one year, provided neither party submits notice of termination. 4. Compensation of DOCTOR: For all services rendered by DOCTOR, under the terms of this agreement, the TRUST shall compensate the DOCTOR as follows: a. The use of properties which are rented by the TRUST, with paid utilities, 242 for living and working quarters, and for other personal uses. b. The use of a telephone listed in DOCTOR'S name, and payment of the telephone bill. c. The use of an automobile for other than TRUST business. d. Reimbursement for all necessary expenses incurred while traveling pursuant to the TRUST's direction. 5. Duties: The DOCTOR hereby agrees that he shall devote his time, attention, knowledge and skills solely to the business and interest of the TRUST, and the TRUST shall be entitled to all of the benefits, profits or other issues arising from or incident to all work, services and advice of the DOCTOR.Petitioner signed for himself, and Lucille A. Sampson and Bruce A. Sampson signed as trustees of the Sampson Business Trust. The Whitesels signed as witnesses. Also on January 1, 1981, W. Clifford Sampson, Inc. ["COMPANY"], contracted with the Sampson Business Trust ["TRUST"] for petitioner's professional services. The contract provided: WHEREAS, the COMPANY is engaged in the business of Osteopathy and desires to contract for the skills of one W. Clifford Sampson, D.O., an Independent Contractor, in the performance of services on behalf of the COMPANY; 243 and WHEREAS, Dr. W. Clifford Sampson is under contract with the TRUST and the TRUST hereby desired Dr. W. Clifford Sampson to perform services, as a sub-contractor, on behalf of the COMPANY with all remuneration therefrom accruing to the TRUST: NOW THEREFORE, in all consideration of the above premises and the mutual covenants and conditions hereinafter contained, IT IS AGREED: 1. SERVICE. The TRUST hereby agrees to furnish the expertise of Dr. W. Clifford Sampson's services to the COMPANY, and the COMPANY does hereby agree to accept the services of Dr. W. Clifford Sampson, upon the terms and conditions set forth herein. The services to be provided shall be understood by all parties to consist of skills denoted an Osteopathic Physician licensed by the State of Ohio. 2. PERFORMANCE. The TRUST hereby agrees that all services as hereinabove listed shall be performed in a good workmanlike manner and that Dr. W. Clifford Sampson will at all times faithfully, industriously, and to the best of his ability, experience, and talents, perform all of the duties that may be required of and from him pursuant to the express and implicit terms hereof, to the reasonable satisfaction of the244 COMPANY. 3. TERM OF SERVICE. The term of this agreement shall be for a period of one year, commencing as of the above date, termination the 1st day of January 1982, OR, until the specific performances agreed to be performed have been completed, subject, however, to prior termination as hereinafter provided. At the expiration date hereof, this agreement shall be considered renewed for regular periods of one year, provided neither party submits notice of termination. 4. COMPENSATION. For all services rendered by Dr. W. Clifford Sampson for the COMPANY, the TRUST shall be compensated for those services by a fee equal to 80% per annum of the income earned for the COMPANY. That fee, in part or in whole, shall be paid on demand of the TRUST. AND, all amounts shall be paid by the COMPANY to the TRUST without any deductions of any kind.Dr. Sampson signed the contract as president of W. Clifford Sampson, Inc. Lucille A. Sampson and Bruce A. Sampson signed as trustees of the Sampson Business Trust. The Whitesels signed as witnesses. On December 31, 1980, the Lucille A. Sampson Pure Equity Trust purportedly leased the petitioners' residence at 5911 W. Alexandria Road, Middletown, 245 Ohio, to the Sampson Business Trust for five years. See n.3, supra. The lease stated the premises were to be occupied for: 1. various activities of management; 2. housing for Dr. W. Clifford Sampson as per contract; and 3. housing for Trustees. Lucille A. Sampson signed the lease as trustee of the Sampson Business Trust. Dr. Sampson and Bruce A. Sampson signed as trustees of the Lucille A. Sampson Pure Equity Trust. The Whitesels signed the lease as witnesses. In 1981, as in 1980, petitioners funneled their income through these various entities in an effort to shift the incidence of taxation. In 1981 W. Clifford Sampson, Inc., purportedly paid $ 54,391 to the Sampson Business Trust. The corporation deducted this amount as professional fees, a component of its cost of goods sold. The Sampson Business Trust's principal source of income was the receipts from Dr. Sampson's osteopathic practice. For 1981, the Sampson Business Trust reported as income $ 54,391 from Dr. Sampson's professional fees (reported on a Form 1099-NEC from the W. Clifford Sampson Company, Inc., professional corporation) and $ 2,916.91 as a management fee allegedly paid by the Lucille A. Sampson Pure246 Equity Trust. The Sampson Business Trust then showed a distribution of $ 29,484 to the Lucille A. Sampson Pure Equity Trust, deductions of $ 27,336 (including rent of $ 10,200 -- see n.3, supra), and no taxable income. Although the Sampson Business Trust's K-1 shows a distribution of $ 29,484 to the Lucille A. Sampson Pure Equity Trust, the Forms 1099-NEC (nonemployee compensation) show a payment of $ 6,500 to that trust and a payment of $ 29,484 to William C. Sampson, for a total of $ 35,984. The figure of $ 35,984 is the amount reported on the 1981 return of the Lucille A. Sampson Pure Equity Trust as income from the Sampson Business Trust. The other item of income reported by the Lucille A. Sampson Pure Equity Trust was the net income of $ 3,426 from the Shaklee products business. Diane Sampson Spears and Bruce A. Sampson each received $ 2,569 as the beneficiaries' share of income in 1981 from the Lucille A. Sampson Pure Equity Trust, and presumably reported those amounts on their tax returns. The Lucille A. Sampson Pure Equity Trust deducted interest, taxes, charitable contributions, bank charges, housing maintenance and repair expenses, management fees and fiduciary fees247 of $ 25,459, reporting no taxable income and no tax due for 1981. The $ 25,459 "fiduciary fees" represented amounts of $ 12,730 for Dr. Sampson and $ 12,729 for Mrs. Sampson, which amounts petitioners reported on their individual income tax return for 1981. Thus, of the $ 54,391 income earned by Dr. Sampson in the performance of osteopathic services in 1981 and of the net profits of $ 3,426 earned by Mrs. Sampson in the Shaklee products business, only $ 25,459 was reported on their tax return that year. In other words, after funneling their total earned income of $ 57,817 through these various paper entities, only 44 percent of the income was reported by them and many of their nondeductible personal and family expenses had been deducted as purported business expenses of those entities. Respondent determined a deficiency in the amount of $ 26,449 in petitioners' tax for the 1981 taxable year. The deficiency was based on including in their income the $ 35,984 income from the Sampson Business Trust 6 and the gross receipts of $ 38,187 from the Shaklee products business, less the $ 25,459 "fiduciary fees" actually reported by petitioners. Respondent now agrees that the cost of248 goods sold and most of the expenses of the Shaklee products business have now been substantiated. See n.2, supra.During 1980 and 1981, petitioners performed all the osteopathic and sales services that produced the income flowing through these various entities. W. Clifford Sampson, Inc., the Sampson Business Trust, and the Lucille A. Sampson Pure Equity Trust did not employ any other osteopaths during 1980 and 1981. Mrs. Sampson performed the services for the Shaklee products business. Petitioners maintained complete control over the income at all times. 249 7The Lucille A. Sampson Equity Trust claimed $ 753 and $ 1,035 in deductions for automobile expenses, on the Schedule C's for Mrs. Sampson's Shaklee250 products business in 1980 and 1981, respectively. No contemporaneous records of the expenditures were maintained. The "records" of the expenses produced at trial were mere estimates. There is no persuasive evidence to establish the reasonableness of these estimates. As noted above, petitioners did not seek or obtain any legal advice before embarking on their family trust arrangement. Before the trial of this case petitioners were furnished information about this Court's many opinions in the family trust area and were furnished copies of some of those opinions. Petitioners were specifically aware of the outcome of the cases of the Truxals and Whitesels, their acquaintances who had similar family trust arrangements and who were involved in various capacities (witnesses, trustees) in petitioners' own family trust arrangement. Whitesel v. Commissioner,T.C. Memo. 1983-9, affd. without published opinion 745 F.2d 59">745 F.2d 59 (6th Cir. 1984); Truxal v. Commissioner,T.C. Memo 1982-616">T.C. Memo. 1982-616. Petitioners were warned before trial about the possibility of the imposition of damages under section 6673. 8251 OPINION It is a basic principle of the tax law that income is taxable to the one who earns it, and the incidence of taxation cannot be shifted by anticipatory assignments of that income through contracts, trusts or other devices. Lucas v. Earl,281 U.S. 111">281 U.S. 111, 114-115 (1930); Commissioner v. Culbertson,337 U.S. 733">337 U.S. 733, 739-740 (1949). Determining who earns the income depends upon which person or entity in fact controls the earning of the income, not who ultimately receives the income. Benningfield v. Commissioner,81 T.C. 408">81 T.C. 408, 419 (1983); Johnson v. Commissioner,78 T.C. 882">78 T.C. 882, 891 (1982), affd. 734 F.2d 20">734 F.2d 20 (9th Cir. 1984) without published opinion; American Savings Bank v. Commissioner,56 T.C. 828">56 T.C. 828 (1971). Here petitioners not only earned the income, they controlled the income at all times, and ultimately received all of the funds except some small sums that their son and daughter may have received. These well-established principles have been followed in a long line of family trust cases252 similar to the present case, and those cases have uniformly rejected the taxpayer's attempts to shift the incidence of taxation by such devices. Hanson v. Commissioner,696 F.2d 1232">696 F.2d 1232 (9th Cir. 1983), affg. a Memorandum Opinion of this Court; Horvat v. Commissioner,671 F.2d 990">671 F.2d 990 (7th Cir. 1982), originally released as an unpublished order 582 F.2d 1282">582 F.2d 1282 (7th Cir. 1978), affg. a Memorandum Opinions of this Court, cert. denied 440 U.S. 959">440 U.S. 959 (1979); Schulz v. Commissioner,686 F.2d 490">686 F.2d 490 (7th Cir. 1982), affg. two Memorandum Opinions of this Court; Gran v. Commissioner,664 F.2d 199">664 F.2d 199 (8th Cir. 1981), affg. a Memorandum Opinion of this Court; Vnuk v. Commissioner,621 F.2d 1318">621 F.2d 1318 (8th Cir. 1980), affg. a Memorandum Opinion of this Court; Luman v. Commissioner,79 T.C. 846">79 T.C. 846 (1982); Vercio v. Commissioner,73 T.C. 1246">73 T.C. 1246 (1980); Markosian v. Commissioner,73 T.C. 1235">73 T.C. 1235 (1980); Wesenberg v. Commissioner,69 T.C. 1005">69 T.C. 1005 (1978). 9253 Here Dr. Sampson performed the osteopathic services and earned the income from his medical practice. Similarly Mrs. Sampson performed the services and earned the income from her Shaklee products business. This case involves simply an attempted anticipatory assignment of income, an attempt to divert petitioners' earned income to another entity by "paper transactions" which have no effect on the economic realities of the situation. United States v. Basye,410 U.S. 441">410 U.S. 441, 450 (1973); Markosian v. Commissioner, supra,73 T.C. at 1241. Here nothing was changed by the interposition of the Lucille A. Sampson Pure Equity Trust (and/or the Sampson Business Trust) between petitioners and the income earned by Dr. Sampson in his osteopathic practice and by Mrs. Sampson in her Shaklee products business except to try to avoid reporting 29 to 44 percent of that income and to try to claim nondeductible personal and family expenses as purported business expenses of the trust(s). On brief petitioners objected to the Court's use of the term "real world" when questioning them about who performed services and who earned the income, contending that the term is "without254 legal precedent." The Court's inquiries were directed toward what happened in the real world as opposed to the world of "financial fantasies." As stated by the Seventh Circuit, in a similar context of tax avoidance gimmickry: The freedom to arrange one's affairs to minimize taxes does not include the right to engage in financial fantasies with the expectation that the Internal Revenue Service and the courts will play along. The Commissioner and the courts are empowered and in fact duty-bound, to look beyond the contrived forms of transactions to their economic substance and to apply the tax laws accordingly. That is what we have done in this case and that is what taxpayers should expect in the future. [Saviano v. Commissioner,765 F.2d 643">765 F.2d 643, 654 (7th Cir. 1985), affg. 80 T.C. 955">80 T.C. 955 (1983).]Without regard to today's tax-shelter-and-tax-gimmick climate, that view is nothing more than what the Supreme Court was voicing in Lucas v. Earl, when it said that tax incidence is not to be decided by "attenuated subtleties," that tax cannot "be escaped by anticipatory255 arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earned it," and that the fruits cannot be "attributed to a different tree from that on which they grew." 281 U.S. at 114, 115. Looking beyond contrived forms to the economic substance of the transaction is what this and other courts do in the family trust area. This is not an approach "without legal precedent" but is solidly grounded in the Supreme Court's earliest opinions on the use of contracts, trusts and other devices to try to shift the incidence of taxation from the person who earned it. The income was properly taxable to petitioners and not to the Lucille A. Sampson Pure Equity Trust or the Sampson Business Trust. In view of our holding on the assignment of income principles, we need not address the grantor trust provisions of section 671 et seq. However, on the facts of this case, it is clear that the income would be taxable to petitioners under these "grantor trust" rules. Vnuk v. Commissioner, supra;Vercio v. Commissioner, supra;Wesenberg v. Commissioner, supra.256 Deductions are a matter of legislative grace, and the taxpayer must establish the elements of entitlement to the deduction claimed. New Colonial Ice Co. v. Helvering,292 U.S. 435">292 U.S. 435 (1934). Here respondent disallowed the local automobile expenses claimed each year on the Schedule C for the Shaklee products business. Petitioners have the burden of proof. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Petitioners have failed to carry their burden. When a taxpayer proves that an expenditure was made, that some part of the 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, the record in this case provides no basis for making any allocation, and indeed no persuasive evidence of any expenditure. On this record, a deduction based on the Cohan rule would be sheer "unguided largesse." Williams v. United States,245 F.2d 559">245 F.2d 559, 560 (5th Cir. 1957). Accordingly, respondent's determination must be sustained. 257 The next issue is whether petitioners are liable for the addition under section 6653(a) for negligence or intentional disregard of rules and regulations. Petitioners have the burden of proof on this issue. Bixby v. Commissioner,58 T.C. 757">58 T.C. 757, 791 (1972); Rosano v. Commissioner,46 T.C. 681">46 T.C. 681, 688 (1966). Dr. Sampson is a well-educated individual, and yet embarked on this family trust gimmick without consulting an attorney and without obtaining any legal advice on the matter. As one court has observed "No reasonable person would have trusted this scheme to work." Hanson v. Commissioner, supra,696 F.2d at 1234. Mrs. Sampson, although engaged in the Shaklee products business, listed her occupation on her individual tax returns as "housewife," and the Shaklee products income was shown only on the Schedule C's filed with the returns of the Lucille A. Sampson Pure Equity Trust. More importantly, both petitioners knew how much they had earned, knew that through these paper trust devices most of their income had miraculously disappeared, and knew that they were only reporting 29 to 44 percent of their earned income. On these facts, 258 and in view of the long line of family trust cases rejecting this discredited gimmick, the negligence addition is well warranted in this case. Lastly, we must consider respondent's request for damages under section 6673. That section permits the Court to award damages to the United States in an amount not in excess of $ 5,000, whenever it appears to the 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." Here petitioners were informed in advance of the trial of the uniformly adverse opinions in the family trust area and were also given copies of some of those opinions. Moreover, petitioners were specifically aware of the adverse outcome of the family trust cases involving their acquaintances, the Whitesels and the Truxals, whose family trust arrangements were similar to their own. The Truxal and Whitesel cases 10 had been handed down by this Court before petitioners filed their petition in this case. Accordingly petitioners knew or should have259 known that their position in this case was legally frivolous or groundless. Also petitioners were warned before the trial that respondent would seek damages under section 6673 if they pursued their frivolous or groundless position. Damages were considered in petitioners' case involving their earlier years, 1975 to 1979, but were not imposed because of a jurisdictional issue for two of those years. 11 As noted in that opinion, damages can be imposed even where adjustments have been made in the taxpayer's favor. See Bell v. Commissioner,85 T.C. 436">85 T.C. 436 (1985). 12 In the instant case, there are adjustments to be made in the Rule 155 computation in petitioners' favor. One adjustment relates to the cost of goods sold and most of the expense items on the Schedule C's for the Shaklee products business. See n.2, supra. At the commencement of the trial, the parties orally260 stipulated that the cost of goods figures and the expense items, other than automobile expense, on the Schedule C's were correct. Respondent so stipulated based on substantiation furnished a day or two before trial. Had such substantiation been produced by petitioners earlier, the matter no doubt could have been disposed of earlier. The other adjustment is one directed by the Court on its own as a result of the Court's close analysis and tracing of the funds through the various paper entities. See n.5, supra. However, these adjustments, while in petitioners' favor, do not represent disputed issues that they have successfully litigated. Instead these adjustments represent corrections to petitioners' taxable income as determined by respondent which respondent and the Court have made in spite of, and not because of petitioners' pursuit of their basically frivolous and groundless position. Accordingly, these favorable adjustments will not serve to insulate petitioners from damages, and the Court awards damages to the United States in the amount of $ 3,500. *261 To reflect the parties' stipulations and the above holdings, 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 years in question, and all "Rule" references are to the Tax Court Rules of Practice and Procedure. ↩2. In the statutory notice of deficiency, respondent included in petitioners' income each year the gross receipts from Mrs. Sampson's Shaklee products business, but disallowed all deductions and costs of goods sold claimed on the Schedule C's filed as part of the Forms 1041 filed by the Lucille A. Sampson Pure Equity Trust. At trial respondent agreed that petitioners were entitled to all properly substantiated Schedule C expenses and costs of goods sold for the Shaklee products business. The parties orally stipulated at the beginning of the trial that the costs of goods sold and all Schedule C expenses for the Shaklee products business had been substantiated except the item of car expenses in the amount of $ 753 for 1980 and $ 1,035 for 1981. ↩3. The Lucille A. Sampson Pure Equity Trust did not report any rental income in connection with this property. However, we note that the Sampson Business Trust whose address was also listed as 5911 W. Alexandria Road, Middletown, Ohio, deducted rent in the amount of $ 10,200 in 1981. ↩4. On brief petitioners emphasize that respondent for 1980 and 1981 issued a "no change letter" to the Lucille A. Sampson Pure Equity Trust. However, those no change letters were expressly qualified by a statement that the trust income was involved in the investigation of another taxpayer, i.e., petitioners herein. ↩5. In the Rule 155 computation Dr. Sampson should also be given credit for the $ 1,960 and $ 1,928 amounts that he reported, in addition to the net distributions from the trust. ↩6. This is the amount purportedly paid by the Sampson Business Trust to the Lucille A. Sampson Pure Equity Trust. There is no explanation as to why respondent did not include the entire $ 54,391 which represents the net professional fees of Dr. Sampson for the year. The professional corporation, Dr. W. Clifford Sampson, Inc., had gross receipts of $ 67,926 and deducted the entire amount of $ 54,391 for Dr. Sampson's earned professional fees and purportedly paid that amount to the Sampson Business Trust. However, respondent has not sought an increased deficiency for 1981, and we will accept the lower figure of $ 35,984. ↩7. Diane Sampsom Spears' testimony established that she did little or nothing as a trustee of the Lucille A. Sampson Pure Equity Trust. At the infrequent meeetings of the board of trustees, she never discussed the main source of trust income, her father's practice as an osteopath. At best they may have discussed home improvements at these infrequent meetings. Indeed, she testified she never voted "no" at a trustee meeting. Bruce A. Sampson did not testify at the trial. Dr. Sampson testified the checks for payment for his osteopathic services were made out to W. Clifford Sampson, Inc., Dr. Sampson, or Dr. W. C. Sampson. Pressed on what conclusion to draw from this, he testified "my wife and I" conttrolled the funds. Mrs. Sampson's testimony as to her role as a "trustee" was vague, conclusory, and wholly unworthy of belief. The Court is satisfied that petitioners, principally Dr. Sampson, exercised complete control over the funds at all times and that the various entities were nothing more than meaningless pieces of paper. ↩8. In petitioners' own case for their earlier years, 1975-1979, damages under section 6673 were considered but not imposed. The Court noted, however, "while we believe that petitioners, in substantial part, did not intend to proceed with a meritorious action in this Court, we note that there was a jurisdictional issue for the taxable years 1975 and 1976," and in a footnote it was pointed out that adjustments in petitioners' favor will not necessarily preclude an award of damages. See Sampson v. Commissioner,T.C. Memo. 1986-231↩. 9. See also Whitesel v. Commissioner,T.C. Memo 1983-9">T.C. Memo. 1983-9, affd. without published opinion 745 F.2d 59">745 F.2d 59↩ (6th Cir. 1984). Moreover, this Court has decided well over 50 of these family trust cases by unpublished Memorandum Opinions,, ruling against the taxpayer in each instance. 10. See Truxal v. Commissioner,T.C. Memo. 1982-616; Whitesel v. Commissioner,T.C. Memo. 1983-9, affd. by unpublished opinion 745 F.2d 59">745 F.2d 59↩ (6th Cir. 1984). 11. See Sampson v. Commissioner,T.C. Memo. 1986-231↩. 12. See also Ruberto v. Commissioner,T.C. Memo. 1987-623; Piche v. Commissioner,T.C. Memo. 1986-29↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619384/	Hewitt Rubber Company of Pittsburgh v. Commissioner. M. S. Lambert, Transferee v. Commissioner. Margaret E. Starr, Transferee v. Commissioner.Hewitt Rubber Co. v. Comm'rDocket Nos. 8239, 8240, and 8241. United States Tax Court1947 Tax Ct. Memo LEXIS 27; 6 T.C.M. (CCH) 1258; T.C.M. (RIA) 47317; November 28, 1947, Decided. T. J. McManus, Esq., William Wallace Booth, Esq., and A. G. Wallerstedt, C.P.A., 747 Union Trust Bldg., Pittsburgh, Pa., for the petitioners. George C. Lea, 28 Esq., for the respondent. OPPERMemorandum Findings of Fact and Opinion OPPER, Judge: This proceeding was brought for a redetermination of income, declared value excess-profits and excess-profits taxes as follows: Declared ValueIncomeExcess-Excess-TaxProfits TaxProfits tax1941$1,935.89$1,186.72$ 3,440.141942None1,626.6512,204.53Total$1,935.89$2,813.37$15,644.67The issues for decision relate to the reasonableness of the salaries paid the employee-stockholders; the amount of expenditures for entertainment; and the effect upon the computation of base period income of an item of salary accrued but not paid in one of the base period years. There is no dispute as to the liability of the individual petitioners as transferees. Findings of Fact Petitioner, Hewitt Rubber Company of Pittsburgh, hereinafter sometimes for convenience called petitioner or the "company", is a corporation organized under the laws of the Commonwealth of Pennsylvania, with its principal office at Pittsburgh, Pennsylvania. Its returns for the periods here involved were filed with the collector of internal revenue for the twenty-third29 collection district of Pennsylvania, at Pittsburgh, Pennsylvania. Petitioners Margaret E. Starr and Max S. Lambert are individuals with residence in Pittsburgh, Pennsylvania. During the periods here pertinent and until its dissolution on December 31, 1944, as hereinafter related, the outstanding stock of the company consisted of 90 shares. Prior to the death of her husband on May 5, 1939, petitioner Margaret E. Starr owned 30 shares of the stock and her husband owned 60 shares, and upon his death she became owner of all of the outstanding capital stock of the company. At the date of the death of Margaret Starr's husband, petitioner distributed only the products of Hewitt Rubber Corporation of Buffalo, hereinafter sometimes called Hewitt, which by written agreement had the power to terminate or renew petitioner's franchise at its option. Before his death her husband had recommended three men to work with Margaret Starr in the business. None of these men was interested. Hewitt was afraid to have Margaret Starr conduct the business alone and they insisted on sending a man to be manager of the business if he was acceptable to Margaret Starr. They sent Max Lambert. On or before30 July 20, 1939, Margaret Starr agreed to transfer 45 shares of the 90 shares of the capital stock of the company outstanding to Max Lambert. That obligation was one of the terms of an oral agreement which Margaret Starr and Max Lambert entered into with the company on July 20, 1939. At all times thereafter, and during the taxable years here in question, Margaret Starr and Max Lambert each owned 50 percent of the outstanding stock of the company. For the taxable years 1941 and 1942, the compensation to Margaret Starr and Max Lambert was paid pursuant to the contract entered into between them and the company. This contract reduced to writing the oral agreement which the parties thereto had entered into on July 20, 1939. Articles "TWO" and "THREE" of such contract provide as follows: "TWO. (a) Mr. Lambert shall receive a drawing account at the rate of $7200.00 per year, payable $300.00 on the 15th and last days of each month, as an advance against his ultimate salary and other compensation. "(b) Mrs. Starr shall receive a drawing account at the rate of $6,000.00 per year, payable $250.00 on the 15th and last days of each month, as an advance against her ultimate salary and other31 compensation. "THREE. (a) The amount available for officers' salaries in excess of the above drawing account of $13,200.00 shall be distributed as follows and in the following order: Mr. LambertMrs. Starr(1) The first $1500.0050%50%(2) The next $200060%40%(3) The balance70%30%"No dividends shall be available for payment to stockholders until the total drawing accounts and salaries of Mr. Lambert and Mrs. Starr combined shall reach $20,000.00. After reaching the first $20,000.00 compensation, the officers' salaries shall be increased by $600.00 for each $1,000.00 of net profit before income taxes. "(b) All net income available for dividends up to a total of 30% on capital stock outstanding shall be paid as dividends. The balance of net earnings may be paid as dividends in whole or in part, or retained as surplus in the company, at the discretion of Mr. Lambert. Dividends, when paid, shall be paid on the basis of 70% to Mr. Lambert and 30% to Mrs. Starr." For each of the years hereinafter mentioned, the company paid Margaret Starr and Max Lambert as compensation the following amounts: Amount of CompensationMargaretMax S.YearE. StarrLambert1936$ 2,700.0019374,800.001938850.5219395,888.22$ 3,200.0019408,550.009,750.00194112,693.0320,715.30194213,188.9421,872.4219438,278.3110,849.3819446,891.118,196.5732 In the years 1940 through 1944 the company paid its stockholders $120,985.06 as compensation, plus travel and entertainment expenses exceeding $24,088.07, plus $6,660 as dividends, and during the same period a total of $5,916.81 was paid to the Federal Government in taxes. During the taxable years 1941 and 1942, all of the products sold by the company were subject to priorities, and such period was a seller's market due to war conditions. The priorities to a great extent determined to whom goods were sold. The company sold the products for Hewitt and it sold products of the Rockwood Company and the Chicago Belting Company. These goods included conveyors and conveyor belts, industrial hoists, sheet goods, and pulleys and drives. Margaret Starr devoted only part time to the business during 1941 and 1942. She was not familiar with the details of the company's business and seldom went to the office, and did not go into the mills to call upon the mill managers or superintendents. Her job was selling by keeping in touch with customers by personal entertaining. She was well acquainted with the wives and families of purchasing agents, and attempted to keep these friendships alive. 33 She frequently entertained and made gifts to the Ochsenhirts. F. W. Ochsenhirts was a purchasing agent for the Jones and Laughlin Steel Co. Petitioner had no way to give reciprocal business in Pittsburgh and it was a small company and did not advertise. Margaret Starr is a graduate of Seton Hill College. She has been president and treasurer of petitioner since May 5, 1939. Max Lambert is 49 years old and has a Ph. D. degree from the University of Chicago. He also has a Bachelor of Engineering degree and took postgraduate work at the Armour Institute of Chicago. For seventeen years prior to entering petitioner's employ he was sales engineer of the Robins Conveying Belt Company, a company affiliated with Hewitt since 1925. He had been in charge of the Robins' Detroit offices for two years, manager of Merchandise Sales for Robins for two years, and he had handled advertising, including conventions and convention exhibits. He was general manager of petitioner from July 20, 1939, to December 31, 1944. He directed all of petitioner's activities, managed the sales, office, and shop. He formulated petitioner's policies. He made the engineering recommendations to customers, prepared engineering34 specifications and kept in touch with operating personnel. Margaret Starr and Max Lambert were responsible for practically all the sales made by petitioner during the period in question. In 1941 and 1942 petitioner also had in its employ a salesman in training, an office manager and a shop man (a belt mechanic) and one or two stenographers. Petitioner's sales, compensation to officers, net income, and the ratio of officers' compensation to sales, for 1936 through 1944, are disclosed in the following table: Officers' CompensationNet IncomeAfterOfficers'Margaret E.Max S.Total toCompen-YearNet SalesJ. G. StarrStarrLambertOfficerssation1936$132,905.66$15,959.33$ 2,700.00$18,659.33$ 3,981.111937158,970.5919,549.144,800.0024,349.143,733.591938100,233.2310,202.36850.5211,052.88(1,025.09)1939101,746.152,395.62 5,888.22$ 3,200.0011,483.84( 504.96)1940150,587.808,550.009,750.0018,300.00( 453.36)1941257,736.4012,693.0320,715.3033,408.338,446.531942278,329.4313,188.9421,872.4235,061.369,635.861943137,257.088,278.3110,849.3819,127.69(1,269.91)1944136,019.426,891.118,196.5715,087.68( 239.00)35 Officers' CompensationRatio ofOfficer's Compen-sation toNet Sales193614.04193715.32%193811.03%1939* 11.29%194012.15%194112.96%194212.60%194313.94%194411.09%Deduction of compensation for Margaret Starr and Max Lambert for 1941 and 1942 was claimed by petitioner, and allowed and disallowed by respondent as follows: 19411942Claimed$33,408.33$35,061.36Allowed21,045.0021,045.00Disallowed$12,363.33$14,016.36The amounts allowed by respondent are reasonable salaries for 1941 and 1942 for the services performed by the respective officers. Expenses for travel and entertainment for 1940 through 1942 were claimed by petitioner, and allowed and disallowed by respondent as follows: 194019411942Expenses Claimed$3,894.60$5,056.11$5,152.21Expenses Allowed3,113.393,860.663,870.82Expenses Disallowed781.211,195.451,281.39Margaret Starr made note of her traveling and entertainment expenses at the end of a month36 and itemized them on vouchers which she submitted to the office manager, who reimbursed her. Neither she nor Max Lambert was able to locate the vouchers for August, 1940, the entire year 1941, August and September, 1942, and January, May, September, October, and December, 1944. On her personal income tax return for 1941 appears the following: BUSINESS EXPENSESAutomobile used for businessGas and Oil$272.14Depreciation385.75$675.89Sales Promotion and Devel-opment, Entertainment ofCustomers not reimbursedto me by my employer127.50TOTAL BUSINESS EXPENSES$785.39 Petitioner does not reimburse her for any automobile expense. Max Lambert keeps a diary in which he entered daily traveling and entertainment expense incurred except items for which he is billed monthly. Vouchers were submitted by him to the cashier for monthly totals, and reimbursements were made. Lambert could not locate his diaries for 1940 and 1941. The amounts allowed by respondent represent the amounts substantiated and 75 percent of the entertainment and traveling expenses which were claimed by petitioner but unsubstantiated by vouchers. For the taxable year 1939 petitioner37 reported a net loss of $504.98 on its return which it filed. This was after deducting as salary an accrual of $2,222.22 which was never actually paid in cash, but was canceled and credited to sur7lus on August 31, 1940. For 1939 a revenue agent recommended disallowance of the $2,222.22 of unpaid salaries and concluded that petitioner had taxable net income of $1,717.26 in 1939. His explanation was: "Under date of May 5, 1939, Mr. J. G. Starr died. On Dec. 31, 1939 when books were closed on [down] item of accrued Officers' salaries was charged to J. Garnet Starr (Mrs. Margaret Starr) and this was included in total salaries of $11,483.84 deducted from income in determining net loss. "This accrued salary of $2,222.22 was not paid on 8/31/41 [08/31/41] this item was transferred to the Surplus account. It is disallowed as a deduction in 1939 under Sect. 19:24-6 Reg. 103." Respondent made no claim for the tax due shown by the revision of the 1939 income, but made such a claim to show there was no net-loss carry-over. Respondent now concedes that on the basis of petitioner's 1939 return it is entitled to a net-loss carry-over in the amount of $504.96. Petitioner had $5,974.3138 cash on hand and $8,334.07 accounts receivable at the end of 1939. Upon the dissolution of the company on December 31, 1944, all of its assets amounting to $27,753.57 in value were transferred to Margaret Starr and Max Lambert in consideration of the cancellation of their capital stock in the company. Margaret Starr and Max Lambert are liable as transferees for the tax due by petitioner. Opinion We are again presented with the problem of what constitutes reasonable salaries of officer-employee-shareholders of a close personal service corporation whose profits were war inflated. See Wood Roadmixer Co., 8 T.C. 247">8 T.C. 247. As in the Wood case, there is no showing here that the large amount of business was attributable to any unusual activity on the part of the employees, and obviously the fact that the salaries were fixed by an arrangement which might have been at arm's-length between Margaret Starr and Max Lambert cannot serve to demonstrate reasonableness as though non-officer stockholders' interests had also been involved. Considering the entire record, including the relationship of the parties to the company, the nature of the employment contract, evidence of the39 work performed, the absence of any substantial dividends, and the sellers' market occasioned by the system of government priorities in the rubber industry, we do not believe that petitioner has established the reasonableness of any greater total salary figure than that allowed by respondent. It may be that the increased volume of business materially added to the work performed by Lambert; but the admitted ease of securing orders and the apparent concentration of Mrs. Starr's activities to that field must correspondingly have reduced her actual value to the company. We make no attempt to allocate total allowable salary as between the two officers. And there is no evidence of any higher salaries being paid for corresponding services in comparable businesses. Nor do we feel that the record discloses that respondent was in error in disallowing in part the travel and entertainment expenses claimed for the years in question. He approved deductions of $3,860.66 out of $5,056.11 claimed for 1941 and $3,870.82 out of $5,152.21 claimed for 1942. The records to substantiate Margaret E. Starr's disbursements were incomplete to an extent not apparently necessary, even considering the nature of40 the claimed expenses, and we are not satisfied from his testimony that Lambert has not included unallowable expense of personal transportation in his claim. The amounts approved reflect an allowance of 75 percent of items unsubstantiated by convincing proof. The doctrine of George M. Cohan v. Commissioner (C.C.A., 2nd Cir.), 39 Fed. (2d) 540, cannot be said on the present record to require more. The last issue relates to a deduction for salary to Margaret E. Starr, accrued in 1939 but not actually paid, which is said to be involved in the computation of excess-profits for 1940 through 1944 and the amount of carry-over and carry-back of the unused portion of the credits. Petitioner first claimed the deduction of the $2,222.22 salary item for 1939 resulting in a loss for that year of $504.98. A revenue agent recommended disallowance of the deduction, with the result of a net income of $1,717.26 for 1939. Respondent now "concedes" the loss and chooses to accept petitioner's return as filed, insisting thus on the smaller base period income; and petitioner seeks the advantage of the originally proposed revision, and of the disallowance of the net-loss carry-over from 193941 incorporated in the deficiency notice presently under review. It may be that respondent's conclusion in the latter respect is equivalent to a determination that there was no net loss in 1939. We shall assume as much for present purposes and grant further that this is presumptively correct, and binding upon him as well as upon the petitioner; so that where he purports to change his determination the burden of proof is upon him. See M. J. Sullivan, 2 B.T.A. 1012">2 B.T.A. 1012; Pepsi-Cola Co., 5 T.C. 190">5 T.C. 190, 198; Security First National Bank of Los Angeles, Executor, 38 B.T.A. 425">38 B.T.A. 425, 434. In no case, however, does the obligation imposed by the burden-of-proof rule require that the evidence be produced by any particular party. The record as a whole must be examined and the burden is met if the necessary evidence exists, whoever produced it. L. Schepp Co., 25 B.T.A. 419">25 B.T.A. 419. The most that can accordingly be said, if we accept petitioner's view that respondent by failing to confer upon petitioner the benefit of a net-loss carry-over thereby determined that it had42 no net loss in 1939, is that the burden of proving the item deductible would fall upon respondent. 1 Assuming this result in petitioner's favor for the sake of the argument, we think that burden has been met. The record shows that the item in dispute was salary accrued on the corporation's books in 1939 in favor of Margaret Starr but not paid, the disallowance of which was recommended under Regulations 103, section 19.24-6 dealing with the application of section 24 (c), Internal Revenue Code. 243 The record further shows that on December 31, 1939, the last date of petitioner's relevant taxable year and for two and onehalf months thereafter, Margaret Starr did not own, directly or indirectly, more than 50 percent of petitioner's stock. It follows that the condition of section 24 (c) (3) that the taxpayer and the person to whom payment is made are not persons between whom losses would be disallowed under section 24 (b) is not met. The latter disallows losses "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." Finally, the statutory restriction on the deduction imposed by section 24 (c) does not become operative unless all three conditions specified coexist. Anthony P. Miller, Inc., 7 T.C. 729">7 T.C. 729, 739 (reversed other ground (C.C.A., 3rd Cir.), 164 Fed. (2d) 268 (Nov. 18, 1947)). We conclude that it affirmatively appears that the salary item in question was not disallowable and hence that the net loss of $504.98 for 1939 was actually sustained44 by petitioner. Having satisfied ourselves that the deduction originally taken was proper, we are not called upon to entertain respondent's motion for leave to amend his pleadings to permit the contention, under Internal Revenue Code, section 734, that petitioner's presently inconsistent position is being sustained. Respondent's motion will accordingly be denied. No issue was raised with respect to the liability of the individual petitioners as transferees. Decisions will be entered under Rule 50. Footnotes. $2,222.22 not paid - Credited to surplus 8/31/40. ↩**. 9.11% after disallowance of unpaid salaries of $2,222.22.↩1. No formal pleading was necessary to raise the issue, since on petitioner's own theory the deficiency notice was inconsistent on its face. And there was no surprise. From the opening statements it is apparent that both parties faced the issue. See Walter Cutcliffe v. Commissioner (C.C.A., 5th Cir.), 161 Fed. (2d) 891↩ (Oct. 24, 1947).2. "(c) Unpaid Expenses and Interest. - In computing net income no deduction shall be allowed under section 23(a), relating to expenses incurred, or under section 23(b), relating to interest accrued - "(1) If such expenses or interest are not paid within the taxable year or within two and onehalf 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 person between whoms losses would be disallowed under section 24(b)↩."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619385/	ESTATE OF ROSS H. COMPTON, DECEASED, BY FIRST NATIONAL BANK OF MIDDLETOWN, EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Compton v. CommissionerDocket No. 1158-73United States Tax CourtT.C. Memo 1974-316; 1974 Tax Ct. Memo LEXIS 4; 33 T.C.M. (CCH) 1453; T.C.M. (RIA) 740316; December 23, 1974, Filed. William E. Rathman, for the petitioner. Donald W. Mosser, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined a $6,992.42 Federal estate tax deficiency against the Estate of Ross H. Compton. The sole issue is whether decedent's assignment of two non-contributory group term life insurance policies5 to his wife approximately 15 months prior to his death was made in contemplation of death within the meaning of section 2035. 1FINDINGS OF FACT Most of the facts have been stipulated and are found accordingly. Decedent, Ross H. Compton, was a resident of Middletown, Ohio, when he died testate on January 17, 1971. He was 46 years of age. Letters testamentary were issued to the First National Bank of Middletown, Ohio. Decedent's Federal estate tax return was filed with the district director of internal revenue at Cincinnati, Ohio. Prior to his death decedent was a project engineer with Armco Steel Corporation ("Armco") in Middletown, Ohio. He had been employed by Armco since 1959. On August 1, 1960, the Equitable Life Assurance Society of the United States ("Equitable") issued a noncontributory group term life insurance policy to Armco covering the lives of eligible Armco employees. Decedent was a covered employee. On June 19, 1970, a new policy was issued to replace the prior policy issued on August 1, 1960. Each eligible employee covered by the Equitable6 policy was issued a certificate evidencing participation in the Equitable plan. Decedent was issued certificate number 1115 with a face amount of $22,500. On July 9, 1968, the Union Central Life Insurance Company ("Union") issued a non-contributory group term life insurance policy to Armco covering the lives of eligible Armco employees. 2 Decedent was a covered employee. Each eligible employee covered by the Union policy was issued a certificate evidencing participation in the Union plan. Decedent was issued certificate number 578442731 with a face amount of $28,500. The premiums for both the Equitable and Union policies were paid by Armco. Neither policy provided for cash, loan or paid-up value to the employees covered by the policies. Each policy was conditioned upon the maintenance of a minimum number of employees in the group and the payment of the annual premium. On May 6, 1966, decedent designated his wife, Joan M. Compton ("Joan"), as primary beneficiary, and his three minor children as equal contingent7 beneficiaries, under both the Equitable and Union policies. On October 1, 1969, in accordance with the suggested procedures for assignment of group life insurance for employees of Armco, decedent designated his estate as the primary beneficiary under both policies, and on October 2, 1969, Joan's birthday, decedent irrevocably assigned all of his rights in each policy to his wife. These assignments vested Joan with the sole and exclusive right to designate and change beneficiaries under the policies; to exercise all options, rights or elections provided in the policies; and to cancel or surrender any interests in the policies. The assignment of these policies was accepted by the respective companies. On October 3, 1969, Joan designated herself as primary beneficiary and her three minor children as contingent beneficiaries of these policies. On December 1, 1970, decedent executed a Revocable Trust Agreement and a will, which replaced an essentially identical will executed in 1962. On the same day Joan executed a will which also replaced an essentially identical will executed in 1962, except that this will provided that in the event decedent predeceased her, Joan's residual estate8 was to pass to the trustee of the Revocable Trust Agreement executed by decedent. In the years prior to his death, decedent had made certain gifts to his wife. On February 27, 1959, decedent and his wife purchased their residence for $23,000, taking title as tenants in common. The $8,000 down payment was paid entirely by decedent. On April 1, 1960, decedent gave his wife 113 shares of stock in Cameron Machine Company.These shares had a cost basis to decedent of $5,494.98, and a fair market value of probably twice that amount on the date of the gift. Decedent had no history of operations, hospitalization or heart disease. He participated in athletics, including tennis, golf, swimming and skiing. Two weeks before his death, decedent and his family had been in Michigan on a skiing vacation. On January 17, 1971, while attending Sunday school class with his family, decedent complained of a headache. He left class early to go home and get some aspirin and returned at the end of class to pick up his wife and children. From there decedent proceeded directly to the hospital emergency room. As he was being admitted, decedent collapsed and died. Death was attributed to acute myocardial9 infarction. Joan, as primary beneficiary of the Equitable and Union policies on the life of decedent, received the proceeds of both policies. None of these proceeds were included in decedent's gross estate on the Federal estate tax return filed by petitioner. In his statutory notice, respondent determined that the two policies represented gifts made in comtemplation of death and should have been reported in decedent's gross estate pursuant to section 2035. 3OPINION The sole question presented in this case is whether the assignment by decedent of two insurance policies on his life was made in comtemplation of death so that the face value of the policies is includible in his gross estate under section 2035. 4 Because the assignments occurred within three years of death, subsection (b) of that section establishes a rebuttable presumption that they were so made. 10 The purpose of section 2035 is "to reach substitutes for testamentary dispositions and thus to prevent the evasion of the estate tax." . The fact that a decedent was not in fear of imminent death is not controlling. The crucial question is one of fact, namely, whether, in light of all the circumstances, the dominant motive in making the assignments was the thought of death or a purpose normally associated with life. ; . Petitioner's burden is particularly heavy where the property transferred is so inherently death-oriented as life insurance. (C.A. 5, 1973). Petitioner first argues that decedent was young, healthy and athletic and did not expect imminent death. Clearly his death was both sudden and completely unexpected. However, expectation of death must not be confused with contemplation of death. The question is not whether decedent expected imminent death but whether the assignment of the policies was motivated by purposes associated with the distribution of11 property in anticipation of death. ; (C.A. 5, 1971), certiorari denied . The physical condition of the decedent is one objective factor to which the courts may look to establish a subjective life motive for a gift, but good health alone is insufficient to overcome the statutory presumption favoring respondent. This is particularly true where the subject of the gift is so testamentary and death-connected in character as life insurance. Indeed, except in the event of death, there is little if any significance or meaning in a transfer of a life insurance policy which had no value except at death. Petitioner also argues that decedent had established a pattern of lifetime giving which is evidence that a gift made by decedent within three years of death was not made in contemplation of death. Decedent in this case had given his wife Joan a half interest in their home purchased in 1959 and certain shares of stock in 1960. He assigned the policies in question to Joan on her birthday in 1969.We are not persuaded that decedent had established, or indeed could establish, 12 a pattern of lifetime giving of sufficient frequency or magnitude to overcome the countervailing consideration that the policies assigned had no value whatsoever except in the event of decedent's death, and the only evident purpose or advantage in assigning the policies appears to be the avoidance of estate taxes at decedent's death. The lifetime gifts, unlike the group term policies, had substantive significance without regard to decedent's death. Petitioner also argues that decedent assigned the policies to give his wife financial security and independence. However, the policies had no value at the time assigned, and Joan was the primary beneficiary both before and after the assignment. Only in the event of his death, moreover, would her financial security be advanced by the assignment, so that petitioner's argument merely reinforces the necessary conclusion that death was contemplated. Moreover, the evidence does not show that Joan took any immediate or definitive steps to plan her estate. Rather, it appears that decedent initiated the planning of his estate and Joan merely executed a will which was both essentially reciprocal to her husband's will and similar to her previous13 will. If the evidence tends to prove anything, it is that the assignment of the group policies and the subsequent execution of a will in trust by the decedent was part of an integrated testamentary plan. See (C.A. 10, 1946). The transfer appears to accomplish no purpose other than to substitute for a testamentary disposition of the property, which, along with avoidance of estate taxes, is not a life motive. Petitioner relies primarily on (Ct. Cl., 1969), a case which also involves the assignment of group term life insurance which lacked any cash or loan value. The Court of Claims found that the decedent was in good health, without any prior history of illness; that he had 14 life insurance policies other than the one in issue which were all owned by his wife and sons, and, in addition, had made several substantial gifts to his wife and sons during the four years prior to his death; and that the assignment of the group policy was of some immediate value to his wife in that it permitted her to plan her own estate. The Court concluded that the executors had carried their14 burden of proving that decedent's dominant motives in making the transfer of the group policy were life-motives and the transfer was not in contemplation of death. We believe that, even assuming that case is considered to have reached a correct conclusion on its own facts, it is distinguishable on those facts. The lifetime gifts in that case were more substantial and frequent than here.Moreover, we are not persuaded that the group term policies significantly affected Joan's ability to plan her estate, or, that if they did, they did so in any sense other than in protecting her estate against the eventuality of decedent's death. Neither are we persuaded by (N.D. Ga., 1972), which is not only distinguishable on its facts, but finds the combination of decedents' youth and good health plus an apparent absence of any motives in transferring the group life insurance involved is sufficient to rebut the presumption contained in section 2035(b). We cannot agree. More in point, in our view, is In that case decedent took out a flight insurance policy and assigned it to his son just before15 embarking on a fatal flight. As in this case, decedent was in excellent physical condition and did not expect to die. The insurance there had no value or significance except in the event decedent were disabled or died. The executrix argued that in making the assignment decedent contemplated that the plane would crash and he would be physically disabled, but he did not contemplate that he might be killed. The Court was not convinced. The Fifth Circuit found on the facts that the taxpayer had failed to meet its burden of proof that the transfer was to accomplish some specific lifetime purpose. We hold that petitioner has failed to carry its burden of proof: the assignment was made within three years of death; the property in question was inherently death-oriented; the policies (non-contributory, group term insurance) provided no present benefit in the form of cash, loan or paid-up value; and the evidence, when considered most favorably to petitioner, is insufficient to establish a dominant, controlling and compelling reason for the assignment unrelated to the possibility of decedent's death. While we give considerable weight to the fact that group term life insurance policies16 without any cash or loan value during decedent's lifetime are the subject matter of the gift, we do not accept respondent's argument that as a matter of law a life-associated purpose can never be established in a case involving the assignment of non-contributory, group term life insurance made within three years preceding the assignor's death. We conclude here only that petitioner has not established the absence of a death-related motive to a degree sufficient to rebut the statutory presumption in this case. Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect during the year in issue. ↩2. This policy was also issued to replace a previously issued policy. The record, however, does not include any information regarding the prior policy. ↩3. Respondent has stipulated that decedent did not retain any incident of ownership in the Equitable and Union group term life insurance policies by reason of decedent's right to terminate his employment with Armco. ↩4. SEC. 2035. TRANSACTIONS IN CONTEMPLATION OF DEATH. (a) General Rule. - The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, in contemplation of his death. (b) Application of General Rule. - If the decedent within a period of 3 years ending with the date of his death (except in case of a bona fide sale for an adequate and full consideration in money or money's worth) transferred an interest in property, relinquished a power, or exercised or released a general power of appointment, such transfer, relinquishment, exercise, or release shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of this section and sections 2038 and 2041 (relating to revocable transfers and powers of appointment); but no such transfer, relinquishment, exercise, or release made before such 3-year period shall be treated as having been made in contemplation of death. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619387/	PATRICIA ANN EATINGER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEatinger v. CommissionerDocket No. 16564-89United States Tax CourtT.C. Memo 1990-310; 1990 Tax Ct. Memo LEXIS 328; 59 T.C.M. (CCH) 954; T.C.M. (RIA) 90310; June 20, 1990, Filed 328 Decision will be entered for the respondent. Robert J. Eatinger, Jr., for the petitioner. Thomas A. Dombrowski, for the respondent. DAWSON, Judge. DAWSONMEMORANDUM OPINION Respondent determined a deficiency of $ 1,235 in petitioner's Federal income tax for 1985. In his notice of deficiency dated April 12, 1989, respondent included in petitioner's gross income as additional alimony the amount of $ 9,790 received as her portion of her former husband's military retirement pay or, alternatively, that such amount constituted taxable pension income to petitioner. Respondent has conceded in his reply brief that the military retirement income payments received by petitioner in 1985 were not alimony. Thus, the only issue for decision is whether the $ 9,790 received by petitioner in 1985 for her share of her former husband's military retirement income, which was paid to her pursuant to an Order of the Superior Court for San Bernardino County, California, was taxable income to her. All of the facts are stipulated and are so found. The stipulation of facts and accompanying exhibits are incorporated herein by this reference. The pertinent facts are summarized below. Patricia Ann Eatinger 329 (petitioner) resided in Highland, California, when she filed her petition in this case. Petitioner married Robert Joseph Eatinger (Lt. Col. Eatinger) in Illinois on May 14, 1955. During their marriage they lived in various community property and non-community property states before finally settling in California. 1Lt. Col. Eatinger served on active duty in the United States Air Force Reserve from January 1952 until his retirement on May 31, 1972. When he retired he was entitled to retirement pay based upon 20 years of active service. In 1977, petitioner and Lt. Col. Eatinger divorced pursuant to the laws of California. On March 28, 1977, and incident to their divorce, the Superior Court for San Bernardino County, California, issued an Order for Custody of Children, Visitation, Child Support, Spousal Support, Division of Community Property and Obligations and Attorney 330 Fees, which, in relevant part, provided as follows: 7. Respondent [petitioner] is awarded as her sole and separate property: * * (h) 42-1/2% of petitioner's [Lt. Col. Eatinger's] military retirement income, being $ 401.00 per month, commencing payments on April 1, 1977. * * * 10. Petitioner's [Lt. Col. Eatinger's] military retirement income shall be shared between petitioner [Lt. Col. Eatinger] and respondent [petitioner] as provided herein. The deductions from said retirement include premium payments on respondent's [petitioner's] survivor benefit plan and life insurance policy premium on the lives of petitioner [Lt. Col. Eatinger] and respondent [petitioner]. These deductions shall continue until the emancipation or majority of the minors as regards their beneficiary status. On July 28, 1981, the above court order was modified by an Order to Show Cause Hearing Minute Order, which, in relevant part, provided: The Court finds Respondent [petitioner] is entitled to receive 42-1/2% of Petitioner's [Lt. Col. Eatinger's] military retirement from the date of the Interlocutory Decree; less amounts of Respondent's [petitioner's] taxes paid by Petitioner [Lt. Col. Eatinger] from the 331 date of said judgment. Arrears to include interest at the legal rate from the date due and principal and interest are to be paid at $ 100.00 per month and continuing to bear interest at the legal rate commencing September 1, 1981, payable 1/2 on the 1st and 1/2 on the 15th.On his 1985 Federal income tax return Lt. Col. Eatinger reported the $ 23,041 retirement pay he received during 1985, and which was shown on the Form W-2P, Statement for Recipients of Annuities, Pensions, Retired Pay, or IRA Payments, issued to him. However, he reduced his taxable income by the total amount paid to petitioner in 1985, as follows: 2Breakdown of Payments to PetitionerAlimonyMil. Ret.3 ArrearsTotalMonth Total 4$ 300 $ 718 $ 100 $ 1,118Year Total3,600 8,612 1,200 13,412During 1985, Lt. Col. Eatinger paid petitioner the 332 amounts due her by sending her checks twice each month. Petitioner neither requested nor received payments directly from the United States Air Force, or from any other agency or department of the United States Government, for any amounts representing the 42-1/2 percent, or any other portion, of Lt. Col. Eatinger's military retirement pay. Petitioner files her Federal income tax returns on the cash receipts and disbursements method of computing income. On her Federal income tax return for 1985 petitioner reported only the $ 3,600 alimony received in that year. In his notice of deficiency respondent increased petitioner's income by $ 9,790, which was her share of Lt. Col. Eatinger's military retirement income received pursuant to the Order of the Superior Court for San Bernardino County, California. Petitioner contends that the amounts she received as her share of her former husband's military retirement pay pursuant to the provisions of the divorce decree constitute a transfer of property due her when the marriage was dissolved, and that such transfer of property is not taxable income to her under section 61 of the Code. 5 To the contrary, respondent contends that petitioner's share 333 of her former husband's military retirement pay received in 1985 represents taxable pension income. We agree with respondent. The general rule of section 61(a) is that, except as otherwise provided by law, gross income includes all income from whatever source derived. Gross income includes pensions. Sec. 61(a)(11). A military retirement pension, like other pensions, is simply a right to receive a future income stream from the retiree's employer. It is a settled principle that Federal law controls how income from property interests will be taxed even though the property interests are created and controlled by state law. United States v. Mitchell, 403 U.S. 190">403 U.S. 190 (1971); Schottenstein v. Commissioner, 75 T.C. 451">75 T.C. 451, 460 (1980). It is also settled law that income from property is taxed to the owner thereof. Helvering v. Clifford, 309 U.S. 331 (1940); Blair v. Commissioner, 300 U.S. 5 (1937); Poe v. Seaborn, 282 U.S. 101">282 U.S. 101 (1930); Lucas v. Earl, 281 U.S. 111">281 U.S. 111 (1930).Here the property interest petitioner received incident to the divorce in 1977 was evaluated by the Superior Court 334 under California community property law to determine the nature of her ownership interest.6335 If the payments she received in 1985 represent income, the income tax consequences necessarily follow ownership. We look to the decisions of the relevant state's highest court to determine state law regarding property ownership and the nature of the property interest created. Commissioner v. Estate of Bosch, 387 U.S. 456">387 U.S. 456 (1967). Although the Supreme Court of California has in the past encouraged trial courts, if feasible, to award all pension rights to the employee spouse, compensating the nonemployee spouse with other community property of equal value, the awarding of the community's pension to the employee spouse is not an absolute requirement. In re Marriage of Gillmore, 29 Cal. 3d 418">29 Cal.3d 418, 428; 629 P.2d 1">629 P.2d 1, 7 (1981).Trial courts have considerable discretion to value and divide community property. This discretion is limited only by the statutory requirement that all community property be divided equally. In re Marriage of Gillmore, 29 Cal.3d at 423; Cal. Civ. Code, sec. 4800 (West 1982). There is no entitlement to in-kind distributions of community property. See, e.g., In re Marriage of Fink, 25 Cal. 3d 877">25 Cal.3d 877; 336 603 P.2d 881">603 P.2d 881 (1980).However, once the community portions are separated the employee spouse may "buy out" the nonemployee spouse. In re Marriage of Gillmore, supra.Under California law a retirement pension represents deferred compensation for past employment and is not a gift from the employer. In re Marriage of Brown, 15 Cal. 3d 838">15 Cal.3d 838, 845; 544 P.2d 561">544 P.2d 561, 565, (1976); Inre Marriage of Fithian, 10 Cal. 3d 592">10 Cal.3d 592, 596; 517 P.2d 449">517 P.2d 449, 451 (1974).Also, "a spouse's entitlement to a share of the community property arises at the time that the property is acquired. (Civ.Code, secs. 5107, 5108, 5110.) That interest is not altered except by judicial decree or an agreement between the parties." Henn v. Henn, 26 Cal. 3d 323">26 Cal.3d 323, 330, 605 P.2d 10">605 P.2d 10, 13 (1980). Petitioner was married 17 of the 20 years her former husband spent in military service. Thus 85 percent of the retirement pension earned was community property subject to division. Her community portion was one-half or 42.5 percent of the retirement pension. As a "property settlement" incident to her divorce, petitioner was awarded, as her sole and separate property, 42-1/2 percent of her former husband's military retirement pension (less survivor 337 benefit premiums and life insurance premiums on the lives of Lt. Col. Eatinger and petitioner). In 1981, petitioner sought and received a modification of the prior Order which also required her former husband to pay the arrearages in past payments, less income taxes, attributable to the pension. It is clear that California courts have considerable discretion to partition community assets limited only by the requirement that the community be divided equally. Even though petitioner neither requested nor received payment directly from the United States Air Force 7 or any other agency of the United States Government, she was entitled to the community property portion of Lt. Col. Eatinger's military retirement pension pursuant to California law. That interest was not modified by court order. We reject petitioner's 338 argument that the court-ordered division of community assets (here the retirement pay) did not result in an entitlement to income. The Air Force paid retirement benefits (the "property asset" here in issue) to Lt. Col. Eatinger from the time he retired in 1972 until his marriage to petitioner was dissolved in 1977 and thereafter. Certainly the retirement payments received from 1972 to 1977 resulted in the receipt of taxable income by the marital community. The parties do not dispute that the Eatingers' right to collect the military retirement pension was a community asset subject to division by the California courts. Here the Superior Court for San Bernardino County computed the community's interest in the pension and awarded both spouses their respective shares. We also reject petitioner's argument that the court-ordered division of this particular community property income changed the character of the payments from "income" to "property" as a result of the divorce. This argument ignores the clear directive of the California Superior Court in its order dividing the community property. The Court ordered that the "military retirement income shall be shared between [the parties]. 339 " It further ordered that petitioner be awarded 42-1/2 percent of the military retirement income as her sole and separate property. Petitioner seemingly argues that she was awarded the present value of her community property share of the military pension benefits and, therefore, the monthly payments she received constitute a recovery of basis. We note, however, that the Order partitioning the community property does not provide a lump sum (i.e., the present value of the pension) to be satisfied in installments. But even if we were persuaded, which we are not, that a portion of the monthly payments is to be applied against her basis in the pension, that basis is zero, and the portion applied against basis nevertheless represents income. Petitioner raises other arguments premised on the assertion that California law requires trial courts in marriage dissolution proceedings to award pension benefits to the employee spouse, compensating the nonemployee spouse with other community assets. We disagree. We do not find this to be the law in California. Petitioner contends that to tax her on her share of her former husband's military retirement pension violates her rights to equal protection 340 of the law under the Due Process Clause of the Fifth Amendment to the Constitution of the United States. This contention is based on a faulty premise and the arguments are not persuasive. Accordingly, we hold that petitioner's share of her former husband's military retirement pay received by her in 1985 pursuant to the California divorce decree was taxable as pension income. See and compare Bagur v. Commissioner, 66 T.C. 817">66 T.C. 817, 823 (1976), remanded on another issue 603 F.2d 491">603 F.2d 491 (5th Cir. 1979); Denbow v. Commissioner, T.C. Memo. 1989-92; and Lowe v. Commissioner, T.C. Memo. 1981-350. For the first time in her reply brief petitioner claims that if her share of her former husband's military retirement pay is taxable income, then she is entitled to a credit for taxes withheld from her share. The Form W-2P issued to Lt. Col. Eatinger for 1985 shows that he received $ 23,040.72 and that $ 2,595.12 in Federal income tax was withheld. Petitioner asserts that her share of the withheld amount is $ 1,102.93, which is 42-1/2 percent of $ 2,595.12. We are unable to consider petitioner's claim for a section 31 credit because such credit does not enter into the computation of deficiencies determined 341 under sections 6211(a) and 6211(b)(1). Redcay v. Commissioner, 12 T.C. 806">12 T.C. 806, 809-810 (1949); Kasey v. Commissioner, T.C. Memo. 1976-266; and McKinnon v. Commissioner, T.C. Memo. 1982-229. Moreover, we note that Title 10, United States Code section 1408(c)(1) (1982), provides that a court may treat "disposable retired or retainer pay" of military personnel either as property solely of the member or as property of the member and his spouse in accordance with the law of the jurisdiction of such court. Disposable retired or retainer pay is, by definition, net of income taxes. Title 10, United States Code, section 1408(a)(4)(C) (1982); and Mansell v. Mansell, 490 U.S. , 109 S.Ct. 2023 (1989). Because, in our view, a court's authority under section 1408(c)(1) to divide a community military retirement pension is limited to the amount that is net of income taxes, all income tax withheld is attributable to the service member spouse. If petitioner has any remedies with respect to a credit for withholding taxes, they lie elsewhere. There is a discrepancy in the amount of underreported income ($ 9,790) stated in the deficiency notice and the amount stipulated ($ 9,812) by the parties as received 342 by petitioner. This is not explained by the record. However, because respondent did not request an increase in the amount of deficiency as required under section 6214(a), he is bound by the amount stated in his notice of deficiency. Estate of Petschek v. Commissioner, 81 T.C. 260">81 T.C. 260, 272 (1983) affd. 738 F.2d 67">738 F.2d 67 (2d Cir. 1984). To reflect the foregoing, Decision will be entered for the respondent. Footnotes1. During their marriage petitioner and Lt. Col. Eatinger lived in Maine (5/55 - 7/56), Georgia (7/56 - 3/57), Texas (3/57 - 9/57), Arizona (9/57 - 12/57), England (2/58 - 3/59), France (3/59 - 12/59), Germany (12/59 - 5/61), Louisiana (5/61 - 7/63), Kansas (7/63 - 12/65), Arizona (1/66 - 7/68), and California (7/68 - 3/77).↩2. Lt. Col. Eatinger also paid petitioner additional amounts pursuant to the order for child support. ↩3. The column entitled "Arrears" denotes back payments due on petitioner's community property interest in Lt. Col. Eatinger's military retirement pay plus interest. ↩4. The military retirement pay received in January was $ 714. The amount received for all other months was $ 718.↩5. All section references are to the Internal Revenue Code of 1954, as amended and in effect for the year in issue.↩6. In McCarty v. McCarty, 453 U.S. 210">453 U.S. 210 (1981), the Supreme Court held that the Federal statutes then governing military retirement pay prevented state courts from treating military retirement pay as community property. Noting the distressed plight of many former spouses of military members, the Supreme Court observed that Congress was free to change the statutory framework. In a prompt and direct response to McCarty, Congress enacted in 1982 the Uniformed Services Former Spouses' Protection Act, which authorizes state courts to treat "disposable retired or retainer pay" as community property. 10 U.S.C. sec. 1408(c)(1) (1982). "Disposable retired or retainer pay" is defined as "the total monthly retired or retainer pay to which a military member is entitled" less certain amounts, such as properly withheld Federal income taxes. Here the initial order (March 28, 1977) of the Superior Court for San Bernardino County predated the McCarty decision. Congress obviously sought to change the legal landscape created by the McCarty decision when it chose June 25, 1981, the day before McCarty was decided, as the applicable date for some of the Act's provisions. 10 U.S.C. sec. 1408(c)(1)↩.7. Title 10, United States Code, section 1408↩, provides a mechanism for former spouses of service personnel to receive court-ordered alimony, child support, and property settlement payments sent directly to them from the military finance center. However, this mechanism did not come into effect until the enactment of the Uniformed Services Former Spouses' Protection Act in 1982.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619389/	Frances I. Warren v. Commissioner.Warren v. CommissionerDocket No. 25193.United States Tax Court1952 Tax Ct. Memo LEXIS 74; 11 T.C.M. (CCH) 986; T.C.M. (RIA) 52291; October 2, 1952Harold E. Smith, Esq., and Ralph R. Quillian, Esq., for the petitioner. Newman A. Townsend, Jr., Esq., for the respondent. RAUMMemorandum Findings of Fact and Opinion This proceeding involves the following deficiencies in income tax and additions to tax determined by the respondent against the petitioner: 50% addition6% addition10% additionYearDeficiencyto taxto taxto tax1944$28,115.12$14,057.56$ 40.5619454,654.312,327.16279.2619469,307.124,653.56585.60$976.0119471,300.44650.22112.92194.09The issues are: (1) Did the respondent err in including unidentified bank deposits in the petitioner's taxable net income for the years 1944, 1945, 1946 and 1947? (2) Is75 the petitioner liable for the 50 per cent addition to tax for fraud provided for in Section 293(b) of the Internal Revenue Code? (3) Is the petitioner liable for the 6 per cent addition to tax prescribed by Section 294(d)(2) of the Internal Revenue Code for substantial underestimate of tax? (4) Is the petitioner liable for the 10 per cent addition to tax provided for by Section 294(d)(1)(A) of the Internal Revenue Code for failure to file a declaration of estimated tax for the taxable years 1946 and 1947? (5) Is the assessment and collection of the deficiency for the year 1945 barred by the provisions of Section 275(a) of the Internal Revenue Code? Other issues raised by the pleadings with respect to minor adjustments made by the respondent for the year 1946 were waived by the petitioner at the trial. Findings of Fact The parties have filed a stipulation as to some of the facts involved herein; that stipulation is hereby adopted as part of our findings, and is incorporated herein by reference. Petitioner is a resident of Atlanta, Georgia. She filed her income tax returns for76 the taxable years with the collector of internal revenue for the district of Georgia. Petitioner and Robert L. Warren were married in September 1923. They had three children. They were separted on or about January 22, 1946, and divorced on or about June 6, 1946. Robert L. Warren died on March 18, 1949. The Warren Produce Company commenced business in 1929. During its existence it had at various times from one to five leased stores in Atlanta which sold poultry and produce. Robert L. Warren operated this business for approximately one year. In the early part of 1930 he became bankrupt and the petitioner purchased the fixtures of the business from a bank which was one of the creditors. Petitioner operated the business from 1930 until it was discontinued in June or July, 1942, during which time her husband had nothing to do with the operation of the stores, except that he worked for petitioner as the buyer for the main store which was located at 195 Edgewood Avenue in Atlanta. Petitioner kept the books of the business, which had approximately thirty employees, and during each of the years 1941 and 1942, its total receipts amounted to approximately $100,000. In a joint return filed77 by petitioner and her husband for 1942, a net loss of $3,837.42 from the operation of the business was reported. Petitioner ceased to operate the poultry and produce business in June, 1942. Thereafter until June 1945, when she lost the leases to the stores, she subleased to her former store managers the buildings and equipment on a profit-sharing basis, each sublessee paying her an amount equal to the rent she paid the owners of the real estate plus a percentage of the profits. In 1942, when the poultry and produce business was discontinued, Robert L. Warren entered the used-car business under the name of R. L. Warren Motor Company. He used the money in the bank account of the Warren Produce Company in the East Atlanta Bank to get started. During 1942, the operations of the used-car business were entered in the same set of books that had theretofore been used for the poultry and produce business. The bank account of the Warren Produce Company was closed out about January 1, 1943, and accounts were opened at the East Atlanta Bank in the name of the R. L. Warren Motor Company and in the name of the petitioner. Petitioner kept the books of the usedcar business during the period the78 company engaged in business, with the exception of the year 1943, when her husband employed a bookkeeper. Petitioner's husband authorized petitioner to sign checks on the account of the company, and she signed a substantial number of checks on this account, some of which were payable to various payees, some to cash with no endorsement, and some to herself with her endorsement. Vendors often would not accept checks for cars, and her husband would on occasion send petitioner to the bank to get cash needed to purchase automobiles. She got this cash by drawing checks on the company account. Petitioner also drew checks on her personal account to pay for automobiles purchased by the company and for some of its expenses. She was at the place of business of the company about once or twice a week. Often when her husband was out of town attending auction sales, employees of the company would come to her home to get checks needed to purchase cars. Checks issued under these circumstances were on her personal bank account at the East Atlanta Bank. The employees were authorized by her husband to purchase cars when he was out of town. Petitioner considered the checks drawn on her account for or79 on behalf of the company to be loans. No notes were given by her husband and no interest was paid by him. The following is a list of checks drawn on the account of the R. L. Warren Motor Company at the East Atlanta Bank during the years 1944 and 1945 payable to petitioner: January 3, 1944$2,225.00January 18, 1944927.00April 21, 194484.81August 14, 1944325.00August 29, 19441,040.00September 11, 19441,500.00December 12, 19446,880.00April 16, 1945500.00June 2, 19457,000.00 With the exception of the April 16, 1945, check for $500, which was a counter check, all of the above-listed checks were endorsed by the petitioner. The following is that portion of the "Notes Payable" account of R. L. Warren Motor Company for the years 1944 and 1945, which reflects loans made by petitioner: 1944DebitsCreditsFeb. 18 F. R. Warren (loan)$1,000.00Mar. 11 F. R. Warren (loan)2,000.00Mar. 13 F. R. Warren (loan)425.00Mar. 13 F. R. Warren (loan)1,080.00Mar. F. R. Warren (loan)900.00Mar. * F. R. Warren (loan)1,075.00Mar. * F. R. Warren$ 900.00Mar. * F. R. Warren1,500.00Mar. * F. R. Warren175.00Apr. 1 F. R. Warren1,740.00May 29 F. R. Warren2,175.00July 12 F. R. Warren (loan)1,285.00Oct. * Frances Warren6,000.00Oct. * Frances Warren1,000.00Dec. * Frances Warren6,880.001945Mar. * F. R. Warren$2,500.00Apr. * Frances Warren4,500.00May * Frances Warren$1,451.75June * Frances Warren7,000.0046.7580 The "credits" to this account record amounts paid to the company or to R. L. Warren by the petitioner, and the "debits" payments made to her. Checks were issued by petitioner on her personal account in 1944 in the amounts of $1,075 on January 29, $1,080 on February 9, $425 on March 9, and $2,000 on March 11, and in 1945 for $46.80 on October 18. Deposits were made in petitioner's bank account on March 20, 1944, December 12, 1944, May 8, 1945, and June 5, 1945, in amounts sufficient to cover the payments made of $175, $6,880, $1,451.75, and $7,000, respectively. The R. L. Warren Motor Company had a safe in its office which was used by petitioner and R. L. Warren exclusively. They were the only persons who knew the combination. The safe had two locked compartments, one for petitioner and the other for her husband. Petitioner kept some cash in her compartment during the years 1944 and 1945. During the year 1944 the petitioner had total bank deposits and withdrawals as follows: Bank balance, January 1, 1944$ 576.12Total Deposits65,382.99Total$65,959.11Disbursements by checks61,715.39Bank balance December 31, 1944$ 4,243.7281 Petitioner's income tax return for the year 1944 disclosed the following.. Income - Rents Leased Stores$7,779.51Less: Depreciation$637.55Repairs534.821,172.37$6,607.14Less: Deduction500.00$6,107.14Less: Surtax Exemption500.00$5,607.14Tax Liability$1,426.07In determining the deficiency for the year 1944, the respondent added to the income reported by petitioner in her return unidentified bank deposits of $45,958.48. In arriving at the amount of $45,958.48, he eliminated from the total deposits of $65,382.99, the rents from leased stores of $7,779.51 reported in petitioner's return, and also $11,645 which he identified as having been received by petitioner from the R. L. Warren Motor Company and deposited in her account during 1944. The checks received by petitioner from the R. L. Warren Company which were eliminated by the respondent from unidentified bank deposits for the year 1944 were the following: January 3$ 2,225August 291,040September 111,500December 126,880$11,645Petitioner received a check from R. L. Warren Company in the amount of $325, dated August 14, 1944, which82 she deposited in her personal account on the same date. In addition to the rental income of $7,779.51 reported by petitioner and eliminated from deposits by respondent, she also received in 1944 from the sublessees $2,660 to reimburse her for rents which she paid to the store owners. She deposited this $2,660 in her bank account for 1944. She did not report this amount in her return as income received or take any deduction for rent paid. During 1944 the petitioner collected from Jesse M. Danger advance rent on a store in the amount of $188.70, which she deposited in her bank account. Danger could not get the money to operate the store and petitioner refunded to him the $188.70 and leased the store to another person. Paul J. Davis, a sublessee of one of petitioner's stores, received some out-of-state checks at a time when he had to leave to join the armed forces. He could not get credit for the amount of these checks at his bank until they cleared. As a matter of accommodation the petitioner deposited these checks, totaling $1,828.93, in her account in 1944, and in exchange therefor gave Davis three checks on her account, one for $483.35 on March 2, one for $484.45 on April 4, 83 and another for $861.13 on May 2. Petitioner purchased a bond for $750 and paid for it by check dated July 6, 1944. She held this bond for a short time and then cashed it. She deposited $700 of the proceeds in her bank account. The petitioner sold fixtures in the store at 815 Gordon Street in 1944, after she lost the lease thereon, for $2,000. Their cost was in excess of $3,000. She deposited the $2,000 in her bank account. She did not report this sale on her 1944 return as she did not think this was necessary because she had not realized any profit. Petitioner sold her home at 808 Argonne Avenue, Atlanta, Georgia, for $6,000 in November, 1944, at which time she received $1,000 earnest money; on December 11, 1944, she received $3,300 from the purchaser, who at the same time assumed the note which represented the balance of the purchase price. The property cost $4,750 in 1940. She made improvements on the house but had no record of the cost. She did not report this sale on her return because in her opinion she had realized no profit. She deposited the $4,300 cash received in her bank account. Petitioner's husband gave her $1,000 for a Christmas present in 1944. She had bought84 a new home and he gave her this money to buy some furniture. She deposited this $1,000 in her bank account. During the year 1944 the petitioner issued checks on her personal account to or for the benefit of the R. L. Warren Motor Company as follows: Checks payable to R. L. Warren,R. L. Warren Motor Co., or tocash, endorsed by R. L. Warrenor the R. L. Warren Motor Co.$16,160.00Checks payable to others containingnotations thereon indicating pur-chases of automobiles or otheritems connected with the used-carbusiness4,396.33Checks payable to others for the ac-count of R. L. Warren or theR. L. Warren Automobile Com-pany10,983.93$31,540.26Petitioner received taxable income during the year 1944, which was not reported in her return for that year, in the amount of $14,385.49. During the year 1945 the petitioner had total bank deposits and withdrawals as follows: First NationalBankEast Atlanta(North AvenueBankBranch)Bank Balance 1-1-45$ 4,243.72NoneTotal Deposits for the year 194540,376.03$3,500.00$44,619.75$3,500.00Withdrawals44,089.272,500.00Bank Balance 12-31-45$ 530.48$1,000.00Petitioner's return for the year 1945 disclosed the following: Income - Rents on leased equipment$1,267.66Less: Repairs609.30$ 658.36Gain on sale of residence1,594.07Fixtures: Sales price$5,200.00Add depreciation allowed3,566.88$8,766.88Less: Cost or other basis6,375.59Capital gain (1/2)$2,391.291,195.65$3,448.08Tax from table$ 606.0085 In determining the deficiency for the year 1945, the respondent added to the income reported by the petitioner in her return unidentified bank deposits of $12,712.53. In arriving at the amount of $12,712.53, he eliminated from the bank deposits of $43,876.03 the following: Received from R. L. Warren MotorCo. and deposited in petitioner'saccount$ 7,000.00Rents from leased stores1,267.66Proceeds from sale of residence17,695.84Receipts from sale of store furnitureand fixtures5,200.00Total bank deposits identifiedby respondent$31,163.50Petitioner received from the R. L. Warren Motor Co. a counter check $500for on April 16th which was deposited by her on April 30. In addition to the rents from leased stores of $1,267.66, reported in petitioner's 1945 return, she also received from the sublessees $616.66 to reimburse her for rent which she paid to the owners of the stores during that year. In her income tax return she did not report the $616.66 nor take any deduction of this amount for rent paid. She deposited $616.66 in her personal account during the year 1945. The capital gain of $2,391.29 reported in petitioner's return for 1945 resulted86 from the sale of her residence for $18,500 in April of that year. She purchased the residence in December 1944. On April 11, 1945, she deposited $17,695.84 of the proceeds of the sale in her bank account. In 1945 the petitioner sold some furniture and draperies to the purchaser of her residence and received $1,167, which she deposited. The East Atlanta Bank charged back to the petitioner's account a bad check of W. B. Austin for $1,600 received from the sale of store fixtures. The check was redeposited and thus was included in deposits twice. During the year 1945 the petitioner issued checks on her account payable to cash or to R. L. Warren, as follows: April 18R. L. Warren$3,000.00July 7Cash300.00September 5Cash400.00September 13R. L. Warren1,300.00 These checks were endorsed by petitioner's husband, with the exception of the check for $300 which was endorsed "Pay to the order of East Atlanta Bank - for deposit only - R. L. Warren Motor Co." On June 19, 1945, petitioner issued a check on her account for $700. This check was endorsed by the Terminal Used Car Exchange. On October 18, 1945, she issued a check on her account payable to87 Boomershine Motors in the amount of $46.80, which was endorsed by the payee. Petitioner's income tax return for the year 1945 was filed on March 13, 1946. The notice determining the deficiency for the year 1945 was issued by the respondent on June 29, 1949. Petitioner received taxable income during the year 1945, which was not reported in her return for that year, in the amount of $8,828.87. R. L. Warren sold his used-car business in the "midsummer" of 1945, and did not engage in business thereafter except for isolated purchases and sales of cars. During the year 1946, the petitioner had total bank deposits and withdrawals as follows: East Atlanta BankFirst Nat'l BankBank Balance, Jan. 1, 1946$ 530.48$1,000.00Total deposits63,890.920$64,421.40$1,000.00Disbursements by checks64,088.691,000.00Bank Balance, Dec. 31, 1946$ 332.71NonePetitioner's income tax return for the year 1946 discloses the following: Rents$ 2,007.50Less: Expenses and depreciation1,842.06$ 165.44Gain on sale of Graham-Paige stock1,165.29Sale of residence, capital gain (1/2 of $3,979.10)1,989.55Adjusted gross income$3,320.28Less: DeductionsChurch$ 50.00Local taxes121.20Attorney fees200.00Truck insurance100.00471.20Net income$2,849.08Tax$ 452.9688 In determining the deficiency for the year 1946, the respondent added to the income reported by the petitioner in her return unidentified bank deposits totalling $22,775.44. In arriving at the amount of $22,775.44, the respondent eliminated from the total bank deposits of $63,890.92 the following: Rents$ 2,007.50Proceeds from sale of residence18,864.59Receipts upon sale of stock11,100.00Sale of stock reported on returnof R. L. Warren1 9,143.3989 Total bank deposits identified byrespondent$41,115.48The $7,000 loan eliminated by the respondent represents the proceeds of a loan of $6,000 from the East Atlanta Bank which petitioner deposited on September 16, 1947, and the proceeds of a loan of $1,000 from the same bank which she deposited on June 26, 1947. The $16,510 eliminated by the respondent represents the portion of the proceeds of a sale of real estate located at 195 Edgewood Avenue which petitioner deposited in her account on June 16, 1947. This real estate was sold on June 15, 1947, for $27,500, the purchaser having assumed a mortgage loan in the amount of $10,000. The $4,773.16 eliminated by the respondent represents the proceeds of a sale of stock of the York Corporation which petitioner deposited. The $562.25 eliminated by the respondent represents salary of $650 she received from the Naval Air Station Officers' Club, less an employment agency fee of $87.75 which she paid by check dated October 11, 1947. She deposited the $650 in her account. Petitioner's son, Robert Reagin Warren, borrowed $1,250 from her in 1946 to purchase an automobile. 90 He paid the loan in 1947 and petitioner deposited the $1,250 received in her bank account. During 1947 petitioner paid the Sharp Appliance Co. $342.75 for a frigidaire. She never received it and the company made a refund. She deposited $328.75 of the amount refunded on December 4, 1947. During the year 1947, the petitioner issued checks on her account to or for the benefit of Robert L. Warren in the amount of $1,542. Petitioner received taxable income during the year 1947, which was not reported in her return for that year, in the amount of $3,331.56. The petitioner filed false and fraudulent returns for each of the years 1944, 1945, 1946 and 1947, with intent to evade tax, and part of the deficiencies determined by the respondent for each of these years was due to fraud with intent to evade tax. Petitioner and her husband filed joint declarations of estimated tax for the years 1944 and 1945 in the amounts of $3,000 and $3,500, respectively. On her income tax return for 1944, the petitioner claimed a prepayment credit for 1944 of $750, and in her return for 1945, she claimed a prepayment credit for 1945 of $606. The petitioner substantially underestimated her tax for each91 of the years 1944 and 1945. Declarations of estimated tax were not filed by the petitioner for the years 1946 and 1947, and reasonable cause for failure to file such declarations has not been shown. Upon the return filed by the petitioner for the year 1945, she omitted and failed to disclose an amount of gross income which was in excess of 25 per cent of the gross income actually disclosed on that return. Opinion RAUM, Judge: The controversy in this proceeding relates to substantial deposits made by petitioner in her bank accounts which were not reflected in her income tax returns for the years 1944 to 1947, inclusive. To the extent that the respondent was unable to trace the source and nature of these deposits, he added them to the income reported by petitioner and determined deficiencies. Petitioner has the burden of proving that the additions made by the respondent did not represent taxable income. Most of her deposits during the taxable years were made in the East Atlanta Bank. She produced lists showing deposits made to this account and checks drawn against it during the years92 1943 to 1947, inclusive. She also produced canceled checks showing amounts paid to or on behalf of Robert L. Warren in each of these years. She was able to identify some of the deposits as resulting from transactions reported in her returns, and some as receipts from transactions which did not result in taxable income. The substance of her testimony with respect to the remaining deposits was that they represented primarily repayment of loans made by her to Robert L. Warren or the R. L. Warren Motor Company. She also testified that she received $100 a week from her husband for household expenses or for support, and that these amounts were also included in her deposits. 2Petitioner testified at the trial. Her memory was good as to some deposits and bad as to others. Her bank account at the East Atlanta Bank was opened early in 1943 at about the same time that the R. L. Warren Motor Company opened a bank account in its name at the same bank. She did not recall whether she had had any substantial amount93 either in the bank or in cash before 1943. She did not recall how much money was put into this account when it was opened or whether it was more or less than $1,000. She was unable to produce any check stubs or duplicate deposit slips that might indicate the source or nature of deposits. She did not remember the first loan made to her husband. She did not recall whether "a lot" of the transfers from her husband to her were in cash. When asked "How did he pay you back? Did he bring the money in and give it to you?", she replied, "I don't recall that." She did not keep a record of how much money her husband owed her at any time during the years 1944 to 1947, inclusive. When questioned concerning deposits of $1,500, $1,500, $1,000, $2,000, and $2,200 made in November 1944, she replied she could not identify them unless they were repayments made by her husband. She thought the $1,000 deposit might have been the down payment on a house she sold during that month. When asked about five deposits totaling $14,500 in June 1945, she testified that two of them totaling $4,200 were from the sale of fixtures, and as to the remaining $10,000 she testified, "Well, I presume it was repayments of loans94 from Mr. Warren." She did not recall what the loans to her husband were for after he sold his business in the midsummer of 1945. She testified that any advances to her husband during 1946 were for purposes other than the automobile business. It was quite apparent from her testimony that she could not, or would not, state the source and nature of a large number of the deposits made in her accounts. Most of the documentary evidence submitted by petitioner was directed to showing how the deposits were expended rather than to showing the source and nature of the deposits. Such evidence is not enlightening where, as here, the amounts of checks issued differ materially from the amounts of the deposits. The excerpt from the notes payable account set forth in our findings indicates that petitioner did make some loans to the R. L. Warren Motor Company. No notes were issued and no interest was paid on such loans. Wherever a repayment of a loan was made and the deposit of the repayment could be identified, it has been eliminated from unidentified deposits. Petitioner's self-serving testimony that a substantial amount of deposits in each year, not reflected in the notes payable account, represented95 repayment of any loans made by petitioner to her husband is neither persuasive nor convincing. We are satisfied, however, that during the year 1944 and the portion of the year 1945, when purchases and sales of used cars were being made, money was being deposited in petitioner's account from the operation of that business and she was issuing checks on her account for the purchase of cars and the payment of certain expenses incurred in connection with the business. Just why petitioner's account was used in this manner is not satisfactorily disclosed. Nevertheless, we have made eliminations from the deposits, in excess of those made by the respondent, to the extent that the evidence indicates that some of the deposits did not result in the realization by petitioner of gain or profit. 3 The record before us is in an unsatisfactory state, but doing our best with the materials at hand we have reached the conclusion, and found as facts, that the petitioner received unreported taxable income in 1944 of $14,385.49, in 1945 of $8,828.87, in 1946 of $22,340.74, and in 1947 of $3,331.56. 96 The next question is whether the respondent was justified in imposing additions to tax for fraud for each of the taxable years. The statute places on the respondent the burden of proving fraud. "Because direct and clear-cut proof of fraud is seldom available, it must be established by a full consideration of the records and testimony offered, the appearance and manner of the witnesses, the conduct of the taxpayer, and all conditions and circumstances surrounding the transactions which produced the disputed income." Wallace H. Petit, 10 T.C. 1253">10 T.C. 1253, 1257. The respondent has established that the petitioner made deposits in her bank accounts of amounts substantially in excess of those disclosed on her income tax returns for the taxable years of years and was familiar with the keeping of books; that she kept no books or other records from which the source and nature of substantial amounts of the deposits made by her in each of the taxable years could be determined; that she failed to report such amounts as income in her returns; and that she had no reasonable excuse for failing to97 include them in her taxable income. "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." M. Rea Gano, 19 B.T.A. 518">19 B.T.A. 518, 533. We are convinced that the petitioner understated her income with intent to evade tax in each of the taxable years. Consequently, the respondent's assertion of additions to tax for fraud for each of the taxable years is approved. In view of our findings that petitioner filed a false and fraudulent return for the year 1945 with intent to evade tax, and that she omitted and failed to disclose in her 1945 return an amount of gross income which was in excess of 25 per cent of the gross income actually disclosed on that return, the respondent's determination of the deficiency for that year was timely under the provisions of Sections 275 (c) and 276 (a) of the Internal Revenue Code. The remaining questions relate to the imposition of the 6 per cent addition to tax prescribed98 by Section 294 (d) (2) of the Internal Revenue Code for substantial underestimate of tax for the taxable years 1944 to 1947, inclusive, and the imposition of the 10 per cent addition to tax imposed under Section 294 (d) (1) (A) of the Internal Revenue Code for failure to file a declaration of estimated tax for the taxable years 1946 and 1947. The petitioner makes no argument on brief that these additions to tax were improperly asserted by the respondent, and contends only that they be based upon the tax liability as determined by this Court. We agree with this contention. Decision will be entered under Rule 50. Footnotes. No dates shown.↩1. The petitioner deposited $9,701 on May 29, 1946. This included the $9,143.39 received from the sale of Fruehauf Trailer stock on May 29th. R. L. Warren reported this sale in his return. The check for $9,143.39 from Courts & Company was issued to petitioner and endorsed by her. On September 17, 1945, an account was opened in the name of petitioner with Courts & Company, investment bankers. This account discloses purchases of 3,000 shares of Graham-Paige stock in September and October 1945 for $31,578.80, and that this stock was sold on January 1, 1946, for $35,442.17. As a result of this transaction, and other previous transactions, Courts & Company issued a check to petitioner in the amount of $36,280.45 on January 11, 1946. This check was endorsed by the petitioner. In her return for 1946 petitioner reported that $2,698.08 of the gain of $3,863.37 was distributed to her husband. She reported the remainder of $1,165.29 as her share of the gain with the notation "I put up $10,000 on 3000 S. Graham Paige and received $11,165.29 back, a gain of $1,165.29." A deposit of $11,100 was made in her bank account at the East Atlanta Bank on January 14, 1946. The Courts & Company account shows other purchases and sales of stock during the year 1946. In reporting her share of the gain on the Graham Paige stock, the petitioner stated that "All other trades that were in my name other than the above were and should have been in R. L. Warren's name". On February 1, 1946, after petitioner and her husband separated, the address on the Courts & Company account was changed to "Mrs. Frances I. Warren, 633 Peachtree Street, c/o Elks Club, Atlanta, Ga." On January 22, 1946, the petitioner and her husband entered into an agreement wherein, after stating that they were separated, that a petition for divorce was about to be filed, and that they were desirous of settling questions of alimony, custody of minor children, etc., the husband among other things agreed to pay petitioner $435 per month for the support, maintenance and education of their three sons for a period of five years, payments to begin on February 1, 1946. This separation agreement was incorporated in the final decree of divorce entered by the Superior Court of Fulton County on or about June 6, 1946. During the months of February to August 1946 the petitioner received $435 per month from Robert L. Warren under the agreement of January 22, 1946. One of these $435 payments was deposited by the petitioner in her bank account on June 21, 1946. The petitioner sold a residence at 361 Tenth Street in the year 1946 for $19,000 and reported the profit realized on the sale in her return for that year. She deposited $18,864.59 of the proceeds in her bank account on February 16, 1946. On February 21, 1946, petitioner issued a check on her account to R. L. Warren in the amount of $20,000. Other checks issued by petitioner on her account during 1946, which were payable to R. L. Warren, or endorsed by him, or which bore notations indicating that they were issued on his behalf, were the following: Jan. 10$ 2,000.00Jan. 19250.00Jan. 2350.00March 122,575.77March 12247.00March 12250.00March 12461.24March 1650.00March 27900.00March 2762.22June 17,000.00August 10293.39Sept. 1350.00Dec. 2115.00$14,204.62On August 31, 1946, another agreement was entered into between petitioner and R. L. Warren wherein, after stating that the latter was indebted to petitioner in the sum of $17,500 and that the parties desired to make provision for the payment of that indebtedness as well as provide for a novation by mutual agreement of the original agreement of January 22, 1946, R. L. Warren conveyed to petitioner two parcels of real estate which was subject to loans aggregating $30,000, in satisfaction of the indebtedness of $17,500 and in complete and full satisfaction and performance of the agreement dated January 22, 1946. The rental income of $2,007.50 which the respondent excluded in his determination of unidentified deposits for the year 1946 was received by the petitioner from one of the properties acquired from her husband on August 31. Petitioner received taxable income during the year 1946, which was not reported in her return for that year, in the amount of $22,340.74. During the year 1947 the petitioner had total bank deposits and withdrawals as follows: Bank Balance at January 1, 1947$ 332.71Total Deposits, 194739,310.97$39,643.68Disbursements by checks39,465.27Bank Balance at December 31,1947$ 178.41In her income tax return filed for the year 1947 the petitioner reported the following: Income N.A.S. OfficersClub$ 650.00Less: Employment AgencyFee87.75$ 562.25Long-term capital loss onstock (1/2 of $4,500)($2,275.13)Long-term capital gain onbuilding, 195 EdgewoodAvenue (1/2 of $10,264)5,132.002,856.87Dividends received120.00Net rents received1,706.99Adjusted gross income$5,246.11Deductions (Standard)500.00Net income$4,746.11Exemptions1,500.00$3,246.11Tax$ 640.43In determining the deficiency for the year 1947, the respondent added to the income reported by petitioner in her return unidentified bank deposits totaling $4,998.06. In arriving at this amount, the respondent eliminated from the total deposits of $39,310.97 made by petitioner during 1947, the following: Loan from East Atlanta Bank$ 7,000.00Gross rents received and depositedThese rents were received from properties R. L. Warren transferred to petitioner under the August 31, 1946, agreement.*↩ 5,347.50Proceeds sale of real estate de-posited16,510.00Receipts from sale of stock4,773.16Salaries562.25Dividends120.00Total deposits identified byrespondent$34,312.912. From February to August 1946, she received $435 a month for support of her children, pursuant to the separation agreement, and she contends that these payments were deposited.↩3. As to petitioner's contention that some of her unidentified deposits represent support payments made to her by her husband, we are not satisfied after a study of all of her deposits that any of them other than the deposit of June 21, 1946, had their source in such payments. And we have excluded $435 from her income on account of the June 21, 1946, deposit.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619391/	Joe Denton Harris, Jr. v. Commissioner. Emma Dunn Harris v. Commissioner.Harris v. CommissionerDocket Nos. 26477, 26478.United States Tax Court1951 Tax Ct. Memo LEXIS 225; 10 T.C.M. (CCH) 477; T.C.M. (RIA) 51148; May 22, 1951225 1. Petitioners' eldest son reached the age of 19 years in 1941, and had his minority disabilities removed in that year under the laws of the State of Texas. On the 31st day of December, 1941, petitioners executed a deed of gift to the son conveying to him a one-third interest in a business known as Peoples Lumber & Supply Company which was the community property of petitioners. On January 1, 1942, petitioner Joe D. Harris, Jr., and his eldest son, Robert Harris, entered into a written partnership agreement under which two-thirds of profits and losses were to be shared by Joe D. Harris, Jr., and one-third by Robert Harris. The latter contributed as his part of the capital the one-third interest which he received as a gift from petitioners and was also to render services to the partnership. After his graduation from college in May 1942, he entered immediately into the services of the partnership and rendered important services to it until in July 1942. He then worked for a shipbuilding plant preparatory to going into the United States Army in September 1942. Held, that a valid and legal partnership was formed January 1, 1942, between petitioner Joe D. Harris, Jr., and his son, Robert226 Harris, and this partnership continued through the years 1944 and 1945, and was not interrupted because of Robert Harris' service in the United States Army. 2. In September 1945, while Robert Harris and Joe Denton Harris, III, were both in the armed forces an unsigned partnership agreement was prepared by petitioner Joe D. Harris, Jr., changing the partnership of Peoples Lumber & Supply Company from a partnership composed of Joe D. Harris, Jr., and Robert D. Harris, to a partnership composed of three members, Joe D. Harris, Jr., Robert D. Harris, and Joe Denton Harris, III, with interests of 50 per cent, 25 per cent, and 25 per cent, respectively, retroactive to January 1, 1945. Held, the facts are not sufficient to sustain a finding of fact that the latter claimed partnership was a valid and legal partnership and the Commissioner is sustained in his nonrecognition of it. 3. In March 1944, a partnership known as Tri-County Lumber Co. was begun at Liberty, Texas, with L. T. Brookshire and Peoples Lumber & Supply Company as partners. In September 1944, a purported partnership agreement was written up and signed making L. T. Brookshire, Joe Denton Harris, III, and Peoples Lumber & 227 Supply Company partners with interests of 25 per cent, 26 per cent, and 49 per cent, respectively. This purported partnership agreement was made retroactive to March 1944. Joe Denton Harris, III, was in the United States Navy at the time and had very little to do, if anything, with the preparation of the partnership agreement. He contributed no capital to the business which originated with him and rendered it no services whatever. The business was sold in the Fall of 1944. Held, that Joe Denton Harris, III, was not a member of the partnership of Tri-County Lumber Co. and should not be recognized as such. Aaron Goldfarb, Esq., 517 City Nat. Bank Bldg., Houston, Tex., for the petitioners. John P. Higgins, Esq., for the respondent. BLACK Memorandum Findings of Fact and Opinion In Docket No. 26477 the Commissioner has determined deficiencies against Joe Denton Harris, Jr., for the taxable years ended December 31, 1944 and 1945, of $5,061.87 and $1,224.47, respectively. The deficiency for 1944 is based upon two adjustments made to the net community income as disclosed by the return as follows: (a) Depreciation disallowed$ 2,500.00(b) Income reported by RobertD. Harris, held taxable toyou17,887.26228 No error has been assigned as to adjustment (a). Adjustment (b) is explained in the deficiency notice as follows: (b) Income reported by a partnership and a business firm to your son, Robert D. Harris, and held to be taxable to you is added to income reported. From partnership, Tri-CountyLumber Company$ 7,495.04From Peoples Lumber & Sup-ply Company (Dayton)10,392.22Total Addition$17,887.26The deficiency for 1945 is based upon two adjustments made by the Commissioner to the net income as disclosed by the return (community). These two adjustments are: (a) Depreciation disallowed$2,500.00(b) Income shown as your sons'now held taxable to you5,663.26No error is assigned as to adjustment (a). Adjustment (b) is described in the deficiency notice as follows: (b) As in prior years, it is held that your sons were not partners with you in the two business operated by you and that the entire gain is taxable to you, as follows: Peoples Lumber & SupplyCompany, Dayton, TexasIncome per return(Form 1065)$9,485.62Amount reported by you6,242.81Additional income$3,242.81Peoples Lumber & SupplyCompany, Mont Belvieu,TexasIncome per return(Form 1065)$6,140.22Amount reported by you3,719.77Additional income2,420.45Total additional income$5,663.26229 In Docket No. 26478 the Commissioner has determined against Emma Dunn (Mrs. Joe Denton, Jr.) Harris for the taxable years ended December 31, 1944 and 1945, deficiencies of $5,151.87 and $1,266.50, respectively. These deficiencies were determined upon the community property basis and were based upon the same adjustments as were made in Docket No. 26477, Joe Denton Harris, Jr., and need not be described here separately. Both petitioners by appropriate assignments of error contest the determination of the Commissioner that there was no valid partnership existing between Joe Denton Harris, Jr., and his two sons, Robert D. Harris and Joe Denton Harris, III, during the taxable years. Findings of Fact Some of the facts have been stipulated and as stipulated are found as a part of our findings of fact and are hereby incorporated by reference. Petitioners Joe Denton Harris, Jr., and his wife Emma Dunn Harris reside at Dayton, Texas. Their income tax returns for the calendar years 1944 and 1945 were filed with the Collector of Internal Revenue for the First District of Texas at Austin, Texas. These returns were filed on the community property basis. Joe Denton Harris, Jr., will sometimes230 hereinafter be referred to as the petitioner. Partnership Between Joe Denton Harris, Jr., and Robert D. Harris Joe Denton Harris, Jr., owned Peoples Lumber & Supply Company, Dayton, Texas, individually in 1941, and for several years prior thereto. Robert Harris, eldest son of Joe Denton Harris, Jr., worked at Peoples Lumber & Supply Company while in grade school and in high school at Dayton, such services having been performed after school hours, vacations and holidays. Robert worked at Peoples Lumber & Supply Company during vacation periods while attending Texas A. & M. during years beginning in the Fall of 1938 until the Spring of 1942. Robert worked at Peoples Lumber & Supply Company after he was graduated from Texas A. & M. from May 1942 until the middle of July 1942. This work consisted in doing important work for Peoples Lumber & Supply Company. Robert Harris had his disabilities as a minor removed by court order on December 31, 1941, and thus became legally able to contract. Joe Denton Harris, Jr., and wife, Emma Dunn Harris, made a gift of one-third of the assets of Peoples Lumber & Supply Company, Dayton, Texas, to their son Robert on December 31, 1941. This deed231 of gift stated, among other things, as follows: " * * we, the undersigned, J. D. HARRIS, JR. and EMMA DUNN HARRIS, * * * for and in consideration of the love and affection which we bear for our son, ROBERT DUNN HARRIS, and for the purpose of enabling him to become a partner in the business heretofore operated by J. D. HARRIS, JR., and thereby, by observation and experience, become familiar with the manner in which trade, industry and commerce are conducted, and by observation learn what are the fruits and rewards of industry, attention and management, have given, granted, transferred, assigned, conveyed and set over, and by these presents do give, grant, transfer, assign and set over unto him, our said beloved son, ROBERT DUNN HARRIS, an undivided one-third (1/3) part, portion and interest in and to all of the assets and properties used in, or in connection with, such business, for the description and sort of which reference is made to the books of account which are being kept of such business, including, but without express limitation thereto, the manufacturing plant or plants, warehouses, logs, timber, cut and uncut, standing timber owned, contracts for the acquisition thereof, 232 manufactured lumber, lumber in process of manufacture, orders on hand for future delivery, accounts and bills receivable, and any and all other asset or property which may reasonably be deemed an asset or property of the business, but not intending hereby to transfer any interest in various or sundry other properties, real or personal, owned by J. D. HARRIS, JR., but not owned or used in connection with the business." Joe Denton Harris, Jr., entered into a written agreement to carry on the business of Peoples Lumber & Supply Company, Dayton, with his son, Robert Harris, as one-third partner on January 1, 1942, and himself as two-thirds partner. This written partnership agreement is in evidence and contains, among other things, certain provisions which we will now describe. The first provision of the agreement was as to the furnishing of capital by the respective partners and concludes by saying: " * * Of such capital so reflected upon such balance sheet, to-wit: the inventory and itemization hereto attached, R. D. HARRIS is the owner of, and has contributed as his contribution to the firm capital, an undivided one-third (1/3), and the other two-thirds. (2/3) of such firm capital233 so shown and exhibited upon such itemization and listing, to-wit: upon such balance sheet, is owned by, and has been contributed as his contribution to the firm capital by, J. D. HARRIS, JR., such property having heretofore been, and such contribution being, community property of him and his wife." The second provision of the partnership agreement has reference to the sharing of profits and losses and contains, among other things, the following provisions: "All losses, if any, shall be borne by the co-partners in the same proportion as their interest, as above stated, in the firm's capital. All profits shall be shared between the two partners as follows, towit: Out of the first profits, there shall first be taken by J. D. HARRIS, JR., as a reasonable compensation for his attending to practically the entire management of the business, the monthly sum of Two Hundred Fifty ($250.00) Dollars per month. All profits over and above such monthly sum of Two Hundred Fifty ($250.00) Dollars per month shall be shared between the partners in the proportion of one-third (1/3) to ROBERT D. HARRIS, and two-thirds (2/3) to J. D. HARRIS, JR., * * but there shall be no withdrawal of profits, save234 and except the withdrawal of the Two Hundred Fifty ($250.00) Dollars per month hereinabove first provided for, except at such times as in the judgment of J. D. HARRIS, JR., such withdrawal will entail no danger or harm to the business. Since the actual profits from month to month may vary greatly, and there may actually at times be months in which no actual profit would be shown upon that month's operations standing alone, it is agreed that J. D. HARRIS, JR. may each month withdraw the above stated sum of Two Hundred Fifty ($250.00) Dollars, appropriately charging the same to himself upon the books of the firm, without the necessity of ascertaining whether or not actual profits have then or theretofore been earned in an amount sufficient to have technically entitled him to make such withdrawal, and, for convenience in the examination of the books, such monthly withdrawal by him shall be set up as a separate account, separate from the accounts showing the withdrawal by the two partners in the proportions above provided of part or all of the remaining profits of the business." The next part of the partnership agreement provides for the management of the business and contains, among235 other provisions, the following: "J. D. HARRIS, JR. shall have full charge and management of the business, and ROBERT D. HARRIS will participate in the management thereof only to such extent as may from time to time be felt by both of the partners to be proper and for the best interest of the business. * * " There are other provisions of the partnership agreement providing for what shall take place in the event that the partnership is dissolved, either by mutual consent or by the death of a partner. It is not believed there is any necessity to set out these provisions in detail. In substance these provisions provide that in event of dissolution each partner or his estate shall receive his proportionate share of the assets after the payment of liabilities. The entire partnership agreement is incorporated herein by reference and made a part of these findings of fact. Robert Harris enlisted in the army in September 1942 and served continuously with the army in World War II until his discharge in 1946, during which time he was precluded from rendering services in behalf of Peoples Lumber & Supply Company, Dayton, Texas. Joe Denton Harris, Jr., and Robert Harris indicated in social236 security tax returns filed with the United States Collector of Internal Revenue, withholding tax returns filed with the United States Collector of Internal Revenue, and Texas unemployment compensation commission returns filed with the State of Texas that they were operating Peoples Lumber & Supply Company, Dayton, Texas, and Mont Belvieu, Texas, as partners. Joe Denton Harris, Jr., and Robert Harris held themselves out to the public and transacted business as partners in the Peoples Lumber & Supply Company, Dayton, Texas, and Mont Belvieu, Texas, after January 1, 1942. After his discharge from the army in 1946, Robert Harris returned to supervise purchases, sales, and disbursement of funds for Peoples Lumber & Supply Company, Dayton, Texas, and Mont Belvieu, Texas, and has continuously performed these services to the present date. He devotes all of his time to the business. The partnership agreement entered into by and between Joe Denton Harris, Jr., and Robert D. Harris January 1, 1942, was entered into with the intent that they should become partners in the ownership and operation of Peoples Lumber & Supply Company and they did in fact become bona fide partners in such business237 firm and this partnership continued to exist throughout the two years here involved, namely, 1944 and 1945. Claim that Joe Denton Harris, III, was a Member in 1945 of the Partnership of Peoples Lumber & Supply Company, Dayton, Texas, and Mont Belvieu, Texas It is claimed that Joe Denton Harris, Jr., Robert D. Harris, and Joe Denton Harris, III, entered into a partnership agreement reflected by an unsigned written agreement to jointly conduct the business of Peoples Lumber & Supply Company, Dayton, Texas, and Mont Belvieu, Texas, wherein Joe Denton Harris, Jr., owned 50 per cent, Robert D. Harris owned 25 per cent, and Joe Denton Harris, III, owned 25 per cent of the business. The purported unsigned written agreement was not introduced in evidence. Robert D. Harris and Joe Denton Harris, III, were both in the armed services of the United States at the time this purported partnership of September 1945 was formed. The evidence does not enable us to make a finding that a bona fide partnership agreement was entered into on or about September 25, 1945, wherein and whereby it was agreed that Joe Denton Harris, Jr., Robert D. Harris, and Joe Denton Harris, III, would own and operate238 the business of Peoples Lumber & Supply Company of Dayton and Mont Belvieu as partners. Tri-County Lumber Company, Partnership A partnership business to carry on the retail sale of lumber was begun by Peoples Lumber & Supply Company and L. T. Brookshire on March 6, 1944, to be known as Tri-County Lumber Company. On the 25th day of September 1944, a purported partnership agreement was entered into which reads as follows: "THE STATE OF TEXAS"COUNTY OF LIBERTY"WHEREAS, a partnership doing business under the trade name of Tri-County Lumber Company has been formed consisting of the following members, to-wit: L. T. Brookshire, Joe D. Harris, III, and Peoples Lumber and Supply Company, which said partnership will deal in the handling of lumber, paints, nails, hardware, cement and such other materials and products as are customarily handled by a lumber yard in conducting its affairs and business, and "WHEREAS, the place of business of the said Tri-County Lumber Company shall be at Liberty, Texas, and shall be regarded as having commenced on the 6th day of March, A.D. 1944, and "WHEREAS, there has been no statement in writing setting forth the ownership of each of the above239 named parties with respect to the proportionate share of each party's interest in and to said company, and "WHEREAS, it is the desire of all parties that an instrument of writing be entered into whereby the fractional interest owned by each will be set out as well as the contract and agreement of said parties insofar as they may deem necessary. "NOW, THEREFORE, KNOW ALL MEN BY THESE PRESENTS: That L. T. Brookshire, Joe D. Harris, III, and the Peoples Lumber and Supply Company hereby acknowledge and declare that the ownership of said company is owned in the following manner, to-wit: L. T. Brookshire, 25%; Joe D. Harris, III, 26%; and Peoples Lumber and Supply Company, 49%. It is further understood and agreed that in the event one of the aforesaid partners desires to sell his interest in said company, then the remaining partners shall have the first right to purchase the interest of said partner so desiring to sell, and shall pay therefor according to the net worth of the partnership at the time of the sale. "It is further agreed and understood by and between all parties hereto that in the event one partner desires to withdraw from said partnership, then the party so desiring to240 withdraw shall give the other partners notice of his intention of so doing by ten days written notice, and the other partners shall then have the right to purchase said partner's interest who desires to withdraw by paying him the net value of his said interest. If the other partners do not desire to purchase the interest of the partner desiring to withdraw, then he shall have the right to purchase the other partners' interest by paying therefor the net value of the respective interests of the other partners at the time of said sale. "Witness the hands of the parties hereto this the 25th day of September, A.D. 1944. [Signed] L. T. Brookshire [Signed] Joe Denton Harris, III Peoples Lumber and Supply Company "By J. D. Harris, Jr." Joe Denton Harris, III, was in the armed forces of the United States at the time the alleged partnership of Tri-County Lumber Company was formed and he knew but little about it. His father wrote him that he had been made a partner in the business. Joe Denton Harris, III, entered active service with the United States Navy in February 1944, and served continuously with the navy in World War II until his discharge on August 1, 1946, during which241 time he was precluded from rendering any services in behalf of Tri-County Lumber Company, Liberty, Texas. The partnership of Tri-County Lumber Company was a partnership in which L. T. Brookshire owned a 25 per cent interest and the remaining interest was owned by Peoples Lumber & Supply Company of Dayton, Texas, of which Joe D. Harris, Jr., and Robert D. Harris were the partners, Joe D. Harris, Jr., owning two-thirds interest and Robert D. Harris owning one-third interest. Partnership Returns 1. A partnership return for the year 1944 on Form 1065 was filed by Peoples Lumber & Supply Company, Dayton, Texas. This return shows "Partners' Shares of Income and Credits" as follows: Joe Denton Harris, Jr., Dayton,Tex. 100% time $3,000.00 plus2/3 balance$23,784.44Robert Dunn Harris, Dayton, Tex.now in U.S. Army. 1/3 after$3,000 deduction10,392.22Total$34,176.662. A partnership return for the year 1944 on Form 1065 was filed by Tri-County Lumber Company (Unincorporated), Liberty, Texas. This return shows "Partners' Shares of Income and Credits" as follows: L. T. Brookshire, Liberty, Texas,for services$ 2,500.0025% remainder earnings7,206.7826% J. D. Harris, 3rd7,495.0449% Peoples Lbr. & Supply Co.14,125.27Total$31,327.09242 3. A partnership return for the year 1945 on Form 1065 was filed by Peoples Lumber & Supply Company, Dayton, Texas. This return shows "Partners' Shares of Income and Credits" as follows: 100% Time. J. D. Harris, Jr.Dayton, Tex. $3,000 plus 50%Balance$6,242.81Nil Robert D. Harris, Dayton,Texas 25%1,621.41Nil Joe D. Harris, 3rd, Dayton,Texas 25%1,621.40Last two partners in U.S.A.Military Service4. A partnership return for the year 1945 on Form 1065 was filed by Peoples Lumber & Supply Company, Mont Belvieu, Texas. This return shows "Partners' Shares of Income and Credits" as follows: 100% J. D. Harris, Jr., Dayton,Tex. 50%$3,719.77Nil Robert D. Harris, Dayton,Tex. 25%1,859.88Nil Joe D. Harris, 3rd, Dayton,Tex. 25%1,859.88Latter two partners in Mili-tary ServiceOpinion BLACK, Judge: There is no issue involved in these proceedings concerning the net income for the taxable years 1944 and 1945 of the alleged partnerships. The issues are which partnerships existed as valid and legal partnership and who were the partners. Petitioner in his brief states the issues which are involved in the following language: 243 "(1) Were Joe Denton Harris, Jr. and Robert Harris bona fide partners, dba Peoples Lumber and Supply Company, Dayton, Texas, and Mont Belvieu, Texas, for the years 1944 and 1945? "(2) Were Joe Denton Harris, Jr., Robert Harris and Joe Denton Harris III bona fide partners, dba Peoples Lumber and Supply Company, Dayton, Texas, and Mont Belvieu, Texas, for the year 1945? "(3) Were Peoples Lumber and Supply Company, Dayton, Texas, L. T. Brookshire and Joe Denton Harris III bona fide partners, dba Tri County Lumber Company, Liberty, Texas, for the year 1944?" We shall take up these issues in their order. (1) Were Joe Denton Harris, Jr., and Robert Harris bona fide partners dba Peoples Lumber & Supply Company, Dayton, Texas, and Mont Belvieu, Texas, for the years 1944 and 1945? We think this question must be answered in the affirmative. The Supreme Court in , stated that in cases of the type which we have here, the basic question is: " * * whether, considering all the facts - the agreement, the conduct of the parties in execution of its provisions, their statements, the testimony of disinterested persons, the relationship244 of the parties, their respective abilities and capital contributions, the actual control of income and the purposes for which it is used, and any other facts throwing light on their true intent - the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise. * " [Italics supplied.] We think the facts support the conclusion that petitioner and his oldest son, Robert Harris, entered into a bona fide and valid partnership January 1, 1942, and that this partnership continued through the two taxable years here involved, 1944 and 1945. We have stated the facts rather fully concerning the organization of this partnership in our findings of fact and we need not repeat them in any great detail here. Briefly these facts are that for a good many years Robert Harris had worked during vacation periods in his father's lumber business. He had grown up in it, so to speak, and both father and son had looked forward to the formation of a partnership when Robert had finished his education and was ready to enter actively in the business. In 1941 he had reached the age of 19 years and had his minority disabilities removed. He expected245 to graduate from A. and M. College of Texas in the Spring of 1942 and to immediately thereafter enter actively into the business. His father and mother executed a deed of gift, giving him a one-third interest in the Peoples Lumber & Supply Company business. Using that as his capital contribution to the partnership, Robert agreed with his father on January 1, 1942, that they would become partners in the Peoples Lumber & Supply Company of Dayton, with one-third profits and losses to be shared by Robert and two-thirds profits and losses to be shared by his father. Petitioner Joe Denton Harris, Jr., was to receive an annual salary of $3,000 for his management of the business. He did in fact receive such salary from the partnership during each of the taxable years and that $3,000 each year is not in controversy. When the partnership was formed January 1, 1942, Robert Harris did not at once enter into the services of the partnership. However, he intended to do so as soon as he graduated from A. and M. College in the Spring of 1942. When Robert did in fact graduate from Texas A. and M. in the Spring of 1942, he at once entered into the services of the partnership and rendered valuable246 and important services to the partnership. This was from sometime in May 1942 to about the middle of July 1942. Robert took employment with Brown Shipbuilding Company after July 15, 1942, until his entry into the army in September 1942, in order to be engaged in defense work. We do not think that the interruption of Robert's services to the partnership by the war and his entering the armed forces would cancel out what seems to have been the organization of a legal and valid partnership between himself and his father. See , affirming the District Court decision. In the Crossley case it was held that a partnership existed between the taxpayer and his son who was prevented from continuing in his position as production manager of an electronic engineering plant by the fact that he was called into the armed forces. Taxpayer and his son intended to, and did, form the partnership prior to the completion of the son's engineering training. In that case the court in affirming the decision of the United States District Court, among other things, said: "In the case at bar the evidence amply supports the trial court's findings that plaintiff247 and his son intended to and did form a bona fide partnership in 1942, that plaintiff regarded his son as a partner and treated him as such, and that after May, 1943, the son was prevented from carrying out his duties of contributing services and capital because he was called into service with the Navy." See also . We hold that petitioner Joe Denton Harris, Jr., and Robert Harris were bona fide partners in the Peoples Lumber & Supply Company, Dayton, Texas, and Mont Belvieu, Texas, for the years 1944 and 1945. (2) We shall next take up issue (2). Were Joe Denton Harris, Jr., Robert Harris, and Joe Denton Harris, III, bona fide partners dba Peoples Lumber & Supply Company, Dayton, Texas, and Mont Belvieu, Texas, for the year 1945? There is no contention that Joe Denton Harris, III, was a partner in 1944. The contention is that he became a partner in September 1945. We are unable to find that petitioner has met his burden of proof as to the taking into the partnership of Joe Denton Harris, III, in September 1945. At that time Joe Denton Harris, III, was in the United States Navy. While it has been testified that some kind of a written partnership248 agreement was written up but not signed by the parties, the evidence seems to clearly show that Joe Denton Harris, III, had but little, if anything, to do with having it written up. It seems to us that when petitioner's testimony and that of Joe Denton Harris, III, is boiled down to its real substance, it amounts to about this: Petitioner decided to take Joe Denton Harris, III, in as a partner and undertook to do it without saying much, if anything, to Robert and Joe Denton Harris, III, about it. In other words, it does not seem to us that the evidence sufficiently discloses that in September 1945 a bona fide partnership agreement was entered into forming a partnership between Joe Denton Harris, Jr., with 50 per cent interest, Robert D. Harris with 25 per cent interest, and Joe Denton Harris, III, with 25 per cent interest. This so-called partnership which petitioner alleges was formed in September 1945 seems to have been, more or less, a unilateral transaction in which petitioner Joe D. Harris, Jr., played the principal part and his sons, Robert and Joe Denton, III, played only passive rolls. They were in the armed forces and knew but little about it. We do not think bona fide partnerships249 are formed in that manner. Another thing which, to our mind, throws further doubt about the validity of the partnership we are now discussing is that the partnership return which was filed for 1945 on Form 1065 undertook to make it effective January 1, 1945, and divided the profits on the basis of 50 per cent to Joe D. Harris, Jr., 25 per cent to Robert D. Harris, and 25 per cent to Jo Denton Harris, III, for the entire year 1945. Retroactive partnerships cannot be formed so far as the income tax is concerned, see . A partnership which existed between petitioner and his son Robert (see our holding on issue (1)) could not in September 1945 retroactively take in Joe Denton Harris, III, as a partner effective January 1, 1945. So, even if we should hold that Joe Denton Harris, III, became a partner in September 1945 (which we do not) nevertheless, there would be no warrant in the law to make this partnership retroactive to January 1, 1945, so far as the income tax is concerned. Under the evidence which we have in the record, the partnership earnings of Peoples Lumber & Supply Company, Dayton, Texas, and Peoples Lumber & Supply Company, Mont Belvieu, 250 Texas, for the year 1945 should be divided on a basis of two-thirds to Joe D. Harris, Jr., and one-third to Robert Harris, after allowing a salary of $3,000 to Joe D. Harris, Jr., for managing the partnership. Our holding that the facts are not sufficient to show that Joe Denton Harris, III, became a member of the partnership in September 1945, does not mean any indication on our part that he did not become a bona fide partner in 1946. We do not have that year before us. When Joe Denton Harris, III, was released from the United States Navy in 1946, he at once returned home and became production manager of Peoples Lumber & Supply Company and devoted all of his time thereto and has done so since then up to the date of the hearing in these proceedings at Galveston, Texas in October 1950. Therefore, we do not want to be understood as indicating that he was not a partner in 1946, and other years thereafter. We do not have those years before us and do not undertake to rule upon them. We simply hold that as to the year 1945, we do not think the facts are sufficient to establish that he became a bona fide partner in that year within the meaning of the Culbertson case [49-1 USTC [] 9323]251 to which we referred under issue (1). (3) We shall now take up issue (3). Were Peoples Lumber & Supply Company, Dayton, Texas, L. T. Brookshire, and Joe Denton Harris, III, bona fide partners dba Tri-County Lumber Company, Liberty, Texas, for the year 1944? In this partnership of Tri-County Lumber Company the Commissioner recognizes the partnership between petitioner Joe Denton Harris, Jr., and the other partner, L. T. Brookshire, but he declines to recognize Joe Denton Harris, III, as a member of the partnership. It may be here remarked that the business of Tri-County Lumber Company was only operated for about seven months in 1944 and was sold in that year and no question with reference to it is involved for the year 1945. Joe Denton Harris, III, was in the navy at the time it was organized. He graduated from Texas A. and M. College in 1943, had his minority disabilities removed in February 1944, and shortly thereafter went into the navy. An oral partnership agreement of Tri-County Lumber Company was entered into in March 1944, and the participants in that agreement were Joe D. Harris, Jr., acting for Peoples Lumber & Supply Company, and L. T. Brookshire. Joe Denton Harris, III, 252 was in the navy. The written partnership agreement purporting to make Joe Denton Harris, III, a partner with an interest of 26 per cent was not written up and signed until September 25, 1944, which was several months after the partnership business of Tr-County Lumber Company was begun. It seems to us that when petitioner's testimony and that of Joe Denton Harris, III, is boiled down to its substance with reference to the organization of this Tri-County Lumber Company partnership, petitioner decided to take Joe Denton Harris, III, in as a partner and to give him a 26 per cent interest in the business without saying much to Joe Denton Harris, III, about it. The gift to his son in such a manner may have been, and doubtless was, an entirely bona fide gift, but we do not think valid and legal partnerships can be formed in such a manner. Cf. , affirming . It is not contended that Joe Denton Harris, III, rendered any services whatever to the partnership of Tri-County Lumber Company nor that he contributed any capital to it, except that which was given to him by his father. Under all the facts and circumstances bearing*253 upon this Tri-County Lumber Company partnership, we hold that Joe Denton Harris, III, was not a partner. We hold under all the facts that the partnership of Tri-County Lumber Company of Liberty, Texas, was a partnership composed of Peoples Lumber & Supply Company with a 75 per cent interest and L. T. Brookshire with a 25 per cent interest. Decisions will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619392/	MARK D. EAGLETON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Eagleton v. CommissionerDocket No. 79553.United States Board of Tax Appeals35 B.T.A. 551; 1937 BTA LEXIS 859; March 2, 1937, Promulgated 859 1. The respondent disallowed a deduction for loss arising out of investment in stock on the ground that the alleged loss in the taxable year was not substantiated. Held, the evidence is insufficient to show that the loss was sustained in the taxable year and the disallowance of the claimed deduction is sustained. 2. Petitioner during the taxable year gave checks to an attorney employed by him which were never cashed and which were returned to petitioner. Petitioner credited the employee in the following year on the books of a newly formed partnership. Held that since the checks were never cashed and were returned, there was no payment in the taxable year so that petitioner operating on a cash receipts and disbursements basis is not entitled to the claimed deduction in the taxable year. 3. Upon the evidence, certain expenditures of the petitioner in connection with a branch law office allowed and certain of them disallowed as ordinary and necessary business expense deductions. 4. Petitioner received cases from attorneys under an agreement to share fees on a certain basis. Petitioner collected all the fees and paid over to the associate attorneys their shares. 860 Held, petitioner and associate attorneys had a joint interest in the fees and although petitioner collected all the fees he had no beneficial interest in the shares of his associates. Therefore, petitioner is taxable only on the portion of the fees in which he individually had the beneficial interest and he should not include in his income tax return the fees of the associate attorneys. Mark D. Eagleton pro se. George D. Brabson, Esq., for the respondent. HARRON 552 This is a proceeding for the redetermination of a deficiency in income taxes for the year 1932 in the amount of $9,940.34. The deficiency results from respondent's disallowance of a claimed stock loss in the amount of $25,000; disallowance of $19,000 claimed as compensation paid; disallowance of $2,153.22 claimed as expenses paid; and by adding to income from law profession an amount of $16,618.84. FINDINGS OF FACT. Petitioner is an individual, residing in St. Louis, Missouri. During the taxable year he was engaged in the practice of law. He keeps his book and files his income tax returns upon a cash receipts and disbursements basis. Issue 1. - The Bethlehem861 Pipe Fittings Corporation was organized under the laws of the State of Delaware, in 1930, for the purpose of manufacturing and selling supplies, tools, and equipment for use in the business of mechanical and contracting engineers and others, as set forth in its certificate of incorporation, and particularly to develop an invention of J. M. Readey. The organization of the corporation was promoted by J. M. Readey, Mark D. Eagleton (petitioner), and James A. Waechter. The corporation maintained offices and did business in St. Louis, Missouri. Petitioner was a director of the corporation. In 1930 petitioner bought $25,000 preferred stock of the corporation in a transaction entered into for profit. During the years 1930 and 1931 petitioner advanced various sums of money to the corporation. The corporation gave J. M. Readey $150,000 common stock for the right to develop his patent. The corporation was not successful and did no business after September 1931, after which time no products were moved in the factories. At a special meeting of the directors, September 24, 1932, a resolution was adopted to dissolve the corporation. On October 27, 1932, the State of Delaware issued a certificate862 of dissolution. At a special meeting of the directors, February 27, 1932, a resolution was adopted to transfer all the assets of the corporation, including real property, personal property, 553 accounts receivable, and all other property to the petitioner in consideration for extinguishment of an indebtedness of the corporation to petitioner in the sum of $44,034.48, money loaned during 1930 and 1931. Accordingly, there were transferred to petitioner assets of a book value of $96,110, as follows: Building, $45,091.49; equipment, $49,271.77; Chicago equipment, $990.18; and furniture and fixtures, $756.60. The building had been purchased by the corporation for a price of $15,000 and $11,408 was still due on the purchase price when transferred to petitioner. Petitioner paid $145.88 per month principal and interest on the balance due. Petitioner still owns these assets. In his return for 1932 petitioner claimed as a deduction a stock loss in the amount of $25,000, which was disallowed by respondent as being "not substantiated." Issue 2. - Waechter, an attorney, was employed by petitioner during 1932 to try cases for the petitioner at an agreed salary of $2,000 per month, 863 or $24,000 per year. Almost every month two checks for $1,000 each were given to Waechter. During the year 1932 petitioner gave Waechter 22 checks, totaling $24,000, as payment of salary, which were accepted as such. Waechter cashed only 5 of these checks in 1932, totaling $5,000. He retained 17 checks, totaling $19,000, and did not cash them for the reason that he did not need the money at the time. The checks have never been cashed. Petitioner had no knowledge, until about the date of January 1, 1933, of the fact that Waechter did not cash these checks. At that time, the petitioner, Waecher, and others, formed a partnership. Petitioner agreed to furnish the initial capital under a partnership agreement. When Waechter told the petitioner that he had not cashed $19,000 of the checks made payable to him in 1932, he agreed with petitioner that he would take a credit on the books of the partnership in the amount of $19,000 subject to his withdrawal at any time. Waechter gave the unendorsed checks to a clerk in petitioner's office in December 1932 and petitioner on January 1, 1933, credited him with $19,000, the full amount of the checks, on the books of the new partnership. 864 Petitioner's bank balance, as of December 31, 1932, was $3,713. The unendorsed checks were drawn against a bank account standing in the name of the petitioner individually. They could not have been cashed after the close of 1932 because the bank account of the petitioner was changed from his name individually into the partnership name of "Eagleton, Henwood and Waechter", beginning January 1, 1933. Waechter reported in his income tax return for the year 1932, $24,000 as salary received from petitioner. Respondent disallowed the petitioner $19,000 of the claimed deduction of $24,000 for compensation to Waechter for the reason that it was "not substantiated as a deduction on a 'cash' basis." 554 Issue 3. - In February 1932 petitioner took over premises at 2318 Randolph Street Formerly occupied by the Bethlehem Pipe Fittings Corporation, pursuant to the transfer of assets of that corporation to him. In March petitioner opened an office in this building, in connection with his law practice, for investigators and stenographers. The Bethlehem Pipe Fittings Corporation had ceased production and business. All equipment and stock had been transferred to the petitioner and865 were kept in storage in the Randolph Street building. Petitioner reported in his income tax return office expenses in connection with his business totaling $14,595.68. Respondent disallowed as "not substantiated" $2,153.22. The total amount disallowed was made up of the following items: $551.30 which petitioner described as rent paid; $254.75 which petitioner described as telephone service; $1,347.17, miscellaneous expenditures, which petitioner described as insurance, supplies, repairs, towel service, and stationery. During the taxable year petitioner paid $1,167.04 in payment of principal and interest due on the mortgage outstanding on the property at Randolph Street. Of this amount, $551.30 is payment of interest on the mortgage. During the taxable year petitioner paid a total of $245.75 to the local telephone company for telephone service at the branch of his law office operated in the Randolph Street building. During the taxable year petitioner paid, by check, miscellaneous items totaling $1,414.46. This total amount was made up of the following subtotals: Towel service, for law office at Randolph St$10.90Electricity, do72.71Gas service, do36.81Repairs to roof, do111.50Purchase of stove, do53.05Insurance, for Randolph St. property378.51Miscellaneous checks750.98866 Out of the various payments made by petitioner, the amount of $551.30 is interest paid on indebtedness. The amounts of $245.75 for telephone service, $10.90 for towel service, $72.71 for electricity, and $36.81 for gas, are ordinary and necessary expenses of carrying on petitioner's law business in the office at the Randolph Street property. Issue 4. - Petitioner's law practice consists chiefly of personal injury suits, most of which are brought to him by outside attorneys for handling. Petitioner's office does all the work in connection therewith and petitioner collects the moneys derived from these cases Petitioner charges against these collections costs and attorneys' fees. The net balance is paid to the client by petitioner. The costs of handling the suits are deducted from petitioner's gross income as business expense. The "attorneys' fees" are broken down into petitioner's 555 fee and the fee of the outside attorney who referred the case. This is in accordance with the agreement under which attorneys bring cases to the petitioner. The petitioner and the outside attorneys have a proportionate interest in the fees resulting from these cases. During the867 taxable year petitioner collected a total of $186,152.60. Out of this amount his fees were $117,974.71. He included this amount in his gross income for the year, which totaled $132,797.08. He credited to associate attorneys their fees totaling $68,177.89. He did not include this last amount in his gross income because he did not consider this as his own income for the reason that he agreed with outside attorneys that in taking cases from them he would share equally with them the fees received. Petitioner keeps a journal accounting record of this part of his business, entitled "Mark D. Eagleton and associates", which was introduced in evidence. This record has two sets of accounts for each month. One set, the left page set, records collections from cases disposed of and disbursement of the collections. The disbursements cover expenses, attorneys' fees and net payment to client. This set of receipts and disbursements balances. The other set of accounts, the right page set, shows only disbursements each month for the account of various cases named. This record shows in detail all disbursements and includes payments to clients, advances to clients, expenses, advances and payments868 to associate counsel, investigators, office, salaries. The right page set of disbursements does not have a receipts account to balance it and is not intended to balance with any of the left page set of accounts. This record shows that during 1932 petitioner paid to outside associate attorneys $51,559.05, made up partly of collections and partly of cash advances in anticipation of collections. The outside associate attorneys were not regarded as employees and these payments were not included in "expense" and so were not deducted from petitioner's gross income. Petitioner filed an individual income tax return for the calendar year 1932. His gross income was $132,797.08, including the $117,974.71 fees referred to above. He deducted expenses of $107,773.18, including expenses of the cases referred to above. His net income thereafter was $25,023.90. Respondent added to net income, as an unsubstantiated item, $16,618.74. Respondent arrived at this figure by trying to balance the account in the left page set of accounts, fees collected for associate attorneys totaling $68,177.89, with the account in the right page set of accounts, disbursements to associate attorneys $51,559.05. 869 The left page account and the right page account are two separate sets of accounts, although they appear in the same journal book. The two columns used by respondent in arriving at the sixteen thousand dollar amount do not have any relation to each other within 556 the requirements of elementary bookkeeping rules. There is not in evidence a credit account to offset the disbursements account totaling $51,559.05 in the taxable year. OPINION. HARRON: Issue 1. - The first question for determination is whether the petitioner is entitled to deduct from gross income of the year 1932 the amount of $25,000, his investment in the preferred stock of the Bethlehem Pipe Fittings Corporation. Respondent disallowed the claimed deduction for the reason that it was "not substantiated." Section 23(e)(2) of the Revenue Act of 1932 allows deductions from gross income for losses sustained during the taxable year if incurred in any transaction entered into for profit. Article 174 of Regulations 77 of the Bureau of Internal Revenue sets forth regulations applicable to obtaining allowance of a deduction for a loss arising from an investment in stock and provides that "If stock870 of a corporation becomes worthless * * its cost or other basis * * * is deductible by the owner in the taxable year in which the stock became worthless, provided a satisfactory showing is made of its worthlessness." The rule is well established that to deduct a loss arising out of an investment in stock the taxpayer must deduct the loss in the year in which it is sustained. ; ; ; . In the instant proceeding the question to be determined is whether the loss in question was sustained in the taxable year, 1932. If the stock had been worthless in 1931, as well as in 1932, petitioner would not be allowed to take the deduction for loss in 1932. ; certiorari denied, ; ; . In September 1931 the Bethlehem Pipe Fittings Corporation ceased all manufacturing and business operations. There is871 no evidence before us to show what the financial status of the corporation was at that time, but it appears from the record that the directors of the corporation decided then that the venture was not profitable and should be discontinued. The petitioner was the chief financial backer of the corporation, a director, owner of 50 percent of the preferred stock (according to his testimony), a creditor, and in close touch with those actively conducting the business. It is reasonable to assume that he was in a position to ascertain whether the corporation was solvent in 1931 and whether his stock had any value then, but the record is silent on this point. Petitioner at the hearing 557 was put on notice by respondent that this item was disputed as a matter of fact and that proof as to facts was necessary. In 1932 the corporation was dissolved. Prior to its dissolution, all assets were transferred to the petitioner in payment of the indebtedness to him of $44,000. The only evidence relating to the aggregate value of the corporation's assets is petitioner's testimony that in his opinion they were worth approximately $20,000. These assets consisted principally of a building872 which had cost the corporation $15,000 and against which there was a first mortgage lien of $11,000, which petitioner assumed, machinery, and other equipment which had been used. From the evidence it is doubtful whether these assets had a value greater than the amount of the debt to petitioner. We are of the opinion that the stock was worthless in 1932. It is material to petitioner's contention to show that the stock in question had some value at the end of the year 1931 to overcome any presption that the loss was sustained prior to the taxable year, 1932. The petitioner, in effect, has asked that this be assumed. However, it is certainly doubtful whether the assets transferred to petitioner in 1932 had any greater value at the end of 1931 than they had in 1932 and there is no evidence before us to show that the corporation had any other assets in 1931 or that it was in a better financial condition at the end of that year than in 1932. From the record and in the absence of evidence to show that the corporation was solvent at the end of 1931, we are unable to assume that the corporation was in fact solvent at the end of 1931. If the corporation was insolvent at the end873 of the year 1931, the loss on its stock was sustained in that year and petitioner should have deducted the loss in his return for the year 1931 without waiting until the corporation was liquidated or dissolved. See ; The petitioner cites ; ; ; and . However, those cases are distinguishable from the instant proceeding in that they involved going concerns whereas in the instant proceeding the corporation had ceased to do business in the prior year. The case of , cited by the petitioner, is not here governing. There it appeared that although the corporation did not operate until about four years after the taxpayer first purchased its stock, it did not become insolvent, and its stock worthless, until the year in which the loss was claimed on the stock. From a review of all the evidence, we are unable to determine that the claimed loss was sustained874 in 1932 so as to be deductible from gross income in the taxable year. The petitioner has failed to establish error in respondent's disallowance of the deduction. Therefore, 558 the respondent's action in disallowing the loss for 1932 is approved. Issue 2. - There is no question in this issue with respect to whether Waechter earned the total amount of $24,000 claimed as compensation paid to him in the taxable year, nor as to whether the salary was reasonable. The question is whether petitioner, on a cash receipts and disbursements basis, may deduct the amount of $19,000 as a business expense in the taxable year when payment was by checks which have never been cashed. The question is whether this amount was "paid or incurred" in the taxable year so as to be deductible under the provisions of section 43 of the Revenue Act of 1932. Section 23(a) of the Revenue Act of 1932 permits the deduction of salaries "paid or incurred" during the taxalbe year, and section 48(c) of such act states that the term "paid or incurred" shall be construed according to the method of accounting on the basis of which the net income is computed. Section 43 1 of the same act sets forth875 the period for which deductions and credits shall be taken. (See also article 341 of Bureau of Internal Revenue Regulations 77.) The petitioner was on a cash receipts and disbursements basis and he was required to make his return on that basis. If the amount in question was not paid in 1932 he may not take the deduction in that year. "It is the purpose of the [Revenue] Act to require returns that clearly reflect taxable income. That purpose will not be accomplished unless income received and deductible disbursements made are treated consistently." See . In that case the Court also stated that "it was not the purpose of the Act to permit gross income actually received to be diminished by taxes or other deductible876 items disbursed in a later year, even if accrued in the taxable year. It is a reasonable construction of the law that the same method be applied to both sides of the account." The provisions of the revenue act referred to in the quotation are practically the same as the pertinent provisions in the Revenue Act of 1932 referred to above. Payment by check is a conditional payment subject to the condition subsequent that the check is paid on presentation thereof to the drawee. When this method of payment is carried through to the performance of the condition subsequent, it is reasonable to conclude that the payment dates back to the time of giving the check, and it has been held accordingly. See , and , affirming . 559 In the case of the Estate of M. A. Bradley, it was pointed out by this Board that "to hold that delay in depositing a check suspends the maker's rights until deposit, would introduce uncertainty into the determination of income so as to make accuracy in accounting impossible. It would distort the reasonable intention877 of the law." In that proceeding the facts showed that a check given in payment of taxes on June 25, 1926, was duly paid on September 21, 1926, and that the payment related back to the date of its delivery. The issue here involved is not the same as in the case of Estate of M. A. Bradley, for the checks given to Waechter in 1932 were never cashed, were returned to the petitioner before the close of the year. Also, the checks could not have been cashed, for at the end of 1932 petitioner's bank balance was only $3,713 and on January 1, 1933, the bank account was closed. Waechter was credited with $19,000 on the books of the partnership on January 1, 1933. After giving Waechter this credit on the partnership books, Waechter could withdraw money and the withdrawals probably would be considered as dating back to the date of the credit. We are not required to pass upon the effect of the credit in 1933 for income tax purposes of petitioner for that year, because that year is not before us. But the transaction throws light on the issue that is before us. We are unable to conclude that the credit given in 1933 was the same as cashing the checks given in 1932 so as to relate the878 payment back to 1932. Two methods of payment are involved - first, an attempted payment by checks which was not carried through to performance of presenting the checks to the drawee for payment; second, establishing a credit on a new set of books to the account of the employee involved. If the first method of payment had been carried out and the checks had been cashed in 1932 or 1933 payment would relate back to the time of giving the checks, under the general rule set forth in But the payment involved was effectuated by the second method and we can not find any support for holding that the credit transaction resulted in payment to Waechter as of any other date than the date of entry of the credit on the partnership books in 1933. In other words, we are unable to hold that the credit given in 1933 related the payment back to 1932. In so holding, we can see no element of uncertainty in determining petitioner's income in the taxable year or jeopardy to accuracy of accounting, the elements going to the reasonableness of the rule of the case of the 879 Shortly before the end of 1932 petitioner took back the checks, preventing any diminution of his income for the year 1932 and making it entirely possible to make accurate his accounting records for 1932 as to cash disbursed 560 or subject to reduction by any outstanding checks. From petitioner's testimony it is evident that he was aware that the arrangement with Waechter would keep cash on hand intact, for he stated as follows: It takes a large sum of money to continue to try to do business with the necessity of advancing to clients. At one time we had over $200,000 in advances to clients alone. So, with that amount of money in the firm, I naturally wanted my partner to put in as much as he could, and if he could not put anything in, at least not to take any out. It is therefore held that no payment was made in 1932 of the $19,000 involved, that petitioner is not entitled to the deduction, being on a cash basis, and the disallowance by the Commissioner is affirmed. During 1932 petitioner gave Waechter a check for $10,000 for services performed in 1931 and Waechter cashed this check in 1932. Petitioner obtained a deduction880 of this amount in his income tax return for 1931. Consequently, there is no issue before us as to an amount of $10,000 paid in 1932. Petitioner has stated in his brief as follows: "Petitioner has at no time claimed, and does not now claim, that he should receive credit in his 1932 return for that payment [$10,000 back salary], having received credit therefor in his 1931 return." Issue 3. - The petitioner claims that the respondent erred in disallowing $2,153.22 of the deduction claimed as ordinary and necessary business expenses because the disallowed portion constitutes the expenses of maintaining the law office at 2318 Randolph Street. The evidence shows that the petitioner did use the office at 2318 Randolph Street in connection with his law practice, and, hence, any ordinary and necessary expenses paid in carrying on such business at that address are deductible. Sec. 23(a), Revenue Act of 1932. No business other than the petitioner's law practice was carried on at that address, since the business formerly carried on by the Bethlehem Pipe Fittings Corporation had been abandoned. The petitioner's acquisition, ownership, and use of that building, together with the machinery881 and supplies stored therein, were not related to his law business, except, of course, the use of the office. Some of the expenditures, so far as the evidence shows, may have been capital expenditures rather than business expenses; others may have been incurred to protect petitioner's investment in the property and may not have had any relation to his law business. Petitioner paid $551.30 interest on the mortgage outstanding on the Randolph Street property. In his income tax return he sought to deduct this amount as "rent" charged to himself as owner for office space. The building had been transferred to him by the Bethlehem Pipe Fittings Corporation. The facts show that this was payment of interest on the mortgage on the building. It is, therefore, not deductible 561 as a business expense, but is deductible under section 23(b) of the Revenue Act of 1932 as interest paid on indebtedness. It is held that this amount is deductible. Petitioner sought to deduct $254.75 paid for telephone service as a business expense. It has been found as a fact that petitioner used the Randolph Street building office in connection with his law practice and that telephone service there882 was in connection with his law practice. Petitioner testified that checks introduced in evidence totaling $245.75 were payments for telephone service. There is a discrepancy of $9 unexplained, which appears to result from some inaccuracy. It is held that the amount of $245.75 is deductible as a business expense. Respondent disallowed as unsubstantiated, $1,347.17, miscellaneous payments claimed deductible. From the evidence and in accordance with the findings of fact it is held that the following payments for various services at the Randolph Street building law office are deductible as business expenses: $10.90, towel service; $72.71, electricity; $36.81, gas service; total, $120.42. From examination of the evidence, we are able to identify the following totals as payments for repairs to roof, $111.50; purchase of stove, $53.05; insurance, $378.51, but there is no proof that all or any portion of each of these items were expenditures made in connection with the law office on Randolph Street. Also, there is no evidence to show whether any or all of the balance of $683.69 of miscellaneous expenditures relates to petitioner's business. It is, therefore, held that these miscellaneous883 expenditures totaling $1,226.75 are not deductible. Issue 4. - This issue requires considering the character of petitioner's business in handling cases brought to him by outside attorneys and whether the total fees collected from this business and all disbursements thereof should be reported by petitioner in his income tax return. Petitioner explains and argues that only part of these fees constitute his income and that he is only the conduit through which there passes certain fees "earned by" and belonging to outside attorneys: and that as for the fees belonging to others, he is not bound to make report of receipt or disbursement. According to his argument, respondent is in error in adding to his taxable income the amount of $16,618.84, because it is not his income and because the figure itserlf is not the difference between two accounts which balance each other. Respondent's theory is that all the fees collected by petitioner in the cases brought to him by outside attorneys are his fees and should be reported in his gross income; that the amounts paid to outside attorneys are in the nature of expense and should be deducted from 562 gross income; that as a matter884 of logic, since petitioner collected $68,177.89 in fees for outside attorneys and paid them only $51,559.05, the difference must be in petitioner's possession and must be included in petitioner's taxable income. We do not agree with respondent that the amount of $16,618.84 is necessarily a true figure of a surplus of fees collected as against fees paid out. It is elementary that the purpose of the income tax law is to tax income actually derived rather than constructively received, and it is assumed that individuals are not to be penalized for being the agency through which income is derived for someone else. See . It has been held that the purpose of the income tax laws is to tax income to the person having the beneficial interest therein but not the mere collector or conduit of income belonging to another. See . Hence, where a person receives money as trustee for another, the tax should not fall on the collector but on the person who has a beneficial interest therein, or if income is produced by property belonging885 to individuals jointly, and total income is collected by one, it has been held that the individual receiving the total income is taxable only on the portion in which he individually had the beneficial interest, the portion paid his associate or associates being received merely in trust for such party or parties. See . In the instant proceedings the undisputed testimony of petitioner shows that he received cases from outside attorneys under agreement with them to divide the fees equally. In 1932 petitioner collected from these cases, $186,152.60. His share of the fees totaled $117,974.71. Associates' fees totaled $68,177.89. Petitioner's fees were about 63 percent of the total fees paid. From the evidence, we are satisfied that the fees allocated to associates were their fees ab initio by the terms of the agreement by which the cases were turned over to petitioner so that petitioner was only taxable for part of the fees yielded by the cases. The petitioner and the outside attorneys had a joint interest in therse cases (the outside attorneys having obtained the cases in the first instance) and although petitioner collected886 the total of fees (the total income produced), he is taxable only on the portion in which he had a beneficial interest. During the taxable year petitioner's interest in the total fees collected was $117,974.71. This he reported in his gross income. From the record and evidence before us, we are unable to determine that his interest consisted of any more than that amount. From petitioner's sworn testimony we are satisfied that he was not entitled to and did not retain any part of the $68,177.89 collected for associates. 563 As for the amount of $16,618.84, we are not convinced that this figure represents an excess in petitioner's favor in the accounts with associates so as to constitute income as alleged by respondent. It is apparent that petitioner's associate attorneys had something of a drawing account with petitioner. He paid them fees which he collected for them, but he also advanced money to them in anticipation of making collections. At the end of a year the outside attorneys may not have received all held for them in their account of collections, or it is possible they might have overdrawn. But from the method of keeping the accounts, we believe respondent887 was in error in regarding as one account the credit account of fees collected for associates in 1932 and the debit account of amounts disbursed to associates in 1932, for these two sets of figures are not debits and credits of one account. There is no possibility of a true balance. Upon the undisputed testimony of petitioner, we are satisfied that he reported his entire income in the taxable year and that he did not retain as his own unreported income any of the fees collected by him for associate attorneys. From the record and the testimony of petitioner, was are of the opinion that he has reported his full income for the taxable year and that consequently respondent was in error in adding the amount of $16,618.84 to petitioner's taxable income. Reviewed by the Board. Judgment will be entered under Rule 50.ARUNDELL and TURNER dissent on the holding covered by the second headnote. Footnotes1. SEC. 43. PERIOD FOR WHICH DEDUCTIONS AND CREDITS TAKEN. The deductions and credits provided for in this title shall be taken for the taxable year in which "paid or accrued" or "paid or incurred", dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619393/	Frank J. Hogan and Marcella M. Hogan v. Commissioner.Hogan v. CommissionerDocket No. 92622.United States Tax CourtT.C. Memo 1963-293; 1963 Tax Ct. Memo LEXIS 52; 22 T.C.M. (CCH) 1500; T.C.M. (RIA) 63293; October 25, 196352 Expenditures held not incurred in the course of travel away from home in pursuit of taxpayers' trade or business. Truman Clare, 1221 First National Bank Bldg., Omaha, Neb. for the petitioners. Maxel B. Silverberg for the respondent. TRAINMemorandum Findings of Fact and Opinion TRAIN, Judge: Respondent determined deficiencies in petitioners' income taxes for the years and in the amounts as indicated: 1957$1,858.0919581,796.9119592,691.50The only53 issue remaining for determination is whether petitioners are entitled to a deduction of $3,600 for 1957 as travel expenses incurred while away from home in pursuit of a trade or business. Findings of Fact The petitioners, husband and wife, reside in Omaha, Nebraska. They filed joint Federal income tax returns for 1957, 1958 and 1959 with the district director of internal revenue in Omaha. Prior to October 1, 1956, petitioner Frank J. Hogan (thereinafter sometimes referred to as "petitioner") had been engaged in the insurance business for approximately 31 years. For approximately 4 1/2 years prior to October 1, 1956, petitioner was president of the Constitution Life Insurance Company in Los Angeles, California. During this period the president of Mutual of Omaha (hereinafter sometimes referred to as "Mutual") attempted to persuade petitioner to take a position with Mutual. On October 1, 1956, petitioner terminated his employment with the Constitution Life Insurance Company and was hired by Mutual. Since then, petitioner has held the positions of secretary, vice president, and executive vice president with Mutual. He is a member of the board of directors and the executive committee54 of United Benefit Life Insurance Company, a subsidiary of Mutual. He is also president of the St. Paul Hospital and Casualty Company, a whollyowned subsidiary of Mutual. For several years he was president of the Wisconsin Casualty Association, which was managed by Mutual. During his first fifteen months with Mutual, petitioner acted as a "troubleshooter" and also did a great deal of work on administrative problems in Mutual's home office in Omaha. In addition, he traveled to various parts of the country in the performance of his duties with Mutual. During the period of January 1, 1957, to August 31, 1957, inclusive, the petitioner was in Omaha for 144 days, in Los Angeles for 41 days, and in other cities for 58 days. On two occasions during this period petitioner was in Omaha for more than a month at a time. Except for the last half of August, petitioner was in no other city as long as two weeks at any one time. For the remainder of the year, petitioner was in Omaha for 77 days and in other cities for 45 days. On November 15, 1956, petitioners purchased a home for $38,500 at 500 Beverly Drive in Omaha, Nebraska. Petitioners sold this home for $45,500 at the end of June 1957 to55 the family who had been renting it since February 1, 1957. About August 7, 1957, petitioners bought another home in Omaha, in which home they were still living at the time of the trial in this case. On their income tax return for 1957 petitioners noted the sale of their first Omaha home but contended that the gain was not recognizable because the gain was derived from the sale of their residence. Subsequently, petitioners conceded that the gain was recognizable in 1957. Opinion Petitioner contends he spent $3,600 for nonreimbursed living expenses in Omaha, Nebraska, during the period January 1, 1957, through August 31, 1957, which expenses were incurred while away from home in the pursuit of his trade or business. Although petitioner points to no statutory provision allowing deduction for such ezpenditures, we gather from the language of the petition and the reply to the amended answer that petitioner's claim is based upon section 162(a)(2). 156 Respondent maintains that petitioner has not substantiated the expenditures, 2 that the expenditures were personal and therefore nondeductible under the provisions of section 262, 3 and that petitioner was reimbursed for the expenditures. We agree with respondent that petitioner has failed to establish that the expenditures were incurred while away from home in the pursuit of his trade or business. Petitioner's 1956 purchase of a home in Omaha approximately six weeks after the commencement of his employment by Mutual, his statement on his 1957 income tax return that this home was his residence prior to its sale in June 1957, his presence57 in Omaha 59 percent of the time during the first eight months of 1957 and 63 percent of the time during the last four months of that year, all militate against any conclusion that petitioner's trade or business during the first eight months of 1957 required that he travel away from home when he was in Omaha. The only item in the record that arguably supports petitioner's contention is a statement in a letter, written by the general comptroller of Mutual to the district director of internal revenue some 2 1/2 years prior to the trial in this case, which stated in part: When Mr. Hogan was first employed by Mutual of Omaha on October 1, 1956, he was temporarily assigned to duty in Omaha, with the understanding that his permanent home was to be in California. It was expected that he would be required to travel rather extensively on Company business, to other cities and other areas of the country. This arrangement, made for the benefit of the Company rather than for the convenience of Mr. Hogan, was understood to be strictly temporary. No definite permanent assignment was made until September 1, 1957, when Mr. Hogan moved his permanent residence to Omaha. There is no indication in58 the letter or any other part of the record as to why it was to the benefit of the company that petitioner maintained his permanent home in California despite the fact that he was to spend the majority of his time at the company's home office in Omaha. Nor is there any further discussion as to how his permanent assignment on September 1, 1957, differed from his temporary assignment prior to that date. This is not a case where an employee was transferred by his employer to a new location on a temporary or indefinite status. Rather, this case involves a man who, by his own choice, sought and obtained employment with a new employer away from his former residence. It may be that neither petitioner nor Mutual was absolutely sure at first that each would be happy with the other. Nevertheless, petitioner has wholly failed in his burden of demonstrating that Omaha was not his tax home and that the exigencies of his business as an employee of Mutual required that he maintain his home in a place other than Omaha. Since this essential link in petitioner's chain of proof is missing, we find it unnecessary to make findings as to whether petitioner substantiated his expenditures and as to whether59 Mutual reimbursed him for those expenditures. Decision will be entered under Rule 50. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated. SEC. 162. TRADE OR BUSINESS EXPENSES. (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 - * * (2) traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; * *↩2. The deficiency notice states, "It is determined that the expenditure represents non-deductible personal living or family expenses." Although this impliedly concedes that the expenditures were made, respondent's counsel raised the substantiation issue in his opening statement at the trial and the insertion of this issue was not objected to, then or later. ↩3. SEC. 262. PERSONAL, LIVING, AND FAMILY EXPENSES. Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619394/	Louis J. Epps v. Commissioner.Epps v. CommissionerDocket No. 6778.United States Tax Court1946 Tax Ct. Memo LEXIS 173; 5 T.C.M. (CCH) 466; T.C.M. (RIA) 46134; May 31, 1946173 On the record, held, that petitioner has failed to sustain his burden of proving that he, as distinguished from his wife and daughter, was not the real partner of his son. Held, further, that petitioner is taxable on the income from the partnership in 1941 which was claimed by his wife and daughter. Edgar W. Pugh, Esq., 3353 Penobscot Bldg., Detroit 26, Mich., for the petitioner. Cecil H. Haas, Esq., for the respondent. HILL Memorandum Findings of Fact and Opinion HILL, Judge: Respondent determined a deficiency in petitioner's income tax liability for the year 1941 in the amount of $18,681.55. The question presented is whether petitioner rather than his wife and daughter is taxable as a partner on 60 per cent of a certain partnership's174 income. Petitioner filed his income tax return with the collector of internal revenue for the district of Michigan at Detroit. The record consists of oral testimony and exhibits. Findings of Fact Petitioner is an individual residing at 746 Collingwood, Detroit, Michigan. At the time of the hearing, December 1945, he was 56 years old. From 1927 to 1931 petitioner was associated with Valley Steel Products Company, first as a salesman, later as vice-president. Valley Steel Products was a firm engaged in buying, selling and warehousing steel. In 1931 petitioner went to work for Consumers Steel Products Corporation, hereinafter referred to as Consumers, which had just recently been organized. Consumers was engaged in the business of buying, selling, warehousing and processing steel. Petitioner became president of Consumers in 1936, was a director and the largest individual stockholder of the company. In 1941 petitioner received a salary and bonus from Consumers in the amount of $25,000. Petitioner had been the dominant force in building up Consumers' business. Bernard S. Epps is petitioner's son. At the time of the hearing he was 34 years old. He left college after completing three175 years and in 1932 went to work as a laborer for Consumers. In 1936 Bernard became purchasing agent for Consumers and in 1941 was receiving an annual salary of $10,000. During the early summer of 1941 the board of directors decided to liquidate Consumers' business. The liquidation was unsuccessfully contested by minority stockholders. After this decision to liquidate, Bernard began discussing with his mother and father the possibility of his, Bernard's, starting a new steel business. Bernard estimated that he would require about $15,000 capital. His mother and father were receptive to the scheme and willing to cooperate with Bernard in establishing the new business. On August 28, 1941, $15,000 was deposited in the Wabeek State Bank of Detroit to an account entitled "Bernard Epps & Company". 1 On the same date a check in the amount of $11,250 was drawn to the order of Bernard S. Epps on this account signed "Epps & Company, L. J. Epps", in the handwriting of petitioner. This check was endorsed by Bernard and deposited to his personal account with Wabeek State Bank on August 29, 1941. 176 A partnership agreement was executed. This agreement recites that it was "made and entered into this - day of September, 1941, but as of the 28th day of August, 1941, * * ." In the bank space before "day of September" is a light pencil marking which looks like 2nd or 3rd. The agreement is signed by Bernard S. Epps, as party of the first part, Lillie J. Epps, party of the second part, and Bernard S. Epps, trustee for Marylin Nan Epps, as party of the third part. Marylin (sometimes referred to in the record as Marilyn) is petitioner's daughter and was 15 years old at the time of the hearing. The agreement recites that the parties thereto have agreed to associate themselves as general partners "for the purpose of buying, selling and dealing generally in steel and all other products of every kind, nature and description whatsoever, * ". The partnership agreement explains the interest of the party of the third part as follows: WHEREAS, the interest of the party of the third part arises through a trust created by Louis J. Epps, as of August 28th, 1941, for the benefit of his daughter, Marylin Nan Epps, and by the express provisions of said trust, the party of the third part is177 directed to enter this partnership and is vested with full, complete and absolute control of said interest and said trust has been made permanent and irrevocable, * * * The agreement further recites that: * * * the respective parties agree that each of the parties hereto have contributed toward the capital of the partnership the following sums: Party of the first part -$3,750.00Party of the second part -$7,500.00Party of the third part -$3,750.00 making a total sum received by the partnership from the parties hereto of $15,000.00. The agreement further provided in part as follows: 1. That the partnership shall be carried on for the purpose above stated. 2. That the partnership business began as of the 28th day of August, 1941, and shall continue for a period of fifteen years, unless sooner terminated by agreement, of the parties or by operation of law. 3. That the partnership shall be conducted and carried on under the partnership firm, style and name of Bernard S. Epps and Company, and with its principal place of business, located in the City of Detroit, Wayne County, Michigan, and inception of the business shall commence at 6450 E. McNichols178 Road, in said City of Detroit; that appropriate papers shall be prepared and filed with the proper authorities, constituting notice of the partnership to the use of such assumed name. 4. It is mutually understood and agreed that by reason of the fact that it is contemplated that the respective parties hereto will be able to furnish services disproportionately to the capital interest they have in the partnership, that notwithstanding the capital interest of the respective parties in and to said partnership as above indicated, the respective parties shall share profits on the following basis: Party of the first part -40%Party of the second part -40%Party of the third part -20% It is further understood and agreed that upon the dissolution of the partnership, all liabilities to third parties shall be satisfied; all sums loaned by any of the parties to the partnership shall be repaid with interest at the rate agreed upon at the time of the loan, and the salary of the party of the first part herein provided shall be paid pro rata to the date of dissolution. Of all balances remaining, the party of the first part shall receive 25% and the party of the second part179 and the party of the third part shall receive 37 1/2% of the first $15,000.00, while the balance of any sum or sums available in excess of $15,000.00 shall be distributed to the parties hereto in the following proportion: Party of the first part -40%Party of the second part -40%Party of the third part -20%5. It is further mutually understood and agreed that notwithstanding anything herein contained to the contrary, the party of the first part will during the life of this partnership agreement contribute 40% and the party of the second part 40% and the party of the third part 20%, toward any losses, whether on capital or otherwise, sustained by the partnership. 6. It is further mutually understood and agreed that the party of the first part shall devote his whole time and attention to the carrying on of the business of this partnership and carry on and manage the same for the common benefit of the partners, to the utmost of his skill and ability, and shall not during the continuance of this partnership, be concerned or engaged, directly or indirectly except with the consent of the parties of the second and third parts, in any other business, by reason180 of the fact that it is not contemplated that the parties of the second and third parts shall actively engage in the conduct of the business, and by reason of the fact that the party of the first part shall devote his full time and attention thereto, it is mutually understood and agreed that while the party of the first part shall be so employed by the partnership, he shall receive a salary of $10,000 per year payable in equal monthly installments. It was also provided that in the event one of the partners died the surviving partners should have an option to purchase the deceased partner's interest at book value. On September 11, 1941, a "Certificate for General Partnership Carrying on Business Under an Assumed Name" was filed with the county clerk of Wayne County, Michigan. This certificate provided in part as follows: 1. The name and style under which such business owned is to be conducted or to be transacted is "Bernard S. Epps & Company." The true or real full name of the persons owning, conducting or transacting such business, with the home and post office address of each, are as follows: Name: Bernard S. Epps; Home Address: 610 Blaine Avenue, Detroit, Michigan; P. O. Address: 181 6450 E. McNichols Rd., Detroit, Michigan. Name: Lillie J. Epps; Home Address: 2727 Cortland Ave., Detroit. Michigan; P. O. Address: 6450 E. McNichols Rd., Detroit, Michigan. Also on September 10, 1941, Bernard and Lillie signed a signature card on the Wabeek State Bank which authorized either Bernard or Lillie to draw checks on the partnership account. On March 2, 1942, but effective as of August 28, 1941, a trust agreement was executed by petitioner as grantor and Bernard as trustee for the benefit of Marylin. This trust agreement provided in part as follows: WHEREAS, Louis J. Epps, the Grantor, has simultaneously herewith turned over to the Trustee the sum of $3,750.00 to be held by him irrevocably in trust for the use and purposes and subject to the powers and provisions hereinafter set forth. NOW, THEREFORE, (1) The Grantor directs that said funds be used to purchase an interest in a partnership known as Bernard Epps and Company, which partnership consists of Bernard S. Epps, Lillie J. Epps and Bernard S. Epps, as Trustee for Marylin Nan Epps. The trust is to continue in effect until Marylin attains 28 years of age or dies prior thereto. At termination, the trust corpus182 is to be distributed to Marylin, if living, otherwise, to her heirs share and share alike. If no heirs survive Marylin then the corpus is distributable to the heirs of Lillie Epps, excluding Bernard. The trustee is given broad management powers and discretion to distribute or withhold trust income. The intention of the grantor is stated to be that income distributed be used for luxuries and not for support or maintenance. On March 12, 1942, petitioner filed a Federal gift tax return with respect to the creation of the trust for Marylin. On February 26, 1942, petitioner filed a Federal income tax return for Marylin as guardian, reporting $10,947.67 as her income from the partnership. On March 24, 1942, a "Notice of Discontinuance of Co-Partnership" signed by Lillie was filed with the county clerk. This notice stated that the business conducted under the name of Bernard S. Epps and Company had been discontinued. On the same date a new certificate of co-partnership was filed reciting that Bernard S. Epps, Lillie J. Epps and Bernard S. Epps as trustee for Marylin Nan Epps were carrying on a business as co-partners under the name of Bernard S. Epps and Company. This certificate was183 dated March 24, 1942, "but as of August 25, 1941." Bernard S. Epps and Company, hereinafter referred to as the Company, commenced its business activity in September 1941. Its office was located at 6450 East McNichols Road in Detroit, which was Consumers' plant. The office is described as a "cubbyhole" and was rented by the Company from Consumers, the rent in 1941 amounting to a total of $140. In addition to Bernard, the Company had one other employee in 1941, one of Consumers' bookkeepers on a parttime basis. The Company's balance sheet as of December 31, 1941, shows fixed assets as consisting of office furniture and fixtures valued at $306.89 and an automobile valued at $535.86. About 90 per cent of the Company's business consisted of selling steel on a brokerage basis. Bernard, for the Company, having mill contacts made while employed by Consumers, arranged sales of steel between prospective buyers and sellers, receiving a brokerage commission therefor. About 10 per cent of the Company's business consisted of buying steel and reselling it at a profit. Some of the Company's customers had formerly been customers of Consumers. Marylin performed no services whatsoever for the Company. 184 Lillie Epps occasionally signed Company checks when Bernard was out of town but otherwise took no active part in the business and knew very little about its conduct or operations. Petitioner, during 1941, was in a position to have rendered considerable services to the Company. He was president of Consumers until December 1941, at which time a receiver was appointed for Consumers. The receiver appointed petitioner to carry on the liquidation. Petitioner, as president of Consumers and as the receiver's agent, was the only executive representing Consumers in the building in which the Company's office was located. By September 1941 Consumers had sold its inventory of steel and had discontinued its buying and selling activities. The Company started its business in that month. The Company rented warehouse storage space from Consumers. In this connection Consumers, through petitioner, rendered certain services to tenants and storage space lessees. These services, among other things, included making arrangements for getting steel into or out of storage from or to customers. Petitioner also paid certain expenses for the Company when Bernard was out of town. Petitioner was reimbursed by185 the Company for such expenses, which included such items as travel and entertainment. Petitioner would get in touch with Bernard by telephone when any matters of importance arose. During 1941, petitioner loaned the Company $12,500. Petitioner borrowed this money from a bank and then loaned it to the Company because the Company at that time had no established loan credit of its own. This loan plus interest was repaid to petitioner by the Company in December 1941. By April, 1942, Consumers had discontinued all its activities and the plant and facilities were sold in May, 1942. In May or June, 1942 petitioner was employed on a part-time basis by the Company and paid as salary for the remaining part of 1942 the amount of $7,166.60. Also in April, 1942, petitioner organized as a sole proprietorship the International Merchandising Company with offices in the Fisher Building, Detroit. In 1942, 1943 and 1944, petitioner received in profits from this Company, the respective amounts of $9,973.52, $13,868.16 and $18,581.26. The balance sheet of Bernard Epps and Company as of December 31, 1941, showed the following: ASSETSCURRENT ASSETSCash in Bank$34,097.13Accounts Receivable27,129.36Merchandise Inventory8,429.10Deosit with American Airlines425.00Miscellaneous Accounts Receivable1,058.00TOTAL CURRENT ASSETS$71,138.59INVESTMENTS50 shares - Luckens Steel Co. Common Stock$ 700.002,000 shares - Consumers Steel Products Corp. (at cost)2,600.503,300.50PREPAID EXPENSES$ 22.00FIXED ASSETSOffice Furniture and Fixtures$ 306.89Automobile535.86$ 842.75Less: Reserve for Depreciation34.22808.53TOTAL ASSETS$75,269.62LIABILITIESCURRENT LIABILITIESAccounts Payable$ 3,997.03Accrued Payroll Tax4.95Accrued Partner's Salary1,529.31TOTAL LIABILITIES$ 5,531.29186 NET WORTHBernard S. Epps, original investment$ 3,750.0040% of Net Profit Calendar Year 194121,895.33$25,645.33Lillie J. Epps, original investment7,500.0040% of net profit calendar year 194121,895.3329,395.33Bernard S. Epps, Trustee for Marilyn Nan Epps, original invest-ment3,750.0020% of net profit calendar year 194110,947.6714,697.6769,738.33TOTAL LIABILITIES AND NET WORTH$75,269.62The balances of the capital accounts as shown on the Company's general ledger as of January 1st of the years indicated, are as follows: Marylin'sYearBernardLillieTrust1942$25,645.33$29,395.33$14,697.67194343,142.1652,000.2227,479.73194439,776.4255,440.4730,736.66194555,293.0074,809.0440,873.03The capital account representing Marylin's trust constituted the only records kept with respect to such trust. Bernard, as trustee, kept no separate accounts. The Company's profits allocated and added to these capital accounts for the years indicated are as follows: Marylin'sYearBernardLillieTrust1942$28,745.78$28,745.78$14,547.39194315,245.1115,245.107,716.55194423,393.1723,393.1712,427.21187 The only withdrawals from these capital accounts from 1941 to 1944, inclusive, were to pay income taxes on the allocated profits. In October 1945 Lillie, in addition to other withdrawals, withdrew $5,000 which was used to pay a note of like amount to the order of petitioner, dated January 30, 1945, and signed by Lillie. The note bore no interest. This note was purportedly made out to petitioner by Lillie to secure the unpaid balance of $7,500 which constituted Lillie's capital contribution to the Company and which had been purportedly borrowed by her from petitioner in August 1941. On January 29, 1945, Lillie paid petitioner by cashier's check $2,500 which purportedly constituted a partial payment on this alleged debt. For the year 1941 the Company filed a partnership return reporting a net income of $58,071.69. On Schedule J of this return the partners' shares were reported as follows: Bernard S. Epps$25,228.69Lillie J. Epps21,895.33Marylin Nan Epps10,947.67Bernard filed an income tax return for 1941 reporting $25,228.69 as income from the Company in addition to $8,590 as salary. Lillie filed a return for 1941 reporting as her sole income $21,895.33188 received from the Company. As previously stated, petitioner, as guardian, filed in February 1942, a return for Marylin, reporting as her sole income $10,947.67 received from the Company. In July 1944, however, Bernard, as trustee, filed a fiduciary return on behalf of Marylin's trust estate for the year 1941. This fiduciary return was labeled "Amended" and the letter of transmittal explained that the fiduciary return was intended to amend the return originally filed by petitioner, as guardian. The fiduciary return filed by Bernard, as trustee, reported as the trust's sole income $10,947.67 received from the Company in 1941. Petitioner filed a Federal income tax return for 1941 reporting as income $25,000 received as compensation from Consumers. No other income was reported. Respondent, in the notice of deficiency dated November 15, 1944, determined that petitioner was taxable on $33,759.79 of the Company's income in addition to the income originally reported by petitioner. Respondent explained this determination as follows: It has been determined that $33,759.79 of the net income of the partnership known as Bernard Epps and Company, Detroit, Michigan, for the year 1941 is taxable189 to you under the provisions of Section 22 (a) of the Internal Revenue Code. The amount held taxable to you has been computed as follows: Net income of partnership as cor-rected$59,599.67Less: Compensation of Bernard S.Epps3,333.36Balance$56,266.31Your share thereof (60% or $56,266.31)$33,759.79The amount held taxable to you represents the portions (as adjusted) of the partnership income reported on the separate 1941 returns of your wife, Mrs. Lillie J. Epps, and Louis J. Epps as Guardian of Marilyn Nan Epps. Opinion Respondent contends that petitioner, rather than petitioner's wife and daughter, is a partner and as such is taxable on 60 per cent of the partnership's income. Petitioner contends that the wife and daughter are bona fide partners under the partnership agreement and that they are taxable therefor on 40 and 20 per cent, respectively, of the partnership's income. We agree with respondent that petitioner is taxable on 60 per cent of the partnership's income. The circumstances leading up to and surrounding the creation of the partnership strongly suggest to us that the partnership was, as a practical matter, 190 essentially a continuation of Consumers' business. In our opinion, the partnership's immediate ability to earn income stemmed from the established good will and reputation of Consumers. The partnership's instantaneous and substantial financial success, we think, resulted in a large degree from the momentum and going concern value inherited, so to speak, from Consumers. That the partnership was a continuation of Consumers' business is suggested by petitioner's failure to satisfactorily explain the reason for Consumers' liquidation. It is suggested that Consumers was liquidated because it became impossible in 1941 to purchase adequate quantities of steel. If this were the real reason for discontinuing Consumers' activities, it would seem imprudent to have established a new business which likewise depended upon the availability of steel. It is stated that the partnership's business consisted primarily of buying and selling steel on a brokerage basis whereas Consumers' business consisted primarily of buying and selling steel on a jobbing basis. It seems apparent to us that both methods of selling steel depend equally upon the availability of steel. Thus, we are unable to accept a tight191 steel situation as an explanation for the liquidation of Consumers. If the primary reason for the liquidation of Consumers and the establishment of the partnership was to switch from jobbing to brokerage activities, no particular business reason can be seen for changing the form of doing business from a corporation to a partnership. It is not apparent to us why it would not have been feasible, solely from a business point of view, for Consumers to have merely contracted its jobbing activities and expanded the brokerage phase of its activities. It is also significant that a group of minority stockholders resisted the liquidation of Consumers. Many of the partnership's customers had formerly been customers of Consumers. It was also not unlikely that the partnership arranged sales for concerns from which Consumers had formerly bought. The partnership commenced its brokerage activities at about the same time Consumers discontinued its buying and selling. The partnership commenced its activities sometime in September 1941 with capital amounting to $15,000. At the end of 1941 in a 4-months period of time, the net worth of the partnership was $69,738.33, representing more than four times192 the original capital invested. The circumstances of the unexplained liquidation of Consumers, the similarity of the business carried on by Consumers and the partnership and the extraordinary and immediate financial success of the latter indicate to us that the partnership's earning capacity was directly or indirectly derived from Consumers, which in turn had been primarily built up and controlled by petitioner. Under the circumstances described above, it would have seemed particularly essential to the success of petitioner's case to show by clear and convincing evidence that petitioner had effectively eliminated himself from participation in and control of the partnership activities. However, the evidence bearing on petitioner's relationship to the partnership is vague and obscure. The burden is on petitioner to overcome respondent's determination that petitioner was a partner in the company. Petitioner has not sustained this burden. The petitioner, during 1941, was in a convenient position to have rendered services and assistance to the partnership. The partnership's "cubby-hole" office was in the same building in which Consumers' offices were located. Petitioner, as the receiver's193 agent in liquidating Consumers, was the only responsible executive in that building. As the receiver's agent, petitioner rendered services to the tenants and customers of Consumers of which the partnership was one. Since Consumers' business activities were substantially curtailed at the time the partnership's business activities were commencing, it is not unlikely that petitioner had sufficient time to devote to the partnership interests. There is some positive evidence in the record indicating that petitioner did in fact furnish valuable services to the partnership. When Bernard was out of town petitioner paid certain partnership expenses as they arose and entertained partnership customers for which he was reimbursed. During 1941 petitioner also loaned $12,500 to the partnership which he had in turn borrowed from a bank. This loan was repaid by the partnership to petitioner before the end of 1941. This loan transaction further illustrates the value to the partnership of petitioner's established reputation and business standing. We found as a fact that petitioner drew a check for $11,250 on the partnership account on August 28, 1941, payable to Bernard. The check was signed by petitioner194 and over his name was printed "Epps and Company". This would indicate that the partnership had an account with the bank on that date and that petitioner was recognized by the bank as authorized to draw on such account. Petitioner contends that this check was signed by his wife whose initials are the same as his, but a comparison of the petitioner's and his wife's signatures on other documents clearly establishes the fact that the signature on the check in question is petitioner's. In any event, the signature card in evidence signed by petitioner's wife and son authorizing them to draw on the partnership account was not executed until September 10, 1941. Furthermore, we can not ignore the fact that petitioner was allegedly employed by the partnership in 1942 on a salary basis. Under these circumstances it would seem that petitioner was in a suitable position to render services to the partnership in 1941 and it appears that he did actually render some services and exercised some control. On the record it is impossible for us to clearly determine the exact character or the precise extent of these services and controls. The facts and circumstances which do appear from the record suggest195 that petitioner could have and did participate in the partnership's activities to considerable degree. Petitioner has not successfully shown that he, in fact, eliminated himself from such activities. Petitioner has not only failed to convince us that the partnership's earning capacity was not to a large extent dependent upon petitioner but he has also failed to establish to our satisfaction that his wife and daughter were, in fact, bona fide partners. We are impressed with the unreality of their position as partners. In the first place, the record is in considerable confusion with respect to the legal formalities and financial arrangements relied on by petitioner as constituting his wife and daughter partners. The date of the partnership agreement is not definitely established. Bernard testified that his mother and father signed the partnership agreement. Petitioner's wife testified that she could not intelligently answer questions with respect to the circumstances under which the partnership agreement was executed. The testimony relating to the alleged loan from petitioner to his wife is confusing and contradictory. The check for $11,250 dated August 28, 1941, which we found as196 a fact was signed by petitioner to Bernard's order, was identified by petitioner's wife as a check petitioner had given to her. Petitioner's wife also testified that she executed a note at that time to the order of her husband to evidence her indebtedness to him for the alleged loan of $7,500. This note is not in evidence and is alleged to have been lost. Actual repayment of this alleged loan did not occur until 1945. The trust established for the benefit of Marylin was not executed until March 1942. This confusion and contradiction relating to the formal papers and arrangements purporting to make petitioner's wife and daughter partners does not, in our opinion, lend particular credibility or substance to petitioner's contention. It is admitted that the wife and daughter performed no services to the partnership of any substantial character. It is also apparent that the capital furnished the partnership, except for Bernard's contribution, originated with petitioner. It is equally apparent, we think, that the partnership earnings were created by personal activity and intangible assets, such as good will, contacts and reputation, rather than by mere capital. See Earp v. Jones, 131 Fed. (2d) 292;197 Schroder v. Commissioner, 134 Fed. (2d) 346; Mead v. Commissioner, 131 Fed. (2d) 323; Francis Doll, 2 T.C. 276">2 T.C. 276, aff'd 149 Fed. (2d) 239, cert. denied 326 U.S. 725">326 U.S. 725 (Oct. 8, 1945); Frank J. Lorenz, 3 T.C. 746">3 T.C. 746, aff'd 148 Fed. (2d) 527; cert. denied, 327 U.S. 786">327 U.S. 786 (March 5, 1946); M. M. Argo, 3 T.C. 1120">3 T.C. 1120, aff'd 150 Fed. (2d) 67, cert. denied, 326 U.S. 762">326 U.S. 762 (Nov. 5, 1945). In this connection it is significant that in four months with an original capital of $15,000 the net worth of the partnership was increased to $69,738.33. The fixed assets of the partnership were negligible, amounting to only $808.53 as of December 31, 1941. It is also significant that the partnership borrowed $12,500 from petitioner which is only slightly less than the original capital and it repaid this amount within the first four months of its existence. This suggests to us that except for the purposes of reallocating income within the family group the original capital of $15,000 could have been borrowed and repaid which would have involved only a short-term interest expense. 198 We can see no business purpose for the inclusion of petitioner's wife and daughter as partners. They were not essential for purposes of raising capital nor did they perform any services. Neither the wife nor the daughter made any withdrawals from their capital accounts except for purposes of paying income taxes during the taxable year. See Frank J. Lorenz, supra, and Leonard W. Greenberg, 5 T.C. 732">5 T.C. 732. The confusion of the record, the failure of the wife and daughter to perform services and their surplusage as a source of capital, in addition to the absence of any apparent business purpose to explain their inclusion as partners, and the fact that the partnership earnings depended upon services rather than capital all combine to impress us with the unreality of the status of the wife and daughter as partners. To sustain petitioner on the record before us would involve two factors. First, we would be required to give substantial recognition for tax purposes to a formal partnership and trust agreement and other financial formalities, the details of which are confused, contradictory and obscure. Secondly, we would be required to accept petitioner's conclusion, 199 in the absence of any substantial factual support or evidentiary proof, that he in fact had nothing to do with the partnership's operations. In other words, we would have to conclude that petitioner did not contribute capital or services to the partnership and that petitioner's wife and daughter did so, under circumstances sufficient to constitute them, and not petitioner, partners. Such a conclusion, in our opinion, is unwarranted, and in fact contrary to the gist of the confused and incomplete evidence before us. We recognize that factually the instant case presents a slightly new variation of the usual family partnership pattern. Under the usual pattern, the husband-taxpayer is formally a member of the partnership agreement and the only question is whether other members of the family have been successfully included. In the instant case the husband-taxpayer is not formally a party to the partnership agreement. Despite this variation we think the fundamental considerations are the same. Where the taxpayer is not formally a party to the partnership agreement, his participation and control may be less readily apparent. This factor does not relieve the taxpayer, however, of his usual200 burden of proof. The taxpayer can not, by merely eliminating himself from the partnership agreement, shift the burden of proving his relationship to the partnership to respondent. Taxpayer can not point to the legal documents, remain mute and prevail. In our opinion this case is governed by the basic principles enunciated by such cases as Lucas v. Earl, 281 U.S. 111">281 U.S. 111; Burnet v. Leininger, 285 U.S. 136">285 U.S. 136; Helvering v. Horst, 311 U.S. 112">311 U.S. 112; Helvering v. Eubank, 311 U.S. 122">311 U.S. 122, as applied to the family partnership situation by Commissioner v. Tower, 327 U.S. 280">327 U.S. 280 (Feb. 25, 1946). We have not been convinced that the partnership's income for 1941 was not to a large extent created by petitioner's contributions of services, skill, capital and other intangible assets. We are not convinced that petitioner, rather than his wife and daughter, was not the real partner of Bernard. Nor are we satisfied that the legal partnership formalities were more than an attempt to reallocate petitioner's income within the family group. We hold, therefore, that petitioner is taxable for 1941 on 60 per cent of the partnership income. Decision will201 be entered for respondent. Footnotes1. On the signature card the account's title has an initial scratched out between Bernard and Epps.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619395/	APPEAL OF EMIL B. MEYROWITZ.Meyrowitz v. CommissionerDocket No. 3241.United States Board of Tax Appeals3 B.T.A. 1327; 1926 BTA LEXIS 2409; April 20, 1926, Decided Submitted November 9, 1925. 2409 Traveling expenses, incurred by the taxpayer in the business of the employing corporation, to be paid out of a fixed salary, are a proper deduction from the income of the taxpayer where there is sufficient evidence to establish such expenditure. Frank C. Myers, Esq., for the taxpayer. W. Frank Gibbs, Esq., for the Commissioner. LOVE 1327 Before MARQUETTE, MORRIS, GREEN, and LOVE. This is an appeal from the determination of a deficiency for the year 1919 in the amount of $1,394.49. The deficiency arose from the refusal of the Commissioner to allow as deductions certain traveling expenses alleged to have been incurred in connection with the taxpayer's business. FINDINGS OF FACT. The taxpayer is an individual residing in New York City. During the year 1919 he was the president and principal stockholder of the following corporations: E. B. Meyrowitz, Inc., of New York; E. B. Meyrowitz, Inc., of Minnesota; and E. B. Meyrowitz, Inc., of Paris, a New Jersey corporation, hereinafter referred to as the corporation. These corporations were engaged in the business of manufacturing and selling surgical and optical instruments. Five stores2410 1328 and a factory were operated in New York City, two stores in St. Paul, one in Minneapolis, one in Detroit, and one in Paris, France. The corporations were affiliated and the stock was closely held by the taxpayer, his wife, two sons, and a daughter. The business was established in 1875 by the taxpayer, and since that time has been owned by taxpayer and his family. In addition to manufacturing and selling their own surgical and optical instruments, the said corporations imported from, and contracted for the manufacture of some of these goods in, France, Switzerland, Austria, and Germany. It was the practice of the taxpayer to make frequent trips to Europe to keep in touch with the Paris store and the European manufacturers, and to get new ideas and first-hand knowledge of European development in surgical and optical instruments. Owing to severe losses suffered during the period 1914 to 1919, due to war conditions, and a loss of approximately $102,000 on a building in New York City, it became necessary for the corporations to economize. In pursuance of that policy the taxpayer agreed with the directors of the corporations that his traveling expenses on business2411 trips would be paid by himself out of his salary, which was fixed at $9,000 per annum. In 1919 it became necessary to make a business trip to get in touch with the manufacturers in Europe whose business relations had been cut off during the prior four years on account of the war. The taxpayer, thereupon, in October, 1919, went to Europe and spent several months in business dealings with foreign manufacturers and sellers of surgical and optical goods in France, Germany, and Switzerland. He also devoted considerable time to the business of the paris store. The expenses of the trip in 1919 were as follows: Steamship passage$815.00Paris headquarters, hotel, meals, etc1,394.00Entertainment for business purposes820.00Taxi fares, tips, stenographic services250.00Railroad fares in Europe250.00Hotel expenses on trips300.00Total3,829.00In computing the deficiency, the Commissioner did not allow any of these expenses as deductions. OPINION. LOVE: The taxpayer was an officer and principal stockholder of several corporations engaged in the manufacture and sale of surgical and optical supplies. It had 10 stores in large cities in the 1329 *2412 United States and one in Paris, France. These corporations also handled European-made surgical and optical supplies. The prestige of the European manufacturers in such field is so well known that the necessity for European connection by a large concern in the United States intending to keep abreast with the times is desirable. This was particularly true in 1919, since business relations with Europe had been cut off for four years on account of the World War. The testimony that the trip was for strictly business purposes and not for pleasure is corroborated by long letters to his sons, introduced in evidence, every sentence of which relates to his activities in respect of the business of the corporations. The corporations did not keep minutes of the meetings, but each director testified that the expenses of the business trips were to be paid from salaries and were not paid by the corporation. We are satisfied that the taxpayer has proved legitimate business expenses to the amount of $3,829 for the year 1919, which he is entitled to deduct from income for that year. Order of redetermination will be entered on 10 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619401/	STONEY AMICK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. H. H. STALLARD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Amick v. CommissionerDocket Nos. 21478, 21480.United States Board of Tax Appeals20 B.T.A. 501; 1930 BTA LEXIS 2110; August 6, 1930, Promulgated 2110 Petitioners held liable as transferees under section 280 of the Revenue Act of 1926. Chester A. Bennett, Esq., for the petitioners. H. B. Hunt, Esq., and J. E. Mather, Esq., for the respondent. BLACK 502 OPINION. BLACK: These proceedings involve the liability of the petitioners as transferees of the assets of the Blake Coal Mining Co. of Stone, Ky., for unpaid profit and income taxes of said company for the years 1920 and 1921 in the respective amounts of $595.97 and $3,127.40. Petitioners question the constitutionality of section 280 and allege in addition that respondent erred in proposing to assess the entire liability against each petitioner. At the hearing it was ordered that the two cases be consolidated and heard together. The Blake Coal Mining Co. was a corporation organized under the laws of the Commonwealth of Kentucky with its principal office and place of business at Stone, Ky. The capital stock consisted of 50 shares, of which petitioner H. H. Stallard was the owner of 34 shares and petitioner Stoney Amick was the owner of 16 shares. In 1922 the mining company sold all of its assets for the agreed price of $25,000, 2111 of which $18,000 was paid and a judgment for the balance of $7,000 was obtained and $1,100 collected thereon. The consideration received from the sale of the assets was distributed to the petitioners in the proportion of their stockholdings, viz, thirty-four fiftieths to H. H. Stallard and sixteen fiftieths to Stoney Amick, being in both instances more than the proposed liability against them. The corporation was dissolved June 16, 1922. The evidence shows that the taxes were duly assessed against the transferor corporation on respondent's November, 1925, supplemental assessment list and are still unpaid and outstanding. All facts necessary to establish liability of petitioners have been duly proved. We have decided in a number of cases that each transferee is liable for the entire tax to the extent of assets received. ; ; . See also . The question of the unconstitutionality of section 280 of the Revenue Act of 1926 has heretofore been urged, and we have held2112 that where a transferee has elected to appeal to this Board he is precluded from questioning the validity of the statute. See also , and . Under the authority of cases above cited, respondent's determination is approved. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619404/	Warren C. Mawhinney, Petitioner, v. Commissioner of Internal Revenue, RespondentMawhinney v. CommissionerDocket No. 93767United States Tax Court43 T.C. 443; 1965 U.S. Tax Ct. LEXIS 142; January 18, 1965, Filed January 18, 1965, Filed 142 Decision will be entered for the respondent. Held: In the absence of a court order awarding custody of a child, where the mother took the child from his father's home without the consent of the father to her sister's home to live, there is no violation of the Pennsylvania kidnaping statute. Leon Turnipseed, 27 T.C. 758">27 T.C. 758, not applicable. Amounts spent for the child's support by his mother and his aunt and uncle are includable in determining total support. Petitioner failed to prove that he provided more than one-half of the child's support for 1959. William Pettit, for the petitioner.Gerald Backer, for the respondent. Dawson, Judge. DAWSON444 Respondent determined a deficiency143 in petitioner's income tax of $ 200.53 for the taxable year 1959. Petitioner conceded one issue raised in the notice of deficiency. We are asked only to decide whether petitioner furnished more than one-half of the support of his son Matthew in 1959 so as to qualify him as a dependent under section 152(a)(1) of the Internal Revenue Code of 1954.FINDINGS OF FACTSome of the facts have been stipulated and are so found.Warren C. Mawhinney (hereafter called petitioner) now resides at 5501 Columbo Street, Pittsburgh, Pa. He filed his 1959 income tax return with the district director of internal revenue, Pittsburgh, Pa.During 1958 petitioner lived in Reading, Pa., with his wife, Elizabeth, and his son, Michael, by a previous marriage. On October 22, 1958, Elizabeth gave birth to a son, Matthew. Because of marital difficulties, Elizabeth left petitioner on December 18, 1958, and took Matthew with her. She moved into the home of her sister and brother-in-law, J. Karl and Ellen Roeder, at 5009 Friendship Avenue, Pittsburgh, Pa., who had occupied the house alone. Elizabeth and Matthew resided with the Roeders throughout 1959.During 1959 petitioner drew checks payable to Elizabeth144 in the following amounts on the dates indicated:Feb. 14$ 25Feb. 2825Mar. 1525Mar. 2825Apr. 2425May 1025June 1525Sept. 95Sept. 2615Oct. 410Oct. 2715Nov. 615Nov. 1415Total250The first 10 checks were drawn before petitioner was under any court order to provide for either his wife or son. On October 5, 1959, the Court of Common Pleas of Allegheny County, Pa., ordered petitioner to pay alimony of $ 15 a week to Elizabeth. Petitioner intended all 13 payments to be for the support of his son. Except for small expenditures on herself, Elizabeth did spend these sums for Matthew's support in 1959.On November 19, 1959, the Domestic Relations Court of Allegheny 445 County, Pa., ordered petitioner to pay $ 15 a week for Matthew's support. During the remainder of 1959, $ 90 was paid pursuant to such order.During 1959 petitioner paid $ 159.20 for medical and hospitalization insurance. Four individuals were covered by this policy: Petitioner, Elizabeth, and petitioner's sons, Michael and Matthew. In 1959 only Matthew received benefits from this policy.Petitioner gave his wife $ 35 in cash for Matthew's support during 1959, 145 as well as a check for $ 72.60 from the U.S. Treasury Department representing a refund of 1958 joint income taxes paid by them.Petitioner paid doctor bills of $ 20 that were not covered by medical insurance. He purchased medicine for Matthew during the year at a cost of $ 10. He also provided a Christmas tree and presents for Matthew at a cost of $ 5.The following items were provided by petitioner for Matthew's support in 1959:Checks drawn to Elizabeth Mawhinney$ 250.00Child-support payments per court order90.00Cash paid to Elizabeth Mawhinney35.00One-half of tax refund check given to Elizabeth Mawhinney36.30Insurance coverage (1/4 of $ 159.20)39.80Medical fees20.00Medicine, Christmas tree, and presents15.00Total486.10Matthew lived in the Roeders' home throughout 1959, sharing a bedroom with his mother. The following expenditures were incurred in maintaining the home:Rent$ 980.00Electricity81.51Gas190.41Telephone163.21The following expenditures were made by the Roeders and Elizabeth Mawhinney for Matthew in 1959:Food$ 283.64Milk90.00Medicines73.13Medical fees48.00Clothes, toys, and furniture222.55Diaper service151.62146 Matthew's total support for 1959 was as follows:Food$ 283.64Rent (1/4 of $ 980)245.00Clothing, furniture, and toys217.55Diaper service151.62Milk90.00Medicine83.13Medical fees68.00Gas (1/4 of $ 190.41)$ 47.60Health insurance (1/4 of $ 159.20)39.80Electricity (1/4 of $ 81.51)20.38Telephone (1/10 of $ 163.21)16.32Total1,268.04446 Petitioner did not provide more than one-half of Matthew's total support during the year 1959.OPINIONPetitioner claimed his son Matthew as a dependent for the year 1959. Respondent disallowed the exemption. He contends that petitioner did not meet the statutory requirement of providing more than one-half of Matthew's support. 1 We have found that the total support provided for Matthew in 1959 was $ 1,268.04. We have also found that petitioner provided only $ 486.10 of this total, and he has thus failed to meet the requirements of the statute.147 Petitioner argues that the $ 373.64 expended for Matthew's food and milk is excessive. These expenditures were established by Elizabeth, who actually fed Matthew during the year. They are explained in detail by her testimony and are supported by schedules. Even if we were to use the amount ($ 206.60) suggested by petitioner for food and milk expenses, which is based on U.S. Department of Agriculture statistics, the resulting decrease in Matthew's total support would not change the result.The petitioner objects to including any portion of the sums spent by his wife and the Roeders for Matthew's housing and clothing because, he argues, they were not "necessaries." He testified that throughout 1959 he maintained a home and had adequate clothing on hand, but was prevented from giving them to Matthew because Elizabeth insisted upon living with her sister and brother-in-law. Regardless of petitioner's willingness to have his son in his own home during 1959, Matthew was housed and clothed elsewhere, and these expenses constitute part of his total support.Petitioner has presented a bizarre argument throughout these proceedings which we think is without any merit. However, since he 148 urged it repeatedly during the trial and in his brief, we feel constrained to comment on it. Under Pennsylvania law both of the parents of a minor child have equal custody rights. 2 Because Elizabeth took Matthew from petitioner's home without his consent, he maintains that this is a violation of the following Pennsylvania statute:447 Kidnapping Child From Persons Having Custody -- Whoever maliciously, either by force or fraud, leads, takes, or carries away, or decoys or entices away, any child, under the age of ten (10) years, from its parent, or parents, or any other person having the lawful charge or care of such child, or the possession of such child, with intent to conceal or detain such child, or with intent to steal any article of apparel or ornament or other thing of value or use, upon or about the person of such child, or knowingly conceals, harbors or detains, or assists in concealing, harboring or detaining, such child, either within or without this Commonwealth, is guilty of a felony, and upon conviction thereof, shall be sentenced to pay a fine not exceeding five thousand dollars ($ 5,000), or to undergo an imprisonment, by separate or solitary confinement at149 labor, not exceeding fifteen (15) years, or both.[Pa. Stat. Ann., tit. 48, sec. 4725.]Thus petitioner asks us to find Elizabeth and the Roeders guilty of the felony described in the above-quoted statute and not allow her or the Roeders to claim Matthew as a dependent in 1959, under the authority of Leon Turnipseed, 27 T.C. 758">27 T.C. 758 (1957).In the Turnipseed case we held that a taxpayer could not claim an exemption for the support of a common law wife who lived in adulterous cohabitation with him in direct and open violation of Alabama law. We fail to see any application of that case to the facts before us here.Petitioner does not dispute the fact that his wife had an equal right to the custody of Matthew. The fact that she assumed total custody without petitioner's consent certainly does not result in kidnaping. 150 Pennsylvania follows the well-established rule that, in the absence of a court order or decree affecting the custody of a child, a parent, or anyone assisting such parent, does not commit the crime of kidnaping by taking exclusive possession of the child. Burns v. Commonwealth, 129 Pa. 138">129 Pa. 138, 18 Atl. 756 (Super. Ct. 1889); Commonwealth v. Myers, 146 Pa. 24">146 Pa. 24, 23 Atl. 164 (Super. Ct. 1892); and see also 77 A.L.R. 314">77 A.L.R. 314-323. Here there has been no violation of State law such as that found in Turnipseed. Petitioner curiously contends that the part of the cost of supporting a dependent in violation of State law is to be excluded in determining the total support provided. A careful reading of Turnipseed and the statute refutes this contention.In any event, petitioner cannot meet the requirements of section 152(a) by merely showing that someone else is not entitled to the exemption he is claiming. He must show that he has provided more than one-half of Matthew's support, whatever its source. The Roeders and Elizabeth Mawhinney are not before us 151 in this proceeding. Consequently, we have no jurisdiction to decide, as petitioner urges us to do, whether or not the Roeders or Elizabeth can claim Matthew as a dependent.In view of the evidence presented, we hold against the petitioner.Decision will be entered for the respondent. Footnotes1. SEC. 152 [I.R.C. 1954]. DEPENDENT DEFINED.(a) General Definition. -- For purposes of this subtitle, the term "dependent" means any of the following individuals over half of whose support, for the calendar year in which the taxable year of the taxpayer begins, was received from the taxpayer (or is treated under subsection (c) as received from the taxpayer): (1) A son or daughter of the taxpayer, or a descendant of either.↩2. Pa. Stat. Ann., tit. 48, sec. 91; 28 Pa. L. Encyc. 250; O'Brien v. City of Philadelphia, 215 Pa. 407">215 Pa. 407, 64 Atl. 551↩ (1906).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619405/	FREDERIC G. KRAPF, JR. AND JUNE B. KRAPF, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentKrapf v. CommissionerDocket Nos. 10809-75, 9261-76.United States Tax CourtT.C. Memo 1978-138; 1978 Tax Ct. Memo LEXIS 375; 37 T.C.M. (CCH) 594; T.C.M. (RIA) 780138; April 11, 1978, Filed Robert E. Schlusser, for the petitioners. Frank Coyne and Carolyn M. Parr, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: Respondent determined deficiencies of $132,381 and $73,633 in petitioners' Federal income tax for the years 1970 and 1971, respectively. The issues for our decision are: (1) Whether amounts disbursed by Frederic G. Krapf Construction Company during 1970 and 1971 for the construction of a yacht constitute taxable dividends to Frederic G. Krapf, Jr., its president and controlling shareholder. (2) If so, whether petitioners omitted an amount in excess of 25 percent of the gross income stated in their return for 1970, thereby extending the statutory period of limitations on assessments for that taxable year to six years pursuant376 to section 6501 (e). 1FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. Frederic G. Krapf, Jr. (hereinafter referred to as petitioner) and June B. Krapf (hereinafter referred to as Mrs. Krapf) resided in Wilmington, Delaware, at the time the petition was filed in this case, Petitioner and Mrs. Krapf timely filed joint individual income tax returns for the calendar years 1970 and 1971 with the Mid-Atlantic Service Center of the Internal Revenue Service, Philadelphia, Pennsylvania. Mrs. Krapf is a party in this proceeding solely because she joined with her husband in filing the joint returns. Petitioner and his three sons, Frederic G., @III, James and Thomas, are involved primarily in the construction industry. The Krapf construction business consists of several corporations: Frederic G. Krapf, Inc., the original business formed by petitioner's father; Frederic G. Krapf Construction Company377 (hereinafter referred to as Krapf Construction); Middletown Construction Company (hereinafter referred to as Middletown Construction); North-South Construction Company (hereinafter referred to as North-South Construction); Frederic G. Krapf and Son, Inc. (hereinafter referred to as Krapf and Son); Innovators of Planners and Developers; and others. Through these corporations, the Krapfs have undertaken all aspects of construction projects from beginning to end. Innovators of Planners and Developers designs buildings and the other corporations construct them. Middletown Construction is licensed to operate in Delaware, North-South Construction is licensed to operate in Florida and Krapf Construction Company is licensed to operate outside Delaware. The construction techniques used by these corporations originated in England and Holland.One such technique is the Bison system of modular construction which was used to complete a high-rise dormitory in Delaware in record time. Other Krapf projects included constructing an antipollution plant in Louisiana, constructing a Marine studies facility for a Delaware university, offering to construct a state prison in approximately one-third378 of the construction time projected by others, and operating large self-propelled barges for disposing of pollutants at sea. Petitioner also designed the pumps and electrical relays for a 125 foot university seagoing research vessel and served other parties as a consultant for the use of self-propelled barges. Krapf Construction has never bid on a project. Instead it presents a conceptual design idea to a customer and negotiates a price for the completed project. The negotiations are conducted with the customer's top executive with decision-making authority. A yacht is conducive to these negotiations because it removes the customer's executive from possible sources of interruption for sufficiently long periods to make a presentation. The yacht named the Krapfcandoit V is the most recent in a series of yachts used for such negotiations. The Krapfcandoit V is an 85 foot ocean-going vessel which is powered by two V-12 diesel engines, each 375 horsepower, driving twin screws through V-drives of petitioner's own design. The purpose of the V-drive design is to permit location of the engine room, which also was designed by petitioner, at the aft end of the vessel as opposed to midship. 379 The engine room itself incorporates a unique system of pumps, piping and valves designed by petitioner for greater safety and compartment flooding control. The vessel is equipped with every safety feature available for its type, including a double bottom, collision bulkheads fore and aft, full navigation equipment, radar and automatic pilot. The interior of the vessel also differs from the ordinary in that all accommodations are the same size, thereby offering equal comfort to all to prevent the possibility of slighting a business guest. For meeting purposes, the vessel has a salon approximately 12 feet wide by 15 feet long which opens out onto the back deck to provide an aggregate length of 25 to 30 feet with a large circular table. The total cost of the yacht was $365,089.30 of which $189,830.34 was paid during 1970 and $106,231.01 was paid during 1971. The word "Krapfcandoit," used as the name of the yacht, has been the trademark of the Krapf family businesses for over 60 years and was initiated by petitioner's father. The word "Krapfcandoit" is intentionally used by the Krapf businesses to convey to the public the message that those businesses have unique skills that permit380 them to undertake projects which other businesses cannot undertake. "Krapfcandoit" appears on the various corporations, buildings and equipment, on the uniforms of company bowling teams, on business cards and on company flags flying over construction projects. The business telephones are answered by that name. As used on the vessel, "Krapfcandoit V" is painted in larger than usual red, white and blue letters across the entire transom on a drawing of a steel girder in billboard fashion. The commercial manner of painting the name on the vessel has caused a yacht club to expell the vessel from the club's moorings. The word "Krapfcandoit" also connotes personal and family pride and appears on many personal objects of petitioner such as his automobile. An abbreviated version of the word ("Cando") appears on petitioner's personal fishing boat, a 31 foot sport fishing Bertram which he co-owns with his youngest son. Prior to the construction of the Krapfcandoit V, petitioner personally owned seriatim four yachts which each bore the name "Krapfcandoit." These vessels were used for both business and personal purposes.Petitioner has been personally interested in yachts and boating for381 as long as he can remember. Petitioner has belonged to the Northeast River Yacht Club since he was fifteen years old and more recently joined a yacht club in Tuscaloosa, Alabama. Petitioner's sons do not belong to yacht clubs and do not have the privilege of using petitioner's yacht club memberships. The yachts prior to Krapfcandoit V were not fully satisfactory for business since they had limited accommodations and lacked many safety provisions. The last had been sold in 1964 or 1965. Without the yachts, however the Krapf businesses were not making as many contracts. Petitioner also learned from acquaintances involved in chartering yachts that the chartering market was good and could be profitable. Acting in his capacity as president of Krapf Construction, petitioner investigated the possibility of acquiring a replacement yacht. Designs for a yacht to be made in the United States were drawn up but the plan was abandoned as too expensive. The impetus for the acquisition of the Krapfcandoit V arose subsequently as an opportunity to have it constructed as one of three identical yachts, thereby obtaining a better price. With the purchasers of the other two yachts petitioner382 obtained designs and drawings of the vessels and obtained a construction estimate from a Holland boat-building company DeConrad, n.v. (hereinafter referred to as DeConrad). Petitioner had originally set up the contract to be between DeConrad and Middletown Construction, but changed the proposed contracting corporation when he realized that Middletown Construction was not licensed to do business outside of Delaware. In a meeting of its Board of Directors on March 20, 1969, Construction authorized petitioner to enter a contract with Jacob Langenberg, president of DeConrad, for the construction of a twin-screw, occean-going yacht at a price not to exceed $175,000. The minutes of the meeting state that the new boat was to replace one that "had been used in the past for the entertainment of customers and the meeting of new customers." Those present at the meeting of the Board of Directors which authorized this action included petitioner, who was the president and 59 percent shareholder; Mrs. Krapf; Frederic G. Krapf III, who was a 13.8 percent shareholder; and one Norman McDowell. The remaining outstanding shares of Krapf Construction were held in equal shares by petitioner's other383 sons, James and Thomas. On March 31, 1969, Krapf Construction entered into a contract with DeConrad for the construction of the Krapfcandoit V at a price of $152,000, delivery to be made on or before July 1, 1970. In order to protect the corporation from liability associated with the yacht, on October 8, 1969, Krapf Construction on the advice of counsel incorporated a wholly-owned subsidiary, Krapfcandoit Marine Co. No. II (hereinafter referred to as Marine) and assigned the contract to it. Petitioner was the first president of Marine and Mrs. Krapf was its secretary-treasurer. On June 15, 1970, Frederic G. Krapf, III, was elected president in place of petitioner, who then became vice-president. Krapf Construction made capital contributions of cash to Marine for the yacht's construction. By October 31, 1972, advances to Marine totaled $365,089.30. Marine's books listed this amount as $1,000 for capital stock, $308,836 contributions to capital in excess of par value and $55,253.30 operating expense loan payable. The loan was repaid by Marine on May 4, 1973. During the construction of the yacht, DeConrad encountered financial and construction difficulties. By the end384 of December 1969 the price of the yacht had been revised upward from the contract price to $180,961. Despite this increase, construction costs to the builder exceeded the revised contract price. On the original contract delivery date only the hull and rough interior iraming were complete. Although the builder subsequently never actually declared bankruptcy or had its property attached by creditors, petitioner feared that creditors of DeConrad might seize the yacht. He met with the other two yacht purchasers and Jacob Langenberg. It was decided that the yachts should be registered in the names of the respective purchasers and removed from Holland as soon as possible. Petitioner and Jacob Langenberg went to the American Consulate to have the Krapfcandoit V registered in the name of Marine. The Consulate declined to register the yacht in the corporate name, however, because petitioner did not have the requisite corporate formalities with him. Petitioner was concerned that the delay which would be required to obtain the corporate documents and seal would result in the yacht being seized by the creditors of DeConrad. Consequently, on February 1, 1971, petitioner registered the385 Krapfcandoit V in his individual name. On his return to the United States on February 9, 1971, however, petitioner executed an affidavit stating that the yacht was and at all times had been the property of Marine. Although petitioner made several trips between the United States and Holland in the following two months, he did not secure the corporate seal and resolutions to change the registry of the vessel to reflect ownership by Marine. At the time of registration the yacht was still incomplete. In anticipation of removing the Krapfcandoit V from Holland at the earliest possible moment, liability and hull insurance were obtained on the yacht effective March 8, 1971, and April 1, 1971, respectively, with Marine named as the beneficiary. The yacht remained under construction in DeConrad's yards until it was sufficiently complete to be moved. At that time, April 24, 1971, a release needed to clear the harbor authorities was issued by DeConrad to Marine and on April 26, 1971, the yacht set out for Dover, England. Although the yacht was mobile, it was incomplete and left Holland with a carpenter, an electrician and a mechanic on board working on the yacht's interior. Others on386 board included petitioner, Jacob Langenberg, a captain, a mate and three crewmen. The yacht stayed in Dover from April 26 through April 28, 1971, and took on ropes, lines, nails, varnishes and other finishing materials. It then set out for a boatyard in Spain for additional work, but on May 6 the yacht developed motor touble in the Bay of Biscayne and had to put in for repairs. The yacht then went on to Gibraltar and from May 12 through June 22, 1971, was in a boatyard in Mirabella, Spain. On May 16 the Dutch crew returned to Holland and several students were hired to do finishing work and cleaning. During this period the gangway, interior furnishings, the refrigerator, a stereo system, toilet vents and emergency lighting were installed. Petitioner returned to the United States on May 16 and left Mrs. Krapf with the yacht to try to get the vessel finished.The hired captain quit and left the yacht. When the school year ended, petitioner's youngest son joined his mother to help supervise the work and captain the ship. Petitioner returned to the yacht on June 23, 1971, and set sail for a boatyard in Naples, Italy, for additional work on the yacht, but became ill and was hospitalized387 for an ulcer on the Island of Majorca. The yacht went on without petitioner and from July 9 through the end of August was in and out of the Naples boatyard where the following work was done: canvass and isinglass windows installed; general carpentry work completed; telephone system installed; work begun on davit; work done on electrical system and hydraulic winches; and painting.Petitioner rejoined the yacht for the period from August 6 to August 24 and October 2 to October 17. After unsuccessfully trying to have the vessel completed in Europe for almost a year, petitioner decided to have it finished in the United States and to forego attempts to charter the yacht in the Mediterranean. Starting on November 1, 1971, the yacht crossed the Atlantic Ocean to Barbados and then to St. Thomas in the Virgin Islands. Coming across the Atlantic the only instruments working properly were the automatic pilot, the sextant and the compass. A second son met the yacht in the Canary Islands. During the final leg of the crossing in early 1972, petitioner was present an additional 49 days, of which 14 were personal charter, 29 were corporate charter, and six were en route from the West Indies388 to the United States. On April 23, 1972, the yacht arrived at Marine's docks in Wilmington, Delaware. Because of the variation in names between the prior registration and the harbor release, the United States Coast Guard declined to register the yacht in Marine's name without a master carpenter's certificate. Jacob Langenberg had prepared such a certificate in the name of Marine at the time the yacht left Holland, but did not give it to petitioner at that time. In the course of preparing for trial petitioner contacted Langenberg and obtained the master carpenter's certificate. The Krapfcandoit V was registered with the United States Coast Guard in the name of Marine on October 5, 1977. During 1972, the first year the yacht was rented, the only customers were Krapf and Son, Krapf Construction, and petitioner individually for the respective aggregate rentals of $38,000, $9,500, and $10,000. The net result was charter fees of $57,500 offset by expenses of $43,515, resulting in taxable income for Marine of $14,595 after accounting for some interest income. The Federal income tax on this amount was entirely offset by the investment credit.Krapf and Son and Krapf Construction claimed389 and were allowed entertainment and expense deductions for the charter fees. For most years since 1972 Marine has continued to show a profit. One employee was hired by Marine to stay aboard the yacht at all times as a full-time mate. Since its purchase, the Krapfcandoit V has been used in conjunction with more than 50 percent of the contracts negotiated by or in performance by Krapf Construction and Krapf and Son. Among the contracts negotiated on board the yacht were contracts to sell a shopping center, to construct additions to it, to construct restaurants, to exchange tracts of land and build two new office buildings, and to build a new building for a liquor importer. Whenever the yacht was chartered to a Krapf company, either petitioner or one of his sons was on board.The yacht has also been advertised for charter at the rate of $500 per day and occasionally has been chartered at that rate. When petitioner individually chartered the yacht for personal purposes, he paid the advertised rate. At the time of trial, petitioner's intention was to retire as head of the Krapf businesses in November 1977. His son, Frederic G. Krapf, III, has already succeeded him as president390 of both Krapf Construction and Marine and has no plans to vary the use of the yacht by Marine. Petitioner timely filed both his 1970 and 1971 tax returns. On September 29, 1976, more than three years after the filing of petitioner's 1970 return, respondent issued a statutory notice of deficiency in the amount of $132,381 based on an alleged constructive dividend of $189,858 for disbursements to build the Krapfcandoit V. The actual amount of disbursements in 1970 for the yacht's construction has been stipulated to be $189,830.34. This amount is more than 25 percent of the amount of gross income reported by petitioner on his 1970 return. On September 24, 1975, respondent issued with respect to petitioners' 1971 return a statutory notice of deficiency in the amount of $73,633 based on an alleged constructive dividend of $107,131 for disbursements to build the yacht. The parties have agreed that the actual disbursement in 1971 was $106,231. The parties previously agreed to an extension of the period of limitations on assessments with respect to 1971 to December 31, 1975.OPINION The primary issue for our decision is whether funds disbursed by Krapf Construction for the construction391 of the yacht Krapfcandoit V constitute a constructive dividend to petitioner, the corporation's controlling shareholder. The yacht was built in 1970 and 1971 for Krapf Construction's wholly-owned subsidiary Marine with funds advanced to Marine by Construction as contributions to capital. Respondent contends that the purchase of the yacht was for the personal benefit of petitioner. Petitioner contends that the yacht was purchased for valid business purposes and that no constructive dividend to petitioner should be found. Cases dealing with the issue of constructive dividends resulting from corporate distributions are legion. See, e.g., Ross Glove Co. v. Commissioner,60 T.C. 569">60 T.C. 569, 595 (1973); Dean v. Commissioner,57 T.C. 32">57 T.C. 32, 40 (1971); Challenge Manufacturing Co. v. Commissioner,37 T.C. 650">37 T.C. 650, 662-63 (1962). The law is well settled that a corporate disbursement may be held to be a dividend for tax purposes if made for the personal benefit of a shareholder rather than for a valid corporate business purpose. Rapid Electric Co. v. Commissioner,61 T.C. 232">61 T.C. 232, 239 (1973);392 Rushing v. Commissioner,52 T.C. 888">52 T.C. 888, 893 (1969), affd. 441 F.2d 593">441 F.2d 593 (5th Cir. 1971); Idol v. Commissioner,38 T.C. 444">38 T.C. 444 (1962), affd. 319 F.2d 647">319 F.2d 647 (8th Cir. 1963). If a corporate disbursement is made for the personal benefit of a shareholder, the amount includable in his income as a constructive dividend is the fair market value of the benefits which he received. Challenge Manufacturing Co. v. Commissioner,supra at 663; Rodgers Dairy Co. v. Commissioner,14 T.C. 66">14 T.C. 66, 73-74 (1950). The burden of proof is on respondent to establish that petitioner omitted an amount more than 25 percent of the gross income reported on his 1970 return in order to extend the statute of limitations for that year to six years under section 6501(e). Philipp Bros. Chemicals, Inc. (Md.) v. Commissioner,52 T.C. 240">52 T.C. 240, 254 (1969), affd. 435 F.2d 53">435 F.2d 53 (2d Cir. 1970); Reis v. Commissioner,1 T.C. 9">1 T.C. 9, 12-14 (1942), affd. 142 F.2d 900">142 F.2d 900 (6th Cir. 1944). Although393 the underlying facts are the same for 1971, the burden is on petitioner to prove that respondent's determination for that year is incorrect. Welch v. Helvering,290 U.S. 111">290 U.S. 111, 115 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure.Both respondent's and petitioner's positions are supported by evidence in the record, but we conclude that on balance a preponderance of the evidence favors petitioner. We find that the disbursements for the Krapfcandoit V were not primarily for the personal benefit of petitioner and, in any event, the value of the benefit received by petitioner did not exceed that received in return in the form of services and cash rentals from petitioner and his family. Although petitioner had a life-long personal interest in boats, Construction had a substantial business purpose in constructing the Krapfcandoit V and we believe that any benefit to petitioner from the yacht's construction was merely incidental. In reaching this conclusion we are not unmindful that close scrutiny is appropriate for arguably personal expenditures by a closely-held corporation. See Baird v. Commissioner,25 T.C. 387">25 T.C. 387, 393 (1955). Petitioner394 was the controlling shareholder and chief executive officer of Krapf Construction as well as the other Krapf-controlled corporations and to some extent the personal desires and actions of petitioner were inseparable from those of his corporations. Prior to the construction of the Krapfcandoit V petitioner had personally owned four yachts which were used for both personal and business purposes. Without petitioner's personal interest in yachting, Krapf Construction probably would not have contracted for the purchase of the Krapfcandoit V. Despite this identity of interests, however, we think Krapf Construction's motivation in purchasing the Krapfcandoit V was primarily business-oriented. A constructive dividend does not result solely because a controlling shareholder may have the primary input into the decision underlying a corporate disbursement. See Joseph Lupowitz Sons, Inc. v. Commissioner,497 F.2d 862">497 F.2d 862, 868 (3d Cir. 1974); Rushing v. Commissioner,supra at 894.Petitioner, Krapf Construction and Marine sufficiently complied with the formalities395 necessary to separate corporate use from petitioner's personal use and charged petitioner the full charter rate for the latter. Under these circumstances petitioner should not be charged with a constructive dividend. The record demonstrates a need for a yacht to adequately conduct corporate business. After the Krapfcandoit IV was sold, Krapf Construction and the other Krapf corporations experienced a slow down in obtaining new contracts. The corporate conclusion that this was due to the lack of a yacht for business purposes appears to have been well-founded. Unlike most construction companies, Krapf Construction and the other Krapf corporations never bid on a job. Instead all contracts were individually negotiated with the customers' chief executives. The quiet isolation and atomosphere ofa yacht proved conducive to these negotiations. The Krapfcandoit V was especially designed to accommodate these negotiations with a large meeting room and with unusually large guest quarters.Beyond providing pleasant surroundings, the yacht had a more direct and visible importance for negotiations with prospective customers. Its engine room, electrical relays and pump system were all of a396 unique design created by petitioner. As such they provided tangible evidence to potential customers of the unique capabilities of the Krapf corporations.Consequently, the yacht facilitated negotiations which led to receiving both general construction contracts and contracts to design marine research facilities. Since its purchase, the Krapfcandoit V has been used in conjunction with more than 50 percent of the contracts of Krapf Construction and Krapf and Son. Moreover the yacht was also occasionally chartered to third parties. In light of these surrounding circumstances and credible testimony that business was suffering without a yacht, we are not prepared to second guess the business judgment that a yacht was necessary for Krapf Construction's business. In addition to the existence of a bona fide corporate business purpose, petitioner's position is supported by the absence of an identifiable fair market value to the personal benefit received. Whenever the Krapfcandoit V was used for petitioner's personal use, he paid the full rate at which the yacht was advertised and occasionally chartered to third parties. It was undoubtedly to petitioner's benefit to have the yacht, which397 he sometimes used for personal purposes, to display his family and corporate slogan and to be owned by his corporations, but this benefit was incidental to the purchase of the Krapfcandoit V for valid corporate business reasons. The fact that a controlling shareholder may derive an indirect or derivative benefit is an insufficient basis on which to find a constructive dividend. Rapid Electric Co. v. Commissioner,supra at 239; Rushing v. Commissioner,supra at 894. Respondent places primary reliance on the irregularities in the registration of the Krapfcandoit V and the alleged personal use of the yacht for the first year after it was removed from Holland. We think that neither of these points requires a finding of a constructive dividend. The irregularities in the registration arose as a result of the exigencies of the moment. As the yacht was being constructed, the builder, DeConrad, was experiencing financial difficulties. Under the threat of potential seizure by creditors, petitioner attempted to register the yacht in the name of Marine398 immediately. Since the American Consulate refused to register the yacht in the name of Marine without the corporate seal and resolutions, understandably petitioner chose to register the yacht in his own name as an interim measure rather than risk loss of the yacht by waiting until the corporate formalities could be supplied. Although the registration was thus initially held nominally by petitioner, previous and subsequent events establish that legal ownership actually resided in Marine. Preliminary investigations into the feasibility of constructing the yacht were made by petitioner in his corporate capacity and at an early stage a formal corporate resolution authorizing the purchase was made. After some confusion as to which Krapf corporation would contract for the boat's construction, the contract was executed between Krapf Construction and DeConrad. Petitioner was at no time individually a party to the contract. Krapf Construction subsequently incorporated Marine as a wholly-owned subsidiary and assigned the yacht contract to it to protect the parent corporation from any liability which might arise from the operation of the yacht. Thereafter, apart from petitioner's initially399 registering the yacht in his own name to preclude the possibility of seizure during an otherwise unavoidable delay in registering the yacht, all the transactions in the record establish that the yacht was actually owned by Marine. Immediately upon returning to the United States petitioner executed an affidavit to that effect. All payments for the boat's construction came from Marine. The Master Carpenter's certificate listed Marine as the owner. Marine was named as the beneficiary of the insurance policies on the yacht. For chartering purposes Marine was held out to the public as the yacht's owner.Petitioner, Krapf Construction and Krapf and Sons each paid Marine for their use of the Krapfcandoit V. Admittedly petitioner was dilatory in obtaining the United States Coast Guard registration in Marine's name, but by the time of trial he had corrected that technical error. In our opinion the Krapfcandoit V was at all times owned by Marine. Nor do we believe that respondent was correct in characterizing the return of the yacht from Holland to the United States as a year-long cruise for the personal benefit of petitioner, his family and friends. The yacht was removed from Holland400 before it was complete in order to insure that it was beyond the reach of DeConrad's creditors. The record is sketchy in places but for the most part it supports petitioner's position that the journey and delays en route were necessitated by attempts to complete the yacht and return it to America. It left Holland with a carpenter, an electrician and a mechanic on board to work on the yacht's interior. Construction materials were picked up in Dover and the yacht proceeded to the Mediterranean for additional work and for possible chartering if the yacht could be completed. After unsuccessful efforts to have the boat fully completed in boat yards in Spain and Italy, the yacht was returned to the United States via the West Indies. The places visited are of a nature generally associated with pleasure cruises but the circumstances of the visits preclude an inference that the journey was for petitioner's personal benefit. Whatever incidental benefit which may have inured to petitioner and his family was offset by substantial benefit to the corporation in services which aided the completion and return of the yacht. The record indicates that after the yacht's arrival in the West Indies401 and subsequent return to the United States a conscientious effort was made to separate personal use from corporate use and to pay the appropriate charter fee. Moreover, rather than basing his deficiency for the amount of any unpaid fair market value for days of personal use, respondent contends that the full cost of the boat should be charged as a constructive dividend. Respondent relies on general allegations that the beneficial ownership lies in petitioner without sufficiently supporting those allegations with specific instances of uncompensated personal use. Even if we were to accept respondent's contention, which we do not, that the yacht was occasionally used for petitioner's personal benefit without compensation to the corporation, that would be insufficient to charge him with a constructive dividend of the full cost of the yacht's construction. Since Marine actually and effectively owned the Krapfcandoit V, the most petitioner could properly be charged with as a constructive dividend is the excess of the fair market value of benefit to petitioner over the amount remitted by petitioner to the corporation for his personal use of the yacht. Nicholls, North, Buse Co. v. Commissioner,56 T.C. 1225">56 T.C. 1225, 1240-41 (1971).*402 Our finding that petitioner fully compensated Marine for his personal use of the Krapfcandoit V precludes charging him with a constructive dividend of any amount, let alone for the full cost of the yacht's construction. Accordingly, we hold that the Krapfcandoit V was purchased for valid corporate business purposes and petitioner received no constructive dividend as a result of disbursements for the yacht's construction in 1970 and 1971. To reflect our conclusion herein, Decisions will be entered for the petitioners. Footnotes1. Unless specified otherwise, all section references are to the Internal Revenue Code of 1954 as amended and in effect during the years in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619406/	Louis N. Pokress and Lucille A. Pokress (Husband and Wife) v. Commissioner.Pokress v. CommissionerDocket No. 32205.United States Tax CourtT.C. Memo 1954-128; 1954 Tax Ct. Memo LEXIS 118; 13 T.C.M. (CCH) 805; T.C.M. (RIA) 54234; August 17, 1954, Filed 118 W. G. Ward, Esq., and Charles B. Costar, C.P.A., First National Bank Building, Miami, Fla., for the petitioners. James R. Harper, Jr., Esq., for the respondent. LEMIRE Memorandum Findings of Fact and Opinion Respondent determined a deficiency in income tax of the petitioners for the year 1946 in the amount of $20,057.44. The contested issue is whether in the taxable year involved petitioners incurred a loss as a result of loans to Pappy's, Inc., a Florida corporation, and whether, if a loss was incurred, it was a business or a nonbusiness bad debt. Findings of Fact Petitioners, husband and wife, are residents of Miami Beach, Florida. Their joint income tax return for 1946 was filed with the collector of internal revenue for the district of Florida. As petitioner Lucille A. Pokress is involved only by reason of having filed a joint return with her husband, Louis N. Pokress, the latter will hereinafter be referred to as petitioner. During the year 1946, and for a period of some 20 years prior thereto, petitioner was engaged in the real estate business in Miami Beach, Florida, representing largely a northern clientele in the purchase and sale of business and119 investment properties, hotels, and restaurants. In representing his out-of-town clients petitioner frequently advanced his own funds as earnest money in order to secure a particular sale. Petitioner, later, would receive his commission on the sale by subsequent reimbursement from the client. In the fall of 1944 Louis Goldman, an associate of petitioner in his real estate brokerage business, advised petitioner that a client in Philadelphia was interested in purchasing Pappy's, Inc., a restaurant in Miami Beach. The client, upon being advised that the sale price for all of the corporation stock was $150,000, asked petitioner to put up the necessary advance money to secure the sale. Thereupon, and in accordance with his usual practice, petitioner advanced the sum of $25,000 to Julius Kasdin, holder of the total outstanding stock of Pappy's, Inc., and hereinafter referred to as Kasdin. Some 10 days after making the $25,000 advance, petitioner was advised by the Philadelphia client that he no longer desired to purchase Pappy's, Inc. Rather than forfeit his $25,000 deposit petitioner decided to consummate the deal with Kasdin. Petitioner did not intend to go into the restaurant business120 but was merely attempting to recoup his $25,000 deposit by finding a subsequent purchaser for Pappy's, Inc.The principal asset of Pappy's, Inc., was a lease on the premises occupied by the restaurant in the Vanderbilt Hotel, Miami Beach. The original lease executed in April 1939 was acquired by Pappy's, Inc., as lessee, on July 30, 1941. The lease provided a fixed rental of $7,000 per annum through 1949, and $7,500 thereafter until June 1, 1954. In addition, the lessee had an option of renewal for an additional 10 years. The lease of July 30, 1941, to Pappy's, Inc., provided that any principal improvement to the leasehold or addition to the fixed assets should become the property of the lessor. The lessee always had the use of the fixed assets and leasehold improvements. By an agreement of November 22, 1944, and a supplemental agreement thereto dated December 7, 1944, petitioner's associate, Louis Goldman, obtained an option good until April 1, 1945, to purchase all the outstanding capital stock of Pappy's, Inc., from Kasdin for the sum of $135,000. Under the terms of the agreement petitioner and Louis Goldman were to be permitted to operate Pappy's, Inc., from the first part121 of December 1944, until April 1, 1945. During that period it was agreed that petitioner would individually guarantee Kasdin against any loss arising from the operation of the business. On April 1, 1945, petitioner and Louis Goldman acquired legal title to all the stock of Pappy's, Inc., for the purchase price of $135,000. Petitioner received 2/3 and Goldman 1/3 of the outstanding stock. All of the corporate stock was then pledged to Kasdin as security for the two promissory notes aggregating $90,000, representing part of the purchase price. The agreement also provided that Pappy's, Inc., would not be liquidated without the consent of Kasdin, and that in the event such a liquidation was approved Kasdin was to acquire a first lien upon the assets of the corporation to the extent that petitioner and Louis Goldman were still individually obligated on their stock payments. Following the acquisition of Pappy's, Inc., petitioner made various attempts in 1945 and 1946 to sell the stock, without success. Pappy's, Inc., made gross sales in the fiscal years indicated in the following amounts: F/Y endedOct. 311944$192,945.261945252,206.261946170,642.70 *122 The corporation continued to lose money and the petitioner, in an effort to salvage his investment, made personal advances totaling $43,922.86. On July 15, 1946, a resolution was adopted by the directors and stockholders to liquidate the corporation. The resolution provided that the assets were to be distributed pro rata to the shareholders who, in turn, were to assume all of the liabilities. On July 25, 1946, the corporation executed an assignment of the lease of July 30, 1941, to petitioner and Goldman. A statement prepared from the books as of July 15, 1946, discloses the following: ASSETS REALIZEDCash$ 468.26Accounts receivable104.05Inventory - food250.00Unexpired insurance620.86Security deposit3,000.00Utility deposits625.00Total assets realized$ 5,068.17LIABILITIES ASSUMEDAccounts payable11,875.85Unremitted withholding taxes36.56Accrued personal property taxes405.72Accrued social security taxes780.78Accrued state unemployment taxes239.13Accrued interest180.00Total liabilities assumed13,518.04Excess of liabilities assumed over assets received$ 8,449.87123 LOSS IN LIQUIDATIONLouis N.LouisTotalPokressGoldmanExcess of liabilities assumed over assets received$ 8,449.87$ 5,633.25$ 2,816.62Capital stock136,500.0091,000.0045,500.00Loans payable to stockholders57,764.8043,922.8613,841.94Totals$202,714.67$140,556.11$62,158.56The lease of July 30, 1941, was never carried as an asset on the books of the corporation. In the early fall of 1946 petitioner contacted one Cummings, who was Howard Johnson's representative in Miami Beach, for the purpose of working out a deal with respect to the lease acquired in the liquidation of Pappy's, Inc.On November 6, 1946, an agreement was executed by and between petitioner, Louis Goldman, the Vanderbilt Hotel Corporation, owners and lessors of the premises in question, Julius Kasdin, and one Henry D. Williams. The agreement first cancelled the existing lease between petitioner, Louis Goldman, and the Vanderbilt Hotel Corporation. It then provided that Henry D. Williams was to become the rent collecting agent for the lease which was to be executed concurrently between the Vanderbilt Hotel Corporation and the Cummings Corporation, 124 a Florida corporation, connected with the Howard Johnson chain and hereinafter referred to as Howard Johnson. This trust or escrow agreement provided that all rentals paid by Howard Johnson were to be paid to Henry D. Williams, who, in turn, was to make annual payments in the following order: (1) to Julius Kasdin in the amount of $8,888.88, representing the installment obligation of petitioner and Goldman for the original stock purchase; (2) to the Vanderbilt Hotel Corporation, as lessor, to the extent of $7,000; and (3) the balance of the payments, if any, to petitioner and Goldman. The trust agreement was to terminate at the end of the first eight years of the concurrent lease, or at such time as petitioner and Goldman had been paid $71,633.32. It was specifically provided in the agreement that in the event payment from Howard Johnson did not equal $7,000, petitioner and Goldman would individually be responsible for the payments to the Vanderbilt Hotel Corporation, lessor. By an agreement dated November 4, 1946, the Vanderbilt Hotel Corporation, lessor, and Howard Johnson, lessee, entered into a 17-year lease for the premises formerly occupied by Pappy's, Inc., in which Howard125 Johnson agreed to pay 8 per cent on the gross receipts up to the first $300,000 and 5 per cent on all gross receipts in excess thereof, with a guaranteed minimum annual rental of $10,000. During the year 1946 Howard Johnson paid $14,000 cash to petitioner and Goldman. Included in this $14,000 was a $10,000 advance as a security which was to be repaid 5 years later in absence of default, and $4,000 in consideration of the 1946 rental. Howard Johnson actually was repaid this $10,000 on December 12, 1951, by Henry D. Williams under the terms of the trust agreement. During the years 1947 and 1951, inclusive, Howard Johnson paid the following amounts to Williams as rental under the terms of the lease with the Vanderbilt Hotel Corporation: YearAmount1947$24,758.72194824,541.03194923,689.72195022,796.83195126,245.90 ($4,417.60advancerental)In each of the years 1947 to 1951, inclusive, the Vanderbilt Hotel Corporation received $7,000 in rental. This rental was the exact payment required under the lease assigned by Pappy's, Inc., to petitioner and Goldman on July 25, 1946. During the years 1947 to 1951, inclusive, Kasdin received payments126 under the trust agreement as follows: YearPrincipalInterest1947$8,888.88$3,075.3219488,888.882,562.4419498,888.882,347.0919508,888.881,813.7619514,444.44695.77 These payments of principal and interest were made on a personal obligation of petitioner to Kasdin in the amount of $63,660 on the original stock purchase. The petitioner individually received the following payments under the trust agreement from the rental paid by Howard Johnson under their lease with the Vanderbilt Hotel Corporation: YearAmount1948$5,14519493,22019503,800The lease of July 30, 1941, assigned in liquidation by Pappy's, Inc., to petitioner and Goldman, had a fair market value of not less than $50,000 on July 25, 1946. On his 1946 income tax return the petitioner claimed a deduction of $43,922.86 as a "Loss resulting from advances to Pappy's, Inc." The claimed deduction was disallowed in its entirety. During the taxable year 1946 the petitioner was not engaged in the trade or business of making loans to corporations. In the year 1946 the petitioner sustained a nonbusiness bad debt loss in the amount of $16,222.77. 127 Opinion LEMIRE, Judge: The question presented is whether the petitioner sustained a loss in 1946 as a result of advances made to Pappy's, Inc., and whether the loss is deductible as a business or a nonbusiness bad debt. It is not disputed that the petitioner advanced funds to Pappy's, Inc., which at the time of the liquidation of the corporation in July 1946 were in the aggregate amount of $43,922.86. The respondent contends that at the time of the liquidation it had assets in excess of its liabilities and that petitioner has failed to establish that he has suffered any loss by reason of his advances to the corporation. The petitioner contends that since Kasdin had a lien upon the corporate assets for the unpaid portion of the purchase price of the shares of capital stock in the event of a liquidation of the corporation, the lease was of no value to the stockholder-creditors and, therefore, the petitioner sustained a loss in the full amount of his loans to the corporation totaling $43,922.86. We find no merit in such contention. The purchase of the capital stock and the loans to the corporation were distinct, unrelated transactions, and must be treated separately for tax purposes. 128 The liability for the unpaid purchase price of the shares of stock was the individual liability of the petitioner, while the repayment of the loans to the petitioner was a corporate liability. The losses, if any, resulting from these two separate transactions may not be commingled either for the purpose of determining the character of the loss or the amount thereof. The question we have to determine is the financial condition of the corporation at the time of its liquidation in July 1946. In our findings of fact we have set forth the statement prepared by the petitioner's auditors showing the assets and the liabilities on the date of liquidation. That statement does not reflect either the fixed assets in the amount of $50,764.44 nor any value to the lease of July 30, 1941. The fixed assets of $50,764.44 represent leasehold improvements and equipment which belong to the lessor on the termination of the lease. As the corporation was discontinuing business, we do not think the so-called "fixed assets" should be included in its assets, but should be considered in valuing the lease which was owned by the corporation at the time of liquidation. However, in determining the assets available129 for distribution the fair market value of the lease on the date of liquidation must be established in order to ascertain the amount of petitioner's loss, if any. Each of the parties offered the testimony of a qualified real estate appraiser as to the value of the lease on July 25, 1946. Their expressed opinions differed widely. The petitioner's expert fixed the value at $10,000 and the respondent's fixed a value ranging from $50,000 to $62,000. Both experts were cross-examined at length with respect to the reasons supporting their opinions. In our judgment the testimony of the respondent's expert witness was the more persuasive and convincing. After careful consideration of all the facts, the expert opinions expressed, and giving appropriate weight to the essential factors used, in determining valuation of property, we have found as a fact that the lease in question had a fair market value of not less than $50,000 on the critical date. Including the lease at a valuation of $50,000 the total assets of the corporation were $55,068.17 and its liabilities were $13,518.04. Therefore, we have found as a fact that the petitioner sustained a loss in 1946 in the amount of $16,222.17, which130 is computed as follows: Assets as per liquidating statement$ 5,068.17Add: Value of leasehold50,000.00Total assets55,068.17Liabilities assumed as per statement13,518.04Net assets41,550.13Petitioner's pro rata share, 2/327,700.09Petitioner's advances to corporation43,922.86Petitioner's net loss$16,222.77Having determined that the petitioner has sustained a loss in 1946 by reason of his loans to the corporation it becomes necessary to ascertain the character of the loss. The petitioner argues that the loss is one incurred in his trade or business. His position is that he had deposited the original $25,000 as a binder on behalf of a client who had defaulted, and in order to protect the funds advanced he was required to purchase the stock. He further contends that as it was customary practice for him to deposit sums as binders for clients in his real estate operations, the original advance of $25,000, in addition to the subsequent loans to the corporation, were transactions in carrying on his real estate business and the resultant loss is deductible as a business bad debt. The difficulty, we think, with this argument is that the petitioner131 is commingling his original investment in the capital stock with his subsequent loans. That petitioner customarily made advances for clients in order to bind a sale is of no importance in determining whether he was in the business of loaning money to corporations. We are here concerned with a loss resulting from loans by petitioner to his corporation. To give such advances the character of a business bad debt the petitioner must establish that he was in the business of advancing funds to corporations. This record is devoid of any evidence indicating that petitioner was in such a trade or business. It is well established that losses arising from loans to corporations by stockholders who are not in the business of making loans to corporations are deductible as nonbusiness bad debts. Omaha Nat. Bank, Adm. v. Commissioner, 183 Fed. (2d) 899; Jan G. J. Boissevain, 17 T.C. 325">17 T.C. 325; Charles G. Berwind, 20 T.C. 808">20 T.C. 808, affd. 211 Fed. (2d) 575. We hold that the petitioner in the taxable year 1946 sustained a nonbusiness bad debt in the amount of132 $16,222.77 which is deductible under the provisions of section 23(k) (4) of the Code. Decision will be entered under Rule 50. Footnotes. The corporation ceased business in May 1946.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619407/	North American Aviation, Inc., Petitioner, v. Renegotiation Board, RespondentNorth American Aviation, Inc. v. Renegotiation BoardDocket Nos. 956-R, 980-RUnited States Tax Court39 T.C. 207; 1962 U.S. Tax Ct. LEXIS 43; October 25, 1962, Filed 43 The amounts of petitioner's excessive profits on renegotiable contracts in 1953 and 1954, determined. Charles Pickett, Esq., Melvin D. Goodman, Esq., and James C. Foley, Esq., for the petitioner.James H. Prentice, Esq., William H. Arkin, Esq., William E. Nelson, Esq., and Harland F. Leathers, Esq., for the respondent. Mulroney, Judge. Withey, J., concurring. MULRONEY 207 Respondent issued its unilateral order determining that for44 the fiscal years 1953 and 1954, ended September 30, petitioner received excessive profits on its renegotiable business in the amounts of $ 6 million and $ 14 million, respectively. By an amendment 208 to its answer respondent now claims excessive profits for 1953 in the sum of $ 16 million and for 1954 in the sum of $ 21,500,000.The evidence was heard by a commissioner of the Court, and his report, with such amendments as we deem appropriate, after consideration of the objections thereto submitted by the parties, is adopted as the basis of our findings of fact.Much of the voluminous evidence is contained in a stipulation of facts.FINDINGS OF FACT.The stipulation of facts is incorporated herein by this reference.Petitioner is a Delaware corporation organized December 6, 1928. Its principal office is at Los Angeles, California. At the time of incorporation petitioner had a paid-in capital of $ 25 million, for which 2 million shares of no par value stock were issued. It later issued additional shares of stock for the shares or assets of other companies and changed the par value of its stock to $ 1 per share.Petitioner began its operations as a manufacturer of airplanes45 in 1935. Prior to that time it held stock in several other companies engaged in the aviation and allied industries but did no manufacturing of its own. Beginning in 1935 it operated a small airplane manufacturing plant located at Dundalk, Maryland, and was also engaged in air transportation.After winning a competitive Air Force award for a new trainer plane in 1935, petitioner built the first unit of its present Los Angeles plant on a leased tract of land which is now known as Los Angeles International Airport. It began manufacturing operations there early in 1936. It then had a book net worth of $ 5,878,000. It had 432 employees in March 1936.During the 1936-1941 period, petitioner's operations steadily expanded. Its floor space was increased from 169,786 square feet on December 31, 1936, to 807,272 square feet on December 31, 1940. The number and types of airplanes completed and delivered by petitioner over the calendar years 1936 to 1940, inclusive, and for the first 9 months of 1941, 1 were as follows:193619371938193919401941(9 Mos.)Trainers822123236559631,614Fighters72368Bombers and reconnaissance289Observation and liaison7712932Total822124007931,2311,71146 209 The advent of World War II greatly increased petitioner's orders for airplanes, particularly those of a military type. The following number and types of planes were manufactured by petitioner and delivered during the years 1942 to 1945, inclusive:1942194319441945Trainers3,1354,6242,9862,149Fighters7647995,6457,651Bombers and reconnaissance1,1103,2104,4632,412Total5,0098,63313,09412,212The aircraft which petitioner manufactured during the 1936-1945 period consisted principally of models of the AT-6 series of advanced trainers, the P-51 Mustang fighters, and the B-25 Mitchell series of medium bombers. The AT-6 trainers were used by the United States and most other Allied countries during World47 War II. The Mustang fighters were designed and produced originally for Great Britain, but were later produced in quantity for the United States. They attained considerable success in combat and were highly regarded by World War II pilots. The B-25 bombers were used principally in the South Pacific. They were used in the first air raid on Tokyo in 1942. In addition to airplanes of its own design, petitioner also manufactured B-24 bombers designed by Convair and C-82 bombers designed by Fairchild. Some of the airplanes manufactured by petitioner during the World War II period were built at its Los Angeles plant and some at Government-owned plants located at Grand Prairie, Texas, and Kansas City, Kansas.At the end of World War II, almost all of petitioner's Government contracts for military airplanes were canceled. Petitioner then ceased operations at Government-owned plants and greatly curtailed its other operations. It built and delivered 143 military planes in 1946, 89 in 1947, 226 in 1948, and 335 in 1949. The number of its employees, which had reached a high of over 87,500 in 1944, dropped to 5,266 by the end of March 1946. Petitioner undertook the manufacture of a small48 commercial plane known as the Navion but this venture proved unsuccessful. It built a total of 1,002 of the Navion airplanes in 1947 and suffered a loss thereon of about $ 11 million.Petitioner's net sales, cost and expenses, and net profits, before any taxes on income, for the years 1946 to 1949, inclusive, were as follows:Net salesCost andProfits (or loss)expenses1946$ 52,743,000$ 49,449,000$ 3,650,000 194719,855,00032,237,000(11,728,000)194894,130,00083,643,00010,811,000 1949124,180,000112,678,00012,056,000 210 As early as 1945 petitioner began to investigate the field of missiles. In 1946 it obtained a Government contract to produce a supersonic missile with a range of 175 to 500 miles. The requirements for this missile were later increased and eventually it became the Navaho cruise-type, intercontinental missile. Petitioner was doing work on the Navaho missile during the years 1953 and 1954. Also, during World War II, petitioner began designing and building jet-powered airplanes. All of the planes produced by petitioner during World War II were piston-driven. The jet-powered designs included the B-45, the first 49 United States jet bomber, the FJ-1, the first United States Navy jet fighter, and the F-86, the first of petitioner's series of Air Force Sabre jet fighters. Petitioner had an order for a small number of FJ-1's at the close of World War II.The missiles on which petitioner had begun experimental work for the Government about 1945 required a large rocket-powered engine. There were no rocket engines of that type being manufactured in this country at that time. In 1946 petitioner began the development of such an engine, using German V-2 rocket engine as a basic design. Also, in 1946 petitioner began work on a missile-guidance system. In 1947 petitioner made an initial investment in a rocket-engine testing range located in the Santa Susana Mountains, north of Los Angeles. The work on the rocket engines and guidance systems was continued and became an important phase of petitioner's operations in 1953 and 1954, and later years. Petitioner's total investment in the Santa Susana testing facilities at the end of 1954 amounted to about $ 3,500,000. The Government's investment was about twice that amount. The testing range is still in use and has greatly expanded since 1954.Petitioner's50 rocket engines have been used in guided missiles and in most of the Government's successful satellite launchings. Petitioner produced and delivered 6 rocket engines in 1953 and 13 in 1954. It was the sole producer of large rocket engines in the United States in those years. Also, in 1953 and 1954 petitioner delivered seven X-10 test missiles and built its first research atomic reactor.Also, about 1946, petitioner began an investigation for the Air Force of the use of atomic power for the propulsion of airplanes and missiles. After about a year's work petitioner found that it was not feasible, and so advised the Air Force. However, on its own initiative, petitioner continued its study of atomic energy for peacetime uses and in 1948 received a contract from the Atomic Energy Commission to conduct research in that field. Work on that contract has continued up to the present time. Also, after World War II, petitioner continued its development work on military airplanes, particularly its F-86 Sabre jet fighters.211 The hostilities in Korea began June 25, 1950. Shortly thereafter petitioner began to receive large Government orders for aircraft, mostly of military types. 51 To fulfill these orders, it had to increase its floor space and facilities. At that time there was a large, partially idle Government-owned airplane plant at Columbus, Ohio, containing about 2,500,000 square feet of floor space. The plant had been built by the Government during World War II and had been used by Curtiss-Wright for the manufacture of Navy fighters. Curtiss-Wright had continued to occupy about one-half of the floor space. Another firm had used the other half for a period, manufacturing prefabricated houses, but it had ceased operations early in 1950. The Government decided in September 1950 to reactivate the Columbus plant and turn it all over to the petitioner. The space that had been occupied by Curtiss-Wright was turned over to petitioner in December 1950, and the balance in April 1951.The Columbus plant was a well constructed plant but it required considerable remodeling and modernization of equipment. This work was done by the petitioner, largely at the Government's expense. It extended over several years, and put a heavy burden on petitioner's engineers and skilled workers.In its operations at the Columbus plant, petitioner had to employ and train a large52 number of employees and establish new sources of supplies. There were from 1,500 to 1,800 Curtiss-Wright employees at the plant at the end of 1950 when petitioner took it over. These were retained by petitioner. A year later, there were over 10,000 employees. At the beginning of 1953, there were 15,204 employees and at about the middle of that year a peak of over 18,000. Petitioner had to transfer a number of its key employees from its Los Angeles plant from time to time to help organize the Columbus plant and train the new employees.At first the Columbus plant was used only for assembling airplanes under a system of transferals from other plants. Later, and during 1953 and 1954, it was used for manufacturing several different models of airplanes and for modifying others.Also, during 1953 and 1954, petitioner operated major plants at Downey and Fresno, California, and during one or both of those years maintained offices at New York; Dayton, Ohio; McClellan, California; and Washington, D.C. It also operated 27 supporting installations such as small manufacturing plants, test facilities, training schools, and warehouses, 17 of which were located at different points in Los Angeles53 County, California, and others at Fresno, Edwards Air Force Base, Palmdale, and Santa Susana, California; Cleveland, Columbus, and Washington Courthouse, Ohio; Detroit, 212 Michigan; Patrick Air Force Base, Florida; and White Sands, New Mexico.The areas of floor space in use by petitioner, at the end of 1953 and 1954, in square feet, and their location, were as follows:Location19531954Los Angeles2,866,2202,877,619Downey1,055,4531,120,675Fresno312,887340,419Columbus3,084,8013,246,124Others1,329,1851,613,033Total8,648,5469,197,870Some of this floor space was owned by petitioner, some was leased from the Government, and some leased from others, as follows:Leased fromOwned bylessors otherOwned byTotalpetitionerthan GovernmentGovernment19532,838,2911,815,5663,994,6898,648,54619542,879,4261,891,4624,426,9829,197,870Most of the floor space at Los Angeles was owned by petitioner while that at Downey and Columbus was owned by the Government. Most of the other floor space, at Fresno and other locations, was leased from private owners. Except for negligible amounts petitioner did 54 not pay rent for the floor space leased from the Government.The plant which petitioner occupied at Downey, California, had been built by another airplane manufacturer and during World War II had been expanded by the Government. It was owned in part by the Government and in part by petitioner until September 1953 when, in a transaction between petitioner and the Government involving other properties, it became wholly Government owned. The plant was used by petitioner both in the manufacture of airplanes and for work on the Navaho missile and related programs.The following table shows the different types and number of airplanes of each type manufactured by petitioner and delivered during 1950-1952 period:195019511952Trainers103321360Fighters309169402Bombers and reconnaissance942919Total506519781The original cost to the petitioner and to the Government of the property owned by each, and in use by petitioner on September 30, 213 1952, 1953, and 1954, according to the best information of the parties, was as follows:North American Property in Use as of Sept. 30, 1952, 1953, and 1954Sept. 30 --195219531954Land and land improvements:Los Angeles$ 1,104,652$ 1,049,055$ 2,527,497Buildings (including buildingequipment):Los Angeles9,848,6279,529,13110,056,788Leasehold improvements:Los Angeles2,103,1512,534,7781,991,515Fresno279,224364,190Total2,103,1512,814,0022,355,705Total land and land improvements,buildings, and leaseholdimprovements13,056,43013,392,18814,939,990Furniture and fixtures, tools, andmachinery and equipment:Los Angeles10,906,73413,050,76914,241,053Columbus1,561,1411,444,435985,835Fresno539,978719,766Total12,467,87515,035,18215,946,654One-sixth interest in cooperative windtunnel at California Institute ofTechnology521,569538,344542,412Total property in use26,045,87428,965,71431,429,05655 Notes:1 Data above exclude construction in progress.2 Included under Los Angeles are both the Los Angeles and Downey plants and their supporting installations. At September 30, 1952, Los Angeles also includes the Fresno plant and its supporting installation.Government-Owned Property in Use as of Sept. 30, 1952, 1953, and 1954Sept. 30 --195219531954Land and land improvements:Los Angeles$ 52,218$ 93,495Columbus65,165133,560Total117,383227,055Buildings (including buildingequipment):Los Angeles (Note 1)$ 4,655,6767,028,0798,854,394Columbus9,176,37419,685,25529,901,731Total13,832,05026,713,33438,756,125Total land and landimprovements, and buildings13,832,05026,830,71738,983,180Furniture and fixtures, tools, andmachinery and equipment:Los Angeles6,774,32413,773,76520,291,349Columbus12,724,44920,282,83725,931,763Fresno14,43216,077Total19,498,77334,071,03446,239,189Total property in use33,330,82360,901,75185,222,369214 Notes:1 Each year includes $ 4,350,000 of Downey plant facilities for which no56 segregation between land, buildings, furniture and fixtures, tools, and machinery and equipment is available.2 Included under Los Angeles are both the Los Angeles and Downey plants and their supporting installations. At September 30, 1952, machinery and equipment in use at the Fresno plant is included under Los Angeles.3 Amounts at September 30, 1954, do not include facilities in use, for which cost information is not available, at the following locations: McClellan Air Force Base, California -- approximately 800 square feet of office space.Huntsville, Alabama -- approximately 240 square feet of office space.White Sands, New Mexico -- approximately 6,000 square feet of rocket engine test area and office space.Patrick Air Force Base, Florida -- approximately 17,600 square feet of hangar space.Palmdale, California -- airport facilities under joint-use with three other aircraft manufacturers.The types and the number of different models of airplanes built by petitioner and delivered to the Government, in each of the years 1953 and 1954, were as follows:Total195319541953-1954Fighters:F-86D7269541,680F-86F1,2355781,813F-86H23638F-100A24850FJ-29192201FJ-304444Total fighters1,9741,8523,826Trainers:T-28A36249411T-28B0206206Total trainers362255617Bombers and reconnaissance:AJ-2P81523AJ-2302555Total bombers and reconnaissance384078Total aircraft2,3742,1474,52157 The Model F-86D was a later, improved model of F-86A, which was the first production model of petitioner's F-86 Sabre 215 jet series. The F-86 was first flown in 1947. It was designed as a straight-wing airplane but was later changed, in the F-86A production model, to a swept-wing design, patterned after the German Messerschmidt 262. Some of the other features of the F-86A and other models of the series were wing slats, hydraulic boosters for pilot controls, and electrically powered adjusters for the horizontal stabilizers. The F-86A was designed for a subsonic speed of over 600 miles per hour but in power dives attained a speed in excess of sound (approximately 750 miles per hour). It was the first tactical aircraft ever to attain such speed. It broke the world's speed record in a straight-away course in September 1948, with a speed of over 670 miles per hour, and held that record for 4 years, until it was broken by a later model of the series, the F-86D.The F-86F was a single place jet-powered fighter-bomber. The designing of this model was begun about May 1950, and was substantially completed in August 1951. It was used in the Korean fighting where it established58 a decided superiority over the Russian built MIG 15. Its "kill ratio" over the MIG 15 was 16 to 1. The F-86F's and F-86D's accounted for the major portion of petitioner's renegotiable business in 1953 and 1954.The F-86H was an improved model of the F-86F fighter-bomber. It was not produced in quantity in 1953 or 1954. It was intended more as an insurance against possible delay in the production of the supersonic F-100A.Petitioner began the designing work on the F-100A in January 1951. It was designed for a newly developed, more powerful jet engine, the J-57, made by Pratt & Whitney. The Government had expended $ 100 million in the development of this engine. The basic design of the F-100A was essentially completed by the end of January 1953. It incorporated some of the features of the F-86 series and also many advanced features. The first F-100A was delivered to the Government in June 1953. A few months later it set a new world's speed record which stood until August 1955. It was superior in performance to any airplane previously built. The development of the F-100A was a major step in aviation.The FJ-2 was an adaptation of the F-86 series built for the Navy. The basic59 design was completed about February 1952. An improved model, the FJ-3, followed. The later model embodied a British designed engine with 25-percent more thrust than the FJ-2 engine.The T-28A and the T-28B models were both trainers produced for the Air Force and the Navy, respectively. They were two-place planes powered by piston-driven motors. They were used for a number of years by the United States and other countries.216 The AJ-2P was a Navy photo-reconnaissance plane, and the AJ-2 a Navy long-range attack plane. They were both large, heavy planes with two piston-driven engines, and a jet engine for added power when needed. The AJ-2 was the only carrier-based plane capable of delivering an atomic bomb at long range. By use of a removable tanker package devised by petitioner it was quickly convertible into a tanker.In addition to the 10 models described above, petitioner during 1953 and 1954 was doing work on 4 other airplane models which were not delivered until later years. Petitioner was also working on guided missiles, rocket engines, electronics, and electro-mechanical equipment and atomic energy facilities.The F-86A, F-86F, and F-86E airplanes were all used60 in the Korean fighting and contributed in a large measure to the air supremacy of the United Nations' Air Forces.In 1954, petitioner's past president and then chairman of the board of directors, James H. Kindelberger, was given the Exceptional Service Award of the United States Air Force, and the Collier Trophy for 1953. The citation for the Air Force Award stated that:JAMES HOWARD KINDELBERGER distinguished himself by rendering exceptional service to the United States Air Force and his country for forty years as an engineer, designer, and producer of military aircraft. His name is synonymous with air power. As one of the small band of American pioneers who has fought for the development of air power through the years, his accomplishments stand out in military aviation progress from the Jenny to the Jet. He has no peer as a designer and producer of air frames for fighter aircraft. By applying scientific manufacturing techniques, he revolutionized the aviation industry. His ability to translate the most exacting requirements of the USAF into mass-produced, yet precision operated aircraft was particularly reflected in the combat performances of the F-51, Mustang fighter, and61 the B-25 Mitchell attack bomber, among the best airplanes produced in their respective classes during the last war. More recently, the North American F-86 Sabrejet has distinguished itself in Korea as the principal United Nations' plane to accept and throw back the challenge offered by the MIG-15 to our air superiority over the battlefield. Our country is indebted to Mr. Kindelberger for his outstanding contribution to the development of the United States Air Force from its modest beginning to its present role of this nation's first line of defense.The Collier Trophy, which was presented by the then President of the United States, was awarded "for development of the first Supersonic Fighter Airplane in service in the United States Air Force, the North American Land Based F-100 Super Sabre." This award is presented annually by the National Aeronautic Association "for the greatest achievement in aviation in America, the value of which has been thoroughly demonstrated by actual use during the preceding year."217 Petitioner's adjusted renegotiable sales, costs and expenses (exclusive of income taxes), and profits (before income taxes) in its Los Angeles and Columbus divisions, 62 were as follows:Los AngelesColumbus1953195419531954Sales$ 432,857,566$ 397,842,517$ 185,199,111$ 251,093,450Costs and expenses400,121,567363,879,094173,446,194230,616,628Profits32,735,99933,963,42311,752,91720,476,822Petitioner's 1953 and 1954 sales and profits, before any taxes on income, by type of contract, on both renegotiable and non-renegotiable business, were as follows:Fiscal year 1953Renegotiable businessSalesCosts andProfitexpenses(loss)Contract category:Cost-plus-a-fixed fee$ 67,749,903$ 64,560,212$ 3,189,691 Incentive-type503,416,337462,707,66840,708,669 Price redetermination4,262,8194,070,571192,248 Fixed price8,556,3988,354,543201,855 No-fee facilities17,874,78918,023,390(148,601)Terminated19,525,96019,092,679433,281 Total renegotiable business621,386,206576,809,06344,577,143 Non-renegotiable business7,308,5835,624,7641,683,819 Total business628,694,789582,433,82746,260,962 Fiscal year 1954Renegotiable businessSalesCosts andProfitexpenses(loss)Contract category:Cost-plus-a-fixed fee$ 88,474,116$ 85,182,367$ 3,291,749 Incentive-type541,329,004490,384,63850,944,366 Price redetermination6,359,4666,020,458339,008 Fixed price6,664,2286,119,874544,354 No-fee facilities14,186,11114,282,573(96,462)Terminated1,248,3281,201,97446,354 Total renegotiable business658,261,253603,191,88455,069,369 Non-renegotiable business2,870,050274,5992,595,451 Total business661,131,303603,466,48357,664,820 63 Petitioner's "Cost-Plus-A-Fixed-Fee" contracts in 1953 and 1954 were, for the most part, contracts for research and development in the fields of rocket engines, guided missiles, guiding systems, nuclear research, and modifying and rebuilding airplanes.More than 80 percent of petitioner's renegotiable business in 1953 and 1954 was derived from so-called "incentive contracts." In general, under this type of contract, the Government and the contractor negotiated a price for a specified airplane, based on estimated average cost per plane, plus a profit, in the Air Force contracts, usually of about 8 percent of estimated costs. This was known as the "initial target price." After a certain number of planes had been built and delivered at the initial target price there was a negotiation of a second target price, known as a "firm target price." This was derived from the actual costs incurred and the estimated costs to complete, plus profits. The actual costs were determined, or estimated as to any unknown costs, after delivery of the last airplane under the contract. If actual costs were less than firm target price the contractor received 218 25 percent of such "under-run," and 64 the Government 75 percent. If actual costs were greater than firm target price the contractor bore 25 percent of the "over-run" burden and the Government 75 percent. The contractor's profits, however, could not exceed 15 percent of estimated costs and the burden of all overruns above 125 percent of firm target costs was borne by the contractor.One of the principal incentive contracts under which petitioner built F86-D's in 1953 and 1954 was AF 33 (600) 6202 dated May 21, 1952 (the initial tentative target) for 707 units at $ 112,678 per unit. There was a revised tentative target contracted January 27, 1953, for 901 units at $ 114,471 per unit. A firm target price of $ 143,156 per unit was negotiated February 9-12, 1954 (contract date April 29, 1954). The final cost was negotiated January 30, 1956 (contract dated March 12, 1956), at $ 120,228 or $ 22,928 per unit under firm target. For 1953 the sales under this contract were $ 13,457, the costs $ 12,149, and the profits, before income taxes, $ 1,308. For 1954 the sales were $ 123,327,866, the costs $ 108,792,599, and the profits $ 14,535,267. Over the entire life of the contract, 1953-1956, the sales were $ 150,871,098, costs65 $ 133,092,191, and profits $ 17,788,907.The firm target price was arrived at by negotiations in which both the contractor and the Government were represented. Some of these negotiations lasted several days. The intervals between initial target and firm target were from less than a year to more than 3 years. The firm target price, usually, but not always, exceeded the initial target price. The final cost, that is, the average per unit cost over the entire contract, usually, was less than the firm target average per unit price. The fact that the contractor was to have the right to use Government facilities free of cost in the performance of some of its contracts was taken into account by the negotiators when the contracts were negotiated. Some or all of these contracts provided for an adjustment in the contract price if the Government should withdraw this right.The "Price Redetermination" contracts were principally for modifying and rebuilding airplanes, for spare parts, and for designing and engineering studies. The "Fixed Price" contracts were primarily for the manufacture of spare parts for airplanes. The "No Fee Facilities" contracts were for the construction or acquisition66 by petitioner, at Government cost, of facilities to be owned by the Government and used by petitioner in performance of Government contracts. "Terminated" contracts were the contracts that were wholly or partially 219 terminated during 1953 and 1954. Under these contracts, petitioner was permitted to recover all reimbursable costs, but not all actual costs, and, in some instances, profits as well.The following schedule shows petitioner's 1953-1954 renegotiable sales, costs, and expenses, and profits, before State and Federal income taxes, on each of the airplane models delivered during those years, as well as on the remanufacture, modification, and repair of aircraft, and on spare parts, under incentive contracts:Fiscal 1953Contract and aircraftmodel or descriptionSalesCosts andProfitexpenses(loss)T-28A$ 25,307,584$ 23,764,918$ 1,542,666 T-28BF-86A18,56915,7752,794 F-86D182,432,359164,916,83617,515,523 F-86E362,546345,58516,961 F-86F202,663,065185,900,66916,762,396 F-86E and F-86F7,640,7807,166,722474,058 F-86H3,552,8153,320,383232,432 F-100A3,940,4433,679,690260,753 AJ-11,740,2411,566,068174,173 AJ-2P14,059,43612,646,9821,412,454 AJ-225,064,98722,895,7202,169,267 XFJ-2 and XFJ-2B1,211,0341,146,73164,303 FJ-210,722,4699,824,222898,247 FJ-3Total incentive contractsfor aircraft478,716,328437,190,30141,526,027 Remanufacture, modificationor repair of aircraft, etc2,737,6202,766,234(28,614)Spare parts21,962,38922,751,133(788,744)Total incentive contracts503,416,337462,707,66840,708,669 67 Fiscal 1954Contract and aircraftmodel or descriptionSalesCosts andProfitexpenses(loss)T-28A$ 9,969,078$ 9,233,315$ 735,763T-28B19,396,27517,603,2491,793,026F-86A4,1864,186F-86D165,366,356146,786,34018,580,016F-86E27,74224,9272,815F-86F89,713,68881,216,3898,497,299F-86E and F-86F670,100624,10845,992F-86H27,870,43825,682,4512,187,987F-100A42,569,31139,455,3973,113,914AJ-1315,651280,65534,996AJ-2P22,194,77220,093,4172,101,355AJ-225,201,66322,847,9072,353,756XFJ-2 and XFJ-2B31,68710,78620,901FJ-298,451,86989,952,8588,499,011FJ-316,763,35914,963,6601,799,699Total incentive contractsfor aircraft518,546,175468,775,45949,770,716Remanufacture, modificationor repair of aircraft, etc4,011,5533,721,440290,113Spare parts18,771,27617,887,739883,537Total incentive contracts541,329,004490,384,63850,944,366Petitioner's different types of non-aircraft renegotiable business, in 1953 and 1954, resulted in sales as follows:19531954Guided missiles$ 27,071,456$ 36,778,103Rocket engines10,267,10214,453,092Electronics and electromechanical equipment18,204,33522,314,479Atomic energy6,591,9506,158,596Total62,134,84379,704,27068 Petitioner's book net worth, its net sales, and its percentage return of profits, 2 both on sales and book net worth, at the beginning of each of the years, for the entire 1939-1954 period (the calendar years 1939-1940, 220 the 9 months' period ended September 30, 1941, and the fiscal years ended September 30, 1942-1954) were as follows:BeginningReturn on beginningYearbookbooknet worthnet worthIn thousandsPercent1939$ 7,557114.12 19409,836104.92 9 months ended Sept. 30, 194112,632140.10 Fiscal year ended Sept. 30:194216,787193.52 194321,395175.89 194429,750166.99 194540,50367.29 194643,9618.30 194739,417(29.75)194839,38927.45 194944,12227.32 195047,99329.56 195151,78630.60 195253,91438.97 195357,44171.72 195465,06183.33 Return onYearNet salesnet salesIn thousandsPercent1939$ 27,60931.24 194036,86228.00 9 months ended Sept. 30, 194160,86629.08 Fiscal year ended Sept. 30:1942235,02613.82 1943463,4848.12 1944680,0497.31 1945376,2747.24 194652,7436.92 194719,855(59.07)194894,13011.49 1949124,1809.71 1950143,0339.92 1951177,6758.92 1952315,2716.66 1953634,6886.49 1954645,8218.39 69 Petitioner's book net worth, in 1953 and 1954, does not reflect the true value of the assets used in the business. It does not include any asset value for goodwill. This goodwill, or know-how, was an asset of great value to petitioner. Petitioner maintained a large staff of trained executives and engineers, highly regarded in the industry, and a great number of skilled mechanics. It had been recognized as one of the country's top airplane designers and manufacturers for a number of years. Since the beginning of World War II petitioner had been relied upon heavily by the Government for several types of military aircraft, especially the fighter types. All but 2 of the 10 different airplane models which petitioner delivered to the Government in the calendar years 1953 and 1954 were combat planes. They comprised about 25 70 percent of all military airplanes and 50 percent of all fighter planes procured by the Government during those years.Also, in the performance of its Government contracts, in 1953 and 1954, petitioner utilized its own facilities and equipment of considerable value which had been fully depreciated in prior years and were not reflected in book net worth. Many other of petitioner's physical assets which were reflected in book net worth had a current value greatly in excess of book value.The average return of income on book net worth is generally higher in the aircraft industry than in other major industries and the return on sales lower. Of 20 leading airplane manufacturers in the United States the ratio of petitioner's profits to book net worth was usually higher than the average over the entire 1942-1954 period. Petitioner ranked ninth and sixth in the industry in the years 1953 and 1954, respectively, in net income as a percentage of net book worth. The average of 20 companies was 60.1 percent in 1953 and 1954, while petitioner's was 69.8 percent in 1953, and 80.7 percent in 1954.221 It has been a long-standing custom of the Government to make progress payments to contractors71 in the airplane industry and in other industries, where construction extends over a long period. Such payments were made to petitioner in 1953 and 1954 at the effective rate of about 70 percent of incurred costs. Legal title to materials and work in progress with respect to such payments vested in the Government. Petitioner also borrowed large sums of money from banks for additional working capital needed in the performance of its contracts. The bank loans amounted to approximately $ 56,500,000 during most of the 1953-1954 period. Petitioner paid interest on such loans of $ 1,853,747 in 1953, and $ 1,790,701 in 1954. These interest payments were not treated as allowable charges against renegotiable contracts, under procurement regulations, but they have been so treated for the purpose of renegotiation.The aircraft industry is highly variable; both the volume of business and profits may fluctuate widely in response to external forces over which it has no control. This is especially true of the segment of the industry which specializes in military aircraft, as does petitioner. In times of war or national peril it may be pushed to capacity production, and suddenly find its business72 reduced to skeleton dimensions. Such was petitioner's experience after the close of World War II. The Government usually reserves the right to terminate its contracts at will. There were 23 cancellations by the Government of petitioner's prime contracts in 1953 and 33 in 1954.For all practical purposes the Government was petitioner's sole customer in 1953 and 1954, and, in fact, during most of the years of petitioner's successful operations. The possibility of the sudden loss of substantially all of its Government business constituted a continuing threat to petitioner's business. Without the Government's contracts petitioner's survival would have been in serious doubt. At best it would have been unable to hold its large organization together, particularly its trained engineers and skilled laborers upon which its operations largely depended.The following table shows the number of military aircraft procured by the Government in the calendar years 1940 to 1954, inclusive, and the number and percentage of such aircraft manufactured by the petitioner:Procured byManufacturedYearGovernmentbyPercentpetitioner19406,02867911.3194119,4452,54413.1194247,6756,03512.7194385,4339,10910.7194495,27214,86215.6194546,8658,22417.519461,417191.319472,1221004.719482,53629211.519492,59234413.319502,77354519.719515,4465339.819529,3021,00010.8195310,6262,51023.619548,7402,13424.473 222 Petitioner, as well as other airplane manufacturers, usually experienced a great many difficulties in producing airplanes that would meet the high standards of perfection set for them by the Government and the severe tests to which they were subjected. None of the airplanes manufactured by the petitioner, or other companies, during 1953 and 1954, was free of troubles. Each model had its own engineering problems. These problems multiplied with each step in the advancement of the art. Every substantial increase in speed, especially, and in range, or engine power, or fire power, gave rise to new problems. This was especially true in the approach to the speed of sound. When first subjected to these high speeds aircraft of proven design developed aerodynamic deficiencies totally unknown to the engineers and pilots. Many of these deficiencies could be detected only by testing and corrected only by trial and error. Some were latent deficiencies that did not appear until the aircraft had been subjected to actual combat conditions. Aircraft with known deficiencies were sometimes considered combat capable and were used successfully. When defects or deficiencies of sufficient74 importance were discovered the aircraft were grounded until corrections could be made.As to efficiency of operations, quality of products, ability to meet production schedules, and pricing on Government contracts, petitioner has at all times here material stood at or near the top of the aircraft industry. In general, as a builder of military aircraft, petitioner during 1953 and 1954 was not excelled by any other member of the industry and equaled by only a few, if any.To meet the urgent production demands of the Air Force some models of the F-86 airplane were built at both the Los Angeles and the Columbus plants. Due to lack of production experience and the use of untrained personnel at the Columbus plant, the unit cost of production there was larger than at the Los Angeles plant. The unit costs at both plants were reduced as production increased. The unit cost production of the F-86F decreased at the Los Angeles plant from $ 120,916 at October 1952, to $ 92,793 for the period March to June 1954, and at the Columbus plant from $ 169,572 for the April 1952 to September 1953 period, to $ 128,821 for the August 1953 to May 1954 period. On a comparative basis, petitioner's production75 costs of military aircraft in 1953 and 1954 were considerably lower than the average of the aircraft industry, and on the whole were the lowest in the industry.Petitioner was especially economical in the use of materials and manpower. It developed, or adopted, and utilized in its operations numerous material and labor-saving devices or ideas, such as the "die quench" method used in shaping "machined grid" formed wings, the integrally stiffened construction of airplane wings, the installation 223 of a system of automatic vacuum collection of salvage scrap, particularly of the high-value aluminium scrap, the purchase of critical materials in template form, the use of the photo-electric cell method of riveting, the organization among its key employees of a revolving conservation committee, and a plant-wide safety program.The accident rate among petitioner's employees, per million of manhours, was 2.21 percent in 1953 and 1.52 percent in 1954, as against 3.8 percent in 1953 and 3.2 percent in 1954 for the aircraft manufacturing industry as a whole, and 13.4 percent in 1953 and 11.9 percent in 1954 for all manufacturing industries.Petitioner utilized all of its plant facilities76 at near full capacity in 1953 and 1954. It operated two full shifts and a skeleton third shift during both of those years.The following schedule shows petitioner's dividends and the earnings retained in the business for the 9 months ended September 30, 1941, and for each of the fiscal years 1942 to 1954, inclusive:YearDividendsNet incomeretained9 months ended Sept.30, 1941$ 2,576,275$ 4,249,679 Fiscal year ended Sept.30:19424,293,7914,607,050 19433,435,0338,355,290 19443,435,03310,753,486 19454,293,7913,457,777 19466,870,0661 (4,544,424)19472 (28,259)19481,717,5174,733,685 19493,435,0333,871,376 19504,293,7913,792,464 19514,293,7912,127,821 19524,293,7913,527,095 19535,152,5497,620,812 19549,446,34112,733,395 195515,457,64916,891,527 195613,224,87715,536,085 195716,030,15417,834,308 195812,824,22313,962,071 The compensation paid or accrued to petitioner's executive officers during 1953 and 1954, including salaries and incentive77 pay, was as follows:19531954J. H. Kindelberger$ 187,500$ 253,637J. L. Atwood141,000183,007R. A. Lambeth69,00081,843R. H. Rice76,00091,940J. S. Smithson69,19381,843A. T. Burton37,70845,431C. J. Gallant51,41668,618L. L. Waite48,63965,212S. G. Anspach31,29239,198Totals711,748910,729The airplanes manufactured by petitioner in 1953 and 1954 contain thousands of different parts. Some of the major parts such as motors, wheels, and various instruments, were provided by the Government 224 without cost to the petitioner. Other parts were obtained by petitioner from subcontractors. It was the policy of the Government to encourage subcontracting in the airplane industry. Petitioner's subcontracting costs amounted to 25 percent of its total costs in 1953 and 1954.Petitioner was responsible for designing the aircraft and assembling the various components into a complete workable unit. This was a task of great complexity, requiring many engineering and mechanical skills. Many difficult problems arose which could be solved only by extensive research and experimentation. In resolving these problems the Government78 contributed a vast amount of assistance to the petitioner and other airplane manufacturers. The Air Force maintained an Air Research and Development Center at Wright Field, Dayton, Ohio, and a Flight Test Center at Edwards Air Force Base, California. The Navy maintained the Naval Air Test Center at Patuxent, Maryland; and there were other various Government facilities at other locations. These facilities and the results of the Government's various tests and experiments were available to petitioner and other aircraft manufacturers in the performance of Government contracts. Government engineers and technical advisers were regularly stationed at petitioner's plants in 1953 and 1954.OPINION.This is a proceeding under the Renegotiation Act of 1951 (50 U.S.C. App. sec. 1218) hereinafter sometimes referred to as the Act, for a redetermination of the amount of excessive profits, if any, received or accrued by petitioner for the years 1953 and 1954 on its renegotiable business. The Renegotiation Board determined that petitioner realized excessive profits of $ 6 million in 1953 and $ 14 million in 1954. The statute giving this Court jurisdiction79 in renegotiation cases (sec. 108 of the Act) provides this Court "may determine as the amount of excessive profits an amount either less than, equal to, or greater than that determined by the Board." The Renegotiation Board now asks us to determine greater amounts of excessive profits than it determined, to-wit: $ 16 million in 1953 and $ 21,500,000 in 1954. Petitioner seeks a determination that it realized no excessive profits in either year. The above-cited provision of the Act also provides a proceeding such as this "shall not be treated as a proceeding to review the determination of the Board, but shall be treated as a proceeding de novo."The Act defines "excessive profits" in section 103(e) as "the portion of the profits derived from contracts with the Departments and subcontracts which is determined in accordance with this title to be excessive." 225 The Act does not provide any measurable objective standards upon which the determination of excessive profits is to be based. It goes on to provide that --In determining excessive profits favorable recognition must be given to the efficiency of the contractor or subcontractor, with particular regard to attainment of80 quantity and quality production, reduction of costs, and economy in the use of materials, facilities, and manpower; and in addition, there shall be taken into consideration the following factors:(1) Reasonableness of costs and profits, with particular regard to volume of production, normal earnings, and comparison of war and peacetime products;(2) The net worth, with particular regard to the amount and source of public and private capital employed;(3) Extent of risk assumed, including the risk incident to reasonable pricing policies;(4) Nature and extent of contribution to the defense effort, including inventive and developmental contribution and cooperation with the Government and other contractors in supplying technical assistance;(5) Character of business, including source and nature of materials, complexity of manufacturing technique, character and extent of subcontracting, and rate of turn-over;(6) Such other factors the consideration of which the public interest and fair and equitable dealing may require, which factors shall be published in the regulations of the Board from time to time as adopted.We have no problem here with respect to the amount of profits petitioner81 derived from its renegotiable contracts during each of the years in question. Section 103 of the Act provides: "The term 'profits derived from contracts * * ' means the excess of the amount received or accrued under such contracts * * over the costs paid or incurred with respect thereto and determined to be allocable thereto." We have stipulated figures of actual costs and payments showing petitioner's profits from renegotiable contracts, which comprise over 90 percent of its entire profits, amounted to approximately $ 44,577,000 in 1953 and $ 55,069,369 in 1954. These contracts, for the most part, were for the production of military airplanes for the United States Air Force and the Navy. The airplanes included trainers, fighters, and bombers, but were predominately fighters. They were produced in large numbers, 1,974 in 1953 and 1,852 in 1954. Non-aircraft renegotiable business accounted for a small part of petitioner's renegotiable business in the years in question. These were contracts relating to guided missiles, rocket engines, electronics, and atomic energy.There were in all some 31 contracts from which petitioner realized renegotiable profits during the years in question. 82 Our determination as to excessive profits is not to be made with respect to amounts received or accrued under separate contracts in each year. The Act provides that the determination as to excessive profits must be made with 226 respect to the aggregate amounts received or accrued each year under all renegotiable contracts unless there is mutual consent for separate contract renegotiation proceedings. Sec. 105(a); 3 cf. Warner v. War Contracts Price Adjust. Board, 14 T.C. 1320">14 T.C. 1320, and United States v. Warsaw Elevator Co., 213 F. 2d 517. This means all of petitioner's receipts or accruals of contract payments and all of its costs and profit figures on all of its business subject to the Act are lumped together so far as they are attributable to each year involved. It is obvious this permits excessive profits from one contract to be offset by deficient profits or losses from another.83 As stated above, we have here stipulated figures of aggregate actual costs and aggregate profits realized by petitioner on the aggregate of its renegotiable business for each year involved. Our task is to determine on all of the facts, after consideration of the statutory factors how much, if any, of the profits realized by petitioner are excessive.It is to be noted that in naming the factors to be considered in renegotiation the Act places special emphasis on the efficiency of the contractor, saying that it "must be" given favorable consideration "with particular regard to attainment of quantity and quality production, reduction of costs, and economy in the use of materials, facilities, and manpower * ." Respondent takes the position that petitioner attained, at best, no more than average efficiency in its operations and is not entitled to favorable consideration under this factor.Respondent argues that in the performance of most of its major contracts petitioner was inefficient in its operations; that the quality of its products was deficient; that it failed to reduce costs and was not economical in the use of materials, facilities, and manpower.The evidence of record is 84 overwhelmingly to the contrary. It shows that in each of these categories petitioner was at or near the top of the aircraft industry. Colonel Gerald F. Keeling, who, during 1953 and 1954, served respectively as technical adviser to the chief of procurement division of the Air Materiel Command and as deputy director of procurement and production of the American Air Force, when asked about North American's efficiency as a producer of airplanes in 1953 and 1954, testified that "North American's efficiency, both as to cost to produce and initial technical design far surpassed any other 227 manufacturer." Lt. Gen. Clarence S. Irvine, who, during 1953 and 1954, was deputy commander for production of the Air Materiel Command, testified that as a producer of airplanes North American was the best -- "From a standpoint of excellence in manufacturing procedures I would say they are within the top two or three. * * I would say that there was no other airplane company better and few as good on an over-all standpoint." Lt. Gen. Lawrence C. Craigie, Deputy Chief of Staff of the Air Force, testified in 1953 and 1954 he rated petitioner "extremely high" as a producer of aircraft in this 85 period and at "the very top group" of aircraft companies. An indication of the high regard in which petitioner was held by the Defense Department is found in the fact that its aircraft accounted for about 24 percent of all military airplanes and about 50 percent of all fighter type airplanes procured by the Government during the years in question.Respondent contends that the airplanes built by petitioner, particularly Models F-86D and F-86F, which were produced in large quantities, the F-100, and some of the other Air Force and Navy models, were of inferior quality. The evidence as a whole refutes this contention. Petitioner's F-86 series pioneered in the field of modern fighter aircraft. They were used extensively in the Korean conflict with outstanding success and contributed largely to the air supremacy of the United Nations forces. The victory ratio of the F-86's over the Russian built MIG-15's was over 10 to 1. The F-86D was a single-place interceptor and the F-86F a fighter-bomber. They were both ordered in large numbers in 1953 and 1954 and were the backbone of the United States Air Defense for several years thereafter. The F-100 was the first operational airplane to86 exceed the speed of sound in level flight. Its advent is considered a milestone in the development of aviation. The FJ-2's and FJ-3's were rated as the best Navy fighters of their time. All of these airplanes admittedly fell short of perfection -- and all of the witnesses agreed that no perfect airplane has ever been built -- but they were the best of their types produced up to that time. Some of them were advanced models and embodied many new features and presented many new and difficult engineering problems. Frequent changes had to be made in each model to keep abreast of the rapid advancement of the art. As production continued petitioner's and the Government's engineers and scientists worked together constantly and under great stress to detect and correct the deficiencies and improve the performance capabilities of each model. We are satisfied that petitioner fully cooperated in these efforts and that it showed commendable diligence and resourcefulness in improving the quality and performance of its airplanes.228 Respondent cites petitioner's failure to meet the production goals on some of its contracts as grounds for denying petitioner favorable consideration for87 efficiency in its operations. While it is true that many of the production schedules specified in the contracts were not met, it was not always the fault of the petitioner. The failure was due to numerous causes, such as structural modifications required by the Government, delays in delivery of engines or other essential components furnished by the Government and subcontractors, and other causes, some of which were not under petitioner's control. There is evidence, too, that the production schedules were known to be unrealistic and would require revision. The evidence does not show any serious delays in production occasioned by petitioner's lack of diligence or capability.In our opinion, the evidence as a whole leaves no doubt that in 1953 and 1954 the petitioner maintained a high degree of efficiency in the manufacture of airplanes under its major contracts, and, accordingly, we have given petitioner favorable consideration under this factor.The other statutory factors will be briefly discussed in the order in which they appear in the statute. "(1) Reasonableness of costs and profits, with particular regard to volume of production, normal earnings, and comparison of war and88 peacetime products."It is to be observed we are dealing with actual costs and not estimated cost figures with respect to separate contracts that were the subject of negotiation between the contracting parties during the performance years. Here we have stipulated figures of actual costs of all renegotiable business of $ 576,809,063 in 1953 and $ 603,191,884 in 1954, and stipulated figures of profits of $ 44,577,143 in 1953 and $ 55,069,369 in 1954. As set forth in our findings, petitioner's unit cost of production decreased as production increased and on the whole, petitioner's costs of producing military aircraft were the lowest in the industry. As to the "reasonableness" of petitioner's profits it is enough to say this will be the ruling consideration in this proceeding. We have found that as to volume of production, petitioner utilized all of its plant facilities at near full capacity during 1953 and 1954 and produced nearly a fourth of the military aircraft procured by the Government during the years in question. Consideration of the subfactors of "normal earnings, and comparison of war and peacetime products" is not very illuminating here. As already pointed out, petitioner89 had no normal peacetime operations outside the field of manufacturing airplanes and other products for military use. "(2) The net worth, with particular regard to the amount and source of public and private capital employed."Here, as in Boeing Co. v. Renegotiation Board, 37 T.C. 613">37 T.C. 613, respondent's primary contention is that petitioner's profits are excessive 229 because they constitute an unreasonable return on book net worth. However, in our consideration of this factor we have done what we did in Boeing, namely, increased petitioner's net worth figure by the value of its design and manufacturing know-how, which we feel is of the value of all its book assets combined.We have also considered large amounts of borrowed capital-interest bearing bank loans -- not reflected in book net worth averaging $ 56,500,000 in 1953 and 1954. We have also considered petitioner's use of leased and Government-furnished facilities. The record shows this is characteristic of the airplane industry where wide fluctuations in volume of business make large investments in facilities impracticable. This also is a cause of high return of income on book net 90 worth. But this fact and the fact that petitioner received high progress payments tend somewhat to reduce the profit that should be allowed to be retained as reasonable in the renegotiation process. "(3) Extent of risk assumed, including the risk incident to reasonable pricing policies."In our consideration of this factor we feel petitioner assumed no risk. Its pricing policies on which its major contracts were negotiated virtually insulated petitioner from any serious risk from that source. While petitioner did suffer losses on some of its contracts, its overall experience shows that the risks were comparatively inconsequential. "(4) Nature and extent of contribution to the defense effort, including inventive and developmental contribution and cooperation with the Government and other contractors in supplying technical assistance."Petitioner made varied and extensive contributions to the defense effort, the most important of which, perhaps, was the designing and production of a large number of superior fighter airplanes. Its F-86 fighter, which composed the major portion of its production in 1953 and 1954, was the backbone of the United States Air Force for a number of years. 91 Petitioner's development of the F-100A, the first supersonic airplane, was a major step in aviation.The evidence is that during 1953 and 1954, as well as in other years, petitioner made notable contributions to the defense effort in the superior quality of its products, its response to the demands for large volume production, its cooperation with the Government and the aircraft industry in solving engineering problems, its economies in the use of materials and manpower, and the development of improved manufacturing techniques. The rocket engine, which petitioner began developing in 1946, served a vital need of the Government in the field of missile development and space exploration.Respondent would deny petitioner any credit whatsoever for contributions to the defense effort in the production of its airplanes in 1953 and 1954, because it was not performing a vital function. Describing 230 petitioner as a designer of "air frames" rather than "airplanes," respondent continues:The distinction intended is not one solely of semantics since the air frame -- which the petitioner and its subcontractors fabricated -- was merely the envelope enclosing the propelling force and the92 myriad of equipment which are essential to make an airplane an effective combat instrument. * The truth is that the building of airplanes, or "air frames," is a highly technical and complex operation. From the earliest sustained power flight there has been a more or less steady advance of the state of the art in air-frame design. This has been greatly accelerated at times by wartime and national defense compulsions. With military aircraft, especially, the demand for advancements in design and increased production have been pressing. Each forward step in design has given rise to new engineering problems.Respondent contends that petitioner was uncooperative with Government representatives and intentionally withheld information or gave misleading information to the Government auditors and renegotiators. This contention is not only contrary to the weight of the evidence but, again, is inconsistent with respondent's requested findings of fact.97. Petitioner benefitted [sic] by the immense amount of governmental assistance which was transmitted to the aircraft manufacturers. The effect was a team effort where governmental personnel, responsible for the development and93 production of aircraft, worked very closely with the contractor in providing assistance, exchanging information, participating in the programs and contributing to the progress and satisfactory development of the planes. * * Colonel Keeling described petitioner as "extremely cooperative and were willing to step out and fix things quickly." General Irvine testified that North American always reacted very fast in any way to improve its product; that "I think I can say without question that they had the fastest reaction of any engineering department in the aircraft industry"; and that he had less trouble and less cost to the Government in obtaining satisfactory solution of the inevitable problems with North American than with the other manufacturers. "(5) Character of business, including source and nature of materials, complexity of manufacturing technique, character and extent of subcontracting, and rate of turn-over."It is well established in the record that the manufacturing of airplanes of the types petitioner furnished, is a complex and difficult business. In its supersonic airplane activities and its rocket engine, missile, and atomic work it was exploring new and advanced94 fields. In all of its manufacturing activities, including its guidance systems, its production operations necessitated precision work with a flexible manufacturing operation that would allow changes for application of 231 new and improved techniques. Ordinary mass-production methods could not be employed to petitioner's type of manufacturing activities.Petitioner complied with the Government policy with respect to subcontracting. It subcontracted about 25 percent of its airplane work.Here the subfactor "rate of turnover" is mentioned. We assume this means inventory turnover. La Grand Industrial Supply Co. v. United States, 22 T.C. 1023">22 T.C. 1023. Consideration of this factor is of limited usefulness because of the nature of petitioner's operation. If we use the gross value of its inventories it had a relatively low inventory turnover: a little more than twice annually. But this does not mean much as petitioner received progress payments equal to about 70 percent of incurred costs and title to inventory items passed to the Government with such progress payments.This petitioner has always had to rely on Government contracts for its very existence. 95 It had practically no business with private customers. There is some merit to the observation made by respondent that in a sense the petitioner was virtually in partnership with the Government during all of its business life.On giving consideration to the entire record and all of the facts in the light of the statutory factors, we feel that petitioner's profits on its renegotiable business for each of the years in question were to some extent excessive. It is our conclusion that petitioner realized excessive profits from its renegotiable contracts of $ 4 million in 1953 and $ 12,500,000 in 1954.Decisions will be entered accordingly. WITHEYWithey, J., concurring: Because in my view this case is in principle indistinguishable on its facts from Boeing Co. v. Renegotiation Board, 37 T.C. 613">37 T.C. 613, and for reasons set forth in Boeing, I concur in the result herein. Footnotes1. In 1941 petitioner changed its accounting period from a calendar year to a fiscal year beginning October 1 and ending September 30. References hereinafter to petitioner's accounting periods will relate to such fiscal years, unless otherwise indicated.↩2. Before any taxes on income and before any adjustment on account of special accounting agreement between petitioner and the Government, but after renegotiation, when applicable, prior to 1953.↩1. Amount by which dividends exceeded net income for the fiscal year.↩2. Loss for the fiscal year.↩3. SEC. 105. RENEGOTIATION PROCEEDINGS.(a) Proceedings Before the Board. -- * * * The Board shall exercise its powers with respect to the aggregate of the amounts received or accrued during the fiscal year (or such other period as may be fixed by mutual agreement) by a contractor or subcontractor under contracts with the Departments and subcontracts, and not separately with respect to amounts received or accrued under separate contracts with the Departments or subcontracts, except that the Board may exercise such powers separately with respect to amounts received or accrued by the contractor or subcontractor under any one or more separate contracts with the Departments or subcontracts at the request of the contractor or subcontractor. * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619409/	JOSEPH C. LEMIRE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; ROY R. CARVER AND HEIDRUM I. CARVER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentLemire v. CommissionerDocket Nos. 11707-86; 11805-86United States Tax CourtT.C. Memo 1988-367; 1988 Tax Ct. Memo LEXIS 392; 55 T.C.M. (CCH) 1527; T.C.M. (RIA) 88367; August 10, 1988James T. Reilly, for the petitioner in docket No. 11707-86. Roy R. Carver and Heidrum I. Carver , pro se in docket No. 11805-86. Kristine A. Roth and Robert N. Trgovich, for the respondent. WILLIAMSMEMORANDUM FINDINGS OF FACT AND OPINION WILLIAMS, Judge: The Commissioner determined deficiencies in petitioners' Federal income tax for the taxable years 1976 and393 1977 and additions to tax for fraud as follows: § 6653(b) 1AdditionPetitionerDocket No.YearDeficiencyto TaxJoseph C. Lemire11707-861976$ 359,723.48$ 179,861.741977177,249.5688.624.78Roy C. Carver and11805-861976$ 352,776.00$ 189,445.00Heidrum I. Carver1977172,055.1986,027.60In these consolidated cases the issues we must decide are (1) whether positioners Lemire and Roy Carver each received unreported income in the amounts of $ 705,000 and $ 344,000 in the years 1976 and 1977, respectively; and (2) whether any portion of the alleged underpayments of tax were due to fraud within the meaning of section 6653(b). FINDINGS OF FACT Some of the facts have been stipulated and are so found. At the time his petition was filed, petitioner Joseph C. Lemire ("Lemire") was incarcerated at a Federal prison in Big Spring, Texas. During the period of his incarceration, he maintained a residence at Wilton, New Hampshire. Petitioners Roy C. Carver ("Carver") and Heidrum394 I. Carver ("Mrs. Carver") were husband and wife during the years in issue. Carver resided at Torrance, California when the petition was filed. Mrs. Carver resided in Morocco at the time the petition was filed.BackgroundRaytheon Company ("Raytheon") is a Delaware corporation doing business in the United States and several foreign countries. Throughout the 1970s, Raytheon, through its wholly owned subsidiary Raytheon Middle East Systems Company ("Raymes") was engaged in numerous construction projects in the Middle East including the construction of an air defense missile system for the Kingdom of Saudi Arabia. Raytheon Subsidiary Support Company ("Rassco"), another wholly owned subsidiary of Raytheon, was responsible for procuring goods and services for Raymes. In 1975 and until he resigned from Raytheon in November, 2 Lemire was the procurement manager for Raymes and Rassco. In that capacity, he procured nonmilitary materials to support Raytheon's overseas operations. Carver was a vice-president of Raymes and general manager of its operations in Saudi Arabia from 1974 until his resignation in 1977. As such, Carver was Raytheon's most senior official in Saudi Arabia. 395 Lemire, in his capacity as procurement manager, provided support materials for Carver's operations in Saudi Arabia. During the years in issue, Interconex, Inc. ("Interconex") was a Delaware corporation with its principal office at New York, New York and doing business as a freight forwarder. Jon T. Stephens was president of Interconex. Lionel W. Achuck was Chairman of the Board of Interconex. International Modular Systems, Ltd. ("IMS") was a Delaware corporation with its principal office at Annapolis, Maryland. In 1976 and 1977, IMS was engaged in the business of exporting prefabricated housing. Arthur R. Thom was president of IMS during the years in issue. Henry C. Holle, an architect, was treasurer of IMS. In May 1976, Raytheon, through Raymes, entered into a contract known as the Triad contract with the Saudi Arabian government to construct an air defense missile system. As part of the Triad project, Raymes agreed to provide modular housing for the Saudi military personnel396 who would man the missile base and their families. Carver was charged with requisitioning, and Lemire with procuring the housing. Normal procurement procedures at Raytheon required a formal requisition for materials prior to awarding a contract and preapproval of large proposed contracts by higher corporate officials. The procurement office for Raymes and Rassco, which Lemire managed, however, was set up as a quick response group to handle requisitions and requirements for Raytheon's overseas operations. Because of short time periods involved, the office frequently had to take shortcuts to expedite shipments. Thus, it was not unusual to receive a request by phone and act on it before processing a formal requisition. The housing requirement for the Triad contract was urgent. After Lemire spoke to Carver, he assigned the procurement request to Gene Waxman, a senior contract administrator. Lemire instructed Waxman to request bids only from suppliers with whom Raytheon had previously dealt because of the short time frame involved. Waxman sent a telex requesting bids to three housing manufacturers on June 21, 1976. He could not recall whether he had spoken to the companies prior397 to sending the telexes, but frequently did so on rush contracts. The telex requested the companies to submit bids by June 23, 1976. Raytheon received the following bids from the three companies that received telexes and a fourth, Bendix International, which telephoned and asked for permission to submit a bid: >100> >101> BendixIMSWestyieldInternational3 Bedroom Homes(200 each)Area1152 sq. ft960 sq. ft1152 sq. ftFactory Price$ 15,552 $ 17,857 $ 15,027 Transportation Port-- 594 -- Transportation to 23,616 19,680 29,827 Saudi ArabiaTotal Price C&F to39,168 38,131 44,854 Saudi ArabiaCost per square foot34 39.7 38.9 Total price (200)7,833,600 7,626,200 8,970,800 4 Bedroom Homes(20 each)Area1440 sq. ftnot 1440 sq. ft.responsiveFactory Price$ 19,440 $ 18,550 Transportation to Port-- Ditto-- Transportation toSaudi Arabia29,520 Ditto36,150 Total price C&F to48,960 54,700 Saudi ArabiaCost per square foot34 Ditto38 Total price (20)979,200 Ditto1,094,000 Total Price - 2208,812,800 N/A 10,064,800 Homes398 AtlanticInternational3 Bedroom Homes(200 each)Area1152 sq. ftFactory Price$ 23,400 Transportation Port-- Transportation to 32,500 Saudi ArabiaTotal Price C&F to55,540 Saudi ArabiaCost per square foot48.21 Total price (200)11,108,000 4 Bedroom Homes(20 each)Area1440 sq. ftFactory Price$ 28,800 Transportation to Port-- Transportation toSaudi Arabia34,100 Total price C&F to62,900 Saudi ArabiaCost per square foot43.7 Total price (20)1,258,000 Total Price - 22012,366,600 HomesThe IMS bid was hand carried to Raytheon by its officers Thom and Holle on June 21, 1976, the same day they were formally asked to submit a bid. The other bids were late. IMS submitted the lowest responsive bid and was awarded the contract (hereinafter the "220 Homes Contract") on June 28, 1976, although a written requisition for the housing was not received until June 29, 1976. In submitting its bid for the housing, IMS, unbeknownst to Waxman, had an unfair advantage. Lemire had telephoned399 Thom, the president of IMS, on June 9, 1976, to provide him with general specifications on Raytheon's housing need. Without that information, IMS would not have been able to submit more than a general bid. As a result of Lemire's phone call, which was in violation of competitive bidding procedures, IMS had more time than the other companies to prepare its bid and knew what Raytheon wanted to see in the bid. IMS' bid included transportation to be provided by Interconex. Pursuant to a teaming agreement signed by Jon Stephens and Arthur Thom on June 7, 1976, IMS and Interconex agreed to work together to submit a bid to Raytheon for construction of modular housing and shipment of that housing to Saudi Arabia. The Teaming Agreement provided in part, IMS and Interconex agree to form a joint venture whereby the parties will work together to develop contracts for the manufacture in the United States, the delivery to Saudi Arabia, and in certain cases the erection there of modular houses designed by IMS. The parties agree that IMS will be named the prime contractor in and that Interconex will be the sub-contractor to IMS for all transportation elements of any relevant project, except400 that, unless otherwise mutually agreed, IMS will arrange to deliver the houses to the port of embarkation and Interconex's transportation responsibilities will commence at the port.IMS submitted its bid to Raymes individually but in its proposal expressly stated that Interconex would provide shipping services. IMS had not worked with Interconex prior to the 220 Homes Contract. Thom and Holle testified that someone in procurement at Raymes suggested that they contact Interconex. They were unable to remember who made the suggestion but dealt primarily with Lemire at Raymes. Thom and Holle were told by Jon Stephens of Interconex that Interconex had performed shipping for Raytheon before and knew how to make the proper arrangements for overseas shipping and to resolve any problems that might arise. Both were given the impression that Interconex would be an acceptable shipper to Raytheon. Thom met with Stephens in New York on June 7, 1976. He questioned the shipping rate that Stephens quoted because he considered it to be high. Stephens, however, assured him that he was quoting a rate that was acceptable to Raytheon. Stephens and Thom prepared and signed the Teaming Agreement401 at that meeting. Stephens testified that the idea for a teaming agreement originated as a result of a meeting with Lemire and Carver. Lemire, Carver, Stephens and Interconex had a business relationship independent of Raytheon (see infra). Raytheon had a company policy to use Behring International for all shipping, with the result that Interconex could not bid directly for the shipping contract. A teaming agreement was suggested as a way to incorporate the transportation bid with a housing bid. Lemire denied any knowledge of a teaming agreement between IMS and Interconex. He acknowledged discussing the use of teaming agreements with Stephens in another context but denied ever discussing Interconex with IMS. We find that Lemire suggested and was aware of the Teaming Agreement with IMS. Lemire was in contact with both Thom and Stephens around the time the Teaming Agreement was signed. The bid proposal that IMS submitted to Raymes specifically referred to Interconex as the shipper, and we find it incredible that Lemire, as manager of the procurement division, would not have read the bid before awarding the contract to IMS. Moreover, because of his relationship with Stephens, 402 we cannot believe that Lemire was unaware of how Interconex came to be a part of the IMS bid. Finally, as discussed below, Lemire had an independent business relationship with Stephens and stood to benefit if Interconex provided shipping services to Raymes. At approximately the same time the 220 Home Contract was awarded, Lemire's division received requests from Carver to purchase three and four bedroom houses and 90 units of "bachelor quarters" for use at "Rayville," a Raytheon installation in Saudi Arabia. The requests were again urgent and Waxman thus requested bids only from vendors with whom Raytheon had dealt previously. IMS again submitted the lowest responsive bid and was awarded the contracts (hereinafter collectively referred to as the "Special Shipment Contract"). 3 On September 1, 1976, IMS entered into a transportation agreement with Interconex pursuant to which Interconex would arrange to ship the houses and bachelor quarters to Saudi Arabia in a single shipment. Generation403 HoldingsImmediately after IMS received the 220 Homes Contract award from Raymes, Thom met again with Stephens. At Stephens' request, the shipping agreement between IMS and Interconex was divided into two parts. IMS entered into one agreement with Interconex and a second agreement with Generation Holdings, Ltd. ("Generation Holdings"), a Liberian company with its office at Geneva, Switzerland. The shipping services agreement between IMS and Generation Holdings was dated June 7, 1976, but signed a few weeks later. Thom signed on behalf of IMS and Louis Isaacs 4 signed on behalf of Generation Holdings. Payments for transportation services were made separately to Interconex and Generation Holdings. Generation Holdings was formed in or about 1974 on behalf of Lionel Achuck for use in his international business dealings. Pierre de Charmant, a Swiss attorney, formed Generation Holdings and, by holding all of its bearer shares, was the technical owner of the corporation. Achuck had power of attorney over the corporation404 which enabled him to instruct de Charmant to act for Generation Holdings on his behalf. Stephens did not have a power of attorney over Generation Holdings but nonetheless caused Generation Holdings to enter into the shipping agreement with IMS without Achuck's knowledge. 5 Stephens subsequently told Achuck that he had used Generation Holdings to enter into the contract with IMS rather than using Coralda Trust Reg., a Swiss corporation over which he had the power of attorney, because the name Generation Holdings sounded more like a shipping company. The original agreement between IMS and Interconex provided for shipment of 220 houses in three sailings at a cost of $ 20.50/square foot payable to Interconex. As a result of the new agreements between IMS and Interconex and IMS and Generation Holdings, the houses were to be delivered in three shipments at a cost of $ 12.65/square foot payable to Interconex and $ 7.85/square foot payable to Generation Holdings. The Special Shipment Contract provided for405 delivery in one shipment at a cost of $ 12.65/square foot payable to Interconex. No transportation agreement between IMS and Generation Holdings providing for services under the Special Shipment Contract was offered into evidence, but because Generation Holdings received payment for the shipment, it appears that such an agreement, perhaps oral, existed. Generation Holdings received $ 775,000 for the shipment of homes under the Special Shipment Contract and $ 678,240 for each of two sailings under the 220 Homes Contract. As a result of an internal investigation at Raytheon, see infra,Interconex and IMS cancelled their agreements on January 6, 1977. Raymes took over the final sailing under the 220 Homes Contract. Generation Holdings thus received a total of $ 2,131,480 from IMS for the three shipments. Generation Holdings, however, performed no services under its contract with IMS. Thom was told that Generation Holdings would take care of "greasing the way," if necessary, to get the shipments through the Saudi Arabian port expeditiously and to arrange whatever documentation was necessary. Its services, however, were not needed. 6 Generation Holdings thus had no expenses, 406 and the money it received was entirely profit. Stephens and Richard Davies, the attorney who signed the shipping agreement between Generation Holdings and IMS under the name Louis Isaccs, caused the payments received from IMS under the shipping agreement to be deposited in Generation Holdings' account at Credit Suisse in Geneva, Switzerland."Joint Ventures"Prior and subsequent to the Triad contract, Lemire and Carver were searching for business opportunities in the Middle East and particularly Saudi Arabia in their individual capacities. Stephens was also seeking business opportunities on behalf of Interconex. Carver and Lemire testified that they were involved in a joint venture with Stephens and Achuck beginning in 1976 to construct a modular housing factory in Saudi Arabia. Stephens and Achuck denied407 that any joint venture existed. Beginning around 1975, Carver, Stephens and Lemire discussed building a factory in Saudi Arabia to produce modular homes for sale to private entities and to the Saudi government. They also discussed shipping prefabricated housing from Europe or the United States to Saudi Arabia. In connection with that proposal, Lemire and Stephens visited a housing company in Colorado but ultimately concluded that the inland transportation costs would make the project economically unsound. As part of their plans, Carver, Lemire and Stephens hoped to supply the housing needs associated with the Triad contract between Raytheon and the Saudi Arabian government. At the last minute, however, the Saudis demanded that Raytheon provide the housing as part of the Triad contract. After the Saudis decided to include the housing needs for the Triad missile base in their contract with Raytheon, Stephens met with Lemire and Carver. At that meeting, Stephens testified, the three devised a plan for obtaining a share of the profits from the housing even though Raytheon was supplying the housing directly to the Saudi government. Lemire suggested that Interconex enter into a408 teaming agreement with a potential housing supplier because it could not bid directly on the transportation portion of the contract. Stephens, on behalf of Interconex, then entered into the Teaming Agreement with IMS. Stephens described the Teaming Agreement as fulfilling two purposes. First, the shipping agreement between Interconex and IMS allowed Interconex to profit from the shipment of housing to Saudi Arabia. Second, the IMS/Generation Holdings shipping agreement allowed Stephens to direct a portion of the revenue from the housing shipments to Generation Holdings. Stephens stated that he, Carver, and Lemire agreed in June 1976 to split the proceeds flowing to Generation Holdings with 50 percent going to Carver and Lemire and 50 percent to Stephens and Achuck. Lemire and Carver denied that there was ever any agreement to divide profits from the 220 Homes Contract and the Special Shipment Contract. Lemire and Carver also denied any knowledge of Generation Holdings or its connection with the contracts. We have already found that Lemire suggested to IMS and Interconex that they enter into a Teaming Agreement. We also accept Stephen's testimony that he, Achuck, Lemire409 and Carver planned to divide the excess profits from the 220 Homes Contract. It does not follow, however, that Lemire and Carver necessarily knew of the existence of Generation Holdings or of its role in diverting funds to Geneva. Regardless of whether Lemire and Carver knew that Generation Holdings was the immediate source of the funds received from Stephens (see infra), they knew that Raytheon was the ultimate source of those funds. The revenue that Generation Holdings received as a result of its shipping agreement with IMS, totalling $ 2,131,480, was deposited at Credit Suisse in Geneva. The first disbursement from the Generation Holdings account took place on October 4, 1976, when Stephens, Carver and Achuck met in Geneva. Carver wanted to form a company to hold the money that Stephens was going to transfer to him and to Lemire, and Stephens and Achuck knew attorneys in Geneva who could help him do so. Achuck introduced Carver to a Swiss attorney, Rene Mezger. Mezger formed Redcon Establishment, a Liechtenstein company with its office at Geneva, Switzerland, on Carver's behalf. Redcon Establishment was a bearer share corporation and Mezger and his associates held410 the shares. Carver had a power of attorney and could direct disbursements from Redcon Establishment. Immediately after Redcon Establishment was formed, Carver and Achuck went to a Swiss bank where Carver opened a safety deposit box in the name of Redcon Establishment. While Carver and Achuck were involved with the formation of Redcon Establishment, Stephens had checks drawn on the Generation Holdings account in the name of Redcon Establishment. He also withdrew currency in the form of Swiss francs from the account. Later that day, Carver, Stephens, Achuck and Mrs. Carver met in the Carvers' hotel room. Stephens gave Carver checks totalling approximately $ 300,000 and Swiss francs worth $ 200,000. Because the banks were already closed, Carver put the checks and cash in the hotel's safe overnight and placed the checks in Redcon Establishment's safety deposit box the next day. After leaving Geneva, Carver met with Lemire in Rome. Carver told Lemire that he had opened an account to hold funds for use in their business ventures in Saudi Arabia and that $ 500,000 had been turned over to them by Stephens. Carver and Lemire characterized the funds in the Redcon Establishment411 account as capital contributions by Stephens and Achuck for use in various joint ventures in Saudi Arabia. They testified that Stephens, Achuck and they were all involved in the joint ventures, although Achuck's role was more that of a silent partner than an active participant, and that Stephens and Achuck provided all of the capital and they provided all of the services. Stephens and Achuck denied that they were involved in any joint ventures with Carver and Lemire. Stephens conceded discussing various business plans with Lemire and Carver but said that none of them got off the ground or went far enough to be considered a joint venture. We find that there was a business relationship among Lemire, Carver, Stephens and Achuck but do not need to decide whether that relationship constituted a "joint venture." Regardless of the nature of the parties' business relationship, the money Lemire and Carver received from Stephens was a share of the profits from the 220 Homes Contract and the Special Shipment Contract that the parties had agreed to share. Perhaps it was intended for subsequent use as a capital contribution, but its character as profit to Lemire and Carver from their fraud412 on Raytheon is clear. Stephens made additional transfers of funds from the Generation Holdings account to Redcon Establishment in 1977 pursuant to the agreement among Carver, Lemire, Stephens and Achuck to share the profits from the IMS/Generation Holdings transportation agreements. The total amount transferred was approximately $ 1 million. The Funds in the Generation Holdings account that were not transferred to Redcon Establishment were transferred to an annuity in Bermuda for the benefit of Stephens and Achuck. No documentation was ever prepared in connection with the transfer of funds to Redcon Establishment. Lemire and Carver characterized the payments as capital contributions for which no loan documentation would be required but at another point Lemire contradicted himself by stating that there was an unwritten agreement to repay Stephens. Stephens testified that he never expected to be repaid and we find that the funds were not intended to be loans.Cayman Islands AccountsCarver and Lemire used part of the money in the Redcon Establishment account on various business ventures. 7 Most of it, however, was moved to two companies in the Cayman Islands for tax413 and secrecy reasons. The Cayman Islands have no income tax and have bank secrecy laws similar to those in Switzerland. Lemire and Carver created accounts in the Caymans to take advantage of the secrecy laws. All of the funds deposited in the Cayman Islands came from Stephens through Redcon Establishment. Lemire travelled to the Cayman Islands in May or June 1977 to form a company called International Resource Management Consultants, Limited ("IRMC"). Lemire met with Derek Harold Mitchley Price, whose company provided a registered office and staff for Cayman Islands companies. Price established IRMC as a bearer share company with himself and a secretary from his office serving as the directors and Lemire and Carver holding the shares. IRMC had a bank account in the Cayman Islands over which Price had sole signatory authority. Lemire had the power to instruct Price to act on behalf of IRMC. Lemire put a small amount of money into the IRMC account at the outset. On June 28, 1977, he sent an additional $ 200,000 for deposit in the account. The $ 200,000 came from Redcon Establishment. On Lemire's414 instructions, Price formed a second company in August 1977 called Redcon Limited. Redcon Limited was also a bearer share company and had the same directors and ownership as IRMC. On November 7, 1977, Lemire delivered three checks totalling $ 500,000 to Price for deposit in Redcon Limited's account. The deposit included the checks that Stephens gave Carver in Geneva in October 1976 and which had been in Redcon Establishment's safety deposit box in Geneva. Lemire also asked Mrs. Carver to wire funds from Redcon Establishment to IRMC. At her request, he sent her written instructions on how to do so because she did not speak English well. Mrs. Carver then wired two additional checks, one in the amount of $ 50,000 and the other for $ 44,000 from Redcon Establishment to Price for deposit in IRMC's account. On Lemire's instruction, Mrs. Carver also withdrew $ 50,000 from the Redcon Establishment account which she kept to cover her living expenses. Lemire deposited a total of $ 794,000 in the Cayman Islands accounts. Carver knew Lemire was opening accounts in the Cayman Islands but testified that he was not aware of any details concerning the accounts and did not think it important415 to find out despite the large amounts of money ultimately deposited there. He also could not explain why it was necessary to transfer money from Redcon Establishment to the Cayman Islands. IRMC was established to receive commissions from a construction contract that Carver and Lemire 8 entered into with an Italian company, Cassini International ("Cassini"). Cassini had a prefabrication plant in Saudi Arabia. Cassini received a $ 200 million contract from the Saudi government in July 1977. Pursuant to a contract that Carver and Lemire entered into with Cassini in London, Carver, Lemire, Stephens and Achuck were to receive a 4-percent commission on the Saudi Arabian project. Lemire and Carver thus expected to receive $ 8 million dollars to split with Stephens and Achuck and which would be deposited in the Cayman Islands to evade United States income tax. The Cassini deal, however, fell through because Carver was forced to resign from Raytheon and leave Saudi Arabia in a hurry in August 1977. 9416 All of the money deposited in the Redcon Limited account came from Redcon Establishment. Carver gave Lemire checks which Lemire carried to the Cayman Islands for deposit. All of the money was to be used to set up a housing factory in Saudi Arabia. The factory, however, was never built and the Redcon Limited account was consolidated with the IRMC account in 1978. Lemire transacted business in the Cayman Islands under the name Jack Milhouse. Lemire first used the name Milhouse in the Cayman Islands in May 1977 when IRMC was incorporated. Jack Milhouse is the name on file with the government of the Cayman Islands as owner of the corporation. Milhouse was also the registered owner of Redcon Limited. Lemire used an alias in conducting business in the Cayman Islands to avoid detection by the Internal Revenue Service and by the Saudi Arabian prince. Between 1977 and 1979 Lemire made several withdrawals from the Redcon Establishment, IRMC and Redcon Limited accounts totalling $ 180,000. For each withdrawal from IRMC and Redcon Limited, Lemire had to sign a loan, but the companies later were dissolved, and none of the money was ever repaid. As previously found, $ 50,000 from Redcon417 Establishment went to Mrs. Carver to cover her living expenses. In addition, Lemire sent $ 80,000 from the Cayman Islands accounts to Carver to cover his expenses in Saudi Arabia. The remaining $ 50,000 was withdrawn from the Cayman Islands companies. Lemire claimed to have used part for business expenses and admitted converting approximately $ 35,000 for his personal use. A total of $ 844,000 was transferred from Generation Holdings to Redcon Establishment in 1976 and 1977. In 1977, Carver and Lemire transferred $ 500,000 from Redcon Establishment to Redcon Limited. Also in 1977, Carver and Lemire transferred from Redcon Establishment $ 294,000 to IRMC and $ 50,000 to Mrs. Carver for her personal use. Thus, a total of $ 794,000 was ultimately transferred from Redcon Establishment to the Cayman Islands and an additional $ 50,000 was converted to Mrs. Carver's personal use. Respondent determined that Carver and Lemire each received $ 1,049,000 from Stephens out of the Generation Holdings account. Stephens' testimony supports only the receipt of a total $ 1,049,000. The record also supports only a finding that Carver and Lemire together received little more than $ 1 million. 418 Carver and Lemire admitted that Stephens transferred approximately $ 900,000 to them in Geneva. Carver also admitted receiving between $ 150,000 and $ 165,000 from Stephens at a bank in Al Khobar. We find that Stephens transferred approximately one-half of the $ 2,131,480 received as a result of the contract between IMS and Generation Holdings to Carver and Lemire, and thus find that Carver and Lemire together received a total of $ 1,049,000, $ 705,000 in 1976 and the balance of $ 344,000 in 1977.Raytheon InvestigationBecause the Saudis' housing requirement for the Triad contract was urgent, the standard procurement policies were not followed. The 220 Homes Contract was awarded to IMS on June 28, 1976, although a written requisition for the housing was not received until June 29, 1976. In addition, Lemire signed the contract, thus legally binding Raytheon, without obtaining the prior corporate approval required on a contract of that value. The Special Shipment Contract was awarded and signed in the same manner but, upon subsequent review, was not approved by higher corporate officials. In 1975, Raytheon management issued a directive that all shipping on Raytheon419 contracts be handled by Behring International. Behring was to act as freight forwarder and to negotiate steamship rates. The reason for using a single freight forwarder was that Raytheon could obtain better rates for large volume shipments. Interconex was also considered as a freight forwarder but at the meeting at which Behring was selected, Lemire's division cast the only vote against Behring and in favor of Interconex. The directive requiring the use of Behring was apparently mandatory only when Raytheon was shipping items and applied only to break bulk shipments. Thus, Lemire and Waxman concluded that if a subcontractor such as Interconex rather than Raytheon handled transportation, the directive would not apply. In 1976, all procurements in excess of $ 10,000 required a summary of award for the contract file. After the 220 Homes Contract was awarded, Waxman prepared a summary of the award to IMS for Raytheon's files. Attached to the summary were copies of the various proposals. IMS's proposal dated June 21, 1976, indicated its intent to use Interconex as the shipper. A procurement review form was also forwarded to Raytheon's corporate headquarters for review. The summaries420 and review form indicated that IMS submitted the lowest responsive bid. Waxman also prepared summaries and procurement review forms for the Special Shipment Contract award. Francis W. Ramsey was an attorney employed as a corporate manager for Raytheon Corporation in 1976. His job was to review large subcontracts. Lemire was supposed to obtain Ramsey's review prior to executing and releasing a subcontract. If he failed to do so, as he did with the subcontracts awarded to IMS, however, the contracts were nonetheless legally binding on Raytheon. Ramsey agreed with Lemire that corporate policy did not require use of Behring. In fact, he could not remember whether he had heard of the Behring directive. Ramsey reviewed the 220 Homes Contract in July 1976. 10 He based his review on materials that Waxman brought him, consisting primarily of spread sheets. Ramsey did not review the original bid documents. The spread sheets indicated that only IMS submitted a responsive bid. Ramsey was not satisfied with the information he received, and although he believed that the Behring directive was not necessarily binding, he was concerned that the subcontractor was providing transportation because421 Raytheon generally provided its own transportation. He approved the contract and took no further action, however, because the contract had already been let. Ramsey reviewed the Special Shipment Contract in September 1976. Waxman again brought him contracts and a spread sheet showing prices. As had the 220 Homes Contract, the Special Shipment Contract had already been let without seeking Ramsey's approval. Again Ramsey found that only IMS had bid responsively. He was concerned about the quoted costs for both the housing and the transportation and discussed his concerns with Lemire. Lemire told him that there had been a mark up on the housing prices because IMS was a highly respected group of architects who specialized in building homes for Saudi Arabian use. Lemire had previously told Ramsey that IMS was a highly efficient automated factory that would be able to meet urgent delivery dates. When Ramsey confronted Lemire with his previous statements, Lemire said he previously thought that IMS was a factory. Ramsey also asked Lemire who the shipper was. Lemire said he422 did not know and would not find out because it was IMS's responsibility, not Raytheon's. Ramsey found out later that day from Waxman that the shipper was Interconex. Lemire knew at the time he awarded the contract that Interconex would provide for transportation. After learning that Interconex was the shipper, Ramsey spoke to James Welty and Ralph Driscoll in Raytheon's transportation department and asked them to find out how much the charter had cost. Within 20 minutes, Welty and Driscoll discovered that there was an estimate on the special shipment of $ 48 per ton, whereas the IMS contracts provided for transportation costs of $ 102 per ton. Ramsey sent a memorandum detailing his findings to Lemire on October 25, 1976. Lemire responded that he had actually saved the company money because if Raytheon had shipped the houses, it would have had to do so under the company-wide agreement with Behring. Behring charged $ 164 per ton. Ramsey argued that Raytheon would have chartered a ship for shipments of this size, and the Behring directive applied only to break bulk shipments, which are always more expensive than charters. Although Raytheon had never chartered a ship before, 423 the Behring directive did not preclude them from doing so. Lemire nonetheless maintained, and continued to maintain at trial, that he had saved the company money. On November 8, 1976, Ramsey, Welty, Lemire and others attended a meeting at Raytheon's corporate headquarters to discuss the IMS subcontracts. Welty had obtained estimates of shipping costs from Behring and information on Interconex's costs from the Federal Maritime Commission and reconstructed what a shipment should have cost. He discovered that Raytheon could save $ 700,000 per voyage by handling the shipments itself. At that time two voyages had been completed and the third was imminent. Lemire stated that he did not think Raytheon would be able to take over the third sailing but would work for the fourth. Raytheon eventually took over the final shipment and saved $ 700,000. The day after the meeting Lemire tendered his resignation, stating that he wanted to devote himself to his other business endeavors. 11424 The Criminal ProceedingsIn September 1981, Carver, Lemire, Achuck, Stephens and Interconex were indicted in the United States District Court for the District of Columbia for violations of 18 U.S.C. §§ 371, 1343, 2314 and 2. The indictments resulted from an investigation of the defendants' roles in the shipment of modular housing to Saudi Arabia under the Triad contract. In December 1982, following a jury trial, Lemire, Stephens, Achuck and Interconex were convicted of four counts of wire fraud in violation of 18 U.S.C. §§ 1343 and 2, one count of transportation of the proceeds of fraud in interstate commerce in violation of 18 U.S.C. §§ 2314 and 2, and one count of conspiracy in violation of 18 U.S.C. § 371. The convictions were affirmed by the United States Court of Appeals for the District of Columbia Circuit. 12 Lemire was sentenced to five years imprisonment and fined $ 19,000. Stephens also received a prison term and Achuck was placed on probation. 425 Carver's criminal case was separated from the other defendants. On December 16, 1982, Carver pled guilty under an Alford plea 13 to one count of wire fraud, a violation of 18 U.S.C. §§ 1343 and 2. He was sentenced to three years' imprisonment and fined $ 1,000. On November 24, 1987, we held a hearing on respondent's Motion to Determine the Admissibility of Prior Criminal Judgments and to Determine the Facts Essential to Sustain those Judgments. After due consideration, we issued an Order that the facts essential to sustain the convictions were admissible as evidence in this case but did not collaterally estop the petitioners from introducing conflicting evidence. We found the following facts to be essential to the criminal convictions: 1. Raytheon and IMS entered into two contracts in 1976, in which IMS agreed to manufacture and deliver prefabricated housing to Saudi Arabia. 2. During 1976 and thereafter, 426 Joseph Lemire, Roy Carver, Jon Stephens, Lionel Achuck and Interconex entered into a scheme to defraud Raytheon Corporation of money on the housing contracts entered into between Raytheon and IMS. 3. As part of their scheme to defraud Raytheon Corporation, Joseph Lemire, Roy Carver, Lionel Achuck, Jon Stephens, and Interconex did cause IMS to enter into a separate shipping subcontract with Generation Holdings on the Raytheon-IMS prefabricated housing contracts. 4. A $ 775,008 check payable to Generation Holdings, a subcontractor of IMS on the housing contracts, was stolen, converted or taken by fraud from Raytheon Corporation by Joseph Lemire, Roy Carver, Jon Stephens, Lionel Achuck and Interconex in the course of their scheme to defraud Raytheon Corporation of money. 5. The $ 775,008 check payable to Generation Holdings was part of the proceeds of the shipping aspect of the contract between IMS and Raytheon, which shipping contract would not have been consummated but for the fraud of Joseph Lemire, Roy Carver, Jon Stephens, Lionel Achuck, and Interconex. 6. In 1976, Joseph Lemire, Roy Carver, Jon Stephens, Lionel Achuck, and Interconex defrauded Raytheon Corporation of427 at least $ 775,008. 7. On or about September 21, 1976, Joseph Lemire, Roy Carver, Lionel Achuck, Jon Stephens, and Interconex for the purpose of executing their scheme to defraud Raytheon Corporation, did cause Jon Stephens to make a telephone call to IMS in which Stephens directed IMS to issue a check to Generation Holdings in the amount of $ 775,008, said amount representing a portion of the proceeds of their scheme to defraud Raytheon. 8. On or about January 7, 1977, Joseph Lemire, Roy Carver, Lionel Achuck, Jon Stephens, and Interconex for the purpose of executing their scheme to defraud Raytheon Corporation, did transmit a telex from the Cayman Islands, British West Indies to IMS in Washington, D.C. in which Generation Holdings purported to release IMS from any remaining obligations on the shipping contract entered into between Generation Holdings and IMS on the Raytheon-IMS housing contracts. 9. On or about January 24 and 26, 1977, Joseph Lemire, Lionel Achuck, Roy Carver, and Jon Stephens, for the purpose of executing their scheme to defraud Raytheon Company, did cause Jon Stephens to make telephone calls to IMS, in which Jon Stephens furthered the efforts of Lemire, 428 Carver, Achuck, Stephens, and Interconex to conceal from the Raytheon Corporation the roles of Interconex Corporation and Generation Holdings in the scheme to defraud Raytheon. 10. That Roy C. Carver received $ 1,049,000 from Jon Stephens as a result of the scheme to defraud Raytheon Corporation, and Roy Carver divided the $ 1,049,000 with Joseph C. Lemire.The evidence presented at trial does not conflict with the facts set forth in our Order which were admitted into evidence as proof but which we now find as facts. OPINION Respondent contends that petitioners each received $ 1,049,000 in unreported income, $ 705,000 in 1976 and $ 344,000 in 1977, and that the resulting deficiencies in income tax are due to fraud within the meaning of section 6653(b). Absent fraud, the statute of limitations bars assessments and collection of any deficiencies for the years in issue. Section 6501(c). Respondent's deficiency determination is presumed correct, and petitioners bear the burden of refuting it by a preponderance of the evidence. Rule 142(a). 14 The burden of proving fraud by clear and convincing evidence rests on respondent. Section 7454(a); Rule 142(b). 429 Gross income includes all income from whatever source derived. Section 61(a). Lemire and Carver entered into an agreement with Stephens and Achuck to defraud Raytheon of money on the 220 Homes Contract and the Special Shipment Contract between Raytheon and IMS. As a result of that scheme, we have found that Carver and Lemire together received $ 1,049,000. Carver and Lemire admitted receiving approximately $ 1 million from Stephens. They maintained, however, that the money constituted a capital contribution to their joint business ventures, which Stephens and Achuck denied. They offered no evidence, other than their testimony, to show that the money received was not taxable income. 15 While we believe that Lemire and Carver intended that the funds be used in their prospective Saudi Arabian business ventures, we also believe the funds were their share of the proceeds of the fraud against Raytheon and are taxable to them. James v. United States,366 U.S. 213">366 U.S. 213 (1961). 430 In his notices of deficiency, respondent took the protective position that Carver and Lemire each received $ 1,049,000 over two years, $ 705,000 in 1976 and $ 344,000 in 1977, because he did not know how the funds were allocated between them. We find that Carver and Lemire received a total of $ 1,409,000, which they divided evenly. Thus, each of them received $ 352,500 in 1976 and $ 172,000 in 1977. Next we must decide whether any pat of the understatements of income resulted from fraud. Fraud is a factual question to be resolved by an examination of the entire record. Rowlee v. Commissioner,80 T.C. 1111">80 T.C. 1111, 1123 (1983). To establish fraud, respondent must introduce clear and convincing evidence that petitioners acted with specific intent to avoid taxes they knew or believed they owed. Stephenson v. Commissioner,79 T.C. 995">79 T.C. 995, 1005 (1982), affd. 748 F.2d 331">748 F.2d 331 (6th Cir. 1984); Rule 142(b). Respondent need not prove the precise amount of the underpayment attributable to fraud, but only that some part of the underpayment of tax for each year is attributable to fraud. Fraud is never presumed, Beaver v. Commissioner,55 T.C. 85">55 T.C. 85, 92 (1970),431 but may be proven by circumstantial evidence because direct proof of a taxpayer's intent is rarely available. Stephenson v. Commissioner,79 T.C. at 1005-1006. Petitioners' entire course of conduct must be examined to determine whether the requisite fraudulent intent exists. Solomon v. Commissioner,732 F.2d 1459">732 F.2d 1459, 1461 (6th Cir. 1984), affg. per curiam a Memorandum Opinion of this Court; Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 223-224 (1971). Respondent has proven that Lemire and Carver received at least $ 1 million as a result of their fraud against Raytheon. That money was taxable, but Lemire and Carver did not include it in income. Respondent, therefore, has met his burden of proving by clear and convincing evidence that there were underpayments of income tax for each year. As discussed below, the underpayments were due to fraud. Courts have relied on a number of indicia of fraud in deciding section 6653(b) cases. Although no single factor is necessarily sufficient to establish fraud, the existence of several indicia is persuasive circumstantial evidence. Solomon v. Commissioner,732 F.2d at 1461; Beaver v. Commissioner,55 T.C. at 93.432 First, a failure to maintain adequate books and records may indicate fraudulent intent. Estate of Upshaw v. Commissioner,416 F.2d 737">416 F.2d 737, 741 (7th Cir. 1969), affg. a Memorandum Opinion of this Court, cert. denied 397 U.S. 962">397 U.S. 962 (1970). Dealings in cash also indicate fraud and heighten the negative effect of inadequate recordkeeping. Friedman v. Commissioner,421 F.2d 658">421 F.2d 658 (7th Cir. 1970), affg. per curiam a Memorandum Opinion of this Court; Nicholas v. Commissioner,70 T.C. 1057">70 T.C. 1057, 1066 (1978). Third, a taxpayer's lack of credibility, inconsistent testimony or evasiveness on the stand are heavily weighted factors in considering the fraud issue. Toussaint v. Commissioner,743 F.2d 309">743 F.2d 309, 312 (5th Cir. 1984), affg. a Memorandum Opinion of this Court. Fourth, a taxpayer's business experience and knowledge of the tax laws may tend to prove or disprove the existence of fraud. See O'Connor v. Commissioner,412 F.2d 304">412 F.2d 304, 310 (2d Dir. 1969), affg. on this issue a Memorandum Opinion of this Court, cert. denied 397 U.S. 921">397 U.S. 921 (1970). Finally, a taxpayer's dishonesty in business transactions433 or willingness to defraud others may indicate a willingness to defraud respondent. Afshar v. Commissioner,T.C. Memo. 1981-241, affd. without published opinion 692 F.2d 751">692 F.2d 751 (4th Cir. 1982), cert. denied 461 U.S. 928">461 U.S. 928 (1983). All of these factors are present in this case and convincingly demonstrate that petitioners acted with fraudulent intent. Petitioners maintained no records relating to their alleged joint venture with Stephens and Achuck or of their agreement to split the profits from the transportation agreement between IMS and Generation Holdings. They presented no written evidence of any of their business ventures in the Middle East. In addition, Lemire, Carver, Stephens and Achuck conducted their dealings primarily in cash, and there were no writings evidencing the transfers of funds from Generation Holdings to Redcon Establishment. We did not find Lemire to be a credible witness. He contradicted himself concerning the money received from Stephens, first testifying that it was contribution to capital and later that it was a loan that was intended to be repaid. We also rejected his testimony that he was unaware of the Teaming434 Agreement between IMS and Interconex and his denial that there was any agreement to split excess profits earned from the transportation agreements with IMS. Carver's testimony also was not entirely credible. We rejected his contentions that there was never an agreement to split profits with Stephens and Achuck. His testimony that Stephens and Achuck, who are experienced businessmen, contributed money for use in a joint business venture without requiring any documentation or requiring Carver and Lemire to account to them for the use of the money is not believable. Further, Carver presented no documentation of any of his business ventures in Saudi Arabia. Lemire was an experienced and sophisticated businessman and had some knowledge of the tax laws. He testified that he opened the Redcon Limited account in the Cayman Islands to receive commissions specifically to avoid Internal Revenue Service scrutiny of the transactions. In addition, he admitted to using the alias Jack Milhouse primarily to avoid detection by the Internal Revenue Service. Lemire's and Carver's dishonesty in their various business dealings is further evidence of fraudulent intent. Both were convicted of defrauding435 their employer, Raytheon. Lemire lied to his superior, Ramsey, concerning the contracts between Raymes and IMS, stating that he did not know that Interconex was the shipper and describing IMS first as a factory and later as a group of architects. In addition, Carver and Lemire opened accounts in Switzerland and the Cayman Islands to take advantage of bank secrecy laws, to avoid disclosing traces of their fraud on Raytheon, and to avoid respondent's scrutiny. Based on the foregoing, we conclude that Lemire's and Carver's actions evidenced an intent to evade Federal income taxes known to be owing and sustain respondent's additions to tax under section 6653(b) for both of the years in issue. As to Mrs. Carver, however, we find that respondent has not met his burden of establishing fraud. Mrs. Carver was present when Stephens made the first transfer of funds from Generation Holdings to Carver. She also transferred funds from Redcon Establishment to the Cayman Islands and kept $ 50,000 for her personal use. The record indicates, however, that Mrs. Carver did not speak English well. Moreover, there is no evidence to indicate that Mrs. Carver knew that any of the money was taxable. 436 We, therefore, hold that Mrs. Carver is liable for the deficiency determined against Carver because she filed a joint return with him, but that she is not liable for the addition to tax for fraud. Decisions will be entered under Rule 155.Footnotes. Heidrum I. Carver did not appear at the trial. ↩1. All section references are to the Internal Revenue Code of 1954 as in effect during the years in issue.↩2. The parties stipulated that Lemire resigned from Raytheon in December 1976. Testimony at trial, however, indicates that he resigned the day after a company meeting held in early November 1976. ↩3. The date of the Special Shipment Contract award is not in the record. The purchase request forms are dated June 25, 1976, and summaries of the award were prepared on August 23, 1976.↩4. Louis Isaacs is a fictitious person. An attorney, Richard Davies, signed the contract on behalf of Generation Holdings using the name Louis Isaacs. ↩5. de Charmant was aware that Achuck and Stephens were partners and apparently believed that Achuck intended for both of them to have power of attorney over Generation Holdings. ↩6. We do not believe that the parties ever intended for Generation Holdings to provide any assistance in getting the shipments through port in Saudi Arabia. Carver testified that he had a lot of influence with a Saudi Arabian prince and was able to ensure that shipments moved through port expeditiously. There was thus no need for Generation Holdings to do so. ↩7. The record does not indicate the exact amount used on these ventures. ↩8. Stephens testified that he had heard about the project but did not participate in it. ↩9. Carver's apartment in London was under surveillance for a three-month period in 1977. Mrs. Carver was living in the apartment at the time. Her phone was tapped and her mail opened. In August 1977, a Saudi prince brought Carver to his office and played the tapes of phone conversations to him. He had previously played the same tapes to the president of Raytheon and demanded that Carver be removed from Saudi Arabia. It is not clear what the tapes revealed, but Lemire testified that the prince was to receive an eight percent commission on the Cassini contract and did not know (apparently until he listened to the tapes) that Carver and Lemire were also taking a share of the profits. ↩10. Lemire had mentioned the contract to Ramsey in June but did not request his approval at that time. ↩11. Just before leaving Raytheon, Lemire had formed a consulting company in New Hampshire called international Business Management Consultants ("IBMC"). Lemire and Carver planned to use the company to pursue business interests in Saudi Arabia. Stephens arranged for IBMC to receive a one-year consulting contract with a Cayman Islands company in the amount of $ 48,000. Lemire received two $ 4,000 payments on the contract.↩12. United States v. Lemire,720 F.2d 1327">720 F.2d 1327 (D.C. Cir. 1983), cert. denied 467 U.S. 1226">467 U.S. 1226↩ (1984). 13. North Carolina v. Alford,400 U.S. 25">400 U.S. 25 (1970). Under an Alford↩ plea, a defendant pleads guilty without admitting guilt based on an acknowledgment that the prosecution has sufficient evidence to assure his conviction. 14. All Rule references are to the Tax Court Rules of Practice and Procedure. ↩15. Petitioners argue that because of the difficulties inherent in proving a negative, i.e., that they did not receive income, we should shift the burden of proving the correctness of the deficiency to respondent. Petitioners cite cases in which courts have considered shifting the burden of going forward. These cases, however, involve assessments with no rational basis, so-called "naked assessments." Some courts will shift the burden of going forward to respondent if the taxpayer introduces some evidence that the assessment or deficiency asserted is arbitrary or excessive. See Helvering v. Taylor,293 U.S. 507">293 U.S. 507 (1935); see also United States v. Janis,428 U.S. 433">428 U.S. 433, 441-442↩ and nn. 9 and 10 (1976). In the instant case, there is an abundance of evidence supporting respondent's deficiency determination, and petitioners have presented no convincing evidence that the deficiency is wrong. Thus, this is not a case in which a shift in the burden of going forward is warranted.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619410/	ARCHIBALD SHERROD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. HENRY LAMBERT SHERROD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Sherrod v. CommissionerDocket Nos. 22257, 22258.United States Board of Tax Appeals16 B.T.A. 622; 1929 BTA LEXIS 2548; May 22, 1929, Promulgated 2548 1. INVESTED CAPITAL. - Where the taxpayer had an operating deficit at the close of the year 1920, but paid no dividends of any kind during that year or 1921 and there was no return of capital to the stockholders either directly or indirectly, held, that respondent erred in reducing the taxpayer's paid-in capital by the amount of an operating deficit and in determining a deficiency for the year 1921. 2. TRANSFEREES. - Petitioners contested the liability of the taxpayer and having proven that the taxpayer is not liable for the additional taxes in controversy, it is held that there is no liability of petitioners as transferees. William S. Pritchard, Esq., for the petitioners. John E. Marshall, Esq., for the respondent. TRUSSELL 622 The respondent reduced by the amount of $51,001.35 the invested capital of the Gadsden Ice & Coal Co. in his determination of that corporation's tax liability for the year 1921, which action resulted in a deficiency in the amount of $1,248.64 being asserted against the said corporation in a 60-day deficiency notice mailed on or about April 14, 1926, to the corporation. The said corporation was dissolved2549 623 in 1923, and under date of November 9, 1926, respondent mailed a notice to each of the petitioners herein, proposing to assess each in the amount of $624.32 as transferees under section 280 of the Revenue Act of 1926. The two proceedings have been consolidated for hearing and decision. Petitioners allege that respondent erred (1) in determining any deficiency against the Gadsden Ice & Coal Co. for the year 1921 and (2) in proposing to assess against each of them the amount of $624.32 as transferees. FINDINGS OF FACT. At the time of the hearing on these proceedings Archibald Sherrod resided at Highpoint, N.C., and Henry Lambert Sherrod resided at Birmingham, Ala. During the years 1920 to 1923, inclusive, both individuals resided in Etowah County, Ala. On August 6, 1920, A. Sherrod and H. L. Sherrod, as individuals, entered into a contract with the Gadsden Ice & Coal Co., an Alabama corporation, hereinafter referred to as the predecessor, for the purchase of its assets for the sum of $100,000. Those assets consisted of an operating ice-manufacturing plant, fuel storage yeards, real estate, equipment, and furniture and fixtures, all situated in the town of Gadsden, 2550 Ala.The two petitioners organized on or about August 24, 1920, under the laws of Alabama, a corporation known as the Gadsden Ice Co., with a fully paid-in capital of $100,000. Each petitioner subscribed for 500 shares of the par value of $100 each and they paid in for such stock $40,000 in cash and $60,000 in interest-bearing notes worth their face amount. The said notes were bona fide paid in to the corporation for stock and were later paid at their face amount. In addition, they paid in $8,980 in cash for working capital. The above-mentioned contract was transferred to the corporation, the taxpayer herein, which purchased the said assets for $100,000 on the basis of $40,000 in cash and $60,000 in notes bearing interest at 8 per cent and secured by a mortgage on the assets. The taxpayer paid off its notes and after the predecessor corporation dissolved the taxpayer had its name changed from the Gadsden Ice Co. to the Gadsden Ice & Coal Co. On August 24, 1920, the taxpayer owned and used in its business the following assets purchased from its predecessor: Machinery$59,000Buildings10,000Real estate30,500Tools and supplies250Furniture and fixtures250Total100,0002551 624 On the same date it had outstanding 1,000 shares of stock of a par value of $100 each. The taxpayer retained all of its assets during its existence, and it paid no dividends of any kind until a final liquidating dividend of $40,000 was paid to each of petitioners after the taxpayer was dissolved in August, 1923, because it was a losing venture. Prior to dissolution there was no return of capital invested by petitioner, either directly or indirectly. The taxpayer's books have either been destroyed or lost and could not be produced at the hearing, except the minute book. The taxpayer filed its income and profits-tax return for the year 1921, reporting a net income of $12,863.54, and an invested capital of $100,000. It computed an excess-profits credit of 8 per cent of invested capital, or $8,000 plus an exemption of $3,000, a total of $11,000, leaving a balance of $1,863.54, on which it computed a profits tax at 20 per cent, equaling $372.71. It then computed an income tax of $1,086.35, or 10 per cent of $10,863.54, which was the balance left after deducting an exemption of $2,000 from the net income of $12,863.54. The said return showed a total tax of $1,459.06, 2552 which was paid. Attached to the return is a comparative balance sheet for the periods ending December 31, 1920 and 1921. For the period ending December 31, 1920, there is included in liabilities a deficit in the amount of $51,001.35. Respondent, in auditing the taxpayer's return for 1921, used a net income of $12,863.54 as reported, but reduced invested capital by the amount of $51,001.35, as a liquidating deficit, which action resulted in a profits tax of $1,801.49 and the total amount of the deficiency of $1,248.64 here in question. OPINION. TRUSSELL: The Revenue Act of 1921, section 326(a), provides that there shall be included in invested capital "(1) actual cash bona fide paid in for stock or shares; (2) actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, * * ." Section 325 of the same Act provides that "The term 'tangible property' means stocks, bonds, notes, * ." There is no question but that the taxpayer had a statutory invested capital of $100,000 on August 24, 1920, and no issue has been raised relative thereto. The first issue involves the correctness of respondent's action in reducing that statutory invested capital2553 for the year 1921 by the amount of $51,001.35. The record does not disclose how the taxpayer sustained the alleged deficit in amount of $51,001.35 after operation for about four months, and from the facts of record it would appear that no such deficit existed except through erroneous bookkeeping. However, in this proceeding the actual amount of the operating deficit is immaterial. 625 The facts are that the taxpayer did set up on its balance sheet of December 31, 1920, the amount of $51,001.35 as an operating deficit, and it appears that respondent assumed that that amount represented a partial liquidation and a corresponding reduction of invested capital. The respondent reduced the taxpayer's invested capital for 1921 from $100,000, as reported on its return, to $48,998.65, which action resulted in the deficiency asserted in the amount of $1,248.64. The facts of record disclose that during the existence of the taxpayer it retained all of the assets which it had purchased from its predecessors; that it retained all of its paid-in capital; that it did not partially liquidate, and that it paid no dividends of any kind until a final liquidating dividend of $40,000 was2554 paid to each of petitioners after the assets were sold and the taxpayer was dissolved in August, 1923. The deficit was an operating deficit and until August, 1923, there was no return of capital invested by the petitioners, either directly or indirectly. During the year 1921 the amount invested by petitioners in the taxpayer remained unchanged and section 326 of the Revenue Act of 1921 makes no provision for the reduction of invested capital of a corporation by the amount of an operating deficit. We are of the opinion that respondent erred in reducing the taxpayer's invested capital for the year 1921 by the amount of $51,001.35. Cf. . Petitioners have contested the liability of the taxpayer for any additional taxes and we are led to the conclusion that there is no deficiency in the tax liability of the taxpayer, the Gadsden Ice & Coal Co., for the year 1921, and accordingly there is no liability on the part of the petitioners herein as transferees under section 280 of the Revenue Act of 1926. Judgment of no liability will be entered for petitioners.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619412/	LOUIS C. DRAPEAU, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. HENRY MORRISSEY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Drapeau v. CommissionerDocket Nos. 81256, 83412.United States Board of Tax Appeals36 B.T.A. 730; 1937 BTA LEXIS 663; October 26, 1937, Promulgated 663 The compensation received by a California inheritance tax appraiser, part of which is paid in a fixed annual amount out of state funds by the state controller and part of which is paid out of the particular estates appraised, is included in taxable income to the extent derived from the appraised estates. Ralph W. Smith, Esq., for the petitioners. Arthur H. Fast, Esq., for the respondent. STERNHAGEN 730 OPINION. STERNHAGEN: The petitioners were, in 1932 and 1933, inheritance tax appraisers of the State of California, Drapeau for Ventura County and Morrissey for Los Angeles County. The Commissioner determined that the entire compensation they received for their services in that capacity was subject to tax, and by including it in their gross income arrived at deficiencies of $27.24 and $29.13 for Drapeau, and $1,029.13 and $527.16 for Morrissey. They assail these determinations on the ground that such tax would be an unconstitutional interference by the Federal Government with the prformance by the state of its essential governmental functions. No facts are in dispute, and the evidence consists largely of a description by the state controller664 and by inheritance tax appraisers of the statutory system 1 governing petitioners' functions and its actual operation. Petitioners were appointed by the state controller. They took the statutory oath prescribed for officers, and held their offices for indefinite terms. Within their respective counties they were assigned to appraise particular estates, the appraisal being subject to approval of the court. Both were lawyers, and they were permitted to engage in practice if it did not interfere with their official duties. Morrissey in fact gave up all other practice during the years in question, and devoted himself entirely to his work as a state appraiser in Los Angeles. Drapeau in fact devoted more time to the practice of law than to state appraisal work. The compensation of such appraisers is a combination of an amount fixed by the controller to be paid by the state, and a fee, in accordance with a statutory schedule, to be paid by the estate, the amount 731 of which is in practice665 subject to the controller's approval. In 1932 Morrissey received $14,090.32 compensation, of which $3,200 was annual compensation from the state, paid by the controller out of inheritance tax receipts, and $10,890.32 was the sum of fees paid out of the estates appraised. In 1933 he received $9,056.35, made up of $3,200 as compensation from the state and $5,856.35 as fees from estates. Drapeau's 1932 total income was reported as derived, $5,545.38 from his law practice and $1,305.66 from his services as appraiser. It is stipulated by counsel that this $1,305.66 was received, 15 percent, or $195.85, from the state and the rest, $1,109.81 from estates appraised. His 1933 reported income was $5,802 from his law practice and $1,141.28 from his services as an appraiser, of which it is stipulated that 15 percent, $171.19, came from the state and $970.09 from estates appraised. The record as to Drapeau is not satisfactory. He did not appear, and the foregoing stipulated facts are all that are in evidence. The state controller testified that generally appraisers in Los Angeles County were paid state compensation of $3,200 a year, and those in San Francisco and other counties $3,000; 666 but there is no testimony whatever as to the method of arriving at Drapeau's compensation. In our opinion, these inheritance tax appraisers are officers of the State of California, performing an essential governmental function. They are a necessary part of the revenue system provided by statute; appointed with an unlimited tenure and not for a specific job; taking a required oath of office; paid by the state; and supported by all the necessary powers of the state in the performance of their duties. If their entire function were to determine the value of taxable inheritances for the purpose of assessing the tax, and they received for this a fixed salary from the state, their immunity from Federal tax as to such salary would be clear. We think it applies no less to that amount paid annually by the state as compensation - the $3,200 received each year by Morrissey and the $195.85 and $171.19 received by Drapeau. These amounts, the controller testified, were fixed expressly with regard to the need for competent and reliable uniform service to the state, and the theory of the constitutional immunity as a necessary protection of the state's bargaining power is applicable. But the667 courts have differed as to the compensation derived from others than the state itself, and, as to the amounts received by these petitioners as fees paid by the estates, it can not be said that the Federal tax operates as a burden upon the state. The appraisal is not entirely an incident of tax collection, but is also an incident of probate. It is apparently largely in this aspect that it is to be paid for by the estate. Although it is made under the aegis of the state 732 controller and the probate court, this is not a ground for Federal tax immunity. See ; ; ; . Cf. ; . The amounts received by both petitioners as fees paid by the estates are properly within their taxable gross income. Judgment will be entered under Rule 50.Footnotes1. Political Code, sec. 445; Probate Code, sec. 605, sec. 609, amended Stats. 1933, ch. 283; Code of Civil Procedure, sec. 1723; General Laws, 1931, Act 8443, secs. 14, 16, 17. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619413/	Robert A. McKinney, Petitioner, v. Commissioner of Internal Revenue, RespondentMcKinney v. CommissionerDocket No. 23758United States Tax Court16 T.C. 916; 1951 U.S. Tax Ct. LEXIS 214; April 26, 1951, Promulgated 214 Decision will be entered under Rule 50. Held that petitioner is not entitled to a deduction under section 23 (u) of the Internal Revenue Code for the payments in question because they do not come within the provisions of section 22 (k) of the Code. Robert A. McKinney, pro se.T. M. Mather, Esq., for the respondent. Hill, Judge. HILL 916 OPINION.The respondent determined a deficiency in petitioner's income tax for the year 1945 in the amount of $ 193.36. The question is whether amounts paid to petitioner's wife for alimony pendente lite, attorney's fees and court costs are deductible from petitioner's income for the year 1945. The respondent has conceded the issue involving the right of petitioner to compute his tax by using the optional standard deduction should his claimed deductions above-mentioned be disallowed by this Court215 to such extent that it would be more advantageous to him to use such standard deduction.All of the facts are stipulated and they are so found.Petitioner's return for the year involved was filed with the collector of internal revenue for the first district of California.The petitioner was married to Thelma Knight McKinney on August 9, 1930, in Carson, Nevada. They separated on or about December 20, 1943. On June 18, 1945, the petitioner filed an action for divorce in San Francisco County, California. On July 19, 1945, Thelma filed an answer to the complaint and a cross-complaint in which, among other things, she requested $ 200 per month for her support and maintenance during the pendency of the divorce action. After a hearing the court entered an order dated July 30, 1945, for alimony pendente lite, counsel fees and court costs. The order of the court directed the petitioner to pay Thelma the sum of $ 120 per month for a period of 2 months, the sum of $ 125 to be paid to Thelma's attorney and the additional sum of $ 20 for costs of court.917 Pursuant to that order the petitioner paid Thelma $ 420, $ 175 to her attorney 1 and $ 20 to the court for costs. He also216 paid $ 100 to his own attorney.An interlocutory decree of divorce was granted to Thelma on January 31, 1946. In this decree it was provided, among other things, that petitioner pay Thelma for her maintenance and support the following sums of money: for the first 2 years, $ 100 per month; for the next 3 years, $ 75 per month; and for the next 2 years, $ 50 per month. None of those amounts are involved in this proceeding. Thereafter a final decree of divorce was entered on February 24, 1947.In the return filed by the petitioner for the year 1945 he claimed a total deduction in the amount of $ 1,115. Of that amount the respondent disallowed $ 715, itemized as217 follows:Alimony pendente lite$ 420Fees for Thelma's attorney175Court costs20Petitioner's attorney's fees100Total$ 715We see no basis whatever for deducting either the attorney's fees for Thelma in the amount of $ 175 or court costs of $ 20, or petitioner's attorney's fees in the amount of $ 100. See George D. Wick, 7 T.C. 723">7 T. C. 723, 724, 727; affd., 161 F. 2d 732; Frank J. Loverin, 10 T. C. 406; Regulations 111, section 29.24-1. See also Lindsay C. Howard, 157">16 T. C. 157. We therefore shall not further consider these items, and direct our attention to the payment of $ 420 which petitioner made to Thelma.Whether the payments of alimony pendente lite are deductible under section 23 (u) depends upon whether they come within the provisions of section 22 (k) 2 set forth in the margin. We agree with respondent that the payments in question here are not properly deductible.218 Section 22 (k) is limited in its application to payments made to "a wife who is divorced or legally separated from her husband under a 918 decree of divorce or of separate maintenance * * ." Frank J. Kalchthaler, 7 T. C. 625, 628. We said in that case as follows:The construction which must be placed upon section 22 (k) with respect to the question presented here is that it relates to periodic payments made under a decree of separate maintenance to a wife who is legally separated or divorced from her husband, but that it does not apply to a decree of separate maintenance made to a wife, who is not legally separated or divorced.See also Charles L. Brown, 7 T. C. 715, and George D. Wick, supra.Since under the facts of this case the payments in question were not made by petitioner at a time when his wife was legally separated or divorced from him within the meaning of section 22 (k) we conclude that the deduction in question was properly disallowed.It follows that the respondent did not err in his determination.Decision will be entered under Rule 50. Footnotes1. It will be noted that the court order provided for payments of $ 120 for two months and $ 125 for fees to Thelma's attorney. It is stipulated, however, pursuant to the order petitioner paid $ 420 to Thelma as alimony pendente lite↩ and $ 175 to her attorney. The discrepancy between these figures and those contained in the court order is not explained.2. SEC. 22. GROSS INCOME. * * (k) Alimony, Etc., Income. -- In the case of a wife who is divorced or legally separated from her husband under a decree of divorce or of separate maintenance, periodic payments (whether or not made at regular intervals) received subsequent to such decree in discharge of, or attributable to property transferred (in trust or otherwise) in discharge of, a legal obligation which, because of the marital or family relationship, is imposed upon or incurred by such husband under such decree or under a written instrument incident to such divorce or separation shall be includible in the gross income of such wife, and such amounts received as are attributable to property so transferred shall not be includible in the gross income of such husband. * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619414/	ANAHEIM SUGAR CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Anaheim Sugar Co. v. CommissionerDocket No. 13521.United States Board of Tax Appeals21 B.T.A. 1092; 1931 BTA LEXIS 2258; January 8, 1931, Promulgated 2258 Certain rentals received in 1920 by the Aldrich Land Co., a corporation affiliated with the petitioner, held to be the income of the Aldrich Land Co. M. F. Mitchell, Esq., and George G. Witter, Esq., for the petitioner. J. Arthur Adams, Esq., for the respondent. MARQUETTE 1092 This proceeding is for the redetermination of a deficiency in income and profits taxes asserted by the respondent for the year 1920 in the amount of $92,352.28. The petitioner alleges that the respondent erred: (1) In disallowing in part deductions from gross income taken by the petitioner for the exhaustion, wear and tear of its assets, and on account of salaries paid; and (2) in taxing to the petitioner the amount of $105,800 received in 1920 by a corporation with which the petitioner was affiliated. FINDINGS OF FACT. The petitioner is a corporation, organized in 1910 under the laws of California. The scope of the company's activites, as authorized by its articles of incorporation, is as follows: * * * SECOND: That for the purposes for which it is formed are to acquire, hold, own, by, sell, convey, hire, lease mortgage, and improve real estate; 2259 to acquire, hold, own, mortgage, sell, deal and trade in all kinds of personal property, rights, privileges and franchises; to acquire, hold, own, buy, sell, improve and develop water rights and privileges, water bearing lands, reservoirs, pipes, pipe lines and ditches, and do and perform and contract for and construct anything to hold, store, convey and distribute water; to build, erect, construct, buy, sell or lease factories for the manufacture of sugar or other products from beets, and to engage in the manufacture of sugar from beets or other products, 1093 and to buy, sell, and deal in sugar produced from beets or came; to buy and sell cattle, or other live stock and to feed cattle; to produce, manufacture and sell the residue or by-products made in the manufacture of sugar, or in connection therewith, and to buy, sell, lease, mortgage, or contract for anything and to do any and all things necessary to the business of manufacturing sugar out of beets or cane or other products; to plant, cultivate and produce beets for the manufacture of sugar therefrom; to buy and sell, to mortgage and pledge, or otherwise deal in and trade in stocks, bonds and securities of every kind2260 and character; to buy, acquire, barter for, sell, exchange, hold, mortgage, pledge and otherwise deal in and trade in the shares of its own capital stock or bonds and in the shares of the capital stock or bonds of every kind of a corporation; to borrow and lend money; to issue bonds, promissory notes and other evidences of indebtedness; and to mortgage and hypothecate all or any of the corporate property including any of its unissued or unsubscribed stock; to negotiate loans and secure the same by mortgage or pledge of shares of its capital stock, whether or not the shares used as security have heretofore been issued or subscribed. To construct, carry out, maintain, improve, alter, work, control and superintend any ways, tramways, railroads, roads, or other works and conveniences which may seem directly or indirectly conducive to any of the objects of this company, or otherwise, and to contribute or otherwise aid in or take part in any such operations; to carry on and conduct the business of manufacturing, wholesaling and retailing sugar, and all sugar and other products indcidental to or in any way connected with the manufacture of sugar; to acquire the good will, rights and property, 2261 and to undertake and assume the whole or any part of the assets and liabilities of any firm, person, association, or corporation and pay for the same in cash, stock of this corporation, bonds or otherwise; to apply for, obtain, purchase, lease, or otherwise acquire any and all trade-marks, trade names, Letters Patent and rights secured thereby and carry on the business involving the same; to conduct, and engage in and carry on any kind of business including the business of merchants, and all things thereto belonging and also buying and selling and retailing all sorts of goods, wares, merchandise, and commodities and produce, also the commission business; and to do any and all other things, and to carry on any and all other business operations which may be necessary or useful or proper or convenient or incidental or auxiliary to the doing, effectuating or accomplishing any or all of the purposes or objects for which the corporation is organized. The petitioner sustained exhaustion, wear and tear of its assets during the year 1920 in the amount of $120,989. In the year 1920 the petitioner paid to its president, A. R. Beck, for services rendered in that year, the amount of $45,000. 2262 The Aldrich Land Co., a corporation, was a holding company, all of the capital stock of which was, during the year 1920, owned by the petitioner. The petitioner and the Aldrich Land Co., filed a consolidated return for that year. During the year 1920 the Walberg-Dozier Land Co. was a corporation which had only qualifying shares outstanding, all of which were owned and held by attorneys for the petitioner. It was used merely as a name through which land transactions were sometimes made for the use and benefit of the petitioner. On August 29, 1919, the Walberg-Dozier Land Co. acquired a lease, with an option to purchase, of about 886 acres of land known 1094 as the Borchard Ranch, situated in Orange County, California. On the same date the Walberg-Dozier Land Co. executed and delivered to the petitioner a statement in writing to the effect that it held the premises described in said lease for the benefit of the petitioner, and the petitioner executed an agreement guaranteeing the rents reserved by said lease. On August 21, 1920, the Walberg-Dozier Land Co. exercised the option under said lease and purchased the Borchard Ranch for $335,000, of which amount $200,0002263 was represented by a mortgage then on the premises. The balance of the purchase price was paid by the Aldrich Land Co. with money advanced to it on August 20, 1920. Title was taken in the name of the Walberg-Dozier Land Co. On August 23, 1920, the Walberg-Dozier Land Co. conveyed the said Borchard Ranch to the Aldrich Land Co. At that time the officers of the petitioner and the Aldrich Land Co. did not desire that competitors should know that the Aldrich Land Co. owned said Borchard Ranch, and the title was not recorded until 1922, when it became necessary for the Aldrich Land Co. to borrow $175,000, secured by said land. On or about October 1, 1920, the Walberg-Dozier Land Co. leased to the General Petroleum Corporation 120 acres, and on October 16, 1920, it leased to the National Exploration Co. 160 acres of the Borchard Ranch. Each lease reserved certain rents and royalties, and in addition the lessees paid to the Walberg-Dozier Land Co. bonuses in the total amount of $105,800. On the dates said leases were made they were assigned by the Walberg-Dozier Land Co. to the Aldrich Land Co., together with said bonuses. Upon receipt of said bonuses the Aldrich Land Co. credited2264 $40,800 thereof to the petitioner and $65,000 to its own mortgage redemption fund account. No part of said amount of $105,800 was distributed as a dividend in 1920. There was no agreement between the petitioner and the Aldrich Land Co. that the income or profits taxes of the Aldrich Land Co. migh be assessed against or collected from the petitioner. The petitioner and the Aldrich Land Co. filed a consolidated return of income for the year 1920. Upon audit of said return the respondent disallowed, in part, deductions taken by the petitioner on account of exhaustion, wear and tear of its assets and salaries paid to its president in 1920, and he also added to the petitioner's income as reported the amount of $105,800 paid in that year as bonuses by the lessees of the Borchard Ranch as hereinabove set forth. OPINION. MARQUETTE: At the hearing counsel for the parties hereto stipulated that in computing its net income for the year 1920 the petitioner 1095 is entitled to deduct $120,989 for the exhaustion, wear and tear of its assets, and $45,000 on account of salary paid to its president in that year. The petitioner's income as heretofore determined by the respondent2265 will be adjusted accordingly. The only other question raised by the record is whether the amount of $105,800 received by the Aldrich Land Co. in 1920, as set forth in the findings of fact, constituted taxable income to the petitioner. It appears to be the position of the respondent that the Aldrich Land Co. did not have title to the Borchard Ranch in 1920, but that title was held by the Walberg-Dozier Land Co. in trust for the petitioner and that, therefore, the rentals in question belonged to the petitioner and constituted a part of its income. We are unable, in the light of the facts disclosed by the record, to agree with the respondent. The evidence establishes that while the option to purchase the Borchard Ranch was taken by the Walberg-Dozier Land Co. in trust for the petitioner, the purchase price, when the option was exercised, was paid by the Aldrich Land Co. with $135,000 cash advanced to it by the petitioner and by the assumption of a mortgage for $200,000, and that two days later the title was conveyed to the Aldrich Land Co. by the Walberg-Dozier Land Co., in the name of which title was first taken; and there is nothing in the record to indicate that the Aldrich2266 Land Co. held the land in trust for, or for the benefit of, any other corporation or person. The fact that the deed to the Aldrich Land Co. was not recorded until 1922 has been satisfactorily explained and does not affect the legal aspect of the situation. Since the land belonged to the Aldrich Land Co. on and after August 23, 1920, the rentals received in October of that year belonged to that company and constituted income to it. While these rentals were income to the Aldrich Land Co., we must consider whether they may, nevertheless, be taxed to the petitioner, which was the owner of all of the capital stock of the Aldrich Land Co. Section 240 of the Revenue Act of 1918 provides that: SEC. 240. (a). That corporations which are affiliated within the meaning of this section shall, under regulations to be prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income and invested capital for the purposes of this title and Title III, and the taxes thereunder shall be computed and determined upon the basis of such return; * * In any case in which a tax is assessed upon the basis of a consolidated return, the total tax shall be computed2267 in the first instance as a unit, and shall then be assessed upon the respective affiliated corporations in such proportions as may be agreed upon among them, or, in the absence of any such agreement, then on the basis of the net income property assignable to each. * * (b) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls 1096 through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests. The petitioner and the Aldrich Land Co. were affiliated during 1920 within the meaning of the section of the statute quoted and they properly, pursuant to the requirements of that statute, filed a consolidated return of income and invested capital. But they did not enter into any agreement as to the allocation of the tax liability shown on the consolidated return. It therefore became the duty of the respondent to compute the taxes upon the basis of the consolidated return and assess them against the two companies on the basis2268 of the net income properly assignable to each. ; . It follows that while in that situation the rentals received by the Aldrich Land Co. from the lessees of the Borchard Ranch constituted income to that company, which should be reported on the consolidated return of the petitioner and the Aldrich Land Co., they are not taxable to the petitioner. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619415/	The Bulkley Building Company v. Commissioner.Bulkley Bldg. Co. v. CommissionerDocket No. 107145.United States Tax Court1943 Tax Ct. Memo LEXIS 474; 1 T.C.M. (CCH) 528; T.C.M. (RIA) 44342; February 2, 1943474 R. J. Bulkley, Esq., 520 Bulkley Bldg., Cleveland, O., and I. W. Sharp, Esq., 530 Bulkley Bldg., Cleveland, O., for petitioner. Lawrence R. Bloomenthal, Esq., for respondent. HILL Memorandum Findings of Fact and Opinion HILL, Judge: Respondent determined deficiencies in petitioner's tax liability for the year 1937 as follows: (a) income tax, $19,139.57, and (b) excess-profits tax $12,894.30. The issues raised by the pleadings are: (1) whether petitioner realized taxable gain in the amount of $177,085.25 as a result of the purchase of its own debentures, together with accrued interest, at less than face value in the taxable year; (2) whether respondent properly disallowed as deductions amortization of discount claimed by petitioner on its Series A and Series B income debentures; (3) whether respondent properly disallowed part of the deduction claimed by petitioner on account of depreciation of a certain theatre building; (4) whether respondent properly included in taxable income of petitioner interest in the amount of $24,360 accrued during the year 1937 on $406,000 principal amount of first mortgage bonds of petitioner's wholly owned subsidiary; and (5) whether respondent properly475 disallowed a deduction for loss of petitioner's investment in certain real property which allegedly became worthless and was charged off petitioner's books during the taxable year. The facts were established by oral and documentary evidence, and stipulation of the parties filed at the hearing. Such stipulation is adopted in full as a part of our findings of fact, and sufficiently summarized below for present purposes. Findings of Fact Petitioner is an Ohio corporation, organized in 1919, with its principal office at Cleveland. At all times pertinent here, its books of account were kept, and its income tax returns made, on an accrual basis. It filed its income and excess profits tax return for the calendar year 1937 with the collector for the 18th district of Ohio. Petitioner is engaged principally in the operation of a commercial and office building, the rental to lessees for operation of a theatre building, and the operation through wholly owned subsidiaries of a garage building, all located on property situated in the City of Cleveland, Ohio. Prior to December 20, 1933, petitioner had outstanding an issue of $513,000 principal amount of six percent gold debentures, some of which476 had already matured, and the Dodge Court Company, a wholly owned subsidiary of petitioner, had outstanding $406,000 principal amount of first mortgage leasehold six percent gold bonds, secured by a mortgage on its leasehold estates in the garage property, some of which bonds had already matured. The Dodge Court bonds were guaranteed as to payment of principal and interest by petitioner. Both issues of securities were in default as to interest and maturities which became due on and after January 1, 1933. A readjustment plan for petitioner's debentures and the leasehold bonds of its subsidiary was proposed by petitioner under date of December 20, 1933. This voluntary plan was subsequently made the basis of proceedings under section 77-B of the Federal Bankruptcy Act, in which proceedings the plan was confirmed and made effective by order of the United States District Court for the Northern District of Ohio, Eastern Division, on December 10, 1935. Under the readjustment plan and order of the Court, the Dodge Court bonds were exchanged (or barred from all rights except the right to be exchanged) for equal principal amounts of a new issue of Series A Bulkley Building Company cumulative477 income debentures, bearing interest at the rate of six percent per annum from July 1, 1932, the last date to which interest had been paid on the old bonds. Under the same plan and court order, the Bulkley Building Company gold debentures were exchanged (or barred from all rights except the right to be exchanged) for equal principal amounts of a new issue of Series B Bulkley Building Company income debentures, bearing interest at six percent per annum from November 1, 1932, the last date to which interest had been paid on the old gold debentures. Pursuant to the terms of the readjustment plan, the Series A income debentures were secured by deposit with the trustee of all old Dodge Court bonds which had been exchanged for them, and the Series B income debentures were secured by the deposit with the trustee of all old Bulkley Building Company gold debentures which had been exchanged for them. The old Dodge Court bonds and the old Bulkley Building gold debentures deposited with the trustee under the debenture agreement were required by the terms of the plan to be kept alive and remain pledged as security for the performance of petitioner's obligations with reference to the two series478 of income debentures. The Series A and Series B cumulative income debentures issued by petitioner both mature on January 1, 1943. Prior to maturity interest if payable only to the extent of the consolidated net income of petitioner and its subsidiaries as defined in the reorganization plan and debenture agreement. All unpaid interest accrues, however, and matures with the principal on January 1, 1943. The old Dodge Court bonds and the old Bulkley Building debentures, including accumulated and unpaid interest, had a fair market value of approximately 9 percent of their respective principal amounts at the time of their acquisition by petitioner in December 1935, pursuant to the order of the court. The new Series. A and Series B income debentures, issued in exchange for the old bonds and debentures, with accumulation of unpaid interest thereon, also had a fair market value of approximately 9 percent of their respective principal amounts at the time and immediately after issuance. During the calendar year 1937, petitioner purchased outstanding Series A income debentures in the principal amount of $73,200, on which interest had accrued at the rate of six percent per annum from July 479 1, 1932 to January 1, 1937 in the amount of $19,764, for purchase prices which aggregated $23,682.50. During the same year petitioner also purchased outstanding Series B income debentures in the principal amount of $114,000, with accumulations of interest at six percent per annum from November 1, 1932 to January 1, 1937, in the amount of $28,500, for purchase prices which aggregated $34,696.25. The income debentures of both series so purchased by petitioner were held uncancelled in petitioner's treasury and carried on its books as assets at their cost to petitioner. No gain was shown on petitioners' books of account, or reported in its income tax return for the year 1937, with reference to the purchase of Series A and Series B debentures. In his determination of the deficiency, respondent charged petitioner with the receipt of taxable gain from such purchases in the amount of $177,085.25, being the difference between the aggregate amounts owed for principal and interest on the purchased debentures as of January 1, 1937, and the aggregate of the amounts paid for same by petitioner. Respondent also excluded from the deductions, in computing petitioners' taxable net income, $12,192 of480 interest accrued during the year 1937 on the debentures so purchased, of which amount $11,125.02 had accrued prior to the time of purchase by petitioner. Petitioner was required by the terms of the ground leases under which it held its various properties to pay ground rents, as a condition of its continued right to use and occupy the premises, during the year 1937 in the amount of $50,266.67, plus real estate taxes and assessments in the amount of $67,617.76. On its balance sheet attached to its income tax return for 1937, petitioner included among its assets "Stocks of domestic corporations" in the amount of $360,500, which consisted of $350,000 in six percent cumulative preferred stock of the Dodge Court Company, $10,000 in common stock of the same company, and $500 in common stock of the Cuyahoga Garage Company. The Dodge Court Company and the Cuyahoga Garage Company, hereinafter called Garage Company, are wholly owned and subsidiaries of petitioner. The Dodge Court Company was organized in 1924 to own and hold certain leasehold estates and garage buildings, which were located on Dodge Court in the City of Cleveland, Ohio. The Garage Company was organized in 1924 to take a lease481 from the Dodge Court Company and operate the business of an automobile storage garage on the premises. The lease provided for the payment of rental in the amount of $100,000 during the calendar year 1937. After providing for an expense of $100,000 for rent due to the Dodge Court Company the books of the Garage Company showed an operating loss for several years prior to 1937. The accumulated deficit in the earned surplus account of the Garage Company at the beginning of the year 1937 was $716,943.10; its operating loss during the year 1937 was $86,301.46, and the deficit in its earned surplus account at the end of that year was $803,244.66. At the beginning of the year 1937 the Garage Company owed the Dodge Court Company $729,857.25 and the Bulkley Building Company $8,296.32. At the end of the year 1937, the Garage Company owed Dodge Court Company $803,286.42, and the Bulkley Building Company $11,089.77. The Dodge Court Company's only source of revenue was rental on its garage building and facilities, which were leased to the Garage Company on a lease which called for a rent of $100,000 per year during the calendar year 1934 and thereafter, on which Dodge Court Company collected 482 year by year whatever the Garage Company was able to pay out of its profits from the operation of the garage, and charged off the balance as uncollectible. The amount of rental actually paid by the Garage Company in the taxable year 1937 was $26,570.83, and the amount charged off as uncollectible by the Dodge Court Company for that year was $73,429.17. The accounts, receivable from the Garage Company in the amount of $8,296 at the beginning of the year 1937 and in the amount of $11,089.77 at the end of the year 1937, shown as assets on the balance sheets of petitioner, were claims against the Garage Company and had only such value, if any, as could be realized upon them out of the assets of the Garage Company. The accounts receivable from the Dodge Court Company, shown as assets on the balance sheets of petitioner, in the amount of $236,070.28 at the beginning of the year 1937 and in the amount of $219,320.36 at the end of the year 1937, the interest receivable on Dodge Court company bonds shown on petitioner's balance sheets in the amount of $122,774.40 at the beginning of the year 1937 and $154,077 at the end of the year 1937, and the bonds of domestic corporations (Dodge Court 483 Company) shown on petitioner's balance sheets in the amount of $392,945.76 at the beginning of the year 1937 and $385,903 at the end of year 1937, were all claims against the Dodge Court Company and had a value only equal to the amount, if any, which could be collected on them from the Dodge Court Company. The assessed values of the land and buildings which petitioner owns or holds under lease in the City of Cleveland, Ohio, including the interests of the lessors as well as the interests of petitioner and its subsidiaries, as fixed by the county auditor of Cuyahoga County for purposes of the tax on real estate for the years 1932 to 1941, inclusive, were as follows: YearLandBuildingsTotal1932$1,451,700$1,371,710$2,823,4101933-19361,161,3701,165,9602,327,33019371,225,7101,170,4802,396,1901938-19411,225,7101,172,9902,398,700Prior to the year 1929, petitioner acquired 38 vacant lots located in Parma, Ohio, on which petitioner's basis for computation of gain or loss was $53,387.53. After the year 1932, petitioner ceased to pay the taxes and assessments which were levied against this property. The assessed values of the lots for the purposes484 of real estate tax, and the amounts of taxes, assessments and penalties levied against them for the years 1931 to 1937 were as follows: AssessedAmount of Taxes and AssessmentsValueFor the YearCumulative Total including Penalties1931$10,680$1,427.07$1,427.07 Billed and paid in 193219328,4501,413.991,413.99 Billed in 1933 but not paid19336,7801,331.372,866.41 Billed in 1934 but not paid19346,7801,262.424,257.54 Billed in 1935 but not paid19356,7801,280.615,665.03 Billed in 1936 but not paid19366,7801,111.816,907.11 Billed in 1937 but not paid19376,6101,109.538,118.48 Billed in 1938 but not paidOf the total taxes, assessments and penalties in the amount of $6,907.11 shown as billed in 1937, the amount of $506.91 was made up of penalties, which, together with interest might have been avoided by paying the $6,400.20 of original taxes and assessments in December 1937 under favor of a special statute known as the Whittemore Act. Under that Act and similar predecessor acts it would have been possible to have paid the taxes and assessment accrued up to date without penalty and interest during any one of several years485 preceding the year 1937. In December 1937 petitioner charged off its investment in the lots as worthless, and claimed in its income tax return for 1937 a deductible loss of $53,387.53. Title to this property was not relinquished at any time prior to or during 1937. The taxes above referred to become a lien on the property in April of the year preceding the year in which billed. The law of Ohio required that the property be assessed at its full true value in money. Petitioner had the money with which to pay the accrued taxes, but upon consideration of the problem as to whether it should pay the taxes and save the property or whether it should abandon the property by not paying the taxes, it was decided to abandon the property and charge the investment off the books as a loss. No proceeding was instituted for foreclosure of the tax lien prior to the close of the year 1937. Petitioner is the owner of a theatre building known as the Allen Theatre, with a lobby entrance through the Bulkley Building on Euclid Avenue, in the City of Cleveland, Ohio, seating approximately 3,000 people. The total cost of this theatre and its equipment, including carrying charges during construction, was486 approximately $1,191,000, of which $400,000 was petitioner's contribution and constitutes petitioner's basis for the computation of depreciation, dating from January 1, 1923. Petitioner had uniformly set up depreciation on this building on its books and claimed deductions for depreciation in its income tax returns on the basis of an estimated useful life of 30 years from January 1, 1923. This basis was never questioned by respondent prior to his examination in connection with the determination of the income tax liability of petitioner for the calendar year 1937. Depreciation set up on petitioner's books and claimed in its income tax returns to January 1, 1937 amounted to $186,666.62, so that on the basis adopted by petitioner there remained an underpreciated basis at January 1, 1937, of $213,333.38. Respondent computed the depreciation allowable on the theatre building for the year 1937 on the basis of a useful life of 50 years from January 1, 1923, resulting in the allowance of the amount of $5,925.93 instead of $13,333.33, as claimed by petitioner. The consolidated gross income of petitioner and its two subsidiaries over operating expenses, deductions exclusive of theatre depreciations487 and interest accrued but not paid, on bonds and debentures, loss before provision for theatre depreciation and interest accrued but not paid on bonds and debentures, and loss after provision for theatre depreciation and interest on bonds and debentures for the years 1932 and 1933 were as follows: 19321933Gross Income$170,023.73$ 14,045.51Deductions exclusive of Theatre Depreciation and accruedbut not paid Interest on Bonds and Debentures178,506.28124,236.18Loss before Provision for Theatre Depreciation and Interest,accrued but not paid, on Bonds and Debentures$ 8,482.55$110,190.67Provision for Theatre Depreciation13,333.3313,333.33Interest, accrued but not paid, on Bonds and Debentures16,310.0057,046.00Loss after Provision for Theatre Depreciation and Intereston Bonds and Debentures$ 38,125.88$180,570.00The gross income of petitioner, deductions exclusive of theatre depreciation and interest on debentures, loss before provision for theatre depreciation and interest on debentures, and loss after provision for theatre depreciation and interest on debentures for the years 1934, 1935 and 1936 were as follows: 193419351936Gross Income$214,647.24$241,737.79$276,117.96Deductions exclusive of Theatre Deprecia-tion and Interest on Debentures306,791.91310,230.17281,466.71Loss before Provision for Theatre Deprecia-tion and Interest on Debentures92,144.6768,492.385,348.75Provision for Theatre Depreciation13,333.3313,333.3313,333.33Interest on Debentures33,426.0033,843.6755,140.00Loss after Provision for Theatre Deprecia-tion and Interest on Debentures$138,904.00$115,669.38$ 73,822.08488 The Allen Theatre building owned by petitioner was constructed of steel and concrete and, disregarding obsolescence, might reasonably be expected to have a physical life of 50 years from January 1, 1923. It is well adapted for the purposes of a motion picture theatre. Since the building was constructed sound equipment and talking pictures have been developed which have largely eliminated orchestras in motion picture theatres, resulting in the presentations of productions continuously in darkened houses. Numerous neighborhood theatres have been constructed since petitioner's theatre building was completed. The development of the radio has also largely occurred since petitioner's theatre was constructed and began operations. The rentals received by petitioner from the Allen Theatre during the years 1924 to 1941, inclusive, including contributions to property taxes in those years in which the lease in effect required the lessee to bear the taxes on the theatre property, and adjusted for the year 1932 by deduction of accrued rental which had to be charged off in that year as uncollectible, may be summarized as follows: The rent collected, exclusive of taxes for each of the years 1924489 to 1931, both inclusive, was approximately $76,495; the lowest rental, including taxes, collected in such period was $92,230.93 in 1924, and the highest rental collected, including taxes, in such period was $96,380.16 in 1931. The net rental collected in 1932, including taxes, was $51,242.60. No rental was collected in 1933 other than $17,051.13 taxes. During the period 1934 to 1941, both inclusive, no taxes were paid by the lessee, and the lowest rental received by petitioner was $9,917.51 in 1934. The highest rental collected during such period was $46,691.10 in 1941. In the tax year 1937, the rental received by petitioner was $40,014.77. There were outstanding throughout the year 1937 a total of 27,400 shares of preferred stock of petitioner of the par value of $100 each, distributed among more than 1,200 holders, and 140,000 shares of the common stock of petitioner distributed among more than 1,300 holders. These shares were not listed on any stock exchange, but there were a few sales "over the counter" from time to time. No sales of either preferred or common shares of petitioner's stock came to the attention of petitioner's officers during the years 1937 and 1938 at prices 490 in excess of $1 per share for the preferred shares and 2 cents per share for the common shares. On December 31, 1937, the current assets of petitioner and its subsidiaries, as shown on the consolidated balance sheet, amounted to $182,205.04, and the liabilities, other than for principal and interest on outstanding debentures, totaled $92,972.19, leaving an excess of current assets over liabilities, other than liabilities on debentures, of $89,232.85. The principal amount of debentures outstanding (excluding those held in petitioner's treasury) was $715,800, and accumulated interest liability on the debentures was $228,234, or a total liability for principal and interest of $944,034. The fixed assets of petitioner and its subsidiaries appeared on the consolidated balance sheet at $3,971,312.59. In addition petitioner had a concealed liability of approximately $125,000 arising out of a deferment of rental, which would have accrued during the 5-year period ended December 31, 1937, under the original leases, until the 5-year period beginning January 1, 1943. Such deferment resulted from amendment of the leases whereby the rental payable was reduced approximately $125,000 during the 5-year491 period ended December 31, 1937, in consideration of an increase in the rentals of approximately the same amount during the 5-year period beginning January 1, 1943. The net liabilities for principal and interest on debentures on deferred rental, which could be paid only out of the fixed assets of petitioner and its subsidiaries, amounted to approximately $979,801.15 at December 31, 1937. The value of petitioner's fixed assets, as carried on the consolidated balance sheet at December 31, 1937, under the designation of plant equipment, less reserves for depreciation, was $3,941,901.54. The fair market value of petitioner's fixed assets, including leasehold estates and buildings, at December 31, 1937, was $1,000,000. Petitioner's theatre building, known as Allen Theatre, had an economic or useful life of 30 years from January 1, 1923. Petitioner's investment of $53,387.53 in the vacant lots located in Parma, Ohio, became worthless in the taxable year 1937. Opinion Issue 1. Did petitioner derive taxable gain as the result of purchasing its own debentures at less than face value, under the circumstances set out in our findings of fact above? During the taxable year 1937 petitioner492 purchased its own outstanding Series A and Series B income debentures in the principal aggregate amount of $187,200, on which interest had accrued in the total amount of $48,264, or a total of principal and interest of $235,464. The total purchase price paid by petitioner for these bonds was $58,378.75. The difference between the two latter sums, or $177,085.25, respondent treated as taxable income. Petitioner contends that it derived no taxable gain from the transaction, but if it should be held that it did derive taxable gain, then the amount is less than that determined by respondent. A solvent corporation which purchases its own bonds at less than issuing price, thereby realizes taxable gain in the amount of the assets previously offset by the obligation of the bonds so purchased. ); ). An insolvent corporation which purchases its own bonds at less than face value, and is still insolvent after the transaction, realizes no taxable gain for the reason that no493 assets are freed from the claims of creditors. ; . If an insolvent corporation procures the cancellation of claims against it so that thereafter it is solvent, with net assets over liabilities to creditors, it realizes taxable income to the extent of its net worth or the amount of assets so freed. , see also . As to so much, the parties are in agreement, but petitioner contends that it was insolvent both before and after it purchased its own debentures in the taxable year, while respondent argues that petitioner was solvent both before and after those transactions. The record discloses that at December 31, 1937, petitioner's current assets exceeded its liabilities, other than liabilities on debentures, in the amount of $89,232.85; its total liability for principal and interest on debentures amounted to $944,034, and there was additional concealed liability for deferred rental of approximately $125,000, 494 so that its net liability on the debentures and for deferred rental, which could be paid only out of fixed assets, was approximately $979,801.15. The question of whether or not petitioner was solvent in the sense that assets exceeded liabilities to creditors, after the purchase of its debentures, therefore, depends upon the value of its fixed assets, consisting of buildings and leasehold estates. It is upon this point that the parties are in disagreement. Petitioner offered the testimony of one expert witness, who indicated that in his opinion petitioner's building at the basic date had a fair market value of approximately $400,000. Respondent offered the testimony of three expert witnesses, each of whom testified to a value of approximately $1,000,000. The depreciated cost, as shown by petitioner's sheet at December 31, 1937, was slightly less than $4,000,000. From a careful consideration of all the evidence on this question, including an analysis of the factors used by the several expert witnesses as the basis for their opinions, and the argument of counsel on brief, we have reached the conclusion, and so found, that the fair market value of the property in controversy was $1,000,000. 495 An extended discussion of the voluminous testimony would serve no useful purpose here. It follows that at December 31, 1937, after the purchase of its debentures, petitioner's assets exceeded its aggregate liabilities to creditors in the amount of $20,198.85, and on such basis was solvent. It also appears that during the taxable year petitioner was a going concern, in complete and unrestricted control of its business affairs, and had sufficient funds to meet all current obligations. We hold, therefore, that petitioner realized taxable income as the result of the purchase of its own debentures in 1937. It is apparent, however, that petitioner's liabilities exceeded its assets prior to the purchase, for $58,378.75, of debentures in the amount of $235,464, including $48,264 accrued interest, since it thereby reduced its liabilities in the amount of $177,085.25 but freed assets from claims of creditors only to the extent of $20,198.85. More simply stated, petitioner was insolvent at the beginning of the taxable year, but as the result of the purchase of its debentures in the same year it became solvent, with net assets of $20,198.85 over and above all liabilities to creditors. This 496 brings the present proceeding squarely within the rule of , and See also the discussion in . Petitioner urges that, disregarding the question of solvency, it derived no taxable gain from the purchase of its debentures, at least in respect of the Series A debentures, for another and different reason. Petitioner says that in legal effect it sold its Series A debentures in 1935 at the cash equivalent of 9 percent of principal amount; that the resulting discount should be amortized over the life of the debentures and that such amortization to December 1937 amounted to approximately 32 percent, which would provide a basis for computing gain or loss of approximately 41 percent of the principal amount, and since the debentures were purchased in 1937 at less than 41 percent of the face value, loss was sustained on the transaction rather than gain realized. We can not agree with petitioner's contention on this point. In 1935 it is apparent that petitioner's wholly owned subsidiary (the Dodge Court Company) 497 was insolvent. It had defaulted in payment of both principal and interest on its bonds, which had been guaranteed by petitioner. Petitioner likewise was in default on its own bonds. To relieve this situation and strengthen its financial position, petitioner, pursuant to order of the court in the proceeding under section 77-B of the Bankruptcy Act, issued the Series A income debentures in exchange for the old bonds of its subsidiary, and the Series B income debentures in exchange for its own old gold debentures. Both series of income debentures were exchanged for equal principal amounts of the old bonds and debentures. Petitioner's secondary liability as guarantor of its subsidiary's bonds had in these circumstances become in effect a primary liability. The new debentures were not "sold" in either a practical or legal sense; they were simply exchanged for and took the place of the old bonds and debentures, although the latter were kept alive as security for the performance of petitioner's obligations under the new securities. The purpose plainly was to amend the terms of the old securities so as to relieve petitioner of a financial burden which it was unable immediately to meet. The498 new securities bore the same rate of interest as the old, and petitioner became the primary obligor in form as well as fact. The only substantial change effected by issuance of the new securities was to extend the maturity dates of the old obligations. There was no substantial change in the investment of the bondholders. The transactions, when viewed as a whole, constituted a recapitalization of petitioner, which was a reorganization giving rise to neither gain nor loss recognizable for tax purposes. Section 112(b) (3) and (g) (1) (D), Revenue Act of 1934. Cf. , affirming . Petitioner so treated the transaction in its income tax return for 1935. The basic or issuing price of the old bonds and debentures is assumed to be par, there being no evidence to the contrary, and it follows that the basic or issuing price of the new income debentures was not 9 percent but face value. Hence, petitioner derived gain from the purchase of the new debentures in 1937 at price less than par, and realized taxable gain to the extent that assets were thereby freed from claims of creditors499 in the amount of $20,198.85. Petitioner also urges the further contention that in any event cancellation of the accumulated interest on the purchased debentures could not result in taxable income, since such interest accrued in loss years and resulted in no tax benefit to petitioner. The stipulated facts show that petitioner did not derive any tax benefit from deductions for accrued interest on the debentures in question, but this becomes immaterial here for the reason that, disregarding the accrued interest, petitioner still derived gain from the purchase of its debentures, resulting in net assets freed from claims of creditors in the amount before stated. On the first issue, respondent's determination is approved to the extent of including in taxable income the sum of $20,198.85. Issue 2. Did respondent properly disallow deductions for amortization of discount claimed by petitioner on its Series A and Series B debentures? Petitioner contends that in legal effect, it sold both series of debentures at a discount measured by the difference between par and the fair market value of the property received therefore (the old bonds and debentures), and that such discount should be500 amortized over the life of the bonds. Petitioner further says that in computing its taxable income for 1937 it is entitled to deduct a proportionate part of the discount on the bonds which remained outstanding during the entire year, on which basis it would be entitled to a deduction of $50,688 on the Series A debentures and a deduction of $62,700 on the Series B debentures. Petitioner urges these contentions without qualification in respect of Series A debentures, but expresses some doubt of the application of its theory in respect of Series B debentures. We think petitioner's contention can not be sustained in the case of either series of debentures. As we pointed out in our discussion under Issue 1, petitioner did not sell its income debentures at a discount or otherwise, but merely exchanged them for old securities issued by itself and its wholly owned subsidiary, under such circumstances that rendered the transaction a tax-free reorganization. Discount is a species of loss, and it is on that underlying basis that amortization deductions are allowable, but neither gain nor loss resulting from a recapitalization-reorganization is recognizable for tax purposes. In such case there501 is no closed transaction deemed sufficient to provide a basis for taxation. In the instant proceeding there was no closed transaction. The investment of the bondholders after the exchange of the securities remained substantially the same as before. No recognizable gain or loss resulted to the bondholders. It would be anomalous to ascribe a different result to petitioner corporation. There was no substantial change in petitioner's liability. The only material effect of the transaction was to extend the due date or maturity of petitioner's obligations. The exchange of debentures for bonds and debentures was wholly without tax consequence. In the case at bar, we think it is plain that, aside from the fact that the transaction was a tax-free reorganization, petitioner is not entitled to deductions for amortization for the reason that it did not issue its Series A or Series B income debentures under circumstances which were the equivalent of "discount." On the second issue, respondent's action is approved. Issue 3. Did respondent properly disallow part of a deduction claimed by petitioner for depreciation on its Allen502 Theatre building? The parties agree that this building cost approximately $1,191,000, of which $400,000 was petitioner's contribution and constitute petitioner's basis for the computation of depreciation, dating from January 1, 1923. The parties also agree that the building had a physical life of 50 years from January 1, 1923. Petitioner had uniformly claimed deductions for depreciation on the basis of a useful life of 30 years, and this basis was never questioned by respondent prior to his determination of the deficiencies for 1937. Respondent computed depreciation allowable for the taxable year on the basis of a physical life of 50 years, instead of a useful life of 30 years, from January 1, 1923, which resulted in the allowance of the amount of $5,925.93 instead of $13,333.33, as claimed by petitioner. It is petitioner's contention that the allowance of a deduction for depreciation on the basis of the physical life of the building should be increased by an allowance for obsolescence on the basis of the useful life of the building; in other words, that the combined allowance for depreciation and obsolescence should be computed on the basis of a useful life of 30 years. Section 503 23 (1) of the Revenue Act of 1936 authorizes a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. Much evidence was offered at the hearing on the question of obsolescence, and the various factors involved. From a careful consideration of such evidence, we have found that the economic or useful life of the building was 30 years from January 1, 1923. It follows that the deduction claimed by petitioner for depreciation and obsolescence represents a reasonable allowance. Respondent's action on the third issue is disapproved. Issue 4. Did respondent properly include in petitioner's taxable income interest in the amount of $24,360 accrued in 1937 on $406,000 principal amount of first mortgage bonds of the Dodge Court Company held by petitioner? In brief, petitioner contends that at the close of the taxable year the ultimate payment of this interest by its subsidiary was so doubtful that the item should not have been accrued or included in income, even though petitioner was on an accrual basis. In the light of the facts in the record, we think petitioner must be sustained on this point. 504 It is well settled that if there is a reasonable and substantial doubt as to whether accruable income is collectible, it should not be included in taxable income. ); , affirmed, , certiorari denied, ; ; ; , affirmed, . In such circumstance, it is immaterial that the taxpayer was on an accrual basis, and it is likewise immaterial that the taxpayer accrued the amount and reported it as taxable income. "If it in fact was not taxable income, an entry on petitioner's books treating it as income could not make it such." The Dodge Court Company's only source of revenue505 was the rental it received on its garage building leased to the Cuyahoga Garage Company. Both of these subsidiaries of petitioner were insolvent. At the beginning of the taxable year 1937 the Garage Company owed the Dodge Court Company $729,857.25, although the amount was shown on the balance sheet of the Dodge Court Company as $462,414.93 because of the fact that the latter company wrote off each year as uncollectible all rental accrued over and above cash collections in excess of that amount. During the years 1934 to 1941, both inclusive, the Garage Company paid to the Dodge Court Company an average annual rental of less than $15,000. The Garage Company was also indebted to petitioner in the amount of $8,296 at the beginning of the year 1937, and in the amount of $11,089.77 at the end of that year. The Dodge Court Company was indebted to petitioner on open account in the amount of $236,070.28 at the beginning of 1937, and petitioner's balance sheet at the beginning of that year disclosed interest receivable on Dodge Court bonds in the amount of $122,774.40. These facts, in our opinion, amply justify the conclusion that there was no reasonable prospect that petitioner would be able506 to collect the additional interest of $24,360 accrued on the Dodge Court bonds for 1937. The amount, therefore, should not have been accrued on petitioner's books nor included in its taxable income. The action of respondent on the fourth issue is reversed. Issue 5. Did respondent properly disallow a deduction for loss of petitioner's investment in certain real estate? Prior to 1929 petitioner acquired 38 vacant lots located at Parma, Ohio, and it is agreed by the parties that petitioner's basis for gain or loss thereon is $53,387.53. There is no controversy that petitioner lost the full amount of its investment. The only question presented for our decision - a very narrow one - is whether the loss was sustained in the taxable year 1937, as contended by petitioner, or in the prior year 1936, as contended by respondent. After 1932, petitioner ceased to pay the taxes and assessments levied against these lots, and the total taxes accumulated to the end of 1936 exceeded the assessed value. The taxes for 1936 were not billed until 1937, but became a lien on the property in the preceding April. Petitioner was financially able to pay all the accrued taxes, but in December 1937, upon507 formal consideration of the matter, decided to abandon the property by not paying the taxes. Also, at that time it charged off its investment as worthless, and claimed a deductible loss of $53,387.53 in its income tax return for 1937, which was disallowed by respondent. Prior to the close of the taxable year no proceeding had been instituted for foreclosure of the tax lien. It was petitioner's responsibility to determine in the first instance the year in which the loss was sustained. In discharge of that responsibility, petitioner affirmatively and after careful consideration of the matter concluded that the loss was sustained in 1937. Nothing appears in the record to question the bona fides of that decision. There was then no tax controversy involving the point, and so far as petitioner knew, it was wholly immaterial for tax purposes whether the loss was sustained in the one year or the other. Petitioner's income tax returns for 1936 and 1937 each disclosed an operating loss far in excess of the loss sustained on the Parma lots. Respondent argues that because the aggregate taxes, which had become a lien on the property at the end of 1936, exceeded the assessed value, the loss was*508 sustained in that year. Such conclusion overlooks the fact that the total assessed taxes did not exceed assessed value until the 1936 taxes were billed in 1937; and in any event, petitioner could at any time in 1937 have paid the taxes without interest or penalties and freed its property from all liens, if it had thought its investment could be saved. The evidence, we think, is insufficient to require us to disturb petitioner's determination of the year in which the loss was sustained. Respondent's action on this issue is reversed. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619416/	Sidney B. and Vera L. Stern, Petitioners v. Commissioner of Internal Revenue, RespondentStern v. CommissionerDocket No. 14176-78United States Tax Court74 T.C. 1075; 1980 U.S. Tax Ct. LEXIS 78; August 14, 1980, Filed 78 Respondent has subpoenaed certain records from Bank of America N.T. & S.A. (Bank). The records related to a trust to which petitioners had transferred contingent shares received under a corporate acquisition, a transfer not disclosed on petitioners' return. The contents of the trust and the transfer had first become known to respondent only after respondent had obtained certain subpoenaed documents from petitioners. Held, under the circumstances, Bank's motion to be reimbursed for costs of compliance with the subpoena is denied. Randall G. Dick, for the petitioners.Alan Summers, for the respondent. Hall, Judge. HALL 1076 OPINIONOn April 29, 1980, the Bank of America N.T. & S.A. (the bank) filed a motion for protective order pursuant to Rule 147(b), Tax Court Rules of Practice and Procedure, requesting the Court to order respondent to compensate the bank for all reasonable costs incurred in connection with the production of additional documents in this case. A brief summary of the prior procedural motions involved in this case is necessary in order to place the bank's request in its proper perspective.On September 26, 1978, respondent issued a statutory notice of deficiency wherein he asserted income tax deficiencies against petitioners Sidney and Vera Stern of $ 1,551,956 for 1971, $ 688,147 for 1972, and $ 55,647 for 1973. One of the80 proposed adjustments concerns a disposition of Teledyne, Inc., stock.Petitioner Sidney Stern organized Fireside Securities Corp. in 1952. He served as the chief executive officer of that corporation and was its majority shareholder. On August 12, 1968, Fireside Securities Corp. entered into a plan and agreement of merger with Teledyne, Inc., under which petitioners were to receive shares of Teledyne stock in exchange for their shares of Fireside Securities. The merger agreement also provided that petitioners could receive additional Teledyne shares in 1972 based upon the performance of Fireside Securities during the interim period.On October 14, 1971, petitioners entered into a sales agreement with Wobaco Trust Ltd. (Wobaco), a Bahamian corporation, 1 acting in its capacity as trustee for Trust No. CT-1109 (hereafter referred to as the Hylton trust). 2 Pursuant to the October 14 agreement, petitioner Sidney Stern transferred 126,867 common shares of Teledyne to the trust in exchange for the trust's promise to pay Stern a yearly annuity of $ 222,757.01. 1077 Similarly, petitioner Vera Stern transferred 17,136 common shares of Teledyne to the trust in exchange for a yearly, 81 single-life annuity to her of $ 27,216.85. Under the agreement, both annuities were to be paid annually commencing on October 14, 1972.The deed of settlement for the Hylton trust recites that it was established in 1971 by Peter Hylton upon the transfer of $ 5,000. 3 In addition to naming Wobaco as trustee, the deed of settlement also provides that the beneficiaries of the trust are Sidney Stern, his spouse, and his 82 issue.In an addendum to their 1971 joint Federal income tax return, the Sterns made the following statement:On October 14, 1971 the taxpayers exchanged the following shares of stock and cash for the right of each to receive a sum annually for the full term of each of their respective lives:Annual sumSidney B. Stern$ 222,757.01Vera F. Stern27,216.85Shares and corporationSale priceSidney B. Stern126,867shares of Teledyne, Inc.$ 2,569,056.70Vera F. Stern17,136shares of Teledyne, Inc.Computation of each annual payment was based upon the fair market value of each share of stock of the above corporation on October 14, 1971, the date of the exchange, and the aggregate fair market value of the above shares and cash on that date was equal to the value of Sidney B. Stern, age 49, receiving the annual83 sum of $ 222,751.01 4 for his lifetime and Vera F. Stern, age 49, receiving the annual sum of $ 27,216.85 for her lifetime, all as determined by Table A(1) of Federal Estate Tax Regulations Section 20.2031-10(e). Pursuant to the provisions of Revenue Ruling 69-74 no gain or loss was recognized on October 14, 1971 and the tax consequences of the receipt of the annual sum by each taxpayer will not commence until the date of the first payment, October 14, 1972.In 1972 and 1973, the Sterns reported the annuity payments as part long-term capital gains and part interest.In his statutory notice, respondent determined that:The annuity realized from the sale of Teledyne shares has an ascertainable fair market value in the year of sale. The entire amount of gain determined under section 1001 is recognized in the year of sale December 31, 1971.1078 In the alternative, it is determined that as grantor of the Bahama Trust (Wobaco Trust Limited -- 84 trustee), you are taxable on the net income from it for the taxable years 1972 and 1973 because you furnished the consideration for the creation of the trusts; the named settlor was settlor in form only; the amounts distributable are deemed to be amounts distributable without the consent or approval of an adverse party under section 677(a)(1), and that the purported annuity agreement is solely a prearranged distribution of income agreement. Your taxable income for 1972 and 1973 has accordingly been increased to include the income of the trust as owner of the trust under section 671 of the Code.Petitioners filed their petition with the Court on December 26, 1978. At that time, they were residents of Reno, Nev.On November 19, 1979, respondent filed a motion for order for production of documents for inspection and copying or to impose sanctions against petitioners. Among the documents requested were:All records, receipts, memoranda, or documentation of any kind not heretofore furnished to respondent which directly or indirectly affect or affected the right of Wobaco Trust, Limited, to mortgage, sell, or otherwise deal or dispose of the securities transferred by the petitioners85 pursuant to the agreement dated October 14, 1971.All letters, memoranda, notes, or documentation of any kind not heretofore furnished to respondent reflecting exchanges of information between petitioners and/or their attorneys and the trustee or other authorized individual or individuals acting for or on behalf of the trust relating to the investment policies to be followed, the amount of trust income to be distributed, and any other facet of trust administration.In his motion, respondent indicated that the above documents were particularly relevant in connection with the alternative contention involving the grantor trust provisions of the Internal Revenue Code.On November 21, 1979, respondent served two subpoenas duces tecum on the bank. These subpoenas called for the production of various documents relating to the Hylton trust. 586 On December 5, 1979, the bank filed a response in which it indicated its inability to comply with the subpoenas on account 1079 of the bank secrecy laws in effect in the Bahamas and in the Cayman Islands. 6On December 5, 1979, a hearing was held in San Francisco at which respondent's counsel, petitioners' counsel, and counsel for the bank were present. At the hearing, petitioners' counsel turned over to respondent documents previously requested in the November 19 motion for order for production of documents addressed to petitioners. 7 As a consequence of the document exchange between petitioners' counsel and respondent, respondent's November 19 motion was denied.87 On January 7, 1980, respondent filed (1) a motion requesting the Court to reconsider its order denying respondent's motion for production of documents, and (2) a motion to enforce the subpoenas served on the bank.On March 10, 1980, respondent filed a motion for order requiring petitioners to seek consent to disclosure of records in the hands of the Bank of America N.T. & S.A. or its Bahamian or Cayman Islands subsidiaries or to impose sanctions.On March 21, 1980, this Court (1) ordered petitioners to give their consent to the bank and its Bahamian and Cayman Islands subsidiaries to disclose to respondent all the records described in the two subpoenas previously served on the bank on November 21, 1979, (2) granted respondent's January 7 motion for reconsideration, and (3) ordered petitioners to request from the trustees of the Hylton trust copies of the documents listed in respondent's November 19 motion for production of documents and to deliver those copies to respondent for inspection. As a result of petitioners' compliance with the Court's March 21 orders, just prior to April 23, 1980, 8 the date on which the trial in this case commenced, 9 respondent was able to obtain copies88 of bank documents relating to the Hylton trust.1080 The bank documents obtained by respondent made several references to a second trust, No. CT-1136 (hereinafter referred to as the Florcken trust). Subsequently, respondent obtained the deed of settlement of the Florcken trust and a sales agreement between petitioner Sidney Stern and World Banking & Trust Corp. (Cayman), Ltd., the trustee of the89 Florcken trust. The deed of settlement of the Florcken trust indicates that it was established in 1972 by Herbert G. Florcken upon the transfer of $ 1,000. 10 In addition to naming World Banking & Trust Corp. (Cayman), Ltd., as trustee, the deed of settlement provides that the beneficiaries of the trust are Vera Stern and her issue.Under the sales agreement, Sidney Stern transferred 136,850 common shares of Teledyne stock to the Florcken trust in exchange for a lifetime annual annuity of $ 203,519.83, with the first annuity payment to begin on September 15, 1975. The Teledyne shares transferred to the trust were those contingent shares received by Sidney Stern pursuant to the merger agreement between Teledyne, Inc., and Fireside Securities Corp. Unlike the prior sale-annuity agreement executed in 1971, the 1972 agreement was not disclosed on petitioners' 1972 joint Federal tax return; nor does it appear that petitioners reported any income from the 1972 transaction90 on their 1972 or 1973 joint Federal income tax returns.The Court was first notified of the existence of the Florcken trust at the April 23, 1980, partial trial held in Phoenix, Ariz. At that time, the Court indicated it would decide what to do with the Florcken trust issue when it reconvened to take further testimony on April 29 in San Francisco. When the trial reconvened in San Francisco, respondent indicated his intention to file a second amended answer to assert additional deficiencies based on the newly obtained information regarding the 1972 sale-annuity transaction. After hearing testimony on April 29, the Court continued this case pending further direction by the Court.On April 24, respondent served the bank with a subpoena 1081 duces tecum for documents relating to the Florcken trust. In response to respondent's subpoena, the bank filed the motion for protective order which is the subject matter of this opinion. In its motion, the bank requested "that the Court condition any order which compels, directly or indirectly, the Bank of America N.T. & S.A. to produce further documents in connection with this litigation pursuant to motion of respondent herein, upon the91 payment by respondent of the reasonable costs of compliance with such Court order."In support of its motion, the bank made the following assertions:1. As of the date of trial in this matter, April 23, 1980, respondent had served six (6) subpoenas duces tecum on various officers of the Bank in connection with this litigation. 112. The Bank has fully complied, either directly or indirectly, with all of those six subpoenas.3. On April 24, 1980, the Bank was served with still another subpoena duces tecum by respondent, requesting all documents and materials in its possession pertaining to a trust, the operation of which is not even an issue presently before this Court.4. The Bank has incurred considerable expenses in connection with the first six (6) subpoenas, particularly those subpoenas served on the Bank on November 21, 1979 which required production of documents protected under foreign secrecy laws. In that regard, the Bank and its related subsidiaries were required to consult frequently with local counsel in the countries in which these documents were located to avoid violation of pertinent secrecy laws. Additionally, the Bank and its related subsidiaries incurred92 considerable expenses in telephone and telegraphic communications necessary to coordinate the compilation and release of documents, not to mention the considerable cost of employees' time in reviewing the documents to ensure that they fell within the scope of the request and the actual reproduction time. Moreover, respondent has now requested the Bank to certify that materials submitted to respondent by petitioner consist of all the materials made available to petitioner from the 1082 trust company files, a task which will involve considerable additional time and expense for the Bank and its related subsidiaries.5. The documents now requested by respondent's most recent subpoena (#7) served upon the Bank would be found, if any exist, in the possession of the same foreign entities who had possession of the Hylton Trust documents, and would be subject to the same prohibitions against disclosure under foreign secrecy laws as were articulated in the Bank's Memorandum of Law in Opposition to Respondent's Subpoenas Duces Tecum filed with the Court on February 29, 1980.6. Should the Court order the production, either directly or indirectly, of documents encompassed, in whole93 or in part, by the subpoena referred to in paragraph 5 above, located at the Bank's overseas trust company subsidiaries, these trust companies will again be required to incur substantial search and duplication costs and will again be required to obtain opinions of local counsel as to the permissibility and appropriate scope of disclosure of requested information. Had these documents been subpoenaed concurrently with those relating to the Hylton Trust, the Bank could have avoided burdensome duplication of costs and time involved in producing these additional materials and the attendant costs of foreign counsel opinions would have been minimized.* * * 8. Before the Bank, or its subsidiaries, are compelled to take any further action to provide documents and related materials to respondent pursuant to subpoena or order of the Court, it is requested that the Court issue an order directing respondent to compensate the Bank for any and all reasonable costs related to producing the requested material including, but not limited to, the cost of obtaining necessary foreign counsel opinions concerning the permissibility and appropriate manner of releasing information protected by foreign 94 secrecy law.On June 9, 1980, respondent filed a motion for order for production of documents for inspection and copying or to impose sanctions. In this motion, respondent requested that petitioners be required to request from the trustee of the Florcken trust copies of all records, documents, or other materials of any kind whatsoever not previously furnished to respondent which relate to the trust's management and operation between95 January 1, 1971, and December 31, 1973. On July 28, 1980, the Court ordered petitioners to give their consents to the bank and its Bahamian and Cayman Islands subsidiaries to disclose to respondent the above materials. Furthermore, the Court ordered petitioners to request copies of the materials from the trustee of the Florcken trust for respondent's inspection.On July 21, 1980, respondent filed a motion for leave to file a second amended answer. The Court granted this motion on July 25, 1980. In his second amended answer, respondent asserted 1083 additional income tax deficiencies for 1972 and 1973 relating to the sale-annuity transaction involving the Florcken trust. Respondent applied the same alternative theories to the Florcken trust that he previously applied to determine the tax consequences of the Hylton trust. In addition, respondent asserted a gift tax deficiency against petitioner Sidney Stern for the quarter ended September 30, 1972.The issue presented by the bank's motion for protective order is whether the Court should condition the further production of documents by the bank on the payment of reasonable costs by respondent. 12 The Bank claims that the96 production of documents related to the Florcken trust will entail a substantial duplication of the costs previously incurred in producing the documents related to the Hylton trust. According to the bank, the blame for this duplication of costs and effort lies with respondent because he did not subpoena the Florcken trust documents concurrently with the Hylton trust documents.Rule 147(b), Tax Court Rules of Practice and Procedure, provides: 1398 Production of Documentary Evidence: A subpoena may also command the person to whom it is directed to produce the books, papers, documents, or tangible things designated therein; but the Court, upon motion made promptly and in any event at or before the time specified in the subpoena for compliance therewith, may (1) quash or modify the subpoena if it is unreasonable and oppressive, or (2) condition denial97 of the motion upon the advancement by the person in whose behalf the subpoena is issued of the reasonable cost of producing the books, papers, documents, or tangible things.1084 Rule 147(b) is substantially the same as Rule 45(b), Federal Rules of Civil Procedure. 14 Notes to Tax Court Rules of Practice and Procedure, 60 T.C. 1137 (1973). In interpreting the scope of Rule 147(b), this Court may look for guidance from its analog in the Federal Rules of Civil Procedure.Compliance with a subpoena duces tecum will necessarily involve some costs. Rule 147(b) does not guarantee that the party at whom a subpoena duces tecum is directed will be reimbursed for those expenses. See Securities & Exchange Commission v. Arthur Young & Co., 584 F.2d 1018">584 F.2d 1018, 1033, (D.C. Cir. 1978), cert. denied 439 U.S. 1071">439 U.S. 1071 (1979). In fact, the language of the Rule indicates that the advancement of costs99 is a means of ameliorating an otherwise oppressive or unreasonable subpoena. See United States v. Friedman, 532 F.2d 928">532 F.2d 928, 937 (3d Cir. 1976); Securities & Exchange Commission v. OKC Corp., 474 F. Supp. 1031">474 F. Supp. 1031, 1037 (N.D. Tex. 1979); 5a J. Moore, Federal Practice, Par. 45.05 [2], n. 45. Absent an oppressive or unreasonable subpoena, the Court will not invoke its powers under the Rule. This construction of Rule 147(b) comports with the general notion that each individual has a general duty to respond to governmental process and to give testimony when properly summoned. Securities & Exchange Commission v. Arthur Young & Co., supra at 1033; United States v. LaPorte City State Bank, an unreported opinion ( N.D. Iowa 1976, 38 AFTR 2d 76-6201, 76-2 USTC par. 9758); United States v. International Business Machines Corp., 62 F.R.D. 507">62 F.R.D. 507 (S.D. N.Y. 1974). As succinctly stated elsewhere:in consequence, subpoenaed parties can legitimately be required to absorb reasonable expenses of compliance * . It follows that the power100 to exact reimbursement as the price of enforcement is soundly exercised only when the financial burden of compliance exceeds that which the party ought reasonably be made to shoulder. And what is reasonable will depend -- as over the legal spectrum it ultimately does -- upon the circumstances of each case. [Securities 1085 at 1033. Fn. refs. omitted.]A facts and circumstances approach recognizes that not all recipients of a subpoena duces tecum are similarly situated. Among the factors that may effect the Court's determination of whether the advancement of costs is warranted are: (1) The nature of the recipient's business, see United States v. Friedman, supra, at 937; Blank v. Talley Industries, Inc., 54 F.R.D. 627">54 F.R.D. 627 (S.D. N.Y. 1972); 15 (2) the size of the recipient's business, see United States v. Covington Trust & Banking Co., 431 F. Supp. 352">431 F. Supp. 352, 356 (E.D. Ky. 1977); United States v. International Business Machines Corp., supra at 510; 16 (3) the estimated cost of compliance, 101 see Securities & Exchange Commission v. Arthur Young & Co., supra at 1033, 1034; Celanese Corp. v. E.I. duPont de Nemours & Co., 58 F.R.D. 606">58 F.R.D. 606, 609 (D. Del. 1973); and (4) the extent to which the recipient must compile information from his records or documents, see United States v. American Optical Co., 39 F.R.D. 580">39 F.R.D. 580, 587 (N.D. Cal. 1966); Ulrich v. Ethyl Gasoline Corp., 2 F.R.D. 357">2 F.R.D. 357, 359 (W.D. Ky. 1942).102 The flexibility inherent in the facts and circumstances approach permits us to recognize that, under certain circumstances, the actions of the person in whose behalf the subpoena 1086 is issued may warrant the advancement of reasonable costs under Rule 147(b). For instance, if, in this case, respondent were to blame for an otherwise avoidable duplication of costs and effort by the bank in supplying the Florcken trust materials, then the result would be different. After careful review of the entire record, we find that the facts do not support the conclusion that respondent is to blame for the late date of the Florcken trust subpoena. Respondent discovered the circumstances surrounding the Florcken trust only after he had, through strenuous efforts, finally been able to obtain the documents relating to the Hylton trust. 17 Whereas the sale-annuity transaction between petitioners and the Hylton trust was disclosed on petitioners' 1971 joint Federal tax return, a similar transaction occurring the following year involving the Florcken trust was concealed. Although we do not know why the latter transaction was not disclosed, it is likely that if it had been disclosed the103 documents of both trusts would have been subpoenaed concurrently.We conclude that the above circumstances do not warrant104 the granting of the bank's motion for protective order.An appropriate order will be issued. Footnotes1. During the years in issue, Wobaco was a 100-percent subsidiary of World Banking Corp., Ltd. The shareholders of World Banking Corp. were the Bank of America (45-percent ownership), the Toronto-Dominion Bank (33-percent), and several leading European banks which owned the balance.↩2. Sometime prior to 1973, the trusteeship of the Hylton trust was transferred to World Banking & Trust Corp. (Cayman), Ltd., a Cayman Islands corporation which was a wholly owned subsidiary of Wobaco. In 1973, World Banking & Trust Corp. (Cayman), Ltd., was replaced as trustee by Canadian Imperial Bank of Commerce.↩3. The tax consequences of the Hylton trust are a central issue in this case. In 1971, Peter Hylton, who is unrelated to petitioners, practiced law in the Cayman Islands.↩4. This amount should be $ 222,757.01.↩5. Although the subpoenas were directed at Bank of America N.T. & S.A., the subpoenas have been construed as also relating to documents held by first-tier and lower-tier subsidiaries of Bank of America N.T. & S.A.↩6. See n.2 supra↩.7. It has come to our attention that included among these documents was a letter dated June 11, 1973, from World Banking & Trust Corp. (Cayman), Ltd., to Elliot Steinberg. This two-paragraph letter bore the caption "Re: Hylton & Florcken Trust" and read, in pertinent part, as follows:"Following on my recent telephone conversation I now enclose, for your information, photo copies of all the various deposit receipts that we, in our capacity as banker, have issued to the above mentioned two trusts in respect to their various Euro dollar deposits, placed with us, since we sold their respective Teledyne shareholdings."↩8. Respondent's ability to obtain these documents has mooted his Jan. 7 motion to enforce the two subpoenas previously served on the Bank of America.↩9. The Court originally scheduled this trial to commence on Apr. 29, 1980, in San Francisco, Calif. Due to the limited availability of a key foreign witness, the parties agreed to take the testimony of this witness on Apr. 23, 1980, in Phoenix, Ariz. The rest of the trial was expected to be completed on the originally scheduled date, Apr. 29, in San Francisco. However, in the time available, it did not prove possible to complete the taking of testimony at that time.↩10. Herbert Florcken is petitioner Vera Stern's father.↩11. The bank attached the following list of subpoenas to its motion:↩1. Nov. 21, 1979Documents relating to Hylton trust.2. Nov. 21, 1979Documents relating to Hylton trust.3. Apr.8, 1980 Documents relating to trust account maintained at Bankof America, N.Y. 4. Apr.8, 1980 Documents relating to the transfer of shares ofTeledyne, Inc., owned by the petitioners. 5. Apr. 17, 1980Documents relating to employment of Peter Hylton.6. Apr. 22, 1980Documents relating to transfer of Teledyne sharesowned by petitioners. 7. Apr. 24, 1980Documents relating to Florcken trust.12. It appears from the bank's motion that among the costs requested are: telephone and telex expenses; the cost of employee search time; legal fees; and duplication costs.↩13. Although the Bank of America's motion for protective order requests relief under Rule 147(b) Tax Court Rules of Practice and Procedure, such relief could have been requested under Rule 103(a)(9). That Rule provides:PROTECTIVE ORDERS(a) Authorized Orders: Upon motion by a party or any other affected person, and for good cause shown, the Court may make any order which justice requires to protect a party or other person from annoyance, embarrassment, oppression, or undue burden or expense, including but not limited to one or more of the following:* * * (9) That expense involved in a method or procedure be borne in a particular manner or by specified person or persons.Regardless of the Rule under which the bank proceeds, we adhere to the views expressed in this opinion.↩14. Rule 45(b), Fed. R. Civ. P., reads as follows:(b) For Production of Documentary Evidence. A subpoena may also command the person to whom it is directed to produce the books, papers, documents, or tangible things designated therein; but the court, upon motion made promptly and in any event at or before the time specified in the subpoena for compliance therewith, may (1) quash or modify the subpoena if it is unreasonable and oppressive or (2) condition denial of the motion upon the advancement by the person in whose behalf the subpoena is issued of the reasonable cost of producing the books, papers, documents, or tangible things.↩15. Particularly relevant is the following excerpt from United States v. Friedman:"A manufacturer, who may only have dealt with a taxpayer quite casually and occasionally, for example, might not be required, as a part of the cost of doing business, to make and unreimbursed record search. A bank, however, whose business is the facilitation of financial transactions, and which keeps records of all customer dealings as a matter of course, if not law, may be required to do so. [532 F.2d at 937↩; fn. ref. omitted.]"16. As stated in United States v. International Business Machines Corp., 62 F.R.D. 507">62 F.R.D. 507, 509-510:"The only distinction between these movants and the prior applications for costs by nonparty deponents is that these movants are larger and the subpoenas served on them are more comprehensive. Consequently, the costs for complying are necessarily greater. But this distinction is hardly a basis for treating the movants currently before the court differently from the previous applicants. In this regard, the observation made by Judge Weinfeld almost twenty-two years ago should be noted:"'Inconvenience is relative to size. Any witness who is subpoenaed suffers inconvenience. An individual operating a small business, for example, or a corporation operated by a sole shareholder, may suffer, in like circumstances, more inconvenience than [a major corporation] with * * thousands of employees. But this inconvenience, whether suffered by witnesses, grand jurors, or jurors, is part of the price we pay to secure * * * the enforcement of our laws.'" Application of Radio Corporation of America, 13 F.R.D. 167">13 F.R.D. 167, 172↩ (S.D.N.Y. 1952). Although the costs of complying with the subpoena are larger for the movants currently before the court, these movants have greater resources to bear these costs."17. As far as we are aware, the only information regarding the Florcken trust in respondent's possession prior to obtaining the Hylton trust documents was the June 11, 1973, letter which petitioner's counsel turned over to respondent at the Dec. 5 hearing. See n.7 supra↩. The fleeting reference to the Florcken trust contained in that letter, however, is not sufficient to blame respondent for the late date of the Florcken subpoena. The June 11 letter disclosed none of the details of the Florcken trust, for example, the circumstances surrounding the creation of the trust, the beneficiaries of the trust, the purpose of the trust, or petitioners' relationship to the trust. Without such information, it is difficult to imagine how respondent could have been expected to have determined whether the Florcken trust would have been of any potential tax consequence to petitioners for the years in issue.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619417/	Zigmont J. LeTowt, Jr., and Virginia C. LeTowt v. Commissioner.Le Towt v. CommissionerDocket No. 94757.United States Tax CourtT.C. Memo 1963-118; 1963 Tax Ct. Memo LEXIS 228; 22 T.C.M. (CCH) 547; T.C.M. (RIA) 63118; April 25, 1963228 Travel Expenses - Secs. 62(2)(B), 162(a)(2), and 262, I.R.C. 1954. Husband was transferred by his employer to Johnstown, Pennsylvania, from Bethlehem, in 1956. He continued to maintain his family home at Bethlehem making weekend trips back and forth and paying lodging expenses in Johnstown during the week. He had no other business or employment. Held: The expenses of his weekly trips and lodging at his place of employment were personal living expenses and not deductible in 1958 and 1959, the years in issue, as ordinary and necessary business expenses, incurred for travel while away from home in connection with employment or in pursuit of a trade or business. Zigmont J. LeTowt, Jr., pro se, 1838 Jennings St., Bethlehem, Pa. Malin Van Antwerp, Esq., for the respondent. HOYTMemorandum Findings of Fact and Opinion HOYT, Judge: In this proceeding petitioners challenge respondent's determination of deficiencies of $488.01 and $532.72 in income tax for the years 1958 and 1959, respectively. The deficiencies result from respondent's disallowance of claimed deductions for travel and living expenses and for a dependency exemption for 1958 for the elder son of petitioners. Petitioners, by stipulation, waive their claim to a deduction for the dependency exemption claimed for 1958, and so the sole issue remaining for decision is as to the travel and living expense deductions. Findings of Fact Two Stipulations of Fact were filed, and the Court finds all facts set forth in both stipulations accordingly. The petitioners are husband and wife, and have resided since 1939 at 1838 Jennings Street, Bethlehem, Pennsylvania. They filed joint income tax230 returns for the calendar years 1958 and 1959 with the district director of internal revenue at Scranton, Pennsylvania. Reference hereinafter made to petitioner will refer to Zigmont J. LeTowt, Jr., as it is his claimed deductions of travel and living expenses at issue here, and Virginia C. LeTowt is a co-petitioner only because of her having filed joint returns with her husband. Petitioner is a graduate of Lehigh University at Bethlehem, and has been employed by Bethlehem Steel Company, hereinafter called Steel Company, since 1939. He worked for this employer at Bethlehem until August 6, 1956, when the section to which he was assigned was moved by the Steel Company to Johnstown, Pennsylvania, approximately 245 miles away. Ever since that time petitioner has been regularly employed and working at Johnstown, and at time of trial in January 1963, more than six years later, he was still employed there by Steel Company. Petitioners purchased their home in Bethlehem in 1946, making a down payment of $1,750, and giving a purchase-money mortgage on the property of $5,000. This mortgage was subsequently refinanced, the last time in 1956, to a face amount of $6,500. Petitioners had four231 children - two sons and two daughters - all of whom were in college in 1958, and three of whom continued their college education in 1959. The elder son, Zigmont J. LeTowt, III, attended Lehigh University at Bethlehem, from September 1951 until June 1954, and the United States Military Academy at West Point from 1954 to June of 1958 when he was graduated and commissioned in the United States Army. Petitioners' daughters attended Moravian College at Bethlehem and lived at home during their college days. The younger son, Jon, entered Middlebury College in Vermont in September of 1958, and at time of trial was still a student there. The children worked to assist in paying for their college education. Because of plans for their children's education, petitioners decided to maintain their home in Bethlehem after the Steel Company transferred petitioner's section to Johnstown. They were established there, owned their home, had loans at the local banks, and concluded that they could only accomplish their plans for educating their children by maintaining this home. Petitioner obtained inexpensive lodgings in Johnstown, visiting his family in Bethlehem weekly through the years. In the calendar232 years 1958 and 1959 he spent the following amounts for weekly rail and bus transportation between Bethlehem and Johnstown, and for lodging in Johnstown: 19581959Transportation$1,098.24$1,550.64Lodging in Johnstown520.00780.00$1,618.24$2,330.64At time of trial, January 7, 1963, petitioner still traveled weekly between his home in Bethlehem and his place of employment at Johnstown. He was not engaged in any other business or employment during the taxable years in question, and his only place of employment was at Johnstown, 245 miles away from Bethlehem. Johnstown was petitioner's principal place of employment in 1958 and 1959, and he was not "away from home" while performing his duties for Steel Company there during those years. The decision to leave his family in Bethlehem and to maintain a home there for them was a personal decision dictated by personal considerations and conclusions, unrelated to petitioner's employment at Johnstown. The expenses incurred by him in 1958 and 1959 for transportation and lodging were personal expenses, not incurred by petitioner in carrying on the business of earning his salary from Steel Company and unrelated233 to the business of his employer. Opinion The essence of petitioner's argument for deductibility of his travel expenses between Bethlehem and Johnstown, and his living expenses at Johnstown, is that his plans for the education of his four children required him to continue to maintain the family home at Bethlehem after his transfer to Johnstown in 1956. He contends that these plans dictated this course of action and that he did not move his family to Johnstown in 1956 because it was not "feasible nor judicious under the circumstances, - and common sense had to prevail." He also argues that home is where the wife is, Bethlehem, and "away from home" is where the bread-winner has to go to earn his salary, Johnstown. We have no alternative but to reject petitioners' appealing and sympathetic arguments. Even if we were to assume that family educational plans could have been accomplished only by the maintenance of the family home when petitioner's employment was transferred to Johnstown in 1956, which petitioner's evidence has utterly failed to establish, we must hold for respondent. In Commissioner v. Flowers, 326 U.S. 465">326 U.S. 465 (1946), the Supreme Court laid down the following234 three conditions for allowing deductibility of traveling expense deductions: Three conditions must thus be satisfied before a traveling expense deduction may be made under § 23(a)(1)(A): (1) The expense must be a reasonable and necessary traveling expense, as that term is generally understood. This includes such items as transportation fares and food and lodging expenses incurred while traveling. (2) The expense must be incurred "while away from home." (3) The expense must be incurred in pursuit of business. This means that there must be a direct connection between the expenditure and the carrying on of the trade or business of the taxpayer or of his employer. Moreover, such an expenditure must be necessary or appropriate to the development and pursuit of the business or trade. As the Court in that opinion stated, all three conditions must be met, and whether or not "away from home" means away from the place where a taxpayer earns his income or away from the place he lives, the third condition must also be met. Here, as we have found, there was no relationship between petitioner's expenditures and his earning of his salary or the business of Bethlehem Steel Company. The235 expenses were personal living and traveling expenses of petitioner, incurred because of his personal family plans. As excellent and as laudable as those plans may be, they do not create deductibility for tax purposes. Petitioner's evidence and arguments all tend to establish the clearly personal nature of the expenses in question. Personal living and family expenses are nondeductible under section 262 of the Internal Revenue Code of 1954. In Carragan v. Commissioner, 197 F. 2d 246 (C.A. 2, 1952), affirming a Memorandum Opinion of this Court, the Court said of a taxpayer, resident in New York, who sought to deduct living expenses in Philadelphia where he worked during the week: Petitioner is fifteen years too late with his argument that living expenses in Philadelphia, his place of business, are deductible as "traveling expenses * * while away from home in the pursuit of a trade or business." * * * A nation of city-hoppers and suburbanites though we may be, the Supreme Court has steadfastly refused to say that traveling expenses are incurred in the pursuit of business when they stem from the petitioner's refusal to bring his home close to his236 job. The job, not the taxpayer's pattern of living, must require the travel. Other courts have consistently denied the deduction in similar factual situations. Martin v. Commissioner, 295 F. 2d 38 (C.A. 3, 1961), affirming per curiam a Memorandum Opinion of this Court; O'Toole v. Commissioner, 243 F. 2d 302 (C.A. 2, 1957), affirming per curiam a Memorandum Opinion of this Court; Hammond v. Commissioner, 213 F. 2d 43 (C.A. 5, 1954), affirming 20 T.C. 285">20 T.C. 285; York v. Commissioner, 160 F. 2d 385 (C.A.D.C., 1947); Robert A. Coerver, 36 T.C. 252">36 T.C. 252 (1961) affd. per curiam, 297 F. 2d 837 (C.A. 3, 1962); Henry C. Warren, 13 T.C. 205">13 T.C. 205 (1949); Robert F. Greep, 12 T.C. 656">12 T.C. 656 (1949). 1This is so even when the employee maintains his established home and incurs traveling expenses at another place while working on a specific job for an indefinite time; Leo C. Cockrell, 38 T.C. 470">38 T.C. 470 (1962);237 Ray A. Smith, 33 T.C. 1059">33 T.C. 1059 (1960); James M. Eaves, 33 T.C. 938">33 T.C. 938 (1960); or when he is unable to move his family to the place of employment because he cannot find a home there; York v. Commissioner, supra; Henry C. Warren, supra; Williard S. Jones, 13 T.C. 880">13 T.C. 880 (1949); or is prevented from moving his family because his job requires him to go to an overseas location; James R. Whitaker, 24 T.C. 750">24 T.C. 750 (1955); Michael J. Carroll, 20 T.C. 382">20 T.C. 382 (1953). We have examined all of the authorities relied upon by petitioners and find them clearly distinguishable, and in most cases not at all in point. The amounts petitioner seeks to deduct represent the cost of lodging while he was in Johnstown, his only and permanent place of employment, and the cost of transportation on weekends to and from the residence of his family in Bethlehem. They had no relation to or connection with the business of Bethlehem Steel Company, petitioner's employer, nor with his own business of earning his salary from that company. The job certainly did not require or justify the expenses but rather they were incurred because of petitioner's*238 "pattern of living," - his decision that to educate his children he had to maintain his family home at Bethlehem after his employment was shifted to Johnstown. We hold that the respondent was required under the law to disallow the deductions claimed by petitioners as traveling expenses in 1958 and 1959, and that he was correct in so doing. They were personal, living or family, expenses made specifically nondeductible by section 262 of the Internal Revenue Code of 1954. Decision will be entered for the respondent. Footnotes1. The provisions of sec. 23(a)(1)(A) of the 1939 Code and of sec. 162(a) of the 1954 Code are identical and have been construed by the courts to require the same conditions in determining deductibility of travel expenses.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619418/	Hawaiian Freight Forwarders, Ltd. v. Commissioner.Hawaiian Freight Forwarders, Ltd. v. CommissionerDocket Nos. 9969, 111693.United States Tax Court1947 Tax Ct. Memo LEXIS 195; 6 T.C.M. (CCH) 601; T.C.M. (RIA) 47149; May 29, 1947195 Reasonable compensation for services of petitioner's officers determined. Louis Janin, Esq., 1120 Mills Tower, San Francisco, Calif., for the petitioner. W. J. McFarland, Esq., for the respondent. VAN FOSSAN Memorandum Findings of Fact and Opinion The respondent determined the following deficiencies in the petitioner's tax liabilities and imposed the penalty noted for the period from196 April 1, 1940, to November 30, 1940, and for the fiscal year ending November 30, 1941: PeriodFiscalTaxin 1940Year - 1941Income$2,971.13$13,448.23Declared value excessprofits2,229.391,667.00Excess profits3,020.6910,348.88Penalty755.17The basic issue is whether or not certain sums accrued on the petitioner's books and payable to its two principal officers as bonuses, are deductible and, together with regular salaries, constituted reasonable compensation for the services of those officers. An alternative issue, arising only if the petitioner does not prevail on the major issue, is whether or not it is entitled to the benefit of Supplement A, as provided by sections 740 to 744, inclusive, of the Internal Revenue Code, for the purpose of computing an excess profits credit based on income. The respondent's imposition of a 25 per cent delinquency penalty for the failure to file a timely excess profits tax return for the taxable period from April 1, 1940, to November 30, 1940, inclusive, is also contested by the petitioner. Findings of Fact Certain facts were stipulated. The portions thereof material to the issues are as follows: 197 The petitioner is a corporation organized and operating in the Territory of Hawaii and has its principal office in Honolulu. It filed its income, declared value excess profits and defense tax returns with the collector of internal revenue for the District of Hawaii. Hawaiian Freight Association, Ltd. was organized as a corporation under the laws of the Territory of Hawaii on March 16, 1933, to engage in the freight forwarding business; it was liquidated and dissolved on or about December 31, 1936, and its assets distributed to its then shareholders who were J. C. Leffel, G. C. Ballentyne and A. G. Schnack, who owned 33 shares, 24 shares and 10 shares, respectively. On or about December 31, 1936, the shareholders created a partnership, Hawaiian Freight Association, and to it transferred the assets and business theretofore owned and operated by Hawaiian Freight Association, Ltd. The interests of the partners were in the same proportions as their shareholdings in the predecessor corporation, and so remained until March 8, 1940. Prior to March 8, 1940, an understanding had been reached between J. C. Leffel and G. C. Ballentyne and Oahu Railway and Land Company, hereinafter called198 Oahu, that a corporation would be formed to take over and operate the assets and business of Hawaiian Freight Association, with Leffel, Ballentyne and Oahu as equal shareholders. It was believed that this would be to the mutual advantage of the parties concerned. On March 8, 1940, an agreement was entered into by and between Schnack, Leffel and Ballentyne with respect to Schnack's interest in Hawaiian Freight Association. Under that agreement Leffel and Ballentyne purchased from Schnack, who desired to withdraw from the partnership, his entire interest therein for $8,000 cash. The petitioner was organized as a corporation under the laws of the Territory of Hawaii, March 13, 1940, with a capital of $120,000, represented by 6,000 shares, issued 2,999 to Leffel and 2,998 to Ballentyne, 3 qualifying shares being nominally issued to others. For this stock there were transferred on March 31, 1940, to the petitioner the business and the following assets formerly owned by Hawaiian Freight Association (the partnership): Cash$ 19,237.07Receivables9,151.08Furniture and fixtures1,341.86Stationery269.99Good will90,000.00Total$120,000.00On July 12, 1940, the199 following agreement was entered into by Leffel, Ballentyne and Oahu: "WHEREAS, the First Parties own stock in Hawaiian Freight Forwarders, Ltd., an Hawaiian corporation, as follows: G. C. Ballentyne 3000 shares of the par value of Twenty Dollars ($20.00) per share; J. C. Leffel 3000 shares of the par value of Twenty Dollars ($20.00) per share; their combined holdings constituting all of the issued and outstanding stock of said corporation; and "WHEREAS, it is the desire of the First Parties that the Second Party become interested in said corporation, and to that end the First Parties have offered to sell to said Second Party out of the stock owned and held by them, Two Thousand (2,000) shares of the capital stock of said corporation (1,000) shares each of the par value of Twenty Dollars ($20.00) for the sum of Fifteen Thousand Dollars ($15,000.00); and "WHEREAS, the First Parties have over the past several years become thoroughly conversant with the business engaged in and conducted by said Hawaiian Freight Forwarders, Ltd.; and "WHEREAS, it is recognized that said corporation is in effect a personal service corporation and that the success or failure of said corporation200 depends on the rendition of satisfactory service by said First Parties, both of whom are officers and employees of said corporation, and that satisfactory salaries make for the rendition of satisfactory service; and "WHEREAS, it has been agreed between the parties hereto that said corporation shall not pay out of its net profits in any one year, a dividend in excess of the aggregate amount of Two Thousand Two Hundred Fifty Dollars ($2,250.00) on all of its outstanding stock until such time as said First Parties shall have been paid from net profits, each, the sum of Thirty-Seven Thousand Five Hundred Dollars ($37,500.00), over and above the fixed annual salary hereinafter referred to, as additional salary by way of bonus for services rendered and to be rendered by them to said corporation, and thereafter, that is, after the full payment of said sum of $37,500.00 to each of said First Parties, and after the payment of an annual dividend of ten per cent (10%) on the par value of all outstanding stock, that said First Parties shall be paid an additional salary by way of bonus, annually, equal to twenty-five per cent (25%), that is, twelve and a half per cent (12 1/2%) each, of the remaining201 net earnings, if any, of said corporation. "NOW, THEREFORE, in consideration of the premises, the First Parties hereby each agree to sell and deliver to said Second Party, One Thousand (1,000) shares (total of Two Thousand (2,000) shares), of the capital stock of the aforesaid corporation standing in his name on the books of said corporation, for the sum of Seven Thousand Five Hundred Dollars ($7,500.00), and said Second Party agrees to accept the same, and to pay therefor in cash upon delivery, to each of said First Parties, the sum of Seven Thousand Five Hundred Dollars ($7,500.00); and "FURTHER, the parties hereto mutually agree: "(a) That after the consummation of the sale aforesaid, they and each of them, will not sell any of the stock standing in their or any of their names on the books of the corporation, until the bonus aforesaid, in the amount of $37,500.00 payable to each of said First Parties, has been paid in full out of the net profits earned by said corporation, and that after payment of the aforesaid bonus, in case any one or more of them should desire to sell his stock in the corporation aforesaid, or in the event of the death of any one or more of the aforesaid202 parties, it is agreed that the other parties hereto shall have the option to purchase and acquire the whole of the stock interest of such party so dying or so desiring to sell his stock, at the fair value thereof, which fair value shall be ascertained as follows: In case the parties can agree upon the price to be paid, then the party or parties desiring to purchase may do so at such price so agreed upon, but in case the representative of the party so dying or the party desiring to sell his stock, and the remaining parties to this contract, cannot agree upon the fair value thereof, then each of the parties shall have the right to appoint one experienced businessman as arbitrator, who, if they can agree shall fix the price, whereupon the remaining parties hereto shall have the right to purchase or refuse to purchase said stock of said party wishing to sell or dying at such figure. In the event that the two arbitrators appointed cannot agree, then they shall choose a third party as umpire, and the decision of the majority thereof shall fix a price at which the remaining parties hereto shall have the right to take or refuse the stock at the price so determined. In case the parties remaining203 refuse to purchase at the price so determined, then the stock may be sold or retained by the owner or his representative at his discretion. "It is further agreed that if any party hereto shall sell his stock to one or both of the other parties hereto, said party so selling will not for the period of ten years from the date of the consummation of any such sale, either directly or indirectly or through the medium of a partnership or corporation, enter into any business in the Territory of Hawaii competing with the business conducted by said Hawaiian Freight Forwarders, Ltd.; "(b) That they will not, either as directors or stockholders, vote to declare a dividend out of the net earnings of said corporation, in excess of the sum of Two Thousand Two Hundred Fifty Dollars ($2,250.00) annually, until the aforesaid bonus of Thirty-seven Thousand Five Hundred Dollars ($37,500.00) payable to each of said First Parties, has been paid in full, and that thereafter, that is, after the payment of the said bonus, and after payment of an annual dividend of ten per cent (10%) on the par value of all outstanding stock, said First Parties shall be paid an additional salary annually by way of bonus, 204 equal to twenty-five per cent (25%), that is, twelve and a half per cent (12 1/2%) each, of the remaining net earnings, if any, of said corporation; and "(c) That they will not, either as directors or stockholders, vote to increase the present salaries of Seven Thousand Two Hundred Dollars ($7,200.00) per annum payable by said corporation to each of the First Parties. "This agreement shall be binding upon the heirs, executors, administrators and permitted assigns of the parties hereto." The following is a true and correct schedule showing the income of Hawaiian Freight Association for each of its calendar years commencing with that ended December 31, 1937, including the capital employed and the drawing of the partners as "salary": 3 months1937193819391940Gross Receipts$246,797.08$250,565.69$275,061.88$92,623.07Freight Charges177,614.61193,708.75220,808.2957,605.65Gross Profit69,182.4756,856.9454,253.5935,017.42Miscellaneous31.46Dividends15.9235.7740.9014.23TOTAL INCOME69,198.3956,892.7154,294.4935,063.11Deductions19,311.2021,830.1424,587.997,404.57NET INCOME$ 49,887.19$ 35,062.57$ 29,706.50$27,658.54Partners' "Salaries"8,015.009,300.0011,000.00Capital at beginning of year16,984.1216,984.1216,984.1216,984.12Accumulated earnings19,208.2114,138.1716,943.74205 "(That portion of the foregoing stipulation which deals with the earnings of Hawaiian Freight Association for the three months ended March 31, 1940, shall not be regarded as a concession on the part of the respondent that only one partnership was in existence during said period, it being the respondent's position that the elimination of A. G. Schnack as a partner on March 8, 1940, terminated the existing partnership and resulted in the creation of a new partnership on that date. It is agreed that if the respondent's position in this respect is sustained, the earnings for such three months period can be prorated on a daily basis.)" The following schedule shows the capital accounts, salaries, distributable income, and withdrawals by each of the partners of Hawaiian Freight Association for the calendar years 1937 to 1939, inclusive: CAPITAL ACCOUNTS WITHDRAWALS1937J. C. LeffelG. C. BallentyneA. G. SchnackCapital %49.2635.8214.92Capital Jan. 1$ 8,366.42$ 6,083.67$2,534.03Salary4,200.003,815.00Profit20,547.8314,941.606,223.58TOTAL33,114.2524,840.278,757.61Drawings15,247.2911,926.483,346.03Balance December 3117,866.9612,913.795,411.581938Balance January 1$17,866.96$12,913.79$5,411.58Salary4,650.004,650.00Profit12,558.779,132.263,803.83TOTAL$35,075.73$26,696.05$9,215.41Drawings20,158.5315,828.723,877.55Balance December 31$14,917.20$10,867.33$5,337.861939Balance January 1$14,917.20$10,867.33$5,337.86Salary5,500.005,500.00Profit9,121.376,632.712,762.71TOTAL$29,538.57$23,000.04$8,100.57Drawings12,293.7611,613.732,803.83Balance December 31$17,244.81$11,386.31$5,296.74206 The record discloses the following additional facts: During the years in controversy Ballentyne was treasurer and a director and stockholder of the petitioner. He was manager of the Honolulu office. His duties there were to make contact with customers on the Islands, to supervise the handling of the freight upon arrival, to make collections and to attend to other necessary business services. He worked a whole day every day of the week and was required to work on Sundays and frequently at night. At the time of the hearing he was 52 years of age. During the same period Leffel was president and a director and stockholder of the petitioner. He was manager of the Chicago office and his duties were to assemble into carload lots all freight delivered in Chicago and originating at Eastern points and to supervise its movement from Chicago to San Francisco, where it was turned over to the Matson steamers for transportation to Honolulu. He also solicited freight to be shipped in the petitioner's care. He worked long hours each day and on Sundays. He was 59 years of age at the time of the hearing. In about 1926 Ballentyne became head purchasing agent of the Hawaiian Pineapple Company and207 served in that capacity for seven years. He received a salary of $500 per month. In 1933 he became manager of the Hawaiian Freight Forwarders, a corporation organized in that year. In 1936 he became manager of the Honolulu office of the Hawaiian Freight Association, a position which he occupied until he became an officer of the petitioner in 1940. Leffel had approximately 15 years' experience with various transportation companies, including the Universal Carloading and Distributing Company, the largest concern of its kind in the world, whose San Francisco office he managed at a salary of $600 per month. During that service he found that export traffic moving to Hawaii was being handled in a very inefficient manner. He was conversant with freight rates, the knowledge of which is very essential to obtaining shipments. Through his efforts the petitioner effected savings for its customers by shipping by the carload, whereas the shipper normally would be charged at the higher less than carload (LCL) rate. The petitioner had at least eight competitors during 1940 and 1941. At the time of its organization no competitor maintained an office in the Hawaiian Islands. The petitioner promptly208 established its office in Honolulu and fixed definite rates for its services. The rates were higher than those of its competitors, who were acting merely as freight brokers. Through the personal attention which Ballentyne and Leffel gave to the shippers and receivers of freight, the petitioner commanded and received the higher rate. The petitioner's services included expediting freight shipments through Chicago, routing shipments, inspecting their loading and packaging, handling consignments at Honolulu, arranging for deliveries, checking rates and charges, handling claims, making contact with Eastern suppliers to ascertain when shipments would be ready for movement, and doing many other such favors for its customers. Its services were completed upon the delivery of the shipment to the customer at destination. It is very difficult to obtain men who are experienced and have knowledge of the type of operation conducted by the petitioner. The petitioner handled about 75 per cent of the total freight traffic to the Hawaiian Islands and much more than the Universal Carloading and Distributing Company, its closest competitor. The bonuses of $10,248.21 and $27,251.79 accrued on the petitioner's209 books (and paid in February of the following year) to each of its two principal officers, Ballentyne and Leffel, for the taxable year ending November 30, 1940, and the fiscal year ending November 30, 1941, respectively, together with their regular salaries, were proper and reasonable compensation for the services performed for the petitioner by such officers. Prior to the execution of the contract of July 12, 1940, Oahu desired to have a connection with the petitioner, since Oahu was in the trucking business and was anxious to have access to incoming freight at the Port of Honolulu. A working capital fund of approximately $30,000 was required to cover the freight and trucking charges advanced by the petitioner for the benefit of its customers and repaid in Honolulu upon delivery of the goods. The petitioner's gross receipts, salary and bonus payments to its two principal officers and taxable net income for the two years here in dispute were reported by it as follows: NovemberNovember30, 194030, 1941Gross Receipts$240,507.57$588,435.91Salary, J. C. Leffel4,800.007,200.00Salary, G. C. Ballentyne4,800.007,200.00Bonus, J. C. Leffel10,248.2127,251.79Bonus, G. C. Ballentyne10,248.2127,251.79Net income after salariesand bonuses, before in-come tax2,018.977,672.49210 The respondent disallowed the bonus accruals to Ballentyne and Leffel in the taxable period ending November 30, 1940, with the following explanation: "* * * It is held that the so-called bonus is in fact a payment by you for property transferred to you by the said G. C. Ballentyne and J. C. Leffel, and that the amount is therefore a capital expenditure and, as such, not a deductible expense of the taxable year. It is further held, even if the amount should be determined to be in fact a payment for services rendered, that the said payment was in excess of a reasonable compensation for the services rendered. The whole amount of the deduction for bonus is therefore disallowed." He disallowed similar amounts accrued in the fiscal year ending November 30, 1941, on the ground that they did "not constitute an allowable deduction as claimed by" the petitioner. The failure of the petitioner to file a timely excess profits tax return for the period from April 1, 1940, to November 30, 1940, was due to reasonable cause (less than $5,000 net income) and not to wilful neglect and hence the petitioner is not liable for the 25 per cent penalty for such failure imposed by the respondent. 211 Opinion VAN FOSSAN, Judge: The fundamental issue before us is whether or not the bonus accrued to each officer of the petitioner on its books for the taxable period under review, together with the regular salaries, constituted reasonable compensation for his services to the petitioner during such periods. In his notice of deficiency the respondent took the ground that the bonus payments (accrued in the taxable years) were made in effect as a part payment of the cost of the petitioner's stock sold by Ballentyne and Leffel to Oahu. He has now abandoned this theory and asserts that they were equivalent to the distribution of earnings to stockholders. The real controversy in the cases at bar, as we see it, is whether or not the amounts paid to Ballentyne and Leffel were "reasonable". We conclude that they were. The terms of the agreement served to inspire Ballentyne and Leffel to extraordinary effort. The record shows that they were very efficient and each officer devoted long hours to the various phases of the business for which he was responsible. Each had the aptitude, the skill, the knowledge, the training and the capacity for hard and sustained effort that were essential to212 the petitioner's success and the consequent growth in its receipts and profits. We observe the marked increase in gross receipts over the previous years during which the partnership operated. In view of the unique type of the petitioner's activity of its dependence on the specialized training and experience of its officers for the operation and success of the enterprise, of the precise and predetermined amount of the bonus and of the demonstrated skill and efficiency of Ballentyne and Leffel, the amounts of the bonus accrued to those officers in the taxable years, together with the regular salaries, are held to be reasonable compensation for their services as such. In view of our decision on the primary issue, it is unnecessary to discuss or decide the alternative issue. Further, there was no necessity to file an excess profits tax return since the petitioner's income was less than the $5,000 specific exemption. Hence, no penalty attaches to the failure of the petitioner to file a timely return. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619419/	UNION C. DEFORD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.DeFord v. CommissionerDocket No. 28483.United States Board of Tax Appeals19 B.T.A. 339; 1930 BTA LEXIS 2419; March 20, 1930, Promulgated 2419 Union C. DeFord, Esq., pro se. John D. Kiley, Esq., for the respondent. VAN FOSSAN 339 This proceeding is for the redetermination of a deficiency of $326.78 in income tax for the year 1922. The question presented is whether or not 100 shares of the Ohio Leather Co. owned by petitioner became worthless in 1922. 340 FINDINGS OF FACT. The Ohio Leather Co. was incorporated on March 18, 1901, pursuant to the laws of the State of Ohio. It was engaged in the manufacture of leather products and its principal place of business in the State of Ohio was in Youngstown. At the end of 1922 there was outstanding $1,610,200 of preferred stock and $1,423,400 of common stock of the corporation, each share having a par value of $100. The company was successful in its business operations up to about August, 1919, at which time it began to incur serious losses because of a large shrinkage in the inventory value of its raw materials and in the price of its manufactured articles. At the close of the year 1920 the corporation's books disclosed a deficit in the sum of $2,070,778.18. During 1921 the directors of the company formed a corporation for2420 the purpose of loaning additional working capital to the Ohio Leather Co., and by use of this additional capital the deficit was reduced slightly so that at the end of 1921 it amounted to $1,941,446.11. On December 10, 1921, the petitioner purchased in the open market 100 shares of the common stock of the Ohio Leather Co. at $19.50 a share. In August, 1922, an audit was made of the affairs of the company by a certified public accountant. In December, 1922, certain of the directors of the company, preferred and common stockholders, and certain individuals who were not stockholders in the Ohio Leather Co., together with the Youngstown Securities Co. as "syndicate manager," entered into an underwriting agreement for the purpose of furnishing new and additional capital to and reorganizing the Ohio Leather Co. under the no-par value stock law of the State of Ohio. In this underwriting agreement it was recited that the Ohio Leather Co. was indebted to various banks in the sum of $2,345,500, which indebtedness would mature for payment "and must be paid or secured to be paid on February 15, 1923," and that the said company, in addition to the funds necessary to liquidate said indebtedness, 2421 was in urgent need of additional working capital with which to prosecute its business successfully. It was agreed in said underwriting agreement, among other things, that the Ohio Leather Co. would reorganize under the no-par value stock law of the State of Ohio with a capitalization of $1,500,000 7 per cent debenture notes, $1,500,000 of 8 per cent cumulative first preferred stock with a par value of $100 per share, $1,000,000 of 7 per cent cumulative second preferred stock with a par value of $100 per share and 75,000 shares of no-par value common stock. It was agreed that the $1,500,000 of 7 per cent debenture notes should be used or applied in the reduction of the bank indebtedness. It was further agreed that the preferred stockholders of the Ohio Leather Co. should each be assessed $50 on each share of their preferred 341 stock and in return should receive for each share of preferred stock held by them one-half of one share of new 8 per cent first preferred stock, one-half of one share of new 7 per cent second preferred stock and one share of no-par value common stock. It was also provided that, on the company's reorganization, the old preferred stockholders who2422 did not exchange their stock on the basis referred to should receive one-fifth of one share 7 per cent second preferred stock for each one share of the old preferred stock held by them. It was further provided in the said underwriting agreement that the holders of the outstanding shares of common stock should be assessed $20 on each share held by them and upon payment of such assessment should receive in exchange for each share of common stock two shares of the no-par value common stock presently to be issued by the reorganized company. The underwriting agreement also contained provisions for the distribution among the parties thereto of the proposed new stock not taken by old stockholders. The petitioner was one of the stockholders who signed the underwriting agreement subscribing for both preferred and common stock of the reorganized company. At the end of 1922 there was no market for the common stock of the Ohio Leather Co. Some so-called "wash" sales of the common stock were made in order to establish a loss for income-tax purposes but there were no bona fide sales. The corporation's financial condition of December 31, 1922, is shown by the following condensed financial2423 statement, based on an audit made by certified public accountants: ASSETSReal estate, plant and equipment$695,306.85Prepaid interest, insurance, and expense45,721.33Inventory, raw stock, work in process and finished leather1,786,947.84Accounts and notes receivable789,496.43Cash315,799.743,633,272.19LIABILITIESCapital stock - common1,423,400.00Capital stock - preferred1,610,200.00Notes payable2,345,500.00Accounts payable160,326.00Reserve for discount and taxes34,157.83Reserve for Federal taxes78,256.90Reserve for contingencies75,000.00Loss for year-90,606.65Deficit-2,002,961.922,093,568.573,633,272.19342 The income-tax return for 1922 filed by the corporation stated as the total deficit for the year 1922 the sum of $2,093,568.57, which corresponds with the amount of total deficit stated in the foregoing condensed financial statement. On February 9, 1923, the president of the Ohio Leather Co. addressed and sent to the stockholders of the company a letter relating to the financial condition of the company and its proposed reorganization under2424 the no-par value stock law of the State of Ohio. In this letter the president of the Ohio Leather Co. stated, among other things, as follows: Commencing with December 31, 1919, this company, due to the rapid decline in the market price of its raw materials and finished products, has charged off $2,659,497.00. As a result of this, the surplus account of the company was entirely wiped out, the value behind the common stock entirely wiped out, and about 40% of the value behind the preferred stock wiped out. In other words, according to our statement to-day, the preferred stock has assets behind if of about $60.00 per share, and the common stock has no assets whatever behind it. This very heavy loss on the raw material and manufactured product of the company was caused, as above stated, by a rapid decline in the market prices thereof, which was not anticipated or expected by either the leaders in the leather industry, and was suffered in common by all other companies in the leather industry. While, as above stated, the assets back of the preferred stock, as shown by our present statement, amount to approximately $60.00 per share, it must be remembered that this is true only if the2425 company is to remain a going concern. If it is not, but is to be liquidated, it is possible that upon liquidation, the value back of the preferred stock would be entirely wiped out and the creditors of the company would receive less than the full value of their claims. The president's letter stated further that $2,345,500 was due banking creditors of the company on notes maturing February 15, 1919, and that if the company was to continue a going concern enough new money must be put into it to reorganize it adequately. The letter asserted in substance that less new capital could be secured from the common stockholders than from the preferred stockholders because the common stockholders had "nothing to save." The president thereupon proceeded to outline in said letter the same plan of reorganization set out in the underwriting agreement before referred to, except that the president stated that the proposed debenture notes were to bear 6 per cent interest. He stated that the shares of common stock would be assessed $20 per share and that "common stockholders paying this assessment will receive two (2) shares of no-par value common stock for each one share of present common stock2426 held by them." The president of the company also stated in the letter that the proposed plan of reorganization, if successfully carried into effect, would, in addition to providing $1,500,000 worth of debenture notes to be used to pay off banking creditors, furnish the company with $1,100,000 worth of new capital. 343 As reasons for urging stockholders to take part in the proposed reorganization which was recommended by the president and board of directors of the company, the president made the following statement: Your board of directors feel that it is very much to the advantage of the stockholders that the company be saved and maintained as a going concern. In the nineteen years, from 1901 to 1919, inclusive, the Company made average earnings per year upon its common stock of 17.7%, notwithstanding a loss of $200,000.00 taken in 1911. In the eight years from 1912 to 1919, inclusive, it made average earnings per year of 29.4% on the common stock. It has a well equipped plant, its product is well and favorably known, and its management, in the opinion of the Board of Directors is efficient. Furthermore, it is engaged in a basic business, because its products are a2427 common necessity and must continue to be. Mr. Lumbard, our Vice President, has developed a new product, which has met with favor in the trade, and the company is now operating practically at the capacity of 1,000,000 feet of finished leather per month. With respect to the stock issue, the proposed reorganization was carried out in the manner stated in the underwriting agreement and recommended in the president's letter. The new stock was issued and delivered to persons subscribing therefor in amounts proportionate to their subscriptions and as a result approximately $1,100,000 new capital was put into the treasury of the Ohio Leather Co.On March 21, 1923, the petitioner received from the Ohio Leather Co. a document, of which the following is a copy, acknowledging receipt for a subscription covering his holdings of 110 shares of the old common stock of the company. We are in receipt of your subscription covering your present holdings of 110 shares of the common stock of this Company. Under this subscription you will be required to make the following payments: Apr. 1, 1923 $550July 1, 1923550Oct. 1, 1923 $550Jan. 1, 1924550Any or all of these2428 payments may be anticipated, if you so desire. Please forward your check to the Dollar Savings & Trust Company, Youngstown, Ohio, by April 1st, delivering with it, properly endorsed, the certificates of stock which you now hold. As soon as possible thereafter receipts covering your payments will be forwarded to you. THE OHIO LEATHER CO.The petitioner thereafter delivered to the company his par value common stock for cancellation, paid in full the assessment of $20 per share on the 110 shares of the old common stock held by him and received two shares of the new no-par value common stock for each share of his old stock. At the time of the hearing he still owned the no-par value common stock in the reorganized company. 344 At the time the underwriting agreement referred to was entered into and up to the time, namely, about March 21, 1923, when the petitioner made a subscription covering his holdings of old common stock, the right to subscribe for the no-par value common stock had no market value. Persons other than stockholders were parties to the underwriting agreement and persons who were neither holders of the old common stock, nor parties to the underwriting2429 agreement were offered and subscribed for new common stock in the reorganized company at the price of $20 for two shares of the no-par value common stock. In his income-tax return for the year 1922 the petitioner deducted the sum of $1,923 as representing a total loss in 1922 on the 100 shares of the common stock of the Ohio Leather Co. purchased by him in December, 1921. The respondent disallowed the deduction. OPINION. VAN FOSSAN: The sole question for our decision is whether or not 100 shares of the common stock of the Ohio Leather Co. owned by the petitioner in 1922 became worthless in that year. We think it is apparent from the facts that at the end of 1922 the stock in question was valueless. The statement of the corporation's financial condition as of December 31, 1922, disclosed that at that time there was common stock outstanding of the par value of $1,423,400, and that there was a total deficit of $2,093,568.57. The equity of the common stockholders in the assets, therefore, was wholly extinguished. If at that time the corporation had been liquidated there would have been nothing to be distributed among the common stockholders. The common stock had a market2430 value of $19.50 per share in December, 1921, but in December, 1922, the facts concerning the financial condition of the company had become public knowledge, and there was no market for the said stock. The only known sales of common stock at that time were "wash" sales made for the purpose of establishing a loss. Under the plan of reorganization initiated in December, 1922, and later substantially carried out, the preferred stockholders not paying the assessment on their stock were to be given a fractional share of the new second preferred stock, but if a common stockholder failed to pay the assessment of $20 per share on his common stock he would have no interest in the company when reorganized. The reason for this discrimination against the common stockholder is clear. The preferred stockholders still had a considerable equity in the assets of the company, but, as the president of the company stated in his letter of February 9, 1923, referred to in the statement 345 of facts, the common stockholder had "nothing to save." Moreover, it appears that in December, 1922, and up to the time the reorganization of the Ohio Leather Co. was carried out, the right of the common2431 stockholders to exchange one share of common stock for two shares of the new no-par value common stock upon payment of an assessment of $20 had no market value. It also appears that persons not then common stockholders could and did subscribe for and receive two no-par value shares in the reorganized company at the price of $20 for the two shares. It follows that at the end of December, 1922, and subsequently, ownership of the par value common stock of the company conferred no benefit or valuable privilege with respect to the reorganization of the Ohio Leather Co.For the foregoing reasons it is our opinion that it is established that the 100 shares of the Ohio Leather Co. common stock in question in this proceeding became worthless in 1922. The deduction claimed in petitioner's return for 1922 on account of such loss is allowed. Decision will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619421/	KENNETH D. AND SANDRA G. MALAMED, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMalamedDocket No. 4111-84United States Tax CourtT.C. Memo 1993-1; 1993 Tax Ct. Memo LEXIS 4; 65 T.C.M. (CCH) 1693; January 4, 1993, Filed 4 For Petitioner: Mark Bernsley. For Respondent: Donna F. HerbertFAYFAYMEMORANDUM OPINION FAY, Judge: This case was assigned to Special Trial Judge Larry L. Nameroff pursuant to section 7443A(b)(4) 1 and Rules 180, 181, and 183. The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE NAMEROFF, Special Trial Judge: This case is before us on petitioners' Motion for Award of Reasonable Litigation Costs (the Motion) filed pursuant to Rule 231 and section 7430. The parties have filed an agreed computation under Rule 155 reflecting their disposition of disputed issues as set forth in . In the notice of deficiency, respondent determined deficiencies in petitioners' Federal income tax for 1979 and 1980 in the amounts of $ 60,062 and $ 63,359, respectively. 5 Respondent also determined additions to tax for negligence under section 6653(a) in the respective amounts of $ 3,003 and $ 3,168. The petition was timely filed on February 17, 1984, and respondent's answer was filed on March 20, 1984. On October 14, 1986, respondent filed a motion to file an amendment to answer, to which petitioners objected. Subsequently, the motion was granted, and, on January 12, 1987, the amendment to answer was filed. In the amendment to answer, respondent asserted an increased deficiency for 1980 in the amount of $ 204,910; thus, for 1980, the total deficiency in dispute was $ 268,269. Respondent also asserted additions to tax for fraud under section 6653(b) of $ 30,031 for 1979, and $ 102,455 for 1980 and, in the alternative, an increased addition to tax for negligence of $ 7,078 for 1980. Additionally, respondent asserted the applicability of section 6621(c), formerly section 6621(d), for both years. This case was consolidated as part of a test case, 2, wherein we decided various issues concerning the so-called ROC project.6 The following schedules relate to docket No. 4111-84 and reflect the adjustments set forth in the notice of deficiency and the amendment to answer and the resolution thereof (adjustments involving the ROC project and the trial are identified by the symbol "ROC"): 1979ITEMADJUSTMENTCORRECTED ADJUSTMENTROC Partnership loss$ 11,960$ 5,980Mining loss750-0-Partnership losses30,2662,051Contributions45,69237,057ROC ITC30,56330,563Amount sec. 6621(c)interest applies ton1 60,062-0-1980LMNS Partnership ROC loss45,97745,977LMNS other losses43,2074,323LMNS Westcliff losses3,371-0-Contributions8,748-0-LMNS substantiation267,077-0-LMNS McMahan Brafman29,7822,599ROC ITC3,5283,528Amount sec. 6621(c)interest applies to1 268,2692,046The Court's opinion and the settlement of the various other issues in docket No. 4111-84 resulted in redetermined deficiencies in tax of $ 32,001 and $ 30,9377 for 1979 and 1980, respectively, no additions to tax for either fraud or negligence, and liability for increased interest under section 6621(c). Pursuant to section 7430(a), the "prevailing party" in any civil proceeding brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty under the Internal Revenue Code may be awarded reasonable litigation costs incurred in connection with such proceeding. Petitioners bear the burden of proof that they are entitled to such an award. Rule 232(e). Under section 7430 (as applicable to the instant case), petitioners may be awarded a judgment for reasonable litigation costs, if they have: (1) Substantially prevailed in the litigation; (2) established that the position of the United States in the civil proceeding was unreasonable; and (3) exhausted the available administrative remedies. 3 After having met these requirements, petitioners must also then substantiate the reasonable litigation costs claimed. 8 To fall within the parameters of the statutory definition of prevailing party provided in section 7430(c)(2), petitioners must establish that: (1) The position of the United States in the civil proceeding was unreasonable; and (2) they have substantially prevailed with respect to the amount in controversy or with respect to the most significant issue or set of issues presented. The term "unreasonable" is not defined in section 7430, but the legislative history provides the following guidelines for determining whether the government's position in the civil proceeding was unreasonable: (1) whether the government used the costs and expenses of litigation against its position to extract concessions from the taxpayer that were not justified under the circumstances of the case, (2) whether the government pursued the litigation against the taxpayer for purposes of harassment or embarrassment, or out of political motivation, and (3) such other factors as the court finds relevant. * * [H. Rept. 97-404, at 12 (1981).]In determining the point in time at which the United States is considered to have taken a position, the Ninth Circuit Court of Appeals, to which appeal of this case9 lies, has held that "the government's position both in its prelitigation administrative proceedings and after the commencement of the litigation should be examined for reasonableness." , affg. an order of this Court. Thus, the Government may take an unreasonable position for purposes of section 7430 as early as its prelitigation administrative proceedings. Petitioner has the burden of establishing that respondent's position was unreasonable. Rule 232(e). The determination of whether respondent's position was unreasonable is based upon all the facts and circumstances as well as the legal precedents relating to the case. , affd. . The Court must "consider the basis for respondent's legal position and the manner in which the position was maintained." . The fact that respondent ultimately loses or concedes the case does not establish that the position taken was unreasonable. ;10 , vacated and remanded on other issues . We now examine each of these factors as they bear on the various issues presented in this case. 1. All ROC IssuesIn , we concluded, inter alia, that the 1979 and 1980 ROC project transactions were not shams and were entered into for profit, but that the at-risk rules contained in section 465(e) applied to limit the amount of losses which petitioners may deduct. As a result of our conclusions, the parties agreed that petitioners are limited to deductions of $ 5,980 in 1979 and zero in 1980. 4 Additionally, prior to trial, petitioners conceded both the disallowance of the ITC claimed and their claim to depreciate the software pursuant to an accelerated method of depreciation. Accordingly, it is clear that petitioners have prevailed as to neither the significant ROC issues 5 nor the amount in controversy as to such issues. Therefore, no amount can be allowed for litigation costs under section 7430 with respect to the ROC issues. 11 2. 1980 LMNS SubstantiationWith respect to the LMNS partnership, respondent asserted12 in the amendment to answer that petitioners were liable for an increased deficiency for 1980 of $ 204,910. For 1980, the LMNS partnership reported $ 635,321 in total income and $ 895,927 in deductions. Respondent questioned the $ 895,927 in deductions because "Through informal discovery, respondent requested that petitioner [sic] provide respondent with substantiation of all expenses relating to LMNS Partnership, however, petitioner has failed to provide a single document substantiating payment of expenses claimed by LMNS Partnership." Ultimately, the parties resolved this issue by settlement, with respondent conceding the full amount in controversy. Accordingly, petitioners prevailed on both the issue and the amount in controversy. Next we must consider the reasonableness of respondent's position. Respondent has the burden of proof on all new matters, such as those raised by the amendment to answer. Rule 41(b). We conclude that respondent's disallowance of the partnership's deductions based upon the failure of petitioners during informal discovery proceedings to substantiate the expenses of the partnership, when such matter was not determined in the notice of deficiency but13 was raised by respondent by amendment to answer, is prima facie unreasonable. Respondent does not allege any facts to support a contrary conclusion, and we hold for petitioners on the issue of reasonableness as to the 1980 LMNS substantiation issue. 3. Additions to Tax for Fraud and/or NegligenceRespondent's position on this issue is based upon allegations that some of the ROC documents were backdated for a fraudulent purpose and that, as an ROC salesman, petitioner husband knew about the alleged overvaluation of the ROC software (which overvaluation ultimately was not proven by respondent). Respondent also contended that petitioner husband had known that the ROC software did not qualify for the ITC and that he fraudulently claimed the ROC deductions on the wrong partnership return. We were not persuaded by respondent's arguments and held that petitioners were not liable for either the fraud or negligence addition to tax. See . However, our holding, based on our view that the evidence did not support respondent's contentions as to the additions to tax, does not ipso facto satisfy petitioners' 14 burden of showing that respondent's position in the litigation was unreasonable as to the additions to tax. Petitioners have made no other contention as to the unreasonableness of respondent's position. Accordingly, petitioners have not shown respondent's position to have been unreasonable as to the additions to tax and are therefore not entitled to recover any litigation costs in regard thereto. 4. All Other IssuesPetitioners have not claimed entitlement to litigation costs as a result of the disposition of any other issues presented in the case. 5. Amount of Costs RecoverableWe now consider the amount, if any, of costs recoverable, bearing in mind that petitioners have prevailed as to the non-ROC LMNS substantiation issue, as to which issue respondent's position was unreasonable. The litigation costs claimed are divided into two categories: ROC issue attorney's fees and costs of $ 9,361.62 and non-ROC issue attorney's fees and costs totaling $ 24,265.38, subject to the limitations of section 7430(b)(1). As to the former amount, petitioners attached to the motion a schedule, by year, of attorney15 and paralegal hours and fees spent on the ROC project. The fees and costs were then allocated to the various dockets involved in the test case, and $ 9,361.62 was allocated to this docket. As to the non-ROC issues, petitioners submitted an affidavit of their counsel in which the non-ROC fees and costs were explained. The claimed amount of $ 24,265.38 related to amounts expended not only in this docket, but also for docket Nos. 15788-85 and 19160-87 (which also involve these petitioners). There is no indication in this record as to the nature and extent of non-ROC issues in the other two dockets. Attorney's fees of $ 1,067.50 (based upon 8.8 attorney hours) plus costs of $ 242.05 were allegedly incurred for the initial preparation and filing of the petitions and designations of place of trial. Resolution of the non-ROC issues allegedly involved 151.8 attorney hours and 63.75 paralegal hours for a total claim of $ 22,640.65, plus costs of $ 705.18. The affidavit neither indicates the years in which the billable hours were incurred nor does it specify the billing rates for the attorney or paralegals. 6 At a hearing on the motion, counsel for petitioner neither apportioned these16 costs to the LMNS substantiation issue nor indicated the billing rate for the paralegals. He did, however, offer that his billing rate has increased from $ 150 per hour at the beginning of this case, in 1984, to $ 225 an hour at the time of the hearing in 1991. 7 In her objection, respondent contended that the amounts claimed as litigation costs included amounts attributable to other dockets and were unreasonable, but made no further statements on this issue either in the objection or at the hearing. In , revd. 17 (Heasley I), the taxpayers litigated their liability for additions to tax asserted pursuant to sections 6653(a), 6659(a), and 6661(a), as well as increased interest under section 6621(c). They were ultimately successful on all issues and thereafter filed a motion to recover litigation costs. In , affd. in part and revd. in part (Heasley II), we held that respondent's position was unreasonable only with regard to the section 6661 addition to tax and allowed the taxpayers to recover litigation costs only as attributable to that issue. Accordingly, because four issues were presented, and respondent was unreasonable as to only one of the issues, we allowed the taxpayers to recover one-fourth of their costs. 8 On the question of the amount of time spent on each issue, we stated: "A breakdown as to issues is not required under our Rules and it is unlikely that attorneys maintain time worked on a case by issue." 18 This case is different. Petitioners' counsel apparently did maintain time records between ROC issues and non-ROC issues. Furthermore, all of the non-ROC issues were settled without the necessity of trial. In Heasley II, it was reasonable to allocate the litigation costs equally to each of the four issues, as it would be virtually impossible to allocate litigation costs on an issue-by-issue basis based on the time devoted to trial preparation, trial, briefs, etc. On the other hand, we do not believe that it is always necessarily required to prorate costs equally between issues. It is possible for an attorney to spend a substantial amount of time to prevail on a small but difficult issue (with respect to which respondent's position was reasonable) and spend very little or no time on a substantial but less difficult issue as to which respondent's position was unreasonable. Congress did not intend to allow recovery for time spent on the former. Accordingly, we have approximated petitioners' litigation costs pertaining to the LMNS substantiation issue, bearing heavily against petitioners whose inexactitude is of their own making. See .*19 First, we have eliminated the initial preparation and filing costs, as they occurred long before the substantiation issue was raised. Then, in the absence of any compelling evidence, we have divided the remaining non-ROC litigation costs by 3 to approximate the costs incurred only in this docket ($ 22,640.65 / 3 = $ 7,546.89). Finally, to reflect the seven other non-ROC issues, take into consideration some aspect of the section 6621(c) issue as it applies to non-ROC issues, and recognize that the substantiation issue was raised initially in 1986 and substantiation issues generally are not very complex, we have allowed petitioners a recovery of $ 3,500. An appropriate order and decision will be entered. Footnotes1. All section references are to the Internal Revenue Code, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Included in the consolidation was docket No. 15788-85, which involved these petitioners for the years 1981 and 1982. The deficiencies in tax determined in that docket were $ 151,672 and $ 154,404 for 1981 and 1982, respectively, plus various additions to tax, as well as increased interest.↩1. Applies to both ROC and non-ROC issues.↩3. Respondent conceded that petitioners exhausted their administrative remedies to the extent made available.↩4. , also held that petitioners were not entitled to any ROC deductions in 1979 and 1980 because petitioners failed to prove that they were entitled to the deductions of the Malamed Family Trust. That trust was a partner in the LMNS Street Software Partnership, which had purchased the ROC's. The parties have not addressed this difference in their stipulations for the purpose of our consideration of the motion, and it is not significant to our disposition of the motion.↩5. Petitioners contend that because they prevailed on most of the ROC issues, they should be deemed to have substantially prevailed. The significant issue was the amount of deductions, ITC, etc. available from the ROC transactions. Although this issue may have had many subissues, for purposes of sec. 7430, the focus is solely on the most significant issue or set of issues.↩6. For comparison purposes, we note that the schedule pertaining to the costs for the ROC issues reflects 1226.5 hours of attorney time, 672.75 hours of paralegal time, and total fees of $ 33,806.05. This suggests an aggregate billing rate of $ 17.80 per hour.↩7. We note that 151.8 hours times $ 150 equals $ 22,770, which amount exceeds the total amount claimed for attorney and paralegal time.↩8. The Court of Appeals for the Fifth Circuit affirmed our method of allocation, but remanded the case to allow the taxpayers to recover one-half of their costs, consistent with the Court of Appeals' opinion that respondent's position was also unreasonable with regard to the addition to tax for negligence. .↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619422/	JEFFERSON PLANTING & MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Jefferson Planting & Mfg. Co. v. CommissionerDocket No. 9600.United States Board of Tax Appeals8 B.T.A. 858; 1927 BTA LEXIS 2795; October 17, 1927, Promulgated 2795 Actual cash values placed by respondent on land, plantation improvements and sugar factory at the time of acquisition in 1903 by petitioner in exchange for its capital stock approved. George C. H. Kernion, Esq., for the petitioner. M, N. Fisher, Esq., for the respondent. TRAMMELL858 This is a proceeding for the redetermination of deficiencies in income and profits taxes of $10,269.02, $17,086.65, and $1,661.01 for the years 1917, 1918, and 1919, respectively. The deficiencies result from the respondent excluding from petitioner's invested capital 859 for each year an amount of $257,230.17, which the petitioner contends represented paid-in surplus, at the time of its organizatiov in January, 1903. FINDINGS OF FACT. In December, 1902, E. Godfrey Robichaux purchased for $120,000 from the Willswood Planting & Refining Co, a sugar plantation, known as the Willswood Plantation, consisting of 3,700 acres of land with certain plantation improvements and a sugar factory of an estimated capacity of 800 tons, located about 10 miles from New Orleans, La. Thereafter, before the end of the year, he sold a one-fifth interest in the plantation2796 to each of four other parties for $24,000 cash or a total of $96,000, retaining a one-fifth interest. In January, 1903, Robichaux and his associates formed the petitioner corporation, which was incorporated under the laws of Louisiana with a capital stock of $120,000. The incorporators then on January 21, 1903, transferred their interests in the Willswood Plantation to the petitioner for its stock amounting to $120,000 par value. In November, 1904, Robichaux and two of the stockholders bought the stock of the two other stockholders on the basis of $325 for each $100 originally invested. OPINION. TRAMMELL: The petitioner contends that in January, 1903, when it exchanged its capital stock of the par value of $120,000 for the assets set out in the findings of fact those assets had an actual cash value of $377,230.17, or a value of $257,230.17 in excess of the par value of the stock issued therefor, which amount it contends represents a paid-in surplus and that it is entitled to have the amount included in its invested capital, for the years 1917, 1918, and 1919. In an audit of the petitioner's returns for these years, the respondent excluded the amount in excess of the par2797 value of the stock from invested capital on the ground that the petitioner had failed to establish that the assets acquired at the time of their acquisition by the corporation had any value in excess of the par value of stock issued therefor, and allocated to the assets values in the following amounts: Depreciable assets$79,600Mules12,500Seeds1,000Land26,900120,000The keystone upon which petitioner rests its contention for the paid-in surplus of $257,230.17 is a retrospective appraisal made in 860 1924 of its assets as of January 21, 1903, concerning which appraisal there was considerable testimony, but which appraisal was not introduced in evidence. The person in charge of making the appraisal testified with respect to the manner of making it and to reproduction cost of the various assets less an estimated amount for depreciation as shown thereon, but did not express an opinion as to the correctness of the figures, or as to the value of the assets at the time acquired. In our opinion the evidence relating to the value on January 21, 1903, of the sugar factory and plantation improvements is not sufficient to sustain petitioner's contentions. 2798 We know nothing as to what the plantation improvements consisted of, when they were made, how long they had been in use, the amount of depreciation actually sustained, the purpose for which used, or their condition as of January 21, 1903. While the person who had charge of making the appraisal expressed no opinion as to the values of the assets, he did testify as to the sales of land similarly situated and comparable with the land acquired by the petitioner. This testimony would tend to show that the land in controversy might have been worth at least $35 an acre, but actual transactions involving the land in controversy is stronger evidence and carries more weight than transactions relating to other lands. The particular land in controversy was purchased only a few weeks prior to the time it was turned in to the corporation for stock. The four other individuals bought their interests on the same basis that Robichaux bought the assets. The person who sold the assets to Robichaux testified that he secured the best price obtainable; that if he could have gotten a better price he would have done so. That transaction was between persons dealing at arms' length who were familiar2799 with the property and was at approximately the time when the corporation acquired the property. From the evidence in the record it would appear that the sale of the stock in November 1904 at $325 per share represented increased or appreciated values which did not exist in December 1902 or in January, 1903. We are unable to find from the evidence submitted that the properties received by the petitioner in exchange for its stock had at the time of their acquisition any greater value than that placed on them by the respondent. Judgment will be entered on 15 days' notice, under Rule 50.Considered by MORRIS and LITTLETON.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619423/	Oddee Smith and Mable B. Smith, Petitioners v. Commissioner of Internal Revenue, RespondentSmith v. CommissionerDocket No. 3342-69United States Tax Court60 T.C. 316; 1973 U.S. Tax Ct. LEXIS 117; 60 T.C. No. 38; May 31, 1973, Filed 117 Decision will be entered under Rule 50. This case, originally decided in 55 T.C. 260">55 T.C. 260, is before the Court on remand from the U.S. Court of Appeals for the Fifth Circuit (457 F.2d 797">457 F. 2d 797) for reconsideration in the light of the subsequent opinion of the Supreme Court in United States v. Generes, 405 U.S. 93">405 U.S. 93 (1972). Upon such reconsideration it is held:1. Debts owing petitioners from Smith Petroleum which became worthless in 1965 were nonbusiness debts, deductible as such.2. Debts owing petitioners from Smith Petroleum for advances made after Smith Petroleum ceased doing business at the end of 1965 which became worthless in 1966 were business debts, deductible as such. Lauch M. Magruder, Jr., for the petitioners.Roy S. Fischbeck, for the respondent. Drennen, Judge. DRENNEN317 OPINIONIn an opinion filed November 3, 1970 (55 T.C. 260">55 T.C. 260), this Court concluded that the losses incurred by petitioner Oddee Smith from debts of Smith Petroleum Service, Inc., becoming worthless in 1965 and 1966 were proximately related to petitioner's trade or business and were deductible as business bad debts under section 166(a)(1), I.R.C. 1954; and decision was entered in accordance therewith on December 3, 1970. In so concluding, we applied the "significant motivation" test as the measure in determining whether the losses were proximately related to petitioner's business because the U.S Court of Appeals for the Fifth Circuit, to which an appeal in the case would lie, had recently held in United States v. Generes, 427 F. 2d 279 (C.A. 5, 1970), that the "significant motivation" test was the measure that should be used. Under the rule adopted by this Court in Jack E. Golsen, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F. 2d 985119 (C.A. 10, 1971), certiorari denied 404 U.S. 940">404 U.S. 940 (1971), we were constrained to apply the measure approved by the Fifth Circuit in deciding this case, although we reiterated our opinion that the "dominant motivation" test was the correct measure. While this case was pending on appeal in the Court of Appeals, the Supreme Court decided, in United States v. Generes, 405 U.S. 93 (1972), that "in determining whether a bad debt has a 'proximate' relation to the taxpayer's trade or business, as the Regulations specify, and thus qualifies as a business bad debt, the proper measure is that of dominant motivation, and that only significant motivation is not sufficient."Thereafter, the Court of Appeals vacated our decision and remanded this case to the Tax Court "for reconsideration in light of United Statesv. Generes," supra.Upon remand petitioners moved that the Court order a further hearing to permit petitioners to submit additional proof with respect to petitioners' motivation in making advances to Smith Petroleum. Over respondent's objection the motion was granted, and the testimony of petitioners' accountant, who120 had not testified at the trial of this case, was taken by deposition. No further evidence was offered by either party.On brief respondent reasserts his objection to receipt into evidence of the deposition of petitioners' accountant on the grounds that the appellate court mandate does not direct or authorize the taking of 318 further evidence and that the evidence was available to petitioners at the original trial, and they should not be given a second opportunity to try their case. It is true that the mandate of the Court of Appeals is silent with respect to a further hearing, and we had considerable doubt whether additional evidence should be considered, particularly in light of the fact that the Supreme Court entered judgment in the Generes case on the record before it rather than remanding the case to the trial court. However, both parties agreed that absent an appellate court order to do so, receipt of additional evidence after remandment of a case is a matter resting solely in the discretion of the trial court. Levitt & Sons, Inc., 5 T.C. 913">5 T.C. 913 (1945), affd. 160 F. 2d 209 (C.A. 2, 1947); Steinhort v. Commissioner, 335 F. 2d 496121 (C.A. 5, 1964). In any event, the question is now moot because we find nothing in the deposition of the accountant that would warrant changing our findings of fact or that would cause us to reach a different conclusion as to petitioner's motivation with respect to the advances and loans to Smith Petroleum.We will decide the issue before us on the findings of fact made in our original opinion, including our conclusion that in making the loans to Smith Petroleum petitioner was significantly motivated by a desire to protect his credit rating which was needed for his road construction business. However, the Supreme Court has told us in Generes that this is not enough to classify the debts as business bad debts.In order to be entitled to deduct the loss on the debts as business bad debts it must be shown that petitioner's dominant motivation in advancing the funds which gave rise to the debts in issue was to protect his construction business or was otherwise proximately related to his construction business. The burden of proof is on petitioners. As implied in our original opinion, we are not convinced from the record that petitioner's dominant motivation for advancing funds to122 Smith Petroleum prior to 1966 was so related, although we do find that petitioner was dominantly motivated by business reasons in making the advances to Smith Petroleum in 1966 after Smith Petroleum ceased doing business.The issue is factual and each case involving the issue must be decided on the record presented in that case. 1 Motivation being a subjective matter, the task is not easy. However, when a distinction has 319 been made between dominant motivation and significant motivation, it is our impression that it must be clear from the record that the primary reason for making the advances which gave rise to the debts was business related rather than investment related, and that an equally balanced dual relationship is not enough, much less a mere "significant" business-related motivation.123 Approaching our task with that understanding, we have reviewed the record in its entirety and have concluded that the business-related motivation has not been shown to be so apparent as to be considered dominant with regard to the indebtedness that became worthless in 1965. When petitioner entered into the oil-well-servicing business which ultimately became Smith Petroleum, it is clear that he expected to make a profit from his investment in that business. He chose to keep it separate from his construction business by operating it first as a partnership and then under a corporate charter. The business was sufficiently successful at first to justify the purchase of a piece of equipment costing in excess of $ 120,000 in 1963. Unfortunately the business slacked off in 1964 and 1965 although its gross receipts nearly equaled those of its only profitable year 1962. However, these gross receipts were not sufficient to cover the expenses which were obviously increased considerably by the amortization of the cost of the new equipment. Starting in 1963 and continuing in 1964 and 1965 petitioner advanced money from his construction business to Smith Petroleum to enable the latter to meet124 its operating costs and other obligations. We feel certain that petitioner, being a successful businessman, would not have started draining money from his construction business in 1963 to keep Smith Petroleum going unless he thought it could be made profitable. We recognize that he did not want Smith Petroleum to go bankrupt for fear that it might adversely affect his credit rating for his construction business, but he could certainly have achieved this result at less cost to himself by terminating the operations of Smith Petroleum sooner than he did. Hence, we are convinced that his principal reason for continuing the business of Smith Petroleum until the end of 1965 and pouring good money after bad into it was the thought or hope that he could either eventually make it profitable or could hold onto it long enough to cut his losses on his investments in it. It is not a convincing argument to say that petitioner would not advance approximately $ 85,000 to Smith Petroleum just to protect his $ 20,000 initial capital investment therein, because the advances were made over a period of 3 years, a bit at a time, and each time an advance was made and not repaid petitioner had an increased125 investment in Smith Petroleum to try to save.The conclusion from the above discussion is that we are not convinced that petitioner's advances to Smith Petroleum in 1963, 1964, and 1965 were motivated primarily to protect the credit rating of his 320 construction business. In fact, we are convinced that those advances were dominantly motivated by his desire to recover his investment in Smith Petroleum or at least minimize his losses on that investment. It follows that the debts that became worthless in 1965 are not deductible as business bad debts.By the end of 1965 petitioner apparently concluded that he could not save Smith Petroleum and tossed in the towel; Smith Petroleum ceased doing business as of the end of 1965. Nevertheless petitioner found it necessary, or at least important, to advance an additional $ 6,844.32 to Smith Petroleum in the early part of 1966 so it could pay off its creditors. When these advances were made Smith Petroleum had no operating income and petitioner had no prospect of recouping his investment therein. However, since petitioner had taken over Smith Petroleum entirely and locally, at least, Smith Petroleum and Smith Gravel, the name under126 which petitioner's construction business operated, had come to be considered a part of the same operation, it became even more important for petitioner's construction business that Smith Petroleum not default on its obligations. At this time we are convinced that what had been a significant motivation surfaced as petitioner's dominant, if not sole, motivation in advancing the additional funds and incurring the additional losses. This was done to protect petitioner's credit rating for bonding purposes in his construction business. We held in our original opinion that advances made with this motivation were related to petitioner's trade or business. We adhere to that conclusion; and since this motivation for the advances made after 1965 was the dominant motivation it follows that the losses suffered in 1966 as a result of those advances were proximately related to petitioner's trade or business, as specified in the regulation. See United States v. Generes, supra. Hence they are deductible as business bad debts under section 166(a)(1), I.R.C.2127 Our conclusions drawn from the evidence in this case, reconsidered in light of United States v. Generes, supra, are that the debts owing petitioner by Smith Petroleum which became worthless in 1965 were nonbusiness bad debts, deductible only as such, but that the debt which became worthless in 1966 was a business bad debt deductible as such. Since these conclusions may require additional computations to arrive at the correct amounts of the deficiencies in petitioners' tax liability,Decision will be entered under Rule 50. Footnotes1. In his briefs on remand respondent stresses the argument that this issue should be decided on the test enunciated in United States v. Gilmore, 372 U.S. 39">372 U.S. 39 (1963), that in determining whether the losses involved were proximately related to petitioner's trade or business we must look to the origin and character of the advances or debts (we assume) rather than the consequences to petitioner's business of not making the advances. We need not consider here whether such argument is apposite because our conclusions would be the same even under that test. We comment in passing, however, that the Gilmore case was not cited by either party in their original briefs filed in this Court, nor was it referred to in the majority opinion of the Supreme Court in United States v. Generes, 405 U.S. 93">405 U.S. 93 (1972). It was cited, without elucidation, by Justice Marshall in his concurring opinion in Generes↩.2. We recognize that in the majority opinion of the Supreme Court in United States v. Generes, supra, it is stated "The debt is one or the other in its entirety, for the Code does not provide for its allocation in part to business and in part to nonbusiness." In Generes↩ there was a single debt involved, created as a result of an indemnification loss incurred by petitioner. We believe the statement quoted above refers to the possibility under the law of attributing a part of a single debt to business and the remaining part of the same debt to nonbusiness where there is a dual motivation in making the advances that give rise to the debts. We do not believe it applies to debt created through a series of advances made over a period of time under differing circumstances such as we find here.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619424/	Leonard M. Japp and Eugenia Japp v. Commissioner.Japp v. CommissionerDocket No. 20264.United States Tax Court1950 Tax Ct. Memo LEXIS 119; 9 T.C.M. (CCH) 705; T.C.M. (RIA) 50200; August 17, 1950119 Herbert Portes, Esq., 59 E. Van Buren St., Chicago 5, Ill., and Leonard Schanfield, Esq., for the petitioners. Charles D. Leist, Esq., for the respondent. LEMIRE Memorandum Findings of Fact and Opinion This proceeding involves a deficiency in income tax for 1944 in the amount of $159,017.47. Of the several issues raised by the pleadings, all except two have been settled by stipulation of the parties. The two remaining issues are whether respondent erred in his refusal to recognize the validity, for federal income tax purposes, of an alleged partnership between the petitioners Leonard M. Japp and Eugenia Japp, doing business as Special Foods Company, and whether respondent erred in his determination that petitioner Eugenia Japp realized a capital gain upon the sale of a partnership interest in a business known as Waulters Potato Chip Company. Some of the facts were stipulated and are so found. The stipulation filed is incorporated herein by reference. Findings of Fact The petitioners are husband and wife residing in Chicago, Illinois. They filed a joint income tax return for 1944 with the collector of internal revenue for the first district of Illinois. 120 Prior to July 1, 1938, George F. Johnson and petitioner Leonard M. Japp, hereinafter referred to as the petitioner, were individually engaged in selling potato chips and allied products in Chicago. On that date they formed an equal partnership under the name of Special Foods Company. After they became partners they divided their sales routes and employed additional salesmen to operate them. By the fall of 1939 the business had expanded and moved into larger quarters, and Johnson ceased driving a truck and took charge of all administrative work and sales. In April 1941 the partnership acquired under a contract for deed a plant for the manufacture and packaging of its own potato chips. The plant was acquired at a total cost of $45,000, of which $3,500 was paid in cash and the balance, plus interest, was payable in monthly installments over a ten year period. Petitioner supervised the installation of machinery and other preparations in the plant to manufacture and package potato chips. In September 1941 the partnership began to manufacture and package its own potato chips, and petitioner thereafter devoted himself to the supervision of production in the plant. Johnson continued to121 have charge of administrative work and sales. By 1944 the business employed about 100 persons, of whom about 20 were salesmen, about four were office employees, and about 75 were production workers in the plant. Johnson continued to have charge of all sales activity through a sales manager, advertising, accounting and other office matters. Petitioner had charge of the production end of the business and the employees engaged therein. Petitioner Eugenia Japp, hereinafter referred to as Eugenia, and the petitioner were married in 1939. Eugenia had an extensive business background. In addition to business training in school and in her parents' bakery, she had several years of experience in general office work, accounting, and office management with business firms in Chicago. Immediately after her marriage to petitioner she became interested in Special Foods Company. She frequently discussed business problems with petitioner and with Johnson, assisted in the office and plant, assisted in expanding the advertising program, developed recipes for the use of potato chips in home cooking, helped eliminate some production problems, and made important improvements in the firm's office management122 and bookkeep ng systems. In April 1944 Eugenia and Marion D. Johnson, the wife of petitioner's partner, formed a partnership and purchased the Waulters Potato Chip Company of Milwaukee, Wisconsin. Each partner invested $11,500 in the business, giving it a total capital of $23,000. Of this amount, $15,000 was paid for the assets of the business and $8,000 was invested as working capital. Eugenia's contribution of capital came entirely from her personal savings. The partners hired a business manager for the Waulters business and also retained Margaret M. Waulters, the former owner of the business, in an advisory capacity. The partners visited the business personally only about one day every two weeks, leaving the routine management of the business to the business manager. Following a series of differences between petitioner and Johnson in the operation of Special Foods Company, on May 8, 1944, Johnson suggested that the partnership be dissolved by one partner buying out the other. He also proposed that the partner who sold out be allowed to buy the interest of the other partner's wife in the Waulters business. Petitioner was opposed to dissolving the partnership and at first was123 reluctant to buy out Johnson because of his inability to handle the administrative and sales end of the business. The partners agreed to take a month to think the matter over. When petitioner discussed the matter with Eugenia, she immediately urged him to agree upon dissolution of his partnership with Johnson and agreed to sell her interest in the Waulters business to Johnson if she and petitioner could buy out Johnson's interest in Special Foods Company. Eugenia insisted that she could take Johnson's place in the business, and on about May 20 she convinced petitioner that they should buy Johnson's interest and form a partnership to operate Special Foods Company. On that date petitioner and Johnson agreed to dissolve their partnership as of May 20 and to liquidate the business unless they agreed within sixty days upon a purchase of one partner's interest by the other. Petitioner and Eugenia employed an attorney to represent them and informed him of their intention to buy out Johnson and to operate the business themselves as partners. On May 26 petitioner and Johnson agreed that Johnson's interest be sold for $150,000. The attorneys representing Johnson and petitioner and Eugenia124 thereafter completed negotiations for the purpose of effectuating the intention of the parties. On June 20, 1944, all necessary documents having been prepared by the attorneys, petitioner and Johnson executed an agreement for the purchase of Johnson's interest for $150,000, payable $10,000 in cash at that time, $40,000 in cash when the transaction was consummated by delivery of all collateral documents, $50,000 in the form of a chattel mortgage installment note, and $50,000 in the form of a trust deed installment note. On the same date Eugenia assigned her interest in the Waulters business to Johnson, who immediately paid her $11,500 as full payment for that interest. Also on June 20 petitioner and Eugenia signed a partnership agreement which provided that they would operate Special Foods Company as equal partners in the sharing of profits and losses and in the assumption of all obligations. Eugenia then contributed the $11,500 she received from Johnson to the capital of Special Foods Company. Petitioner later made a gift to Eugenia of a one-half interest in Special Foods Company, less the amount of cash contributed by her, reporting the gift in a gift tax return but paying no125 gift tax. Under the partnership agreement petitioner was designated general manager of the business at a salary of $200 per week. Eugenia was to receive a salary of $75 per week. After the partnership agreement was executed petitioner and Eugenia informed their employees, business acquaintances, and the general public of the new partnership. They also executed a certificate of doing business under an assumed name and formally notified the Potato Chip Institute, the banks, the appropriate state authorities, and the collector of internal revenue that they were the joint owners and the new partners of Special Foods Company. Until about July 10, when the transaction with Johnson was consummated by delivery of all notes, deeds, and collateral documents, Johnson continued to perform services for the business on a salary basis, having waived all right to any share of profits earned after May 20. On about July 10 Johnson terminated all connection with the business and Eugenia thereafter assumed full control of the administrative end of the business. Petitioner and Eugenia immediately completed arrangements with the banks where Special Foods Company did business for either of them to sign126 checks for the partnership. On August 2, 1944, having paid the balance due on the Special Foods Company plant, petitioner and Eugenia took title to the property as joint tenants. New insurance policies covering the business property were issued to petitioner and Eugenia, under Eugenia's direction, by a new insurance agent whom she contacted. After Johnson left the business Eugenia took over all his work with the exception of the supervision of truck maintenance, working on a full-time basis in the business throughout the taxable period here involved. She assumed full responsibility for all administrative work of the business, taking charge of the office and books and records, hiring office and sales employees, supervising sales and business policy, approving bills, writing most of the partnership checks, and managing the advertising program. Under Eugenia's direction the advertising done by Special Foods Company was coordinated into a regular program and expanded to approximately four times what it had been in the previous year. She also made improvements in the payroll, cost, accounting, and sales records of the business. Petitioner concerned himself primarily with supervising127 plant operation and production. He also checked bills for production supplies, signed some checks, and supervised truck maintenance, but left all other administrative responsibilities to Eugenia. During the period from January 1, 1939, through May 20, 1944, the Special Foods Company earned the following net income: YearAmount1939$ 9,474.22194013,329.94194119,363.68194252,401.041943109,773.921944 (through May 20)112,085.80A partnership income tax return was filed for Special Foods Company for the fiscal period May 21, 1944, through January 31, 1945, reporting net income of $151,479.44, of which $73,458.47 was considered distributable to Eugenia and $78,020.97 distributable to petitioner. The partnership books show that during this period petitioner withdrew $29,586.85 from the business and that Eugenia withdrew nothing. The unwithdrawn balances of earnings considered distributable to petitioner and Eugenia during this period were credited to their respective capital accounts. The true net income of Special Foods Company for the fiscal period May 21, 1944, through January 31, 1945, after giving effect to the adjustments made in accordance128 with the stipulation filed in this proceeding, was $165,990.09. None of the income was reported by petitioner and Eugenia in their joint return for 1944 since the return was filed upon a calendar year basis while the Special Foods Company books were kept and the partnership return was filed upon a fiscal year basis ending January 31, 1945. The partnership of the petitioner and Eugenia to operate Special Foods Company was formed for business purposes with a bona fide intention to form a real and true business partnership for all purposes. Opinion LEMIRE, Judge: The principal issue we must determine is whether the petitioner and his wife, Eugenia, were equal partners during the taxable period of May 21, 1944, through January 31, 1945, in a partnership doing business as the Special Foods Company. Respondent determined that they were not, and has taxed all of the income of the business realized from May 21, 1944, through December 31, 1944, to the petitioner as the sole owner of the business. In the determination of whether the validity of the partnership here involved should be recognized for federal tax purposes, the ultimate question for decision is whether the partnership is129 real within the meaning of the federal revenue laws. That is, we must determine, considering all the facts throwing light upon their true intent, whether the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise. . No lengthy discussion of our findings of fact is warranted here. An analysis of the facts shows that Eugenia was largely responsible for petitioner's continued participation in the business after dissolution of his partnership with Johnson. Eugenia also intended to take, and did take, Johnson's place in the business as a full partner. She had equal authority in the management of the business and played a vital part in the successful operation of it. She contributed a substantial amount of capital to the business, worked in the business as a partner, and was known as a partner to everyone connected with the business. The evidence is that the parties intended for her to become, and that she did become, a partner, in the fullest sense, in the operation of the business. Respondent contends that even if the agreement of June 20, 1944, created a bona130 fide partnership, it cannot be given retroactive effect to May 21, 1944, which is the date when petitioner claims the partnership came into existence. We think that the facts support respondent's contention. The chronological order of events was as follows: The dissolution of petitioner's partnership with Johnson was proposed on May 8; on about May 20 petitioner and Eugenia decided to buy out Johnson and to become partners; on about May 26 petitioner and Johnson agreed upon dissolution of the partnership through sale of Johnson's interest to petitioner and Eugenia, and the sale was made on June 20, after which petitioner and Eugenia entered into their partnership agreement. Prior to June 20 Eugenia contributed nothing to the business in the form of either capital or services, had no voice in its management, and was no more than an interested party who intended to become a partner in the future. An intent to become partners in the future does not fulfill the requirements of a partnership. We conclude that petitioner and Eugenia became partners in the Special Foods Company on June 20, 1944. It follows that the income realized from the*131 business during the period May 21 to June 20, 1944, was the income of petitioner alone and is taxable to him in his personal return for that year. The remaining issue is whether respondent erred in his determination that Eugenia realized a capital gain on the sale of her interest in the Waulters Potato Chip Company to Johnson. The petitioners contend that Eugenia invested $11,500 in the business and sold her interest for the same amount, realizing no gain upon the sale. The evidence is that Eugenia and Marion D. Johnson each invested $11,500 in the business, $7,500 of which was in payment for the assets and $4,000 a contribution to working capital, and that Johnson bought Eugenia's interest for $11,500. Respondent's determination that Eugenia realized a gain upon the sale was apparently based solely upon his determination that she paid $7,500 for the assets of the business without taking into account her additional investment of $4,000 for working capital. The petitioners have thus sustained their burden of proof on this issue. We conclude that respondent's determination was in error. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619425/	PHILLIP E. KOCH and MARTHA R. KOCH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentKoch v. CommissionerDocket No. 9616-76.United States Tax CourtT.C. Memo 1979-147; 1979 Tax Ct. Memo LEXIS 378; 38 T.C.M. (CCH) 650; T.C.M. (RIA) 79147; April 16, 1979, Filed John L. Thompson, for the petitioners. Stanley379 H. Smith, Jr., for the respondent. TANNENWALDMEMORANDUM OPINION TANNENWALD, Judge: Respondent determined a deficiency of $397.41 in petitioners' income tax for 1974. Petitioners dispute only that portion of the deficiency attributable to respondent's determination that payments received by Phillip E. Koch, while participating in an oral surgery residency program, did not qualify for exclusion from gross income under section 117 of the Internal Revenue Code. 1All the facts were stipulated. The stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference. Petitioners filed a joint individual income tax return for the taxable year 1974 with the Internal Revenue Srevice Center, Chamblee, Georgia. Petitioners were residents of Augusta, Georgia, on the date the petition herein was filed. Petitioner Phillip E. Koch (hereinafter petitioner) graduated from dental school on July 1, 1974, and began a three-year oral surgery residency program380 at the Medical College of Georgia, Augusta, Georgia. The three-year program was intended to qualify petitioner to become board certified as an oral surgeon. The residency program involved classroom work and assignments to rotations at Talmadge Memorial Hospital, Veterans' Administration Hospital, University Hospital, and certain oral surgery outpatient clinics, all of which are located in Augusta, Georgia. Petitioner was required to sign a one-year house officer agreement prior to the beginning of each one-year period of the residency program. Under the agreement for the period July 1974 through June 1975, the petitioner was to be paid $10,100 per annum; under the July 1975 through June 1976 agreement, $11,100; and under the July 1976 through June 1977 agreement, $11,600. The increases in payments were not based on his financial needs. The agreements also provided that petitioner was entitled to two weeks vacation with pay per year; free parking; free laundry service for certain uniforms; and hospitalization, malpractice, and life insurance. Six residents participated in the oral surgery residency program which began in July 1974. Yearly payments to two of the six residents381 were made by Talmadge Hospital, while the Veterans' Administration Hospital paid one resident and the University Hospital paid the remaining three. From July 1, 1974, through June 30, 1975, petitioner was paid by the University Hospital, although all three of the agreements which he signed were captioned "Talmadge Hospital House Officer Agreement." State and Federal taxes were withheld from the payments petitioner received under the house officer agreement in 1974. If petitioner left the residency program before three years elapsed, he was under no obligation to repay any sums received under the house officer agreements. However, the Medical College of Georgia anticipated that each resident admitted to the program would participate in it for the entire three years. Petitioner did complete the program and is now a practicing oral surgeon in Georgia. He was not required to enter the employ of the Medical College of Georgia or the three hospitals involved in the residency program upon completion of the program.In the house officer agreements, the hospital agreed to provide a suitable environment for educational experiences in the special area of residency. Petitioner agreed to382 perform satisfactorily the customary services of residency; to conform to hospital policies, procedures, and regulations; and to refrain from engaging in outside remunerative work without express permission of the chairman of the oral surgery department. During the first two months of the residency program, petitioner was required to spend much of his time atending classes in anatomy and physical diagnosis. Petitioner also spent some of his time during this period observing third-year residents in the oral surgery clinics. Occasionally, under direct supervision, he would perform minor surgical procedures on clinic patients. At the end of the first two months of the residency program, petitioner was required to submit a report to the school on his observations. In the third month of his residency, petitioner was required to participate in a full-time pulmonary medicine rotation, and in the fourth month in a full-time gastrointestinal rotation, at the Veterans' Administration Hospital. During this time, petitioner was part of the medicine service at the Veterans' Administration Hospital, was listed on the house staff roster, and was covered by malpractice insurance, on which383 he did not pay the premiums. He had regular assigned duty hours, received one free meal per day while on duty, and was required to be on call, and sleep at the hospital, every third night. Hospital doctors supervised and instructed him in his various duties, which included physical diagnosis of patients and writing of their medical histories. Throughout the third and fourth months, petitioner received oral examinations to insure that he was satisfactorily completing his courses of study. During the fifth and sixth months of the residency program, petitioner was assigned to the oral surgery clinic at Talmadge Memorial Hospital where he carried out assigned duties, including some minor oral surgery suprevised by the senior resident and the attending staff physician. During the first six months of his residency program, petitioner's time spent in fulfilling the requirements of the program was allocated as follows: Classroom work70 percentObservation10-15 percentPatient care10-20 percentIf a resident had been unavailable to perform his assigned duties during his first six months in the residency program, the hospitals and clinic involved would not have384 been required to hire additional staff physicians in order to provide adequate and efficient patient care. Thereafter, if a resident had failed to fulfill his responsibilities, the hospitals and clinics would have been required to hire additional physicians. After the first six months in the residency program, petitioner was given increasing responsibilities until he became the doctor in charge of a patient's care, rather than being supervised by the doctor in charge. He spent his seventh through ninth months in a full-time anesthesia rotation at the University Hospital and Talmadge Hospital, where, as his experience increased, he was given greater responsibility for performing the duties of a fully qualified anesthesiologist. During the tenth through the twelfth months of the residency program, petitioner was again assigned to the oral surgery service. His responsibility for patient care and for performing surgical operations in the oral surgery clinics and operating rooms increased throughout this period. Petitioner spent the first month of his second year in a full-time neurosurgery rotation in which his duties included examining patients, diagnosing neurological disorders, 385 and writing up patient histories, diagnoses, and treatments. The remainder of petitioner's second year and his entire third year in the residency program involved a full-time assignment to the oral surgery service where petitioner rendered patient care, performed major surgical operations, taught first-year residents, supervised less experienced residents, and carried out administrative duties. During most of petitioner's last two and a half years in the residency program, he was listed on hospital or clinic house staff rosters, was covered by malpractice insurance on which he did not pay premiums, had regular assigned duty hours, received one free meal per day while on duty, and was on call and required to sleep at a hospital every third night. Petitioner performed approximately 1,000 operatons in the outpatient clinic and 250 operations in hospital operating rooms during his residency. A substantial number of such operations were performed after the first six months of the residency program. During the entire period of the residency program, petitioner, along with the other residents, was required to teach his share of a weekly one-hour class summarizing recent publications386 in medical and dental journals relating to oral surgery, a weekly one-hour lecture on substantive oral surgery topics, and a two-hour weekly instructional course on oral surgery topics. All residents were also required to assist a professor in teaching dental students. Approximately five or six days of petitioner's time per year were devoted to teaching. The issue for decision is whether $1,800 paid to petitioner in 1974, 2 during the first six months of his participation in an oral surgery residency program, qualifies for exclusion from gross income under section 117. 3387 Section 117 excludes from gross income any amount received as a scholarship or fellowship grant. Respondent concedes that the applicable limitations on exclusion of scholarships and grants from income, contained in section 117(b)(2), have been met and that the only issue presented is whether the payments constituted a scholarship or grant. Section 1.117-4(c), Income Tax Regs., provides that "any amount paid * * to * * * an individual to enable him to pursue studies or research" shall not be considered an amount received as a scholarship or fellowship grant "if such amount represents either compensation for past, present, or future employment services or represents payment for services which are subject to the direction or supervision of the grantor." The test to be applied under the regulation is whether the primary purpose for making the payments to the taxpayer was to educate and train him in his individual capacity or to compensate him for services rendered. Weinberg v. Commissioner,64 T.C. 771">64 T.C. 771, 776 (1975); Reese v. Commissioner,45 T.C. 407">45 T.C. 407, 411 (1966), affd. per curiam 373 F.2d 742">373 F.2d 742 (4th Cir. 1967). In Bingler v. Johnson,394 U.S. 741">394 U.S. 741, 751 (1969),388 the Supreme Court sustained the validity of section 1.117-4(c) of the regulations, emphasizing that its thrust is to deny an exclusion for payments given in return for a quid pro quo, as distinguished from "relatively disinterested, 'no-strings' educational grants." The determination as to whether any particular payments were made in order to obtain a substantial quid pro quo from the recipient is necessarily factual in nature. Phillips v. Commissioner,57 T.C. 420">57 T.C. 420, 425 (1971); Proskey v. Commissioner,51 T.C. 918">51 T.C. 918, 922 (1969). Petitioner's term as a resident extended from July 1974 through June 1977. Petitioner admits on brief that in 1975 and 1976 he was engaged primarily in patient care, but contends that his activities in the latter part of his residency do not reflect on the nature of the payments he received in 1974. He argues that since he served only the first six months of his three-year residency in 1974, months devoted in large part to study and observation, the primary purpose of the payments he received in 1974 was the furtherance of his education and training in his individual capacity. We disagree. We believe that it is necessary389 to consider the residency program as a whole in order to evaluate the nature and purpose of the payments received by petitioner in 1974 for his participation in the program. See and compare Leathers v. United States,471 F.2d 856">471 F.2d 856, 861 (8th Cir. 1972); Woddail v. Commissioner,321 F.2d 721">321 F.2d 721, 724-725 (10th Cir. 1963), affg. T.C. Memo. 1962-232; Dietz v. Commissioner,62 T.C. 578">62 T.C. 578, 585 (1974); Ehrhart v. Commissioner,57 T.C. 872">57 T.C. 872, 883 (1972), affd. 470 F.2d 940">470 F.2d 940 (1st Cir. 1973). 4 To consider the first six months of the program in isolation from the rest would ignore the fact that, in virtually any skilled job, a new employee is less productive than an experienced one and must spend some time in on-the-job training. In the process, the employee acquires new skills and education. But, it would be naive to believe that an employer's motive in paying an employee during a training period is to allow the employee to obtain an education. Such payments are made by the employer in expectation of future services and it is the payor's motive for making the payments, not the recipient's motive for accepting390 them, that determines whether the payments represent compensation. Adams v. Commissioner, 71 T.C. (Dec. 28, 1978); Proskey v. Commissioner,supra at 925. 5 Although a resident was under no obligation to remain in the program after his first year, the Medical College of Georgia anticipated that any resident beginning the program would, in fact, serve the entire term of residency, and, therefore, petitioner's activities throughout his residency are relevant herein. The record clearly indicates that, in each year of his residency, petitioner was expected to, and did, render services of substantial value in exchange for the stipend he received. Thirty-two of the thirty-six months of petitioner's residency were spent391 in full-time hospital and clinic rotations, examining, diagnosing, and treating patients. During those months, he was listed on hospital or clinic house staff rosters, was covered by malpractice insurance, had regularly assigned duty hours, received one free meal per day while on duty, and was on call and required to sleep at a hospital every third night. Petitioner also had teaching and administrative responsibilities. He performed more than 1,000 operations during the residency program. In the first year alone, petitioner spent eight months in full-time hospital and clinic rotations. By the end of the first year, he had significant responsibility for rendering patient care and his services were necessary to efficient operation of the hospitals and clinics at which he worked. In addition, as petitioner himself notes, throughout his residency, his relationship with the hospitals and clinics involved in the program had many of the characteristics of an employer-employee relationship. Petitioner signed a house officer agreement each year of the program which provided him with an annual stipend.The stipend was increased every year in amounts unrelated to his financial need. He392 also received fringe benefits including malpractice coverage, hospitalization insurance, life insurance, and two weeks paid vacation. Parts of the payments were withheld for FICA and income tax purposes. On his part, petitioner agreed to refrain from any outside remunerative work, to adhere to hospital rules, and to fulfill the duties assigned to residents unless he obtained express permission from the chairman of his department. All of the foregoing factors have been held to be indicative of the existence of an employer-employee relationship. See Parr v. United States,469 F.2d 1156">469 F.2d 1156, 1158 n.5 (5th Cir. 1972); Adams v. Commissioner,supra, and cases cited therein; Brubakken v. Commissioner,67 T.C. 249">67 T.C. 249, 259 (1976). 6 Compare Bailey v. Commissioner,60 T.C. 447">60 T.C. 447, 452 (1973).At the very least, the scope of our examination should encompass the entire one-year period of the contract under which the 1974 payments were made, since petitioner was contractually bound to perform the services required of him for a year and his stipend was fixed on393 an annual basis. But, payments may be intended as compensation for future services, even where there is no contractual undertaking to render future services, if there is a clear expectation that the recipient will do so. Ehrhart v. Commissioner,supra at 882; MacDonald v. Commissioner,52 T.C. 386">52 T.C. 386, 393 (1969). Even if we were to confine our examination to the first six months of the residency program, we would conclude that petitioner performed substantial services in exchange for which he was compensated. We note our difficulty in reconciling the stipulation that 70 percent of petitioner's responsibilities in the first six months of the residency program involved classroom work with the facts (also stipulated) that petitioner spent the third and fourth months of the program in full-time hospital rotations, on call every third night, and spent at least part of the fifth and sixth months working in the oral surgery clinic. That petitioner's work during his first six months as a resident was directly supervised by more experienced doctors and was not essential to efficient operation of the hospitals and clinics (i.e., replacement physicians394 would not have been hired (see p.7, supra)) is not inconsistent with a conclusion that the payments he received were compensatory in nature. See Brubakken v. Commissioner,supra at 256. See also, Fisher v. Commissioner,56 T.C. 1201">56 T.C. 1201, 1215 (1971), wherein we stated that "even if the [hospital] could do without residents, it did not do without them; it used their services, and it paid for them." 7Weighing all the facts, we conclude that, after an initial training period, petitioner was primarily engaged in rendering patient care and provided the hospital and clinics with valuable and substantial services in return for which he received a stipend. To the extent that payments to petitioner in his first six months exceeded the value of his services to the hospitals and clinics during those months, those payments were made in the expectation that petitioner would render future services, both those which he was contractually bound to perform under the one-year house officer agreement and those which the hospitals395 and clinics anticipated he would perform in the last two years of his residency. In short, we hold that the payments received by petitioner in 1974 represented compensation for substantial services performed by him in 1974 and thereafter and are, therefore, not excludable from income under section 117. Decision will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect in the taxable year in issue, unless otherwise stated.↩2. Petitioner received $5,050.02 in 1974 for participation in the residency program but, in accordance with section 117(b)(2)(B)↩, limited his deduction to $300 times the number of months of his participation in the program during the taxable year. 3. Section 117 provides in relevant part: 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, including the value of contributed services and accomodations; and (2) any amount received to cover expenses for -- (A) travel, (B) research, (C) clerical help, or (D) equipment, which are incident to such a scholarship or to a fellowship grant, but only to the extent that the amount is so expended by the recipient.(b) Limitations. -- * * *(2) Individuals who are not candidates for degrees. -- In the case of an individual who is not a candidate for a degree at an educational institution (as defined in section 151(e)(4)), subsection (a) shall apply only if the condition in subparagraph (A) is satisfied and then only within the limitations provided in subparagraph (B). (A) Conditions for exclusion. -- The grantor of the scholarship or fellowship grant is -- (i) an organization described in section 501(c)(3) which is exempt from tax under section 501(a), (B) Extent of exclusion. -- The amount of the scholarship or fellowship grant excluded under subsection (a)(1) in any taxable year shall be limited to an amount equal to $300 times the number of months for which the recipient received amounts under the scholarship or fellowship grant during such taxable year, except that no exclusion shall be allowed under subsection (a) after the recipient has been entitled to exclude under this section for a period of 36 months (whether or not consecutive) amounts received as a scholarship or fellowship grant while not a candidate for a degree at an educational institution (as defined in section 151(e)(4)).↩4. See also, Lancaster v. Commissioner,T.C. Memo. 1978-72↩. 5. Petitioner's argument that to consider the nature of his activities during his entire residency is an elevation of form over substance is without merit. On the contrary, we find his approach of isolating the six months of the three-year program which occurred in 1974, and disregarding the remaining two and a half years, to be rigid and formalistic.↩6. See also, Ulvestad v. Commissioner,T.C. Memo. 1979-60↩.7. See also, Ulvestad v. Commissioner, footnote 6, supra; Hof v. Commissioner,T.C. Memo. 1979-55↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619427/	Appeal of JOSEPH GARNEAU CO., INC.Joseph Garneau Co. v. CommissionerDocket No. 40.United States Board of Tax Appeals1 B.T.A. 75; 1924 BTA LEXIS 249; November 21, 1924, decided Submitted September 2, 1924. 249 The Board has jurisdiction over an appeal involving a deficiency in tax determined by the Commissioner subsequent to the passage of the Revenue Act of 1924. George R. Beneman, Esq., for the taxpayer. A. Calder Mackay, Esq. (Nelson T. Hartson, Solicitor of Internal Revenue) for the Commissioner. JAMES 76 Before the Board, en banc.This appeal was heard upon a motion of the Commissioner to dismiss the petition for want of jurisdiction. FINDINGS OF FACT. The petition was filed August 21, 1924. It appears therefrom that the taxpayer is a New York corporation with its principal office at 109 Hudson Street, New York, N.Y. On December 27, 1923, the Commissioner notified the taxpayer pursuant to the provisions of section 250(d) of the Revenue Act of 1921 that deficiencies in income and profits taxes for the years 1918 and 1919 had been discovered in the sums of $5,705.92 and $41,888.76, respectively, and that the taxpayer would be given 30 days in which to appeal in connection therewith. The taxpayer duly appealed to the Commissioner and the case was by him referred to the Committee on Appeals and Review. Thereafter, on April 2, 1924, the250 decision of the committee affirming the deficiency in tax as first discovered was submitted to the Commissioner and approved by him, and the taxpayer was notified of such decision on April 4, 1924. On April 18, 1924, the taxpayer requested reconsideration of the case by the Commissioner and the case was taken under advisement and reaffirmed April 25, 1924. On April 29, 1924, further request was made for reconsideration and the case was again taken under advisement. Reconsideration was denied on May 8, 1924. Again on May 10 and May 14, 1924, protest was made against the decision and again the case was taken under advisement. On May 16, 1924, the taxpayer was notified by J. G. Bright, Deputy Commissioner, that the tax as set forth in the letter of December 27, 1923, would be assessed. It is admitted by counsel for the taxpayer that the deficiency in tax was assessed on May 27, 1924. It is admitted on behalf of the Commissioner that the tax has not been paid. On June 2, 1924, the Revenue Act of 1924 was passed and became generally effective. On July 17, 1924, the Commissioner addressed to counsel for the taxpayer a letter reading in full as follows: Mr. GEORGE R. BENEMAN,251 Union Trust Building, Washington, D.C.SIR: Reference is made to your letter of May 14, 1924, requesting a reconsideration of the action of the Bureau upon the appeal of The Joseph Garneau Co., Inc., New York, N.Y., from the decision of the Income Tax Unit holding that it is not entitled to claim a deduction from the gross income of the years 1918, 1919, and 1920 for obsolescense of good will. Your letter and the file in the case have been given very careful consideration. After such consideration the Bureau is of the opinion that the claim for the obsolescense deduction must be denied in accordance with O.D. 818 (4 C.B. 178). The taxpayer continued to import wines and liquors after the effective date of national probihition and it must be assumed that the contracts which this taxpayer had with foreign exporters of wines and liquors were availed of in the carrying on of the wine business from October, 1920, to the effective date of the Willis-Campbell Act in 1921. The decision of the Bureau communicated to the taxpayer under date of April 4, 1924, is hereby confirmed and the request for a further consideration of the case is denied. Respectfully, 252 D. H. BLAIR. Commissioner.77 DECISION. The motion of the Commissioner is denied. OPINION. JAMES: Whether the Board has jurisdiction of this case depends upon the construction of section 250 of the Revenue Act of 1921, and sections 274, 280, and 283 of the Revenue Act of 1924. We have already determined in the Appeal of Everett Knitting Works,1 B.T.A. 5">1 B.T.A. 5, that this Board has no jurisdiction to entertain an appeal in any case in which the deficiency in tax was determined, assessed, and paid prior to the date of the enactment of the Revenue Act of 1924. In so deciding, the Board held: The Board was created to give the taxpayer a chance to have an open and neutral consideration of his liability for a deficiency before he is required to pay. The harsh rule of payment first and litigation afterwards was sought to be mitigated. The creation of the Board of Tax Appeals by section 900 was, in our opinion, remedial legislation, and the purpose in the mind of Congress in the enactment of that legislation should be made effective wherever possible. The question in this case is whether the Commissioner determined a deficiency in tax to be253 due before or after the passage of the Revenue Act of 1924. Section 274(a) provides in this respect as follows: If, in the case of any taxpayer, the Commissioner determines that there is a deficiency in respect of the tax imposed by this title, the taxpayer, except as provided in subdivision (d), shall be notified of such deficiency by registered mail, but such deficiency shall be assessed only as hereinafter provided. Within 60 days after such notice is mailed the taxpayer may file an appeal with the Board of Tax Appeals established by section 900. Section 280 reads in full as follows: If after the enactment of this Act the Commissioner determines that any assessment should be made in respect of any income, war-profits, or excessprofits tax imposed by the Revenue Act of 1916, the Revenue Act of 1917, the Revenue Act of 1918, or the Revenue Act of 1921, or by any such act as amended, the amount which should be assessed (whether as deficiency or as interest, penalty, or other addition to the tax) shall be computed as if this act had not been enacted, but the amount so computed shall be assessed, collected, and paid in the same manner and subject to the same provisions and254 limitations (including the provisions in case of delinquency in payment after notice and demand) as in the case of the taxes imposed by this title, except as otherwise provided in section 277. Under the provisions of section 1104, the Act of which the above sections are a part became effective on June 2, 1924, but Title II, of which such sections are also a part, became as provided in section 283 effective on January 1, 1924. If, therefore, subsequent to June 2, 1924, the Commissioner determined that a deficiency was due, jurisdiction of the case is conferred upon the Board. If the Commissioner determined prior to that date that a deficiency was due, jurisdiction is not conferred upon the Board. The dates to be considered on the record are December 27, 1923, April 4, May 16, May 27, and July 17, 1924. A deficiency in tax was discovered by the Commissioner and the taxpayer notified 78 thereof under date of December 27, 1923. The Revenue Act of 1921 provided in section 250(d) that in such cases the Commissioner should notify the taxpayer of the discovery of such deficiency. Thereupon, an appeal to the Commissioner was provided for, if made within 30 days from such255 notification. The notification of December 27, 1923, was manifestly not a determination of a deficiency by the Commissioner. It was merely notice to the taxpayer to show cause why a deficiency should not be determined. On April 4, 1924, the taxpayer was notified that the Committee on Appeals and Review had recommended the assessment of the deficiency previously discovered and that the Commissioner had approved that recommendation. On May 16, 1924, the Commissioner notified the taxpayer that the tax as determined in the letter of December 27, 1923, would stand and would be assessed. Standing alone and without the happening of subsequent events, it would appear that such a notification to the taxpayer would constitute a determination by the Commissioner. Under the provisions of the Revenue Act of 1921, however, all appeals by taxpayers were to the Commissioner. The Committee on Appeals and Review was a body constituted by the Commissioner for the purpose of advising him, but in no sense as a separate body or possessing any statutory authority. The determination of a tax deficiency rested with the Commissioner and with him alone. Under these circumstances, repeated requests256 for redeterminations were after April 4, 1924, submitted to the Commissioner and entertained by him, the last of such request having been made on May 14, 1924. Finally, on July 17, 1924, the Commissioner in unmistakable language determined that the decision theretofore made and which he specifically mentions as "the decision of the Bureau" should be affirmed by him. The Commissioner states, "your letter and the file in the case have been given very careful consideration", and "the request for further consideration of the case is denied". Clearly, the Commissioner up to July 17, 1924, was giving consideration to the case and on that date made his determination. Our attention is directed by the Commissioner to the importance of the fact that assessment of the tax was made on May 27, 1924, and thus was a determination prior to June 2, 1924. But assessment is an act not communicated to the taxpayer except in the form of a subsequent notice and demand for payment by the collector. The statute clearly differentiates the several steps of determination, assessment, and collection, and requires the Commissioner to notify the taxpayer of his determination as the very foundation of257 his appeal. Moreover, under section 283 all the provisions of section 274 are related back to January 1, 1924, and the assessment in this case was made subsequent to that time. Only determination that a tax is due is mentioned in section 280 as relating to the date the Act was passed. Determinations made prior to June 2, 1924, under prior revenue acts and completed by assessment prior to January 1, 1924, or closed by payment of the tax, are clearly outside our jurisdiction, but where doubt arises we believe the statute is susceptible to construction as remedial legislation and should be liberally construed to give relief to taxpayers such as the one now before us. Bearing 79 in mind the similarity of the provisions in section 250 of the Revenue Act of 1921 and section 274 of the Revenue Act of 1924, it would appear that Congress intended that acts done between January 1 and June 2, 1924, under the prior Act, should be treated as having been done under the latter, and specifically made the section in question retroactive for the purpose of permitting the taxpayers whose appeals under the prior acts had not been closed to continue them under the latter act to conclusion258 before this Board. To hold otherwise would result in denial of appeal in all cases in which assessments had been made under the act of 1921 but not finally determined until subsequent to the passage of the Revenue Act of 1924. Such, we believe, was not the intent of Congress. The motion is denied and the appeal will be restored to the calendar for further proceedings.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619428/	Herbert C. Johnson and Edna A. Johnson, Petitioners, v. Commissioner of Internal Revenue, RespondentJohnson v. Comm'rDocket No. 60342United States Tax Court1958 U.S. Tax Ct. LEXIS 153; 118 U.S.P.Q. (BNA) 42; 30 T.C. 675; June 24, 1958, Filed 153 Decision will be entered under Rule 50. 1. Held, that the transfer of November 17, 1947, by Herbert C. Johnson to National Die Casting Company, Inc., a corporation of which he owned all the common stock, and his immediate family, all the preferred stock, of all his right, title, and interest in certain letters patent constituted a sale of assets held longer than 6 months by Herbert C. Johnson; and that the payments received, even though paid periodically and dependent upon gross sales, were entitled to long-term capital gains treatment.2. Held, further, that the transaction between Herbert C. Johnson and his wholly owned corporation served a valid business purpose and was not in fact a sham. Raymond H. Schultz, Esq., and David C. Kenyon, Esq., for the petitioners.Charles B. Wolfe, Jr., Esq., for the respondent. Fisher, Judge. FISHER42 676 Respondent determined income tax deficiencies and additions to tax as follows:Additions toYearDeficiencytax undersec. 291 (a)1951$ 5,295.6719524,140.60$ 207.0319537,691.80The principal issue before the Court is whether certain payments received by petitioner Herbert C. Johnson154 in connection with the transfer of a patent to a corporation of which he owned all of the common stock, and his immediate family owned all the preferred stock, are taxable as ordinary income or as long-term capital gains. Edna A. Johnson is Herbert's wife and is also a petitioner because they filed joint returns for the years in question.FINDINGS OF FACT.Some of the facts have been stipulated and are incorporated herein by reference.Petitioners Herbert C. and Edna A. Johnson are residents of Wilmette, Illinois. They filed joint Federal income tax returns as follows:YearDate filedPlace filed1951Mar. 14, 1952Collector of internal revenue, 1st district, Illinois1952Mar. 24, 1953District director of internal revenue, Chicago,Illinois.1953Mar. 15, 1954District director of internal revenue, Chicago,Illinois.Herbert C. Johnson (hereinafter referred to as petitioner) entered into the tool and diecasting design business in his individual capacity in 1923. Prior to that date he was employed as a draftsman and engineer by the Alemit Die Casting Co. From 1923 to December 17, 1941, Johnson conducted his business under the name National Die Casting155 Company. Johnson's business was primarily that of a job shop or custom manufacturer, that is, making diecasting and metal parts and products for other manufacturers either on a bid or contract basis. Johnson also manufactured and sold metal products of his own. One 677 of the prime products 43 manufactured and sold by Johnson was a single-stroke fruit juice extractor.The manufacture of this juice extractor was based upon certain patents granted to Johnson. The description of the device to which the patent relates is as follows:DescriptionApplicationDateTermPatentdatepatentedin yearsNo.Juice extractorJune 5, 1936Aug. 25, 1936141 101,000Juice extracting deviceJune 8, 1936Aug. 24, 1937172,090,913Juice extracting deviceMar. 31, 1937Sept. 27, 1938172,131,440Juice extractorJan. 12, 1938Mar. 29, 1938141109,062Juice extractorJan. 12, 1938Aug. 16, 1938141 110,897Juice extracting deviceJan. 17, 1938Oct. 31, 1939172,177,939In addition to the above, Johnson received other letters patent, all granted prior to December 17, 1941, which patents concern not only juice extractors but heaters, 156 mirrors, and other such devices.With the outbreak of World War II, Johnson found it difficult to obtain essential metals required in his business. He concluded that in order to stay in business he would have to engage in war products production. Johnson approached his attorney who advised him to incorporate his business inasmuch as the Government contracts he secured involved new and different work. On December 17, 1941, Johnson caused to be formed the National Die Casting Company, Inc., an Illinois corporation, to which he transferred his manufacturing business previously operated as an individual.At the time National Die Casting Company, Inc. (hereinafter called National), was incorporated, Johnson transferred all of his manufacturing assets to the corporation except the letters patent referred to above and certain real estate.The reason that Johnson did not, at that time, transfer the patents and realty to the corporation was because he did not wish to subject these assets to the potential risk of National's obligations arising out of its activities in war work. Johnson wished to assure himself of the opportunity, if he so chose, to exploit the patents in his individual 157 capacity at the termination of the war period.After experiencing initial difficulty in retooling, National manufactured, under Government contracts, material for the war effort from the time of its incorporation until the latter part of 1945. The corporation was subject to renegotiation of its Government contracts. During this period National did manufacture and sell to the Navy fruit juice extractors covered by the above-listed patents. These sales, however, were small in quantity and their production was not continuous but was sporadic.Johnson did not receive any royalties from the manufacture or sale of the fruit juice extractors to the Navy by National. He never asked 678 for any compensation nor did he enter into any oral or written agreement with respect to his right to compensation for the use of the letters patent by National.The termination or cutoff date of National's war work came in the latter part of 1945. National was considering several products for civilian use at that time. It had developed an automatic record changer that could be applied to radio sets and would change intermixed 10- and 12-inch records. It planned to manufacture these record changers158 after the war but could not get parts. National decided to concentrate on the production of fruit juice extractors because of the few parts required, and the manufacturing know-how which it already possessed. This product permitted it to reconvert to civilian production quickly and to capitalize on existing civilian demand.Johnson gratuitously permitted National to use his patents in the manufacture of these juice extractors. Such gratuitous permission was given by Johnson to National on a temporary basis.Johnson temporarily permitted National to manufacture these fruit juice extractors under his six patents until National was through the period of contract renegotiation with the Government.After the period of contract renegotiation, Johnson decided to continue to operate National as a corporation and not to go back into business as an individual. He consulted an attorney concerning the sale to National of the patents held in his name. He was advised that only those patents that he owned prior to the incorporation of National could be sold. The other patents which had been granted Johnson subsequent to National's incorporation could not be sold as National, in the opinion159 of Johnson's attorney, had "shop rights" in those patents.44 On November 17, 1947, Johnson entered into a written agreement with National regarding the six aforementioned fruit juice extractor patents. The agreement is as follows:AGREEMENT1. This agreement entered into November 17, 1947, as of the 1st day of October, 1947, by and between HERBERT C. JOHNSON, of Wilmette, Illinois (hereinafter called JOHNSON), and NATIONAL DIE CASTING COMPANY, a corporation of Illinois, having its principal place of business at Lincolnwood, Illinois (hereinafter called NATIONAL).WITNESSETH:2. Whereas, JOHSON [sic] is the owner of the entire right, title and interest in and to the following United States Letters Patent:PatenteePatent No.DateJohnson2,090,913Aug. 24, 1937Johnson2,177,939Oct. 31, 1939Johnson2,131,440Sept. 27, 1938JohnsonDes.101,000Aug. 25, 1936JohnsonDes.109,062Mar. 29, 1938JohnsonDes.110,897Aug. 16, 1938679 3. Whereas, NATIONAL desires to purchase said patents and JOHNSON is willing to sell said patents to NATIONAL:4. Now, Therefore, in consideration of these premises, and of the mutual convenants and agreements hereinafter160 set forth, it is hereby covenanted and agreed by and between parties hereto as follows:5. Contemporaneously with the execution and delivery of this agreement, JOHNSON agrees to sell, assign, transfer and convey all his right, title and interest in and to said patents, and each of them, to NATIONAL together with all rights of action and recovery for past infringement thereof.6. NATIONAL acknowledges receipt of said assignment and in consideration thereof and as the purchase price thereof agrees to pay to JOHNSON at the times, in the manner, and for the periods hereinafter set forth a sum equal to 6% of the selling price of all products sold by NATIONAL embodying any one or more of the inventions, devices or designs covered by any one or more of the above described unexpired patents, and 80% of all royalties or other compensation received by NATIONAL from the licensing or other disposition of any one or more of said patents to others, and 80% of all net recoveries of damages, profits or royalties on account of infringement of any of said patents by others.7. NATIONAL further agrees that said payments shall be made by NATIONAL to JOHNSON for each successive three-month period after161 October 1, 1947 (commencing with the three-month period ending December 31, 1947) within thirty (30) days after the end of each such three-month period, during the entire remaining term of said patents and until the last of such patents shall have expired.8. At the time such payments are due, NATIONAL shall, and hereby agrees to, furnish JOHNSON with a statement, which shall be sworn to by an officer of NATIONAL if requested by JOHNSON, setting forth in detail the quantity and selling price of each product sold by NATIONAL during the previous three-month period for which such payment is due embodying an invention, device or design covered by any one or more of said patents which has not expired prior to the commencement of such three-month period and separately showing the name of each licensee or other person from whom royalties or other compensation or damages has been received during such three-month period and the amount of royalties, other compensation or damage received from each.9. For the purposes of this agreement products are deemed "sold" when invoiced by NATIONAL and the word "sold" includes the lease or other disposition of such products from which NATIONAL receives162 compensation, and the "selling price" is the net compensation to which NATIONAL is entitled for products sold after deducting trade discounts and freight or other allowances allowable to the purchaser but before deducting commissions or fees to brokers, agents or sales representatives.10. This agreement shall be binding upon and inure to the benefit of JOHNSON, his heirs, executors, administrators and assigns, and NATIONAL, and its successors.In Witness Whereof, JOHNSON has hereunto set his hand and seal and NATIONAL has caused this agreement to be executed and its corporate seal to be hereto affixed by its duly authorized corporate officers./s/ Herbert C. Johnson (SEAL)Herbert C. JohnsonNational Die Casting CompanyBy /s/ G. W. HanneyVice PresidentAttest:/s/ Edna A. JohnsonSecretary680 Contemporaneously with the execution of the agreement set forth above, Johnson executed and delivered to National an assignment of the six fruit juice 45 extracting patents. Said assignment is as follows:ASSIGNMENTWhereas, HERBERT C. JOHNSON of the Village of Wilmette, County of Cook, State of Illinois is the owner of the entire right, title and interest in and to the following163 described United States Letters Patent:PatenteePatent No.DateJohnson2,090,913Aug. 24, 1937Johnson2,177,939Oct. 31, 1939Johnson2,131,440Sept. 27, 1938JohnsonDes.101,000Aug. 25, 1936JohnsonDes.109,062Mar. 29, 1938JohnsonDes.110,897Aug. 16, 1938Whereas, said Herbert C. Johnson is desirous of conveying the entire right, title and interest in and to said patents to NATIONAL DIE CASTING COMPANY, an Illinois corporation, having its principal place of business in the County of Cook, State of Illinois, and said NATIONAL DIE CASTING COMPANY is desirous of acquiring said patents.Now, Therefore, in consideration of the sum of One Dollar ($ 1.00) and other good and valuable consideration, the receipt whereof is hereby acknowledged, said HERBERT C. JOHNSON does hereby sell, assign, transfer and convey unto said NATIONAL DIE CASTING COMPANY, its successors and assigns, the entire right, title and interest in and to the aforesaid Letters Patent, including any divisions, continuations, reissues and extensions of said patents, or any of them, together with all rights of action and recovery for past infringement of said patents, or any of them; 164 and the said HERBERT C. JOHNSON does hereby covenant and warrant that as of the date hereof he is the true and lawful owner of the entire right, title and interest in said Letters Patent, and each of them, and has full right and power to convey the same, and that the same are free and clear of all liens, charges and encumbrances whatsoever.In Witness Whereof, said HERBERT C. JOHNSON has hereunto set his hand and seal this 17th day of November, A. D. 1947 as of the 1st day of October, A. D. 1947./s/ Herbert C. Johnson (SEAL)State of IllinoisCounty of CookSSI, Phyllis A. Yeager, a Notary Public in and for the County and State aforesaid, do hereby certify that HERBERT C. JOHNSON, personally known to me to be the same person whose name is subscribed to the foregoing instrument, appeared before me this day in person and acknowledged that he signed, sealed and delivered the said instrument as his free and voluntary act for the uses and purposes therein set forth.Given under my hand and notarial seal this 17th day of November, A. D. 1947./s/ Phyllis A. YeagerNotary Public.My commission expires: June 20, 1951The assignment was recorded in the United States Patent Office on165 November 19, 1947.681 Johnson received from National, under the agreement set forth above, the sums of $ 16,794.55 in the calendar year 1951; $ 10,238.20 in the calendar year 1952; and $ 11,853.35 in the calendar year 1953. Said sums are equal to 6 per cent of the selling price, as defined by the agreement, of all products sold by National, embodying any one or more of the inventions, devices, or designs covered by any one or more of the unexpired patents covered by the said agreement. The 6 per cent rate is not an unreasonable rate.During the period of time in which Johnson gratuitously allowed National to use his patents for fruit juice extractors, National reopened its New York City sales office which had been closed for the duration of the war and had a sales representative in Los Angeles, California. National advertised fruit juice extractors in national magazines. National also purchased additional equipment which was applicable to the production and manufacture of juice extractors as well as other types of products which it made.During the period January 1, 1947, to December 31, 1953, inclusive, Johnson owned the 2,000 authorized, issued, and outstanding shares166 of common stock of National, having a par value of $ 25 per share.During the same period the 1,000 authorized, issued, and outstanding shares of preferred stock of National, having a par value of $ 100 per share, were owned as follows: 920 shares by Edna A. Johnson, wife of Herbert; 40 shares by Herbert C. Johnson, Jr., son of Herbert and Edna; and 40 shares by Richard E. Johnson, son of Herbert and Edna.Herbert C. Johnson was president of National from 1941 until July 1952, when he became secretary and treasurer. He was also a director of National from the inception of the corporation. His wife was also a director, and there were other directors of which one was G. W. Hanney, who signed the agreement on behalf of National.The agreement of sale and the assignment 46 to National of the six fruit juice extractor patents by petitioner was fair and reasonable as judged by the standards of a transaction entered into by parties dealing at arm's length. The sale and assignment to National by petitioner served a valid business purpose, and conveyed the whole right, title, and interest of petitioner in the patents in question to National, which had theretofore operated, and continued to167 operate as a separate business entity.The agreement of sale and assignment by Johnson to National of the six patents relating to the fruit juice extractors was a sale of assets held for more than 6 months, entitled to treatment as long-term capital gains.OPINION.The principal issue before us is whether certain payments received by petitioner Herbert C. Johnson pursuant to the agreement and the 682 assignment of November 17, 1947, are ordinary income or long-term capital gain.It is respondent's general theory and first contention that the proceeds from any alleged sale of letters patent, which are payable periodically over a period coterminous with their use or are contingent on the production and sale of patented articles, are royalties and are to be taxed as ordinary income. Respondent further contends, in the alternative, that the alleged sale of the letters patent in the instant case is without substance and lacks a business purpose. Respondent concedes that the letters patent are capital assets in the hands of petitioner.Neither party suggests that section 117 (q) of the Code of 1939 is applicable to the facts in the instant case, or that the provisions thereof are168 in any way determinative of the issues before us. See .Respondent has clung with tenacity to his first contention through nearly 12 years of extensive litigation during which time the courts have, however, consistently held against him.We have recently had occasion to express our views in relation to this contention in , in which we said, in part:It is clear that the transfer of a patent results in a capital gain or loss if the patent was a capital asset in the hands of the transferor and if the transaction amounted to a sale or assignment as distinguished from a license agreement. , affirmed per curiam (C. A. 3, 1953). It is not necessary that the payment from the transfer be a lump sum in order to constitute capital gain, but may be cast in the form of a percentage of sale or profits, or an amount per unit manufactured or sold, or any combination of the foregoing. ;169 . * Respondent on brief notes that he is not unmindful of our consistent position but requests us to reexamine the whole area with a view toward upsetting our prior decisions. We have, of course, given full consideration to respondent's argument, but we are unconvinced, and see no occasion to change the approach which we have followed in earlier cases. As we said in :Certainly, we are not disposed to reexamine the Myers case. It has been followed in too many cases, and has become too firmly imbedded in the law to justify reopening the issue at this time.See also ; .Respondent's alternative contention that the transaction was a sham and served no business purpose is not supported by the facts. Respondent makes it clear that he does not seek to deny any taxpayer the right to deal with his controlled corporation, but alleges that 683 there must be a business purpose, without170 which, he reasons, the transaction must be treated as a sham.Respondent contends that National was already the owner of a perpetual, unlimited license in the nature of a shop right, to make, use, and sell the patented articles as a result of the gratuitous use of the patents by National from 1945 to November 17, 1947. See (W. D. Pa., 1931); (C. A. 2, 1952).Assuming, arguendo, that National acquired such a license in the nature of a shop right, we have been cited no authority, and have found none, for the position that petitioner could not grant and convey to National greater rights than that of a licensee, i. e., the rights of an absolute owner of the patents. To the contrary, we have held that such a grant may be made even if shop rights existed, and that such a grant would not make the agreement a sham or fiction. . 47 See also .We think171 it is clear from the record that National operated as a separate business entity and that the sale and assignment by petitioner to National of all his right, title, and interest in the six juice extracting patents was not a sham, but was a bona fide transfer for a valid business purpose. Petitioner did not transfer his patents at the time National was originally organized because he did not wish them to become subject to the possible liabilities of National, which was embarking on the production of unfamiliar articles for the war effort. He did not transfer his patents immediately after the cessation of hostilities because National was still subject to Government contract renegotiation, with its possible business uncertainties. After the renegotiation period, he decided to and did transfer the patents to the corporation, and received a fair and reasonable rate of compensation. Under the circumstances, his acts were readily understandable, and there appears to be no reason why he should not have done so.Viewing the record as a whole, there is no justification for disregarding the separate legal entity of the corporation as distinguished from its shareholders. "An agreement between172 a corporation and its sole stockholders is valid and enforcible, if the arrangement is fair and reasonable, judged by the standards of a transaction entered into by parties dealing at arm's length." (C. A. 7, 1954). We have found that the agreement between National and petitioner was fair and reasonable under the above-quoted standard, and the stipulation of the parties lends support to this view.*684 We conclude, therefore, that the transaction was a sale of assets held for the requisite statutory period, and that long-term capital gains treatment is to be applied.Decision will be entered under Rule 50. Footnotes1. Design.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4669046/	FILE COPY BILL OF COSTS TEXAS COURT OF APPEALS, EIGHTH DISTRICT, AT EL PASO No. 08-20-00047-CV In the Matter of the Guardianship of Janet Church, An Incapacitated Person v. (No. 18-0190-CP4 IN COUNTY COURT AT LAW NO. 4 OF WILLIAMSON COUNTY) Type of Fee Charges Paid By MOTION FEE $10.00 NOT PAID N/A CLERK'S RECORD $10.00 UNKNOWN UNKNOWN SUPREME COURT $50.00 INDIGENT INDIGENT CHAPTER 51 FEE $30.00 INDIGENT INDIGENT STATEWIDE EFILING $25.00 INDIGENT INDIGENT FEE $100.00 INDIGENT INDIGENT INDIGENT FILING Balance of costs owing to the Eighth Court of Appeals, El Paso, Texas: $10.00 Court costs in this cause shall be paid as per the Judgment issued by this Court. I, ELIZABETH G. FLORES, CLERK OF THE EIGHTH COURT OF APPEALS OF THE STATE OF TEXAS, do hereby certify that the above and foregoing is a true and correct copy of the cost bill of THE COURT OF APPEALS FOR THE EIGHTH DISTRICT OF TEXAS, showing the charges and payments, in the above numbered and styled cause, as the same appears of record in this office. IN TESTIMONY WHEREOF, witness my hand and the Seal of the COURT OF APPEALS for the Eighth District of Texas, this March 12, 2021. Elizabeth G. Flores, Clerk	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4619429/	ROBERT F. DUNCAN, JR. and GLYNDA V. DUNCAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDuncan v. CommissionerDocket No. 16335-84.United States Tax CourtT.C. Memo 1987-392; 1987 Tax Ct. Memo LEXIS 389; 54 T.C.M. (CCH) 98; T.C.M. (RIA) 87392; August 11, 1987. 389 In Feb. 1982, P entered into a contract with Masters Financial under which he sold Mid-South leases on a commission basis. Later in 1982, a corporation was formed with P as president and sole stockholder. P, allegedly on behalf of the corporation, entered into a second contract with Masters Financial under which he sold Music Masters leases on a commission basis. P reported only a small amount of the commissions received under the two contracts, while the corporation reported the remainder as nontaxable income. Held:(1) All of the commissions paid under the two contracts must be reported by P, because all of such commissions were earned by him. (2) P's failure to report all of the commissions was fraudulent, and Ps are liable for the additions to tax for fraud under sec. 6653(b)(1) and ( 2), I.R.C. 1954. 390 Robert F. Duncan, Jr., and Glynda V. Duncan, pro se. Willard N. Timm, for the respondent. SIMPSONSIMPSON, Judge: The Commissioner determined the following deficiency in, and additions to, the petitioners' Federal income tax for 1982: Additions to TaxSec. 6653(b)(1)Sec. 6653(b)(2)DeficiencyI.R.C. 19541I.R.C. 1954$ 43,765.93$ 21.882.96$ 2,074.21The issues for decision are: (1) Whether the commissions on the sale of certain tax shelters were earned by and includable in the income of the petitioners or by a corporation organized by them, and (2) whether the petitioners are liable for the additions to tax for the fraudulent underpayment of tax pursuant to section 6653(b)(1) and (2). FINDINGS OF FACT Some of the facts have been stipulated, and those facts391 are so found. The petitioners, Robert F. Duncan, Jr., and Glynda V. Duncan, husband and wife, maintained their legal residence in San Jose, Costa Rica, at the time the petition in this case was filed. They filed their joint Federal income tax return for 1982 with the Internal Revenue Service Center in Chamblee, Georgia. Mr. Duncan graduated from the United States Military Academy at West Point as a distinguished scholar and earned a master's degree from the University of Virginia and a Ph.D. in economics from Harvard. He served in the U.S. Army during the Second World War and Korea; later, he was honorably discharged and entered the Reserves. Currently, he is retired from the Reserves at the rank of Colonel. In 1957, Mr. Duncan started an insurance agency in Charleston, South Carolina, known as Robert Duncan & Associates (the agency). Many years later, the petitioners were married, and Mrs. Duncan became an agent for the agency. The agency was initially only in the insurance business, but eventually it became involved in selling securities. Since 1957, Mr. Duncan has been involved in many different business ventures. At some time prior to 1982, Mr. Duncan met with392 Jim Bryant, president of the U.S. Tax Planning Service, in the Cayman Islands. Mr. Duncan was interested in marketing some tax shelters, and Mr. Bryant suggested that he use the master sound recording programs because they would "fit" middle-income taxpayers. During 1982, Mr. Duncan owned and operated the agency in Mount Pleasant, South Carolina. On February 23, 1982, he entered into a "Contract Representative Agreement" with Masters Financial, Inc. (Masters Financial). Masters Financial was the "licensee" under contract as an independent sales contractor with Mid-South Music Corporation (Mid-South). Mr. Duncan, as contract representative, was authorized to sell Mid-South leases of master sound recordings. The contract provided that upon the receipt of lease payments by Masters Financial, Mr. Duncan was to receive commissions, ranging from 15 to 20 percent of the monthly rentals, depending upon the arrangement for the payment of the rentals. Later in 1982, the petitioners, along with others, organized a corporation called Trend Corporation (Trend). Trend was a Nevada corporation allegedly domiciled in the Virgin Islands. Mr. Duncan was director, president, and sole shareholder393 of Trend during 1982. Mrs. Duncan was vice president and assistant secretary of Trend during 1982. Trend listed its 1982 address as being the same as the agency's business address. The petitioners were the only authorized signatories for the Trend bank account at Bankers Trust of South Carolina until December 1, 1982, when Sue J. Mauney was added as an authorized signatory. Mr. Duncan actually continued to control Trend's bank account and write checks on the account during 1982 and 1983. Mr. Duncan and Trend never had a written agreement between them for services or for distribution of income or profits. On September 16, 1982, another Contract Representative Agreement was entered into with Masters Financial. This contract listed "Robert F. Duncan T/A Trend Corporation" as the contract representative. Masters Financial was also the licensee under contract as an independent sales contractor with Music Masters, Ltd. (Music Masters). Mr. Duncan was authorized to sell Music Masters leases of master sound recordings. The contract provided that upon receipt of lease payments by Masters Financial, the contract representative was to receive a commission of 30 percent regardless of394 payment plan. In addition, in an addenda to the contract, the contract representative was to receive an "override of 10%" of all business generated by George Haraka, and the addenda stated that "The commission of 30% to be paid to Contract Representative (Duncan) shall be retroactive to include all business previously submitted for Music Masters, Ltd., Lessor." The addenda was signed by Mr. Duncan. During 1982, Mr. Duncan negotiated leases with individual investors in Music Masters and Mid-South music tax shelters. At the time of the investment, an investor either paid the entire payment on the lease or made a downpayment with subsequent monthly payments. Most of the downpayments and full payments were made to Mr. Duncan directly and subsequently deposited into the agency account or his personal account. On some occasions, the initial payments were made to Trend and deposited in Trend's account. Deferred payments on the leases were paid directly to Masters Financial, which paid commissions to either Mr. Duncan or Trend. The commission checks issued by Masters Financial were payable to either Robert F. Duncan or Robert F. Duncan T/A Trend Corporation. All commission checks395 were sent to the agency's business address. In 1982, $ 99,178.40 in commissions was paid for the sale of Mid-South leases; of such amount, $ 16,713.60 was paid to Mr. Duncan and $ 82,464.80 was paid to Trend. Commissions of $ 40,553.00 were paid by Masters Financial for the sale of Music Masters leases; all of such commissions were paid to Trend. Throughout 1982 and 1983, many of the checks drawn on the Trend bank account at Bankers Trust were issued for the benefit of the petitioners or their family. At least $ 66,474.00 was withdrawn for such purposes in 1982 and $ 75,000.00 in 1983. Many of the withdrawals were described as "loans" to Mr. Duncan, but there has been no other evidence indicating that such withdrawals were in fact loans, other than the testimony of Mr. Duncan. After the close of 1982, Masters Financial issued a Form 1099-NEC (statement for recipients of nonemployee compensation) showing that commissions of $ 139,731.40 had been paid to "Robert Duncan t/a Trend Corp." Subsequently, Mr. Duncan called Masters Financial and complained about the amount and name show on the Form 1099. Pursuant to a request by Mr. Duncan, Masters Financial issued new Forms 1099396 showing payments of $ 17,052.60 to Robert Duncan and $ 122,678.80 to Trend. The same practices were followed by Masters Financial, Mr. Duncan, and Trend in 1983. In that year, leases of Mid-South and Music Masters were sold, commission payments made by Masters Financial to Mr. Duncan or Trend, and checks were drawn on the Trend bank account for the benefit of the petitioners and their family. During 1983, a house was purchased in Costa Rica in the name of Trend using as part payment the proceeds of a $ 100,000 loan secured by Mr. Duncan from Bankers Trust in February 1983. He assigned personal assets and commissions as security for the loan and was personally liable on the note. He also pledged his stock in Trend as collateral for the loan, and he personally paid the interest on the loan. On their joint Federal income tax return for 1982, the petitioners reported commissions from Masters Financial of $ 17,052.60. For its taxable year ending March 31, 1983, a tax return was filed for Trend with the Virgin Islands. On that return, Trend reported receiving commissions of $ 193,325.80, but such commissions were treated as nontaxable. In his notice of deficiency issued to397 the petitioners, the Commissioner determined that the petitioners should have reported all of the commissions received from Masters Financial because Mr. Duncan was the true earner of all such commissions. The Commissioner also determined that the petitioners were liable for the additions to tax under section 6653(b) for fraud. OPINION The first issue to be decided is whether all of the commissions reported by the petitioners and Trend from the sale of master recording leases are taxable to the petitioners. The petitioners contend that Trend was a separate taxable entity and the proper party to bear the tax burden on the commissions reported by it. The Commissioner contends that Mr. Duncan was the true earner of such income and that Trend was merely acting as his alter ego in receiving any portion thereof. The burden of proof with regard to this issue is on the petitioners. Rule 142(a), Tax Court Rules of Practice and Procedure; 2Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). 398 The question is basically one of substance versus form. It is clear that a taxpayer may adopt any form for the conduct of business and that such form cannot be ignored merely because it results in tax savings. Noonan v. Commissioner,52 T.C. 907">52 T.C. 907, 909 (1969), affd. per curiam 451 F.2d 492">451 F.2d 492 (9th Cir. 1971). In fact, it is a well settled principle that a taxpayer has the legal right to decrease the amount of what otherwise would be his taxes, or to avoid them altogether, by means which the law permits. Commissioner v. Tower,327 U.S. 280">327 U.S. 280, 288 (1946); Gregory v. Helvering,293 U.S. 465">293 U.S. 465, 469 (1935). However, it is a basic concept of tax law that income must be taxed to him who earns it. Commissioner v. Culbertson,337 U.S. 733">337 U.S. 733 (1949). Likewise, an equally fundamental principle is that a person who earns income cannot avoid taxation by directing it to another person. United States v. Basye,410 U.S. 441">410 U.S. 441 (1973); Lucas v. Earl,281 U.S. 111">281 U.S. 111 (1930). Determining who earned the income depends upon which person in fact controlled399 the earning of the income and not who ultimately received the income. Johnson v. Commissioner,78 T.C. 882">78 T.C. 882, 891 (1982), affd. without published opinion 734 F.2d 20">734 F.2d 20 (9th Cir. 1984); Verrcio v. Commissioner,73 T.C. 1246">73 T.C. 1246, 1254-1255 (1980); American Savings Bank v. Commissioner,56 T.C. 828">56 T.C. 828, 839-842 (1971). When a taxpayer, through his own efforts, earns the right to income, or otherwise exercises dominion and control over its disposition, he is liable for the taxation of such income, even though he does not actually receive the proceeds. Actual receipt of income is not the only way that income can be realized for purposes of tax laws, and an anticipatory assignment of income which a taxpayer is about to receive does not prevent the gain from being taxable to him. The commissions at issue in this case were received under two contracts. In deciding the first issue, we shall discuss each contract separately. It was on February 23, 1982, that Mr. Duncan entered into the contract with Masters Financial to sell Mid-South leases of master sound recordings and receive commissions based upon such sales. Trend was400 not in existence at such time, and it was Mr. Duncan who was a party to such contract, not Trend. There is no indication that Trend had any connection whatever with this contract, and Trend certainly possessed no right to any commission income generated from the sale of Mid-South leases. Moreover, it was Mr. Duncan who negotiated Mid-South leases with individual investors and earned the right to receive commissions in accordance with the terms of the contract. Thus, it is clear that Mr. Duncan, through his own efforts, earned the commissions paid under this contract. Therefore, all of the commissions paid pursuant to the contract to sell Mid-South leases are taxable to the petitioners. By the time of the making of the second contract, the contract providing commissions on the sale of Music Masters leases, Trend had been organized. Nevertheless, matters were still controlled by Mr. Duncan. He was director, president, and sole stockholder of Trend during 1982. Trend listed its address as being the same as the agency's address during 1982. Mr. Duncan actually negotiated the sales of the Music Masters leases, and Mr. Duncan and Trend never had a written agreement between them401 for services or for distribution of income or profits. Mr. and Mrs. Duncan were the sole signatories on Trend's bank account for most of 1982. During that year, there were many checks drawn on that account by Mr. Duncan. Many of those checks were for the benefit of the petitioners and their family. Some of such checks were marked "loan to RFD," or similarly. However, no further evidence has been presented regarding the alleged loans, except for the unsubstantiated, self-serving testimony of Mr. Duncan. Mr. Duncan claims to have resigned as president and as a director of Trend in 1982 and to have sold his stock in January 1983, but the record as a whole shows that he maintained control of Trend throughout 1982 and into 1983. In fact, in February 1983, he borrowed $ 100,000 which Trend used to buy a house; he assumed liability on such loan, paid the interest thereon, and purported to pledge his stock in Trend as security for the loan. The fact that the Forms 1099 reported most of the commissions as payable to Trend is not controlling for income tax purposes. Pond v. Commissioner,12 B.T.A. 865">12 B.T.A. 865 (1928).402 Irrespective of whether Trend was a viable entity, the economic practicalities and substance of the arrangement must take precedence over the corporate form. Commissioner v. Court Holding Co.,324 U.S. 331">324 U.S. 331, 334 (1945); Blueberry Land Co. v. Commissioner,42 T.C. 1137">42 T.C. 1137, 1146-1147 (1964), affd. 361 F.2d 93">361 F.2d 93 (5th Cir. 1966). The evidence indicates that Trend was organized for the sole purpose of acting as a "pocketbook" for the petitioners. Trend was merely acting as Mr. Duncan's alter ego in purporting to receive some of the commissions. Mr. Duncan may not avoid taxation of the income earned by him by directing that income to another entity. United States v. Basye, supra;Lucas v. Earl, supra.We are convinced that Mr. Duncan was the true earner of the commissions paid pursuant to the two contracts with Masters Financial and that he is the proper party to bear the burden of paying the taxes on such income. The second issue for decision is whether the petitioners are liable for the additions to tax for fraud under section 6653(b) for 1982. 403 Section 6653(b)(1) provided that if any part of an underpayment of tax required to be shown on a return is due to fraud, there shall be added to such tax an amount equal to 50 percent of the underpayment. Section 6653(b)(2) provided for an additional amount equal to 50 percent of the interest payable on the portion of the underpayment attributable to fraud. 3 The Commissioner bears the burden of proving fraud by clear and convincing evidence. Rule 142(b); sec. 7454(a); Drobny v. Commissioner,86 T.C. 1326">86 T.C. 1326, 1348-1349 (1986); Otsuki v. Commissioner,53 T.C. 96">53 T.C. 96, 105 (1969); Acker v. Commissioner,26 T.C. 107">26 T.C. 107, 111-112 (1956). To establish fraud, the Commissioner must show that a petitioner intended to evade taxes which he knew or believed that he owned, by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. Webb v. Commissioner,394 F.2d 366">394 F.2d 366, 377-378 (5th Cir. 1968), affg. a Memorandum Opinion of this Court; Powell v. Granquist,252 F.2d 56">252 F.2d 56, 60 (9th Cir. 1958); Acker v. Commissioner, supra at 111-112.404 In deciding whether the Commissioner has established fraud on the part of a petitioner, we may consider the entire record properly before us. Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181, 199 (1976), affd. without published opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978); Imburgia v. Commissioner,22 T.C. 1002">22 T.C. 1002, 1004 (1954). Fraud will never be presumed. Beaver v. Commissioner,55 T.C. 85">55 T.C. 85, 92 (1970). However, when direct evidence of fraud is not available, circumstantial evidence is permitted. Spies v. United States,317 U.S. 492">317 U.S. 492, 499 (1943); Rowlee v. Commissioner,80 T.C. 1111">80 T.C. 1111, 1123 (1983). Fraud may be inferred where an entire course of conduct establishes the necessary intent. Rowlee v. Commissioner, supra;Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 223-224 (1971); Otsuki v. Commissioner,53 T.C. at 105-106. When a claim of ignorance or honest mistake is set forth, this Court must consider a petitioner's intelligence, education, and tax expertise in making its determination. Drobyn v. Commissioner, supra; Iley v. Commissioner,19 T.C. 631">19 T.C. 631, 635 (1952).405 We have already determined that the commissions attributable to the two contracts with Masters Financial were earned by Mr. Duncan and that his failure to report all of such commissions resulted in an underpayment of tax for 1982. The evidence in the record clearly and convincingly establishes that the underpayment of tax was fraudulent. Mr. Duncan is a well educated and experienced businessman who has knowledge in the field of taxation. He graduated from the U.S. Military Academy at West Point as a distinguished scholar and earned a master's degree from the University of Virginia and a Ph.D. in economics from Harvard. He has been involved in many business ventures, including insurance and securities. Mr. Duncan set up Trend for the sole purpose of shifting to Trend taxable income earned by him. The result of this arrangement was the petitioners' omission of a very substantial amount of income for 1982. In addition, the petitioners have failed to cooperate with the Commissioner throughout the course of his investigation. With the exception of a few bank statements, the petitioners have provided no records for trail concerning the corporation. In a letter written by Mr. 406 Duncan to the Commissioner, he claimed to know nothing about Trend, denied that he was a stockholder or officer, and claimed to be a mere consultant in 1982. However, the record established that during 1982, Mr. Duncan was president and sole shareholder in Trend, was in control of Trend's bank account, was responsible for selling master recording leases, and used funds n Trend's bank account for his own benefit. Finally, Mr. Duncan has offered no credible explanation for the understatement of income for 1982. When a taxpayer with sophistication in tax matters fails to report substantial amounts of income and is uncooperative with the IRS and when he fails to offer any credible explanation of his conduct, we must conclude that the omissions of income were not due to mere oversight. We must infer that these acts were deliberate and that the underpayment of tax was due to fraud by Mr. Duncan. Stone v. Commissioner,56 T.C. at 224-225; Smith v. Commissioner,32 T.C. 985">32 T.C. 985, 987 (1959). Therefore, we hold that the Commissioner has proven, by clear and convincing*407 evidence, that the underpayment of tax in 1982 was due to fraud within the meaning of section 6653(b). 4Decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during the year in issue.↩2. Any reference to a Rule is to the Tax Court Rules of Practice and Procedure. ↩3. The provisions of sec. 6653(b)(1) and (2)↩ have been amended with respect to returns which become due after Dec. 31, 1986. See sec. 1503(a), Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2742. 4. The petitioner have not raised an issue as to the amount of additional interest determined by the Commissioner under sec. 6653(b)(2)↩. We have decided that the entire underpayment of tax was due to fraud; consequently, we sustain the Commissioner's determination.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619430/	JOSEPH V. FREDETTE, JR., and SUE FREDETTE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Fredette v. CommissionerDocket No. 1365-73.United States Tax CourtT.C. Memo 1975-122; 1975 Tax Ct. Memo LEXIS 249; 34 T.C.M. (CCH) 587; T.C.M. (RIA) 750122; May 5, 1975, Filed Joseph V. Fredette, Jr., pro se. Wayne M. Bach. for the respondent. BRUCE MEMORANDUM FINDINGS OF FACT AND OPINION BRUCE, Judge: Respondent determined a deficiency in petitioners' Federal income tax for the calendar year 1970 in the amount of $356.13. The issue remaining for decision is whether petitioner is entitled to dependency exemptions for his three minor children who lived with their mother (the former spouse of petitioner Joseph V. Fredette, Jr.) during 1970. FINDINGS OF FACT Some of the facts have been stipulated and the stipulation of facts, together with the exhibits attached thereto, are incorporated by reference. Petitioners are husband and wife251 who resided in Shively, Kentucky at the time of the filing of their petition. Petitioners filed a joint Federal income tax return for 1970 and Sue Fredette, the second wife of petitioner Joseph V. Fredette, Jr., is a petitioner herein solely by virtue of having filed a joint return with her husband. When used hereinafter, "petitioner" will refer to Joseph V. Fredette, Jr. Petitioner was formerly married to Peggy Constance Fredette. Three children were born of that marriage: Joel M., Deborah Lynn, and Tina Marie. Petitioner and Peggy were divorced in Hardin County, Kentucky, on February 18, 1962. At that time petitioner was serving on active duty with the United States Army and was stationed at Fort Knox, Kentucky. A copy of the divorce decree was not offered in evidence. It appears, however, from the testimony and admissions of the petitioner that custody of the three children was awarded to their mother. It also appears that there was no provision in the divorce decree providing for the payment of child support and no provision granting dependency exemptions for the children to the petitioner, the non-custodial parent. Prior to the divorce and thereafter until sometime in 1968, 252 when petitioner was released from military service, a "Dependents' Class Q Allotment" was made to Peggy by the Army for her benefit and that of petitioner's children. Such an allotment is a payment made directly to a serviceman's wife or children by the Army from money withheld from the serviceman's military pay. The record does not disclose the amount of the allotment made to Peggy and the children in this case. In 1969, after petitioner was released from the military service and apparently the Class Q Allotment had been discontinued, an Order for Support was entered against petitioner by the County Court for Jefferson County, Kentucky, which directed petitioner to make bi-monthly payments of $60.00 for the support of his three minor children. Pursuant to the order of the Jefferson County Court, petitioner paid $1,260.00 during 1970 to the Division of Uniform Support, Jefferson County Attorney's Office, for child support. Of this amount, $120.00 represented arrearages for support payments which were due in 1969. During the taxable year 1970, Peggy and the three children resided in Champlain, New York. Peggy earned no income during 1970 and she and the three children lived in the253 house of Peggy's father, Homer Pelkey. The State of New York furnished a portion of the support for the three children during 1970. The record does not disclose the amount of the support furnished the children by the State of New York or by their grandfather. Nor is there any evidence in the record as to the total support received by the children during the year 1970. OPINION Section 151(e) of the Internal Revenue Code of 19541/ provides for a dependency exemption for each dependent as defined in section 152. Section 152(a) defines the term "dependent" as including, among others, a son or daughter "over half of whose support for the calendar year in which the taxable year of the taxpayer begins, was received from the taxpayer (or is treated under subsection (c) or (e) as received from the taxpayer.)" Petitioner claims he is entitled to three dependency exemptions because the $1,260.00 he contributed in 1970 was over one-half the amount necessary to support his children. We accept this amount as petitioner's contribution toward the support of his children even though254 a portion thereof consisted of payments in arrears for 1969. Frank P. Gajda,44 T.C. 783">44 T.C. 783 (1965). We do not accept, however, petitioner's contention that this amount of support entitles him to the dependency exemptions because it is over one-half of an amount he claims was necessary to support his three children. The statute imposes a different and more definite standard, based on actual expenditures by the parents, to determine which divorced parent is entitled to the dependency exemptions. This case presents a factual question and we begin with a consideration of section 152(e). Section 152(e) 2/ was added to the Code to provide specific rules for determining which divorced or separated parent would be entitled to the dependency exemptions for their minor children. Section 152(e)(1) provides as a general rule that a child of divorced parents is to be treated, for the purpose of section 152(a), as receiving over half his support from the parent having custody the greater portion of the year. Two exceptions to this general rule are contained in section 152(e)(2), and if either exception is met, the children are treated as having received over half of their support255 from the parent not having custody. Since the petitioner furnished over $1,200.00 in support, and since there was no written agreement between the parents as to which one would be entitled to the deduction under section 151, we are concerned here only with the exception contained in section 152(e)(2)(B). 256 The respondent did not deny that petitioner expended at least $1,200 in support of his children nor did respondent seek to prove that the custodial parent, Peggy, had provided amounts in excess of petitioner's contribution. Section 152(e)(2)(B)(ii). Rather, the respondent contends that the "special rule" of section 152(e)(2) is inapplicable here since petitioner has failed to show, as the statute requires, that the children received over one-half their support in 1970 from their parents, petitioner and Peggy. This Court has held that the reference in section 152(e)(2) to "parents described in paragraph (1)" means parents who are divorced or legally separated and who have contributed over one-half the support of their children during the tax year. Harvey L. Hopkins,55 T.C. 538">55 T.C. 538 (1970). 3/ We agree with respondent that this threshold question must be determined before the presumptions of section 152(e)(2) are applicable. As indicated by our findings, Peggy and the three children resided in the home of Peggy's father during 1970 and they received financial assistance from the State of New York. Since we cannot determine from the record whether the children257 received over one-half their total support from their parents, nor did petitioner seek to provide such essential information under section 152(e)(3), we must conclude that 152(e) is inapplicable to our inquiry. To resolve the issue before us, therefore, we must turn to the basic support test contained in section 152(a). Petitioner clearly bears the burden of proving that his expenditures exceeded one-half the total amount actually provided for the childrens' support. Harvey L. Hopkins,supra; Rose D. Seraydar,50 T.C. 756">50 T.C. 756 (1968). Accepting the fact that petitioner contributed $1,260.00 in 1970, he has failed to meet his burden of showing the total amount of support actually expended in behalf of the children during that year from all other sources. No evidence was introduced into the record as to the kind or amount of support provided by the childrens' maternal grandfather, the State of New York, or Peggy. Because of this failure of proof, we are unable to determine the total258 amount of support, and, similarly, find it impossible to determine whether petitioner's expenditures exceeded one-half of that unknown amount. Accordingly, we must sustain respondent's deficiency determination. Decision will be entered for the respondent.Footnotes1. / All references are to the Internal Revenue Code of 1954, as amended.↩2. / SEC. 152. DEPENDENT DEFINED. * * * * *(e) Support Test in Case of Child of Divorced Parents, Et Cetera.-- (1) General Rule.--If-- (A) a child (as defined in section 151(e)(3) received over half of his support during the calendar year from his parents who are divorced or legally separated under a decree of divorce or separate maintenance, or who are separated under a written separation agreement, and (B) such child is in the custody of one or both of his parents for more than one-half of the calendar year, such child shall be treated, for purposes of subsection (a), as receiving over half of his support during the calendar year from the parent having custody for a greater portion of the calendar year unless he is treated, under the provisions of paragraph (2), as having received over half of his support for such year from the other parent (referred to in this subsection as the parent not having custody). (2) Special Rule.--The child of parents described in paragraph (1) shall be treated as having received over half of his support during the calendar year from the parent not having custody if-- (A)(i) the decree of divorce or of separate maintenance, or a written agreement between the parents applicable to the taxable year beginning in such calendar year, provides that the parent not having custody shall be entitled to any deduction allowable under section 151 for such child, and (ii) such parent not having custody provides at least $600 for the support of such child during the calendar year, or (B)(i) the parent not having custody provides $1,200 or more for the support of such child (or if there is more than one such child, $1,200 or more for all of such children) for the calendar year, and (ii) the parent having custody of such child does not clearly establish that he provided more for the support of such child during the calendar year than the parent not having custody. For purposes of this paragraph, amounts expended for the support of a child or children shall be treated as received from the parent not having custody to the extent that such parent provided amounts for such support.↩3. / See also, Jack C. Edwards,T.C. Memo 1975-72">T.C. Memo 1975-72; Parker C. Folse, Jr.,T.C. Memo 1973-98">T.C. Memo 1973-98; Income Tax Regs., § 1.152-4(a)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4619431/	MARVIN L. AND KATHLEEN McKINNEY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMcKinney v. CommissionerDocket No. 42449-84.United States Tax CourtT.C. Memo 1987-393; 1987 Tax Ct. Memo LEXIS 390; 54 T.C.M. (CCH) 103; T.C.M. (RIA) 87393; August 11, 1987. Marvin L. McKinney, pro se. Matthew A. Lykken, for the respondent. PARRMEMORANDUM FINDINGS OF FACT AND OPINION PARR, Judge: In his notice of deficiency dated October 3, 1984, respondent determined a deficiency in income tax due from petitioners in the amount of $ 946 for the taxable year 1981, based upon wages totaling $ 5,878 from various employers, which petitioners had failed to report on their original return. Petitioners do not contest that they failed to report $ 5,878 in wage income on their original return. However, on or about February 6, 1984, 1 petitioners filed an amended return, Form 1040X, for 1981 and claimed a refund, which respondent disallowed. On the amended return petitioners increased taxable income by $ 5,878, but claimed a short-term391 capital loss of $ 3,000, moving expenses of $ 583.24, and a child care credit of $ 256. We must decide whether petitioners are entitled to the amounts claimed on the amended return. Petitioners resided at Houston, TX., when they filed their petition in this case. In 1980 petitioners ran a day-care center in Oklahoma City, OK., doing business as "Today's Child." In August and October of 1980 petitioners paid amounts totaling $ 5,520 2 to a builder, Ben McNeill of Capital Funding, Inc., as the downpayment on some rental duplexes to be built for petitioners. In December 1980 petitioners discovered the builder was moving out of his office. The duplexes were never built. In 1981 Security National Bank and Trust Company sued Capital Funding, petitioners, and others, and petitioners sued McNeill and others as third-party defendants, in connection392 with the builder's default. The suit was settled on February 4, 1982, with judgment for petitioners in the amount of $ 4,520 plus $ 1,200 attorney fees. The bank's suit against petitioners was dismissed. Unfortunately, the judgment awarded to petitioners was never paid. Petitioners seek to claim a short-term capital loss of $ 3,000 in connection with the builder's default. Alternatively, petitioners claim a bad-debt loss. Regardless of the merits and nature of petitioners' claim, their loss did not occur in 1981, the year in issue. They discovered the default in 1980 and won a judgment in 1982 which was subsequently not paid. Petitioners' loss is not allowable in 1981. Petitioners sold Today's Child in 1981 and filed for bankruptcy. When Mr. McKinney's job at the telephone company in Oklahoma City, OK., was downgraded, he resigned and moved with his family to Houston, TX., in August 1981. Mrs. McKinney obtained work within a week, but Mr. McKinney did not find a job until October. Neither petitioner had a position when they moved to Houston, TX., but believed they would have more opportunity there than in Oklahoma City, OK. Petitioners seek to deduct $ 583.24 as393 moving expenses in 1981. Section 217 3 provides a deduction for moving expenses paid or incurred during the taxable year. Section 217(c) provides that this deduction shall not be allowed unless the taxpayer is employed full-time for at least 39 weeks during the 12-month period immediately following the move. We need not speculate as to whether any of this amount can properly be deducted as moving or job hunting expenses, because petitioners unfortunately have no records to substantiate that any expenses were actually paid. Petitioners bear the burden of proving respondent's determination as incorrect. Rule 142(a). Petitioners have moved frequently since 1981 and no longer have records. While we sympathize with their predicament, we are required to find that they have not met their burden of proof and are thus not entitled to the deduction claimed. Finally, petitioners claim a child care credit of $ 256. Section 44A, as in effect in 1981, provided394 a credit in the amount of 20 percent of qualifying child-care expenses. Mr. McKinney could not testify how much was spent for child care or the dates it was paid, nor did he present any cancelled checks, receipts, or other documentary evidence. Again, petitioners have not met their burden of proof and we must disallow the claim. Decision will be entered for the respondent.Footnotes1. The amended return is dated January 11, 1984, and stamped "received" by the Internal Revenue Service Center in Austin, TX., February 6, 1984. ↩2. Of this amount, $ 700 is drawn on checks indicating Today's Child as the source. Because of our holding, we need not decide whether this amount is deductible by petitioners. ↩3. Unless otherwise indicated all section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue, and 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/4619434/	Guy A. Van Heusden, Transferee, Petitioner, v. Commissioner of Internal Revenue, Respondent; Estate of E. J. Van Heusden, Deceased, Transferee, Melanie Van Heusden, Executrix, and Title Insurance and Trust Company, as Special Administrator, and Applicant for Letters of General Administration as Successor Executor to Melanie Van Heusden, Executrix, Petitioner, v. Commissioner of Internal Revenue, RespondentVan Heusden v. CommissionerDocket Nos. 2358-63, 2357-63United States Tax Court44 T.C. 491; 1965 U.S. Tax Ct. LEXIS 65; June 28, 1965, Filed 65 Decisions will be entered for the respondent. Petitioners held an option to purchase a tract of real property. In anticipation of the resale of the tract they formed a corporation to which they assigned the option. The corporation then consummated the purchase and resale, following which the assets of the corporation were distributed in complete liquidation to petitioners. Held, the nonrecognition treatment of section 337, I.R.C. 1954, is not available to petitioners because the corporation was collapsible, sec. 341, I.R.C. 1954. Sec. 337(c) (1) (A). Samuel J. Foosaner, for the petitioners.John J. Hopkins and Julius M. Jacobs, for the respondent. Train, Judge. TRAIN491 Respondent has asserted that petitioners are liable as transferees of West Cocoa Acres, Inc., for a deficiency in the latter's 1958 income taxes in the amount of $ 65,668.01. Since petitioners have conceded that they are liable as transferees for any deficiency, the issue for our decision is whether there is any underlying deficiency. This depends upon whether or not West Cocoa Acres, Inc., was a collapsible corporation within the definition of section 341 of the 1954 Code 1 so as to render inapplicable the 66 nonrecognition provisions of section 337.492 FINDINGS OF FACTSome of the facts have been stipulated and are incorporated herein by this reference.Guy A. Van Heusden (sometimes hereinafter referred to as petitioner) is a resident of Melbourne, Fla. E. J. Van Heusden, petitioner's father, died a resident of Altadena, Calif., on February 17, 1961. Title Insurance & Trust Co. of California is the duly appointed executor of his estate. Petitioner and his father will sometimes hereinafter be referred to as petitioners.On October 11, 1957, West Cocoa Acres, Inc. (sometimes hereinafter referred to as the corporation), was organized in Brevard County, Fla.; its certificate of incorporation was filed with the secretary of state of Florida on October 17, 1957. Petitioners were the sole owners of the stock of the corporation.On March 12, 1959, the corporation filed with the district director of internal revenue at Jacksonville, Fla., its Federal income tax return for 1958 showing no taxable income. Schedule D of the return disclosed the acquisition by the corporation of 760 acres of land on October 67 11, 1957, at a cost of $ 231,773.09, sale thereof on May 16, 1958, for $ 418,000, and sales expenses with respect thereto of $ 56,208.43. A long-term capital gain of $ 130,018.48 was claimed to be nontaxable, the claim being accompanied by the following explanation:Corporation has been liquidated pursuant to Section 337 of the 1954 Internal Revenue Code. All assets, inclusive of proceeds of sale, have been distributed to shareholders in exchange for their stock. Transaction is reflected for informational purposes only since gain is chargeable to stockholders and not to the corporation.Petitioner, an engineer employed by North American Aviation Co. (hereinafter sometimes referred to as Aviation), first took up residence in Brevard County, Fla., in 1952 when he was transferred by Aviation from its California office to its office at Patrick Air Force Base in Brevard County, Fla. The transfer was in connection with the establishment at Cape Canaveral (now known as Cape Kennedy) of testing facilities to flight-test the missiles which Aviation was building for the Government under the Navajo program.Due to the rapid advance in missile technology, the Navajo program became obsolete and 68 the Government canceled it in July 1957. Aviation began reducing its Florida staff and finally recalled the remaining employees to California. Petitioner left the employ of Aviation at the end of August 1957 but chose to stay in Brevard County, Fla., to participate in the area's economic growth attributable in large part to space activities at Cape Canaveral.493 For several years before he left Aviation, petitioner had entered into several real estate transactions, as shown in the following table:Cost ofProperty involvedDate acquiredentireDate soldpropertyVacant lotMay 1955$ 1,000.00June1956 1/3 interest in 540 acresJuly 1, 1955176,160.05Feb.1, 1956 410 acresOct. 195693,304.16Dec.1956 Vacant landMar. 5, 195731,075.75Sept. 10, 1957169 1/2 interest in 180 acres Oct. 12, 195666,100.00May17, 1957 1 6/7 interest in 80 acres Nov. 12, 195626,000.00May17, 1957 Land deposit1,000.00Dec.9, 1957 Sale pricePetitioner'sProperty involvedof entireshare ofpropertyprofit (loss)Vacant lot$ 1,000.00($ 171.62)1/3 interest in 540 acres422,280.0064,428.68 410 acres143,500.0049,211.69 Vacant land45,000.009,261.60 1 1/2 interest in 180 acres 102,158.6525,620.49 1 6/7 interest in 80 acres 45,403.8514,764.66 Land depositNone(1,000.00)Petitioner's biggest real estate venture during this 1955-58 period occurred soon after he left Aviation in 1957, when he contracted to purchase a 760-acre tract (sometimes hereinafter referred to as the El Pico tract) for $ 215,000. He then assigned the contract to the corporation. The corporation consummated the purchase of the land and then sold it in 1958 for $ 418,000. The instant case centers around this transaction, the details of which are more fully set forth in subsequent findings of fact.At the time he left Aviation in August 1957, petitioner, together with his former supervisor and two former fellow employees, planned to develop a shopping center; but nothing came of it because of the complexity of the undertaking. Sometime later, at the end of 1957 or early in 1958, the four formed and operated the Continental Development Corp., which designed and built homes on single lots in established communities, and sold them to homebuyers. Prior to this venture, petitioner's first income-producing activity after leaving Aviation was with Atlantic Construction 70 Co. which he and another person organized, and owned equally. They engaged in the general contracting business -- submitting bids for the erection of homes and, in some instances, for the erection of stores on land owned by others.Petitioner first became interested in the 760-acre El Pico tract some months before he left Aviation when he read in the newspapers that a 20,700-acre tract owned by Hotchkiss and Kislak was being subdivided into smaller units. This 20,700-acre parcel was located almost in the center of Brevard County, and the El Pico tract was situated in the most desirable part of that parcel.Petitioner conducted his negotiations with Hotchkiss and Kislak through John J. Kabboord (sometimes hereinafter referred to as Kabboord), a local real estate broker whom he knew for many years and with whom he had previous real estate transactions. The negotiations culminated in two contracts between petitioner and El 494 Pico Investment Corp. (a Hotchkiss and Kislak company) for the purchase by petitioner of the El Pico tract, consisting of two contiguous parcels of 280 acres and 480 acres. The two contracts are sometimes hereinafter referred to as the El Pico contract.The El Pico 71 contract was signed September 3, 1957, a few days after petitioner left Aviation. It provided for a purchase price of $ 215,000, payable $ 30,000 in cash on signing of contract, and by delivery of a $ 185,000 promissory note, secured by a purchase money mortgage, which was to be paid in installments. Supplemental agreements with regard to the El Pico contract were executed on October 26, 1957, but they did not change the substance of the transaction.Although the custom and usage in Brevard County required the seller to pay a 10-percent brokerage commission, the El Pico contract provided that "The parties agree that Ocean Realty, Inc. * * was the real estate broker who negotiated this agreement; and the Buyer agrees to pay said broker the real estate broker's commission due said broker in accordance with agreement this day made by Buyer with said broker." The seller 72 insisted on this provision and was willing to make a compensating adjustment in the purchase price; and petitioner was willing to accept it, provided it resulted in no overall increase in price and required no greater outlay in cash than he originally intended. The final contract provisions took these factors into consideration.Kabboord carried on his brokerage business as Ocean Realty, Inc. The brokerage commission agreement between him and petitioner, referred to in the El Pico contract, was an oral one, the substance of which was that Kabboord was to receive $ 10,750 (5 percent of the purchase price) out of the proceeds from the resale of any portion or subdivision of the El Pico tract, plus an additional 5 percent of any profits realized on such sales or minus 5 percent of any losses sustained on such sales. The precise method of securing the payments of this commission arrangement was left for later determination.About 3 weeks after the El Pico contract was signed, a salesman for Ocean Realty, Inc., entered into negotiations (with petitioner's knowledge and approval) for the sale of the El Pico tract. By the end of September or the beginning of October 1957, the negotiations 73 had reached a satisfactory stage and petitioner consulted with his real estate counsel, Edward L. Trader of Melbourne, Fla. (sometimes hereinafter referred to as Trader), and with his New Jersey tax counsel with respect thereto.As a result of these consultations, petitioner had Trader organize the corporation, with nominee incorporators and officers (consisting of Trader, his secretary, and Kabboord), to which he assigned the El Pico contract. The organization of the corporation and the assignment both took place on October 11, 1957.495 That same day the corporation, by Trader, its president, entered into two contracts for the sale of the El Pico tract to Ann L. Krohne, who was the nominee of a Palm Beach, Fla., purchasing syndicate, for $ 418,000. Ocean Realty, Inc., was named the broker in the transaction and was to receive a commission of $ 41,800 (10 percent of the purchase price) from the corporation, as seller. The closing date was set for some time between May 1 and May 15, 1958.On November 1, 1957, petitioner held a conference at Trader's office in Melbourne, Fla., with his tax attorney and Trader concerning the formation of the corporation, the implementation of the brokerage 74 commission agreement on the El Pico transaction, and the consummation of the El Pico and Krohne contracts.Petitioner's tax attorney drafted a memorandum of the conference which he sent to his law partner in New Jersey together with a letter reflecting the decisions reached. The letter stated in part:All of the foregoing is to be done by us in contemplating [sic] of keeping consistent record with a view to a subsequent plan of liquidation, and the liquidation of the corporation to be along the lines which we discussed with Van on his recent trip to Newark. * * Petitioner's trip to Newark, referred to in this letter, took place prior to the purchase of the El Pico tract.The November 1, 1957, meeting was recorded as a special meeting of the corporation's board of directors. The minutes thereof contained a discussion of the desirability of taking the assignment of the El Pico contract, a resolution to accept the assignment of that contract, a discussion of the details of the brokerage commission on the El Pico transaction, a resolution to assume petitioner's obligation to pay that brokerage commission, and a resolution ratifying and approving the Krohne contracts and the authority of 75 Trader to execute the Krohne contracts as president of the corporation.On November 15, 1957, the board of directors passed a resolution approving the corporation's purchase of the El Pico tract and authorizing the president and secretary to execute the purchase money mortgage and to do all other acts necessary to consummate the El Pico transaction.On May 2, 1958, the board of directors passed a resolution adopting a plan for the liquidation of the corporation and for the distribution to its stockholders of all its assets, including the proceeds from the sale of the El Pico tract under the Krohne contract, after paying its "remaining liabilities and expenses incidental to such sale." The same day the plan of liquidation was ratified and approved by the stockholders of the corporation.The closing of the Krohne agreement of October 11, 1957, took place on May 16, 1958. The Krohne promissory note and purchase money mortgage, received at the closing, were placed in escrow with a 496 bank with instructions to apply the proceeds towards the payment of the commissions still due Kabboord and, after paying out such other corporate obligations as petitioner might direct, to turn over the balance 76 to petitioners by depositing equal amounts thereof to their respectively designated bank accounts.Between the dates of its organization in October 1957 and its liquidation in December 1958, the corporation opened its own bank account into which its receipts were deposited and from which its various disbursements were made. When the corporation was liquidated it paid the remaining balance therein to petitioners and closed out the bank account.By the end of December 1958, the corporation was completely liquidated and all of its remaining assets were distributed equally to the two petitioners.On March 8, 1963, respondent mailed to petitioners notices of liability for $ 65,668.01, plus interest as provided by law, as transferees of the corporation. The notices were based upon respondent's determination that the corporation had realized taxable ordinary income from the sale of its 760 acres in 1958, which produced a deficiency of $ 65,668.01 in income taxes due from the corporation for that year.No part of the $ 65,668.01 has been paid by or on behalf of the corporation and there are no corporate funds or assets with which to pay said $ 65,668.01.West Cocoa Acres, Inc., was a collapsible 77 corporation within the definition of section 341(b).OPINIONThe issue for decision is whether the corporation organized by petitioners was a collapsible corporation as defined in section 341(b). If the answer is in the affirmative, as respondent contends, the corporation is taxable on the gain from its sale of the El Pico tract, and petitioners are liable as its transferees. If it is found not to have been collapsible, respondent concedes that the corporation will recognize no gain because of section 337, and petitioners will prevail.The facts necessary to our decision are not complex. Petitioner had become interested in the growth of Brevard County, Fla., where he had been engaged in some prior real estate transactions. He acquired the El Pico tract on September 3, 1957, shortly after he left his employment with Aviation. The purchase price was $ 215,000. A short time later the broker through whom petitioner had purchased the property advised petitioner that he had been contacted by a prospective purchaser. On October 11, 1957, after negotiations by the broker in petitioner's behalf had reached a satisfactory stage, petitioners, on the advice of counsel, caused the corporation 78 to be formed and assigned the contract of purchase to it. On the same date 497 the corporation entered into contracts for sale of the property for $ 418,000, the closing date to be in May 1958. The board of directors of the corporation adopted a plan of complete liquidation on May 2, 1958, the closing was held on May 16, 1958, and the corporation was in fact liquidated in December 1958, its assets being distributed equally to the petitioners.The issue as drawn by the parties is the collapsibility of the corporation. If it is collapsible, the corporation is denied the nonrecognition privilege of section 337 because of section 337(c)(1)(A). 279 We agree with respondent that the corporation was collapsible. The parties are in agreement that the relevant statutory provisions are the portions of section 341(b) which define collapsible corporations and section 341 assets as follows:SEC. 341. COLLAPSIBLE CORPORATIONS.(b) Definitions. -- (1) Collapsible corporation. -- * * * the term "collapsible corporation" means a corporation formed or availed of principally * * * for the purchase of property which (in the hands of the corporation) is property described in paragraph (3), * * * with a view to -- (A) * * * a distribution to its shareholders, before the realization by the corporation * * * purchasing the property of a substantial part of the taxable income to be derived from such property, and(B) the realization by such shareholders of gain attributable to such property.* * * (3) Section 341 assets. -- For purposes of this section, the term "section 341 assets" means property held for a period of less than 3 80 years which is -- (A) stock in trade of the corporation, or other property of a kind which would properly be included in the inventory of the corporation if on hand at the close of the taxable year;(B) property held by the corporation primarily for sale to customers in the ordinary course of its trade or business;They further agree that three conditions must be met here to satisfy the definition of a collapsible corporation. It must be (1) formed or availed of principally for the purchase of property (2) which is 498 held by the corporation primarily for sale to customers in the ordinary course of its trade or business (3) with a view to a distribution to its shareholders before the realization by the corporation of a substantial part of the taxable income to be derived from the property.It is clear that the corporation was formed or availed of principally to purchase the El Pico tract. Whatever the motive of petitioners in forming the corporation to conceal their identity, the purpose which was served by its formation was the purchase and resale of the El Pico tract. Section 341(b) is directed toward the function performed by the corporation, not the underlying motives of the taxpayer 81 in causing its creation. Cf. Braunstein v. Commissioner, 374 U.S. 65">374 U.S. 65 (1963).The second requisite of collapsibility is that the El Pico tract be a section 341 asset, as defined in section 341(b)(3), supra . Petitioner contends that the El Pico tract was neither inventory nor property held primarily for sale to customers in the ordinary course of the corporation's trade or business. Relying in part on Maxwell Temkin, 35 T.C. 906 (1961), and Jacobson v. Commissioner, 281 F. 2d 703 (C.A. 3, 1960), reversing 32 T.C. 893">32 T.C. 893 (1959), they contend that their intention was to hold the El Pico tract as an investment rather than for sale. The above-cited cases are inapposite, and as a factual determination, we find against petitioners on this point. The cases both deal with the presence of the view to collapsibility and conclude that the corporations were not availed of with such a view because the sales were made because of unforseen circumstances.The proper inquiry is to the purpose for which the El Pico tract was held at the time of sale by the corporation. This question is most often litigated under section 1221(1), which has spawned "a basketfull of cases." Recordak Corporation v. United States, 325 F. 2d 460, 461 (Ct. Cl. 1963). 82 Various criteria have been judicially developed to determine whether property is held primarily for sale to customers in the ordinary course of business, but as one court has stated, "each case must in the end stand on its own bottom and must be decided on its own peculiar facts." Murray v. Commissioner, 238 F. 2d 137, 138 (C.A. 10, 1956). Without reciting the various criteria (see, e.g., D. L. Phillips, 24 T.C. 435 (1955); Maudlin v. Commissioner, 195 F. 2d 714 (C.A. 10, 1952); Pool v. Commissioner, 251 F. 2d 233 (C.A. 9, 1957)), we conclude that the corporation was not holding the property primarily as an investment. On the facts presented, this conclusion appears inescapable. Petitioner's transfer of the El Pico tract to the corporation at a time when negotiations for a resale had proceeded almost to the point of fruition makes it clear that the corporation's basic function was to consummate a sale. Cf. Morris Cohen, 39 T.C. 886 (1963). Whatever petitioner's original purpose may 499 have been in acquiring the property, 3 its character in the hands of the corporation can hardly be described as an investment. Since the corporation's only trade or business was to deal with this 83 property, the El Pico tract was a "section 341 asset" within the meaning of section 341(b)(3)(B).The remaining requisite of collapsibility is the proscribed "view," which consists of three facets: (a) a view to a distribution, (b) before realization of a substantial part of the taxable income to be derived from the property, and (c) the realization by petitioners of gain attributable to the property.Any doubt that petitioners contemplated a distribution at the time they formed the corporation is dispelled by their attorney's letter to his law partner advising that the corporate records should be prepared "with a view to a subsequent plan of liquidation," to take place about the time of the sale to 84 the Krohne interests. Petitioner's own testimony that the corporation was to have only a temporary existence corroborates the existence of a view to a distribution. Max N. Tobias, 40 T.C. 84">40 T.C. 84, 99 (1963). Cf. Southwest Properties, Inc., 38 T.C. 97">38 T.C. 97 (1962).This distribution was to occur before the realization of a substantial part of the taxable income to be derived from the sale of the El Pico tract. Although the corporation technically received the proceeds of the sale before the distribution to petitioners, section 1.337-1 485 of the Income Tax Regulations provides, in part, that the nonrecognition treatment of section 337 does not apply if the shareholders would have been taxable under section 341 had the distribution been made before the sale. The validity of this regulation has been sustained by us in Sproul Realty Co., 38 T.C. 844 (1962). Without such an interpretation, the section 337(c) exception for collapsible corporations would be rendered meaningless. Sproul Realty Co., supra at 857 fn. 5. Since there was a distribution to petitioners of the proceeds and they realized gain thereon, the three conditions of the "view" are satisfied.500 We reject petitioners' contention that no view was present because the corporation "merely became the assignee of a completed package" and thus did not make any "purchase" of the property. Section 341(b)(2)(B)586 deems a purchase to have been made where, as here, the corporation holds property having a basis determined with reference to the cost basis in the hands of one who made the purchase.There remains one further contention by petitioners which merits a brief discussion. On reply brief petitioners contend that --all that was to be done actually had been done before the formation of the corporation itself. The corporation did not engage in any affirmative acts stemming from its own initiative. The steps which it took were merely perfunctory and pursuant to commitments which had been previously made.The corporation itself did not enter into the contract to purchase the real estate here in issue. This purchase agreement had already been executed and the corporation merely took an assignment of it.Because of this, petitioners would in effect have us view the sale as having been made by them rather than by the corporation. The Supreme Court has laid this type of contention to rest in National Carbide Corp. v. Commissioner, 336 U.S. 422 (1949), and Moline Properties v. Commissioner, 319 U.S. 436">319 U.S. 436 (1943), 87 by reaffirming the elementary principle that a corporation has an existence separate and distinct from its shareholders. The corporation in the instant case was created by petitioners to perform a business function. It was acting as a principal, not merely as an agent of petitioners, cf. National Carbide Corp., supra at 437, and was a viable entity. Even if it were merely a de facto corporation as petitioners contend, it is taxable as a corporation pursuant to section 7701(a) (3) and the regulations thereunder.Our decision that the El Pico tract was a "section 341 asset" is dispositive of the issue of whether the gain realized by the corporation is taxable as ordinary income or as capital gain. Cf. Sproul Realty Co., supra.Transferee liability having been conceded by petitioners,Decisions will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated.↩1. The remaining interests in these parcels were owned by petitioner's father. The parcels were assembled and sold together.2. SEC. 337. GAIN OR LOSS ON SALES OR EXCHANGES IN CONNECTION WITH CERTAIN LIQUIDATIONS.(a) General Rule. -- If -- (1) a corporation adopts a plan of complete liquidation on or after June 22, 1954, and(2) within the 12-month period beginning on the date of the adoption of such plan, all of the assets of the corporation are distributed in complete liquidation, less assets retained to meet claims,then no gain or loss shall be recognized to such corporation from the sale or exchange by it of property within such 12-month period.* * * (c) Limitations. -- (1) Collapsible corporations and liquidations to which section 333 applies. --This section shall not apply to any sale or exchange -- (A) made by a collapsible corporation (as defined in section 341(b)↩), * 3. Petitioners' contentions that they planned to hold the property for a subsequent appreciation in value, though immaterial to this issue, may, when coupled with Guy Van Heusden's prior real estate dealings, indicate a reason other than the concealment of petitioners' identity, for the creation of the corporation. However, since their motive for creating the corporation is immaterial, Braunstein v. Commissioner, 374 U.S. 65">374 U.S. 65↩ (1963), we need not resolve this question in reaching our decision.4. Sec. 1.337-1 General. * * sales or exchanges made by a collapsible corporation (as defined in section 341(b)) are excluded from the operation of section 337 by section 337(c). Accordingly, except as provided in section 341(e)(4), section 337 does not apply to any sale or exchange of property whenever the distribution of such property in partial or complete liquidation to the shareholders in lieu of such sale or exchange would have resulted in the taxation of the gain from such distribution in the manner provided in section 341(a) as to any shareholder or would have resulted in the taxation of the gain in such manner, but for the application of section 341(d)↩. * * 5. SEC. 341. COLLAPSIBLE CORPORATIONS.(b) Definitions. -- * * * (2) Production or purchase of property. -- For purposes of paragraph (1), a corporation shall be deemed to have manufactured, constructed, produced, or purchased property, if --* * * * (B) it holds property having a basis determined, in whole or in part, by reference to the cost of such property in the hands of a person who manufactured, constructed, produced, or purchased the property, * * *↩	01-04-2023	11-21-2020

Subsets and Splits

No community queries yet

The top public SQL queries from the community will appear here once available.