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https://www.courtlistener.com/api/rest/v3/opinions/4619437/ | Alex Frieder, Petitioner, v. Commissioner of Internal Revenue, RespondentFrieder v. CommissionerDocket No. 63800United States Tax Court28 T.C. 1256; 1957 U.S. Tax Ct. LEXIS 83; September 27, 1957, Filed *83 Decision will be entered for the petitioner. Gift Tax -- Splitting Gifts by "Spouses" -- Timeliness of Signifying Consent -- Sec. 1000 (f) (1) (A) and (2) (B) (i), I. R. C. 1939. -- Consent of a wife to be considered as making one-half of gifts of her husband was timely signified on his return reporting those gifts despite fact that previously her son by a prior marriage had filed for her a return reporting gifts which she had made in the same year but prior to her marriage to the petitioner. Harris K. Weston, Esq., for the petitioner.Conley G. Wilkerson, Esq., for the respondent. Murdock, Judge. MURDOCK *1256 OPINION.The Commissioner determined a deficiency of $ 1,278.03 in the petitioner's gift tax for 1953. The only issue is whether the petitioner's wife can be regarded as having made one-half of the gifts in*84 question. The facts have been submitted by a stipulation which is adopted as the findings of fact.Section 1000 (f) (1) (A) of the Internal Revenue Code of 1939 provides that a gift made by a husband or by a wife to a third party may be considered as made one-half by each spouse under certain circumstances. It also provides that "an individual shall be considered as the spouse of another individual only if he is married to such individual at the time of the gift and does not remarry during the remainder of the calendar year." Subparagraph (1) (B) provides that "[subparagraph] (A) shall be applicable only if both spouses have signified * * * their consent to the application of subparagraph (A) in the case of all such gifts made during the calendar year by either while married to the other." Section 1000 (f) (2) (B) (i) is as follows:(B) Time. -- Such consent may be so signified at any time after the close of the calendar year in which the gift was made, subject to the following limitations -- (i) the consent may not be signified after the 15th day of March following the close of such year, unless before such 15th day no return has been filed for such year by either spouse, in*85 which case the consent may not be signified after a return for such year is filed by either spouse;The petitioner married Helen G. Salinger, a widow, on June 18, 1953. The petitioner made present gifts to each of his three adult children on or about December 2, 1953. The largest gift was $ 5,700 and their total amount was $ 16,167.13.The petitioner and Helen were absent from the United States from December 6, 1953, until May 10, 1954.*1257 The petitioner and Helen each executed a gift tax return on May 28, 1954, and filed it on June 2, 1954, showing the above-mentioned gifts and showing on each that the other spouse consented to have the petitioner's gifts considered as having been made one-half by himself and one-half by Helen, his wife. Each signed the consent of spouse on the other's return. Each return was accompanied by an affidavit stating that the taxpayer was continuously absent from the United States from December 6, 1953, until May 10, 1954, and for that reason was unable to file a gift tax return at an earlier date. The excuse for the late filing was apparently satisfactory. The stipulated facts do not show whether or not gifts made by Helen before her marriage*86 were shown on her return.The Commissioner does not argue that the gifts in question should not be regarded as having been made one-half by each spouse on the facts thus far stated. There would be no tax due on the petitioner's gifts in such case, since they were present gifts each in an amount less than the annual exclusion. The Commissioner's only contention is that Helen could not properly consent after March 15, 1954, under the law and the regulations because she had filed a gift tax return on that earlier date. Helen made substantial gifts in trust for her two adult children early in June 1953, prior to her marriage to the petitioner. Her son, as her attorney in fact, filed on her behalf on March 15, 1954, a gift tax return reporting the gifts which she had made in the previous June, showing gift tax liability in the amount of $ 26,537.80. The son corrected an error in that return by an amendment filed on May 7, 1954, and reported the resulting additional liability of $ 450. He explained on each form that the taxpayer was absent from the United States. The parts of those forms relating to consent by a spouse were all left blank. Helen, then the petitioner's wife, filed*87 an affidavit on June 4, 1954, dated June 2, 1954, stating the time during which she was absent from the United States; that her son, as attorney in fact, had filed gift tax returns on her behalf; and that they were correct, with an exception not here material. All of the returns herein were filed with the district director of internal revenue at Cincinnati, Ohio.Section 86.20 of Regulations 108 provides that a return may be filed by an agent if the taxpayer is unable to file the return within the time prescribed because of absence, but in such case the return filed by the agent must be ratified by the taxpayer within a reasonable time after being able to do so, "otherwise the return filed by the agent will not be considered the return required by the statute." The ratification must be in the form of an affidavit filed with the Commissioner. Helen filed such a ratification on June 4, which was after she had properly signified her consent to split her husband's gifts. Thus the documents filed by the son earlier in the year did not form *1258 a complete return as required by the law and regulations until June 4, 1954. The Commissioner states in his reply brief that "the result*88 for which petitioner now contends * * * could have been accomplished by filing with her ratification, the consent of Mrs. Frieder to treat the petitioner's gifts as made one-half by her." His theory is, apparently, that both would relate back to March 15, 1954. The necessity for such action is not apparent when, as here, she had previously signified her consent to the splitting of her husband's gifts. A consent which was not effectively signified until after the 15th of March following the close of the calendar year to which it applies may not be revoked. Sec. 1000 (f) (3) (B). All of the filings of forms by or for Helen in 1954 combine to form her gift tax return for 1953.The Commissioner's position herein is not supported by either the words or the spirit and intention of section 1000 (f). Section 1000 (f) (2) (B) was intentionally made more liberal than the original provisions of section 374 (f) (2) of H. R. 4790, 80th Cong., 2d Sess. Helen was not the wife of the petitioner at the time she made the gifts to her children. Neither party suggests that those gifts are in any way within the provisions of section 1000 (f), and it is obvious that they were not. The definition*89 of "spouse" for all purposes of section 1000 (f) is based on marriage at the time of the gifts and does not depend on whether or not they were married at the time of filing returns or signifying consent. The gift tax returns for Helen, filed by her son in her absence, related to gifts made by her as an unmarried woman, when she was not a "spouse" within the definition of section 1000 (f). Those forms were not "spouse" returns referred to in section 1000 (f) (2) (B) (i). The language of that provision is rather complicated, perhaps unnecessarily so. It provides, in a case like this one, that a consent may be signified at any time up to and including the filing of the first spouse return for the year of the gifts. It does not refer to a return of a grantor solely for gifts made when such grantor was unmarried. Its purpose appears to have been to preclude, for administrative convenience, more than one opportunity after March 15 of the succeeding year for a spouse, as grantor, to claim a consent of his mate, or as nongrantor, to grant a consent to be a co-grantor.Section 86.3a (b) of Regulations 108 provides that consent must be signified by both spouses; that may be done on a *90 single return; "[however], wherever possible notice of the consent is to be shown on both returns" if each spouse files a return for the year. It is not claimed that it would have been possible for Helen's son to have granted or withheld her consent as a spouse in regard to gifts made by her new husband when he acted on her behalf on March 15, 1954. It was not until the petitioner made out his gift tax return for 1953 that the question of the signification of consent by Helen became *1259 important and meaningful. Only then could the required mutual consent be signified on a return reporting the gifts involved. Helen and the petitioner then complied fully with the requirements of section 1000 (f) and the petitioner should not be deprived of the benefits of that section because prior to that time Helen's son had filed a gift tax return for her with respect to gifts made before she became a spouse within the meaning of section 1000 (f).The first spouse return to be filed, within the meaning of section 1000 (f), was the one reporting the gifts of the petitioner to his three children, the only gifts made by a spouse as defined in that section. The Commissioner knew that consent*91 had to be signified in that return or the entire gifts would be taxable to the petitioner. The earlier documents filed in Helen's name by her son did not relate to gifts by a spouse and could not have misled the Commissioner or complicated the administration of the gift tax laws.Decision will be entered for the petitioner. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619438/ | GERALD W. JORDAN AND GAY JORDAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentJordan v. CommissionerDocket No. 33170-87United States Tax CourtT.C. Memo 1991-50; 1991 Tax Ct. Memo LEXIS 67; 61 T.C.M. (CCH) 1804; T.C.M. (RIA) 91050; February 7, 1991, Filed *67 Decision will be entered under Rule 155. W. Curtis Elliott, Jr. and William R. Culp, Jr., for the petitioners. Andrew J. Dempsey, for the respondent. SWIFT, Judge. SWIFTMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies in petitioners' Federal income tax as follows: YearDeficiency1982$ 7,385.2619836,797.37Petitioners operated a distributorship for the Amway Corporation (Amway) that generated substantial gross income in 1982 and 1983. Respondent concedes that petitioners' Amway distributorship constituted a trade or business operated for profit, and respondent for 1982 and 1983 has allowed petitioners substantial business expense deductions relating to their Amway distributorship. 1 At issue are certain further business expense deductions relating to petitioners' Amway distributorship that were claimed by petitioners on their Federal income tax returns but denied by respondent on the ground that the business purpose for the expenses has not been adequately established.*68 FINDINGS OF FACT Certain facts have been stipulated and are so found. Petitioners are married and filed joint Federal income tax returns for 1982 and 1983. Petitioners resided in Kingsport, Tennessee, at the time their petition was filed. Since September of 1971, petitioners have been Amway distributors. Amway is a privately owned company that sells household and personal products through a network of independent distributors. Many Amway distributors, including petitioners, work in husband-wife teams and conduct their Amway activities on a part-time basis, in addition to having full-time jobs. In theory, Amway distributors generate receipts by selling products out of their homes directly to customers, and by recruiting new distributors who become down-line distributors of the sponsoring distributor and a part of his or her sales organization. Each down-line distributor, in turn, can sponsor additional new distributors, all of whom become a part of the initial distributor's Amway organization, which organization can grow to unlimited width and depth. Amway does not assign exclusive geographical territories to any distributors. In accordance with a complex formula, a distributor*69 receives bonuses and commissions from Amway based on the sales volume of his or her entire sales organization, including direct sales to customers and the sales made by down-line distributors. The distributor is also responsible for paying performance bonuses to down-line distributors. Initially, new distributors purchase all Amway products from their immediate up-line sponsor. Once, however, a distributor's sales organization reaches a certain level of monthly sales volume, the distributor becomes a "direct distributor" and purchases products directly from Amway. Obviously, it is in the best interest of each distributor to have down-line distributors who successfully sell products and who recruit productive additional down-line distributors. There are several levels of direct distributors, based on progressively higher levels of monthly sales volume. In ascending order, the levels of direct distributors are Ruby, Pearl, Emerald, Diamond, Double Diamond, Triple Diamond, Crown, and Crown Ambassador. As explained, respondent has stipulated that petitioners' Amway distributorship constituted a trade or business during 1982 and 1983. Petitioners were Pearl level direct distributors, *70 and their organization consisted of over 400 down-line distributors that went as far as 12 levels deep. For a number of years, petitioners' receipts from their Amway distributorship had been substantial, and in 1982 and 1983 the gross income was $ 42,882 and $ 41,613, respectively. During 1982 and 1983, petitioner Gay Jordan spent approximately 40 to 60 hours per week working on matters pertaining to the Amway distributorship. Her primary responsibilities included general office work (for example, correspondence, telephone calls, scheduling appointments, and making bank deposits), bookkeeping, managing and training downline distributors, ordering, processing and delivering products, and recruiting new down-line distributors. Petitioners have one child, Stacey, who was born on October 28, 1968. During 1982 and 1983, petitioner Gerald Jordan was a fulltime employee of Tennessee Eastman Company (Tennessee Eastman). He also worked an average of 20 to 25 hours per week on matters pertaining to his and his wife's Amway distributorship. Gerald Jordan frequently spent weekday lunch hours meeting with current and prospective down-line distributors. Gay Jordan occasionally joined her*71 husband at these luncheon meetings. Petitioners spent many evenings and weekends on Amway activities, making presentations to potential new distributors, following up with down-line distributors, training and motivating current down-line distributors, consulting with their up-line distributors, and attending Amway meetings, conferences, and conventions. Frequently, following evening Amway presentations, Gerald Jordan would adjourn to a local coffee shop or restaurant to continue discussing the Amway business and products with a small group of potential down-line distributors. Gerald usually paid the relatively modest bill for coffee and light refreshments at these discussions. Documentation of Gerald Jordan's expenses relating to his luncheon and evening meetings in connection with the Amway distributorship consists primarily of a combination of receipts (some of which bear notations of the names of individuals in attendance at the meetings) and an appointment book with names written in next to "lunch" or "dinner." Occasionally, petitioners' Amway activities involved out-of-town overnight travel to meetings and conventions sponsored by the national or regional Amway organization. *72 Petitioners used their personal automobile to travel to these meetings and conventions, except for one trip on which they flew. The schedule set forth below reflects petitioners' overnight travel in 1982 and 1983 relating to these Amway sponsored meetings and conventions. Most of the trips appear to have been taken by both petitioners or by Gerald alone. Receipts for trips numbered 1 and 7 in 1983 indicate that three individuals stayed in the hotel room, and presumably petitioners' daughter Stacey accompanied her parents on those trips. Nights AwayLocationfrom HomeMileage19821.Cincinnati, OH& Richmond, IN 2894 2.Atlanta, GA* 2669 3.Charlotte, NC* 2580 4.Kansas City, MOair & Indianapolis, IN 3travel5.VA Beach, VA* 71,012 6.Gatlinburg, TN2116 7.Charlotte, NC2427 8.Washington, DC3807 9.W. Palm Beach, FL42027 19831.Knoxville, TN3266 2.Lynchburg, VA1413 3.Knoxville, TN2235 4.Charlotte, NC3507 5.Charlotte, NC2399 6.Pigeon Forge, TN1224 7.Knoxville, TN4219 8.Pile Island, GA3620 9.Charlotte, NC3450 10.Nashville, TN2601 11.Fairfield Glade, IN1406 12.Charlotte, NC2557 *73 The meetings and conventions petitioners attended while on the above overnight trips were similar in nature. Motivational talks were given by the most successful (usually Diamond level or above) Amway distributors. The presentations included some training lectures and the introduction of new products. Mrs. Jordan took detailed notes relating to presentations made at the meetings and conventions. Typically, the meetings and conventions began on Friday evening at 7:00 or 8:00 p.m., adjourned at 1:00 or 2:00 a.m., started again Saturday morning at 9:30 a.m., continued throughout the day, with several hours off during the afternoon, and adjourned again late Saturday evening or early Sunday morning. Sunday there would often be optional worship services offered in the morning and small group meetings for several hours in the afternoon. Most of the meetings and conventions*74 were attended by several thousand people, and petitioners often attended with a significant contingent of down-line distributors from their organization. The Amway annual voting members convention, which petitioners attended in June of 1982 and 1983, included the election of the board of directors of the Amway distributors' association and a demonstration of new Amway products to be introduced for the fiscal years beginning each September 1. Only Amway distributors who had reached the level of direct distributor or higher were eligible to vote at the annual conventions, and they had to be present to cast their votes. Approximately 10,000 people attended the Amway annual voting members conventions in 1982 and 1983. Occasionally petitioners participated in recreational activities during the conventions or weekend meetings. On October 13 through 17, 1982, at the Amway southeastern region distributors' meeting in West Palm Beach, Florida, Gerald Jordan played golf with several Diamond level direct distributors. Gerald regarded the golf game as an opportunity to discuss Amway business informally and to pick up pointers from highly successful Amway distributors. In June of 1982, *75 Gerald Jordan also participated in a fishing trip during the Hale reunion seminar in Virginia Beach, Virginia. With some regularity, petitioners were involved in recruiting and training new down-line distributors several levels below them (especially if the immediate sponsors were relatively new to Amway or geographically remote and unable to travel), and a number of petitioners' overnight trips related to such recruiting and training. At meetings held on those trips, petitioners presented the Amway sales marketing plan to potential new down-line distributors. The overnight trips petitioners took for recruiting and training are reflected in the schedule set forth below. Again, most trips appear to have been taken by petitioners together or by Gerald Jordan alone, except for trips in 1982 numbered 7, 9, and 11, on which Stacey apparently accompanied petitioners. Nights AwayLocationfrom HomeMileage19821.Canton, NC12622.Baltimore, MD17933.Baltimore, MD25984.Abbeyville, AL18075.Baltimore, MD213526.Chesapeake, VA210717.Sandusky, OH214948.Lafayette, IN27759.Baltimore, MD& Chesapeake, VA 290210.Chesapeake, VA289411.Chesapeake, VA390019831.Cincinnati, OH& Kokomo, IN 2-0-2.Cincinnati, OH& Kokomo, IN 211273.Cincinnati, OH& Kokomo, IN 113514.Winston-Salem, NC& Charlotte, NC 16265.Cincinnati, OH27016.Cincinnati, OH2600*76 At the beginning of 1982, petitioners owned five automobiles: a 1981 Cadillac; a 1979 Trans Am; a 1978 Firebird; a 1977 Cadillac; and a 1976 Chevrolet Blazer. Until sometime in February of 1982, Gerald Jordan used the 1976 Blazer as his primary vehicle for commuting to work at Tennessee Eastman. In February of 1982, Gerald traded the Blazer for a 1982 Jeep Eagle, which then became his primary commuting vehicle. In May of 1983, Gerald traded the Jeep Eagle for a 1983 Pontiac 6000, which he then used for commuting during the remainder of 1983. During 1982 and 1983, the 1979 Trans Am, the 1978 Firebird, and the 1977 Cadillac were used only for personal travel, and petitioners apparently claimed no business expenses with regard to the use of those automobiles. At the end of each week, Gerald Jordan estimated and recorded in a written log the mileage incurred on the 1981 Cadillac, the 1982 Jeep Eagle, and the 1983 Pontiac 6000. The odometer readings reflected in Gerald's log do not in all instances conform with odometer readings taken when the cars were purchased or repaired. Notations in the logs regarding the purpose of local trips were cryptic and often consisted of no more *77 than "lunch with" and a last name. Although, as explained, the Jeep Eagle and the Pontiac 6000 were used primarily for commuting, Gerald Jordan frequently conducted Amway business on his lunch hour or immediately after work, and therefore he also used those vehicles for Amway business purposes. The 1981 Cadillac was used primarily for Amway business. Respondent has conceded that the 1981 Cadillac, the Jeep Eagle, and the Pontiac 6000 were used for Amway business purposes, and the parties have stipulated that the only issue for decision regarding the vehicles is what percentage of the total use of the three vehicles related to petitioners' Amway distributorship. Respondent contends that the appropriate percentage of business use was significantly smaller than that claimed by petitioners. The following schedule reflects the percentage of business use claimed by petitioners and allowed by respondent. 198119821983 CadillacJeep EaglePontiac1982Claimed by petitioner100%56%-0- Allowed by respondent26%18%-0- 1983Claimed by petitioner100%40%71%Allowed by respondent26%19% 22%Petitioners' daughter, Stacey, who was 14 and 15 years*78 old during 1982 and 1983, assisted in petitioners' Amway distributorship an average of 10 to 20 hours per week. Stacey kept some records of her work in a notebook, and periodically she and Gerald discussed the amount and difficulty of the work she had completed and the pay she should receive. Stacey was not paid at a set hourly rate. Stacey's responsibilities included handling telephone calls, keeping records of orders, sorting and boxing products to be shipped, and cleaning the meeting and storage rooms containing Amway products. During 1982, Stacey was paid approximately once a month in amounts ranging from $ 25 to $ 465, for a total of $ 1,620. During 1983, Stacey was paid approximately twice a month in amounts ranging from $ 12 to $ 275, for a total of $ 2,940. 2During 1982 and 1983, petitioners sponsored several sales contests*79 and promotions for their down-line distributors. For example, in a cash-drawing bonus, each down-line distributor who made $ 100 in retail sales in a week was eligible to draw an envelope that contained a "mystery amount" of cash, generally ranging from $ 1 to $ 50. Promotional prizes were offered by petitioners to individuals who allowed down-line distributors to conduct Amway product demonstrations in their homes. Petitioners have submitted receipts showing expenditures of $ 3,415 in 1982 and $ 1,452 in 1983 relating to such prizes and awards. Petitioners also made various business gifts to Amway associates in 1982 and 1983. Petitioners received assistance from their up-line distributors and petitioners periodically made gifts to them. Receipts have been offered that substantiate expenditures of $ 545 in 1982 and $ 393 in 1983 relating to such gifts. Documentation for the gifts indicates the dates of purchase and usually reflects a notation such as "plaque to John Cameron, Centerbrook," "flowers to John Meade, Coeburn, Va.," "gift to Jim & Kathy Paullin, Atlanta, Ga.," "Toby's birthday," and "shower gift." Several people were given more than one gift per year; for example*80 in 1982, four gifts with a total value of $ 143 were given to Ron and Toby Hale. Included in petitioners' 1982 and 1983 Federal income tax returns were two Schedule C's, one relating to petitioners' Amway distributorship and one relating to petitioners' activities promoting Amway products and training Amway down-line distributors. For convenience, we have combined the two Schedule C's in each year. The following tables show, for each expense item on the Schedule C's, the amounts originally claimed as deductible by petitioners, the amounts allowed and disallowed by respondent (as reflected in respondent's notice of deficiency), and the amounts still at issue. 1982Allowed inNotice of Still ClaimedDeficiencyDisallowed at issueBad debts$ 23 $ 23 $ -0- $ -0- Bank servicecharges 4949-0--0-Car expense6,6181,4485,1703,997Commissions17,79617,796-0--0-Depreciation:Cadillac 3,4805642,9162,916Eagle 1,8435271,3161,316Home office 800800-0--0-Dues &publications 268268-0--0-Freight289289-0--0-Insurance909757152-0-3Local meals 804-0-804652Office supplies1,2861,286-0--0-Rent72069525-0-Repairs767599168-0-Supplies742742-0--0-Taxes306306-0--0-4Out-of-town-travel 4,4489503,4993,347Utilities & phone1,7261,726-0--0-Stacey's wages1,458-0-1,4581,458Standing ordercharges 960960-0--0-Handling charges26694172-0-Servicing fees367367-0--0-Prizes3,7611,5232,2382,238Gifts267-0-267267Demos & samples377377-0--0-Food & meetingsupplies 79477617-0-Seminars &training 426426-0--0-5TOTAL $ 51,549$ 33,346$ 18,202$ 16,191*81 1983Allowed inNotice of Still ClaimedDeficiencyDisallowed at issueAdvertising$ 218 $ 218 $ -0- $ -0- Bank servicecharges 6868-0--0-Car expense5,1681,3753,7933,586Commissions18,47118,653-0--0-Depletion204-0-204-0-Depreciation:Cadillac 3,4805642,9162,916Pontiac 2,5439641,5801,580Home office 800800-0--0-Heat pump -0-204-0--0-Dues &publications 131131-0--0-Freight670671-0--0-Insurance244244-0--0-Office expense543543-0--0-Repairs2,6786672,011-0-Supplies399399-0--0-Taxes395395-0--0-6 Out-of-town travel 3,124-0-3,1243,124Utilities & phone1,9221,922-0--0-Stacey's wages2,683-0-2,6832,683Servicing fee192192-0--0-Handling charges168168-0--0-Standing ordercharges 623623-0--0-7Local meals 2,1886281,5601,729Prizes-0--0--0-1,452Gifts757-0-757757Demos & samples7676-0--0-Room rental449449-0--0-Seminars &training 1,245-0-1,245-0-8TOTAL $ 49,439$ 29,952$ 19,873$ 17,827*82 The following table shows the gross income (apparently net of cost of goods sold), total expenses, and net income of petitioners with regard to their Amway distributorship as reported on their Federal income tax returns and as determined in respondent's notice of deficiency. Per Notice Per Returnof Deficiency1982Amway gross income$ 42,882 $ 42,882Amway total expenses51,549 33,346Amway net income (loss)$ (8,667)$ 9,5361983Amway gross income$ 41,613 $ 41,613Amway total expenses49,439 29,952Amway net income (loss)$ (7,826)$ 11,661Respondent has conceded the deductibility of expenses relating to some of the overnight trips petitioners took to Amway-sponsored meetings and*83 conventions. In addition, respondent conceded at trial that all of the amounts at issue with regard to out-of-town travel, entertainment, and local meals have been substantiated for purposes of section 274(d) 9, but respondent has reserved the question of whether such expenses qualify as ordinary and necessary expenses under section 162. OPINION As indicated in the above schedules, there are six categories of deductions remaining at issue: (1) Local meals -- $ 652 for 1982 and $ 1,729 for 1983; (2) out-of-town travel -- $ 3,347 for 1982 and $ 3,124 for 1983; (3) car expenses and depreciation -- $ 8,229 for 1982 and $ 8,082 for 1983; (4) amounts paid to petitioners' daughter Stacey -- $ 1,458 for 1982, $ 2,683 for 1983; (5) prizes -- $ 2,238 for 1982 and $ 1,452 for 1983; and (6) gifts -- $ 267 for 1982 and $ 757 for 1983. The primary issue for decision is whether these expenses satisfy*84 the ordinary and necessary requirements of section 162. With regard just to the gifts, we also must decide whether the substantiation requirements of section 274(d) have been satisfied. We reiterate that respondent has expressly conceded the for-profit issue under section 183 that typically is involved in Amway-related cases. Section 162 allows a deduction for all ordinary and necessary expenses of carrying on a trade or business. Generally, to be deductible under section 162, expenses must be directly connected with or pertaining to the taxpayer's trade or business. Sec. 1.162-1(a), Income Tax Regs.The term "ordinary" is used principally to distinguish currently deductible expenses from capital expenditures, which must be amortized over the useful life of an asset. Commissioner v. Tellier, 383 U.S. 687">383 U.S. 687, 689-690, 16 L. Ed. 2d 185">16 L. Ed. 2d 185, 86 S. Ct. 1118">86 S. Ct. 1118 (1966), affg. 342 F.2d 690">342 F.2d 690 (2d Cir. 1965), revg. a Memorandum Opinion of this Court; Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 113-116, 78 L. Ed. 212">78 L. Ed. 212, 54 S. Ct. 8">54 S. Ct. 8 (1933). The term "necessary" imposes the requirement that the expenses be "appropriate and helpful" to development of the taxpayer's business. Commissioner v. Tellier*85 , supra at 689; Welch v. Helvering, supra at 113. Section 162(a)(1) allows the deduction of "a reasonable allowance for salaries or other compensation for personal services actually rendered." In order to deduct gifts under section 162, section 274(d) imposes additional substantiation requirements. Specifically, the taxpayer must have adequate records or sufficient evidence to corroborate his or her own statements regarding the cost of the gifts, the date and description of the gifts, the business purpose of the gifts, and the business relationship to the taxpayer of the persons receiving the gifts. Section 274(b) limits the deductible amount relating to business gifts to any one person in a given year to $ 25. Section 262 provides that, except as otherwise expressly allowed, no deductions for personal, living, or family expenses shall be allowed. Local MealsRespondent urges us to disallow as personal expenses under section 262, petitioners' expenses for local meals, consisting primarily of weekday luncheons and evening refreshments. Petitioners contend that the local meals related to Amway meetings and involved many different people from*86 their Amway organization, rather than the same people on every occasion. Thus, petitioners contend that the expenses of local meals qualify as ordinary and necessary expenses of their Amway distributorship. While the number of occasions when petitioners paid for local meals is not entirely clear from the record, we believe petitioners' estimates are approximately correct. For 1982, 87 local meals at a total cost of $ 804 comes to $ 9.24 for each local meal, presumably for at least two people. For 1983, 240 local meals at a total cost of $ 1,560 comes to $ 6.50 for each local meal, again for at least two people. We note that the situation before us differs from Moss v. Commissioner, 80 T.C. 1073">80 T.C. 1073 (1983), affd. 758 F.2d 211">758 F.2d 211 (7th Cir. 1985) relied upon by respondent, which involved daily partnership business luncheon meetings. We are convinced that petitioners paid for a significant number of local meals during 1982 and 1983 that related primarily to their Amway distributorship. See Wedemeyer v. Commissioner, T.C. Memo 1990-324">T.C. Memo 1990-324. Petitioners, however, have not met their burden of proving that all of the expenses they incurred*87 for local meals were ordinary and necessary expenses of their Amway distributorship. Petitioners' recordkeeping was not sufficient to enlighten us as to the appropriateness or helpfulness of many of the expenses of the local meals. On the evidence before us, we find that petitioners are entitled to deduct additional expenses for local meals in the amount of $ 400 for 1982 and zero for 1983. Out-of-town TravelRespondent asserts that petitioners are not entitled to deduct the expenses of attending certain Amway meetings and conventions. Respondent argues that petitioners attended the meetings and conventions primarily for personal social reasons. Respondent also argues that petitioners should not be allowed to deduct their expenses of traveling to recruit and train down-line distributors for whom they were not direct sponsors. Respondent argues that taking such trips was not a good business practice and that the trips cost more than petitioners could possibly generate in sales commissions and bonuses. Petitioners contend that attendance at the Amway meetings and conventions was ordinary and necessary because it helped them train and motivate their down-line Amway distributors. *88 They claim that it was a common, ordinary and necessary practice for owners of large Amway distributorships to attend these meetings and also to incur reasonable travel expenses in recruiting and training down-line distributors. On the evidence before us in this case, we conclude that the expenses petitioners incurred in attending the Amway meetings and conventions constituted ordinary and necessary business expenses. The agendas of the meetings and Mrs. Jordan's extensive notes taken at the meetings demonstrate that most of petitioners' time at the meetings was devoted to business. It was especially appropriate that petitioners attend the Amway conventions as over 100 of petitioners' down-line distributors attended the Amway conventions at issue. Petitioners' Amway distributorship relied heavily on novice or part-time salespeople, and frequent motivational meetings appear to have been helpful to sustaining the sales and growth of petitioners' distributorship. In addition, because petitioners' organization was dispersed over a large area as it branched out through an increasing number of down-line distributors, it was not always possible to have local sponsors conduct the necessary*89 training. Petitioners have met their burden of proving that the trips to recruit and train down-line distributors were taken for business purposes, and that they were appropriate and helpful under the test of Welch v. Helvering, supra.It is not entirely clear from the record whether petitioners are claiming the expenses for their daughter Stacey, who apparently accompanied them on several trips. No effort was made to show that the expenses of Stacey's travel constituted ordinary and necessary business expenses. We hold that the expenses at issue for out-of-town travel are allowed, but only to the extent that they relate to expenses attributable to petitioners' travel and not to their daughter's travel. Automobile Expenses and DepreciationRespondent argues that the automobile expenses and depreciation at issue were personal expenses. Petitioners maintain that their mileage logs are sufficient to prove the business mileage claimed. We are not convinced that none of the mileage in dispute related to petitioners' personal social activities, and petitioners have not met their burden of proving that the claimed mileage related to their Amway distributorship. *90 In light of all the evidence, we find that the appropriate percentage of business use of the vehicles are as follows: 198119821983 CadillacJeep EaglePontiac198260%18%-0- 198360%19%22%Payments to StaceyRespondent contends that amounts petitioners paid to their daughter Stacey are not deductible because petitioners have not proven that the amounts were reasonable or that the amounts were paid for services actually rendered. Petitioners assert that Stacey worked an average of 10 to 20 hours per week helping with the Amway distributorship and that she was paid at the reasonable rate of approximately $ 2 to $ 3 per hour, depending on the nature and difficulty of the work. Although payments for services rendered by minor children to a related party must be carefully scrutinized, they are not automatically disallowed. See Eller v. Commissioner, 77 T.C. 934">77 T.C. 934 (1981); Denman v. Commissioner, 48 T.C. 439 (1967). Here, it is clear that Stacey participated in her parents' Amway distributorship and that she rendered services to the distributorship on a regular basis. However, we are troubled by petitioners' *91 recordkeeping regarding Stacey's work. Based on the evidence before us regarding the payments to Stacey, we allow as deductions under section 162 $ 1,000 in 1982 and $ 1,500 in 1983. PrizesRespondent maintains that petitioners have failed to meet their burden of proving the business purpose under section 162 of the prizes given to Amway associates during 1982 and 1983. Petitioners assert that the receipts and canceled checks submitted as evidence adequately support their claim to these deductions. Petitioners further state that the prizes awarded were effective in increasing the sales of Amway products. Petitioners rely on Rev. Rul. 69-510, 2 C.B. 23">1969-2 C.B. 23, for the proposition that prizes given to customers are deductible business expenses. After examination of the record, we hold that petitioners are entitled to deduct additional expenses of $ 1,892 for 1982 and $ 1,452 for 1983 relating to the prizes. Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (2d Cir. 1930). These amounts were substantiated and represent prizes awarded to down-line distributors and customers for motivational purposes. See McCue v. Commissioner,*92 T.C. Memo 1983-580">T.C. Memo 1983-580. GiftsRespondent asserts that petitioners have failed to meet their burden of proving the deductibility under section 274 of expenses relating to the gifts made to their Amway associates during 1982 and 1983. Petitioners maintain that the receipts and canceled checks submitted as evidence support their claim to these deductions. Section 274 provides more stringent substantiation requirements than section 162. Each requirement of section 274 must be proven for each expense. General, vague proof does not meet the rigorous requirements of section 274. Smith v. Commissioner, 80 T.C. 1165">80 T.C. 1165, 1172 (1983). Substantiation of the business relationship, for example, must be particular as to name, title, or other specific designation. Dowell v. United States, 522 F.2d 708">522 F.2d 708, 716 (5th Cir. 1975). On the evidence before us and in light of the requirements of section 274, we hold that petitioners are not entitled to deduct any of the amounts claimed as business gifts in 1982 or 1983. Decision will be entered under Rule 155.Footnotes1. The fact that petitioners' Amway distributorship generated substantial gross income and that respondent conceded that petitioners' Amway distributorship constituted a for-profit trade or business distinguishes this case from a number of cases previously litigated in this Court involving Amway distributors. See e.g., Elliott v. Commissioner, 960">90 T.C. 960 (1988), affd. without published opinion 899 F.2d 18">899 F.2d 18 (9th Cir. 1990); Rubin v. Commissioner, T.C. Memo 1989-290↩.*. Respondent has allowed the expenses claimed with respect to the 1982 trips numbered 2, 3, and 5 to Atlanta, GA, Charlotte, NC, and Virginia Beach, VA.↩2. The differences between the total amounts paid to Stacey as documented by cancelled checks and the lesser amounts claimed as deductions by petitioners have not been explained.↩3. Listed as "advertising" on petitioners' Schedule C.↩4. Listed as "travel & entertainment" and "lodging & meals" on petitioners' Schedule C.↩5. Due to rounding, the total amount reflected for some columns does not necessarily reflect the sum of the expenses in each column.↩6. Listed as "travel & entertainment" and "lodging & meals" on petitioners' Schedule C.↩7. Listed as "promotion expenses" on petitioners' Schedule C.↩8. Due to rounding, the total amount reflected for some columns does not necessarily reflect the sum of the expenses in each column.↩9. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as in effect for the years in issue.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619439/ | ESTATE OF JOHN FREDERICK DAVIS, Deceased; FIRST NATIONAL BANK OF OMAHA, Executor, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Davis v. CommissionerDocket No. 1636-76.United States Tax CourtT.C. Memo 1978-69; 1978 Tax Ct. Memo LEXIS 442; 37 T.C.M. (CCH) 341; T.C.M. (RIA) 780069; February 23, 1978, Filed *442 Kent O. Littlejohn, Michael L. Sullivan, Ronald C. Jensen, for the petitioner. Ronald M. Frykberg, for the respondent. QUEALYMEMORANDUM FINDINGS OF FACT AND OPINION QUEALY, Judge: Respondent determined a deficiency in estate tax of petitioner in the amount of $255,236.09. All other issues having been resolved by agreement of the parties, the sole question remaining for determination is the fair market value as of the date of death of the decedent of 28,938 shares of First West Side Bank of Omaha, Nebraska, directly or indirectly owned by the decedent. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference. The decedent, John Frederick Davis (hereinafter referred to as the decedent) was born on June 22, 1910, and died testate on March 23, 1972. At his death, Davis was a resident of Omaha, Nebraska. Decedent's last will and testament was admitted to probate in the County Court of Douglas County, Nebraska. The First National Bank of Omaha (petitioner) was appointed and is now the duly qualified and presently acting Executor of the Estate*443 of John Frederick Davis. Letters testamentary were granted the petitioner on May 9, 1972. Petitioner, as Executor of the estate, timely filed a Federal estate tax return with the District Director of Internal Revenue at Omaha, Nebraska. On the date the petition was filed herein, the petitioner had its principal office in Omaha, Nebraska. On March 23, 1972, the date of decedent's death, decedent directly owned 25,708 shares of the common stock of First West Side Bank of Omaha, Nebraska (hereinafter referred to as the Bank). The decedent also owned all of the stock of Dalar Corporation, which in turn owned 3,230 shares of the stock of the Bank. Decedent thus owned directly or indirectly a total of 28,938 shares of the stock of the Bank. As of March 23, 1972, the Bank had outstanding 75,000 shares of common stock, which were owned as follows: StockholderNo. of SharesStanley J. Bednar9,375James Irving7,499Farmers & Merchants Bank,Bloomfield, Nebraska1,515Emerson Insurance Agency1,515Blair Insurance Agency1,665W. E. Jahde150John Frederick Davis25,708John R. Lauritzen24,243Dalar Corporation3,230Ronald L. Hale50Patrick M. Conway50Total Outstanding75,000*444 John R. Lauritzen was decedent's brother-in-law. Farmers & Merchants Bank, Emerson Insurance Agency, and Blair Insurance Agency were controlled by Mr. Lauritzen. Thus, 28,938 shares of the Bank were owned or controlled by Mr. Lauritzen. Pursuant to restrictive agreements between various other shareholders and decedent and Mr. Lauritzen, decedent and Mr. Lauritzen had a right to purchase, in equal shares, the stock of such other shareholders as might offer their stock for sale. The purpose of such agreements was to maintain, insofar as possible, equality of ownership between the decedent and Mr. Lauritzen. The shares owned by Stanley J. Bednar were subject to an agreement that if he desired to sell or transfer his shares, or upon termination of active participation in the Bank, he was required to offer them for sale to the remaining stockholders in proportion to their holdings at a price equal to the adjusted book value of the stock determined by formula. The shares owned by James Irving were also subject to an agreement that if he desired to sell or transfer his shares, or upon termination of active participation in the management of the Bank, he was also required to offer*445 them for sale to decedent and Mr. Lauritzen (50 percent to each) at a price equal to the adjusted book value of the stock determined by formula. An agreement dated October 13, 1960, between decedent and Mr. Lauritzen provided as follows: This agreement is made and entered into this 13th day of October, 1960, by and between JOHN F. DAVIS, hereinafter referred to as the First Party, and JOHN R. LAURITZEN, hereinafter referred to as the Second Party. WHEREAS, the first and second parties are presently the owners and holders of sixty-two per cent of the authorized and issued capital stock of First West Side Bank, each owning an equal amount; and WHEREAS, first party and second party have expended capital and devoted their energies, skill and talent to the development of the First West Side Bank; and WHEREAS, first parties desire that the First West Side Bank should continue to receive their joint attention during their lives and the attention of the survivor after one of them is deceased; and WHEREAS, the first party and second party wish to avoid any difficulty or inconvenience which might be encountered should the stock of either of them pass into other ownership without*446 their consent; NOW THEREFORE, in consideration of the mutual agreements and promises contained herein and for other valuable consideration, the receipt of which is hereby acknowledged, the parties agree as follows: 1. The provisions of this agreement shall apply to any and all shares of capital stock of the First West Side Bank of Omaha, Nebraska, that are presently owned or hereafter acquired and irrespective of the manner of acquisition. 2. During the joint lives of the parties, they promise and agree to and with each other that neither of them shall or will, during the life of the other, sell or otherwise transfer his shares of said stock or any portion thereof to any person, corporation, or other legal entity not a party to this Agreement except as hereinafter provided. 3. Should the parties wish to sell or transfer said shares or any portion thereof to certain corporations in which they alone, or together with their respective wives and/or children, own a controlling interest they may do so; however, such a transfer may be made only after the corporation acquiring said shares has agreed in writing to be governed in strict accordance with the provisions of this Agreement*447 as though it was a party hereto and after a resolution to this effect has been passed by its Bard of Directors at any regular meeting of said Directors or at a special meeting called for this purpose pursuant to its Articles of Incorporation or By-Laws. A copy of the corporate assent to so be bound by the provisions of this contract, together with a copy of said corporate resolution, both duly signed by the President and Directors, will be delivered to the party not participating in the transfer of said shares before any such transfer is consummated. 4. During the joint lives of the parties, should one of them desire to dispose of said shares of stock to anyone except his wife, one or more of his children, or a controlled corporation, as referred to in the preceding paragraph, the shares must first be offered to the other party and the offer shall be made in writing. The party to whom the offer is made shall have six months from the date of the offer within which to purchase said stock at a price per share determined by the sum of the capital, plus the surplus; plus the undivided profits; plus all unaccrued reserve accounts whether allocated or not after deducting taxes which*448 would have been payable had such reserves been then transferred to undivided profit; plus or minus the net bond profit or loss, after taxes, computed as though said bonds had been sold at market; plus 10% of the total value thus obtained. This total, after the addition of said 10%, shall then be divided by the total number of issued and outstanding shares of First West Side Bank; all determined as of the date the offering party notifies the other party of his intention to offer said stock for sale. 5. At the expiration of said six month period, if the party to whom said offer has been made declines to purchase said stock then it may be offered for sale to the public or otherwise at the discretion of the party desiring to sell, except that in such event, each stockholder of the First West Side Bank, except the seller, shall have the right of first refusal with respect to any offer of purchase received by the selling party and all such stockholders, except the seller, shall have the right to purchase a proportion of such stock equal to the ratio of the number of shares owned by him to the total shares owned by the remaining shareholders, excluding the seller, at the same price per*449 share as has been offered the selling party, or they may purchase the shares offered for sale in whatever proportion they may, among themselves, agree; however, all said shares being offered for sale by the selling party must be purchased by the remaining stockholders enjoying said rights of first refusal. Should said stockholders agree to purchase all of the stock of the party selling, they shall indicate their intention to do so in writing and shall buy said shares within ninety days from the date the from the date the party selling has notified them in writing of their option to exercise their right of refusal and the price which he has been offered. If the party to whom said stock is initially offered declines to purchase said stock, either specifically or by lapse of time, as provided in Paragraph 4, above, and if the remaining stockholders fail to purchase the shares of the selling party within the time prescribed, then the provisions of this Agreement shall no longer be binding upon the party selling the shares. 6. It is further provided, however, that should either the first or second party wish to sell, give or otherwise transfer said shares to either their wife, children*450 or a controlled corporation, as referred in Paragraph 3, above, they may do so subject to the provisions of this Agreement, and said wife or children shall hold the shares of said stock subject to the provisions of this Agreement and in the precise manner as though said stock was still owned by either the first or second party. 7. All certificates of stock of the First West Side Bank owned by either of the parties, whenever acquired, shall plainly indicate on the face of said certificates, as follows: "The shares of stock represented by this certificate are subject to the terms of an Agreement dated October 13, 1960, a copy of which is on file with the Trust Department of First National Bank of Omaha, Nebraska." 8. The provisions of this Agreement shall be binding upon the executors, administrators, heirs, or assigns of the parties. 9. This Agreement may be amended or altered in any provision and such change shall become effective when reduced to writing and signed by the first and second parties. This Agreement is executed in Omaha, Nebraska, on the date first above written. The Bank was organized under the laws of Nebraska in 1954. At the time of decedent's death, *451 the Bank was a highly successful commercial banking operation located in the immediate area of the Crossroads Shopping Center, approximately six miles west of downtown Omaha. The Bank's main offices were located in a three-story building which was remodeled and substantially expanded in 1969. The Bank also maintained a banking facility within the shopping center. At the date of decedent's death, the Bank ranked as the sixth largest commercial bank in Omaha in terms of total deposits.The Bank's total deposits were as follows: Total Deposits Date(Millions)December 31, 1967$21.1December 31, 196826.6December 31, 196928.1December 31, 197032.0December 31, 197136.2March 23, 197237.1The Bank's financial condition at December 31 of the years 1967 through 1971 was as follows: (000 omited) 19711970196919681967Assets: Loans$23,322$20,926$21,336$16,237$13,612Government obliga-tions10,1096,7215,2618,7416,927Other7,1218,3295,1544,1052,768Total assets$40,552$35,976$31,751$29,083$23,307Liabilities: Deposits$36,167$31,976$28,116$26,576$21,112Other liabilities1,0991,0731,024385434Reserves378319350Capital accounts2,9082,6082,2612,1231,761Total liabilities,reserves andcapital accounts$40,552$35,976$31,751$29,083$23,307Book value per share(75,000)$38.78$34.77$30.14$28.30$23.48*452 During the years 1967 to 1971, inclusive, the only dividend paid by the Bank was a distribution in cash of $1.00 per share in the year 1971. As of the close of business on March 23, 1972, the daily statement of the Bank reflected the following: Assets: First National Bank, Omaha$ 4,033,605.84Omaha National Bank, Omaha16,939.16Cash467,417.99Total Cash -- Subtotal4,517,962.99Cash Items Not in Process of Coll.- 422,524.22U.S. Government Bonds4,399,371.87Fed. Fds.950,000.00Municipal Bonds6,511,151.28Israel Bds.20,000.00Overdrafts56,156.98Commercial Loans10,293,958.94Real Estate Loans4,636,325.09Installment Loans8,773,083.12Furniture and Fixtures175,576.59Leasehold Improvements902,665.98Interest Earned, Not Collected310,970.81Income Accdued, Not Collected3,756.42Prepaid Expenses2,358.60Accrued Expense--Taxes, Interest, etc.551,979.41Bank Premises512,954.52Difference Account537.43Customer Postal Guarantee15,855.00Short Account186.78Total Assets$42,212,327.59Liabilities: Deposits$37,143,589.48Capital1,500,000.00Surplus542,500.00Undivided Profits705,178.70Reserve for Losses on Loans1.00Reserve Personal Loans435,377.95Reserve for Taxes, Interest, Insurance257,235.06Postal Guarantee15,855.00Bond Interest109,691.35Loan Interest244,740.60Personal Loan Interest117,800.00Dealer Loan Interest46,796.41F.H.A. Interest13,899.34Service Charges and Collections100,494.34Exchange3,539.97Safety Deposit Rental4,369.90Rental Income12,699.00Interest Collected, Not Earned958,555.49Total Liabilities$42,212,327.59*453 In the estate tax return of decedent, the 25,708 shares of the Bank directly owned by decedent were valued at $36.00 per share. In the statutory notice of deficiency, respondent determined the shares had a value of $75.00 per share. The same valuation was likewise adopted by respondent in the determination of the value of the stock of Dalar Corporation. At the date of decedent's death on March 23, 1972, the 28,938 shares of the common stock of First West Side Bank owned or controlled by the decedent had a fair market value of $45.00 per share. OPINION The decedent died on March 23, 1972, owning or controlling 28,938 shares of the common stock of First West Side Bank, being 38.58 percent of the total stock outstanding. Mr. Lauritzen, decedent's brother-in-law, also owned 28,938 shares of such stock. By agreement with the other stockholders, provision was made for the decedent and Mr. Lauritzen to acquire any additional stock which might be offered for sale in equal shares. The only question for decision is the determination of the fair market value of the decedent's stock of the Bank as of the date of decedent's death. In the decedent's estate tax return, such stock was*454 valued at $36.00 per share. In the notice of deficiency, respondent determined a value of $75.00 per share. Petitioner presented the opinion of an expert witness who testified the fair market value of the stock was not more than $28.00 per share. Respondent countered with an expert witness who testified that the fair market value of the stock was no less than $59.00 per share. The Court is thus faced with a wide variance of opinion as to the value of the stock in question. The determination of the fair market value of decedent's stock as of March 23, 1972, requires a conclusion of fact based upon the record before the Court.In light of the testimony of respondent's witness, no presumption of correctness attaches to respondent's determination of the notice of deficiency that the fair market value of such stock was $75.00 per share. It is for the Court to determine that value under the hypothetical assumption as to the price at which the stock would change hands in a negotiation between a willing seller and a willing buyer, neither of whom was under any compulsion to buy or sell. In making that determination, however, consideration must be given to the conditions attaching to any*455 sale of the stock, namely, the restrictive agreement between petitioner and Mr. Lauritzen. Respondent argues, without much conviction, that the restrictive agreement did not survive the decedent. To so hold would defeat the very purpose sought to be achieved by the decedent and Mr. Lauritzen, jointly to be in a position to direct and control the affairs of the Bank. Petitioner's expet witness testified that in his opinion, the fair market value of the stock on the basic date was not more than $28.00 per share. His opinion was predicated solely upon his judgment, in the light of offerings of bank stocks in relation to price earning ratios, book value, and dividend yields. His only knowledge of the area served by the Bank was derived from a brief visit during which he rode around the area in order to acquaint himself with the demographics of the neighborhood. Except for this visit, he was a stranger to Omaha. He assumed that the purchaser would have little information in regards to the stock of the Bank, except for the financial statements filed with the regulatory agencies. He thus failed to take into account the likelihood, if not the fact, that in a transaction between a*456 buyer and seller involving 38.58 percent of the total stock outstanding, detailed information in regards to the operations of the Bank and the conditions of its loan portfolio would be taken into account. Petitioner's expert witness likewise failed to attach any significance to the fact that decedent's stock constituted 38.58 percent of the total stock outstanding. While a purchaser of such a block of stock could not exercise control without an accommodation between the purchaser and Mr. Lauritzen, the same was true to Mr. Lauritzen, who also owned or controlled 38.58 percent of the Bank's stock. For all practical purposes, between them they owned the Bank. We are not dealing with the sale of a few hundred shares of the stock which carry with them no voice in the management of the Bank. Petitioner's expert witness stated that in his opinion the most important consideration was book value. When this statement is coupled with the disparity beteen the value of $28.00 per ahre, as testified to by the witness, and a book value of $38.00 per share, the Court is inclined to give little weight to the testimony of the witness. The respondent's expert witness was likewise a stranger*457 to the area. His opinion was predicated largely upon quoted prices for bank stocks and stocks of bank holding companies in buy or sell offerings. On that basis, he assumed that 10 times 1971 earnings would be a fair price for stock. In his testimony, this witness failed to give effect to the restrictive buy and sell agreement between the decedent and Mr. Lauritzen. He sought to avoid the apparent ceiling imposed on any sale of the stock by that agreement on the assumption that in the event of a sale Mr. Lauritzen would join with the decedent and offer absolute control of the Bank in order to attain the maximum price. There is no basis to support that assumption. In the final analysis, however, respondent's expert witness predicated his opinion of value on the further assumption that, joined by Mr. Lauritzen, decedent's stock will be exchanged in a tax-free transaction with First National of Nebraska, Inc., a transaction which was not as of March 23, 1972, or as of the date of the trial, permitted by Nebraska law. It is on the basis of that assumption that respondent's expert witness places a value of $59.00 per share on the decedent's stock. Since the assumption was not predicated*458 either on the conditions which prevailed on March 23, 1972, or on a reasonable expectation as to the future, the opinion of this expert is of little value. As a starting point, the Court would have preferred to have the opinion of the appraiser who valued the stock at $36.00 per share in the estate tax return. Presumably, he was knowledgeable of the local market and the value of the Bank's stock in the Omaha business community. Unfortunately, petitioner did not present the testimony of that appraiser. The Court is not convinced that the stock should be valued at less than book value as of the date of death. The Bank had experienced a steady year-to-year growth. It was a highly liquid condition, with outstanding loans being divided almost equally between governmental obligations, commercial loans, and real estate and installment loans. Looking at the daily statement as of March 23, 1972, a prospective purchaser would have every reason to believe that the book value of the stock reflected sound banking practices and that value was not in jeopardy. As a purchaser of 38.58 percent of the total outstanding stock, he undoubtedly would also have access to additional information. *459 In the absence of any proof to the contrary, the Court can only assume that such information would be consistent with the daily statement. While there is some difference between the parties, and neither side has presented proof with respect to what value would be attributable to the stock if the formula provided for in the restrictive agreement were to be applied as of March 23, 1972, there is indication that a sale pursuant to the agreement between the decedent and Mr. Lauritzen, as of the valuation date, would be made at a price of approximately $45.00 per share. Respondent argues that the price which would result from the application of the formula in the restrictive agreement does not impose an absolute ceiling on the maximum value which might be attributed to the stock, citing . As was pointed out in that case, there may be some difference of opinion with respect to the weight to be attached to the restrictive agreement. Under the circumstances of this case, however, and in the absence of any showing that the restrictive agreement was a substitute for a transfer of interest subject to the estate*460 tax, the circumstances are indistinguishable from . It is unreasonable to assume that decedent might realize a price for the stock which would be materially in excess of the price provided by the formula without the cooperation and participation of Mr. Lauritzen. Furthermore, the formula was agreed upon between the decedent and Mr. Lauritzen, both knowledgeable with respect to this Bank and to the banks in the area, and neither intending to take advantage of the estate of whichever might die first. It is obvious that their intent was to provide for the retention of control of the Bank by the survivor on a fair and equitable basis. On the record before the Court, a hypothetical value arrived at as a result of the formula agreed upon between the two constitutes the best evidence available. Upon a consideration of all of the evidence, the Court finds that the fair market value as of March 23, 1972, of decedent's interest in the First West Side Bank of Omaha, Nebraska was $45.00 per share. Decision will be entered under Rule 155. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619440/ | E. A. LANDRETH CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. E. A. LANDRETH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ADELLE H. LANDRETH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.E. A. Landreth Co. v. CommissionerDocket Nos. 15835, 16842, 16843.United States Board of Tax Appeals11 B.T.A. 1; 1928 BTA LEXIS 3877; March 16, 1928, Promulgated *3877 1. Where one purchased an oil and gas lease and certain water rights and was unable financially to pay the purchase prices and develop the property, and where he from time to time solicited and received assistance from others, and where such others so contributing had no voice in the selection of contributors, and where such properties were managed by the purchaser in whose name the legal title was vested, held, that such an enterprise was a joint adventure. 2. Where individuals associated themselves together for the purpose of transacting business under corporate forms and methods, held, that the entity so formed was for income-tax purposes an association, irrespective of the fact that exclusive authority was conferred upon their managing agent who was styled trustee and who held the legal title to all its property. 3. Section 1107 of the Revenue Act of 1926 does not deprive the Commissioner of the right to review his own decisions. 4. Invested capital of an association determined in accordance with the provisions of section 331 of the Revenue Act of 1918. 5. Basis for gain or loss determined in case of sale of property of an association. 6. Where association*3878 A transferred certain of its assets to association B, and where such assets constituted all the assets of association B, and where association B paid association A for said assets with the whole of its capital stock, which capital stock was distributed by association A to its stockholders, held, that in the absence of a showing by petitioners that association A did not have a surplus equal to or greater than the amount of distribution, such distribution was taxable as a dividend. Claude Collard, C.P.A., and M. M. Mahany, Esq., for the petitioners. Bruce A. Low, Esq., for the respondent. MILLIKEN *2 These proceedings were by agreement consolidated for hearing and decision, and involve the following deficiencies in income and profits taxes: In the proceeding of E. A. Landreth Co. the deficiencies are, for the year 1920, $29,411.03, and for the year 1921, $36,084.05. In the proceedings of E. A. Landreth and Adelle H. Landreth, the deficiencies are for the year 1920, and in each proceeding the deficiency is $2,312.23. In its petition, E. A. Landreth Co. asserts the following errors: (a) That respondent classified petitioner and the*3879 Landreth Water Co. as associations; (b) that the respondent consolidated the net income and invested capital of the petitioner and of the Landreth Water Co.; (c) that respondent erred in further reviewing petitioner's return for the year 1920, after he had previously examined its return and determined its income; (d) failure of respondent to allow as a deduction from gross income for the year 1920, certain labor and teaming expenses in the amount of $14,948.54; (e) failure of respondent to determine that the amount of taxes paid by petitioner for the year 1920, was $7,339.10, the amount actually paid, instead of $8,049.33; (f) failure of respondent to allow as deductions from gross income for the years 1920 and 1921, adequate allowances for depreciation and obsolescence sustained with respect to the following assets, to wit: Year 1920Owned by E. A. Landreth Co.Owned by Landreth Water Co.(1) Hale lease equipment.(7) Pipe and fittings.(2) Camp equipment; furniture and fixtures.(8) Frame building.(9) Machinery.(3) Two Dodge automobiles.(10) Automobiles.(4) One Dodge automobile.(5) Ford automobile.(6) Frame shack.Year 1921Owned by E. A. Landreth Co.Owned by Landreth Water Co.(11) Hale lease equipment.(17) Pipe and fittings.(12) Baker-Gannon lease equipment.(18) Buildings.(13) Stoker lease equipment.(19) Machinery. (14) Automobiles.(20) Automobiles.(15) Camp equipment.(16) Furniture and fixtures.*3880 (g) failure of respondent to compute the correct amount of taxable gain or loss for the year 1921 arising from the sale or other disposition of the following assets, to wit: Owned by E. A. Landreth Co.Owned by Landreth Water Co.(1) Hale lease.(8) Pipe, fittings, buildings, machinery and automobiles.(2) Automobiles.(3) Camp equipment.(4) Dismantling and salvaging losses.(5) Casing.(6) Furniture and fixtures.(7) Abandonment of Thompson and Vick leases.*3 (h) failure of the respondent to include in gross income for the year 1921, other income in the sum of $344.70; (i) failure of the respondent to determine the correct amount of deductions from gross income for the year 1921, to wit: (1) Production expense$6,159.33Instead of $6,741.58 as allowed by respondent.(2) General expense.(3) Drilling expense113,390.32Instead of $122,676.48 as allowed by respondent.(4) Farm maintenance1,208.38Instead of $1,996.92 as allowed by respondent.(5) Interest and discount.(j) failure of respondent to allow as a deduction from gross income for the year 1921, depletion sustained in relation to the Hale lease; (k) *3881 failure of respondent to allow as a deduction from gross income for the year 1921, a bad debt; (l) failure of respondent to determine that the cost to petitioner of certain assets which were transferred to the Landreth Water Co. in the year 1920 was the sum of $60,224.44; (m) action of respondent in determining that the transfer of assets by petitioner to the Landreth Water Co. in the year 1920 constituted a dividend in kind in the sum of $81,916.11; (n) failure of respondent to determine the petitioner's correct invested capital for the years 1920 and 1921; (o) failure of respondent to correctly compute petitioner's income and profits taxes for the years 1920 and 1921; (p) failure of respondent to grant petitioner special relief under the provisions of the Revenue Acts of 1918 and 1921; (q) failure of respondent to allow as deductions for the year 1921, losses arising from abandoned leases in the sum of $48,200; and (r) action of respondent in reducing the cost of sale of certain properties by the amount of depreciation and depletion sustained for the purpose of determining gain or loss. At the hearing, petitioner waived errors (f) 2 to 20, inclusive; (g) 2, 3 and 6; (i) 2 and*3882 5; (j); (k); (p) and (r); and respondent admitted error as to errors (e); (h) and (i) 1, 3 and 4. In the appeals of E. A. Landreth and Adelle H. Landreth, the following errors are asserted in each petition: (1) That respondent *4 determined that the E. A. Landreth Co. and the Landreth Water Co. were associations during the year 1920; (2) action of respondent in including in community income dividends from E. A. Landreth Co. for the year 1920 in the amount of $24,711.25; and (3) failure of respondent to include in community income for the year 1920 distributive income of the E. A. Landreth Co. in the amount of $12,094.66. FINDINGS OF FACT. In April, 1920, E. A. Landreth purchased in his own name but for the benefit of the Metex Petroleum Corporation, a Delaware corporation of which he was then the representative, a two-thirds interest in an oil and gas lease on an 80-acre tract of land in Stephens County, Texas, known as the Hale lease. The price of the two-thirds interest was $200,000. The Metex Petroleum Corporation was financially unable to raise funds sufficient to pay for the lease and the liability on the contract of purchase devolved upon E. A. Landreth, individually. *3883 He called his brother, W. H. Landreth, to his assistance and they used their own funds to pay the purchase price of the lease and also raised money on their personal endorsements. E. A. Landreth interested friends and other relatives in the enterprise with the result that by September 8, 1920, the following persons had paid in to the enterprise the amounts opposite their respective names: W. H. Landreth$77,500E. A. Landreth77,500J. P. Landreth10,000Wm. Allison10,000Roger Bennett6,000Marian Bennett2,500John Wise$5,000James L. Smith5,000J. A. Cotton5,000W. D. Mardick1,500200,000The contributors, other than E. A. Landreth and W. H. Landreth, began to make their contributions to the fund in June, 1920. Up to September 8, 1920, there was no agreement or understanding as to the form or manner in which the enterprise should be conducted, nor as to the liability of the respective contributors, as between themselves or as to third persons. During this period, the control of the enterprise was left to the sole discretion and management of E. A. Landreth. The funds so contributed and all other funds accruing to the enterprise were*3884 deposited by E. A. Landreth in bank to the credit of E. A. Landreth, trustee, this being the designation of an account to the credit of which E. A. Landreth had deposited funds belonging to himself and to the Metex Petroleum Corporation and another company which he had theretofore represented. Prior to September 8, 1920, purchases of equipment were made in the name of E. A. Landreth or E. A. Landreth & Co., or possibly E. A. Landreth Co. All credit for such purchases was extended solely to E. A. *5 Landreth and W. H. Landreth. Prior to September 8, 1920, E. A. Landreth and W. H. Landreth had acquired, for a cost not shown, certain water rights, including a water lease on property adjacent to the Hale lease. These rights were acquired as a part of the original enterprise and for the purpose of furnishing water for the operation of that lease and also for the purpose of selling water to other oil operators in the neighborhood. Under date of September 8, 1920, the contributors above named executed the following instrument in writing: That We, the undersigned, W. H. Landreth, of Joplin, Missouri, and E. A. Landreth, of Breckenridge, Stephens County, Texas, have acquired*3885 for E. A. Landreth Company and its successors and assigns, various oil and gas rights, including leasehold interests, contract rights, option rights, fees and various other interests in land lying and being situated in the County of Stephens and State of Texas, and elsewhere; And also certain water franchises, rights, privileges and options, including the right to conduct, maintain and operate a water system in said Stephens County, Texas; which said property shall be owned and held by E. A. Landreth Company, the legal title of which shall vest in E. A. Landreth, the sole trustee of said estate. And it is agreed by the parties hereto that the said trustee shall be known and dealt with, and said trust estate known and dealt with, and sue and be sued as E. A. Landreth Company: And all property which shall hereafter be assigned to said E. A. Landreth Company shall vest in said trustee, his successors or assigns, and shall be owned and held by him, his successors and assigns as such trustee in trust for the purposes set forth in the following articles, and which are hereby agreed to by the parties hereto: ARTICLE I. The trust estate herein created and hereby provided for shall exist*3886 for a term of twenty-five years from date hereof, and at the termination of which it shall be the duty of said trustee or his successor, to wind up and liquidate the affairs of said trust estate, and to distribute the cash arising therefrom pro rata among the holders of the beneficial certificates hereinafter referred to according to the number of shares held by each; provided that such distribution shall be made prior to the expiration of such period of time, if said trustee at any time shall decide to terminate said trust. ARTICLE II. Said trust estate shall be owned absolutely and unconditionally by the said trustee and his successors, but the beneficial interest in the dividends which may be declared by the said trustee and his successor, in the corpus of said trust estate at the termination thereof after liquidation, as hereinbefore provided, shall be evidenced by Two thousand shares, of the par value of One Hundred & No/100 ($100.00) Dollars each, which are fully paid and non-assessable, and the said shares are at the present time owned by the following persons, to-wit: SharesW. H. Landreth775E. A. Landreth775J. P. Landreth100Wm. Allison100Roger Bennett60Marian Bennett25John Wise50James L. Smith50J. A. Cotton50W. D. Mardick15*3887 *6 The shares shall be evidenced by certificates issued and signed by said trustee or his successor, and shall be personal property, and the shares shall be assignable, but so far as the interest of the trust estate shall be concerned shall be assignable only on the books kept by said trustee, and said trustee may be the owner of any number of shares. ARTICLE III. Said trustee and his successors shall have the power to bind and act for said trust estate, and said trust estate shall be held by said trustee and his successors, and he shall have full control and management of said trust estate according to his discretion. And he is hereby vested with the right of disposition of said trust estate and any and all parts thereof, by sale, barter, lease, mortgage or otherwise, as well as all increases arising therefrom and all of the fruits, interests and revenues which may arise therefrom, and of all properties into which said trust estate may be invested, and it shall be his duty to invest and re-invest the funds of said trust estate according to his best judgment, for the purposes hereinafter set forth. And he shall have the power to make contracts binding upon said trust*3888 estate, upon such terms as he shall deem fit; and he is hereby empowered to do and perform any and all things whatsoever which he shall deem for the benefit of said trust estate, and which shall be consistent with the general purposes set forth in this instrument. And in this connection it is understood that said trustee or his successor, shall have absolute power to do and perform any and all things herein set forth. ARTICLE IV. Said trustee is authorized to use said trust property and funds in conducting the following businesses, to-wit: Leasing and purchasing the right to prospect for gas and petroleum, and buying and selling such rights; prospecting for such minerals and drilling of wells and otherwise seeking to locate the same; producing, refining and marketing gas and petroleum, and buying and selling the same; building suitable tanks, pipe lines and other means for the preservation, transportation and merchandising of any gas or petroleum so found; acquiring franchises for the laying of pipe lines and conduits for the transportation and merchandising of gas and petroleum, and selling or supplying such minerals to corporations, municipalities or individuals; manufacturing*3889 and selling gas; acquiring franchises for the transportation or conveyance and delivery of gas; and providing means for such transportation and conveyance, and utilizing the same; acquiring by lease, purchase or otherwise such property, real or personal, as said trustee may deem proper or necessary for the purpose of carrying the business and purposes of this trust. To purchase water rights, franchises, privileges and options, including the right to conduct, operate and maintain a water system for the purpose of selling water to individuals, firms, corporations, municipalities, and holding and using, selling, trading, assigning, pledging, mortgaging, transferring and conveying such property, both real, personal or mixed, which may belong to said estate, and issuing shares, bonds, certificates and other obligations; and to secure the payment thereof by mortgages, pledges or Deeds of Trust of the whole or any part thereof of the property or the funds of this trust, and generally to incur debts which shall be chargeable against such trust funds. In short, said trustee and his successor shall have the absolute right and power of using the funds of the trust estate to purchase in any*3890 manner he may deem fit, or under any terms and conditions *7 he may deem advisable, and to sell and dispose of the same, or any part thereof, under any terms and conditions he may deem advisable, any real estate, options, chattels, real or personal property of any kind or character which may belong to said trust estate. ARTICLE V. The trustee shall not, nor his successor, be liable for any errors of judgment, or for any loss arising out of any act or omission in the execution of this trust so long as said trustee acts in good faith; nor shall he be personally liable for the acts or omissions of any agent or servant appointed by or acting under him; it being expressly understood that the trustee herein shall be personally liable only for his personal breach of trust. Said trustee or his successor shall not be personally liable on any contract, claim or demand, or for any torts arising out of the conduct of the business or incident thereto of this trust estate to any one whomsoever: It being expressly understood that all persons whomsoever shall look to the property and assets of said trust estate for the satisfaction of his or their claims or demands, whether contractual*3891 or otherwise, and not to the trustee personally. And if said trustee shall be required to pay any sum or sums of money on account of any act of his made and performed in good faith in the performance of his duties as such trustee, then he shall be indemnified therefor out of said trust estate, and his claim for indemnity shall take precedence and priority over any other claim or claims against said trust fund and estate, save and except the lien creditors. ARTICLE VI. The trustee shall have no power to bind the shareholders personally, or to call upon them for the payment of any sum of money or assessment whatsoever, other than such sum or sums as they may have in this agreement agreed to pay, and may at any time in the future agree to pay by way of subscription to new shares or otherwise. All persons, concerns and corporations extending to or contracting with or having any claim or claims against said trustee or his successor, shall look only to the funds and properties of the trust estate for the payment of any such contract or claim, or for the payment of any damages, judgment or decree, or any money that may otherwise become due and payable to him from the trustee, and*3892 neither shareholders nor officers, present or future, shall be personally liable therefor. In any written order, contract or obligation which the trustee or officer of this trust shall give, authorize or enter into, it shall be the duty of the trustee and officer to stipulate or cause to be stipulated, that neither the trustee or officers, or shareholders shall be held to any personal liability under or by reason of such order, contract or obligation; and all letter-heads, bills and other stationery shall have printed thereon, notice to the public that E. A. Landreth Company is a trust estate, and that only the assets of said estate are chargeable with its debts and obligations, and that neither the trustee nor the officers nor shareholders are personally liable therefor. ARTICLE VII. Said trustee is authorized to use a seal upon all papers and instruments affecting the title of any real estate belonging to said trust estate; which seal shall contain the words "E. A. Landreth Company". *8 ARTICLE VIII. The trustee or his successor shall from time to time appoint one of the shareholders as President, and W. H. Landreth is made, and he is hereby selected and appointed*3893 the President of said E. A. Landreth Company, with such power and authority as the trustee herein shall deem proper to confer upon him. Such officer shall hold the office at the will of the trustee herein, and said trustee shall have authority to select and appoint his successor. The trustee herein shall act as SECRETARY and TREASURER of said trust estate, but he is hereby authorized and empowered to appoint any one of the shareholders of said trust estate to act in the capacity of Secretary and Treasurer, with such powers and authority as said trustee may confer upon him by instrument in writing duly executed by such trustee, and having the seal of said E. A. Landreth Company. ARTICLE IX. The trustee herein shall act in such capacity during the life of this instrument, or at the will of said trustee: That is, said trustee or his successor hereunder reserves the right at any time to cease acting hereunder as trustee and to be released of any duties or responsibilities hereunder; and in the event of resignation or death of said trustee the President of E. A. Landreth Company is authorized to appoint his successor, which appointment shall be made by an instrument in writing, *3894 duly executed by the President of E. A. Landreth Company and bearing the seal of said E. A. Landreth Company, a copy of which shall be filed for record in the office of the County Clerk of Stephens County, Texas. ARTICLE X. The death of a shareholder or trustee shall not operate to determine the trust, nor shall it entitle the legal representative of the deceased shareholder to an accounting or to take any action in the courts or elsewhere against the trustees or his successor, but the executors, administrators or assigns of any shareholder shall succeed to the rights of the deceased shareholder, upon the surrender of the certificate for shares owned by him. The ownership of shares hereunder shall not entitle the shareholder to any title in or to the trust property whatsoever, or the right to call for a partition or division of the same, but only to receive and collect the dividends that may be declared and paid, and the beneficial interest in the event of liquidation. And it is expressly declared and agreed that the shareholders are cestuis que trustents, and hold no other relation to the trustees than that of cestuis que trustent hereunder. ARTICLE XI. All subscribers*3895 hereto, and all subsequent subscribers to or owners of shares, as well as their heirs, executors, administrators and assigns, shall be bound by the agreements and provisions herein contained, as well as all amendments, alterations and additions which may hereafter be made in accordance with the terms hereof. In witness to all of the above the parties forming this trust agreement hereunto subscribe their names, this the 8th day of September A.D. 1920. At the time of the purchase of the Hale lease, E. A. Landreth opened a set of books in which entries were made from the date of the purchase of the lease down to and through the years here involved, *9 to wit, 1920 and 1921. Little, if any, change was made in the form of bookkeeping during the said period. At the time of the organization of E. A. Landreth Co. it acquired the two-thirds interest in the Hale lease which had theretofore been purchased by E. A. Landreth, and for which he had paid from the funds under his management the purchase price. This lease and equipment had at the date it was acquired by the E. A. Landreth Co. a fair market value of $600,000. E. A. Landreth Co. acquired and owned all the equipment on*3896 the lease. This equipment had a cost on September 8, 1920, of $193,034.84. The fair market value of the two-thirds interest in the lease acquired by the E. A. Landreth Co. plus the value of the equipment was, on said date, $464,344.95. The value of the water rights is not shown. On October 28, 1920, J. Connor Wise executed the following instrument in writing: DECLARATION OF TRUST LANDRETH WATER COMPANY. STATE OF TEXASCounty of Stephens ss.THAT I, the undersigned, J. Connor Wise of Breckenridge, Stephens County, Texas, have acquired for the Landreth Water Company and its successors and assigns, certain water franchises, rights, privileges, and options, including the right to conduct, maintain and operate a water system in Stephens County, Texas, together with reservoirs, pipe-lines, machinery and equipment. Which said property shall be owned and held by Landreth Water Company, the legal title of which shall vest in J. Connor Wise, sole trustee of said Trust Estate, NOW, THEREFORE, KNOW ALL MEN BY THESE PRESENTS: ARTICLE I. The said J. Connor Wise, Trustee, hereby declares to all persons who are now and may become shareholders herein, that he will hold said*3897 properties, including claims and effects of all kinds so acquired, and to be acquired, by the "Trust Estate", or by him as Trustee; together with the proceeds therefrom and the income thereof, in trust during the continuance of this Trust Estate, and shall manage and dispose of the same in the manner, and subject to the stipulations herein contained; and the said Trustee and his successors will hold all of the said properties in trust for the benefit of shareholders in the Trust Estate, in proportion to the number of shares held by each in the Trust Estate. ARTICLE II. The Trust Estate hereby created shall be known as Landreth Water Company which shall continue in existence for a period of twenty-five (25) years from date hereof, unless sooner dissolved in the manner hereinafter set forth. ARTICLE III. The Trustee is authorized to use said Trust property and funds to purchase water rights, franchises, privileges and options, including the right to conduct, operate and maintain a water system for the purpose of selling water to individuals, *10 firms, corporations, municipalities, and holding and using, selling, trading, assigning, pledging, mortgaging, transferring*3898 and conveying such property, both real, personal, or mixed, which may belong to said Trust Estate, and issuing shares, bonds, certificates and other obligations, and to secure the payment thereof, by mortgages, pledges, Deed of Trust of the whole or any part thereof, of the property or the funds of this Trust, and generally to incur debts which shall be chargeable against such Trust funds. In short said Trustee and his successors shall have the absolute right and power of using the funds of the Trust Estate to purchase in any manner, he or they may deem fit, or under any terms and conditions he or they may deem advisable, and to sell and dispose of the same or any part thereof, under any terms or conditions he or they may deem advisable, any real estate, options, chattels, real or personal property of any kind or character which may belong to said Trust Estate. ARTICLE IV. The management and control of the Trust Estate and all its properties shall be vested in J. Connor Wise, and his successors, and he or they shall have sole power of management of the business of the Trust Estate, and exclusive power and authority to sell and convey, as Trustees, the said properties or any*3899 part thereof, and to distribute the revenues and the profits and all funds that may come into their hands as Trustees to and for the benefit of the respective shareholders. ARTICLE V. The Trustee may select a manager, or managers, for all or any part of the Trust Estate property, or business, and may employ such agents, servants, and employees, fixing their compensation, and entrusting them with such authorities and duties as he may deem wise, including the authority to buy and sell goods, wares, merchandise, material, supplies, machinery, appliances, and other things necessary to its operation in the course of business. ARTICLE VI. The Trustee shall hold office for the entire life of the Trust, but may be removed at any time for misconduct, or breach of trust, by a majority vote of the shareholders at a meeting held for that purpose only. That in the case of the death, resignation or removal of the Trustee a new Trustee may be appointed by a majority in interest of the outstanding shareholders at a meeting held for that purpose only. ARTICLE VII. The title to all property which is ever acquired by the Trust Estate shall be in the Trustee, as such, the survivor of*3900 him, under a Declaration of Trust for and on behalf of the Trust Estate. In all deeds of conveyances to said Trustee, or to his successors, it shall be set forth that such grant, conveyance, or transfer is to him or them as Trustees of Landreth Water Company to be held subject to the Declaration of Trust made pursuant to the Trust Estate, and the amendments thereto. ARTICLE VIII. Shareholders in this Trust Estate shall have no legal or equitable right to the Trust properties held from time to time by the Trustee herein provided *11 for, and especially shall they have no right to call for any partition of the trust property, or dissolution of the Trust; but the shares shall be personal property carrying the right of division of the net profits when and as the same may be distributed by the Trustee, and at the termination of the Trust by expiration of the period fixed for its existence or dissolution otherwise, the shareholders shall be entitled to a division of the principal and the profits in due proportion to the number of shares held by each. ARTICLE IX. The debt, insolvency, or bankruptcy of a shareholder or the transfer of his interest by sale, gift, devise, *3901 descent, operation of law, or otherwise during the existence of the trust shall not work a dissolution thereof, or have any effect on the same, its operation, or mode of business, nor shall it entitle his representatives, heirs, or assigns, to an accounting, or to take any action in the courts, in law or in equity, or otherwise against the Company, its members, its Trustee, or its property, or assets, or business operations, which shall remain intact and undisturbed thereby; but they shall only succeed to the right of the original member to the certificate of membership and the shares it represents subject to this Declaration of Trust and amendments thereto. ARTICLE X. The Trustee shall have no power to bind the shareholders personally, or to call upon them for payment of any sum of money or assessment whatsoever, other than such sum, or sums, as they may have in this agreement agreed to pay and may at any time in the future agree to pay by way of subscription to new shares, or otherwise. All persons, concerns, and corporations extending to or contracting with, or having any claim, or claims, against said Trustee, or his successors, shall look only to the funds and properties*3902 of the Trust Estate for the payment of any such contract or claim, or for the payment of any damages, debt, judgment or decree, or any money that may otherwise become due and payable in any way to him from the Trustee, and neither the Trustee nor the shareholders, present or future, shall be personally liable therefor, or any debt incurred, or engagement, or contract made by the Trustee, or any agent, or servant acting under them on behalf of the Trust Estate. Furthermore, the funds and property of the Trust Estate of every character shall stand primarily charged with the burden of paying any claim or money demand established or existing on account of the operations and business of the Trust Estate, whether founded on contract or tort, to the end that the shareholders of the Trust Estate may be protected from personal liability on account thereof. ARTICLE XI. The Trustee, nor his successors, shall not be liable for any errors of judgment, or for any loss arising out of any act or omission in the execution of this Trust, so long as said Trustee or his successors act in good faith; nor shall he, or they, be personally liable for the acts or omissions of any agent or servant appointed*3903 by or acting under him or them; it being expressly understood that the Trustee herein shall be personally liable only for his personal breach of trust. Said Trustee, nor his successors shall not be personally liable on any contract, debt, claim, or demand, or for any torts, arising out of the conduct of the business, or incident thereto, of this Trust Estate to any one whomsoever; it being expressly understood that all persons whomsoever shall look to the property and assets of said Trust Estate for the satisfaction of his or their *12 claims or demands, whether contractual or otherwise, and not to the Trustee personally. And if said Trustee shall be required to pay any sum, or sums of money on account of any act of his made and performed in good faith in the performance of his duties as such Trustee, then he shall be indemnified therefor out of said Trust Estate and his claim for indemnity shall take precedence and priority over any other claim or claims against said Trust Fund and Estate, save and except the lien creditors. ARTICLE XII. The Trustee shall distribute the net profits annually, or at shorter intervals, after sufficient provision has been made for reserves*3904 for depreciation, depletion and obsolescence. ARTICLE XIII. The number of shares of said Landreth Water Company shall be five hundred (500) shares of the par value of one hundred ($100.00) dollars each. Additional shares may be issued by the Trustee at such times, in such amounts, and for such considerations as he may determine. Provided that the owners of shares appearing of record at the time of issuance of additional shares, shall have a prior right, for at least ten (10) days, after notice to them to subscribe for and purchase such additional issue in the same proportion in which they then own the existing shares, after the expiration of which period of time, if not taken by them, such increase shall be subject to sale to others. The notice provided for in this Article shall be given by mailing a letter to each holder of share or shares to his registered Post Office address, and notice period shall begin with the day such notice or letter is mailed. ARTICLE XIV. A dissolution of the Trust Estate may be effected by the Trustee upon obtaining the written consent of a majority in interest of the registered shareholders; but the Trust Estate shall not be dissolved at*3905 any time prior to the period fixed herein for its dissolution while there is outstanding against the property of the Trust Estate the bonds or obligations of the Trustee, as such, secured by a mortgage on the property of the Trust Estate, without the written consent of the bondholders, and any dissolution shall be made without prejudice to any debts or claims against the Trust Estate, contracted by the Trustee. The Trust Estate may be continued beyond the period fixed for its termination by the Trustee, or the form of organization may be changed by the Trustee for purposes not inconsistent herewith. IN WITNESS WHEREOF, the said J. Connor Wise, Trustee, hereinbefore mentioned, has hereunto set his hand and seal in token of his acceptance of the Trust hereinbefore mentioned, for himself and his successors, this 28th day October of 1920. On the same day E. A. Landreth Co. sold to the Landreth Water Co., for the recited consideration of $50,000, the following described property in Stephens County, Texas: Casing and pipe$33,791.20Buildings4,734.00Machinery8,432.60Automobiles3,042.2050,000.00*13 The fair market value of said property on*3906 the date of sale was $50,000. This property included three Bessemer gas engines which cost $3,300; three Dodge automobiles which cost $4,500; and three Ford automobiles which cost $2,100. Prior to October 28, 1920, E. A. Landreth and the E. A. Landreth Co. had expended for the construction of the water plant on said property, $14,948.54. On the same day, the E. A. Landreth Co. conveyed to Landreth Water Co. the water lease and rights above referred to. The Landreth Water Co. paid the recited consideration of $50,000 with the whole of its capital stock, to wit, 500 shares. These shares the E. A. Landreth Co. immediately distributed among its stockholders in proportion to their holdings in the E. A. Landreth Co. E. A. Landreth was the holder of 775 shares of such stock out of a total of 2,000 shares issued, and received thirty-one eightieths of the Landreth Water Co. stock. Respondent valued the assets of the Landreth Water Co. at the date of the transfer at $81,916.11, valued E. A. Landreth's share of the Landreth Water Co. stock at $31,742.50, and determined that this payment in stock was a dividend, the whole of which was subject to a surtax, and deducted said sum of $81,916.11*3907 from the consolidated invested capital of petitioner and the Landreth Water Co.During the early part of 1921, petitioner abandoned wells Nos. 1, 7, and 8 on the Hale lease and thereby suffered a loss on the equipment of such wells in the amount of $3,078.57. Thereafter, in the year 1921, the Hale lease was sold to the Humble Oil & Refining Co., for $250,000. Petitioner received as its share of the purchase price, being for its share in the lease and for the equipment, all of which it owned, the sum of $183,666. In the early part of 1921, petitioner acquired an oil and gas lease known as the Vick lease on a 20-acre tract of land in Stephens County, Texas, for which it paid $15,000, $10,000 of this amount being for the lease and $5,000 for equipment. Soon thereafter, petitioner sold a one-half interest in the lease for $40,000, and in its income-tax return for 1921, reported a gain of $35,000. Petitioner sunk two wells which produced oil but not in quantity justifying further operation. These wells were plugged and the lease abandoned in 1921. Petitioner then removed its equipment to other leases, except pipe and casing in well No. 2, which had cost $2,247.56. Of this latter*3908 amount, petitioner sold part for $349.60. The remainder which was abandoned had cost $1,897.96. In November, 1921, petitioner purchased an oil and gas lease, known as the Thompson lease, on a 16-acre tract of ground in Limestone County, Texas, for which it paid $48,000 cash and agreed to pay the further sum of $16,000 out of oil to be extracted. The cash payment was made and petitioner incurred expenses in connection with the sale for commissions to agents in the further amount of *14 $4,800. On this property petitioner sunk a well to a depth of 850 feet, without striking oil. The depth which oil is found in this field is about 3,000 feet. Immediately east of the leased property a fault was discovered. Thereupon and in 1921, petitioner abandoned said lease and removed its equipment. Prior to the time petitioner abandoned the lease, wells had been sunk west of this fault and had come in dry. At the date of the abandonment of the lease, it had been demonstrated that to sink the well deeper would have been to incur an unnecessary expense. Petitioner abandoned equipment on this lease which cost it $2,019.68. Petitioner, in 1921, abandoned other leases which it had*3909 acquired and by reason of such abandonment lost certain equipment. The losses of equipment on said leases are as follows: Mussbaum$4,902.65Steuben Ranch2,362.83Graham5,372.97Stoker3,231.80Baker-Gannon1,547.23In 1921, the Landreth Water Co. sold all its assets for a price, the exact amount of which is not shown, but which was in the neighborhood In August, 1925, petitioner received the following letter: AUGUST 8, 1925. E. A. LANDRETH COMPANY, P.O. Box W, Breckenridge, Texas.SIRS: Reference is made to your protest dated July 6, 1925, in which exception is taken to the proposed assessment of additional tax in the amount of $1012.39 for the period April 20 to December 31, 1920, as set forth in office letter dated June 27, 1925. In view of the statement made in your brief the net income as reported in your amended return has been accepted without change and the proposed additional assessment cancelled. You are, however, entitled to an overassessment of $60.48 due to the fact that you prorated the $2,000.00 specific exemption for 8-11/30 months, whereas, you were entitled to the full $2,000.00. Net income reported on amended return$80,631.85Profits tax shown on return, Sec. 302$27,652.43Net income$80,631.85Less:Profits tax$27,652.43Exemption2,000.0029,652.43Balance taxable at 10%$50,979.425,097.94Total tax assessable$32,750.37Tax assessed32,810.85Overassessment$60.48*3910 *15 The overassessment shown herein will be made the subject of a Certificate of Overassessment which will reach you in due course through the Office of the Collector of Internal Revenue for your district and will be applied by that official in accordance with Section 281(a) of the Revenue Act of 1924. Respectfully, J. G. BRIGHT, Deputy Commissioner.Thereafter, on March 13, 1926, respondent determined the deficiency for the year 1920 above set forth. OPINION. MILLIKEN: Respondent has determined that from the date of the purchase of the Hale lease in April, 1920, petitioner was taxable as a corporation as that term is defined in section 1 of the Revenue Act of 1918, and section 2 of the Revenue Act of 1921. These sections provide that "The term 'corporation' includes associations, joint stock companies, and insurance companies." It remains to apply this definition to the facts as found. Up to September 8, 1920, the date the deed of trust was executed, the contributors to the fund which was held and managed by E. A. Landreth had entered into no agreement as to their rights as between themselves or as to third persons. There was not even an understanding*3911 between them. The only testimony on this point is that of E. A. Landreth. On cross examination he testified: Q. In discussing this matter with your bank, did you inform them at that time that you expected to perfect some sort of an organization? A. No, sir. Q. It was just between you and the members that this matter was understood? A. We had not even an understanding with the members. Q. Well, they were not led to believe, or they did not put their money into your charge under the assumption that it would remain a partnership or joint venture or something of that sort, did they? They expected you to make some sort of organization, perfect some sort of organization which would exempt them from liability? A. They put their money in there solely on my responsibility and in any way I wanted to handle the proposition. Q. Yes, sir; but was it the understanding that some sort of organization would be perfected whereby they would be exempted from further liability? A. That never was brought up. Q. You are positive as to that? A. Absolutely. It is clear that prior to September 8, 1920, the contributors had not attempted to secure a corporate charter; *3912 they did not constitute a stock company since they had issued no stock and had no authority to issue stock (33 C.J. 878); and they were not an insurance company. *16 The question remains, Were these contributors during this period operating as an association? In Hecht v. Malley,265 U.S. 144">265 U.S. 144, it is said: The word "association" appears to be used in the Act in its ordinary meaning. It has been defined as a term "used throughout the United States to signify a body of persons united without a charter, but upon the methods and forms used by incorporated bodies for the prosecution of some common enterprise." 1 Abb. Law Dict. 101 (1879); 1 Bouv. Law Dict. (Rawle's 3d Rev.) 269; 3 Am. & Eng. Enc. Law (2 Ed.) 162; and Allen v. Stevens (App. Div.), 54 N.Y.S. 8">54 N.Y.S. 8, 23, in which this definition was cited with approval as being in accord with the common understanding. Other definitions are: "In the United States, as distinguished from a corporation, a body of persons organized, for the prosecution of some purpose, without a charter, but having the general form and mode of procedure of a corporation." Webst. New Internat. Dict. "[U.S.] An organized*3913 but unchartered body analogous to but distinguished from a corporation." Pract. Stand. Dict. * * * A careful review of the testimony fails to disclose that during the period from April to September 8, 1920, the persons who contributed to the fund in the hands of E. A. Landreth conducted their business "upon the methods or forms used by incorporated bodies" or that their enterprise had the "general form and mode of procedure of a corporation." On the other hand, the evidence shows that at the beginning only E. A. Landreth was interested in the Hale lease and this solely by reason of the fact that the Metex Petroleum Corporation, for whose benefit the purchase was made, was financially unable to pay the price and handle the enterprise. Thereupon, E. A. Landreth first called upon his brother, who aided him by endorsing notes for borrowed money. Thereafter, and in June, 1920, others began to contribute. This continued until September 8, 1920, when all had contributed. It is shown that during this period E. A. Landreth carried on the business without consultation with the others. It appears that when he needed additional funds he secured them from whomsoever he pleased and without*3914 regard to the wishes or consent of the other contributors. The enterprise conducted up to September 8, 1920, was in the nature of a joint adventure. Cf. Alger Melton v. Commissioner,7 B.T.A. 717">7 B.T.A. 717. The fact that the Hale lease and the water rights stood in the name of E. A. Landreth does not detract from this view. In Irvine v. Campbell,121 Minn. 192">121 Minn. 192; 141 N.W. 108">141 N.W. 108, it is said: Real estate belonging to a partnership, whether the legal title be in one or more of the partners, is impressed with a trust for the benefit of the partnership, which follows it until it passes into the hands of a bona fide purchaser. Arnold v. Wainwright,6 Minn. 358">6 Minn. 358 (Gil. 241), 80 Am.Dec. 448; Harvin v. Jamison,60 Minn. 348">60 Minn. 348, 62 N.W. 394">62 N.W. 394; Stitt v. Rat Portage Lumber Co.,98 Minn. 52">98 Minn. 52, 107 N.W. 824">107 N.W. 824. The same rule applies where the parties engage in a joint enterprise the subject-matter of which is real estate. Bond v. Taylor,68 W. Va. 317">68 W.Va. 317, 69 S.E. 1000">69 S.E. 1000; *3915 Floyd v. Duffy,68 W. Va. 339">68 W.Va. 339, 348, 69 S.E. 993">69 S.E. 993, 33 L.R.A. *17 (N.S.) 883; Botsford v. Van Riper,33 Nev. 156">33 Nev. 156, 110 Pac. 705; King v. Barnes,109 N.Y. 267">109 N.Y. 267, 16 N.E. 332">16 N.E. 332; Withers & Gates v. Pemberton 3 Cold (Tenn.) 56; Davis v. Kellar,74 S.W. 1100">74 S.W. 1100, 25 Ky. Law Rep. 279; Fueschsel v. Bellesheim,14 N.Y.St.Rep. 610; Crenshaw v. Crenshaw (Ky.) 61 S.W. 366">61 S.W. 366; Kauffman v. Baillie,46 Wash. 248">46 Wash. 248, 89 Pac. 548; Jones v. Davis,48 N.J.Eq. 493, 21 Atl. 1035. Taking all the facts into consideration, we are of the opinion that during the period April, 1920, to September 8, 1920, the enterprise was conducted as a joint adventure and that the contributors to the fund should be taxed as joint adventurers. When we come to the trust agreement of September 8, 1920, a more difficult problem is presented. On this date for the first time the various contributors agreed upon a form of business organization. We say "business organization" for the reason that article 4 of the trust agreement provides that the company*3916 was authorized to conduct every branch of the oil and gas business from acquiring and selling oil and gas leases to refining and marketing the finished product, including the acquisition of franchises for and the installation and operation of pipe lines. The trust agreement also authorized the company to own and operate water plants and to sell water to individuals, corporations, and municipalities. The company was organized to transact business and the evidence shows that it did transact business. Cf. Appeal of Durfee Mineral Co.,7 B.T.A. 231">7 B.T.A. 231. The company had a capital stock represented by shares which were transferable but against the company only on its books. It had a name similar to a corporate name and a seal. It differed from an ordinary corporation or joint stock company only in that instead of having a board of directors, or trustees, as they are sometimes called, it operated through one person, styled a trustee, who for the term of the trust had uncontrolled authority in the management of its affairs and who was not subject to removal, except, of course, by a court for cause. Respondent asserts that the company was an association and relies solely*3917 upon Appeal of Durfee Mineral Co., supra. This case is not directly in point, since it was there found that the shareholders had a modicum of control over the trustees. Petitioner contends that since the shareholders could not and did not exercise any control over the trustee, the enterprise was a trust and, therefore, taxable as such, and cites Williams v. Milton,215 Mass. 1">215 Mass. 1; 102 N.E. 355">102 N.E. 355; Crocker v. Malley,249 U.S. 223">249 U.S. 223; and Hornblower v. White, 21 Fed.(2d) 82, and attempts to differentiate Hecht v. Malley,265 U.S. 144">265 U.S. 144. With respect to the fact that there was in the instant case but one trustee, it may be said that we do not think it can be successfully maintained that there could be no association or joint stock company if the sole trustee was subject to control of the shareholders. We pass, therefore, to the vital question - whether for income-tax purposes *18 such control is the distinguishing test between an association or a joint stock company, on the one hand, and a trust or partnership, on the other. We use the qualifying phrase "for income-tax purposes, *3918 " since the classification of taxpayers by the various revenue acts controls as against the classifications adopted by State courts for State purposes. See Burk-Waggoner Oil Association v. Hopkins,269 U.S. 110">269 U.S. 110. This disposes of the fact that the Massachusetts courts hold that trusts similar in many respects to the company here involved are partnerships or pure trusts, depending on whether the beneficiaries can or can not exercise control over the trustees. It is immaterial for the purpose of this proceeding whether the Massachusetts courts would hold that E. A. Landreth Co. was a trust (Williams v. Milton, supra), or that the Texas courts might hold it to be a partnership (Thompson v. Schmitt,115 Tex. 53">115 Tex. 53; 274 S.W. 554">274 S.W. 554). The question is not what this company would be deemed under the laws of either of these States or of any State, but what it was for income-tax purposes under the Revenue Acts of 1918 and 1921. In Hecht v. Malley, supra, the case of *3919 Crocker v. Malley, supra, is discussed at length and the effect of its decision limited to the particular facts of that case. The Hecht case involved three "Massachusetts trusts," which are described by the court as follows: The Hecht Real Estate Trust was established by the members of the Hecht family upon real estate in Boston used for offices and business purposes, which they owned as tenants in common. It is primarily a family affair. The certificates have no par value; the shares being for one-thousandths of the beneficial interest. They are transferable; but must be offered to the trustees before being transferred to any person outside of the family. The trustees have full and complete powers of management; but no power to create any liability against the certificate holders. There are no meetings of certificate holders; but they may, by written instrument, increase the number of trustees, remove a trustee, appoint a new trustee if there be none remaining, modify the declaration of trust in any particular, terminate the trust, or give the trustees any instructions thereunder. The Haymarket Trust is strictly a business enterprise. It was established*3920 by the original subscribers who furnished the money for the purchase of a building in Boston used for store and office purposes. The shares are of the par value of $100 each. Except as otherwise restricted, the trustees have general and exclusive powers of management, but no power to bind the certificate holders personally. At any annual or special meeting of the certificate holders, they may fill any vacancies in the number of trustees, depose any or all the trustees and elect others in their place, authorize the sale of the property or any part thereof, and alter or amend the agreement of trust. The Crocker, Burbank & Co. Ass'n is also a business enterprise. It was formerly entitled the Wachusett Realty Trust. The certificates have no par value; the shares being for ninety-six thousandths of the beneficial interest in the property. The trustees originally held the fee of certain lands subject to a long lease and the stock of a Massachusetts corporation engaged in *19 manufacturing paper and owning and operating several mills. In *3921 Crocker v. Malley,249 U.S. 223">249 U.S. 223 (1919), in which the original trust instrument was before the court, it was held that the trustees were not subject as to the dividends received from the corporation to the tax imposed by the Income Tax Act of 1913 (38 Stat. 172) upon the net income of "every corporation, jointstock company or association * * * organized in the United States," but were subject only to the duties imposed by the Act upon trustees. The original trust agreement involved in that case has now, however, been modified, with the assent of the certificate holders. By this modification, "the form of (the) organization" was specifically "changed to that of an association," under its present name. The trustees were authorized to surrender the stock of the manufacturing corporation, to acquire instead its entire property, and to carry on the business theretofore conducted by it, or any substantially similar business. The title to all the trust property "and the right to conduct all the business" were vested exclusively in the trustees, who were authorized to designate from their number a president and other officers and to prescribe their duties. The certificate*3922 holders were authorized, at any meeting, to remove any trustee and elect trustees to fill any vacancies. Since the modification of the trust agreement, the trustees have carried on the manufacturing business in substantially the same manner as it was formerly conducted by the corporation. The court, after quoting at length from its opinion in the Crocker case, said: This opinion is based primarily upon the view that the Income Tax Act, considering its purpose, did not show a clear intention to impose upon the trustees as an "association" a double liability in reference to the dividends on stock in the corporation that itself paid an income tax, when considered as "trustees" they were by another provision of the Act exempt from such payment. And the language used arguendo in reaching this conclusion that the trustees could not be deemed an association unless all trustees with discretionary powers are such, and that there was no ground for grouping together the beneficiaries and trustees in order to turn them into an association - is to be read in the light of the trust agreement there involved, under which the trustees were, in substance, merely holding property for the*3923 collection of the income and its distribution among the beneficiaries, and were not engaged, either by themselves or in connection with the beneficiaries, in the carrying on of any business. Zonne v. Minneapolis Syndicate,220 U.S. 187">220 U.S. 187, 190, 31 Sup.Ct. 361, 55 L. Ed. 428">55 L.Ed. 428. And see Smith v. Anderson, L.R., 15 Ch.Div. 247. It results that Crocker v. Malley is not an authority for the broad proposition that under an Act imposing an excise tax upon the privilege of carrying on of business, a Massachusetts Trust engaged in the carrying on of business in a quasi-corporate form, in which the trustees have similar or greater powers than the directors in a corporation, is not an "association" within the meaning of its provisions. We conclude, therefore, that when the nature of the three trusts here involved is considered, as the petitioners are not merely trustees for collecting funds and paying them over, but are associated together in much the same manner as the directors in a corporation for the purpose of carrying on business enterprises, the trusts are to be deemed associations within the meaning of the Act of 1918; this being*3924 true independently of the large measure of control exercised by the beneficiaries in the Hecht and Haymarket cases, which much exceeds that exercised by the beneficiaries under the Wachusett Trust. We do not *20 believe that it was intended that organizations of this character - described as "associations" by the Massachusetts statutes, and subject to duties and liabilities as such - should be exempt from the excise tax on the privilege of carrying on their business merely because such a slight measure of control may be vested in the beneficiaries that they might be deemed strict trusts within the rule established by the Massachusetts courts. (Italics supplied.) The outstanding thought that runs through the whole of this opinion is that the "Massachusetts trusts" therein involved were associations for Federal tax purposes for the reason that the shareholders had associated themselves together under the form of a corporation for the purpose of engaging in a business. The Crocker case is distinguished, not on the ground that the shareholders could exert no control over the trustee, but on the ground that the Wachusett Trust was not engaged in business. *3925 Then following the statement to the effect that where a trust is organized for the purpose of carrying on a business under corporate forms, it is an association independently of whether the beneficiaries exercised such a measure of control over the trustees as to constitute the trust a partnership under the laws of Massachusetts, and, on the other hand, that such a trust is an association even though it would be held by the Massachusetts courts to be a strict trust by reason of lack of such control. It thus appears that the court discards the test of control in determining whether such a trust is an association, under the revenue acts, and makes the test whether it was or was not organized for purely business purposes. This seems to be the true distinction. See Cook on Corporations, Vol. III (8th ed.), p. 2251. In appeal of Durfee Mineral Co., supra, we said: Shareholders have little or no authority practically, in any case, and it appears that the use of the control test, alone, is illogical and prolific of litigation and further confusion. In the instant case the shareholders voluntarily entered into the trust agreement. The trust was not imposed upon*3926 them by a third person. They, themselves, granted to the trustee the authority covered by the trust agreement and whatever powers he exercised and whatever rights the contributors denied themselves arose from a contract voluntarily entered into by all the parties. These persons could have voluntarily conferred such authority upon trustees on directors for a specified term. There is nothing sacred in a one-year term for directors and there is no logical reason why such authority could not be conferred for a longer period. The vital question presented is not whether the absence of control of the trustee by the shareholders determined that E. A. Landreth Co. was a trust as distinguished from a partnership, but whether, under all the facts of this case, E. A. Landreth Co. was as association, even though the *21 shareholders had by contract voluntarily divested themselves of the right to control the trustee for the whole life of the company. The nature of the right of stockholders to vote their stock is discussed at length in *3927 General Inv. Co. v. Bethlehem Steel Corporation,87 N.J.Eq. 234, 100 Atl. 347. The facts in that case were that the Bethlehem Steel Corporation had originally a capital stock of $30,000,000, divided equally between preferred and common stock, all stock having voting rights. The corporation increased its capital stock by $45,000,000, all the new stock being common stock but none of which had voting rights. It was the intent of those who proposed the plan that the management of the corporation should be retained by its old management. This plan was attacked on the ground, among others, that the purpose of the plan was to continue the old management, irrespective of the fact that the new issue, which was common stock, amounted to three-fifths of the entire capital stock, and that this would result in giving to a minority the control of the corporation. The court in holding the new issue of stock valid said. It is almost impossible to get a definition of "common stock" or a statement of what classes of stock may be issued, and the necessary rights and privileges of the classes, that is satisfactory. Thompson, § 3426, in referring to common stock, says that*3928 the name itself indicates its nature, and it is so called because it is the common stock, or the stock which private corporations generally issue; and is usually the only kind authorized. He says the universal rule is that the owners of common stock are entitled to a pro rata dividend of profits, and to a pro rata participation in the management of the corporation; that the holders of common stock sometimes have a preference in the management of the corporation. In section 3425 with reference to classes of stock he states: "The first general division of stock in into common or preferred stock; and these two classes are again subdivided into almost an infinite variety." Section 859: "The rule that a right to vote follows the ownership of stock means only that in the absence of any common restriction upon all the stock, or upon a class of stock, this right prevails. That is, the right of a stockholder to vote can not be arbitrarily abridged and is not subject to universal restriction. But the rule is equally emphatic, if not so general, that restrictions may be placed upon the right to vote; or, as sometimes stated, the right to vote may be separated from the ownership of stock. *3929 It must be remembered, in this connection, that stockholders can make any agreement respecting their stock, or the voting of it, that they may see fit or deem wise, except agreements that are void as against public policy."He cites Miller v. Ratterman,47 Ohio St. 141">47 Ohio St. 141; 24 N.E. 496">24 N.E. 496, Supreme Court of Ohio. There the question was as to whether preferred stock might be issued without voting privileges. The court said: "It is true that one characteristic of stock, generally, is that it can be voted upon. But this is not essential. Indeed, instances may arise where it is good policy to prohibit the voting upon stock" - citing cases. Thompson, § 859, contains the statement: "So, it has been established that holders of preferred stock may be denied the right to vote the same at any meeting of the holders of the capital stock *22 of the corporation. The legality of such restriction is not based on the theory that preferred stockholders are guaranteed a dividend but rather on the inherent power of the corporation to restrict the voting power. It is simply a contract relation between two classes of stockholders, in which the public*3930 has no concern." He instances a great number of cases where restrictions with respect to voting has been imposed upon common stock; i.e., one stockholder should not vote more than a fourth of the total, a stockholder should not vote more than 100 shares, nonresidents should not vote, purchasers of forfeited stock should not vote, even though not liable for the amount due until the amount due was paid. "There is no rule of public policy which forbids a corporation and its stockholders from making any contract they please in regard to restrictions on the voting power." Cook on Corporations, § 622B. "Inasmuch as preferred stockholders are members of the company, and except in so far as their rights may be altered by the contract, statute, or by-law under which the shares are issued, entitled in all respects to the same rights as other shareholders, it follows that they have the same voting rights as other shareholders. The right of shareholders to vote is, however, like the right to dividends or to participate equally in a division of capital on liquidation regarded as a private matter for each shareholder which he may waive if he choose. Consequently, a provision that*3931 shareholders of a certain class shall have no right to vote is, if assented to by them, quite valid. Such a provision might theoretically be made as to either the preferred to the deferred (Machen calls common deferred shares), but it is much more common with respect to the preferred shares so as to compensate the other shareholders for the preference of the preferred stockholders as to dividends." Machen, § 570. "A stockholder has no right to vote at corporate meetings, whether the stock is common or preferred, if it is so stipulated when the stock is issued, for the stipulation is then a term of his contract." 3 Clark & Marshall, p. 1966. Mackintosh et al. v. Flint P.M.R. Co. (C.C.) 32 Fed. 350, and Id.34 Fed. 582, is referred to in Clark & Marshall as authority for the proposition that preferred stock may be given the exclusive privilege of voting, at least in that case for a time. Counsel have not referred me to any case enunciating a public policy which would require that all common stockholders should have the voting privilege. In this state it has been held that the matter is purely one of contract. *3932 McGregor v. Home Ins. Company of N.J.,33 N.J.Eq. 181; In re Newark Library Ass'n. 64 N.J. Law, 218, 43 Atl. 435. This seems to be the rule in the other states. (Italics supplied.) The above case and the numerous authorities cited therein seem to make clear that stockholders can by contract deprive themselves of the right to vote the stock and thereby remove from themselves the right to control a corporation. This is precisely what the persons who signed the trust agreement did. We are of opinion that the shareholders voluntarily associated themselves together under the name of E. A. Landreth Co. for the purpose of engaging in business, using that term in its broadest sense, under the methods and forms used by corporate bodies; that they did so engage in business; that the fact that they by voluntary contract delegated to the trustee powers which they might have *23 exercised, except for such delegation, in no way alters the fact that they constituted an association within the meaning of the Revenue Acts of 1918 and 1921; and that on September 8, 1920, there came into existence a new taxable entity which was taxable as a corporation, *3933 which possessed all the rights and privileges of a corporation for tax purposes, and that on that date the company acquired the assets theretofore held by E. A. Landreth for the benefit of his co-joint adventurers in consideration of the issue of its capital stock. In reaching this conclusion, we have not overlooked the decision of the United States District Court of Massachusetts in Hornblower v. White, supra, where the court adheres to the distinction which is drawn by the Courts of Massachusetts between trusts and partnerships. Until the Supreme Court expresses views at variance with their decision in Hecht v. Malley, supra, we feel called upon to follow what we believe to be the correct interpretation of that decision. What we have said with reference to the E. A. Landreth Co. applies with equal force to Landreth Water Co.Both companies were taxable as associations. Since the stock of both companies was held by the same persons and in the same proportions, respondent did not err in determining that the two companies were affiliated. Petitioner contends that since respondent had once determined its tax for the year 1920 as shown*3934 by the letter of August 8, 1925, he could not thereafter redetermine the tax and on this point relies on section 1107 of the Revenue Act of 1926, which provides: In the absence of fraud or mistake in mathematical calculation, the findings of facts in and the decision of the Commissioner upon (or in case the Secretary is authorized to approve the same, then after such approval) the merits of any claim presented under or authorized by the internal-revenue laws shall not, except as provided in Title IX of the Revenue Act of 1924, as amended, be subject to review by any other administrative or accounting officer, employee, or agent of the United States. It appears that the determination made in the letter of August 8, 1925, and in the deficiency letter which is the basis of this proceeding, were made by the same officer, to wit, the Commissioner of Internal Revenue, and we know that the same individual held this office during the whole period involved. No administrative or accounting officer other than the Commissioner has attempted to review his first finding. This contention is without merit. As shown in the findings of fact, the amount of $14,948.54 which petitioner claimed*3935 in his petition as a deduction in 1920 on account of labor and teaming expenses was in fact a capital expenditure made on the water plant which was transferred to the Landreth Water Co. Respondent is affirmed as to this item. *24 We have found that petitioner's interest in the Hale lease had a value as of September 8, 1920, the date of petitioner's organization, of $464,344.95 and that this amount included the value of the equipment which had theretofore cost $193,034.84. The exact cost of the equipment is shown and the value which we have placed upon petitioner's interest in the lease is, we believe, conservative. E. A. Landreth, who has had long experience in the oil and gas business, testified that this lease, including equipment, had a value on September 8, 1920, of from $500,000 to $750,000, and that in January, 1921, an offer of $600,000 was made for the lease. Petitioner introduced a computation made in 1927 which shows a higher value, but this computation contains facts which were not known in September, 1920. Taking into consideration the opinion of E. A. Landreth as to the value of the lease and the fact that an actual offer for it of $600,000 was made, we*3936 are of opinion that the lease and equipment was well worth $600,000 on September 8, 1920. Since the interest or control of the joint adventurers remained the same in the association formed on September 8, 1920, the invested capital could not be computed with an allowance greater than the cost of acquisition to the prior owners. See section 331 of the Revenue Act of 1918. Cf. W. A. Sheaffer Pen Co.,9 B.T.A. 842">9 B.T.A. 842. The amount of $464,344.95 should be included in the cost of the lease to petitioner in computing the gain or loss arising from its sale in 1921. Next, petitioner asserts error as to respondent's determination of the depreciation sustained during the year 1920 upon the equipment on the Hale lease. There is no dispute as to the rate. We have found the original cost of the equipment to be $193,034.84. Depreciation should be computed upon this amount, plus any addition to the equipment that may have been made after September 8, 1920. The losses incurred by petitioner in 1921 in the sale of the Hale lease and loss of equipment thereon and by the abandonment of the Vick, Mussbaum, Steuben Ranch, Graham, Stoker, and Baker-Gannon leases should be computed*3937 in accordance with the facts found. Petitioner asserts that respondent erred in determining that the cost of the assets conveyed by it to the Landreth Water Co. was $81,916.11 instead of $60,224.44, which amount petitioner asserts was a true cost and that respondent erred in determining that said transfer resulted in a dividend in kind to the extent of $81,916.11. The allegation with respect to the first error was denied, and it may be pointed out in passing that although petitioner has proven that the property set forth in the findings of fact had a then market value of $50,000, it has failed to prove what was the cost of such property, and also what was the cost or value, if any, of the water *25 rights which were transferred at the same time. In the absence of such evidence, the determination of respondent as to the value of the property acquired by the Landreth Water Co. is approved. In so far as petitioner, E. A. Landreth Co., is concerned, only two results can flow from this valuation (1) what was the amount of loss on the sale of the assets of Landreth Water Co. in 1921, and (2) what was the amount of the consolidated invested capital as of October 28, 1920. On*3938 the first point, as above shown, there is not sufficient evidence to show that respondent's determination was erroneous. When we come to the second point, we find that respondent has reduced the consolidated invested capital by the amount of the value of the stock of Landreth Water Co., which was distributed by petitioner to its stockholders. While this distribution served to reduce invested capital of petitioner, E. A. Landreth Co., it could not reduce the invested capital of the group. To hold otherwise would be to lose sight of the well defined distinction between the statutory concept of invested capital and capital stock. The consolidated invested capital of the group could be neither increased nor decreased by transfers of shares of stock which did not "break up the affiliation." Cf. Farmers Deposit National Bank,5 B.T.A. 520">5 B.T.A. 520. Since it appears that respondent has reduced the invested capital of the group by the amount of the value of the dividend, this amount should be restored to the consolidated invested capital. E. A. Landreth and Adelle H. Landreth, in their respective appeals, assert three errors. The first error alleged is to the effect that respondent*3939 erred in determining that the E. A. Landreth Co. and the Landreth Water Co. were associations. This contention has already been disposed of adversely to petitioners' contention. The second and third allegations are quite confusing and nothing can be found in the record which in any way indicates what was the basis upon which the amounts therein alleged can be predicated. It is sufficient to say that if E. A. Landreth Co. had on October 28, 1920, an earned surplus of equal or greater value than the value of the dividend as found by respondent, there was no error in respondent's determination in this respect. Since we are not informed as to what, if any, was the surplus of E. A. Landreth Co. on said date, respondent's action in determining that the whole of said dividend was taxable at surtax rates must be affirmed. Reviewed by the Board. Judgment will be entered upon 15 days' notice, under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619441/ | MILTON H. SORIANO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; SWANI J. SORIANO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSoriano v. CommissionerDocket Nos. 18995-89, 23453-89United States Tax CourtT.C. Memo 1991-2; 1991 Tax Ct. Memo LEXIS 2; 61 T.C.M. (CCH) 1622; T.C.M. (RIA) 91002; January 7, 1991, Filed *2 Decision will be entered under Rule 155 in docket No. 18995-89. Decision will be entered for the respondent in docket no. 23453-89. Milton H. Soriano, pro se at docket No. 18995-89. Ronald E. Braley and Paul A. Tonella, for the petitioner at docket No. 23453-89. Lisa M. Oshiro, for the respondent. SWIFT, Judge. SWIFTMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined separate deficiencies in petitioners' Federal income tax liabilities as follows: Docket No. 18995-89YearDeficiency1985$ 4,84719864,589Docket No. 23453-89YearDeficiency1985$ 3,19419868,187The primary issue for decision*3 in these consolidated cases is whether amounts paid in 1985 and 1986 by petitioner Milton H. Soriano to petitioner Swani J. Soriano are to be treated as alimony payments or as a division of community property. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Petitioner Milton H. Soriano (Milton) resided in Seattle, Washington, at the time he filed his petition. Petitioner Swani J. Soriano (Swani) resided in San Francisco, California, at the time she filed her petition. Milton and Swani were married on October 14, 1971. Swani filed for divorce in 1979. The Superior Court for King County, State of Washington, granted the divorce on March 31, 1981. After a trial as to the proper division of the community property, a final decree of dissolution of the marriage and a division of the community property was entered on April 11, 1983. The Superior Court found that because Milton controlled the community assets, all community property should be awarded to him, except for various personal belongings, and that Milton would be required to make a lump-sum payment to Swani to equalize the value of the property each received with respect to the community property. *4 The amount of the lump-sum payment to be made by Milton to Swani was $ 315,988. Because of the illiquidity of the property, the Superior Court ordered that Milton could make payment to Swani of the $ 315,988 lump sum in four installments over four years: $ 65,988 one month after the decree of divorce and division of community property became final; $ 100,000 at the end of the first year; $ 100,000 at the end of the second year; and $ 50,000 at the end of the third year. These installment payment obligations with respect to Milton's lump-sum payment obligation were to be secured by Milton's personal residence, by additional real estate, and by other personal assets. The Superior Court further found that if Milton timely paid to Swani the $ 315,988 pursuant to the installment schedule set forth above, both Milton and Swani would be left with substantial estates and that in that situation maintenance or support payments to Swani would not be appropriate. The Superior Court also found, however, that if its final decree of divorce and division of community property was appealed by either party (delaying payment of the lump-sum installment obligations to Swani and thereby delaying *5 distribution to her of her share of the community property), "temporary maintenance" payments would be required to be made by Milton to Swani in the amount of $ 2,000 per month until final termination of the appeal or until Milton made the first installment payment with regard to his lump-sum payment obligations, whichever occurred first. The Superior Court further found that any temporary maintenance payments made by Milton under this provision were not to be charged against the total $ 315,988 lump sum ultimately to be paid to Swani as part of the division of community property. Milton appealed many aspects of the Superior Court's findings with respect to the division of community property. The Court of Appeals of the State of Washington rendered its decision with respect to Milton's appeal on July 21, 1985. After making a number of adjustments and recharacterizing some of the property, the appellate court generally affirmed the Superior Court's findings. The appellate court specifically upheld the Superior Court's award of maintenance payments during the pendency of any appeal, stating as follows: Maintenance is awarded under [Revised Code of Washington] 26.09.090 based*6 upon the need of the recipient after considering several factors which include the resources of the paying party and the standard of living established during the marriage. See also Stringfellow v. Stringfellow, 53 Wn. 2d 359">53 Wn.2d 359, 333 P.2d 936">333 P.2d 936 (1959).[T]he wife has . . . the right to support and maintenance, as befits her station in life, during the pendency of the appeal if she establishes a need therefor. Stringfellow, at 360. The record before the trial court fully apprised it of the wife's need, the resources of the husband, and the standard of living of the parties, all of which support the maintenance award. The appellate court, however, in part, modified the Superior Court's findings in that the appellate court held that the total amount of the monthly temporary maintenance payments Milton made to Swani during the pendency of the appeal should reduce the total amount of the lump-sum payment due Swani under the division of community property. In this regard, the appellate court stated briefly as follows: The subsequent decision in the Stringfellow dissolution, Stringfellow v. Stringfellow, 56 Wn. 2d 957">56 Wn.2d 957, 962, 350 P.2d 1003">350 P.2d 1003, modified*7 , 353 P.2d 671">353 P.2d 671 (1960), taxed similar payments against the property division. This action by the Supreme Court occurred at the conclusion of the appellate proceedings and was taken in view of the property division and the parties' situation. Such action is also appropriate in the circumstances of this case. The temporary maintenance shall be taxed against the property division, to reduce the final payment under the decree. Milton made the $ 2,000 monthly maintenance payments to Swani during the pendency of the appeal. The monthly maintenance payments Milton made to Swani in 1983 and in 1984 were deducted by Milton and included by Swani as alimony on their separate Federal income tax returns for those two years. Milton also deducted as alimony the $ 24,000 in total monthly maintenance payments he made to Swani in each of 1985 and 1986 on his Federal income tax returns for those years. Swani's Federal income tax returns for 1985 and 1986, however, were filed after the July 21, 1985, decision of the Washington appellate court, and because the appellate court reduced the amount of the $ 315,988 lump-sum payment Swani was to receive under the division of community property*8 by the amount of the monthly maintenance payments she received from Milton, Swani and her tax representatives did not, on Swani's Federal income tax returns for 1985 and 1986, treat the total $ 24,000 in maintenance payments Swani received in each of those years as alimony income. On audit, respondent determined that the $ 24,000 in total maintenance payments Swani received in 1985 and in 1986 was alimony and should be included in Swani's income. In light of the position taken on Swani's 1985 and 1986 tax returns regarding the nonincludability of the maintenance payments, and to protect the revenue, respondent also disallowed the alimony deductions claimed on Milton's 1985 and 1986 Federal income tax returns. OPINION With certain exceptions not applicable here, with regard to divorce or separation instruments executed before January 1, 1985, section 71(a)(1) 1 provides that payments are included in income as alimony if they are received by a wife from her husband or ex-husband as periodic payments incident to a divorce decree and in discharge of the husband's legal obligation arising out of the marital or family relationship. 2 Section 215 provides the corollary rule that such *9 payments are deductible to the husband or ex-husband. The requirement that the payments be received*10 because of the marital or family relationship is based on the premise that alimony payments are received for the support and maintenance of the wife, rather than in satisfaction of vested property rights. Wright v. Commissioner, 543 F.2d 593">543 F.2d 593, 597 (7th Cir. 1976), affg. 62 T.C. 377">62 T.C. 377 (1974). In determining whether payments are to be treated as taxable alimony or support payments, on the one hand, or as a nontaxable distribution of community property, on the other, some of the factors to consider are whether there is a stated total fixed sum to be paid, whether the amount of the payments are related to the husband's income and the wife's needs, whether the payments continue without regard to the remarriage or death of the wife, and whether the wife relinquished any of her vested property rights in return for the payments. Riley v. Commissioner, 649 F.2d 768 (10th Cir. 1981); Beard v. Commissioner, 77 T.C. 1275">77 T.C. 1275, 1284-1285 (1981). The labels placed upon the payments by a state court are not necessarily controlling, Riley v. Commissioner, supra at 773-774; Hayutin v. Commissioner, 508 F.2d 462 (10th Cir. 1974), and all facts and circumstances will be considered*11 in resolving this fact issue. Wright v. Commissioner, 62 T.C. 377">62 T.C. 377, 389 (1974), affd. 543 F.2d 593">543 F.2d 593 (7th Cir. 1976). As explained, Swani argues that because the July 21, 1985, Washington appellate court reduced the total amount Swani was to receive as her part of the distribution of community property, the maintenance payments were effectively and retroactively recharacterized and, with respect to 1985 and 1986, should now be treated as nontaxable distributions of community property. We disagree. The monthly maintenance payments awarded to Swani in 1983 by the Washington superior and appellate courts clearly constituted alimony support payments. They were periodic in nature and were based on the monthly maintenance needs of Swani and the income resources of Milton. Both Swani and Milton treated the monthly payments received in 1983 and 1984 as alimony, includable in income by Swani and deductible by Milton, and those payments are not distinguishable from the payments at issue for 1985 and 1986. The Washington Superior Court certainly regarded the monthly maintenance payments as support payments, not as part of the division of community property. As we read and understand*12 the decision of the Washington appellate court, it also analyzed and regarded the monthly maintenance payments as just that (i.e., as temporary support or alimony payments), and it upheld the Superior Court's imposition of those payments as such. The fact that a reduction was made to the total amount of Swani's share of the community property does not, in our opinion and on the facts of this case, convert the monthly maintenance or alimony payments into a division of the community or marital property. For the reasons stated, the $ 24,000 in maintenance payments Swani received in 1985 and 1986 are includable in her income and are deductible by Milton. Respondent, at trial, argued summarily that because Milton realized a substantial benefit in 1986 when the appellate court reduced the payment Swani was to receive under the division of community property, the tax benefit rule of section 111 or the discharge of indebtedness rule of section 61(a)(12) applies and the amount by which Swani's share of the community property was reduced should be included in Milton's income. We disagree. The tax benefit rule of section 111 has no application because the reduction in the amount Milton *13 was to pay under the division of community property did not represent a "recovery" of any portions of Milton's maintenance payments. The appellate court's reduction in the amount Milton was to pay under the division of community property obviously was influenced by the amount of the maintenance payments, but that reduction simply represented part of the determination and analysis by the appellate court as to the proper division of the community property, not a recovery to Milton of maintenance payments he previously made. The discharge-of-indebtedness-income rule of section 61(a)(12) also has no application to the facts of this case because no indebtedness of Milton's was discharged. Milton had no fixed obligation under the Washington Superior Court's decision with regard to the decision of community property because that decision never became final and was modified on appeal. Milton's only obligation with regard to the division of community property came into effect with the finality of the appellate court decision, and no discharge occurred at any time with respect to any portion thereof. Milton raises two additional items as deductible interest expense. No substantiation, *14 however, has been provided, and we sustain respondent's disallowance of these items. Decision will be entered under Rule 155 in docket No. 18995-89. Decision will be entered for the respondent in docket No. 23453-89. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as in effect for the years in issue.↩2. Section 71(a)(1), with certain exceptions not applicable here, as in effect for divorce and separation instruments executed before January 1, 1985, provided as follows: SEC. 71. ALIMONY AND SEPARATE MAINTENANCE PAYMENTS. (a) General Rule. -- (1) Decree of divorce or separate maintenance. -- If a wife is divorced or legally separated from her husband under a decree of divorce or of separate maintenance, the wife's gross income includes periodic payments (whether or not made at regular intervals) received after such decree in discharge of (or attributable to property transferred, in trust or otherwise, in discharge of) a legal obligation which, because of the marital or family relationship, is imposed on or incurred by the husband under the decree or under a written instrument incident to such divorce or separation. Respondent refers us in his trial brief to a version of section 71 not applicable until later years.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619442/ | Clarence B. Mitchell, Petitioner, v. Commissioner of Internal Revenue, RespondentMitchell v. CommissionerDocket No. 3889United States Tax Court6 T.C. 159; 1946 U.S. Tax Ct. LEXIS 304; January 31, 1946, Promulgated *304 Decision will be entered under Rule 50. In 1941 petitioner, in contemplation of a divorce proceeding, transferred certain securities in trust for life to his wife, with remainder to his four children, and also transferred certain other property directly to his wife. The transfers to his wife were made in settlement of his obligation to support her. Later the settlement was embodied in a divorce decree by a Nevada court by which petitioner was granted a divorce from his wife. In a gift tax return petitioner included the value of the remainder interest which he gave to his four children, but did not include as a taxable gift the value of the property settlement which he had made upon his wife in lieu of alimony and in discharge of his obligation to support her. The Commissioner, in his determination of the deficiency, has included this latter interest as a taxable gift. Held, following Herbert Jones, 1 T.C. 1207">1 T. C. 1207, and Edmund C. Converse, 5 T. C. 1014, that such conveyance by petitioner to his wife was made without donative intent in an arm's length transaction settling her right to maintenance and support from*305 petitioner and is not subject to gift tax. Robert F. Graham, Esq., and James A. Velde, Esq., for the petitioner.Harold H. Hart, Esq., for the respondent. Black, Judge. BLACK *159 The Commissioner has determined a deficiency of $ 49,860.57 in petitioner's gift tax for the calendar year 1941. The deficiency is based upon a determination by the Commissioner that petitioner is taxable upon property transferred as a gift in 1941 of the value of $ 506,931.14, instead of $ 142,857.01 as reported by petitioner on his gift tax return. The chief item of increase in the amount reported by petitioner was explained in the deficiency notice as follows:It is held that the transfer in trust under date of February 25, 1941, constituted a completed gift for the beneficiaries of said trust, and that no deduction is allowable therefrom*306 for the value of the interest transferred for the use and benefit of Marjorie King Mitchell.Respondent has filed an amended answer in which he claims an increased deficiency based on the inclusion, as a taxable gift, of additional *160 property of the value of $ 36,635.80 transferred to the wife in 1941. Petitioner not only contests the original deficiency and the increased deficiency, but claims an overpayment of $ 4,189.75 in gift tax for the calendar year 1941.FINDINGS OF FACT.Many of the facts have been stipulated and the stipulation of facts is incorporated herein by reference.Petitioner is an individual who resides in Chicago, Illinois. The return for the period here involved was filed with the collector for the first district of Illinois. The petitioner and his former wife, Marjorie King Mitchell, sometimes hereinafter referred to as Marjorie, were married in Chicago, Illinois, in 1924, and thereafter they moved to Santa Barbara, California. In the fall of 1940 they separated, and he informed her that he proposed to get a divorce and remarry. She continued living in their home in Santa Barbara and he returned to Chicago. At the time of the separation she was *307 36 years old and he 42, and there were 4 children of the marriage, the oldest 15 and the youngest 4 years old.In October 1940 petitioner consulted an attorney in Chicago with respect to reaching a settlement with his wife and obtaining a divorce. His attorney advised him that it was his obligation to support his wife and that the settlement of that obligation would have to be the subject of negotiations with her. She retained counsel in Chicago to attempt a settlement of the question of alimony and support in connection with the separation and divorce of the petitioner and herself. From the middle of October 1940 until the first week in February 1941, her attorneys carried on negotiations with his attorney for the settlement of his obligation to support her. Her father, Garfield King of Chicago, actively participated, attended all meetings of the attorneys, and was insistent that his daughter secure her rights. Her attorneys obtained a full statement of petitioner's assets for the purpose of determining what property, securities, and life insurance he had. They also obtained copies of his income tax returns for three years in order to determine what his income had been.At the*308 beginning of the negotiations Marjorie's father insisted that she was entitled to 75 percent of everything that petitioner had. Her attorneys later demanded that she be given the family home in Santa Barbara, an insurance policy on petitioner's life, and 60 percent of all of his other property outright. The petitioner rejected these proposals. Negotiations were continued and finally it was agreed (a) that the petitioner would transfer the Santa Barbara house, certain household goods, and the $ 25,000 insurance *161 policy, which had a cash surrender value of $ 6,135.80, to her outright, and (b) that he would transfer 50 percent of his other property, consisting solely of securities, to trustees under a trust agreement which would provide for payment of the trust income to her for life and for distribution of the trust corpus to their 4 children upon her death or when all of the children had attained the age of 25 years, whichever event should occur last. In arriving at the settlement, consideration was given by Marjorie's attorneys to the amount of income she would need to live as she had been living, the amount of petitioner's income, the amount of principal it would take*309 in a trust to produce the amount of income which Marjorie needed, and the probable amount of annual income that would be produced by the property placed in trust under the terms of the settlement.In addition to providing for the transfers mentioned above, the agreement contained mutual provisions under which each party relinquished, released, and waived to the other party all rights of dower, homestead, inheritance, descent, and distribution which each party might have as husband or widower, or as wife or widow, as the case may be, by reason of the marital relations existing between them. The agreement also provided that in the event of a divorce the transfers under the agreement should be in full satisfaction of all rights of alimony and support. This provision reads as follows:10. It is further mutually covenanted and agreed between the parties hereto that, in the event that either party should hereafter sue the other and obtain a decree of divorce or for separate maintenance, the provisions for payments to be made by the party of the first part and for the division of property and settlement of property rights, as hereinbefore set out, and the covenants and agreements herein*310 contained, shall be in lieu and in full of any and all rights or claims of either party against the other for alimony and support (including support for the children), either temporary or permanent, and in lieu of all dower, homestead or other rights or interests or claims on the part of either party, whether before or after the death of either or the other of the parties, or whether by way of inheritance, survivorship, or otherwise, against the other party, or his or her estate, or in, to or against the property of the other party * * *.The opening recitals of the agreement contained the following statement with respect to the desire of the parties to provide for the separate maintenance of the wife and to settle all rights in the property of each other:Whereas, the parties hereto desire to make arrangements for the separate maintenance of the party of the second part, and desire to settle now and forever all rights of property, dower rights, homestead rights, and all other property rights, including all rights of each party in and to any and all community property and claims growing out of the marriage relation existing between them which *162 either of them has or may have*311 against the other, and all rights which either of them has or may hereafter have in the property, of every kind and nature, real, personal and mixed, now owned by the other, or which may be hereafter acquired by the other * * *.The recital concluded by stating that the parties, in consideration of the settlement, desired to discharge the petitioner's liability for support:* * * and in consideration of the settlement effected by the terms hereof to release party of the first part from any and all further liability and obligation to contribute to the support of the party of the second part * * *.On February 5, 1941, the only real estate owned by the petitioner was the family home in Santa Barbara, California. The paragraphs in the agreement about the relinquishment of all rights of dower, homestead, etc., by both petitioner and his former wife were included by the attorneys in order to make certain that, after having settled the question of alimony and support, their entire interests in each other's property were completely cut offOn February 11, 1941, Marjorie granted a power of attorney to an attorney at law of Reno, Nevada, authorizing him to enter her appearance in any action*312 for divorce that might be brought against her in Nevada by petitioner, to accept service of any and all papers in such action, to file an answer or any other pleading, motion or demurrer, to consent to the setting of the action for trial and participating in the trial thereof, and to take every step necessary for the protection of her interest, and ratifying and confirming all that he might do in the premises.On February 27, 1941, pursuant to the agreement of February 5, 1941, petitioner entered into a trust agreement in writing with the Northern Trust Co., an Illinois corporation, and Garfield King of Chicago, Illinois, as trustees. The trust agreement provided that the uncome of the trust estate should be paid to Marjorie for life and after her death to the surviving issue of her and the petitioner, per stirpes. It also provided that the trust should terminate when all their surviving children should attain the age of 25 years, or upon the death of the last survivor of the 4 children before attaining the age of 25 years, or upon the death of Marjorie, whichever event should occur last; that, upon the termination of the trust, the principal of the trust estate should be transferred*313 to the issue then surviving, per stirpes; and that, in case of a complete failure of issue during Marjorie's lifetime, the trust should terminate and the entire trust estate be transferred to her. Exhibit A to the trust agreement listed the securities to be placed in the trust.On various dates from March 12 to March 20, 1941, petitioner transferred securities having an aggregate fair market value of $ 506,931.14 *163 to the Northern Trust Co. as trustee. In March 1941, pursuant to the agreement of February 5, 1941, petitioner transferred to his former wife his interest in other property, as follows:Household furniture and fixtures$ 8,000.00California improved real estate22,500.00Insurance on petitioner's life6,135.80Total36,635.80The value of the remainder interest in the property transferred in trust was $ 180,462.41 and the value of Marjorie's life interest in the trust property at the time of the transfer was $ 326,468.73. The fair market value of all property owned by petitioner before the transfers was $ 1,050,498.08.On March 13, 1942, petitioner filed a gift tax return for the calendar year 1941, in which the remainder interest in the securities*314 transferred in trust under the agreement of February 27, 1941, was reported as a taxable gift. The total tax of $ 17,784.61 shown on line 8 of the return was paid on March 13, 1942. A 30-day letter issued by the Bureau of Internal Revenue indicated an overassessment of $ 2,979.02 in gift tax against the petitioner for the calendar year 1941. In a subsequent conference with representatives of the Bureau it was tentatively agreed that the amount of the overassessment was $ 4,189.75. The amount of the computed overassessment was based upon a redetermination of the value of the property transferred in trust and upon the correction of an error made by petitioner in computing the tax in the return. In computing the tentative overassessment the Bureau did not include as a gift the value of Marjorie's life interest in the trust or of the other property transferred outright to her.On December 8, 1943, in a notice of deficiency, the Commissioner determined a deficiency of $ 49,860.57 based upon the inclusion of the wife's life interest in petitioner's taxable gifts. On January 4, 1944, petitioner filed a claim for a refund of an overassessment of $ 4,189.75.After the petition was filed*315 in this Court contesting the deficiency determined by respondent, the Commissioner filed an amended answer asking for an increased deficiency in the amount heretofore stated.OPINION.The Commissioner in his determination of the deficiency in petitioner's gift tax for the calendar year 1941 increased the value of some of the securities which petitioner had reported in his gift tax return. Also, the Commissioner added to the value of the gift as reported by petitioner the value of the life interest which petitioner had conveyed in trust for his former wife, Marjorie K. Mitchell. *164 By an amended answer he seeks to include in the taxable gifts made by petitioner to his former wife the value of the household furniture and fixtures and the California improved real estate and the cash surrender value of a life insurance policy transferred outright by petitioner to his former wife. The values of all these properties, including the value of the wife's life estate in the securities transferred in trust and the value of the remainder interest of petitioner's four children, have been agreed upon by the parties in the stipulation which has been filed. There is, therefore, no issue*316 before us as to values. Petitioner concedes he is taxable on the gift of the remainder interest of his four children and there is, therefore, no issue on that score.The only issue we have to decide is whether taxable gifts were made by petitioner when, pursuant to a settlement agreement which was expressly approved in the decree of divorce and merged into the decree, he created a life interest in a trust for the benefit of his former wife and transferred other property to her outright in order to obtain the discharge of his obligation to support her. The applicable statute and regulations are printed in the margin. 1*317 Petitioner, in support of his contention that the life interest in certain securities which he transferred in trust for the benefit of his wife and the property which he transferred to her outright in the divorce settlement were not gifts with any donative intent, but were a settlement arrived at in an arm's length transaction after much negotiation, cites and relies upon ; , and . We think these cases support petitioner's contention. That petitioner received a thing of real and substantial value when by reason of the transfers in question he was relieved of any further legal obligation to support his wife is apparent from the nature of the obligation. The duty of a husband to provide his wife with support and maintenance is not dependent upon contract or the ownership of property. It is a public duty owed to the state, as well as the wife, *165 with criminal sanctions frequently imposed by statute for violation. By obtaining the discharge of this legal obligation, the petitioner*318 was relieved of making continuing cash expenditures for years to come. This, in our opinion, constitutes consideration in money or money's worth within the meaning of the statute printed in the margin and in no sense represents a gift.Petitioner argues correctly, we think, that it would be an error to hold that payments made as directed by a court of competent jurisdiction for the support of the wife and without agreement constituted taxable gifts, and, since this is so, transfers agreed upon to avoid litigation but expressly approved and directed to be made by judicial order should not be considered taxable gifts. Petitioner further argues that, since the courts every day are determining the amounts to be paid in support money, it is also correct to say that the obligation to support is a thing which is reducible to a money value and in the great majority of cases is more likely to be correctly valued as a result of negotiations by the interested parties than by judicial determination. We think these arguments are sound.In the instant case counsel who represented petitioner's wife in the negotiations for settlement testified at the hearing. His testimony was to the effect that, *319 in reaching a figure as to what part of his property petitioner should transfer for the benefit of his wife in discharge of his legal obligation to support her, the attorneys took into consideration the amount she would need to live as she had been living, the amount of petitioner's income, the principal it would take in trust to produce the income which she needed, and the probable annual income that would be produced by the property placed in trust under the terms of settlement. It seems to us that it would be altogether unwarranted to hold that transfers made in such a settlement represent gifts with a donative intent.Respondent in his brief does not discuss , and He does discuss , and contends that that case was wrongly decided and should no longer be followed by this Court in view of the Supreme Court's later decisions in , and . In ,*320 we discussed these Supreme Court cases and pointed out why we did not think they were controlling in cases such as we had there and in the Herbert Jones case. We think it is unnecessary to repeat what we said in the Converse case in distinguishing Merrill v. Fahs and Wemyss v. Commissioner. It is sufficient to say that we think the same distinction applies here. Consequently, we decide the issue involved in favor of petitioner.Decision will be entered under Rule 50. Footnotes1. SEC. 1002 [I. R. C.]. TRANSFER FOR LESS THAN ADEQUATE AND FULL CONSIDERATION.Where property is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the value of the property exceeded the value of the consideration shall, for the purpose of the tax imposed by this chapter, be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year.Sec. 86.8 [Regulations 108]. Transfers for a consideration in money or money's worth↩. -- Transfers reached by the statute are not confined to those only which, being without a valuable consideration, accord with the common law concept of gifts, but embrace as well sales, exchanges, and other dispositions of property for a consideration in money or money's worth to the extent that the value of the property transferred by the donor exceeds the value of the consideration given therefor. However, a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm's length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money's worth. A consideration not reducible to a money value, as love and affection, promise or marriage, etc., is to be wholly disregarded, and the entire value of the property transferred constitutes the amount of the gift. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619443/ | Edgar Hill v. Commissioner.Hill v. CommissionerDocket No. 57266.United States Tax CourtT.C. Memo 1956-286; 1956 Tax Ct. Memo LEXIS 5; 15 T.C.M. (CCH) 1492; T.C.M. (RIA) 56286; December 31, 1956Edgar Hill, 117 Simpson Avenue, Memphis, Tenn., pro se. Raymond Whiteaker, Esq., for the respondent. BRUCE Memorandum Findings of Fact and Opinion BRUCE, Judge: The respondent determined a deficiency in the income tax of the petitioner for the calendar year 1952 in the amount of $381. The sole issue is whether the petitioner is entitled to the dependency credits under section 25(b) of the Internal Revenue Code of 1939, for a daughter-in-law and her two minor children, petitioner's grandchildren, or any of them. Findings of Fact Petitioner*6 resides in Memphis, Tennessee. He filed an individual income tax return for the year involved with the director of internal revenue for the District of Tennessee, wherein he reported total income, from wages, in the amount of $4,557.73, against which income tax in the amount of $173.14 was withheld. In addition to exemptions for himself, his wife, and two children of his own, Doris Gene Hill and Linda Carroll Hill, petitioner claimed dependency credits for his daughter-in-law, Virginia Hill (wife of his son, Herman Hill) and her two children, Sandra Ann Hill and Harold Thomas Hill, then approximately one and two years of age, making a total of seven exemptions claimed. By taking the standard deduction and computing his tax from the table attached to the return, petitioner reported his tax liability as "None" and requested a refund in the amount of the tax withheld. Respondent disallowed the dependency credits claimed for the daughter-in-law and two grandchildren, for lack of sufficient evidence to establish that petitioner paid more than half their support during the year 1952. During the year involved petitioner occupied a house which he owned or was in the process of buying. In*7 addition to his wife and their two children, Doris Gene and Linda Carroll, petitioner's son, Herman, the latter's wife, Virginia and their two children, Sandra Ann and Harold Thomas, lived in the same house with petitioner. Petitioner's son, Herman, was employed a part of the year involved by the Trojan Luggage Company and contributed "$5.00 every once in a while" to petitioner toward the support of the children or of the household. Virginia also worked at the same place for a part of the time but she contributed nothing toward the support of her children or of the household. The petitioner furnished more than one-half the cost of the support of his two grandchildren, Sandra Ann Hill and Harold Thomas Hill, during the year 1952. The evidence fails to establish that petitioner contributed over one-half of the support of his daughter-in-law, Virginia Hill. Opinion The question for decision is whether petitioner furnished more than one-half the support of his daughter-in-law and two grandchildren during the year 1952, so as to entitle him to a dependency credit for any or all of them under the provisions of section 25(b) of the Internal Revenue Code of 1939. 1 No records were kept*8 and no evidence offered as to the total amount expended specifically for the support of the daughter-in-law and the two grandchildren. Petitioner testified, however, that he provided the home not only for himself, his wife, and two of their other children, but also for his son Herman and the latter's wife and their two children. Herman worked a part of the year and made small contributions to petitioner from time to time toward the household expenses. Virginia also worked for a small portion of the year but she made no contribution whatever toward the support of her children or the expenses of the household. *9 While the evidence is not as complete and specific as might be desired, we think it fairly establishes that petitioner furnished more than one-half the support of his two grandchildren and that he is entitled to the credit claimed on their account for the taxable year. On the other hand, there is no evidence as to how much Herman and Virginia had earned and spent on themselves. Accordingly the evidence is not sufficient to establish that petitioner furnished more than one-half the support of his daughter-in-law and he is not entitled to the credit claimed on her account. Decision will be entered under Rule 50. Footnotes1. SEC. 25. CREDITS OF INDIVIDUAL AGAINST NET INCOME. * * *(b) Credits for both Normal Tax and Surtax. - (1) Credits. - There shall be allowed for the purposes of both the normal tax and the surtax, the following credits against net income: * * *(D) An exemption of $600 for each dependent whose gross income for the calendar year in which the taxable year of the taxpayer begins is less than $600, except that the exemption shall not be allowed in respect of a dependent who has made a joint return with his spouse under section 51 for the taxable year beginning in such calendar year. * * *(3) Definition of Dependent. - As used in this chapter the term "dependent" means any of the following persons over half of whose support, for the calendar year in which the taxable year of the taxpayer begins, was received from the taxpayer: (A) a son or daughter of the taxpayer, or a descendant of either, * * *(H) a * * * daughter-in-law, * * * of the taxpayer. * * *↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619447/ | RICHARD E. BUSCH, JR. AND JEAN N. BUSCH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; BUSCH CLINIC OF FORT WAYNE, INC., FORMERLY FT. WAYNE CHIROPRACTIC CLINIC, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBusch v. CommissionerDocket Nos. 4498-79, 12822-80, 12823-80.United States Tax CourtT.C. Memo 1983-98; 1983 Tax Ct. Memo LEXIS 689; 45 T.C.M. (CCH) 772; T.C.M. (RIA) 83098; February 14, 1983. Randall S. Goulding, for the petitioners. Elsie Hall, for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: In these cases which have been consolidated, the Commissioner determined deficiencies in and an addition to petitioners' Federal income taxes as follows: Addition toTaxabletax underDocket No.YearsDeficiencySection 6653(a) 14498-791973$3,509.5619746,198.7719755,753.9612822-80Ending: 9/30/761,713.042 $85.6512823-8019766,497.22*691 The issues for decision are: (1) Whether certain corporate distributions made to petitioner Richard E. Busch, Jr., (Dr. Busch) during the taxable years 1973, 1974 and 1975 by his wholly owned corporation, Busch Clinic of Fort Wayne, Inc., (the corporation) were taxable dividends or bona fide loans; and (2) whether $8,437.50 was contributed to the profit sharing trust of the corporation, so as to be deductible under section 404(a) on its return for the taxable year ended 1976 and, correspondingly, whether Dr. Busch contributed $8,437.50 to the profit sharing trust entitling him to a reduction of his notes payable to the corporation, or failing substantiation, such reduction reflected on the corporation's books was a forgiveness of indebtedness constituting a dividend. FINDINGS OF FACT Some of the facts in this consolidated case have been stipulated. The stipulation*692 of facts and stipulated exhibits are incorporated herein by this reference. Petitioners Richard E. Busch, Jr., and Jean N. Busch, docket Nos. 4498-79 and 12823-80, husband and wife, resided in Fort Wayne, Indiana, when they filed their joint Federal income tax returns for years 1973, 1974, 1975 and 1976 and when they filed their petition in this case. Jean N. Busch is a party herein solely by reason of filing joint Federal income tax returns with petitioner. The other petitioner, Busch Clinic of Fort Wayne, Inc., formerly Ft. Wayne Chiropractic Clinic, Inc., docket No. 12822-80, also maintained its corporate headquarters in Fort Wayne, Indiana, when its petition in this case was filed. All returns for the taxable years in issue were timely filed by petitioners Busch and the corporation with the Internal Revenue Service in Memphis, Tennessee. During all the years in issue, Dr. Busch was a chiropractic physician employed by the corporation. At the time of trial, Dr. Busch had been licensed in the State of Indiana for 13 years. Dr. Busch formed the corporation on September 29, 1970. The purpose of the corporation was to provide professional chiropractic care and services. *693 During all of the years in issue, Dr. Busch owned 100 percent of the stock of the corporation. He was also a director and president of the corporation. The retained earnings of the corporation as reflected on the U.S. Corporate Income Tax Returns, Forms 1120 are as follows: Fiscal Year EndingRetained EarningsSeptember 30, 1973$19,277.38September 30, 197439,285.53September 30, 197559,703.91September 30, 197674,427.75The corporation did not declare any dividends to its sole shareholder and Dr. and Mrs. Busch did not report any dividends on their returns for any of the taxable years in issue. The petitioner-corporation maintained an account designated "Notes Receivable - RE Busch" on its books and records. This account reflected advances and payments to Dr. Busch. Amounts of outstanding advances to Dr. Busch by the corporation were as follows: December 31, 1973December 31, 1974December 31, 1975$11,358.78$28,260.873 $40,358.29The outstanding balances of the withdrawals from the corporation as of December 31, 1973, 1974 and 1975 increased by $10,963.11, $16,902.09 and $12,097.42, respectively. *694 No interest was accrued, owed or paid to the corporation by Dr. Busch on the amounts advanced to him as reflected in the "Notes Receivable - RE Busch" account until October 30, 1976. This was six months after the revenue agent first contacted Dr. Busch regarding an audit. No collateral was given by Dr. Busch to the corporation to secure the advances recorded in the "Notes Receivable - RE Busch" account. The record book of the corporation did not contain any corporate resolutions authorizing the advances to Dr. Busch or establishing a ceiling on the amounts which could be advanced to Dr. Busch during the years in issue. In 1981, approximately one month before trial, Dr. Busch prepared and inserted into the corporate record book a Notice and Resolution authorizing and limiting the amounts of such advances. These documents were back-dated December 11, 1972. There were numerous small debit entries to the "Notes Receivable - RE Busch" account. Some of the debit entries were for payment of personal expenses, such as clothing and football tickets. Other debit entries related to the payment of mortgage expenses and the construction of the building housing the corporation (the*695 property). Title to this property was held in the names of petitioners Richard E. Busch, Jr., and Jean N. Busch. The property had two other tenants besides the petitioner-corporation. Dr. and Mrs. Busch reported the rental income and expenses on their individual returns. The property was never transferred to the corporation. The cost of the facility was about $265,000. The total amount of the borrowings until fully repaid in 1980 exceeded $300,000. No interest was paid until 1976, when Dr. Busch paid petitioner-corporation $5,806.53 as interest. A vast majority of the proceeds from the advances went to the cost of the new facility. Specific withdrawals applied to the building costs are not known. The balance was used by Dr. Busch for personal purposes. During the taxable years 1973, 1974 and 1975, 11 promissory demand notes were executed. None of these notes was interest bearing and none set forth a repayment schedule. While most of these notes are related to debit entries in the "Notes Receivable - RE Busch" account, there were many debit entries for substantial sums not covered by promissory notes. The credit entries to the "Notes Receivable - RE Busch" account consisted, *696 among other things, of small book entries for rentals collected from other tenants in Dr. Busch's building and deductions from his salary. Also credited to this account was $6,000 borrowed by Dr. Busch from the corporation's profit sharing trust. The sources of other amounts credited to this account were not established. The bookkeeper for the corporation erased figures on and rewrote a ledger page of the "Notes Receivable - RE Busch" account shortly before trial. In his statutory notice of deficiency, the Commissioner increased Dr. and Mrs. Busch's taxable income based on the net increases in the loan account as follows: 197319741975$10,963.11$16,902.09$12,097.42On September 30, 1973, the corporation instituted a profit sharing plan for the benefit of its employees called the "Fort Wayne Chiropractice Clinic, Inc. Profit Sharing Plan" (the plan). The corporate minutes of September 28, 1973, reflect an intention to qualify the plan under section 401 and to make contributions to the plan deductible under section 404(a). On December 10, 1976, Dr. Busch transferred to the Profit Sharing Trust account stock valued at $8,437.50. He did so on behalf*697 of the corporation. The corporation made a corresponding journal entry crediting his "Notes Receivable - RE Busch" account with $8,437.50, the amount of the transfer. The corporation deducted the contribution made on its behalf as a profit sharing expense. A statement from Merrill Lynch, Pierce, Fenner & Smith, Inc., confirms that 500 shares of EG & G stock were transferred from Dr. Busch's account to the trust account. Another monthly statement dated July 30, 1976, shows that Dr. Busch previously purchased 500 shares of EG & G stock on July 29, 1976. In his statutory notice of deficiency, the Commissioner disallowed the amount deducted by the corporation as a contribution to the pension trust because "it has not been established that any amount was paid or that if said amount was paid, that said amount was for an ordinary and necessary business expense, or was expended for the purpose designated." The Commissioner correspondingly increased Dr. and Mrs. Busch's taxable income by $8,437.50 for unreported constructive dividends by virtue of the forgiveness of indebtedness resulting from the credit to Dr. Busch's "Notes Receivable" account. OPINION The first issue for decision*698 is whether cash advances to Dr. Busch from his wholly owned corporation were bona fide loans as contended by petitioner or constructive dividends as determined by the Commissioner. Section 61 provides that gross income includes dividends. Section 301 provides that a distribution of property by a corporation to a shareholder with respect to its stock, to the extent of that distribution, is a dividend as defined by section 316 and includable in gross income. A dividend is defined as any distribution of property made by a corporation to a shareholder out of its earnings and profits accumulated after February 28, 1913. Property is defined in section 317 as including money, securities and any other property. Whether the advances to Dr. Busch are loans or dividends is a factual question determined from all the surrounding facts and circumstances. Chism's Estate v. Commissioner,322 F.2d 956">322 F.2d 956 (9th Cir. 1963); Roschuni v. Commissioner,29 T.C. 1193">29 T.C. 1193, 1202 (1958), affd. *699 per curiam 271 F.2d 267">271 F.2d 267 (5th Cir. 1959), cert. denied 362 U.S. 988">362 U.S. 988 (1960); Wilson v. Commissioner,10 T.C. 251">10 T.C. 251, 256 (1948), affd. 170 F.2d 423">170 F.2d 423 (9th Cir. 1948). The character of the transaction depends on the intent of the taxpayer when the withdrawals were made. Haber v. Commissioner,52 T.C. 255">52 T.C. 255, 266 (1969), affd. 422 F.2d 198">422 F.2d 198 (5th Cir. 1970); White v. Commissioner,17 T.C. 1562">17 T.C. 1562, 1568 (1952).When the withdrawer is in substantial control of the corporation, such control invites a special scrutiny of the transaction. Baird v. Commissioner,25 T.C. 387">25 T.C. 387, 393 (1955).We reject petitioner's contention that the payments at issue were bona fide loans. The burden of proof is upon petitioner. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). The evidence presented was not persuasive. This is particularly so in light of the "doctoring" of the corporate minutes and the ledger sheets. We are not inclined to give much weight to the corporate ledger as proof that the advances were intended to be bona fide loans. See Doyle v. Mitchell Brothers Co.,247 U.S. 179">247 U.S. 179 (1918).*700 Furthermore, though some of the advances recorded were reduced to promissory notes, many were not. The evidence of repayments to the corporation, likewise, lends little support to petitioner's claim. No repayment schedule was established and the repayments that were made were irregular and did not significantly reduce the outstanding amounts. There was no security or interest arrangements of the type associated with a normal debtor-creditor relationship. Petitioner argues that a majority of the advanced money was used for a valid business purpose. Title to the commercial property, however, was in petitioner's name and he considered the rent from the other tenants to be his personal income. We are not convinced that because the money was used to finance and construct the office building that there was not a significant amount of benefit to petitioner personally. In Kaplan v. Commissioner,43 T.C. 580">43 T.C. 580, 595 (1965), we said that it is well settled that withdrawals made from a corporation by its controlling stockholder, without security, and without interest, for his*701 own personal use and benefit, and without any intention to repay constitute distributions by the corporation with respect to its stock and are, therefore, taxable dividends. The objective factors present in this case as presented by the evidence and the testimony of the witnesses convince us that the amounts advanced to petitioner were not intended to be bona fide loans. We conclude that these amounts constituted constructive dividends to petitioner from his wholly owned corporation. Petitioner has failed to carry his burden of proof. We hold for the respondent on this issue. The second issue is whether a transfer of stock by Dr. Busch to the corporation's profit sharing trust on behalf of the corporation entitled the corporation to a deduction under section 404(a). Contributions to qualified plans are deductible under section 404(a)(1) and 404(a)(3) only in the taxable year "when paid," subject to the section 404(a)(6) grace period. The amount must be "paid" regardless of the employer's method of accounting and it must be in "cash or its equivalent" to get a deduction. Don E. Williams Co. v. Commissioner,429 U.S. 569">429 U.S. 569 (1977).*702 Respondent does not argue that the section 404(a) payment requirement cannot be met by a transfer of property. Instead, he disputes that petitioner has "clearly shown that a transfer of property occurred at all." Petitioner has presented credible evidence in the nature of a third party document clearly showing that the stock was transferred. Petitioner has made a prima facie case. The burden of going forward with rebuttal evidence, therefore, shifts to respondent. Respondent has presented no more than conjecture and innuendo to support his vague claim that even though a transfer occurred, Dr. Busch did not relinguish control of the stock sufficient to effect a meaningful transfer. We hold for petitioner-corporation on the issue of the deduction and, correspondingly, for the petitioner in his individual capacity on the related dividend issue. Decision will be entered for the respondent in docket No. 4498-79.Decisions will be entered for the petitioners in docket Nos. 12822-80 and 12823-80.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended. ↩2. Although petitioner did not assign error to this addition to tax in its petition, this is immaterial. In light of our holding for petitioner on the underlying issue, there is no underpayment to which the addition to tax could attach.↩3. This figure reflects the correction for a $180 cumulative error.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619450/ | OLIVER LEE REINERTSON AND MEREDITH VIRGINIA REINERTSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentReinertson v. CommissionerDocket No. 10186-75United States Tax CourtT.C. Memo 1977-130; 1977 Tax Ct. Memo LEXIS 309; 36 T.C.M. (CCH) 564; T.C.M. (RIA) 770130; May 4, 1977, Filed *309 Oliver Lee Reinertson, pro se. James D. Vandever, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent determined a deficiency of $1769.84 in petitioners' Federal income tax for the year 1973. We are called upon to decide a variety of constitutional questions relating to the asserted deficiency. FINDINGS OF FACT The petitioners, Oliver Lee and Meredith Virginia Reinertson, resided in Newport Beach, California, at the time of filing the petition herein. During 1973 petitioner, Oliver L. Reinertson, was employed in auto sales, and Meredith V. Reinertson was a teacher. Respondent has disallowed the following deductions claimed on the petitioners' 1973 income tax return in the amounts indicated: AmountAmountAmountClaimedAllowedDisallowedContributions$1955.00$320.00$1635.00Medical Expenses1735.00-0-1735.00Business Expenses7583.00-0-7583.00Petitioner Oliver L. Reinertson appeared and testified that his records had either been lost or destroyed. No documentary evidence relating to the year in issue was introduced at the trial, petitioners instead relying*310 on a variety of constitutional defenses. However, the record includes a chart containing an "eight year average" of comparable deductions petitioners took on their Federal income tax return for the years 1966 to 1973. OPINION Petitioners contend that requiring them to substantiate their deductions would violate their fifth amendment rights. Additionally, they contend that they are entitled to a jury trial under the seventh amendment, and that the graduated income tax is unconstitutional. We have previously held that requiring petitioner to substantiate his deductions under circumstances like those before us does not violate the fifth amendment. Roberts v. Commissioner,62 T.C. 834">62 T.C. 834 (1974). It is well settled that the graduated income tax imposed by the Internal Revenue Code is consistent with the Constitution. Brushaber v. Union Pac. R. Co.,240 U.S. 1">240 U.S. 1 (1916). We have also held that the seventh amendment to the Constitution does not require a jury trial in this Court. Swanson v. Commissioner,65 T.C. 1180">65 T.C. 1180 (1976); Dorl v. Commissioner,57 T.C. 720">57 T.C. 720 (1972), affd. per curiam 507 F. 2d 406 (2nd Cir. 1974).*311 Petitioners also assert that the inability to redeem currency in gold or silver deprives it of its status as income under the Internal Revenue Code. The courts have considered this issue extensively in recent years and uniformly decided this question against petitioners. Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181 (1976). See also United States v. Schmitz,542 F. 2d 782 (9th Cir. 1976); Cupp v. Commissioner,65 T.C. 68">65 T.C. 68 (1975), on appeal (3d Cir. July 26, 1976). Petitioners have declined to offer any substantiation, instead preferring to rest on their constitutional arguments. However, petitioners have the burden of proving that the respondent's determination is incorrect. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142, Tax Court Rules of Practice and Procedure. Something more than petitioners' bare assertion that his return is correct is required to sustain this burden. Roberts v. Commissioner,supra.We therefore sustain respondent's determination. Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619451/ | Beverly B. Cook and Mary L. Cook v. Commissioner.Cook v. CommissionerDocket No. 4032-63.United States Tax CourtT.C. Memo 1965-168; 1965 Tax Ct. Memo LEXIS 164; 24 T.C.M. (CCH) 897; T.C.M. (RIA) 65168; June 24, 1965*164 Held, petitioner Beverly B. Cook is not entitled to deduct as business expenses for the years involved, amounts of automobile expenses which are in excess of the amounts actually paid or incurred. Beverly B. Cook, pro se, 6145 Salem Rd., Cincinnati, Ohio. Rodney G. Haworth, for the respondent. PIERCE Memorandum Opinion PIERCE, Judge: Respondent determined deficiencies in income tax as follows: YearPetitionerDeficiency1957Beverly B. Cook$111.051958Beverly B. Cook32.461959Beverly B. and Mary L. Cook212.581960Beverly B. and Mary L. Cook105.131961Beverly B. and Mary L. Cook131.74The only issue raised by the pleadings is whether the petitioners are entitled to deduct as business expenses for the respective years involved, amounts of automobile expenses which are in excess of the amounts actually paid or incurred. All of the facts have been stipulated, and they are so found. These facts are summarized as follows. Beverly B. Cook and Mary L. Cook, the petitioners herein, are husband and wife residing in Cincinnati, Ohio. For each of the calendar years 1957 and 1958 petitioner Beverly B. Cook filed an individual*165 income tax return with the district director of internal revenue at Cincinnati; and for each of the calendar years 1959, 1960, and 1961, both petitioners filed a joint income tax return with the same district director of internal revenue. Mary L. Cook is a party to this case solely by reason of having joined in filing the joint returns; and therefore the husband, Beverly B. Cook, will hereinafter be referred to as the "petitioner." Petitioner, during all years involved, was a Methodist minister who also practiced law 1 day a week. In the pursuit of his business activities, he paid or incurred automobile expenses (including depreciation) during said years, as follows: Expenses paidYearor incurred1957$1,306.1519581,014.9819591,043.8819601,386.0219611,327.98 For the above years, he claimed on his income tax returns, the following deductions for automobile expenses incurred in his business. 1957$2,360.6119581,976.3219592,015.3019601,815.0719611,967.10 The amount so claimed for the year 1957 was based on an estimate of 9 cents per mile for automobile mileage applicable to his business; and the amount so claimed*166 for each of the years 1958, 1959, 1960, and 1961, was based upon an estimate of 10 cents per mile. Section 162(a) of the 1954 Internal Revenue Code provides, so far as here material: 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, * * * [Emphasis supplied.] Respondent's position is that petitioner is entitled to deduct only those expenses that were actually paid or incurred; and in his notices of deficiency herein, he allowed deductions for such amounts. Petitioner, on the other hand, contended at the trial (he did not file any brief herein), that he is not limited to the amounts of expenses actually paid or incurred but is entitled to deduct the larger amounts which he claimed on his returns, that were based on his own estimates. We agree with respondent. In the case of L. L. Moorman, 26 T.C. 666">26 T.C. 666, 679, this Court said: For the years 1949, 1950, and 1951 the petitioner claims as transportation expenses the amounts of $5,406.95, $5,784.11 and $4,680.62, respectively. These*167 were calculated at the rate of 10 cents per mile traveled. The respondent has disallowed approximately one-fourth of such claimed expense. The petitioner has not adduced any proof whatsoever as to the reasonableness of the rate of 10 cents per mile. The record is devoid of any evidence upon which we can make an independent judgment. * * * Under the circumstances, we approve the respondent's determination in this respect. The circumstances stated in the above case are substantially the same as those in the instant case. Here also, the petitioner has not adduced any proof whatsoever as to the reasonableness of the rates per mile which he estimated; and here also, the record is devoid of any evidence which would justify us, by use of an independent judgment, to allow deductions for any amounts other than those which petitioner conceded that he had actually expended, and which respondent has already allowed. It is true that, with respect to certain years subsequent to those here involved, the Internal Revenue Service issued a ruling (Rev. Proc. 64-10, 1 C.B. 667">1964-1 C.B. 667) in which it announced that it would, subject to certain specified conditions and limitations, accept*168 the use of certain stated mileage rates for determining deductible costs for operating a passenger automobile in a trade or business or for the production of income. However, this ruling expressly indicates that such simplified method may be used only "for periods after December 31, 1962." Accordingly the same is not applicable or available for use in the instant case. Petitioner has not cited any similar ruling which is applicable to the years here involved, and our search has not revealed any such ruling. In the circumstances here present, we approve the respondent's determinations as to the amounts deductible. Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/2540184/ | 706 F. Supp. 2d 210 (2010)
Kathleen KINDELAN, Plaintiff,
v.
DISABILITY MANAGEMENT ALTERNATIVES, LLC, UnitedHealth Group Short Term Disability Plan, Defendants.
No. C.A. 08-329-ML.
United States District Court, D. Rhode Island.
April 20, 2010.
*212 Vicki J. Bejma, Law Office of Stephen M. Robinson, Providence, RI, for Plaintiff.
George P. Kostakos, Littler Mendelson, P.C., Providence, RI, for Defendants.
MEMORANDUM AND ORDER
MARY M. LISI, Chief Judge.
This matter is before the Court on cross motions for Summary Judgment (Docket # 24, 25) and Defendants' Motion to Strike Portions of Plaintiffs Motion for Summary Judgment, Statement of Facts and Related Exhibit (Docket #38). For the reasons set forth below, Defendants' Motion to Strike is GRANTED in part and DENIED in part; Plaintiffs Motion for Summary Judgment is DENIED; and Defendants' Motion for Summary Judgment is GRANTED.
I. STANDARD OF REVIEW
A motion for summary judgment should be granted "if the pleadings, the discovery and disclosure materials on file, and any affidavits show that there is no genuine issue as to any material fact and that the movant is entitled to judgment as a matter of law." Fed.R.Civ.P. 56(c)(2). A "`genuine' issue is one that could be resolved in favor of either party, and a `material fact' is one that has the potential of affecting the outcome of the case." Calero-Cerezo v. U.S. Dep't of Justice, 355 F.3d 6, 19 (1st Cir.2004) (quoting Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248-50, 106 S. Ct. 2505, 91 L. Ed. 2d 202 (1986)).
The moving party bears the burden of establishing that no genuine issues of material fact exist. National Amusements, Inc. v. Town of Dedham, 43 F.3d 731, 735 (1st Cir.1995). Once the moving party has made the requisite showing, the nonmoving party "may not rely merely on allegations or denials in its own pleading; rather, its response mustby affidavits or as otherwise provided in [the] ruleset out specific facts showing a genuine issue for trial." Fed.R.Civ.P. 56(e)(2).
The standard of review utilized by "the district court in [an] ERISA case differs in one important aspect from the review in an ordinary summary judgment case." Orndorf v. Paul Revere Life Ins. Co., 404 F.3d 510, 517 (1st Cir.2005). Generally, the Court draws all reasonable inferences in the light most favorable to the nonmoving party. See Continental Casualty Co. v. Canadian Universal Ins. Co., 924 F.2d 370, 373 (1st Cir.1991). "However, in an ERISA benefit-denial context, `the district *213 court sits more as an appellate tribunal than as a trial court.'" Cusson v. Liberty Life Assurance Co., 592 F.3d 215, 224 (1st Cir.2010) (quoting Leahy v. Raytheon Co., 315 F.3d 11, 18 (1st Cir.2002)). "`Summary judgment is simply a vehicle for deciding the issue,' and consequently, `the non-moving party is not entitled to the usual inferences in its favor.'" Id. (quoting Orndorf, 404 F.3d at 517).
This standard "does not permit a district court independently to weigh the proof." Leahy, 315 F.3d at 18. Rather, the "district court must ask whether the aggregate evidence, viewed in the light most favorable to the non-moving party, could support a rational determination that the plan administrator acted arbitrarily in denying the claim for benefits." Id.
With these principles in mind, the Court considers the factual record and the parties' arguments.
II. FACTS
Kathleen Kindelan ("Plaintiff") was employed by UnitedHealth Group, Inc. ("UnitedHealth") from November 29, 1993 until her resignation in 1998. On March 27, 2006, she resumed working for UnitedHealth as a full-time Clinical Care Manager. As a Clinical Care Manager, Plaintiff's job entailed "considerable walking and sitting" and traveling between her office and various hospitals to perform on-site reviews. Plaintiff was required to travel from "unit to unit" within a hospital with her computer so that she could enter data onsite and then return to the office to enter additional data. See Plaintiffs Ex. 13, p. 5-6.
On or before October 4, 2007,[1] Plaintiff withdrew from work because of an injury to her back and neck. On October 4, 2007, Plaintiff applied for Short Term Disability Benefits ("STD Benefits") under the UnitedHealth Group Short Term Disability Plan (the "STD Plan"). UnitedHealth engaged Disability Management Alternatives, LLC ("DMA"), an unrelated third party administrator, to make claim determinations under the STD Plan.
Initially, DMA approved Plaintiffs claim. Then, on October 24, 2007, Plaintiff was notified that her claim was denied. Plaintiff appealed DMA's determination on November 28, 2007. On February 21, 2008, Plaintiff was informed that DMA's decision to deny Plaintiffs application for STD Benefits was upheld. After exhausting her administrative remedies, Plaintiff commenced this action for judicial review on August 29, 2008.
A. Plaintiffs Medical History and the October 2007 "Flare Up"
Prior to her employment at UnitedHealth, Plaintiff had an extensive history of chronic back and neck problems dating back to 1979.[2] Plaintiff had undergone a series of surgeries that provided intermittent reliefthe last surgery was a "lumbar interbody fusion" performed in October of 2005. By January of 2006, Plaintiff had recovered from the "lumbar interbody fusion" and was able to return to work.
According to Dr. Palumbo's notes, Plaintiff continued to do "reasonably well" and "tolerated her work related duties without major difficulties" for the twenty months *214 following the October 2005 procedure, that is from January 2006 through September 2007. Then, on October 3, 2007, Plaintiff returned to Dr. Palumbo "with a recent flare of her back pain and lower extremity symptoms" (the "October 3, 2007 Visit"). Plaintiffs Ex. 5, p. 3. Dr. Palumbo's notes indicate that Plaintiff reported "major and increased difficulties with tolerating her work related duties." Id. His notes go on to state as follows
On examination [Plaintiff] is somewhat agitated today and anxious. Her gait pattern is slow, but normal. She does have moderate restriction of lumbar flexion and extension with exacerbation of back pain. There is no motor weakness in the lower extremities. Her nerve root tension signs are mildly positive/equivocal.
Id. Dr. Palumbo recommended that Plaintiff should "come out of the work force for a period of four to six weeks. Hopefully the reduced stress will reduce her symptomatology." Id. Dr. Palumbo advised Plaintiff to "utilize a home exercise program and consider the use of non-steroidal anti-inflammatory medication for her pain symptomatology." Id.
Plaintiff did not return to work after the October 3, 2007 Visit. On November 13, 2007, Plaintiff returned to Dr. Palumbo for a follow-up assessment of her back and lower extremity pain (the "November 13, 2007 Visit"). During this visit, Dr. Palumbo noted that Plaintiff had "not had much in the way of improvement in her symptoms" since her last visit. Plaintiffs Ex. 7, p. 3. Plaintiff reported that she had exacerbated symptoms when she stood or walked for a prolonged period of time. Dr. Palumbo determined that Plaintiff had
residual symptomatology which significantly limits her capacity to participate in gainful employment on a full time basis. With this in mind, it is my opinion that she is totally disabled from work on a permanent basis. She will be applying for social security disability benefits in the near future.
Id.
B. The UnitedHealth Short Term Disability Plan
As an employee of UnitedHealth, Plaintiff was enrolled in the STD Plan. The STD Plan is governed by the provisions of the Employee Retirement Income Security Act of 1974, as amended, 29 U.S.C. §§ 1001 et seq. ("ERISA"). Plaintiffs Ex. 3, p. 4. The STD Plan provides that "UnitedHealth Group, and any other persons or entities to whom UnitedHealth Group delegates fiduciary authority, has the sole and exclusive authority and discretion to interpret the plans' terms and benefits under them, and to make factual and legal decisions about them." Id.
In accordance with this provision, UnitedHealth entered into a Master Services Agreement with DMA, which authorizes DMA to make claim determinations under the STD Plan. The Master Services Agreement grants DMA the discretionary authority to "(i) construe and interpret the terms of the Plans; and (ii) make final, binding determinations regarding the availability of benefits under the Plans." Defendants' Ex. C, p. 2.
The STD Plan provides that an individual is "Disabled" when she is "unable to perform with reasonable continuity the Material Duties of [her] Own Occupation because of a non-work related Medical condition." Plaintiffs Ex. 3, p. 18. The STD Plan further provides that an individual is "Disabled" when all of the following conditions are met
You have been seen face-to-face by a Physician about your Disability within 10 business days of the first day of absence related to the Disability leave of absence;
*215 Your Physician has provided Medical Evidence that supports your inability to perform the Material Duties of your Own Occupation;
You are under the Regular and Appropriate Care of a Physician; and
Your Medical Condition is not work-related and is a Medically Determinable Impairment.
Id. at 10. The STD Plan also lists disabilities that are not covered, including conditions that
cannot be verified and measured using generally accepted standard medical procedures and practices. These conditions are commonly referred to as self-reported conditions and include but are not limited to headaches, dizziness, fatigue, loss of energy, pain and upper extremity cumulative trauma disorder.
Id. at 14 (emphasis added).
C. Plaintiffs Application for STD Benefits
Plaintiff applied for STD Benefits on October 4, 2007. To support Plaintiffs application, Dr. Palumbo faxed Plaintiffs medical charts to DMA. Those charts consisted of Dr. Palumbo's notes from November 27, 1996 through September 25, 2007. See Plaintiffs Ex. 4. Plaintiffs application was initially approved for the period October 1, 2007 through October 15, 2007. Plaintiffs Ex. 9. Then, on October 22, 2007, DMA Case Manager Christina Kozlowski contacted Dr. Palumbo and requested additional medical evidence. On that same day, Dr. Palumbo faxed Kozlowski his medical notes from the October 3, 2007 Visit.
By letter dated October 24, 2007, Plaintiff was notified that her claim for STD Benefits was denied. Plaintiffs Ex. 10. The letter explained that the STD Plan does not pay benefits for "self-reported conditions" that "cannot be verified and measured using generally accepted standard medical procedures and practices." Id. The letter advised Plaintiff that if she disagreed with the determination, she could appeal the decision within 180 days of the date that she received the letter. The letter also advised Plaintiff that if she elected to appeal the determination, her appeal should include a "detailed narrative report from [her] physician from October 1, 2007 through present . . ." and any other documentation that may assist DMA in reviewing her claim. Id.
D. Plaintiffs Appeal of the Denial of her STD Claim
On November 28, 2007, Plaintiff appealed DMA's decision. Plaintiff's Ex. 12. To supplement her appeal, Dr. Palumbo's office faxed Kozlowski his notes from the November 13, 2007 Visit. Plaintiffs Ex. 7.
On February 21, 2008, DMA sent Plaintiff a letter informing her that DMA's decision to deny her claim for STD Benefits was upheld. Plaintiffs Ex. 17. The letter explained that Dr. Amy Hopkins, Board Certified in Internal Medicine and Occupational & Environmental Medicine, had performed an "independent medical file review on February 18, 2008 and determined that [Plaintiffs] medical records do not support an inability to perform [her] required job duties as of October 1, 2007." Plaintiffs Ex. 17, p. 3.
According to Dr. Hopkins,
You were doing well in 2006 and most of 2007. You have chronic right lower extremity pain, which was relieved with Lyrica. You reported a flare of [your] back and leg symptoms in October 2007 attributable both to work and psychological stress. You did not provide any information about what might have changed either at work or at home. You attributed the symptoms to work, but your symptoms did not improve being out of work, which makes the connection more tenuous. The only change in *216 treatment was a home exercise program and a non-steroidal anti-inflammatory medication. . . . There was no mention of treatment for and recovery from an acute flare. There was no mention of what activities you were doing at home and what functionality you reported. . . . Dr. Palumbo ordered x-rays of the lumbar spine, which were unremarkable, but no further testing, such as [an] MRI, to explain this sudden change in your condition.
Id. at 3-4. By letter dated May 15, 2008, Plaintiff was informed that DMA's denial of her STD Benefits claim made her ineligible for long-term disability benefits. Plaintiffs Exhibit 19.[3]
III. APPLICABLE STANDARD OF REVIEW UNDER ERISA
The parties disagree about the applicable standard of review for Plaintiffs STD Benefits claim. Defendants argue that the "arbitrary, capacious or an abuse of discretion" standard of review should apply. Plaintiff, however, urges this Court to apply a heightened standard of review based on her contention that there was a conflict of interest between UnitedHealth and DMA.
A. "Arbitrary, Capricious or Abuse of Discretion" Standard
An administrator's denial of STD Benefits eligibility is generally reviewed under a de novo standard. Thompson v. Coca-Cola Co., 522 F.3d 168, 175 (1st Cir. 2008). When an ERISA plan gives the administrator discretion to determine eligibility for benefits, as in this case,[4] the reviewing court must uphold the decision unless it is "arbitrary, capricious, or an abuse of discretion." Cusson, 592 F.3d at *217 224 (citing Gannon v. Metro. Life Ins. Co., 360 F.3d 211, 213 (1st Cir.2004)).
Under this "generous standard," the Court inquires into whether Defendants' decision was "reasoned and supported by substantial evidence." Medina v. Metro. Life Ins. Co., 588 F.3d 41, 45-46 (1st Cir. 2009). "Put differently, [the Court] will uphold [Defendants'] decision to deny disability benefits if `there is any reasonable basis for it.'" Id. (quoting Wallace v. Johnson & Johnson, 585 F.3d 11, 14-15 (1st Cir.2009)).
B. "Conflict of Interest" Standard of Review
Plaintiff argues that a heightened version of the "arbitrary, capricious, or abuse of discretion" standard of review applies in this case because the financial arrangement between UnitedHealth and DMA created a structural conflict. The Court recognizes that this conflict of interest analysis involves a "newly refined standard"it therefore briefly rehearses the evolution of recent case law. Denmark, 566 F.3d at 8.
The Supreme Court elucidated the applicable standard of review in an ERISA case involving a structural conflict. Met. Life Ins. Co. v. Glenn, 554 U.S. 105, 128 S. Ct. 2343, 2346, 171 L. Ed. 2d 299 (2008). In Glenn, Metropolitan Life Insurance Co. served as both the plan administrator and the insurer of Sears, Robebuck & Co.'s long-term disability insurance plan. The plan granted Metropolitan Life Insurance Co. the "discretionary authority to determine whether an employee's claim for benefits is valid; it simultaneously provide[d] that Metlife (as insurer) [would] itself pay valid benefit claims." Id. at 2346. The Supreme Court held that where
the entity that administrates the plan, such as an employer or insurance company, both determines whether an employee is eligible for benefits and pays benefits out of its own pocket[,] . . . this dual role creates a conflict of interest; a reviewing court should consider that conflict as a factor in determining whether the plan administrator has abused its discretion in denying benefits; and the significance of the factor will depend upon the circumstances of the particular case.
Id. The Supreme Court added that it did not mean to imply a change in the standard of review, "say, from deferential to de novo review," because "conflicts are but one factor among many that a reviewing judge must take into account." Id. at 2351, 2356.
The First Circuit had the opportunity to apply the newly refined standard from Glenn in Denmark v. Liberty Life Assur. Co., 566 F.3d 1 (1st Cir.2009), where Liberty Life Ins. Co. both evaluated the benefits claims and paid for the benefits. The First Circuit opined that after Glenn, courts are "duty-bound to inquire into what steps a plan administrator has taken to insulate the decisionmaking process against the potentially pernicious effects of structural conflict." Id. at 20-21. Moreover, "in cases in which a conflict has in fact infected a benefit-denial decision, such a circumstance may justify a conclusion that the denial was itself arbitrary and capricious (and thus, an abuse of discretion)." Id.
More recently, the First Circuit considered the Glenn holding in Cusson v. Liberty Life Assurance Co., 592 F.3d 215 (1st Cir.2010). In Cusson, Liberty served as both the administrator and payer of the LTD benefits plan. Id. at 223. The Court acknowledged that "[a]lthough the presence of a conflict of interest does not change the standard of review in this case, the conflict can itself, under certain circumstances, be accorded extra weight in the court's analysis." Id. at 224. The *218 court noted that the employee bears the burden of showing that the conflict influenced the arbitrator's decision. Ultimately, the Court determined that Cusson had failed to show that Liberty was improperly influenced by the conflict. Liberty's decision to terminate Cusson's benefits was therefore affirmed. Id.
C. Applicable Standard of Review in this Case
The threshold question before the Court is whether the facts of this case create a structural conflict. If the Court determines that no structural conflict exists, it will apply the traditional "arbitrary, capricious or abuse of discretion standard." Cusson, 592 F.3d at 224. If, however, the Court accepts Plaintiffs allegation that a structural conflict existed between UnitedHealth and DMA, it will "consider that conflict as a factor" in determining whether DMA abused its discretion in denying Plaintiffs claim. Glenn, 128 S.Ct. at 2351 (emphasis added).
Plaintiff contends that there is a structural conflict in this case because UnitedHealth paid DMA a significant amount of money to administer the plan and that that financial agreement motivated DMA to "slant" its decisions in UnitedHealth's benefit. Plaintiff was given the opportunity to conduct limited jurisdictional discovery on this very issue. The discovery revealed that DMA received a substantial portion of its annual gross income from UnitedHealth in 2007. The discovery revealed that Dr. Hopkins also earned a substantial amount of money from DMA for her services in 2007, but the discovery did not indicate what percentage of her total annual income that amount represented.[5]
As the First Circuit explained in Cusson, the employee bears the burden of establishing that a conflict exists and that that conflict influenced the decision to deny benefits. Cusson, 592 F.3d at 225. Plaintiff has not met her burden here. The financial arrangement between UnitedHealth and DMA is far different from the structural conflicts found in Glenn, Denmark, and Cusson. In all three of those cases, the structural conflict arose because the plan administrator both evaluated the claim and paid the benefits of the insurance plan. See also Colby v. Assurant Employee Benefits, 603 F. Supp. 2d 223, 236 (D.Mass.2009); Frost v. Hartford Life Ins. Co., Civ. No. 09-sv-120-SM, 2010 D.N.H. 17, 2010 WL 335507 (D.N.H. Jan. 28, 2010).
Here, while UnitedHealth contracted with DMA to serve as the plan administrator and to make STD Benefits eligibility determinations, it paid the STD Benefits. As the plan administrator, DMA interprets the terms of the plan and makes the "final, binding determinations regarding the availability of benefits under the Plans." Defendants' Ex. C. Moreover, DMA engaged Dr. Hopkins to perform an "independent medical file review." Plaintiffs Ex. 17, p. 3. Dr. Hopkins is not an employee of DMA; she is an independent contractor paid by DMA on a per-review basis to conduct reviews. These facts are not sufficient to establish a structural conflict. The appropriate standard of review to be applied here is therefore the traditional "arbitrary, capricious, or abuse of discretion" standard without regard to any claim of conflict of interest. Cusson, 592 F.3d at 223.
IV. DISCUSSION
The Court must now determine whether Defendants' denial of Plaintiff's claim for *219 STD Benefits was "arbitrary, capricious, or an abuse of discretion." Plaintiff argues that DMA's reliance on Dr. Hopkins' decision does not satisfy this standard because Dr. Hopkins ignored Plaintiffs substantial medical history and mis-characterized Dr. Palumbo's medical records and recommended treatment plan. In response, Defendants argue that both DMA and Dr. Hopkins conducted careful reviews of Plaintiff's claim and made a reasonable decision that Plaintiff did not qualify for STD Benefits.
A. "Disability" and "Self-Reporting Condition"
Plaintiff argues that DMA lacked a reasonable basis for denying her claim for STD Benefits. In response, Defendants contend that DMA did not abuse its discretion because (1) Plaintiff failed to establish that she was "Disabled" as defined by the STD Plan and (2) her condition was excluded under the STD Plan as a "self-reporting condition."
First, the Court addresses Defendants' contention that DMA and Dr. Hopkins were reasonable in their conclusions that Plaintiffs condition did not satisfy the definition of "Disabled" under the STD Plan. The STD Plan provides that an individual is "Disabled" when she is "unable to perform with reasonable continuity the Material Duties of [her] Own Occupation because of a non-work related Medical condition." Plaintiffs Ex. 3, p. 18.
Plaintiff argues that she was "Disabled" under the STD Plan, because her condition prevented her from performing the "considerable walking and sitting" and traveling from "unit to unit" within a hospital that her job entailed. Plaintiffs Ex. 13, p. 5-6. Dr. Palumbo's report does not, however, establish with any specific medical evidence that Plaintiffs condition prevented her from fulfilling those duties. The Court, therefore, finds that Defendants did not abuse their discretion in concluding that Plaintiff did not satisfy the definition of "Disabled" under the STD Plan.
Second, Defendants argue that their denial of Plaintiff's claim for STD Benefits was not an abuse of discretion because her injury was excluded under the STD Plan as a "self-reporting condition." The STD Plan lists conditions that are not "Disabilities" under the STD Plan. Plaintiffs Ex. 3. That list includes "self-reporting conditions." Id. at 14. "Self-Reporting conditions. . . cannot be verified and measured using generally accepted standard medical procedures and practices." They include, but are not limited to, "headaches, dizziness, fatigue, loss of energy, pain and upper extremity cumulative trauma disorder." Id.
A close look at Dr. Palumbo's medical reports from Plaintiffs October 3, 2007 and November 13, 2007 visits supports the conclusion that Plaintiffs injury was a "self-reporting condition." In both reports, Dr. Palumbo relied on Plaintiffs own account of her pain and symptoms. He did not verify her symptoms with generally accepted medical practice. For example, Dr. Palumbo's notes from the October 3, 2007 Visit indicate that Plaintiff appeared "distressed," was "somewhat agitated. . . and anxious," and was "finding major and increasing difficulties with tolerating her work related duties." Plaintiffs Ex. 5, p. 3. Other than a physical examination which revealed that Plaintiffs "gait pattern [was] slow but normal" and "moderate restriction of lumbar flexion and extension with exacerbation of back pain," Dr. Palumbo did not verify that the reported symptoms were caused by a medical condition. Id.
Dr. Palumbo's notes from the November 13, 2007 Visit further support the conclusion that Plaintiffs injury was a "self-reporting *220 condition" not substantiated by medical evidence. Those notes reveal that Plaintiff had "not had much in they way of improvement in her symptoms" since the last visit, and continued to be "afflicted by significant back pain, but particularly right leg pain." Plaintiffs Exhibit 7, p. 3. Based on that report from Plaintiff, Dr. Palumbo concluded that Plaintiff was "totally disabled from work on a full time basis." Id.
As Dr. Hopkins' report emphasizes, Dr. Palumbo did not provide any information about what might have "changed either at work or at home" to cause Plaintiffs "flare up," nor did he provide medical evidence to explain Plaintiffs sudden "flare up." See Plaintiffs Ex. 17, p. 3 ("Dr. Palumbo ordered x-rays of the lumbar spine, which were unremarkable, but no further testing, such as [an] MRI, to explain this sudden change in [her] condition."). The Court, therefore, finds that DMA did not abuse its discretion in concluding that Plaintiff was not "Disabled" and that her claimed injury was a "self-reporting condition" as defined by the STD Plan.
B. Dr. Hopkins' Review of Plaintiff's Medical History
Plaintiff contends that Dr. Hopkins review was arbitrary because she ignored Plaintiffs extensive medical record. There is little doubt that Plaintiffs history of back, neck, and leg problems was extensive. The issue, however, is whether Plaintiffs medical history was sufficient to establish that her October 2007 "flare up" was a "Disability" under the STD Plan.
After Plaintiffs "lumbar interbody fusion" in October of 2005, Plaintiff was "doing reasonably well" for 2006 and most of 2007. Plaintiffs Ex. 4, p. 10. By January of 2006, Plaintiff had recovered from the "lumbar interbody fusion" and was able to return to work. For the next twenty months, from January of 2006 through September of 2007, Dr. Palumbo found that Plaintiff continued to do "reasonably well" and "tolerated her work related duties without major difficulties." It was only after that period of twenty months that Dr. Palumbo indicated that Plaintiff had a "recent flare of her back pain and lower extremity symptoms" and "needed to come out of the work force for four to six weeks." Plaintiffs Ex. 5, p. 3.
The Court finds that both DMA and Dr. Hopkins acknowledged Plaintiffs extensive medical history and were reasonable in their conclusion that her medical history alone would not support a finding that Plaintiff was "Disabled" under the STD Plan. Given the history of twenty months of doing "reasonably well" between when Plaintiff had recovered from her October 2005 procedure and her October 2007 "flare up," Defendants did not abuse their discretion when they denied Plaintiffs claim for STD Benefits.
C. Dr. Palumbo's Treatment Recommendation
Plaintiff argues that Dr. Hopkins unreasonably faulted Dr. Palumbo for failing to recommend a specific treatment plan. Dr. Hopkins summarized Dr. Palumbo's treatment plan as follows"The only change in treatment was a home exercise program and a non-steroidal anti-inflammatory medication . . . There was no mention of treatment for and recovery from an acute flare. There was no mention of what activities [Plaintiff was] doing at home and what functionality [she] reported." Plaintiffs Ex. 17, p. 3.
This Court has reviewed the medical notes that Dr. Palumbo sent to DMA and finds that Dr. Hopkins' characterization of Dr. Palumbo's treatment plan was accurate. In Dr. Palumbo's report from the October 3, 2007 Visit, Dr. Palumbo wrote that he had "advised [Plaintiff] to utilize a home exercise program and consider the *221 use of non-steroidal anti-inflammatory medicine for her pain symptomatology." Plaintiffs Ex. 5, p. 3. The Court therefore concludes that Dr. Hopkins acted reasonably in basing her findings on Dr. Palumbo's failure to recommend a specific treatment plan to Plaintiff in October of 2007.
D. Award of Benefits by the SSA
Plaintiff contends that the Social Security Administration's determination that she was eligible for Social Security Disability benefits demonstrates that DMA's denial of her STD Benefits was unreasonable. The First Circuit has held, however, that "benefits eligibility determinations by the Social Security Administration are not binding on disability insurers." Pari-Fasano v. ITT Hartford Life & Accident Ins. Co., 230 F.3d 415, 420 (1st Cir. 2000). This is because the "criteria for determining eligibility for Social Security disability benefits are substantively different than the criteria established by many insurance plans." Id. Consequently, the fact that Plaintiff was awarded Social Security disability benefits is one factor that may weigh in her favor, but it is not given controlling weight. It therefore does not overcome the mountain of support that weighs in favor of Defendants' denial of Plaintiff's STD Benefits.
E. Evidence Subject to Defendants' Motion to Strike
The Court granted Defendants' Motion to Strike Portions of Plaintiff's Motion for Summary Judgment, Statement of Facts 50-52, and Supporting Exhibits involving cases from other jurisdictions where Dr. Hopkins served as the independent medical reviewer. Even if the Court had denied Defendants' Motion in its entirety and were to consider the underlying evidence, the outcome would not change.
Plaintiff cites a myriad of cases from other jurisdictions in an attempt to establish that Dr. Hopkins was biased against Plaintiff in this case. Most notably, Plaintiff cites Petroff v. Verizon North, Inc., Civ. No. 02-318, 2004 WL 1047896 (W.D.Pa. May 4, 2004). In Petroff, the court concluded that a heightened degree of scrutiny should be applied because of "Dr. Hopkins' selective `pick and choose' approach in reviewing the medical records in the case." Id. at 13 ("Tellingly absent from Dr. Hopkins' report is a reference to Dr. Babins' complete office note . . .").
The facts of this case are distinguishable from the facts of the Petroff decision and the other cases cited by Plaintiff. Here, Dr. Hopkins did not employ a `pick and choose' approach to Plaintiffs medical records. Dr. Palumbo's notes from Plaintiffs October 3, 2007 and November 13, 2007 visits are so deplete of medical evidence and a specific treatment plan, that Dr. Hopkins had nothing to `pick and choose' from. Dr. Palumbo's notes reveal a self-reported injury, a generic treatment plan and no medical documentation, such as an MRI, to explain the "sudden change in [Plaintiffs] condition." Plaintiffs Ex. 17, p. 3-4. Accordingly, even if the Court had denied Defendants' Motion to Strike in its entirety, the Court would still conclude that Defendants' denial of Plaintiff's application for STD Benefits was not an abuse of discretion.
F. Plaintiffs Assertion of Defendants' Procedural Error
In addition to Plaintiffs contention that UnitedHealth abused its discretion in denying her application for STD Benefits, Plaintiff argues that DMA violated her right to rebut Dr. Hopkins' statements before her application was denied. In response, Defendants contend that DMA gave Plaintiff ample opportunity to submit additional information to support her claim for STD Benefits during both the initial determination phase and the appeal process.
*222 9 C.F.R. § 2560.503-1(h)(2)(ii) provides
(h) Appeal of adverse benefit determinations.
(1) In general. Every employee benefit plan shall establish and maintain a procedure by which a claimant shall have a reasonable opportunity to appeal an adverse benefit determination to an appropriate named fiduciary of the plan, and under which there will be a full and fair review of the claim and the adverse benefit determination.
(2) Full and fair review. Except as provided in paragraph (h)(3) and (h)(4) of this section, the claims procedures of a plan will not be deemed to provide a claimant with a reasonable opportunity for a full and fair review of a claim and adverse benefit determination unless the claim procedures
. . . (ii) Provide claimants the opportunity to submit written comments, documents, records, and other information relating to the claim for benefits . . .
The issue is therefore whether Plaintiff had a "reasonable opportunity" to appeal her adverse benefits determination, including the opportunity to supplement her application with additional information relating to her claim.
Plaintiff was provided with several opportunities to appeal and supplement her original application. First by letter dated October 24, 2007, Plaintiff was notified that her claim for STD Benefits was denied. Plaintiffs Ex. 10, p. 2. In that letter, Plaintiff was notified that she had the opportunity to appeal in writing within 180 days from the date that she received the letter, and that her appeal should include her physician's reports and any other documentation that she deemed helpful for DMA's review. Id. Then again in a letter dated November 5, 2007, Plaintiff was notified that after a review of her claim, the denial had been affirmed, but that she could file an appeal within 180 days of the date that she received the letter. Plaintiffs Ex. 11.
In fact, Plaintiff elected to appeal DMA's decision and she did supplement her application with Dr. Palumbo's report from the November 13, 2007 Visit. Plaintiffs Ex. 7, p. 3. In addition, Dr. Palumbo discussed Plaintiffs condition directly with Dr. Hopkins. This Court therefore concludes that not only was Plaintiff given ample opportunity to appeal DMA's decision, but she was also sufficiently informed that she could supplement her application with additional evidence and she actually took full advantage of those opportunities.
V. CONCLUSION
For the reasons detailed above, this Court finds that Defendants' decision to deny Plaintiffs application for STD Benefits was not "arbitrary, capricious, or an abuse of discretion." Defendants' Motion to Strike is GRANTED in part and DENIED in part; Plaintiffs Motion for Summary Judgment is DENIED; and Defendants' Motion for Summary Judgment is GRANTED.
SO ORDERED.
NOTES
[1] Neither party provides the exact date that Plaintiff withdrew from work. The Court assumes that it was on or before October 4, 2007, when Plaintiff applied for STD benefits.
[2] Plaintiff began treating with Dr. Mark Palumbo, of University Orthopedics, in 1996. To support Plaintiff's claim for STD Benefits, Dr. Palumbo faxed Christina Kozlowski, a case manager at DMA, Plaintiff's medical charts. DMA relied upon Dr. Palumbo's medical charts to determine whether Plaintiff was eligible for STD Benefits under the STD Plan. The parties also rely on those charts to chronicle Plaintiff's medical history.
[3] Defendants filed a Motion to Strike from the Record (1) Section 11(A)(2) of Plaintiff's Motion for Summary Judgment entitled "Dr. Amy Hopkins' Previous Reviews," (2) Facts 50-54 in Plaintiff's Statement of Undisputed Facts, and (3) Plaintiff's Exhibit 20, which contains Stipulated Facts concerning Dr. Hopkins from a 2006 case in the Central District of California.
Defendants emphasize that Section 11(A)(2) of Plaintiff's Motion for Summary Judgment is based on cases from other jurisdictions that are unrelated to this case. Defendants argue that those facts are not relevant or admissible in this case, because they were not part of the administrative record. In response, Plaintiff argues that the evidence is relevant because Defendants have held Dr. Hopkins out to the Court as an "independent file reviewer." Plaintiff contends that she should, therefore, be permitted to establish that Dr. Hopkins was biased in favor of UnitedHealth.
While ERISA cases are typically adjudicated on the record, "courts have permitted only modest, specifically targeted discovery" to address a conflict of interest. Denmark v. Liberty Life Assurance Co., 566 F.3d 1; 10 (1st Cir.2009). This discovery must be "narrowly tailored so as to leave the substantive record essentially undisturbed." Id. The Court concludes that Facts 50-53 from Plaintiff's Statement of Undisputed Facts are not relevant and are beyond the scope of specifically targeted discovery in this case. Defendants' Motion to Strike Plaintiff's facts 50-52, Exhibit 20, and Section 11(A)(2) of Plaintiff's Motion for Summary Judgment is therefore granted.
The Court denies Defendants' Motion to Strike, however, on Plaintiff's Facts 53 and 54. These facts contain the financial arrangement between DMA and Dr. Hopkins. This evidence is relevant to this case, because it pertains to Plaintiff's claim of Dr. Hopkins' potential bias.
Finally, this Court notes that even if it had denied Defendants' Motion in its entirety, the extraneous cases Plaintiff relies on would not be outcome determinative, as this Court discusses in Section IV.E.
[4] The STD Plan provides that "UnitedHealth Group, and any other persons or entities to whom UnitedHealth Group delegates fiduciary authority, has the sole and exclusive authority and discretion to interpret the plans' terms and benefits under them, and to make factual and legal decisions about them." Plaintiff's Ex. 3, p. 4 (emphasis added).
[5] The Court is aware of the dollar amounts involved, however, because the discovery is subject to a protective order which this Court will not disturb, the Court uses the descriptor "substantial." | 01-04-2023 | 10-30-2013 |
https://www.courtlistener.com/api/rest/v3/opinions/4619452/ | Stoner-Mudge, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentStoner-Mudge, Inc. v. CommissionerDocket No. 21174United States Tax Court15 T.C. 419; 1950 U.S. Tax Ct. LEXIS 65; October 10, 1950, Promulgated *65 Decision will be entered for the respondent. On August 31, 1944, just prior to the close of the fiscal year ended September 30, 1944, petitioner borrowed certain funds with which it purchased from the shareholders of Impervious Varnish Co. all of the latter's capital stock. Petitioner computes its excess profits credit on the income basis. In the taxable years involved, respondent in computing the excess profits credit determined that by reason of petitioner's acquisition of the aforesaid capital stock, it sustained a capital reduction under the provisions of section 713 (g) (5) of the Internal Revenue Code. Held:(1) Petitioner, after the acquisition of all the shares of another corporation, became a member of a controlled group.(2) There is no ambiguity in the provisions of section 713 (g) (5), as added to section 713 (g) by section 216 of the Revenue Act of 1942.(3) Respondent's determination was made in conformance with the provisions of section 713 (g) (5) and is, therefore, sustained. Jacquin D. Bierman, Esq., for the petitioner.Edwin P. Friedberg, Esq., for the respondent. Leech, Judge. LEECH*419 OPINION.The respondent determined deficiencies in excess profits taxes against petitioner for the fiscal years ending September 30, 1944, 1945, and 1946 in the respective amounts of $ 1,618.72, $ 14,559.35, and $ 1,369.40. The question presented is whether petitioner's acquisition on August 31, 1944, by purchase from shareholders of 100 per cent of the outstanding stock of Impervious Varnish *420 Co., constituted a capital reduction within the intendment of section 713 (g) (5) of the Internal Revenue Code.The facts have been stipulated and are so found.Petitioner is a Pennsylvania corporation having its principal office in Pittsburgh, Pennsylvania. It is engaged in the manufacture of paints, lacquers*67 and other chemicals. It filed its returns for the periods involved with the collector of internal revenue for the 23rd district of Pennsylvania.Impervious Varnish Co. is a Pennsylvania corporation with its principal office in Rochester, Pennsylvania. At all times relevant herein, it has been engaged in the manufacture of paints, lacquers and varnish. As of August 31, 1944, its authorized and outstanding capital stock consisted of 7,500 shares of no-par common stock.In August and prior to August 31, 1944, petitioner borrowed from the Union National Bank of Pittsburgh, Pennsylvania, the sum of $ 210,000. On August 31, 1944, with such funds, it purchased from the stockholders of Impervious Varnish Co. all of the capital stock of that corporation, paying therefor the sum of $ 207,624.75.As of January 1, 1940, petitioner had accumulated earnings and profits of $ 123,360.97, and as of August 31, 1944, its accumulated earnings and profits were $ 328,550.84.The accumulated earnings and profits of petitioner at the end of each of the taxable years involved were as follows:Sept. 30, 1944$ 284,965.82Sept. 30, 1945307,851.57Sept. 30, 1946321,714.66During all the years*68 relevant herein, petitioner's excess profits credit has been computed on the basis of income in accordance with the provisions of section 713 of the Internal Revenue Code. Petitioner had no capital additions entering into the computation of its excess profits credit based on income for any of its excess profits tax taxable years.During all the relevant years herein, the excess profits credit of Impervious Varnish Co. has been computed on the basis of invested capital in accordance with the provisions of section 714 of the Internal Revenue Code.In determining petitioner's excess profits credit based on income, the respondent determined that the adjusted basis of the stock of Impervious Varnish Co. in the hands of petitioner, to wit: $ 207,624.75, constituted a capital reduction under section 713 (g) (5). 1*69 *421 Petitioner makes no claim that it was not a member of a controlled group, since it owned 100 per cent of the stock of Impervious Varnish Co. Petitioner apparently concedes, as we think it must, that if the provisions of section 713 (g) (5) are literally applied the respondent's determination is correct. Petitioner, however, insists that such section must be construed in the light of the Congressional purpose, which was to provide an adjustment designed to prevent a duplication of excess profits credit resulting from certain capital changes; that petitioner's acquisition of such capital stock did not result in any duplication of excess profits credit as between it and the Impervious Varnish Co., and that it did not constitute a capital change. Petitioner would have us invoke the canon of construction that courts are not bound to apply the literal phrasing of statutes when the clearly indicated purpose of Congress seems to require broader or narrower interpretation. Smith Enterprise Co. v. Commissioner, 167 Fed. (2d) 356; Carlisle v. Commissioner, 165 Fed. (2d) 645; Darby-Linde Co. v. Alexander, 51 Fed. (2d) 56;*70 Federal Deposit Ins. Corp. v. Tremaine, 133 Fed. (2d) 827. Conceding the soundness of the rule, we think the rule may not properly be invoked here since the basis for its application is that the Congressional purpose is not sufficiently disclosed or clearly indicated. We may assume that one of the purposes of enacting section 713 (g) (5) was to prevent the duplication of excess *422 profits credit. Cf. Morganton Full Fashioned Hosiery Co., 14 T.C. 695">14 T. C. 695. But that does not mean that such was its sole purpose. The statute itself expresses no such limited purpose.The general purpose of the excess profits tax was to provide revenue for the war emergency out of abnormal profits from large governmental expenditures for the war effort. Commissioner v. South Texas Lumber Co., 333 U.S. 496">333 U.S. 496. The act imposing the tax contains numerous provisions for computing the excess profits tax, including various provisions relating to allowances, credits, relief, etc. True, we are here primarily concerned with the credit provisions contained in section 713 (g) (5). It is a cardinal rule, however, *71 that a statute is to be construed as a whole, and not as though each of its provisions was independent and unaffected by others. Alexander v. Cosden Pipe Line Co., 290 U.S. 484">290 U.S. 484, 496; Helvering v. New York Trust Co., 292 U.S. 455">292 U.S. 455. The particular section of the statute here in controversy is to be read in the light of the purposes for which the Excess Profits Tax Act was enacted.Section 713 (g) (5) was added to section 713 (g) by section 216 of the Revenue Act of 1942. It was in force during all the taxable periods involved herein. That section clearly prescribes what is to be treated as a reduction of capital for the purpose of computing the excess profits credit based on income. If it were the intention of Congress that there should be a reduction of capital only where a duplication of excess profits credit would result, it is fair to assume more appropriate language would have been used. In neither the Senate Report 2 nor the House Committee Report 3 is there any indication that the statute was to be so limited. Their respective statements explaining the provisions are substantially the same. The Finance*72 Committee Report is set forth in the margin. 4*73 *423 Petitioner argues that to apply the statute literally produces a harsh and inequitable result under the particular circumstances disclosed here. That such a literal application of the section may possibly result in hardship does not empower us to "sacrifice the plain, obvious and rational meaning of the statute." Deputy v. duPont, 308 U.S. 488">308 U.S. 488, 498.The language of section 713 (g) (5) being clear and unambiguous, we apply it as written.Petitioner also contends that section 713 (g) (5), relating to adjustments resulting from capital changes, means changes in its capital stock, and that the circumstances of its acquisition of all the capital stock of the Impervious Varnish Co. with borrowed money did not constitute such a capital change. We think petitioner takes too narrow a view. It seems clear to us that the term "capital" in the statute is used in its broader sense and designates that portion of the corporate assets which is utilized in the conduct of the business and for the purpose of deriving profits.Petitioner, in the alternative, advances the argument that since a corporation is not to be treated as a member of a controlled*74 group until it acquires more than 50 per cent of the stock of another corporation, the capital reduction should not exceed in the instant case 50 per cent of its cost of such stock. Stated differently, petitioner says since ownership of 50 per cent of the stock of another corporation is treated as excluded capital instead of a reduction in capital, to hold that it sustains a capital reduction of 51 per cent merely because it acquires one additional share produces a curious and illogical result. The basis of the rule is "control." The statute makes no provision for computing the capital reduction on any percentage of the adjusted cost basis of the shares held in excess of the number constituting control. The statute merely provides how the capital reduction is to be computed where control exists. There is no merit in petitioner's alternative position.We, therefore, hold that the respondent has properly applied the provisions of the statute in computing petitioner's capital reduction, and his determination is sustained.Decision will be entered for the respondent. Footnotes1. SEC. 713. EXCESS PROFITS CREDIT -- BASED ON INCOME.* * * *(g) Adjustments in Excess Profits Credit on Account of Capital Changes. -- For the purposes of this section --* * * * (5) If on any day of the taxable year, the taxpayer and any one or more other corporations are members of the same controlled group, then the daily capital reduction of the taxpayer for such day shall be increased by whichever of the following amounts is the lesser: (A) The aggregate of the adjusted basis (for determining loss upon sale or exchange) of stock in such other corporation (or if more than one, in such other corporations) acquired by the taxpayer after the beginning of the taxpayer's first taxable year under this subchapter, minus the aggregate of the adjusted basis (for determining loss upon sale or exchange) of stock in such other corporation (or if more than one, in such other corporations) disposed of by the taxpayer prior to such day and after the beginning of the taxpayer's first taxable year under this subchapter, or(B) The excess of the aggregate of the adjusted basis (for determining loss upon sale or exchange) of stock in all domestic corporations and of obligations described in section 22 (b) (4), held by the taxpayer at the beginning of such day over the aggregate of the adjusted basis (for determining loss upon sale or exchange) of stock in all domestic corporations and of obligations described in section 22 (b) (4), held by the taxpayer at the beginning of its first taxable year under this subchapter.If any stock or obligations described in subparagraph (A) or (B) was disposed of prior to such day, its basis shall be determined under the law applicable to the year in which so disposed of. The excluded capital of the taxpayer for such day shall be reduced by the amount by which the taxpayer's daily capital reduction for such day is increased under this paragraph. As used in this paragraph, a controlled group means one or more chains of corporations connected through stock ownership with a common parent corporation if (i) more than 50 per centum of the total combined voting power of all classes of stock entitled to vote, or more than 50 per centum of the total value of shares of all classes of stock, of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations and (ii) the common parent corporation owns directly more than 50 per centum of the total combined voting power of all classes of stock entitled to vote, or more than 50 per centum of the total value of shares of all classes of stock, of at least one of the other corporations.↩2. S. Rept. 1631, 77th Cong., 2d Sess., C. B. 1942-2, p. 644.↩3. H. Rept. 2333, 77th Cong., 2d Sess., C. B. 1942-2, p. 475.↩4. This section, which is identical with section 210 of the House bill, is applicable to taxable years beginning after December 31, 1941, and applies to any taxpayer which is a member of a controlled group and which owns stock in one or more corporations in such controlled group acquired after the beginning of the taxpayer's first taxable year under the excess profits tax. In general, it provides that such stock owned by the taxpayer on any day of the taxable year shall increase the daily capital reduction for such day (or, if the taxpayer has made no previous distributions resulting in daily capital reduction, such stock owned by the taxpayer on such day shall be a daily capital reduction for such day).Two rules are provided by this section for the determination of the amount of the daily capital reduction on account of such stock for any day of a taxable year beginning after December 31, 1941. The first rule is to the effect that the daily capital reduction on account of such stock for such day shall be the aggregate of the adjusted basis (for determining loss upon sale or exchange) of the stock acquired by the taxpayer after the beginning of the taxpayer's first taxable year under the excess profits tax, minus the aggregate of the adjusted basis (for determining loss upon sale or exchange) of the stock disposed of by the taxpayer prior to such day and after the beginning of the taxpayer's first taxable year under the excess profits tax. The second rule limits the amount of such daily capital reduction to the excess of the aggregate of the adjusted basis (for determining loss upon sale or exchange) of excluded capital, held by the taxpayer at the beginning of such day, over the aggregate of the adjusted basis (for determining loss upon sale or exchange) of excluded capital, held by the taxpayer at the beginning of its first taxable year under the excess profits tax. The daily capital reduction on account of such stock for any such day shall be an amount equal to the lesser of the amounts determined by the application of the foregoing rules.In case any stock or obligation referred to in section 215 is disposed of prior to the day for which the computation is being made, its basis shall be determined under the law applicable to the year in which so disposed of. The excluded capital of the taxpayer for any such day shall be reduced by the amount by which the taxpayer's daily capital reduction for such day is increased under this section.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619453/ | Ames Trust & Savings Bank, Petitioner, v. Commissioner of Internal Revenue, RespondentAmes Trust & Sav. Bank v. CommissionerDocket No. 14982United States Tax Court12 T.C. 770; 1949 U.S. Tax Ct. LEXIS 199; May 13, 1949, Promulgated *199 Decision will be entered under Rule 50. Outstanding obligations evidenced by "certificates of deposit" issued by petitioner bank, not subject to check, bearing interest, and payable only at maturities of 6 months and 1 year, held includible in borrowed capital under section 719, Internal Revenue Code, for purposes of computing petitioner's excess profits credit. Economy Savings & Loan Co., 5 T.C. 543">5 T.C. 543. J. R. Austin, Esq., for the petitioner.Frank M. Cavanaugh, Esq., for the respondent. Opper, Judge. OPPER*771 By this proceeding petitioner challenges respondent's determination of deficiencies in excess profits tax for the years 1943 and 1944 in the amounts of $ 3,603.38 and $ 271.07, respectively. Petitioner claims an overpayment for the year 1944 in the amount of $ 880.13.The above deficiencies result from respondent's action in failing to include as borrowed invested capital 50 per cent of petitioner's daily average outstanding certificates of deposit, in computing its excess profits credit for the years 1942, 1943, and 1944.FINDINGS OF FACT.The parties have filed a stipulation of facts which we hereby find accordingly. *200 Petitioner, an Iowa banking corporation created in 1913, has been engaged exclusively in a general banking business in Iowa. Throughout the taxable period it was a member of the Federal Deposit Insurance Corporation. It filed the returns here in controversy with the collector for the district of Iowa.Petitioner issued certificates of deposit on a standard form as follows: Certificate of DepositAmes Trust and Savings BankAmes, Iowa, 192 . No. Has Deposited in This Bank Dollars $ Payable to the Order of In Current Funds on the Return of This Certificate Properly Endorsed Months After Date With Interest at the Rate of Per Cent Per Annum.No Interest After MaturityNot Subject to CheckCashier TellerIt was petitioner's practice to repay the principal amount of those certificates only upon maturity, except where the holder made a showing of unusual circumstances and forfeited accrued interest for the preceding six months.During the years 1942, 1943, and 1944 petitioner had outstanding certificates of deposit on the above standard form in the following daily average amounts:1942$ 36,972.26194338,708.02194441,201.28*201 Each of the above outstanding certificates had a maturity date of either six or twelve months from its date of issue.For each of the years 1942, 1943, and 1944 petitioner submitted to the Federal Reserve Bank a report of its condition as of December 31. As a subhead under "Liabilities," line 14 of the form upon which the *772 above reports were submitted was captioned "Time deposits of individuals, partnerships, and corporations." Line 19, also under "Liabilities," was captioned "Total Deposits (items 13 to 18, inclusive)." Petitioner's obligations under its outstanding certificates of deposit which had been executed on the standard form set out above were included in the amounts reported on lines 14 and 19 of the reports of condition. Those amounts for the years 1942, 1943, and 1944 were as follows:YearLine 14Line 191942$ 513,060.11$ 2,402,173.831943613,959.923,501,769.391944802,718.354,435,560.65OPINION.That the instruments in controversy were certificates of indebtedness within the meaning of section 719, Internal Revenue Code, 1 follows from the holding in Economy Savings & Loan Co., 5 T.C. 543">5 T.C. 543, reviewed *202 other issues (C. C. A., 6th Cir.), 158 F.2d 472">158 F.2d 472. That case, as this, involved a certificate of deposit, and respondent relied upon the definition contained in Regulations 112, sec. 35.719-1:The term "certificate of indebtedness" includes only instruments having the general character of investment securities issued by a corporation as distinguishable from instruments evidencing debts arising in ordinary transactions between individuals * * *But we held:* * * that the certificate of deposit issued by petitioner is a certificate of indebtedness, an instrument having the general character of an investment security, and thus is within the meaning of section 719 * * *having previously concluded in language equally applicable here:* * * Are the funds deposited with petitioner under the circumstances hereinabove set forth invested in petitioner's business? Does this certificate have the general character of investment securities? We think these questions must be answered in the affirmative. * * **203 In construing the succeeding sentence of the regulations, the question of whether ordinary bank deposits are includible in borrowed capital was not decided. That sentence reads:* * * Borrowed capital does not include indebtedness incurred by a bank arising out of the receipt of a deposit and evidenced, for example, by a certificate of deposit, a passbook, a cashier's check, or a certified check.*773 We said:Respondent argues that petitioner was really in the banking business and therefore the money deposited with it, as evidenced by the certificates hereinabove referred to, must be excluded in computing petitioner's borrowed capital. Respondent claims that these certificates fall squarely within the definition set forth in the regulations excluding indebtedness incurred by a bank * * *. Respondent's suggestion that petitioner was really in the banking business and that the funds evidenced by the certificates herein involved are analogous to the deposits of a bank is not borne out by the evidence. The distinction between ordinary bank deposits and the deposits such as these was recognized in Stoddard v. Miami Savings & Loan Co., 63 F.2d 851">63 F.2d 851*204 * * *We do not pass on the question of whether or not petitioner is in the banking business. We think that is immaterial to the precise question presented * * *.The regulation is manifestly directed at the ordinary bank deposit of a demand nature. Under the principle of noscitur a sociis, the association of certificates of deposit with passbooks and checks satisfies us that what was referred to was a certificate of demand deposit. It may well be that ordinary bank deposits, even though represented by a certificate, would not be the kind of investment security to which the statute has reference. See Kellogg Commission Co., 12 T.C. 182">12 T.C. 182. We find it unnecessary to express an opinion on this subject, since the purpose of the legislation and the form of the regulation satisfy us that it has no application here.The certificates of deposit in question had maturities of six months or a year; they bore interest; they were payable only upon maturity and were not subject to check. That, unlike West Construction Co., 7 T.C. 974">7 T.C. 974, the business here assumed the risk of the investment seems demonstrable from the consequence*205 of a loss of the funds. The holder of the certificate would be repaid, and repayment would be by the petitioner and not by the Federal Deposit Insurance Corporation, which (12 U. S. C. 264 (l) (7)) insures the depositor and not the bank. Cf. Brann & Stuart Co., 9 T.C. 614">9 T.C. 614; acq. 2 C.B. 1">1948-2 C.B. 1. In all respects, these certificates are as comparable to the investment securities envisaged by the regulation as those involved in Economy Savings & Loan Co., supra.The mere fact that petitioner in its other capacities may have dealt with depositors as a banking institution is insufficent to qualify that result here as it was there.Decision will be entered under Rule 50. Footnotes1. SEC. 719. BORROWED INVESTED CAPITAL.(a) Borrowed Capital. -- The borrowed capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following:(1) The amount of the outstanding indebtedness (not including interest) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust, plus * * *↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619454/ | GEOFFREY ROY AKERS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAkers v. CommissionerDocket No. 1650-77.United States Tax CourtT.C. Memo 1979-217; 1979 Tax Ct. Memo LEXIS 314; 38 T.C.M. (CCH) 876; T.C.M. (RIA) 79217; May 29, 1979, Filed Geoffrey Roy Akers, pro se. David N. Brodsky, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined a $3,152.22 deficiency in petitioner's 1974 income tax, plus a $157.61 addition to the tax under section 6653(a). 1 Due to concessions by the parties, the sole issue remaining is whether petitioner has substantiated charitable contributions in 1974 in an amount in excess of $78. FINDINGS OF FACT Some of the facts have been stipulated by the parties and are found accordingly. Petitioner resided*315 in Norwich, Connecticut, at the time he filed his petition. During 1974 petitioner was a member of The First Church of Christ, Scientist, Boston, Massachusetts, and The First Church of Christ, Scientist, New London, Connecticut. On his 1974 income tax return petitioner deducted charitable contributions as follows: First Church of Christ, Scientist, Boston$6,945First Church of Christ, Scientist, New London1,620Salvation Army and Boy Scouts110Total$8,675Attached to the return was an itemized list setting forth the specific cash contributions made to the Boston and New London churches on each Sunday of the year. This itemization was not a contemporaneous diary of such contributions. On his 1974 return petitioner reported gross income of $24,225.31. Respondent disallowed petitioner's deductions for charitable contributions during 1974 to the extent they exceeded $78 on the grounds that petitioner had failed to substantiate such contributions. OPINION Section 170(a)(1) provides that "[a] charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary * * *." Section 1.170A-1(a)(2)(iii), *316 Income Tax Regs., provides that the District Director may require statements from donee organizations corroborating claimed contributions. Petitioner claims he made his large donations to the Church in cash and anonymously so that no verification from the donee is possible. The only documentary support furnished by petitioner for the claimed contributions was the schedule attached to his 1974 return. The schedule, which is in inverse chronological order, is not a contemporaneous diary. Petitioner testified at trial that he made his claimed contributions anonymously because of his religious convictions as a Christian Scientist. However, it is clear that such convictions are almost uniquely his, since the assistant treasurer of the First Church of Christ, Scientist, testified that less than one percent of the donations received by the Mother Church in Boston each year are from anonymous donors. The Mother Church receives between seven million dollars and eleven million dollars annually in donations. Moreover, members of the Church may receive verification of thier donations in many different ways. Some members mail cash to the Church in letters identifying themselves; the*317 treasurer's office records the name of each such donor and the amount contributed. Some members mail checks to the Church. Receipts are given by the Church upon request. Some members place checks in the Sunday collecton plates. Thus, petitioner easily could have made his donations in such a manner that they could have been verified by the Church had he so desired. Petitioner's only evidence of substantiation in this case beside the schedule attached to the return is his testimony. 2 We are not persuaded by that evidence that petitioner made charitable constributions in 1974 in excess of the $78 allowed by respondent. Petitioner, on whom the burden of proof rests ( Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure), has failed to carry his burden. Decision will be entered under Rule 155.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the year in issue.↩2. Petitioner did not present any evidence with respect to the claimed contributions to the Salvation Army and the Boy Scouts.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619455/ | BURNET OUTTEN JR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentOutten v. CommissionerDocket No. 12447-81.United States Tax CourtT.C. Memo 1984-81; 1984 Tax Ct. Memo LEXIS 592; 47 T.C.M. (CCH) 1120; T.C.M. (RIA) 84081; February 21, 1984. Burnet Outten, Jr., pro se. Warren P. Simonsen, for the respondent. TANNENWALDMEMORANDUM FINDINGS OF FACT AND OPINION TANNENWALD, Judge: Respondent determined the following deficiencies in petitioner's Federal income tax: Additions to taxYearDeficiencySec. 6651(a) 1Sec. 6653(a)1972$76.00$19.00$3.801976421.42105.3621.071977327.0081.7516.351978413.00103.2520.651979255.0063.7512.75Petitioner has conceded that he received income in the amounts determined by respondent. 2 We must determine whether petitioner is entitled to deduct certain claimed business expenses, whether petitioner's failure to file income tax returns during the years in issue was due to reasonable cause, and whether petitioner is liable for additions to tax for negligence or intentional disregard of rules and regulations within the meaning of section 6653(a). *594 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioner resided in Florida when he filed his petition herein. No individual Federal income tax return was filed by petitioner for any year between 1972 and 1979, inclusive. Partnership income tax returns were filed by Western Metal Products Company (Western Metal) for 1977 through 1979. Western Metal was established in 1941. Petitioner has had a continuing interest in Western Metal since its founding. 3During the 1940's and from 1954 to 1956, Western Metal apparently conducted manufacturing operations. At all other times, and perhaps even during the time Western Metal was involved in manufacturing, Western Metal conducted atomic energy research. There is no indication in the record that anyone other than petitioner conducted any of this research for Western Metal. Since petitioner was the sole participant in Western Metal's nuclear research activities, we shall sometimes refer to Western Metal's actions as petitioner's. *595 In 1951, according to petitioner, Western Metal conducted an experiment which resulted in nuclear fusion. However, petitioner did not "discover" that nuclear fusion had occurred until 10 years later, when he was doing further research. This experiment was repeated by Western Metal, according to petitioner, in 1971. 4 Petitioner believes that the world was initially created by this nuclear fusion process. Over the years, petitioner has made numerous attempts to inform scientists and government officials of Western Metal's miraculous "discovery," which he asserted has never been duplicated by anyone else. Some of petitioner's correspondents have expressed polite interest in petitioner's project; others have evaluated petitioner's claims and found them of "no merit." Neither petitioner nor Western Metal has ever received any income, let alone a profit, from this nuclear fusion process. In 1978, Western Metal established a book value for its process of $50,000,000. On the 1977 through 1979 partnership tax returns, petitioner listed net operating losses of $100,000, $10,000,000, *596 and $5,000,000, respectively. These losses were described as due to "write-off of capitalized research work." Petitioner apparently concluded that this write-off was justified because government officials were ignoring him and his "discovery." 5Petitioner submitted lists of expenditures which respondent concedes were made by petitioner for the purposes indicated, but not that*597 they were expended for business purposes. The amounts spent during the years in issue are as follows: 1972 -- $1,273.08 plus $519 (office in home); 1976 -- $1,324.40 plus $906 (office in home); 1977 -- $794.31 plus $911 (office in home) plus $272.33 (moving expense); 1978 -- $900.42 plus $720 (office in home); 1979 -- $1,039.19 plus $720 (office in home). 6OPINION Petitioner is faced with a multitude of obstacles to overcome before we can find the expenses at issue herein deductible. Although there are numerous grounds upon which most or all of these expenses can be denied, we will discuss only one such ground. The deductibility of these expenses under section 162 (trade or business expenses), section 165 (losses incurred in a trade or business or in a transaction entered into for profit), or section 212(1) and (2) (expenses incurred in the production of income) turns on whether Western Metal's research activity was carried on with a bona fide profit objective. 7Dreicer v. Commissioner,78 T.C. 642">78 T.C. 642 (1982),*598 affd. in an unpublished opinion (D.C. Cir., Feb. 22, 1983); Bessenyey v. Commissioner,45 T.C. 261">45 T.C. 261, 273-274 (1965), affd. 379 F.2d 252">379 F.2d 252 (2d Cir. 1967). A taxpayer's declaration of a profit motive is not controlling; profit objective must be determined by a careful analysis of all the facts and circumstances, and those facts and circumstances are entitled to greater weight than a taxpayer's mere statement of intent. Dreicer v. Commissioner,supra at 645. The burden of proof on this issue rests with petitioner. Rule 142(a). The regulations under section 183 list the following nine relevant factors*599 which should normally be taken into account in determining whether an activity is engaged in for profit: (1) The manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) expectation that assets used in activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; (9) elements of personal pleasure or recreation. Section 1.183-2(b), Income Tax Regs. Without specifically addressing each factor in the regulations, the following summary of the facts reveals that petitioner has not carried his burden of proving a profit objective. Although petitioner allegedly first produced nuclear fusion in 1951, he did not become "aware" of his "discovery" for ten years. Petitioner has neither described nor proved the manner in which he carries on his research, his expertise, or the amount of time and effort expended by him in carrying*600 on the activity. Petitioner merely contends that he has performed this experiment twice, that he studies nuclear research a great deal, and that he has made numerous efforts to convince others, including high-ranking government officials and prominent scientists, of the success of his experiment, although no one has shown any great interest. Western Metal's "process" by which nuclear fusion allegedly occurs has never been patented. Petitioner has never, so far as we know, made a nickel as an inventor; Western Metal has never earned any income from petitioner's "discovery." Petitioner has been supported by his parents and by trusts established by them; the income received from these sources, in conjunction with whatever other assets petitioner owns, has apparently been sufficient to sustain petitioner without forcing him to seek gainful employment. Finally, petitioner seems to find religious significance in his discovery, i.e., that nuclear fusion somehow pertains to the creation of the universe. 8*601 On this record, we cannot accept petitioner's contention that he or Western Metal had a bona fide profit objective during the period 1972 through 1979. By the beginning of that period, it was clear that the scientific community was not interested in the "discovery," even though enormous sums were being spent annually by public and private concerns on nuclear research. Surely, by that time, the "discovery" would have generated at least some, if not substantial, income if it had been of any monetary value whatsoever. Petitioner's contention that research firms invest lots of time and money in projects that do not generate income simply misses the point. Western Metal's sole activity was promoting a "discovery" that time had shown would never be profitable. In light of the scientific community's lack of interest, it must have been clear to petitioner, at least by the years in issue, that the "discovery" would never generate any income, let alone a profit, for him or Western Metal. Consequently, the expenses incurred by petitioner or Western Metal during the years in issue were not incurred by a taxpayer operating with a profit objective.Cf. White v. Commissioner,23 T.C. 90">23 T.C. 90 (1954),*602 affd. per curiam 227 F.2d 779">227 F.2d 779 (6th Cir. 1955). Compare Avery v. Commissioner,47 B.T.A. 538">47 B.T.A. 538 (1942); section 1.183-2(c), Example 6, Income Tax Regs. They are therefore not deductible under section 162 or section 165 or section 212(1) and (2).Such being the case, since the activities of petitioner and Western Metal generated no income during the years in issue, none of the expenses incurred by him and/or Western Metal are deductible under section 183(b). Petitioner also has the burden of proving that his failure to file income tax returns during the years in issue was due to reasonable cause (section 6651(a)) and that he did not negligently or intentionally disregard rules and regulations within the meaning of section 6653(a). Rule 142(a). As petitioner has not addressed either of these two issues, he has failed to carry his burden of proof relating thereto and respondent's determination with respect to the additions to tax is sustained. Decision will be entered for the respondent.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue, and all references to Rules are to the Tax Court Rules of Practice and Procedure. ↩2. Petitioner received the following income during the years in issue: 1972 - $2,597.75 in dividend and trust income; 1976 - $4,690.69 in interest, dividend, and trust income; 1977 - $4,609.60 in interest, dividend, and trust income; 1978 - $5,063.90 in interest, dividend, and trust income; 1979 - $4,442.06 in interest, dividend, and trust income.↩3. Petitioner claimed, on the 1979 partnership tax return, that Western Metal had had the following owners since 1951: 1952-1968sole proprietorship (petitioner)1969-1974partnership (petitioner, 50 percent; John A.Outten (son), 50 percent)1975-1976sole proprietorship (petitioner)1977partnership (petitioner, 50 percent; Janet A.Outten (daughter), 50 percent)1978partnership (petitioner, 90 percent; Janet A.Outten (daughter), 10 percent)1979partnership (petitioner, 50 percent; Janet A.Outten (daughter), 10 percent; four otherchildren, 10 percent each)Consequently, of the years in issue, Western Metal was, according to petitioner, a partnership in 1972, 1977, 1978, and 1979 and a sole proprietorship in 1976. No partnership document or other supporting material other than the three partnership returns has been submitted into evidence. Consequently, it is unclear whether there was in fact a partnership. However, for the reasons below (see pp. 5-6, infra,↩ and n. 7), we need not determine whether or not a partnership existed.4. Neither petitioner nor Western Metal has a patent or has applied for a patent on this process.↩5. On the 1977 partnership return, petitioner stated his basis in his partnership interest as follows: * Partner's contributed property (other than money) has been in the form of intellectual property which has been the result of 35 years of complex research work and for which a monetary basis has not yet been established. There has also been some contribution of used machinery -- such as old welding generators and other items used in the partnership's experimental research program. No more extensive statement of petitioner's basis in his partnership interest has ever been presented to the Court. To the extent that personal services entered into the calculation, they may not be taken into account in determining basis. Cf. Hutcheson v. Commissioner,17 T.C. 14">17 T.C. 14, 19↩ (1951).6. Petitioner also submitted lists of expenditures for 1973, 1974, and 1975. These expenses totalled $6,670.43, of which at least $1,684 was attributable to home office expenses.↩7. Because a bona fide profit objective is a critical finding for both partnerships and sole proprietorships, there is no reason for us to determine in which form Western Metal was conducted. The same criteria apply in determining whether petitioner was a sole proprietor in 1976 or a partner in 1972, 1977, 1978, or 1979; in the latter instance, the determination is made at the partnership level. Madison Gas & Electric Co. v. Commissioner,72 T.C. 521">72 T.C. 521, 564-565 (1979), affd. 633 F.2d 512">633 F.2d 512↩ (7th Cir. 1980).8. Petitioner's briefs seize upon this alleged religious significance and contain extensive argument about scientific experimentation and religious freedom in the context of the relationship between church and state (which we find to be totally irrelevant to this case), during the course of which petitioner explores history from Thomas Jefferson to Ronald Reagan and from the Bible to reports by the Atomic Energy Commission.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619460/ | Clara Hellman Heller Trust No. 7610, Wells Fargo Bank & Union Trust Company, Trustee, Petitioner, v. Commissioner of Internal Revenue, RespondentHeller Trust v. CommissionerDocket No. 6932United States Tax Court7 T.C. 556; 1946 U.S. Tax Ct. LEXIS 103; August 15, 1946, Promulgated *103 Decision will be entered under Rule 50Deduction -- Depreciation -- Exhaustion of Cost of Canceling a Lease. -- An amount paid by lessor for cancellation of a lease is in the nature of a capital expenditure to obtain possession during the unexpired term of the lease and is to be recovered through annual deductions for depreciation spread over the unexpired term of the canceled lease. Lloyd W. Dinkelspiel, Esq., for the petitioner.A. James Hurley, Esq., for the respondent. Murdock, *104 Judge. MURDOCK *556 OPINION.The Commissioner determined a deficiency of $ 26,119.22 in income tax for the calendar year 1941. The issues for *557 decision are (a) whether the Commissioner erred in disallowing a part of a deduction of $ 56,000 paid by the petitioner in 1941 to a lessee to cancel a lease so that it could enter into a more desirable contract with the United States Government for a lease of the premises with an option to buy, and, (b) whether he erred in disallowing a part of a deduction of $ 4,800 paid by the petitioner in 1941 for services rendered in negotiating the above transactions. The facts have been stipulated and the stipulation is adopted as the findings of fact.The petitioner is a trust created in 1938 by Clara Hellman Heller. A bank is trustee. The return for 1941 was filed with the collector of internal revenue for the first district of California.The petitioner leased a ranch of about 37,333 acres to Edward A. Heller on October 31, 1939, for five years from November 1, 1939. The lessee could cancel the lease at the end of any year by giving notice of 90 days. The lessee took possession and entered into subleases. He continued in *105 possession and paid the rent until his lease was canceled.The United States Government desired to lease or buy the ranch for a military reservation in 1940 and entered into negotiations with the petitioner to that end. The petitioner was unable to effectuate any lease or sale of the ranch to the United States of America or to any other person unless it first secured a cancellation of the lease to Edward H. Heller; and Edward H. Heller was unable to agree to such cancellation unless he also secured cancellation of the subleases which he had entered into. It was agreed between them that there should not be canceled from under the lease about 450 acres of the leased property which was used as headquarters for the operation of the ranch and about 1,393 additional acres which were subleased to R. I. Branch under an agreement which could not be canceled. The petitioner and Edward H. Heller estimated the cost to Heller of canceling the lease and subleases, exclusive of the headquarters acreage and sublease to R. I. Branch above referred to, and agreed that such cost would be $ 65,000, which amount would have to be paid by the petitioner to Heller in order to make the property available*106 to the United States.Contemporaneously with the negotiations between the petitioner and Edward H. Heller, negotiations took place between the petitioner and the United States as to the basis upon which the ranch property, with the exceptions above noted, should be leased by the petitioner to the United States.The negotiations above referred to were consummated between the petitioner and Heller and between the petitioner and the United States of America and resulted in the execution of an agreement dated the 21st day of October 1940, between the petitioner and Heller, and in a lease dated the same date between the petitioner and the United States of America.*558 Heller agreed to terminate and cancel all subleases theretofore entered into by him as sublessor except a certain sublease dated May 1, 1940, entered into between him and R. I. Branch, sublessee, covering approximately 1,400 acres hereinbefore referred to, and to surrender his lease of the ranch property except in so far as it covered the ranch headquarters tract and the area under sublease to Branch. It was further provided in the agreement between the petitioner and Heller that Heller should be paid the sum of $ *107 65,000 in consideration of the execution by him of the agreement, which sum was to be paid in installments of $ 9,000 on or before December 15, 1940, and of $ 8,000 each, commencing with the 15th day of January 1941, until the sum of $ 65,000 should have been paid; it was further provided that the payments should be payable out of, and only out of, the amounts received or to be received by the petitioner as rental from the United States of America under the lease between the petitioner and the United States of America or from the proceeds of the purchase of the ranch should the United States of America exercise its option to purchase.The ranch property, except the headquarters area and the area under sublease to Branch, was leased to the United States of America for a term beginning on the 21st day of October 1940, and ending with the 30th day of June 1941, with an option to the United States to renew the lease from year to year upon 90 days' advance notice, no renewal, however, to extend the period of occupancy beyond the 30th day of June 1946. The monthly rental for the initial term was stated to be $ 10,416.66, and it was provided that the rental of $ 10,416.66 was to continue*108 for that part of the first renewed term up to and including one year after the commencement of the original term and thereafter the rental was to be $ 5,000 per month. It was provided that the Government in any event should pay to the petitioner, as lessor, rental in the amount of $ 125,000 for the first 12 months of the term, commencing with the 21st day of October 1940, at the monthly rate of $ 10,416.66, and that thereafter the rental should be at the rate of $ 5,000 per month during the renewal period of the lease. The rental in excess of $ 5,000 per month for the first year of the lease was charged by the petitioner in order to absorb the additional costs incurred by the petitioner in canceling its lease with Heller. The petitioner granted to the Government an option to purchase the property, including the headquarters area and the area subject to sublease to Branch, for the sum of $ 500,000.The United States of America went into possession of the premises and Heller vacated or caused the premises to be vacated on or about the date of the agreements, October 21, 1940. The United States paid to the petitioner the sum of $ 10,416.66 per month up to and including *559 *109 October 21, 1941. The petitioner paid to Heller the sum of $ 9,000 prior to the end of the taxable year 1940, and the sum of $ 56,000 during the taxable year 1941.Jesse H. Steinhart, attorney at law, rendered legal services to the petitioner in the year 1940 in connection with the lease between the petitioner and the United States, and was paid therefor in the year 1941 as compensation the sum of $ 1,500. Additional services were rendered by him to the petitioner in the year 1941, for which compensation in the amount of $ 300 was paid in 1941.R. Pardow Hopper rendered services to the petitioner during the year 1940 as its agent in carrying on negotiations with the United States, which culminated in obtaining the aforesaid lease, and he was paid as compensation therefor in the year 1941 the sum of $ 3,000.The United States of America, on or about March 31, 1941, exercised its option to renew the lease for a period of one year from and after July 1, 1941. Subsequently, on or about March 18, 1942, the lease was again renewed by the United States for an additional period of one year from and after July 1, 1942.The United States, on or about December 17, 1942, pursuant to its option*110 as provided in the lease, purchased the ranch from the petitioner.The petitioner is, and in the years 1940 and 1941 and at all times herein mentioned was, on a cash receipts and disbursements, calendar year basis, for Federal income tax purposes.The Commissioner, in determining the deficiency, added to income as reported $ 42,735.32 representing disallowance of $ 41,391.32 of the deduction of $ 56,000 claimed as payment on account of cancellation of the lease and disallowance of $ 1,344 of the deduction of $ 4,800 claimed as expenses in connection with the lease. His explanation was in part as follows:* * * The amount of $ 56,000.00 paid in 1941 to Edward H. Heller was claimed on the income tax return for 1941 as deductible in its entirety. On the income tax return filed for the year 1940, the above-mentioned $ 9,000.00 was claimed as a deduction and the return was accepted as filed. It is held that the above mentioned $ 56,000.00 is amortizable over the period of time remaining on January 1, 1941 (January 1, 1941 to November 1, 1944) that the above-mentioned lease that had been made with Edward H. Heller had provided for producing a deduction of twelve forty-sixths of $ 56,000.00, *111 or $ 14,608.68, and a disallowance of $ 41,391.32.In 1941 the amount of $ 4,800.00 was paid for services performed in connection with obtaining in 1940 the lease with the United States Government mentioned hereinabove. The entire amount was claimed on the return as deductible in the year 1941. It is held that said $ 4,800.00 should be amortized over the life of said lease, October 21, 1940 to June 30, 1941, without taking renewals into account, and that eighteen twenty-fifths of $ 4,800.00 is deductible in the year 1941, producing a deduction of $ 3,456.00 and a disallowance of $ 1,344.00.*560 The petitioner paid Heller $ 65,000 to cancel his lease. Thereafter, the net income from the property would not be reflected clearly until gross income therefrom was offset in some way by a deduction or deductions for the $ 65,000 expenditure. The problem of how to deduct amounts paid to cancel leases has not lent itself to a simple logical solution which proves entirely satisfactory in all cases. Some taxpayers have attempted to deduct such expenditures as ordinary and necessary expenses of the year of payment or accrual (sec. 23 (a), I. R. C.), but the Commissioner resisted. He*112 pointed out, inter alia, that the beneficial effect of the expenditure would extend over the unexpired term of the canceled lease and the entire amount ought not to be offset against the income of one year alone, thus distorting income for that year, but should be spread over the longer period through deductions, authorized under section 23 (l) for depreciation, representing the gradual exhaustion of the beneficial effect of the outlay. Some spread obviously tends to reflect annual income more clearly. See section 43. Different taxpayers have urged the adoption of different rules on this subject to seek the greatest benefit in their particular cases. The desirability of some general rule is apparent both from the standpoint of administration and from that of taxpayers needing some settled practice to plan for and follow.An expenditure of this kind was allowed to be deducted as an ordinary and necessary expense in Higginbotham-Bailey-Logan Co., 8 B. T. A. 566, but that case was soon repudiated in Henry B. Miller, 10 B. T. A. 383, in which it was held that an amount paid for cancellation of a lease was in the nature*113 of a capital expenditure to obtain possession during the unexpired term of the canceled lease and was recoverable through annual deductions for depreciation spread over the unexpired term of the canceled lease. This rule is now generally accepted. Mertens Law of Federal Income Taxation, vol. 2, sec. 12.32, footnote. Charles B. Bretzfelder, 21 B. T. A. 789; Harriet B. Borland, 27 B. T. A. 538.Both parties here recognize that expenditures made to cancel leases are capital in their nature and are not deductible as ordinary and necessary expenses, but are to be spread over a period. The petitioner argues that the rules established by the cases are that amounts paid to cancel leases merely to permit the owner to regain possession for his own use are deductible over the unexpired term of the canceled lease, but where the cancellation is sought for the purpose of obtaining another capital asset, as a new and more desirable lease, they are to be recovered through deductions spread over the life of the new asset. We do not find this nice distinction in the decided cases nor do we deem it a real distinction. $ 9,000 of the*114 total of $ 65,000 paid to cancel the Heller lease was paid and recovered through a deduction against *561 income claimed and allowed in 1940. The remaining $ 56,000 was paid in 1941. A taxpayer on a cash basis has no right to any deduction until he pays the amount sought to be deducted. A payment must be deducted over some period beginning with the taxable year in which paid. The taxpayer argues that the payment for cancellation of the lease was made solely as a prerequisite of obtaining the new lease with the Government, it is a part of the cost of that asset, and it should be recovered ratably over the term of that new lease. It argues further that there is no asset which is exhausting over the unexpired term of the canceled lease and it is unrealistic to spread the deductions over that longer period when the petitioner is being compensated for the $ 65,000 through payments from the new lessee during the first 12 months of the new lease. Some merit must be recognized in this argument but a part of it has been considered in the cases cited above. It also overlooks the fact that the canceled lease related to a definite period and that there is reason in spreading the cost*115 of cancellation over that period. The possession obtained by the cancellation is possession for that period particularly, whether longer or shorter than the term of the new lease. We see no sufficient reason here to depart from the general rule that the cost of canceling a lease is recoverable through deductions spread over the unexpired term of that lease.The next question is, What is "a reasonable allowance" for the exhaustion of this term during 1941? No reason or basis appears for allowing more or less than a ratable portion of the $ 56,000 which the 12 months of 1941 bear to the unexpired term of the Heller lease as of January 1, 1941. The Commissioner has allowed the amount thus computed.The Commissioner has held that the $ 4,800 paid in 1941 for services was a capital cost of the new lease and should be recovered over the life of that lease, October 21, 1940, to June 30, 1941, without taking renewals into account. No part of the cost could be recovered in 1940 because payment was not made until 1941. The entire amount should be recovered in that year if the renewals are not to be taken into account. The Commissioner has not made any issue as to renewals being taken*116 into account, so no decision is required upon that point.Decision will be entered under Rule 50 | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619461/ | C. P. Chamberlin, et al., Petitioners, * v. Commissioner of Internal Revenue, RespondentChamberlin v. CommissionerDocket Nos. 27598, 27599, 27600, 27601, 27602, 27603United States Tax Court18 T.C. 164; 1952 U.S. Tax Ct. LEXIS 211; April 30, 1952, Promulgated *211 Decision in each proceeding will be entered for the respondent. Income -- Stock Dividend. -- The petitioners received a pro rata dividend paid in shares of preferred of the distributing corporation on its voting common, the only class then outstanding, pursuant to a prearranged plan embracing the authorization of the new preferred on terms imposed by insurance companies which agreed to purchase them for a stated consideration if, as, and when issued, the issuance thereof as a stock dividend, and the concurrent sale thereof for cash to petitioners. Held, that the purposes of the issuance of the preferred was concurrently to place that issue in the hands of others not then stockholders, thereby altering the preexisting proportionate interests of the common stockholders and setting up an entirely new relationship amongst all the stockholders and the corporation and at the same time to enable the common stockholders to derive cash in hand from their capital investment in the corporation. Held, further, that such dividend, when received, was the equivalent of a cash dividend constituting ordinary taxable income. Raymond H. Berry, Esq., and Ralph W. Barbier, Esq., for the petitioners.A. J. Friedman, Esq., for the respondent. Tietjens, Judge. Raum, J., concurs in the result. Opper, J., concurring. Arundell, J., dissenting. TIETJENS*164 These consolidated proceedings involve income tax deficiencies determined by respondent for the calendar year 1946, against petitioners in the respective amounts, as follows:PetitionerDocket No.DeficiencyC. P. Chamberlin27598$ 343,650.86Grace A. Chamberlin2759963,225.55John H. Toner2760019.620.37Benjamin James Carl276017.244.29Guy V. Schrock276029,177.83Robert Pierce and Josephine H. B. Pierce2760314,635.19In the proceeding of Grace A. Chamberlin, Docket No. 27599, the respondent also determined an income tax deficiency of $ 1.08 for the calendar year 1947 and petitioner concedes the correctness thereof.The only issue presented is whether the petitioners received dividends taxable as ordinary income *214 in 1946, upon receipt of a pro rata dividend paid in shares of preferred stock of the distributing corporation on its voting common stock, the only class then outstanding, when the authorization of the new preferred and issuance thereof as a stock dividend and an immediate sale thereof for cash, were all in pursuance of a prearranged plan.*165 The additional assignments of error in Docket Nos. 27602 and 27603 have been abandoned.The stipulated facts and numerous exhibits made a part thereof are included herein by reference.FINDINGS OF FACT.The stipulated facts are so found.The petitioners are individuals and during the period in question each was a resident of the State of Michigan. They filed their individual income tax returns for the calendar year 1946 with the collector of internal revenue at Detroit for the district of Michigan.The Metal Mouldings Corporation, hereinafter referred to as the Metal Company, is a Michigan corporation with its principal office in Detroit, Michigan. For many years and at all times material here, the Metal Company has been engaged in the business of manufacturing metal mouldings and bright work trim used in the manufacture of automobiles. *215 The Metal Company was incorporated on December 2, 1924, with an authorized common capital stock of $ 25,000 which was increased in 1935 to $ 150,000 represented by 1,500 shares of $ 100 par value voting common stock and remained at that authorization until further increased in 1946. From 1940 until December 20, 1946, the issued and outstanding common stock totaled 1,002 1/2 shares, of which Clarence P. Chamberlin and his wife Grace A. Chamberlin together owned 83.8 per cent, and during that period the only change in the holders of such outstanding stock was caused by the death of Edward W. Smith on October 11, 1946, and the transfer of his shares to his estate.The directors of the Metal Company from 1940 to February 12, 1946, consisted of Clarence P. Chamberlin, Grace A. Chamberlin, and Edward W. Smith. On February 12, 1946, the board of directors was increased to five and in addition to the aforenamed persons also included John H. Toner and Raymond H. Berry. After Edward W. Smith's death on October 11, 1946, the board of directors consisted of the four remaining members for the balance of 1946.The officers of the Metal Company from 1940 to the end of 1946 were as follows: Clarence*216 P. Chamberlin president and treasurer throughout; John H. Toner vice president and general manager throughout; Grace A. Chamberlin vice president and assistant treasurer until February 12, 1946, then vice president until October 18, 1946, and thereafter secretary; Edward W. Smith secretary until his death on October 11, 1946; and Benjamin J. Carl assistant secretary and assistant treasurer until February 12, 1946.The business of the Metal Company prospered. As reflected by its books of account for the indicated years prior to 1946 and for the *166 first 6 months of 1946, its earned surplus, net profits after Federal income tax, and cash dividends paid on the outstanding common stock were as follows:Net profitsYearSurplusafter taxDividends1937$ 307,137.71$ 294,651.49$ 175,437.501938226,351.70273,927.32175,437.501939272,954.56414,552.56300,750.001940305,757.12423,696.21300,750.001941678,863.71438,966.74200,500.001942917,330.4518,946.4050,125.001943964,990.47276,603.92100,250.001944711,072.77264.027.84100,250.0019451,086.552.60346,540.59200,500.001st 6 months 19461,267,566.77215,184.84*217 At the end of the first 6 months of 1946 the Metal Company's balance sheet reflected total assets of $ 2,488,836.53 and included in current assets, inter alia, $ 722,404.56 cash and $ 549,950 United States Government bonds and notes.On December 16, 1946, the stockholders of the Metal Company adopted a resolution that the company's authorized capital stock be increased from $ 150,000 to $ 650,000 represented by 6,500 shares of $ 100 par value common stock, and on December 19, 1946, a Certificate of Increase of Capital Stock was duly filed. On December 20, 1946, the stockholders and directors of the Metal Company adopted identical resolutions declaring a dividend of five shares of common for each share of common outstanding, aggregating 5,012 1/2 shares, to be issued pro rata to the stockholders on that date and, further, that the company's accounts be adjusted by transferring $ 100 per share for each share so issued, or a total of $ 501,250 from earned surplus to capital account. The stock dividend was issued and the company's accounts were adjusted accordingly.On December 26, 1946, the stockholders of the Metal Company adopted resolutions that article 5 of the articles of *218 incorporation of the Metal Company be amended to authorize a total of 14,520 shares of all classes of capital stock consisting of 8,020 shares of 4 1/2 per cent cumulative $ 100 par value preferred and 6,500 shares of $ 100 par value voting common. On December 27, 1946, a Certificate of Amendment of the company's articles of incorporation was duly filed with the Michigan authorities and as so amended set forth in lengthy detail all the designations and powers, preferences and rights, and the qualifications, limitations, or restrictions of all classes of stock. 1*219 *167 On December 28, 1946, the Metal Company's stockholders and directors adopted identical resolutions declaring a stock dividend of 1 1/3 shares of the newly authorized 4 1/2 per cent cumulative preferred for each share of common outstanding, aggregating 8,020 shares, to be issued pro rata to the holders of common stock outstanding at the close of December 27, 1946, and, further, that the company's accounts be adjusted by transferring $ 100 per share for each share of preferred so issued, or a total of $ 802,000, from earned surplus to capital account. The stock dividend was issued and the company's accounts were adjusted accordingly.The distribution of the Metal Company's outstanding capital stock immediately prior to and upon the above-mentioned recapitalizations and issuances of stock dividends, was as follows:No. ofsharesStock dividendcommonPer cent ofinStockholderprior andcommoncommonon 12/20/46ownedon 12/20/46C. P. Chamberlin700 69.833,500 G. A. Chamberlin140 13.97700 R. Pierce52.55.24262.5J. H. Toner50 4.99250 G. V. Schrock32.53.24162.5B. J. Carl25 2.49125 Est. E. W. Smith2.5.2412.5Total1,002.51005,012.5*220 Commonstock (onlyStock dividendStockholderclass) outstandinginat close ofpreferred12/27/46on 12/28/46C. P. Chamberlin4,2005,600G. A. Chamberlin8401,120R. Pierce315420J. H. Toner300400G. V. Schrock195260B. J. Carl150200Est. E. W. Smith1520Total6,0158,020The preferred shares issued by the Metal Company on December 28, 1946, to the persons and in the number of shares as set out in the next preceding paragraph, were temporary typewritten stock certificates which were complete in form. On the same day, the company purchased, affixed to its stock record book and canceled the required Federal documentary stamps with respect to the issuance of those shares.*168 The Metal Company's balance sheets as of June 30, 1946, and December 31, 1946, are summarized as follows:AssetsJune 30, 1946Dec. 31, 1946Cash$ 722,404.56$ 445.836.53U. S. Government bonds and notes549,950.00567,400.72Accounts receivable, less reserve144,977.97283,372.57Inventories and work in process548,035.31642,053.86Prepaid and deferred expenses65,739.0228,684.67Plant and equipment, net457,729.67475,478.84Cash earmarked for acquisition of plant facilities,machinery, equipment226,000.00Total assets2,488,836.532,668,827.19Liabilities and capitalCurrent and various others$ 698,128.08$ 668,815.28Reserves, various207,706.84Capital stock:4 1/2 percent cumulative preferred, $ 100 par,outstanding802,000.00Common stock, $ 100 par, outstanding100,250.00601,500.00Earned surplus1,267,566.77596,511.91Profit and loss, after estimated tax215,184.842,488,836.532,668,827.19*221 The earned surplus as of December 31, 1946, was in an amount as per an accompanying earned surplus statement, which is summarized as follows:Balance at Dec. 31, 1945, as restated (after including certainadjustments of reserves)$ 1,425,438.61Net profit for year 1946, after income tax664,798.302,090,236.91Deduct:Cash dividends on common stock ($ 100 per shareon 1,002 1/2 shares and $ 15 per share on6,015 shares)$ 190,475Dividend of 5,012 1/2 shares common stockat $ 100 par value501,250Dividend of 8,020 shares 4 1/2 per centcumulative preferred stock at $ 100 parvalue802,0001,493,725.00Balance at Dec. 31, 1946596,511.91On December 30, 1946, as the result of prior negotiations, the individual holders of 8,000 shares of 4 1/2 per cent cumulative preferred stock of the Metal Company (which constituted all the outstanding preferred except for 20 shares held by the Estate of Edward W. Smith, deceased) signed a "Purchase Agreement" with the Lincoln National Life Insurance Company (hereinafter called Lincoln) and the Northwestern *169 Mutual Life Insurance Company (hereinafter called Northwestern). *222 The agreement provided that those individuals "hereby confirm their agreement with" the insurance companies, subject to the terms and conditions therein set forth, for the sale of 4,000 shares of such preferred stock to each of those insurance companies, severally, at a cash price of $ 100 per share plus the amount of dividends accrued thereon from November 1, 1946, to date of delivery. Each of the insurance companies "confirmed and accepted" that agreement as of December 30, 1946. As authorized by a board of directors' resolution of December 30, 1946, the Metal Company signed an endorsement of the purchase agreement for the stated purpose of making "to and with" the insurance companies "the representations, warranties and agreements contained in" several enumerated sections of that agreement and pertaining to affairs of and/or corporate actions by the Metal Company. 2*223 On December 30, 1946, the individual holders of the 8,000 shares of preferred delivered their stock certificates endorsed in blank to the agents of the two insurance companies which transferred to Clarence P. Chamberlin, as agent for the stockholders, funds payable at a Detroit bank for the total amount of the purchase price. Chamberlin, by delivery of his personal checks, thereupon distributed the proceeds of the sale pro rata to the interested parties. The expenses incident to the sale which the individual stockholders were obligated to pay on a pro rata basis and which were paid by them on December 30, 1946, embraced $ 3,000 fee to the attorneys for the insurance companies; $ 2,000 fee to the attorneys for the stockholders; $ 8,000 commission to William Blair & Company, the broker in the transaction; $ 480 Federal documentary stamps; and $ 20.22 miscellaneous expense of the Detroit bank, or a total of $ 13,500.22. As to each of the individual stockholders, the number of 4 1/2 per cent cumulative preferred shares sold to the two insurance companies, the purchase price received *170 at $ 100 par plus dividends accrued to date, and the pro rata portion of the expense incurred, *224 are as follows:No. of sharesPriceStockholdersoldreceivedExpenseC. P. Chamberlin5,600$ 564,130.00$ 9,450.00G. A. Chamberlin1,120112,826.001,890.00R. Pierce42042,309.75708.75J. H. Toner40040,295.00675,00G. V. Schrock26026,191.75438.75B. J. Carl20020,147.50337.50Totals8,000$ 805,900.00$ 13,500.00Immediately upon completion of the sale of the 8,000 shares of preferred to the insurance companies on December 30, 1946, the certificates representing such shares were delivered to and canceled by the Metal Company. On the same date, there was issued to Lincoln and Northwestern, respectively, the Metal Company's temporary typewritten stock certificates for 4,000 shares of its 4 1/2 per cent cumulative preferred stock. On April 21, 1947, those temporary certificates, numbered 8 and 9, were canceled and in lieu thereof the Metal Company's definitive printed stock certificates, identical to the temporary ones except in form, were issued to the insurance companies.On April 26, 1949, the Metal Company filed with the proper Michigan authorities, a Certificate of Decrease of Capital Stock pursuant to resolution that*225 the authorized preferred stock be decreased by 2,000 shares, which had theretofore been retired and canceled in accordance with the company's amended charter. On October 6, 1950, a similar certificate was filed for an additional decrease of 1,000 shares of preferred which had been likewise retired and canceled.The above-mentioned transactions, in December 1946, involving the Metal Company's issuance of preferred shares as a stock dividend to petitioners herein and the latters' immediate sale thereof to the insurance companies, were the culmination of negotiations directed toward that result. In the latter part of 1945, Raymond H. Berry held a conference with Wallace Flower, a partner of William Blair & Company, investment bankers of Chicago, to consider certain income tax problems of Berry's clients, the Metal Company and its stockholders. It was explained that the Metal Company had such a large accumulated earned surplus it was fearful of being subjected to the surtax provided for by section 102, Internal Revenue Code, but that at the same time C. P. Chamberlin, the majority stockholder, was not willing to have the company distribute any substantial portion of its earned surplus*226 as ordinary dividends because his individual income was taxable at high surtax rates. Flower's advice was sought as to a means whereby the stockholders could withdraw, or otherwise derive cash benefits of about $ 1,000,000 of the Metal Company's accumulated *171 earnings in the form of capital gains rather than as taxable dividends. Flower advised that the tax problems might be solved by having the Metal Company capitalize $ 1,000,000 of its earned surplus through issuance of preferred stock, subject to provisions for rapid retirement, as a stock dividend to its common stockholders followed by their immediate sale thereof to a life insurance company for cash with the resulting profits taxed as capital gain. Chamberlin assented to the plan.Prior to and during December 1945, Flower communicated with an official of Lincoln's investment department, giving detailed history and financial data of the Metal Company, the tax problem involved, and suggestions as to the proposed issuance and retirement of preferred stock. The Lincoln official answered that his company was interested if terms could be worked out as to the amount of preferred to be issued and proper safeguards thereof*227 including the Metal Company's maintenance at all times of net current assets equal to one and one-half times the amount of the preferred issue and of cash and United States bonds equal thereto. During 1946 Chamberlin sought and received legal advisory opinions on the proposed plan. In October 1946 Flower advised Lincoln as to the Metal Company's willingness to make any reasonable covenants as to the maintenance of assets and a retirement sinking fund, and also the desirability of proceeding with the plan prior to the end of that year. Shortly thereafter the Lincoln official went to Detroit, inspected the plant and business of the Metal Company, discussed the proposed plan, and suggested amendments thereto in accord with Lincoln's investment policies. On November 11, 1946, that official made a detailed written report to Lincoln as to the Metal Company's facilities, business, operations, earnings, etc., and stated, inter alia, that the "purpose of this [issue of $ 1,000,000 preferred] is to enable the owners to take money out of the company and to pay thereon a capital gains tax of 25 per cent rather than the normal personal income tax rates" and that the negotiated "terms seek*228 to give the degree of protection usually found in a first lien bond issue."On November 20, 1946, Lincoln wrote to Flower that its finance committee approved of an $ 800,000 preferred stock issue and the purchase of one-half thereof on prescribed terms as to the dividend rate, sinking fund, etc., and also certain restrictions as to payment of any dividends on the common stock. Thereupon Flower communicated with Northwestern, giving all the details and terms of the proposed stock issue and seeking that company's interest in purchasing one-half thereof. Communications were exchanged between the two insurance companies and also the principals and the broker. Northwestern made a detailed investigation of the Metal Company, its affairs, and of the terms and conditions of the proposed preferred stock issue. About *172 two weeks before December 30, 1946, Northwestern's committee on investments approved the purchase of $ 400,000 of the preferred stock to be issued by the Metal Company and passed the matter over to its legal department for conclusion of the transaction.No agreement of purchase and sale was entered into between any of the petitioners and either of the two insurance*229 companies prior to the "Purchase Agreement" executed on December 30, 1946, but the stockholders and directors of the Metal Company took the necessary actions to put the negotiated plan into effect, as hereinbefore set out, only after the insurance companies signified their willingness to participate in the purchase if, as, and when the preferred stock was issued on the terms and conditions prescribed by them and as specifically set out in company's charter as amended on December 27, 1946, authorizing the issuance of preferred shares, in the certificates of stock as issued on December 28, 1946, and in the "Purchase Agreement" as executed on December 30, 1946.In reporting the sale of preferred stock of the Metal Company in their 1946 tax returns, each petitioner reported his proportion of the proceeds as a net long term capital gain from the sale of capital assets held for more than six months. Each petitioner used a substituted cost basis per share, in amounts as shown in the stipulation, and determined the holding period by including the holding period of the common. As to each petitioner, respondent determined that the value of the shares of the 4 1/2 per cent cumulative preferred*230 stock of the Metal Company received in December 1946 constituted a dividend taxable as ordinary income and further determined that the value was the amount received by each petitioner on the sale of the shares; that is, the par value plus dividends accrued from November 1, 1946, to December 30, 1946. Respondent allowed the expenses incurred in the sale as a deduction.OPINION.The petitioners contend that the essential facts material to a decision are that the Metal Company had only one class of stock outstanding, namely, voting common, on December 28, 1946, on which date it distributed a pro rata stock dividend of its preferred shares; that thus the facts herein parallel those in Strassburger v. Commissioner, 318 U.S. 604">318 U.S. 604; and that accordingly the rule in the cited case is conclusive of the present controversy in favor of petitioners. We do not agree. Without discussing the Strassburger case at the present time, it is our opinion that the issue presented of whether the stock dividend of preferred on common constituted income to the stockholders (petitioners) must be determined from a consideration of all the facts and circumstances surrounding*231 the issuance of such dividend and not by a consideration limited to the characteristics of the stock declared as a dividend.*173 Congress has provided generally in section 22 (a) of the Internal Revenue Code for the inclusion in gross income of "dividends" and has defined that term in section 115 (a) of the Code. 3 However, Congress qualified both of those provisions by section 115 (f) (1)3 which excludes a stock dividend to the extent that it does not constitute income within the Sixteenth Amendment to the Constitution. Thus Congress has provided the statutory basis for taxing (as ordinary income) stock dividends to the full extent that thereby the stockholder's interest in the distributing corporation's accumulated earnings or profits come to fruition as "incomes" within the meaning of the Sixteenth Amendment.*232 With respect to the constitutional issue involved the Supreme Court in Eisner v. Macomber, 252 U.S. 189">252 U.S. 189, said that a proper regard for the genesis as well as the clear language of the Sixteenth Amendment4 requires that, except as applied to income, it shall not be extended by loose construction so as to repeal or modify the clauses of Article 1 of the Constitution requiring apportionment and that in order to give proper force and effect to both provisions, "it becomes essential to distinguish between what is and what is not 'income' as the term is there used, and to apply the distinction, as cases arise, according to truth and substance, without regard to form." The Court further said that "Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, * * *." As to the constitutional meaning of the term "incomes," as involved in that case, the Court reiterated its earlier definition that "Income may be defined as the gain derived from capital, from labor, or from both combined," (with the proviso that it include profit from sale or conversion of capital assets) with further elucidation*233 by several succinct statements directed towards emphasis on a gain or something of exchangeable value, proceeding from property, severed from the capital however invested, and coming in, being derived; that is, received or drawn by the recipient for his separate use, benefit and *174 disposal, as constituting income from property within the concept of the Sixteenth Amendment.A review of the Supreme Court decisions involving stock dividends (see footnote 5 for a limited discussion of cases as they arose) leads us to the conclusion that, irrespective of the varying provisions of the taxing statutes involved therein, each case was decided upon its own facts and circumstances as establishing whether the receipt of a particular kind of stock dividend is in fact taxable. We are led to *175 *234 the further conclusion that the principles announced in those cases certainly do not rest upon mere matters of the form or nomenclature attending a stock dividend distribution, but, rather, are rooted in the Court's firm conclusions of ultimate fact as to the real substance of the transaction involved, that is, the essential nature of the stock dividend distributed and the attendant interests and rights affected thereby.*235 In the Macomber case the Court concluded that a "true stock dividend made lawfully and in good faith" is not income as distinguished from the normal dividend in money or other divisible property actually distributed out of the corporation's assets for the stockholder's separate use and benefit and thus representing income to the stockholder derived from his capital investment. The real substance of the transaction there involved, was that the corporation's undivided profits were so absorbed in its business as to be impracticable of separation for actual distribution, and a readjustment of capital for corporate purposes was made by declaring a dividend of common on common charged against surplus and credited to capital account. Under the circumstances that dividend did not, as the Court said, "alter the pre-existing proportionate interest of any stockholder or increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they stood before." The net result was that each common stockholder merely had a pro rata increase in number of certificates evidencing the same proportionate interest he theretofore owned in the corporation as a whole*236 and nothing had been severed from his capital investment or realized as income derived therefrom.In the Koshland case the corporation had outstanding voting common and preferred subject to redemption and preferential rights. It had sufficient cash surplus to pay a dividend on the preferred in cash but elected to pay in common shares. Subsequently the preferred was redeemed. Under the circumstances the receipt of the common did alter the preexisting proportionate interest represented by the preferred shares and further, the distribution of such a dividend disturbed the relationship previously existing amongst all the stockholders and the corporation. The real substance of the transaction was that new interests were thereby derived from the stockholder's capital investment and constituted income when received. Under essentially similar circumstances in the Gowran case a dividend on common was paid in preferred shares, which were subsequently redeemed, and the same rule obtained that such a stock dividend constitutes income when received.The Griffiths case involved, as did Eisner v. Macomber, a dividend of common on common and since the Court construed the *237 statute as *176 embodying the result of Eisner v. Macomber, it held the dividend nontaxable.In the Sprouse case the stock dividend of nonvoting common was distributed, against available earnings or profits, on both classes of stock outstanding consisting of voting and nonvoting common. The dividend distribution did not alter the voting rights of the voting common, or its rights to share in dividends and liquidation. The real substance of the transaction was that no essential change was brought about, by the issue of dividend shares, in the proportionate interests amongst all the stockholders. Thus it was held that the stock dividend was not taxable under the Griffiths rule as distinguished from Koshland.The Sprouse case was decided in the same opinion with the Strassburger case wherein the circumstances were that the sole stockholder of common, the only class outstanding, received a dividend in nonvoting preferred declared against available earnings. The dividend stock was not sold or otherwise disposed of. The distribution brought about no substantial change in the stockholder's interest in the net value of the corporation; before he owned it*238 all and after the event he retained all the incidents of ownership. Therefore, the stock dividend was not taxable under the statute when received.In the instant proceeding the Metal Company, as restated for the purpose of its books of account, had an earned surplus in excess of $ 1,425,000 on December 31, 1945. On June 30, 1946, that company's current assets included a total of $ 1,272,354.56 in cash and Government bonds and notes. Its net profits, after estimated income tax, amounted to $ 215,184.84 for the first six months of 1946 and to $ 664,798.30 for the entire year 1946. The Metal Company's accumulated earnings and profits to a large extent, were not absorbed in its plant, property, or business for corporate purposes and were available for distribution in cash or other divisible property as dividends on its voting common stock, its only class of capital stock of which 1,002 1/2 shares were outstanding and 83.8 per cent thereof held by Chamberlin and his wife and the balance by five other persons.Notwithstanding the ability to pay out normal dividends in a very large amount which would represent income to the stockholders, the Metal Company elected to declare two successive*239 stock dividends in December 1946, both of which involved a recapitalization of the corporation by amendment to its charter and a transfer of an amount equivalent to the par value of both issues of stock dividends totaling $ 1,303,250 from surplus to capital account. After such stock dividends and also cash dividends of $ 190,475 on outstanding common during 1946, the Metal Company's earned surplus amounted to $ 596,511.91 at December 31, 1946. The first pro rata stock dividend of $ 501,250 par value common on outstanding common on December *177 20, 1946, is not at issue herein, but is a part of the factual circumstances involved. The second pro rata stock dividend of $ 802,000 par value preferred on outstanding common on December 28, 1946, is in issue.Looking at the dividend of preferred on common from the standpoint of merely a pro rata distribution of new shares on the then one class of shares outstanding with the result that at the time received the same group of stockholders retained the same proportionate interests in the entire net value of the corporate assets as they had before and disregarding the circumstances and terms of the issue, it might be said that as a matter*240 of form the stock dividend constituted one which fell within the Sprouse and Strassburger cases. The primary burden of the petitioners' argument is to that effect. However, as established by the cited cases, not form, but the real substance of the transaction is controlling.If we turn to what we consider to be the real substance of the transaction, the facts show conclusively that the stock dividends were not in good faith for any bona fide corporate business purpose. The company was concerned only with the immediate necessity of greatly reducing its accumulated earned surplus not needed in its business, which accumulated surplus otherwise would make it subject to the possible imposition of a surtax provided for by section 102, Internal Revenue Code. At the same time, the company's stockholders were concerned only with immediately realizing for themselves at least $ 800,000 cash in hand because of the existence of the company's accumulated earnings, but because of the individual tax consequences they wanted the distribution in some form other than as ordinary cash dividends. In order to accomplish these desired ends negotiations were had in which the Metal Company, *241 its stockholders, and the insurance companies participated and came to a complete understanding as to procedure, terms, etc.; the stage was set in detail to meet the requirements of all parties concerned for the two successive recapitalizations of December 20 and 28, 1946, and also for the formal execution of the prearranged contract of sale (the Purchase Agreement) of the preferred dividend shares on December 30, 1946, for cash in the amount of the par value plus dividends accrued to date of delivery. In the Purchase Agreement the Metal Company agreed that on the closing date it had surplus of not less than $ 350,000 available for dividends on the preferred or for use in redemption thereof. The parties contemplated closing the transaction not later than December 31, 1946.The terms of the company's amended charter authorizing the issuance of the new preferred and the provisions contained in those shares were specifically dictated by the insurance companies to meet their investment requirements "to give the degree of protection usually *178 found in a first lien bond issue." The issuance of the two successive stock dividends against a transfer of $ 1,303,250 from surplus to*242 capital account was not because of investment or use thereof in the corporate business. Instead, it was solely for the security of the new preferred, and for that purpose the amended charter required, so long as any preferred remained outstanding, that the company maintain net working capital in an amount equal to 150 per cent of the par value of outstanding preferred or $ 750,000 whichever amount was greater and that the company maintain current assets in an amount not less than 200 per cent of current liabilities. Further, so long as the preferred remained outstanding, the amended charter immediately effected a material change not only in the dividend rights of the common shares, but also their voting rights as to further changes in the corporate charter, capital structure, and other matters.The real purpose of the issuance of the preferred shares was concurrently to place them in the hands of others not then stockholders of the Metal Company, thereby substantially altering the common stockholders' preexisting proportionate interests in the corporation's net assets and thereby creating an entirely new relationship amongst all the stockholders and the corporation. Further, the*243 new preferred was to be redeemed out of the corporation's assets in a comparatively short period of time. With such a predetermined purpose, the dividend was not a true stock dividend made in good faith within the meaning of the cited Supreme Court decisions. A further real and, in fact, the most important, purpose of the issuance of the preferred was to enable the common stockholders to derive cash in hand almost simultaneously, in an agreed amount, solely because of and from their preexisting capital investment in the company. The entire plan was designed primarily for the benefit of the common stockholders whose will was the will of the corporation. The fact that in form no cash or divisible assets of the company were actually withdrawn from the corporation on December 28, 1946, is immaterial, for that condition existed in the Koshland and Gowran cases. Also, compare Bazley v. Commissioner, 331 U.S. 737">331 U.S. 737, where, after a recapitalization-reorganization involving an exchange of outstanding shares of a corporation for its short term debenture bonds was not recognized as a tax free reorganization within section 112 of the Code, it was *244 determined that the transaction had the same result, taxwise, as a distribution by the corporation of available cash earnings equivalent to the value of the bonds. In short, the last cited cases applied the doctrine that substance controls as opposed to form.We think the attendant circumstances and the conditions under which the preferred stock in this case was issued effectively preclude application of the principles of Strassburger, supra. We conclude that the dividend received by petitioners on December 28, 1946, was *179 not a true stock dividend, but the equivalent of a cash dividend distribution out of available earnings thus constituting ordinary taxable income in the amount of the value of the preferred shares received. Having in mind the agreed sale price of the preferred shares and the company's agreement as to available surplus for dividends thereon on the closing date of the prearranged transaction, we further conclude that the value of the preferred shares, when received on December 28, 1946, was not less than the equivalent of the amount received from the concurrent sale, as determined by respondent.The respondent's determination*245 is sustained.Decision in each proceeding will be entered for the respondent. OPPEROpper, J., concurring: The suggestion which I find implicit in the present opinion that the actual, rather than potential, sale of the preferred stock is what made this a taxable dividend and distinguishes it from Strassburger1 seems to me to impose additional difficulties in a field already overburdened with problems. 2The decision in Strassburger being apparently the result of a chronological accident in the presentation of cases, and constituting what would otherwise presumably have been the view*246 of a minority of the justices then composing the Supreme Court 3 should, it seems to me, be limited rigorously to its precise facts. Among other distinctions, the taxpayer there was the sole stockholder of the declaring corporation so that any discussion of a change in proportionate interests flowing from that dividend is unwarranted. Cf., e. g., Higgins v. Smith, 308 U.S. 473">308 U.S. 473.*247 But as long ago as 1938 it was held by us in a reviewed opinion without dissent that, in just such a case as this, a dividend of preferred on common where only common had been outstanding was taxable to the several shareholders of the corporation there concerned. *180 Frank J. and Hubert Kelly Trust, 38 B. T. A. 1014. 4*248 This was the result in essence of considering the attributes of the rights of common stockholders as among each other and against the corporation; and the effect of a dividend upon those rights in "that their interest after the dividend became to some extent transferable in parts where before it could be disposed of only as a whole." We went on to say in language that seems to me still peculiarly applicable to such situations as this (p. 1017): "Petitioner's donors, by transferring the preferred stock, as in fact they did, could then dispose of a part of their interest in the earnings and assets of the corporation without in any way disturbing the distribution of voting control." See also Helms Bakeries, 46 B. T. A. 308. 5It would be my conclusion that not the fact but the possibility of such a sale as took place here is what made this dividend taxable, and that the significance of the sale here is not that it occurred, and certainly not that the taxability of the dividend depended upon it; but that it is cogent and in fact inescapable evidence of the critical proposition that such a sale could take place and that its effect could be precisely that described in the Kelly Trust case, supra.I accordingly concur in the conclusion presently being reached but would arrive at the same one even though the stock in question were not actually the subject of a sale. ARUNDELLArundell, J., dissenting: In holding that the dividend received by the petitioners was not "a true stock dividend made in good faith," I think that the majority fails to give due consideration*249 to one important factor. That is, that the character of what a stockholder receives from his corporation for tax, as well as other purposes, is definitively settled by the action of the directors of the corporation in making the declaration on which the distribution is based.If, on the declaration of a dividend, the directors provide for the medium of distribution, the stockholders must take it in the form so provided. A corporate distribution must "be taken as it emanates from the board." State v. B. & O. R. R., 6 Gill, (Md.) 363; Staats v. Biograph Co., 236 F. 454">236 F. 454; General Utilities & Operating Co., 29 B. T. A. 934, affd. 296 U.S. 200">296 U.S. 200. If the directors declare, and the corporation pays, a stock dividend, that is all that the stockholder can receive. What constitutes a stock dividend has not been open to serious question, at least since the decision in Gibbons v. Mahon, 136 U.S. 549">136 U.S. 549, *181 was handed down in 1890. That decision laid down the proposition that in the receipt of a stock dividend "the proportional interest of each shareholder*250 remains the same. The only change is in the evidence that represents that interest * * *." 136 U.S. at 559, 560. The principle so declared in Gibbons v. Mahon was the basis of the decision in Towne v. Eisner, 245 U.S. 418">245 U.S. 418, and has been the touchstone of decision in cases involving the taxability of stock dividends ever since. See the summary of cases in the footnote in the majority opinion.Whether or not a dividend in stock changes the proportional interest of shareholders needs no lengthy discussion in these cases. We know from the decisions that a dividend of common on common does not, Eisner v. Macomber, 252 U.S. 189">252 U.S. 189; neither does a dividend of preferred on common where only common is outstanding, Strassburger v. Commissioner, 318 U.S. 604">318 U.S. 604, while a dividend of common on preferred does work a change and results in the realization of constitutionally taxable income, Koshland v. Helvering, 298 U.S. 441">298 U.S. 441, even though not taxed by the Revenue Act then in force. In the Koshland case, the Court pointed out*251 that "The company had a surplus sufficient to pay the preferred dividends in cash, but elected to pay them in common stock" (emphasis added). This is in line with the thought expressed in Gibbons v. Mahon, supra, that whether a "distribution is an apportionment of additional stock representing capital, or a division of profits and income, depends upon the substance and intent of the action of the corporation, as manifested by its vote or resolution * * *."None of the stock dividend cases turn upon the question of the intent of the stockholder, at the time of the receipt, as to the disposition that he will make of his dividend. He may have no intention or plan at all; he may intend to keep it, to give it away, or to sell it. But I do not see how these considerations can change the character of the distribution as manifested by the "substance and intent of the action of the corporation" in making the distribution. Gibbons v. Mahon, supra.Indeed, in the average case, the corporate directors and officers cannot be expected to know what disposition the stockholders will make of their dividend stock. One of*252 the stockholders in this company did not dispose of its dividend stock.My view that the character of a distribution depends upon the intent and action of the corporation is supported by the wording of the Code. Section 115(f)(1) speaks of "A distribution made by a corporation to its shareholders * * *." It says nothing about what the stockholders do with the distributions. That is taken care of by other sections, such as the gain or loss provisions and the gift tax sections.*182 I also think that in these cases we do not properly come to the question of good faith. That may be a proper consideration in cases where Congress has provided for the postponement of a tax under facts which, without statutory provision, would result in the imposition of a tax concurrently with the happening of the event. Under the early taxing statutes, reorganization exchanges gave rise to recognizable gains that were currently taxed. Marr v. United States, 263 U.S. 536">263 U.S. 536. By the enactment of provisions presently contained in Code section 112(b), the tax may be postponed. Under such provisions, it is proper to inquire as to whether there is a good faith compliance*253 with the statutory intent rather than a mere surface compliance. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465. Here we start with the basic proposition that under the decisions of the Supreme Court stock dividends are not income. The Congress has manifested an intent not to treat them otherwise. Griffiths v. Commissioner, 308 U.S. 355">308 U.S. 355. Therefore, we have only the clear-cut question of whether the distributions here under consideration were, or were not, stock dividends. If they were, whatever plan there may be for their disposition cannot convert them into income any more than Congress could make them income as it attempted to do in the Revenue Act of 1916 and which gave rise to Eisner v. Macomber. Footnotes*. Proceedings of the following petitioners are consolidated herewith: Grace A. Chamberlin; John H. Toner; Benjamin James Carl; Guy V. Schrock; Robert Pierce and Josephine H. B. Pierce, Husband and Wife.↩1. Except as specifically limited the common stock retained the usual privileges thereof. The preferred shares, among other things, are entitled to cumulative cash dividends at the rate of $ 4.50 per annum payable quarterly commencing from November 1, 1946; are subject to redemption on any quarterly dividend date in whole or in part (in multiples of 500 shares) at par plus specified premiums and accrued dividends; are subject to mandatory retirement, at par plus specified premiums and accrued dividends, in the amounts of 2,000 shares on May 1, 1948, and 1,000 shares on May 1st of each succeeding year until fully retired on May 1, 1954. In the event of certain default in dividend payments or annual retirements, the holders of the preferred, voting as a class, are entitled to elect a majority of the total number of the company's directors. So long as any preferred shares remain outstanding the consent of the holders of at least 75 per cent thereof, is required to validate certain actions including changing the articles of incorporation or capital structure, the sale of all or substantially all of the company's property, or the incurrence of indebtedness for borrowed money in excess of a certain amount. Also, so long as any preferred shares remain outstanding, inter alia↩, the company may not declare or pay cash dividends upon any stock junior to the preferred, unless there is no default in payment of dividends upon and the annual retirements of the preferred; unless the sum of amounts paid or made available for dividends, redemptions and additions to any sinking fund subsequent to December 31, 1946, on shares of any class, plus the proposed declaration on the junior stock, does not exceed the company's net income earned subsequent to December 31, 1946; and, further, unless after giving effect to the proposed declaration on the junior stock, (a) the net working capital of the company will not be reduced below an amount equal to 150 per cent of the aggregate par value of all outstanding preferred or $ 750,000 whichever amount is greater, and (b) the current assets of the company (as defined) will not be reduced to an amount less than 200 per cent of current liabilities of the company (as defined).2. Those representations, etc., were, among other things, with respect to the validity of the corporate charter and of the authorization and issuance of the preferred stock; the financial condition of the company on November 30, 1946, as theretofore represented to the insurance companies; the issuance of the December 1946 common and preferred stock dividends and resulting adjustments to earned surplus and capital account and also the payment of certain cash dividends; the non-existence of any undisclosed contingent liabilities, pending suits or unusual contracts; the fact that there had been no negotiations for sale of the preferred to anyone but the insurance companies with reliance upon the latters' representation of purchase thereof for investment and that the issuance and private sale of the preferred would not fall within section 5 of the Securities Act of 1935, as amended; the appointment of a registrar and transfer agent for the preferred stock if requested; the subsequent furnishing of certified annual financial statements of the company to the insurance companies; the company's undertaking to have at the time of the closing of the purchase agreement a surplus of not less than $ 350,000 available for dividends on the preferred stock; and the company's agreement that its covenants and representations shall survive the execution of the purchase agreement and delivery of the preferred stock.↩3. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.(a) Definition of Dividend. -- The term "dividend" when used in this chapter * * * means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made. * * ** * * *(f) Stock Dividends. -- (1) General rule. -- A distribution made by a corporation to its shareholders in its stock or in rights to acquire its stock shall not be treated as a dividend to the extent that it does not constitute income to the shareholder within the meaning of the Sixteenth Amendment to the Constitution↩.4. "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration."↩5. In the Revenue Act of 1913 Congress made no specific provision for taxing stock dividends and in Towne v. Eisner, 245 U.S. 418">245 U.S. 418 (1918) it was held that a dividend of common on common was not intended to be taxed as income. The Revenue Act of 1916, section 2 (a), in defining the term dividendsprovided, that a "stock dividend shall be considered income, to the amount of its cash value." In a test of that provision in Eisner v. Macomber, 252 U.S. 189 (1920), involving a dividend on outstanding common paid in common stock against earned surplus invested in plant and property for corporate purposes, it was held that under the Sixteenth AmendmentCongress lacked the power "to tax without apportionment a true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder [emphasis added]," and that the 1916 Act in imposing a tax because of such a dividend contravened cited clauses of Article 1 of the Constitution. Thereafter (as subsequently noted in the Koshland and Griffiths cases), although the Macomber case dealt with a stock dividend of common on common, it was immediately given a broader interpretation as a basis for tax exemption of stock dividends. In section 201 (d) of the 1921 Revenue Act Congress provided that "A stock dividend shall not be subject to tax * * *" and that statute and subsequent reenactments thereof until the 1936 Act were construed by Treasury Regulations as exempting all dividends paid in stock of the distributing corporation even though in the intervening years the Supreme Court had pointed out in numerous cases involving reorganizations that a distinction existed between the Macomber type of stock dividend and one which gave the stockholder a different proportionate interest than before. In Koshland v. Helvering, 298 U.S. 441">298 U.S. 441 (May 18, 1936) involving the basis for determining gain, under the Revenue Acts of 1926 and 1928, upon a sale or other disposition of preferred shares on which a dividend in voting common had been declared, the Court held that the dividend common shares gave the stockholder an interest different than theretofore owned and constituted income within the Sixteenth Amendment even though Congress had not taxed it as of the time of its receipt and therefore the basis of the preferred was not to be apportioned between the two classes of stock. The same rule was applied in Helvering v. Gowran, 302 U.S. 238">302 U.S. 238 (1937) involving a similar question under the 1928 Act, but where the taxpayer received a dividend of preferred on common when both classes were outstanding. In the Revenue Act approved June 22, 1936, Congress enacted a provision since retained in the law (section 115 (f) (1) of that Act and of the Code) which, while expressed in negative terms, taxes all stock dividends which constitute income within the Sixteenth Amendment. That provision was involved in Helvering v. Griffiths, 318 U.S. 371">318 U.S. 371 (March 1, 1943) wherein the Government sought to have the Supreme Court reconsider and overrule the Macomber case, but the Court did not reach that issue because it concluded that the statute before it did not undertake to impose the tax that was there challenged. The Court made an exhaustive review of the tax legislative history and court decisions on stock dividends and held that the new taxing provision was not intended as a Congressional attack on the law expressed in the Macomber case which remained the law except that the Koshland decision in effect limited Macomber to the kind of stock dividend there dealt with. In Helvering v. Sprouse and Strassburger v. Commissioner, decided together at 318 U.S. 604">318 U.S. 604 (April 5, 1943), involving section 115 (f) (1) of the 1936 Act, Sprouse received a dividend of nonvoting common on voting common in a pro rata distribution on both voting and nonvoting common outstanding, and Strassburger as the owner of the entire stock of a corporation received a dividend of preferred on common. With little discussion the Court held that neither stock dividend was taxable under the statute within the rule in the Griffiths case, in that as to Sprouse there was no change in the relationship amongst the stockholders or between them and the corporation and as to Strassburger, he owned the entire interest in the corporation both before and after. The Court distinguished Koshland↩, saying that in the circumstances there disclosed the common stock dividend on preferred with both classes outstanding was income in that there was a resultant essential change in the proportional interest of the stockholder.1. Strassburger v. Commissioner, 318 U.S. 604">318 U.S. 604↩.2. See, e. g., Edwin L. Wiegand, 14 T.C. 136">14 T. C. 136, reversed sub nom. Tourtelot v. Commissioner (C. A. 7), 189 F.2d 167">189 F. 2d 167, affd. (C. A. 3), 51-5 C. C. H. para. 9365 (June 26, 1951), 51-4 PH para. 72484, reversed on rehearing (C. A. 3), 194 F. 2d 479↩.3. Of the eight justices participating in the Griffiths case ( Helvering v. Griffiths, 318 U.S. 371">318 U.S. 371), three dissented on the ground that after the 1936 amendment all stock dividends were taxable. Of the same eight justices participating in the Strassburger case these three apparently felt themselves committed by the Griffiths decision, but three different ones dissented on the ground that, although some stock dividends were not taxable, that case was ruled by Koshland v. Helvering, 298 U.S. 441">298 U.S. 441 -- which of course was the basis for the decision in Kelly Trust, infra -- that preferred on common had always been a taxable dividend even before the amendment. Thus, six out of the eight participating justices would presumably have held the Strassburger dividend taxable had that case been presented before the Griffiths case. See DeWind, "Preferred Stock 'Bail-Outs' and the Income Tax," 62 Harv. Law Rev. 1126, 1145; Darrell, "Recent Developments in Nontaxable Reorganizations and Stock Dividends," 61 Harv. Law Rev. 958↩.4. This decision was at first affirmed on the same theory as that adopted in the opinion below (C. A. 8), 39-4 C. C. H. para. 9624 (July 19, 1939). Due, however, to the retroactive amendment to the basis provisions of section 113, that opinion was withdrawn and the case remanded for disposition in accordance with the subsequently enacted legislation, 106 F. 2d 1002↩.5. "* * * It is obvious the preferred stockholders received property rights of actual and exchangeable value which changed the proportionate interest in the net assets of the corporation as between the preferred and the common stockholders." (p. 321.)↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619462/ | BRIAN P. HATCHER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Hatcher v. CommissionerDocket No. 18162-81.United States Tax CourtT.C. Memo 1983-192; 1983 Tax Ct. Memo LEXIS 595; 45 T.C.M. (CCH) 1244; T.C.M. (RIA) 83192; April 7, 1983. Bonnie L. Cameron, for the respondent. *596 DRENNENMEMORANDUM FINDINGS OF FACT AND OPINION DRENNEN, Judge: Respondent determined that petitioner Brian P. Hatcher was liable as a transferee of Edwin P. Hatcher to the extent of $1,943.11. 1 The sole issue for decision is whether petitioner is liable under section 6901 2 as a transferee of assets, for the deficiency in income taxes, interest, and additions to tax due from the transferor, Edwin P. Hatcher. FINDINGS OF FACT Petitioner Brian P. Hatcher (petitioner) resided in Dearing, Ga., at the time the petition was filed. On March 20, 1978, respondent sent to the transferor, Edwin P. Hatcher (Edwin), petitioner's father, a statutory notice of deficiency for 1976 determining a deficiency in income tax of $1,622 and an addition to tax under section 6653(a) of $81. On July 28, 1978, Edwin filed with this Court a petition requesting a redetermination of the deficiency and addition*597 to tax. This case was tried and decided against Edwin in docket No. 6385-78 on March 6, 1979, for the full amount of the income tax deficiency and section 6653(a) addition to tax. On October 18, 1979, the Internal Revenue Service served a summons on Edwin requiring him to furnish information as to his assets and liabilities to aid it in the collection of the 1976 tax liability. Edwin did not comply with the summons. The Internal Revenue Service then attempted to locate assets belonging to Edwin by searching the county records where Edwin's residence was located for property belonging to either Edwin or his spouse. Although Edwin and his spouse did not have any real property listed in their names, 3 it was discovered that Edwin had transferred 9.52 acres of real property to petitioner on March 19, 1977. Edwin had originally purchased this property in April 1973 at a cost of $3,900. The transfer of the real property by Edwin to petitioner was for "love and affection" and was thus without consideration. On the date of the transfer, the real property*598 had a fair market value of $4,750, and was subject to a prior encumbrance of $865, for a net value of $3,885. At the time of the transfer, Edwin was indebted to the Federal Government for income taxes for 1974, 1975, and 1976 in the total amount of $5,678.57. A Federal tax lien which encompassed unpaid 1974 and 1976 income taxes was filed against Edwin. In addition, a notice of levy was served on Edwin's employer for any amounts due Edwin. However, since Edwin had no real property listed in his name in the county of his residence, and since he had recently quit his job and no funds were due him, these actions did not result in the collection of any of the taxes due. On April 15, 1981, respondent issued a notice of transferee liability to petitioner. Neither petitioner nor Edwin appeared personally or through counsel at the trial of this case. OPINION The only issues is whether petitioner is liable as a transferee of assets for income tax, interest, and addition to tax due from the transferor, Edwin P. Hatcher, for the taxable year 1976 in the total amount of $1,943.11. Section 6901(a)(1)(A) provides that the liability, at law or in equity, of the transferee of property*599 for the taxes of the transferor may be assessed, paid, and collected in the same manner as in the case of the taxes with respect to which the liability was incurred. This provision merely provides a procedure by which respondent may collect taxes. Commissioner v. Stern,357 U.S. 39">357 U.S. 39, 42-45 (1958). Whether a transferee is actually liable for the unpaid tax liability of the transferor is determined under State law. Commissioner v. Stern,supra;Segura v. Commissioner,77 T.C. 734">77 T.C. 734 (1981). Respondent has the burden of proving that petitioner is liable as a transferee. Sec. 6902(a). Rule 142(d). 4 Petitioner bears the burden of proving that the transferor was not liable for the unpaid tax liability. Rule 142(d). 5The State law applicable in the instant case is that of Georgia.Ga. Code Ann. sec. 18-2-22, provides in pertinent*600 part that: The following acts by debtors shall be fraudulent in law against creditors and others and as to them shall be null and void: (3) Every voluntary deed or conveyance, not for a valuable consideration made by a debtor who is insolvent at the time of the conveyance. 6A debtor is insolvent within the meaning of this section, if after the voluntary deed or conveyance, property left or retained by the debtor is not ample to pay his existing debts. Chambers v. Citizens & S. Nat'l Bank,242 Ga. 498">242 Ga. 498, 249 S.E.2d 214">249 S.E.2d 214 (1978). A conveyance fraudulent to creditors in violation of section 18-2-22, Ga. Code Ann.*601 , may be set aside. United States v. Hickox,356 F.2d 969">356 F.2d 969 (5th Cir. 1966). This remedy is available to any creditor at the time of the transfer who thereafter reduces his claim to a judgment lien. 7United States v. Hickox,supra at 972. Once the conveyance is set aside title to the property remains with the judgment debtor subject to judgments subsequently obtained. Coleman v. Law,170 Ga. 906">170 Ga. 906, 154 S.E. 445">154 S.E. 445 (1930). In the instant case, it is clear that the voluntary conveyance by Edwin to petitioner in consideration for "love and affection" was not made for valuable consideration. Accordingly, if the transfer rendered Edwin insolvent, it may be set aside. At the time of the conveyance,*602 Edwin owed the Federal Government $5,678.57 in back taxes. Following the conveyance, respondent has presented evidence that Edwin did not have any real property to which a Federal tax lien could attach, and that Edwin was not due any funds from his employer which could be levied upon. Respondent also established that Edwin was not recorded as the owner of the house in which he resided. We believe that respondent has made a prima facie showing that after the transfer of the land to petitioner, Edwin did not have ample property left to pay his existing debts. 8 Accordingly, the transfer was fraudulent and could be set aside under State law. In addition to establishing that petitioner is liable as a transferee under State law, it is also necessary for respondent to prove that the transfer occurred during or after the period in which the tax in question applies, *603 and that all reasonable efforts have been made to collect the tax liability from the transferor before the proceeding against the transferee was commenced. 9Tax liabilities accrue when the taxable period ends, not when the tax is due and payable. Leach v. Commissioner,21 T.C. 70">21 T.C. 70 (1953). 10 Thus, the liability of Edwin for his taxable year 1976 accrued on December 31, 1976, when his taxable year ended. The transfer of the real estate by Edwin to petitioner was made on March 19, 1977, and therefore the transfer of land occurred after the period in which the tax liability arose. It is also clear that respondent by serving a summons upon Edwin requiring him to furnish information as to his assets and liabilities, by searching the county records where Edwin resided for property belong to Edwin, and by recording a Federal tax lien and serving Edwin's employer with a notice of levy, made a reasonable effort to collect the tax liability from Edwin before proceeding against petitioner. Since respondent has established*604 all the necessary elements to show transferee liability, the only question remaining to be resolved is the amount of petitioner's liability. 11 Where property is transferred to a transferee without consideration, the transferee is liable for the transferor's deficiency, interest, and addition to tax to the extent the fair market value of the property at the time of the transfer exceeded the amount the transferee paid for it. Nader v. Commissioner,323 F.2d 139">323 F.2d 139 (7th Cir. 1963), affg. a Memorandum Opinion of this Court. Kohler v. Commissioner,37 B.T.A. 1019">37 B.T.A. 1019 (1938). 12 At the time of the transfer, the property had a fair market value of $4,750 and was subject to a prior encumbrance of $865, for a net value of $3,885. This amount is sufficient to cover the asserted liability and, therefore, petitioner is liable for the entire amount of the deficiency, interest, and addition to tax. 13*605 Decision will be entered for the respondent.Footnotes1. The $1,943.11 consists of the following: Transferor's deficiency of $1,622, addition to tax under sec. 6653(a) of $81, and interest of $240. ↩2. All section references are to the Internal Revenue Code of 1954, as amended and in effect for the taxable year in issue.↩3. The house where Edwin and his family were residing was not listed under Edwin's or any member of his family's name.↩4. All rule references are to the Tax Court Rules of Practice and Procedure. ↩5. Since petitioner did not appear at trial, he has failed to meet this burden. Furthermore, the tax liability of the transferor has already been determined by a final decision of this Court.↩6. Respondent also asserts that the conveyance made by Edwin violated paragraph 2 of sec. 18-2-22, Ga. Code Ann. which provides: "(2) Every conveyance of real or personal estate, by writing or otherwise, and every bond, suit, judgment and execution, or contract of any description had or made with intention to delay or defraud creditors, where such intention is known to the taking party; * * *" Due to our holding that the conveyance violated paragraph 3 of this section, it is unnecessary to decide this question.↩7. As is discussed more fully herein, the Federal Government became a creditor of Edwin's at the end of 1976 when the income tax liability for 1976 arose. In addition, the Government became a lien creditor when the taxes were assessed. See secs. 6321 and 6322. Finally, the liability of Edwin has already been reduced to judgment. Therefore the remedy of Ga. Code Ann., sec. 18-2-22↩, is available to respondent.8. Once respondent establishes the prima facie case of transferee liability, it is incumbent upon petitioner to come forth and present evidence in rebuttal. Nau v. Commissioner,27 T.C. 999">27 T.C. 999 (1957), affd. 261 F.2d 362">261 F.2d 362↩ (6th Cir. 1958). Petitioner who did not appear at trial has not done so.9. Saba v. Commissioner,T.C.Memo. 1979-397↩.10. See also LeFay v. Commissioner,T.C.Memo. 1982-420↩.11. The elements necessary to establish transferee liability have been expressed in a variety of ways by the courts. A comprehensive list includes the following: (1) The transfer of property must be made during or after the period for which the liability in question has accrued, (2) The transferor must have been liable, (3) All reasonable efforts must have been made to collect the tax liability from the taxpayer before the proceeding against the transferee is commenced, (4) There must have been a transfer of assets having value to the transferee from the transferor or from some preceding transferee (the transfer might be one in a series of distributions which eventually rendered the transferor insolvent), (5) This transfer of assets must have left the transferor insolvent * * *, See 9 Mertens, Law of Federal Income Taxation, sec. 53.06. pp. 10-11. Each of these elements has been established in the instant case. ↩12. See also Saba v. Commissioner,supra.↩13. Petitioner is his petition made several confusing constitutional arguments. Since petitioner did not appear at trial to raise these issues or raise them by brief, we deem them waived. We also refer petitioner to Philips v. Commissioner,283 U.S. 589">283 U.S. 589↩ (1931). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619464/ | FLOYD E. FISHER and PATRICIA J. FISHER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentFisher v. CommissionerDocket No. 10273-78.United States Tax CourtT.C. Memo 1980-183; 1980 Tax Ct. Memo LEXIS 406; 40 T.C.M. (CCH) 398; T.C.M. (RIA) 80183; May 21, 1980, Filed Floyd E. Fisher and Patricia J. Fisher, pro se. Timothy M. Cotter, for the respondent. TANNENWALDMEMORANDUM FINDINGS OF FACT AND OPINION TANNENWALD, Judge: Respondent determined a deficiency in petitioners' income tax for the taxable year 1975 in the amount of $2,291.36. A*408 concession having been made by petitioners, the sole issue before us is whether petitioners' farming activity in 1975 constituted a trade or business or an "activity not engaged in for profit," within the meaning of section 183(a). 1FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and stipulated exhibits are incorporated herein by this reference. Petitioner Floyd E. Fisher resided in Jamesville, New York, and petitioner Patricia J. Fisher resided in Syracuse, New York, at the time the petition herein was filed. During the years 1970 through 1976, petitioners were married to each other; they have since divorced. Petitioners timely filed their Federal income tax returns for the taxable years 1971 through 1976. 2Prior to her marriage to Floyd E. Fisher and continuing at least until trial, petitioner Patricia Fisher was employed as a technician, on a full-time basis, by Bristol Laboratories, Division*409 of Bristol-Myers Co. Petitioner Floyd Fisher (hereinafter Fisher) owns, and owned at least during 1971 through the date of trial, a 119-acre farm in Jamesville, New York. The farm consists of approximately 110 acres of tillable land and 8 to 10 acres of woods. In the early 1960's, Fisher, an only child, inherited this farm from his father, who had operated the farm since at least 1929. Fisher graduated from high school in 1947. From 1947 to approximately 1950, he worked in a dairy or milk plant. During those years, he also assisted his father in operating the farm, as he had since his youth. In 1950, Fisher bought a milk route, which he operated until at least 1952. In February 1952, Fisher began shipping and selling milk from cows that he had purchased and/or raised, which he maintained on the farm. Since he was a child, he had wanted to be a farmer. In 1969, Patricia Fisher began living on the farm and assisting Fisher in its operation. Fisher ruptured a disc in his back in the winter of 1969-1970. It was his second ruptured disc; he had also injured his back in 1947. His son, who had graduated from high school in 1969 and then continued his education in nearby*410 Morrisville for two years, left home for a job in Wisconsin in August 1971. Fisher kept his dairy cows until February 1972, with the aid of hired help, but was unable to continue milking. At that time, he sold all the cows which produced milk, two bulls used in the dairy operation, and a bulk tank used to store milk produced by the cows. After selling their dairy cows, petitioners still maintained additional animals on the farm. They purchased and raised some cattle to be sold for beef, including one a year used for personal consumption. Fisher considered going back into the dairy business with the cows he was raising, but had not done so as of the date of trial. Petitioners also had horses on the farm. Fisher had had two pet ponies since 1954, which died in 1974. Around 1974, he obtained a pair of sorrels to be used as work horses. He was not able to break the horses for use in farming until some time subsequent to 1975. Petitioners fed their animals with hay and grain grown on the farm, but were forced to also purchase special feed for the calves. Much of their crop remained on the farm after harvesting for this purpose, rather than being sold. Fisher had been married*411 prior to his marriage to Patricia Fisher. As a result of his divorce from the prior wife, he had been required to make payments totaling $18,000. In order to have extra income with which to pay his bills, Fisher began working part-time as a bus driver for the James L. DeWitt Central School in the spring of 1972. That autumn, he began work for the La Fayette Central School District, La Fayette, New York, as a light mechanic and substitute bus driver. This position, which required him to work generally 40 hours per week, continued until April 1977, at which time he reinjured his back. He continued running the farm with the aid of hired help and by working on the farm each day before and after his job with the school district. He no longer is employed outside of the farm. During 1975, heavy storms destroyed much of the first planting of crops, necessitating a second plowing with attendant increased expense. Also, in May 1975, Fisher fractured his pelvis, when he fell off his tractor; his neighbors helped out in running the farm and received half of the crop for so doing. Fisher's farming operations had been profitable in 1971, but after he sold the dairy cows, he never again*412 showed a profit (aside from the gain on his sale of the dairy cows, bulls, and bulk tank in 1972). He reported on his tax returns the following receipts and deductions (amounts have been rounded off): 1971197219731974Receipts: Dairy Products$27,325$ 1,718$ $ Grain, Oats, Hay4008501,982Miscellaneous453150Reported Gross Profit$27,778$ 2,118 *$1,000$1,982Deductions26,14210,5236,0746,994Farm Income (Loss)$ 1,636($ 8,405)($5,074)($5,012)197519761977Receipts: Dairy Products$ $ $ Grain, Oats, Hay4582,082Miscellaneous113104Reported Gross Profit$$ 571$2,186Deductions11,4319,7449,920Farm Income (Loss)($11,431)($9,173)($7,734)On his tax returns, Fisher individually reported no nonfarm income in 1971, but he reported nonfarm income of $1,086 in 1972 and $6,292 in 1977. On their joint returns, petitioners reported the following amounts of nonfarm income in 1973 through 1976: Patricia J.Interest/FisherFisherDividendsTotal1973$8,180$ 7,489$220$15,88919749,1639,32814618,63719759,09910,6205019,76919769,02714,6932823,748*413 OPINION The only issue presented is whether petitioners' farming activity in 1975 constituted an "activity not engaged in for profit" under section 183(a). Section 183(a) provides that "if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section." Section 183(b)(1) allows those deductions which would be allowable without regard to whether or not such activity is engaged in for profit. Section 183(b)(2) provides that deductions which would be allowable only if such activity is engaged in for profit shall be allowed "but only to the extent that the gross income derived from such activity for the taxable year exceeds the deductions allowable by reason of paragraph (1)." Section 183(c) defines an "activity not engaged in for profit" as "any activity other than one with respect to which deductions are allowable for the taxable year under section 162 or under paragraph (1) or (2) of section 212." The test for determining whether an activity is engaged in for profit is whether the individual engaged in the activity with the primary purpose and intention of making a profit; the taxpayer*414 must have a bona fide expectation of realizing a profit, although such expectation need not be reasonable. Section 1.183-2(a), Income Tax Regs.; Engdahl v. Commissioner, 72 T.C. 659">72 T.C. 659, 666 (1979); Golanty v. Commissioner,72 T.C. 411">72 T.C. 411, 425-426 (1979), on appeal (9th Cir., Aug. 31, 1979). Whether the petitioners had the requisite intention is a question of fact to be determined on the basis of all the facts and circumstances. Allen v. Commissioner, 72 T.C. 28">72 T.C. 28, 34 (1979); Dunn v. Commissioner, 70 T.C. 715">70 T.C. 715, 720 (1978), affd. on another issue 607 F.2d 995">607 F.2d 995 (2d Cir. 1979). The burden of proof is on the petitioners, Golanty v. Commissioner, supra at 426; Boyer v. Commissioner, 69 T.C. 521">69 T.C. 521, 537 (1977), on appeal (7th Cir., July 7, 1978), with greater weight given to objective facts than to the petitioners' mere statement of their intent. Section 1.183-2(a), Income Tax Regs.; Engdahl v. Commissioner, supra at 666; Churchman v. Commissioner, 68 T.C. 696">68 T.C. 696, 701 (1977). See. H. Rept. 91-413 (Part 1), 3 C.B. 200">1969-3 C.B. 200, 245; S. Rept. *415 91-552, 3 C.B. 423">1969-3 C.B. 423, 490. No one factor is conclusive and thus we do not reach our decision herein by merely counting the factors enumerated in section 1.183-2(b), Income Tax Regs., which support each party's position. Dunn v. Commissioner, supra at 720. We found the petitioners to be candid, honest, and totally believable witnesses and we are satisfied that they subjectively intended to derive a profit from their farming activity. The question which we must therefore resolve is whether the weight of objective factors negates their intention. Our examination of the facts and circumstances herein is colored by the legislative history of section 183. This section was added to the Code as section 213 of the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 571, to prevent high income taxpayers from profiting through the harvesting of their taxes rather than their farms. In enacting this section, Congress intended to codify the distinction between a business and a hobby drawn by prior case law and the prior hobby loss statutory provision (section 270) which was considered inadequate. H. Rept. 91-552, 1969-3 C.B. at 489. The House*416 bill would have limited deductions in the case of any activity not carried on with "a reasonable expectation of realizing a profit." H. Rept. 91-413, supra; H.R. 13270, 91st Cong., 1st Sess., sec. 213, 115 Cong. Rec. 21798. The Senate bill rejected this and substituted the simple test of an activity "not engaged in for profit." The Senate Finance Committee report stated that the purpose of the change was to prevent-- the rule from being applicable to situations where many would consider that it is not reasonable to expect an activity to result in a profit even though the evidence available indicates that the activity actually is engaged in for profit. For example, it might be argued that there was not a "reasonable" expectation of profit in the case of a bona fide inventor or a person who invests in a wildcat oil well. A similar argument might be made in the case of a poor person engaged in what appears to be an inefficient farming operation. The committee does not believe that this provision should apply to these situations or that the House intended it to so apply, if the activity actually is engaged in for profit. S. Rept. 91-552, 1969-3 C.B. at 489-490.*417 (Emphasis added.) The Conference Committee adopted the Senate version (H. Rept. 91-782, 3 C.B. 644">1969-3 C.B. 644, 657), and it subsequently became section 183 of the Code. The legislative history thus shows a recognition of the losses that real farmers often incur, along with a concern to close a loophole. 3 Respondent's regulations similarly recognize the problems faced by real farmers. In particular, one of the examples discusses the situation in which a farm on which the taxpayer did much of the required labor was not profitable for 15 years because of the rising costs of operating farms, yet the activity of farming could be found to be engaged in for profit. Section 1.183-2(c), Example (4), Income Tax Regs. 4 While some of the facts in the instant case may be distinguishable from those in the example, we think the distinctions less important than the similarities as regards the policy behind it. *418 Admittedly, petitioners' record keeping for the years subsequent to 1971 was somewhat deficient in failing to record receipts, and there is very little evidence of any effort to improve operations. Compare Golanty v. Commissioner, 72 T.C. at 430. At the same time, the record indicates that the primary thrust of the operation was to keep petitioners' heads above water in a desperate situation. In this latter context, we attach less significance to the fact that Fisher's injury and the weather problems in 1975 merely increased petitioners' losses, rather than prevented the farm from showing a profit in that year (one in which they reported no gross income from farming). Similarly, we discount the impact of the change in 1972 from a profitable dairy operation into a losing proposition, because it was necessitated by Fisher's back injuries. The fact is that a very real attempt was made to continue the remainder of the farm operations as before. Although Fisher had another job from 1972 through 1977 at which he worked during most of that period 40 hours per week, he continued running the farm by attending to the chores before and after work (as did Particia Fisher), *419 aided sporadically by hired help. On the other side of the coin, we attach considerable significance to the fact that Fisher's life was farming. He persevered in his attempts to profit at it despite rising costs, both by planting crops and by even trying again to raise cattle, possibly for dairy purposes. Petitioners' receipts from the sale of crops were so low because much of the crops was used to feed the young stock. He has not given up, although he now has no outside employment against which to offset his losses. Moreover, petitioners are not affluent individuals interested primarily in having the tax collector share in their farm losses. Cf. section 1.183-2(b)(8), Income Tax Regs.; Engdahl v. Commissioner, 72 T.C. at 670. 5 We are convinced that Fisher obtained outside employment (and the resulting nonfarm income) in order to offset his farm losses, rather than the converse. 6 Thus, the instant case is distinguishable on its facts from those cases relied on by respondent in which the taxpayers engaged in their loss activities while living comfortably on their outside incomes. Golanty v. Commissioner,supra;Dunn v. Commissioner,supra;*420 Jasionowski v. Commissioner, 66 T.C. 312">66 T.C. 312 (1976); Benz v. Commissioner, 63 T.C. 375 (1974); Bessenyey v. Commissioner, 45 T.C. 261">45 T.C. 261 (1965), affd. 379 F.2d 252">379 F.2d 252 (2d Cir. 1967). 7 Finally, we think it unlikely that petitioners would continue an activity costing them thousands of dollars and entailing so much personal labor without a profit motive. Engdahl v. Commissioner,72 T.C. at 670. The long and the short*421 of the matter is that we think that, on balance, the objective factors, including the bleak financial picture of the farm activities after 1972, are more explainable in terms of inefficient operations, which the Senate had in mind when it liberalized the "reasonable expectation" standard to that of an activity "not engaged in for profit," than in terms of negating the petitioners' expectation of profit. Hindsight leading to a conclusion of lack of efficiency should not cause us to substitute our judgment for that of a taxpayer who has made a good faith effort. See Jefferson Patterson v. United States, 198 Ct. Cl. 543">198 Ct. Cl. 543, 556, 459 F.2d 487">459 F.2d 487, 494 (1972). Based upon the record as a whole and after considering all the facts and circumstances, we hold that petitioners engaged in their farming activities in 1975 with a bona fide expectation of making a profit. 8To reflect a concession by petitioners, Decision*422 will be entered under Rule 155. Footnotes1. All section references, unless otherwise indicated, are to the Internal Revenue Code of 1954, as amended and in effect in 1975.↩2. Petitioners filed individual returns for 1971 and 1972 and joint returns for 1973 through 1976.↩*. Not including $15,955 in capital gains from sale of cows, bulls, and bulk tank used in dairy operations.↩3. See also section 1251, limiting the farm losses an individual with substantial nonfarm income may recognize, which was added to the Code by section 211 of the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 571. ↩4. Example (4). The taxpayer inherited a farm of 65 acres from his parents when they died 6 years ago. The taxpayer moved to the farm from his house in a small nearby town, and he operates it in the same manner as his parents operated the farm before they died. The taxpayer is employed as a skilled machine operator in a nearby factory, for which he is paid approximately $8,500 per year. The farm has not been profitable for the past 15 years because of rising costs of operating farms in general, and because of the decline in the price of the produce of this farm in particular. The taxpayer consults the local agent of the State agricultural service from time-to-time, and the suggestions of the agent have generally been followed. The manner in which the farm is operated by the taxpayer is substantially similar to the manner in which farms of similar size, which grow similar crops in the area are operated. Many of these other farms do not make profits. The taxpayer does much of the required labor around the farm himself, such as fixing fences, planting crops, etc. The activity of farming could be found, based on all the facts and circumstances, to be engaged in by the taxpayer for profit.↩5. See also Ong v. Commissioner, T.C. Memo. 1979-406↩. 6. Compare Wroblewski v. Commissioner, T.C. Memo. 1973-37↩, in which the taxpayer placed every cent he had into the purchase, operation, and improvement of his farm. When he ran out of money, he took on a temporary job. His farm was never profitable, but we found on that record that the taxpayer had a bona fide intention of making a profit. 7. See also Pickering v. Commissioner, T.C. Memo. 1979-243; Ballich v. Commissioner, T.C. Memo. 1978-497; Hurd v. Commissioner,T.C. Memo 1978-113">T.C. Memo. 1978-113; Conyngham v. Commissioner, T.C. Memo. 1964-194↩.8. Respondent has not challenged the amount of petitioners' farm deductions, only their character under section 183. We, therefore, do not concern ourselves with determining which, if any, of petitioners' expenditures might have been personal in character.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619466/ | STEVE A. HEBRANK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHebrank v. CommissionerDocket No. 19274-80.United States Tax CourtT.C. Memo 1982-496; 1982 Tax Ct. Memo LEXIS 248; 44 T.C.M. (CCH) 978; T.C.M. (RIA) 82496; August 30, 1982. *248 P, a pipefitter, earned wages during 1977 and 1978. He filed false Forms W-4 with his employers and claimed that he was exempt from withholding. He filed a false Form 1040 for 1977 and no Form 1040 for 1978. Held, P's wages constitute income received by him. Held, further, P is liable for the addition to tax for fraud under sec. 6653(b), I.R.C. 1954. Steve A. Hebrank, pro se. Peter D. Bakutes, for the respondent. SIMPSONMEMORANDUM FINDINGS OF FACT AND OPINION SIMPSON, Judge: The Commissioner determined the following deficiencies in and additions to the petitioner's Federal income taxes: Addition to taxsec. 6653(b)YearDeficiencyI.R.C. 1954 11977$1,304.00$652.001978186.0093.00The issues for decision are: (1) Whether in 1977 and 1978, the petitioner received "income" in the amounts determined by the Commissioner; and (2) whether any part of the underpayment of taxes for such years was due to fraud within the meaning of section 6653(b). FINDINGS OF FACT Some of the facts have been stipulated, and those facts are so found. The petitioner, Steve A. Hebrank, was a legal resident of Riverview, Fla., at the time he filed his petition in this case. Mr. Hebrank was a pipefitter and a member of the Plumbers and Pipefitters Union Local 624. During 1977 and 1978, he received job referrals through the hiring hall of such union. During*250 such years, he secured employment from the employers and received wages from them as follows: EmployerWages1977Limbach Company (Limbach)$ 807.00Power Systems, Inc. (Systems)1,836.00Davy Powergas, Inc. (Davy)846.00Bechtel Power Corp. (Bechtel)2,266.00Hunter Corporation (Hunter)981.00Power Piping Company (Piping)3,533.00Morrison Construction Co. (Morrison)62.00$10,331.001978Catalytic, Inc. (Catalytic)$ 2,232.61Omega Steel & Services, Inc. (Omega)158.34Southeastern Constr. and Maint., Inc. (Southeastern)2,018.42$ 4,409.37From each such employer, Mr. Hebrank received copies of the Forms W-2 showing the amount of wages received by him. During 1977, he also received $27 of interest income. Mr. Hebrank filed a return for 1976, which reflected that he received in such year adjusted gross income of $10,467.30, that income tax of $1,512.72 had been withheld, and that there was a tax liability of $1,410.66. Throughout 1977 and 1978, Mr. Hebrank had no dependents, and he has never been married. In March 1977, he signed and filed a Form W-4 (Employer's Withholding Allowance Certificate) with Piping, in which he*251 claimed no allowances for dependents and stated that he was single. Accordingly, such company withheld $197.72 from his wages. On or about June 22, 1977, Mr. Hebrank signed and filed a Form W-4E (Exemption from Withholding) with Davy. In such form, he claimed to be exempt from withholding and certified that he incurred no liability for Federal income tax for 1975 and that he anticipated that he would incur no liability for Federal income tax for 1976. Although such certificate referred to tax liabilities for 1975 and 1976, it is clear that he intended to refer to such liabilities for 1976 and 1977. On or about September 21, 1977, he signed and filed a Form W-4 with Hunter. On such form, he wrote that he was "exempt" from withholding and also indicated that he was married. Such form contained the following statement: Under the penalties of perjury, I certify that the number of withholding exemptions and allowances claimed on this certificate does not exceed the number to which I am entitled. If claiming exemption from withholding, I certify that I incurred no liability for Federal income tax for last year and that I anticipate that I will incur no liability for Federal income*252 tax for this year. [Emphasis added.] On or about November 18, 1977, Mr. Hebrank signed and filed a Form W-4 with Bechtel, on which he wrote "exempt" and checked the box indicating that he was married. Such form contained the same certificate as the Hunter form with respect to this tax liability for 1976 and 1977. As a result of Mr. Hebrank filing such Forms W-4, Davy, Hunter, and Bechtel did not withhold any income taxes from his wages; nor did Limbach, Systems, and Morrison. On or about April 17, 1978, Mr. Hebrank signed and filed a Form W-4 with Southeastern. On such form, he wrote that he was "exempt" and that he was married. Similarly, Mr. Hebrank filed a Form W-4 dated May 11, 1978, with Omega, on which he wrote "Exempt" twice and checked the box for married. On May 9, 1978, he signed and filed a Form W-4 with Catalytic, on which he claimed to be single and "exempt"; but on May 30, 1978, he signed and filed another Form W-4 with Catalytic, on which he indicated that he was married and claimed ten exemptions. The Forms W-4 filed with Southeastern and with Catalytic contained the certification that he had no Federal tax liability for 1977 and expected none for 1978. Neither*253 Omega nor Catalytic withheld any Federal income taxes from the wages of Mr. Hebrank in 1978; but notwithstanding his request to be treated as exempt, Southeastern withheld $175.41 from his wages.In April 1978, Mr. Hebrank filed with the Internal Revenue Service a two-page document (Form 1040) for 1977. Across the top of such form was the following printed statement: FILED UNDER PROTEST--RETURN RECEIPT REQUESTED--PETITION FOR REDRESS OF GRIEVANCES--ALL ATTACHMENTS ARE INTEGRAL PART OF THIS RETURN--OTHER MATERIALS INCLUDED BY REFERENCE. The margins of such form also included the printed statements that he was confused as to the meaning of "dollars" and "gross income," that he was making certain constitutional objections, and that the form was signed involuntarily under threat of statutory punishment. On such Form 1040, Mr. Hebrank indicated that his wages were "under $2100." He claimed one exemption and indicated that he was single. He provided no information in response to the other requests for information on the return and indicated that he was asserting constitutional privileges against the disclosure of such information.He entered the word "NONE" on the lines for tax*254 liability and balance due IRS. Prior to the filing of such form for 1977, Mr. Hebrank discussed the material on the form with his co-workers. For 1978, Mr. Hebrank filed no documents with the IRS purporting to be a Federal income tax return. Sometime prior to July 1981, the Commissioner established a project in the Lakeland, Fla., area to determine the concentration of erroneous filings of Forms W-4. Such project revealed that many of the area employers were receiving a large percentage of "exempt" Forms W-4 from various craftsmen in the construction industry who were hired through the union hall.Furthermore, such project revealed that a large number of such craftsmen were plumbers and pipefitters. In his notice of deficiency, the Commissioner determined that the petitioner had received unreported income in 1977 and 1978. He also determined that the underpayment of taxes for those years was due to fraud within the meaning of section 6653(b). OPINION The first issue for decision is whether Mr. Hebrank earned income subject to tax during 1977 and 1978 in the amounts determined by the Commissioner. The petitioner has the burden of disproving such determination. Rule 142(a), *255 Tax Court Rules of Practice and Procedure2; Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). At trial, Mr. Hebrank conceded that the $27 of interest he earned constituted income and failed to dispute any of the substantive adjustments made by the Commissioner. Instead, he appears to maintain that his wages are not "income" because they merely constitute an exchange of his services for money and because there had been no showing that he realized a gain on such exchange. He argues that it is unconstitutional to tax him in the absence of such a gain. These arguments have been considered and rejected repeatedly by courts, and by now, such arguments are recognized as frivolous. It has long been held that wages constitute income. United States v. Buras,633 F. 2d 1356 (9th Cir. 1980), and cases cited therein; sec. 61(a)(1). Furthermore, the 16th Amendment is constitutional as applied to the petitioner. See Stanton v. Baltic Mining Co.,240 U.S. 103">240 U.S. 103 (1916); Brushaber v. Union Pac. R.R.,240 U.S. 1">240 U.S. 1 (1916); Cupp v. Commissioner,65 T.C. 68">65 T.C. 68 (1975), affd. without pub. opinion 559 F. 2d 1207 (3d Cir. 1977).*256 Accordingly, we sustain the Commissioner's determination of the deficiencies for both 1977 and 1978. The only issue remaining is whether to sustain the Commissioner's determination of fraud under section 6653(b), which provides in part: (b) Fraud.--If any part of any underpayment * * * of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment * * * The Commissioner has the burden of proving, by clear and convincing evidence, that some part of the underpayment for each year was due to fraud.Rule 142(b); sec. 7454(a); Levinson v. United States,496 F. 2d 651 (3d Cir. 1974); Miller v. Commissioner,51 T.C. 915">51 T.C. 915, 918 (1969). He must show that the taxpayer intended to evade taxes which he knew or believed that he owed by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. Stoltzfus v. United States,398 F.2d 1002">398 F. 2d 1002, 1004 (3d Cir. 1968), cert. denied 393 U.S. 1020">393 U.S. 1020 (1969); Webb v. Commissioner,394 F. 2d 366 (5th Cir. 1968),*257 affg. a Memorandum Opinion of this Court; Acker v. Commissioner,26 T.C. 107">26 T.C. 107 (1956). The presence of fraud is a factual question to be determined by an examination of the entire record. Mensik v. Commissioner,328 F.2d 147">328 F. 2d 147, 150 (7th Cir. 1964), affg. 37 T.C. 703">37 T.C. 703 (1962); Otsuki v. Commissioner,53 T.C. 96">53 T.C. 96 (1969). Since fraud can seldom be established by direct proof of intention, the taxpayer's entire course of conduct can often be relied on to establish such fraudulent intent. Stone v. Commissioner,56 T.C. 213">56 T.C. 213, 223-224 (1971); Otsuki v. Commissioner,53 T.C. at 105-106. In our judgment, the evidence in the record over-whelmingly establishes that Mr. Hebrank fraudulently underpaid his taxes during both of the years in issue.At trial, Mr. Hebrank appeared to be an intelligent man who was well aware of the obligation to file returns and pay taxes. He properly filed a return for 1976; yet, the document he submitted for 1977 clearly did not constitute a return within the meaning of section 6011 and the regulations thereunder. See Jarvis v. Commissioner,78 T.C. 646">78 T.C. 646 (1982);*258 Thompson v. Commissioner,78 T.C. 558">78 T.C. 558 (1982); Reiff v. Commissioner,77 T.C. 1169">77 T.C. 1169 (1981); see also United States v. Moore,627 F. 2d 830 (7th Cir. 1980); United States v. Smith,618 F. 2d 280 (5th Cir. 1980); United States v. Johnson,577 F. 2d 1304 (5th Cir. 1978). Furthermore, Mr. Hebrank filed no return at all for 1978. While the failure to file a return does not in itself establish fraud, such failure may properly be considered with other facts in determining whether any underpayment of tax is due to fraud. Habersham-Bey v. Commissioner,78 T.C. 304">78 T.C. 304 (1982); see also Marsellus v. Commissioner,544 F.2d 883">544 F. 2d 883, 885 (5th Cir. 1977), affg. a Memorandum Opinion of this Court; Stoltzfus v. Commissioner,supra; Beaver v. Commissioner,55 T.C. 85">55 T.C. 85 (1970). In Habersham-Bey, we recently held that the failure to file returns, when coupled with the submission of a false Form W-4 to avoid withholding, was in itself indicative of an intent to evade the payment of income taxes. 78 T.C. at 313. We find Habersham-Bey to be particularly*259 apposite here. In addition, during 1977 and 1978, Mr. Hebrank filed false Forms W-4 on at least seven separate occasions. On such forms, he falsely stated that he was "exempt" from withholding because he was not liable for taxes for the past and current years, that he was married, or that he was entitled to ten exemptions. With one employer, Mr. Hebrank's filing status changed within a period of 3 weeks from "single" and "exempt" to married with ten exemptions. We do not believe his testimony that he "must have just hit the wrong box" or that he did not enter some of the information on such forms. Mr. Hebrank admitted that he received copies of all of his Forms W-2. Yet, the Form 1040 that he submitted for 1977 indicated that his wages were "under $2100." Compare Jarvis v. Commissioner,supra. The filing of the false Forms W-4 and the filing of such false Form 1040 for 1977 are further evidence of Mr. Hebrank's fraudulent intent.See United States v. Afflerbach,547 F. 2d 522, 524 (10th Cir. 1976); United States v. Porth,426 F. 2d 519 (10th Cir. 1970); Habersham-Bey v. Commissioner,supra.Moreover, *260 his testimony ws vague and evasive, and he offered no credible excuse for any of his acts and omissions during the years at issue. In view of all these circumstances, we are convinced that Mr. Hebrank intended to evade the payment of taxes during 1977 and 1978. Accordingly, we sustain the Commissioner's determination of fraud under section 6653(b). Decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue code of 1954 as in effect during the years in issue.↩2. All references to a rule are to the Tax Court Rules of Practice and Procedure.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619469/ | TONY MALTESE AND JOSEPHINE MALTESE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; NINO'S PIZZA SHOP, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMaltese v. CommissionerDocket Nos. 25320-86; 36798-86.United States Tax CourtT.C. Memo 1988-322; 1988 Tax Ct. Memo LEXIS 350; 55 T.C.M. (CCH) 1343; T.C.M. (RIA) 88322; July 27, 1988. *350 Joseph S. Binder, for the petitioner. Russell K. Stewart, for the respondent. WILLIAMSMEMORANDUM FINDINGS OF FACT AND OPINION WILLIAMS, Judge: In these consolidated cases the Commissioner determined deficiencies in petitioners Tony and Josephine Malteses' Federal income tax and additions to tax as follows: Additions to taxSectionSectionSectionSectionYearDeficiency6651(a) 166616653(a)(1)6653(a)(2)1980$ 31,704$ 7,908.25$ - $ 1,798.40- 198167,56316,881.90- 3,718.60* 198226,6956,606.662,669.501,509.55 **The Commissioner also determined deficiencies in petitioner Nino's Pizza Shop, Inc.'s ("Nino's") Federal income tax and additions to tax as follows: Additions to taxSectionSectionSectionYearDeficiency6653(a)(1)6653(a)(2)66611980$ 14,382$ 719.10- - 198143,4522,172.60* - 198213,525676.25 **$ 1,352.50*351 The issue we must decide is whether respondent's method of reconstructing Nino's gross receipts and taxable income for its taxable years 1980, 1981, and 1982 was reasonable. Petitioners conceded at trial that Nino's understated its gross receipts but they dispute the amount of the understatement determined by respondent. Petitioners also conceded at trial that to the extent we determine that Nino's income was understated, those amounts will be considered distributions by Nino's petitioners Maltese and taxed as a dividend or return of capital in accordance with the earnings and profits determined in the statutory notice of deficiency. At trial petitioners also conceded liability for the additions to tax, but not in the amounts determined by respondent. Some of the facts in this case have been stipulated and are so found. Petitioners Maltese were husband and wife during the years in issue and resided in Flemington, New Jersey when their petition was filed. Petitioners filed their joint Federal income tax returns for each taxable year in issue late. Nino's was a corporation having its principal place*352 of business in Chalfont, Pennsylvania when its petition was filed, and all the stock of Nino's was owned by petitioner Tony Maltese. During the years in issue, Nino's operated a pizza shop selling pizza, sandwiches, soda and snacks. Although the pizza store operated primarily in Lansdale, Pennsylvania, Nino's opened and operated other stores at other locations during 1980, 1981, and 1982. The pizza store had both a grill and oven for sandwiches and pizza, together with a counter and seating area for customers. In excess of 70 percent of the pizza store's sales were taken out by customers. Petitioners' two sons, Salvatore and Philip Maltese, were employed by Nino's and worked at the pizza ship seven days a week. Salvatore was responsible for making all the pizza sold at Nino's and for ordering and paying for supplies purchased from Collica Quality Foods while Philip was responsible for making sandwiches for sale to customers. Nino's prices for pizza for the years in issue were as follows: Pizza Size198019811982Regular$ 3.75$ 4.00$ 4.25Large4.755.005.25Sicilian6.006.256.50Toppings increased the price of the pizza by approximately*353 $ .75 per item. Of every 100 pizzas sold, Nino's sold approximately 40 medium pizzas, 56 large pizzas, and four Sicilian pizzas. The records of Collica Quality Foods ("Collica") and Roma Food Enterprises ("Roma"), two of Nino's suppliers, show that Nino's purchased at least 298, 412 and 326 hundred-pound sacks of flour in the years 1980, 1981, and 1982, respectively. Some of Nino's purchases from Roma and Collica were made by cash. These purchases exceeded the purchases reported on Nino's Federal income tax returns during 1980, 1981 and 1982 by at least $ 36,698, $ 41,848 and $ 39,781, respectively. Nino's reported taxable income or loss of $ 801, $ 3,001 and ($ 961), respectively for 1980, 1981 and 1982. Petitioners did not maintain adequate books and records of Nino's receipts, costs, or expenses, although petitioners regularly consulted an accountant. Not all of Nino's receipts were deposited in Nino's business bank account, and some of the expenses of the business were paid with cash taken from daily receipts. In the absence of adequate records for Nino's, respondent reconstructed Nino's gross receipts. Respondent derived Nino's gross receipts from the estimated number*354 of pizzas which could be made from the amount of flour purchased by Nino's during the years at issue. In the statutory notice of deficiency respondent based his determination on the assumption that Nino's made 135 pizza pie crusts whether medium or large out of each 100 pound bag of flour it purchased. Respondent determined that Nino's gross receipts were understated by $ 102,158, $ 170,084 and $ 101,587 for 1980, 1981, and 1982, respectively. Accordingly, respondent determined that petitioners received distributions from Nino's of $ 66,305, $ 99,871, and $ 42,000 for 1980, 1981 and 1982, respectively. Petitioners contend that respondent's determination was unreasonable. They claim that Nino's could make only 95 to 100 medium pizzas out of 100 pound bag of flour, 60 to 70 large pizzas out of a 100 pound bag of flour and 35 to 40 Sicilian pizzas out of a 100 pound bag of flour. Petitioners also contend that they sold at cost several bags of flour each week to Rose Peters who worked at a doughnut shop nearby and gave away flour periodically to a friend from New Jersey named Solina. Solina is deceased, but petitioners failed to produce Peters as a witness at trial. Respondent's*355 determination of deficiency is presumptively correct. Petitioners have the burden of going forward with the evidence as well as the ultimate burden of persuasion that respondent's determination in the statutory notice is incorrect. Welch v. Helvering, 290 U.S. lll (1933); Rule 142(a), Tax Court Rules of Practice and Procedure. A showing by petitioners, however, that the statutory notice is arbitrarily excessive or without foundation shifts the burden of going forward with the evidence to respondent. Helvering v. Taylor,290 U.S. 507">290 U.S. 507 (1935). We are troubled by the respondent's method of reconstruction. Respondent made no effort to compare the pizzas sold by Nino's with those sold by the larger retail chains that provided the information for formulating this method. Nevertheless, petitioners did not present any evidence that persuades us that respondent's determination was arbitrary or without foundation. The only evidence presented at trial to rebut respondent's assumption that Nino's made and sold 135 pizzas per 100 pound bag of flour was the testimony of petitioner Tony Maltese and his son Salvatore who stated that Nino's could make only 95 to 100 medium*356 pizzas per 100 pounds of flour rather than the 135 assumed by respondent. On balance we are more troubled by the Malteses' testimony than by respondent's method. The Malteses testified that one reason respondent's reconstruction was inappropriate to Nino's is because they gave two to three bags of flour away each week and sold four to five each month at cost. To sustain such generosity, Nino's would have had to pass on more than half of its documented flour purchases at cost or by gift. This story is too implausible to believe and, moreover, casts doubt on all their testimony. Furthermore, petitioners did not call as witnesses anyone to whom petitioners sold flour at cost or who could confirm their gifts. "The rule is well established that the failure of a party to introduce evidence within his possession and which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable." Wichita Terminal Elevator Co. v. Commissioner,6 T.C. 1158">6 T.C. 1158, 1165 (1946) affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). Petitioners must bear the consequences of their failure to maintain adequate records (despite their regularly consulting*357 an accountant). In light of our perception of the witnesses' testimony and petitioners' failure to keep accurate books and records for Nino's from which a return could be recreated, we find the Malteses' unsupported testimony unpersuasive. We therefore, hold that respondent's determinations of deficiencies are correct and that Nino's gross receipts for its taxable years 1980, 1981, and 1982 were understated by $ 102,158, $ 170,084, and $ 101,587, respectively. Pursuant to their concessions, petitioners received distributions from Nino's in the amounts of $ 66,305, $ 99,871 and $ 42,000 for their taxable years 1980, 1981 and 1982, respectively. Decisions will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954 as in effect during the years in issue, unless otherwise indicated. ↩*. 50% of interest due on $ 67,563. ** 50% of interest due on $ 26,695. ↩*. 50% of interest due on $ 43,452. ** 50% of interest due on $ 13,525. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619470/ | M. F. TARPEY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Tarpey v. CommissionerDocket No. 2948.United States Board of Tax Appeals4 B.T.A. 1056; 1926 BTA LEXIS 2108; September 25, 1926, Decided *2108 Actual losses proved by competent evidence are the only basis for deduction for obsolescence of tangible property. Paul S. Marrin, Esq., for the petitioner. George E. Adams, Esq., for the respondent. LANSDON *1057 The Commissioner asserts deficiencies in income and profits taxes for the years 1918 and 1919, in the respective amounts of $19,091.82 and $28,317.62, or a total of $47,409.44. The controversy arises from the disallowance of certain deductions from the income of the petitioner for the taxable years on account of obsolescence of wine vineyards and losses of profits sustained as a result of national prohibition legislation. FINDINGS OF FACT. The petitioner is a citizen of the United States, and a resident of the State of California at Tarpey's Vineyard, where he is engaged in the production of wine, raisin and table graphes. At January 1, 1918, he was the owner and operator of vineyards comprising 1,150 acres of which 840 acres were planted to wine grapes and the remainder to raisin and table grapes. In 1918, he abandoned and destroyed the vines on 200 acres of wine-grape vineyards, leaving 640 acres planted to wine grapes. *2109 In his income and profits-tax returns for 1918 and 1919, the petitioner made the following deductions from his gross income for the respective years on account of losses alleged to have been sustained as a result of national prohibition legislation: 1918, obsolescence $56,539.90, loss of profits $61,727.32, or a total of $118,267.22; 1919, obsolescence $61,879.89, loss of profits $67,338.90, or a total of $129,018.79. Upon audit the Commissioner disallowed such deductions and determined the deficiencies here involved. It is stipulated that the prices per ton received for wine grapes sold by the petitioner were as follows: 1918, $75.36; 1919, $99.92; 1920, $126.48; 1921, $113.84; 1922, $81.52; 1923, $76.72; 1924, $72.56. OPINION. LANSDON: The petitioner asks for the deduction of $118,267.22 and $129,018.79 from his gross income for the years 1918 and 1919 on account of obsolescence of 640 acres of wine-grape vineyards and loss of profits from operation of the same during the respective years, and relies on the provisions of section 214(a)(8) of the Revenue Act of 1918, which is as follows: A reasonable allowance for exhaustion, wear and tear of property used in the trade*2110 or business, including a reasonable allowance for obsolescence. There is no dispute of the reasonable allowance for the exhaustion. wear and tear of the petitioner's vineyards. The parties agree on the basic value per acre at March 1, 1913, on the useful life of vineyards of the type owned by the petitioner, on the rate of depreciation, and on the total amount of deductible depreciation. Such depreciation *1058 has been computed, deducted, and allowed. The only question for our consideration is whether the petitioner is entitled to further deductions from his gross income for the taxable years on account of obsolescence and loss of profits, resulting from national prohibition, in the amounts set forth in our findings of fact. It is obvious that this petitioner seeks to apply the provisions of the law to his advantage on a purely hypothetical basis. If Federal prohibition legislation had totally destroyed the market for wine grapes, the petitioner might then have been entitled to a reasonable allowance for the obsolescence of his wine-grape vineyards; but even in such an event, not proved in this proceeding, we know of no law that would authorize the deduction of estimated*2111 profits from gross income in the determination of Federal tax liability. The record completely refutes the theory and the argument of the petitioner. The market for wine grapes was not destroyed in 1918. Instead of losses during the taxable year, it is proved by the stipulation that the taxpayer obtained higher prices for his crops, and it is a fair presumption that such increase in receipts resulted in increased profits. Judgment for the Commissioner. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619471/ | PAUL E. RUPLINGER AND MILDRED E. RUPLINGER, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, RespondentRuplinger v. CommissionerDocket No. 12636-82.United States Tax CourtT.C. Memo 1984-166; 1984 Tax Ct. Memo LEXIS 503; 47 T.C.M. (CCH) 1430; T.C.M. (RIA) 84166; April 3, 1984. Paul E. Ruplinger, pro*504 se. Karl Zufelt and Martin F. Klotz, for the respondent. KORNERMEMORANDUM FINDINGS OF FACT AND OPINION KORNER, Judge: Respondent determined deficiencies in petitioners' income tax for the calendar years 1978 and 1979 in the respective amounts of $4,812.04 and $5,124.96, together with additions to tax for 1978 of $240.60 and for 1979 of $256.24, both under the provisions of section 6653(a). 1 After concessions, the following issues remain for our decision: (1) Whether petitioners were entitled to deductions, as claimed in their returns, alleged to have been incurred in carrying on a trade or business in the State of Utah; (2) whether petitioners were entitled to investment credit in each of the years 1978 and 1979, with respect to certain assets allegedly purchased by them in those years for use in connection with said alleged trade or business; (3) whether petitioners were entitled to deductions in 1978 and 1979 for certain expenses allegedly incurred by petitioner Paul E. Ruplinger on behalf of a partnership of which he was a member; (4) whether petitioners are liable to additions to tax for negligence under section 6653(a). 2*505 FINDINGS OF FACT At trial, the parties filed stipulations of fact with certain joint exhibits, and such stipulated facts are incorporated herein by this reference. Petitioners Paul E. Ruplinger and Mildred E. Ruplinger, husband and wife, were residents of San Diego, California, during the calendar years 1978 and 1979, and at the time of filing their petition herein. They timely filed joint Federal income tax returns for the calendar years 1978 and 1979. 3In 1978 and 1979, petitioner, who was 72 years old in 1978 and was a retired highway engineer, receiving a retirement pension from the State of California, owned property in Beaver County, Utah, consisting of a rural tract of approximately 10 acres and a 2-unit duplex house in the town of Beaver. This property was approximately 600 miles from petitioner's residence in San Diego, California. Except for a metal quonset hut of approximately 20 X 70 feet and a well with electric pump, the rural tract was unimproved. There were some pens on the property for the purpose of holding pheasants, but in 1978 and 1979, these were in a state*506 of disrepair. One of the two units in the duplex house in the town of Beaver was reserved for the use of petitioners, when they came to visit the property. The other unit was rented out occasionally, and otherwise was unoccupied. In San Diego, petitioners devoted some of their time to the raising of pheasants. Some of the birds appear to have been bred, whereas other birds were purchased.During the years in question, petitioners sold some pheasants. Others were transported by petitioners to the property in Beaver County, Utah, and were released to run wild. Petitioner made to attempt to trap, shoot or sell these birds. In the year 1978, petitioner realized income from the sale of some trees on the Beaver County property. In both 1978 and 1979, petitioner realized gross income from the rental of certain mechanical equipment which he had on the Beaver County property. A summary of the sources and amounts of gross income derived by petitioner from the Beaver County property is as follows: SOURCE19781979Sale of Pheasants$ 270$210Sale of Trees168Services and Rent ofEquipment1,048301$1,486$511During the years in question, petitioner*507 paid the following expenses with respect to the Beaver County property: EXPENSE19781979Fuel$169Insurance4740Electricity4443Purchase Pheasants20Telephone18$280$101In each of the years 1978 and 1979, petitioner made two trips from San Diego to visit his Beaver County property. For each of the years 1978 and 1979, petitioner reported gross income and expenses from the Beaver County property on Schedule C attached to each return, as income and expense from carrying on a trade or business. For 1978, total expenses in the amount of $7,695.20 were claimed, and $10,581.29 was claimed for 1979, including, inter alia, items such as car and truck expenses, depreciation, repairs and supplies. For 1978, a net loss of $6,299.28 was shown from this operation, and a net loss of $10,070.19 was shown for 1979. In addition, petitioner claimed investment credit in his 1978 return in the amount of $463.30 for alleged new property placed in service in that year costing $4,633 (not otherwise identified), and, for 1979, claimed investment credit of $850, for alleged used property placed in service costing $8,500 (also not otherwise identified). *508 Upon audit, respondent disallowed the net losses claimed by petitioner with regard to the Beaver County operation for 1978 and 1979, on the grounds that petitioner had not established that such losses had been incurred, nor that they were incurred in carrying on a trade or business. The net effect of respondent's determinations was to allow petitioner's claimed expenses only to the extent of income reported. With respect to petitioner's claimed investment credits, respondent for 1978 allowed a credit of $13.30 for new property with a cost basis of $133.00. He disallowed the balance of the claimed credit for 1978, and all of it for 1979, for lack of substantiation. During the years 1978 and 1979 petitioner was a partner with his son in a partnership using the name A-1 Land Clearing. This partnership was engaged in demolishing buildings and clearing land. Petitioner reported his distributive shares of the partnership net income in Schedule E of his tax returns for each year but, in addition, claimed further deductions in connection therewith of $5,881.40 in 1978 and $8,991 in 1979 on account of alleged unreimbursed out-of-pocket expenses which he had incurred on behalf of the*509 partnership, for such items as automobile mileage, promotion and entertainment expenses. Upon audit, respondent disallowed these claimed additional expenses in their entirety. 4In his statutory notice of deficiency herein, respondent further determined that petitioners were liable to a 5 percent addition to the deficiency determined, under section 6653(a), for negligence or intentional disregard of rules and regulations. OPINION Issue I. Losses From Beaver County Property.Issue II.Investment Credit.Respondent determined that the net losses claimed by petitioners for each of the years 1978 and 1979 with respect to their activities at the Beaver County, Utah, property were not allowable, both (a) *510 because the amounts claimed were not substantiated, and (b) because petitioner had not shown that he was engaged in a trade or business or in a transaction entered into for profit. The latter point would require an extensive consideration of the applicable law under sections 162, 183 and 212, with all the gloss that the many cases decided under those sections have added to the body of the law in this area. In this case, however, no such extensive examination is necessary, because petitioners have completely failed to substantiate the claimed losses. Respondent's statutory notice clearly placed in issue the question of the substantiation of the claimed expenses, to the extent thawt they exceeded the gross income from the Beaver County operation, and petitioners had the burden of proof to establish that they actually incurred the expenses for which business deductions under section 162 were claimed in their returns. To the extent disallowed by respondent, they also had the burden of establishing the costs, qualifying nature of the property and year placed in service, with respect to property for which they claimed a credit against tax under section 38. ;*511 Rule 142(a). This they have completely failed to do. There is no evidence in this record to support the various out-of-pocket expenses claimed in summary form by petitioners on Schedule C of their returns, beyond the minor amounts stipulated by the parties and detailed in our findings, and there is likewise no substantiation of the costs, years of acquisition or even identification of the various tangible assets on which petitioners were claiming investment credit. Even if we were able to find in this record that petitioner's activities with respect to his Beaver County property rose to the level of a trade or business, the claimed deductions and investment credits would therefore still not be allowable. Petitioner candidly admitted at trial that he kept no books and records, and nothing in the nature of cancelled checks or other acceptable evidence was offered to verify the amounts, either in whole or in detail, of the various expenses, depreciation, and other items which would have supported his position. Given this total failure of proof, we can do nothing else but hold for respondent on this issue. 5*512 Issue III. Expenses Incurred on Behalf Of The Partnership.Respondent likewise disallowed expenses claimed by petitioner for alleged unreimbursed amounts expended by him for the benefit of a partnership of which he was a member, on the grounds that (a) such expenditures had not been substantiated and (b) that the expenses were not incurred in connection with a trade or business of the petitioner. Here again, petitioner's failure of proof was total. Not a scrap of evidence was presented substantiating the amounts for alleged automobile mileage, travel and entertainment and other similar expenses which petitioner claimed to have spent on behalf of the A-1 Land Clearing partnership. We therefore must again sustain respondent's determination, noting further that even if petitioner had proved the expenditures claimed by him on behalf of the partnership, such proof would not of itself be sufficient to allow these amounts to petitioner as an individual deduction. Where expenses of a partnership are paid by a partner and there is no agreement among the partners that such expenditures must be made by him, the expenses, even though proved, are to be considered to be expenses*513 of the partnership and not of the individual partner, and are therefore not deductible by him. . No such proof was offered in the instant case. Issue IV. Additions To Tax Under Section 6653(a).Respondent determined additions to the deficiencies under section 6653(a), having determined that petitioner was negligent, or intentionally disregarded respondent's rules and regulations. The burden of proof on this issue was upon petitioners, ; . Given the large amounts claimed as deductions by petitioner, both with respect to the Beaver County property as well as the A-1 Land Clearing partnership, and petitioner's apparent failure to make any pretense of keeping adequate records by which such expenditures could be substantiated, we can find no error in respondent's determination on this issue, and it is accordingly approved. Decision will be entered under Rule 155.Footnotes1. All statutory references herein are to the Internal Revenue Code of 1954 as in effect in the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, except as otherwise noted. ↩2. A further technical issue is presented with regard to the correct amount of petitioners' liability for self-employment tax. This issue is automatically controlled by the outcome of issues (1), (2) and (3), noted above, and will not be referred to further herein. The parties are in apparent agreement on this, neither one having mentioned it at trial or on brief.↩3. All references hereinafter to "petitioner" refer to petitioner Paul E. Ruplinger.↩4. Respondent also disallowed all the charitable contributions claimed by petitioners in their returns in the amounts of $5,401 in 1978 and $5,480 in 1979. The parties have now stipulated, however, that petitioners are entitled to charitable deductions for 1978 of $5,401 and $9,060 in 1979, subject to the applicable 50 percent of adjusted gross income limitation of sec. 170(b)(1), such amounts to be given effect in the recomputation herein under Rule 155.↩5. In an apparent attempt to bolster his position that his activities with respect to the Beaver County property constituted a trade or business, petitioner attached to his brief a number of ex parte affidavits and other documents from persons who were not called as witnesses herein. Ex parte affidavits and statements in briefs do not constitute evidence and will not be considered by the Court. Rule 143(b); ; see .↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619472/ | LOUIS ROBERT DeMAURO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDeMauro v. CommissionerDocket No. 12143-92United States Tax CourtT.C. Memo 1994-460; 1994 Tax Ct. Memo LEXIS 465; 68 T.C.M. (CCH) 721; September 19, 1994, Filed *465 Decision will be entered for respondent. Louis Robert DeMauro, pro se. 1For respondent: Keith L. Gorman. PARRPARRMEMORANDUM FINDINGS OF FACT AND OPINION PARR, Judge: Respondent determined a deficiency in petitioner's Federal income tax for 1989 of $ 32,486 and an addition to tax under section 66622 in the amount of $ 562. The issues for decision are: (1) Whether petitioner failed to report gain from the sale of his residence; (2) whether petitioner failed to adequately support his expenses relating to his trade or business; *466 and (3) whether petitioner is liable for the section 6662 addition to tax. We hold for respondent on all three issues. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts, supplemental stipulation of facts, and attached exhibits are incorporated herein by this reference. At the time the petition herein was filed, petitioner resided in Burlington, New Jersey. Petitioner was married; however, he filed his income tax return as head of household for the year at issue. Petitioner has conceded that he is not entitled to head of household status since he was legally married during all of 1989. Petitioner worked as a division manager for a real estate company, Previews International, Inc. (Previews) from 1976 through 1988. In 1988 Previews was closed by its owners Coldwell Banker. In 1989, petitioner accepted an offer to work for a line of Coldwell Banker known as Coldwell Banker Previews. There petitioner was responsible for the listing, marketing and sales of the upper tier home market. This work was previously conducted by Previews. Pursuant to the terms of the offer, petitioner would perform services as an independent contractor and was compensated*467 through commissions and reimbursement of all business expenses as incurred. Petitioner's employment with Coldwell was terminated in October of 1989. Petitioner formed a corporation on October 2, 1989, to carry on his real estate sales business. However, pursuant to litigation with Coldwell Banker, an injunction was issued against the corporation from operating in the United States. Petitioner sold his residence at 1117 Delaware Avenue, Delanco, New Jersey, on December 14, 1989, for $ 285,500, in part, to defray costs of the litigation, and in part to continue operating his real estate business. The parties stipulated that the adjusted basis of the property on the date of the sale was $ 163,500; the expenses incurred totaled $ 33,996; and thus the gain on the sale of the residence was $ 88,004. Petitioner did not report any gain on the sale of the property on his 1989 Federal income tax return. At all relevant times, petitioner has maintained his personal residence within the United States and has not rolled over the gain on the sale of the home into the purchase of another qualified residence. In a letter dated November 28, 1989, from petitioner to Justin Spain Real Estate*468 Inc., petitioner requested that the proceeds from the sale be held on deposit until after January 12, 1990. The contract for sale, dated December 1, 1989, provides for $ 20,000 to be paid upon the signing of the contract and for the balance in the amount of $ 265,500 to be paid at settlement. The contract also provided in pertinent part: Buyer agrees to allow Seller, Louis DeMauro, to remain in property until January 14, 1990, at a rental of $ 22.00 per day.Neither the contract nor the settlement provided for any type of escrow arrangement. The settlement took place on December 14, 1989, and provided for cash in the amount of $ 133,429.74, after adjustments, due to seller. On his 1989 Schedule C, petitioner deducted $ 20,961.02 in expenses. Petitioner maintained no books and records, and he stated that the amounts deducted on his Schedule C were estimates of the expenses incurred during the year. Petitioner also claims that the expenses were categorized incorrectly. He presented invoices for expenses, but in most cases the record lacks proof that the expenses were in fact paid; that they were business related; or that they were not otherwise reimbursed by Coldwell. *469 Respondent has allowed petitioner $ 4,756 of his claimed Schedule C expenses. Respondent issued a statutory notice of deficiency to petitioner. In the notice respondent asserted a deficiency in and additions to petitioner's 1989 Federal income tax in regard to unreported capital gain income; the disallowance of Schedule C expenses; disallowance of medical expenses; 3 assessment of self-employment tax; 4 and a penalty for negligence or intentional disregard of rules and regulations pursuant to section 6662. OPINION As an initial consideration, petitioner raised *470 a number of arguments for the first time at trial and on brief. Any issue not raised in the pleadings shall be deemed to be conceded. Rule 34(b)(4). This Court has held on numerous occasions that it will not consider issues which have not been properly pleaded. Foil v. Commissioner, 92 T.C. 376">92 T.C. 376, 418 (1989), affd. 920 F.2d 1196">920 F.2d 1196 (5th Cir. 1990); Markwardt v. Commissioner, 64 T.C. 989">64 T.C. 989, 997 (1975), and cases cited therein. Accordingly, we will not consider any of these issues. Issue 1. Gain on Sale of ResidencePetitioner asserts that the gain is not taxable because of the deferral provisions under section 1034. Respondent asserts that petitioner did not satisfy the requirements under section 1034. Gain from the sale of a personal residence is not recognized, provided a new residence is either purchased or constructed by the taxpayer within a period beginning 2 years before the date of such sale and ending 2 years after such date and the adjusted sales price of the old residence is less than the cost of the new residence. Sec. 1034(a), (c). The running of the period of time to purchase*471 a replacement residence is suspended for the period in which the taxpayer has a "tax home" outside the United States, not to exceed 4 years after the date of the sale of the old residence. Sec. 1034(k). The term "tax home" means with respect to any individual, such individual's home for purposes of section 162(a)(2). Sec. 911(d)(3). An individual shall not be treated as having a tax home in a foreign country for any period for which his abode is within the United States. Id. "Tax home" is considered to be the taxpayer's regular or principal place of business or if none, then his place of abode in a real or substantial sense. Commissioner v. Stidger, 386 U.S. 287 (1967). To qualify for nonrecognition, petitioner must physically occupy or live in the new home before the expiration of the replacement period. Bayley v. Commissioner, 35 T.C. 288">35 T.C. 288 (1960); Stanley v. Commissioner, 33 T.C. 614 (1959). The courts, and in particular this Court, have unequivocally abided by this rule. Henry v. Commissioner, T.C. Memo. 1982-469. Absolute compliance is required*472 even where the taxpayer was prevented from acquiring or moving into the new residence on time due to circumstances beyond his control. Bayley v. Commissioner, supra (construction delay); Gelinas v. Commissioner, T.C. Memo. 1976-103, affd. without published opinion 573 F.2d 1285">573 F.2d 1285 (1st Cir. 1978) (construction wrongfully delayed by acts of a state agency). The decisions consistently hold that the time limits of section 1034 are uniformly applicable, and the courts are without authority to weigh the merits of the events precipitating delay to determine whether the time limits may be waived or extended. Henry v. Commissioner, supra.Petitioner asserts that (1) he was unable to meet the section 1034 requirements because a lien was placed on his bank account by respondent relating to the 1985 year, and (2) he intended to relocate to England. Respondent counters that petitioner has not complied with the section 1034 requirements and any actions on her part do not affect the statutory time for rollover. Although petitioner's purchase may have been affected by*473 respondent's lien, we are precluded from providing him with any relief. The rule is strict and "Extensions of section 1034(a)'s time limits are available only when a specific statutory provision so provides." Henry v. Commissioner, supra (citing Moore v. Townsend, 577 F.2d 424">577 F.2d 424, 428 n.7 (7th Cir. 1978)). The only evidence petitioner presented regarding relocation outside of the United States was his own self-serving testimony. Petitioner was not transferred to England, and he has continuously been living in the United States. To obtain the extension of time to purchase a replacement residence, he must comply with the statute by relocating outside the United States. Although petitioner may have planned to relocate to England, petitioner did not move to England. We conclude that the additional time provided by section 1034(k) does not apply. Since petitioner did not comply with the statute, he cannot defer the gain on the sale of his residence. Petitioner's final argument for not reporting the gain in 1989 is that the gain was reported on his Federal income tax return for 1990. Petitioner asserts that the proceeds*474 were deposited into an escrow account and were not distributed to him until January 1990. Respondent contends that the purported escrow deposit, pursuant to the letter dated November 28, 1989, from petitioner to the real estate agent, was at petitioner's request, and therefore the proceeds were properly includable in petitioner's 1989 income. Petitioner counters that the buyer wanted the proceeds put in escrow until petitioner vacated the house and until petitioner proved that there was no lien on the house as a result of the litigation with Coldwell. Generally, cash basis taxpayers, must include all items of income in the gross income for the taxable year in which actually or constructively received. Sec. 451(a); sec. 1.451-1(a), Income Tax Regs. "Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time". Sec. 1.451-2(a), Income Tax Regs. The doctrine of constructive receipt is not to be lightly applied but to be invoked only where the facts clearly justify the conclusion that the amount*475 alleged to have been constructively received is subject to the taxpayer's unfettered withdrawal and free demand although not actually reduced to possession. Dial v. Commissioner, 24 T.C. 117">24 T.C. 117, 123-124 (1955). The doctrine of constructive receipt has often been expressed to mean that "[a] taxpayer may not deliberately turn his back upon income and thus select the year for which he will report." Stone v. Commissioner, T.C. Memo. 1984-187 (quoting Hamilton National Bank v. Commissioner, 29 B.T.A. 63">29 B.T.A. 63, 67 (1933)). The doctrine of constructive receipt will not be invoked if funds are deposited into a bona fide escrow account pursuant to an agreement between the purchaser and seller of property. McLaughlin v. Commissioner, 113 F.2d 611 (7th Cir. 1940); Warren Jones Co. v. Commissioner, 60 T.C. 663">60 T.C. 663 (1973), revd. on other grounds 524 F.2d 788">524 F.2d 788 (9th Cir. 1975); Johnston v. Commissioner, 14 T.C. 560">14 T.C. 560 (1950). However, sale proceeds, or other income are constructively received when *476 available without restriction at the taxpayer's command; the fact that the taxpayer has arranged to have the sale proceeds paid to a third party and that the third party is, with taxpayer's agreement, not legally obligated to pay them to taxpayer until a later date, is immaterial. Harris v. Commissioner, 477 F.2d 812 (4th Cir. 1973) (citing Griffiths v. Commissioner, 308 U.S. 355">308 U.S. 355 (1939)), revg. 56 T.C. 1165">56 T.C. 1165 (1971). Petitioner provided no evidence of the purchaser's involvement with an escrow arrangement aside from petitioner's self-serving testimony. The only evidence pertaining to the matter is the letter from petitioner to the real estate agent. Neither the contract for sale nor the settlement, both executed after the letter, provides for, or refers to the purported escrow. Therefore petitioner's escrow argument is without merit. Based on the foregoing, we hold that the sale of petitioner's residence was taxable in 1989 and thus respondent's determination is sustained. Issue 2. Schedule C ExpensesPetitioner claims that the expenses reported on his Schedule C are allowable, albeit*477 improperly categorized and estimated in some respects. Petitioner testified that certain of his expenses relate to his contract with Coldwell but that he did not receive reimbursements for all his expenses. Respondent disallowed petitioner's expenses that could not be verified or substantiated. Respondent also asserts that to the extent the expenses relate to petitioner's contract with Coldwell, the expenses are not deductible because they were subject to reimbursement. To the extent the expenses relate to his business after his termination from Coldwell, respondent asserts that such expenses are not deductible by petitioner because they were not substantiated or, in the alternative, were incurred on behalf of his corporations. Respondent argues against the Court's estimating the amount petitioner is entitled to deduct since petitioner has not provided a means of making a reasonable estimate of expenses. We first address respondent's lack of substantiation argument. As we have noted in the past, taxpayers in each instance bear the burden of proving respondent is incorrect in her determinations. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933).*478 Moreover, deductions are a matter of legislative grace, and taxpayers bear the burden of proving that they are entitled to any deductions claimed. Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435 (1934). A taxpayer can deduct all the ordinary and necessary expenses paid during the year in carrying on any trade or business. Sec. 162(a). However, taxpayers are required to keep such records as the Secretary deems sufficient to show whether or not such taxpayer is liable for tax. Sec. 6001. A taxpayer is responsible for substantiating the amount of a deduction claimed, and if the taxpayer fails to do so, the Commissioner is justified in denying the deduction. Hradesky v. Commissioner, 65 T.C. 87">65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d 821">540 F.2d 821 (5th Cir. 1976). The mere fact that a taxpayer cannot prove the amount of an otherwise deductible item is ordinarily not fatal because we may, if convinced by the evidence, estimate the amount of deductible expenses incurred. Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (2d Cir. 1930) (known as the Cohan rule). The estimate*479 must, however, have some reasonable evidentiary basis. Vanicek v. Commissioner, 85 T.C. 731">85 T.C. 731, 743 (1985). The evidence must show that at least the estimated amount was actually spent or incurred for the stated purpose. Williams v. United States, 245 F.2d 559 (5th Cir. 1957); Swedelson v. Commissioner, T.C. Memo. 1991-10. And in making the estimate, the Court will closely scrutinize a taxpayer whose inexactitude is of his own making. Cohan v. Commissioner, supra; Manning v. Commissioner, T.C. Memo. 1993-127. Petitioner has not offered any evidence to prove that respondent's determination is incorrect. Furthermore, petitioner has not offered evidence proving payment; or if payment was made he has not offered evidence that adequately substantiates the expenses. Due to the lack of evidence in the record we are not capable of estimating any deductible amount. As we have said, the burden is on the petitioner to prove entitlement to claimed deductions. Rule 142(a); New Colonial Ice Co. v. Helvering, supra.*480 Petitioner's testimony, in the absence of corroborating documents, is insufficient to overcome respondent's determination that the deductions are improper. Based on our conclusion it is not necessary that we discuss respondent's alternative arguments. Accordingly, we sustain respondent's determination that petitioner's deductible expenses on Schedule C are limited to $ 4,756. Issue 3. Addition to TaxRespondent has determined an addition to tax under section 6662. Section 6662(b)(1) provides an addition to tax for negligence or disregard of rules or regulations. Negligence is defined as any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue laws, and the term disregard includes any careless, reckless, or intentional disregard of rules or regulations. Sec. 6662(c). The taxpayer has the burden of proving that the Commissioner's determination of the additions to tax is erroneous. Rule 142(a); Luman v. Commissioner, 79 T.C. 846">79 T.C. 846, 860-861 (1982); Bixby v. Commissioner, 58 T.C. 757 (1972). Petitioner presented no evidence to establish that he was not negligent or did not*481 disregard rules or regulations. Petitioner did not maintain records, as required by law and he failed to sustain his burden of proof on any of the issues. We hold that petitioner is liable for the addition to tax under section 6662. To reflect the foregoing, Decision will be entered for respondent.Footnotes1. Petitioner was originally represented by I. Jay Katz of Widener University School of Law Tax Clinic. (Entry of Appearance -- dated Sept. 14, 1993). Petitioner determined he did not require assistance of counsel, and the Court granted Mr. Katz's motion to withdraw on Nov. 24, 1993.↩2. All section references are to the Internal Revenue Code in effect for the taxable year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩3. The elimination of medical expense is an automatic adjustment due to the increase in petitioner's adjusted gross income. See sec. 213(a). The parties have stipulated to this fact.↩4. The increase to self-employment tax is an automatic adjustment due to the increase in petitioner's self-employment income resulting from the disallowance of certain expenses as discussed in issue (2). See secs. 1401-1403. The parties have stipulated this fact.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619473/ | Albert A. Lazisky and Elizabeth Lazisky, Petitioners v. Commissioner of Internal Revenue, Respondent; Magnolia Surf, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentLazisky v. CommissionerDocket Nos. 11004-76, 170-77United States Tax Court72 T.C. 495; 1979 U.S. Tax Ct. LEXIS 100; June 14, 1979, Filed *100 Decision will be entered under Rule 155 in docket No. 11004-76.Decision will be entered for respondent in docket No. 170-77. Allocation of purchase price between goodwill and covenant not to compete determined. "Strong-proof" doctrine applied. Harvey Radio Laboratories, Inc. v. Commissioner, 470 F.2d 118 (1st Cir. 1972). Word "order" for purposes of sec. 50(a)(2)(B), I.R.C. 1954, and the investment credit defined. Sec. 50(a)(2)(B) applied. Joseph C. Cortellino and Eugene D. Bernstein, for the petitioners in docket No. 11004-76.Charles Demakis, for the petitioner in docket No. 170-77.James A. Boyce, for the respondent. Sterrett, Judge. STERRETT*496 In a notice of deficiency dated October 4, 1976, respondent determined a deficiency in income taxes paid by petitioners Albert A. Lazisky and Elizabeth Lazisky, docket No. 11004-76, for their taxable year ended December 31, 1971, in the amount of $ 30,724.52. In a notice of deficiency dated October 4, 1976, respondent determined deficiencies in income taxes paid by petitioner Magnolia Surf, Inc., docket No. 170-77, for its taxable years ended March 31, 1972 and 1974, in the respective amounts of $ 8,113 and $ 2,517.75. After concessions *101 the only remaining issues for our decision are (1) the proper allocation of the sales price of a business between goodwill and a covenant not to compete, and (2) whether or not petitioner Magnolia Surf, Inc., is entitled to a certain investment tax credit. 1FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.Albert A. and Elizabeth Lazisky, petitioners in docket No. 11004-76, are husband and wife. They filed their joint Federal income tax return for their taxable year ended December 31, 1971, with the Director, Internal Revenue Service Center, Andover, Mass. At the time their petition was filed *102 herein, they resided in Manchester, Mass. Petitioners in docket No. 11004-76 shall be hereinafter referred to as the Laziskys. Petitioner Albert A. Lazisky shall be referred to as Lazisky.Magnolia Surf, Inc. (New Surf), petitioner in docket No. 170-77, is a corporation engaged in the restaurant business. New Surf was incorporated under the laws of the State of Massachusetts on March 11, 1971. At the time its petition herein was filed, New Surf's principle office was located in Manchester, Mass. New Surf filed its Federal income tax returns for its taxable years ended March 31, 1972, through March 31, 1974, with the *497 Director, Internal Revenue Service Center, Andover, Mass. At all times relevant hereto, all New Surf's issued and outstanding stock was owned by Christopher Sabanty (Sabanty).Magnolia Surf, Inc. (Old Surf), is a liquidated Massachusetts corporation which had engaged in the restaurant business, operating The Surf restaurant in Manchester, Mass. All Old Surf's issued and outstanding stock had been owned at all times relevant hereto by the Laziskys. The Laziskys had purchased The Surf restaurant in 1956 for $ 28,000. At that time the restaurant grossed approximately *103 $ 50,000 to $ 70,000 per year. By the time the Laziskys sold The Surf in 1971, it was grossing approximately $ 750,000 a year and could seat approximately 457 people. This growth was due to a combination of many factors: good food, service, prices, and atmosphere; a good location on the shore near two main highways leading to Gloucester, Mass.; and a well-known name. The Surf did very little advertising during Lazisky's tenure there, relying primarily on word of mouth to bring in customers.Ownership of The Surf's business and assets under the Laziskys was divided between Old Surf and the Laziskys. The Laziskys owned the land and buildings occupied by The Surf. Old Surf, in turn, owned all the remaining assets of the business including the intangible personal properties used in connection with the restaurant business: the name "The Surf" and the business and goodwill of the restaurant.During all The Surf's years of growth Lazisky worked, not only as president of the corporation, but also as a chef in the restaurant kitchen. In 1967 and again in 1969, at the ages of approximately 43 and 45, Lazisky had heart attacks. After his last heart attack, Lazisky was advised by his physician *104 to sell The Surf and retire from the restaurant business. Immediately after his release from the hospital following this last heart attack, Lazisky put The Surf up for sale. Serious negotiations between Lazisky and Sabanty for the sale of The Surf did not begin, however, until 1971.The negotiations leading up to the sale agreement were conducted in an informal manner. The prime concern of both Sabanty and Lazisky, who represented both himself and Old Surf, was to establish an agreed upon sales price. This they set at $ 427,000. Having done this, the two principals turned the detail work of finalizing the agreement over to their respective *498 attorneys and other representatives. At no time during these negotiations did either principal discuss the allocation of any of the sales price to the covenant not to compete.The product of all these negotiations was the Purchase and Sale Agreement (agreement) entered into by the parties on February 24, 1971. The agreement was between Old Surf, the Laziskys, and Sabanty. In it Sabanty agreed to purchase all the assets of Old Surf, plus the real estate owned by the Laziskys. Part 1 of the agreement said in relevant part:1. Sale *105 of Certain Assets: The SELLERS agree to sell and the BUYER agrees to buy the following:(a) REAL ESTATE: The land with the buildings thereon belonging to the said Albert A. Lazisky and Elizabeth Lazisky * * *.(b) PERSONAL PROPERTY: All tangible property now owned by MAGNOLIA SURF, INC. and used or usable in connection with said restaurant * * *.(c) The BUYER shall be given all rights of the SELLERS in and to the use of the name, THE SURF, and its business and Good-Will.Included in the list of assets sold to Sabanty were all Old Surf's customer lists and lists of reservations, employee lists, and all relevant licenses.Part 3 of the agreement was labeled "PURCHASE PRICE." In this part Sabanty agreed to pay the sellers as follows: (1) $ 20,000 upon signing the agreement; (2) $ 347,000 upon delivery of the appropriate deed and bill of sale; and (3) $ 60,000 by way of a note from Sabanty bearing 9.5-percent interest payable with 5 years in monthly installments of $ 1,260.20, secured by a mortgage on the real estate and a chattel mortgage on the personalty transferred under the agreement. Part 3 of the agreement also contained a comminution of the sales prices as follows:(4) Said sum [the *106 total sales price] represents the aggregate of the sums to be paid for the properties to be conveyed and transferred as follows:Real Estate$ 175,000Furniture, fixtures and equipment170,000Inventory15,000Name, business and Good-Will67,0002 427,000*499 Part 5 of the agreement, entitled "COVENANTS OF SELLERS," provided as follows:(c) The Bill of Sale to be delivered at the closing will contain the restrictive covenant by which the said Albert A. Lazisky and Elizabeth Lazisky will agree to the following:(1) Not to engage in the restaurant business, either directly or indirectly, as owners, partners, stockholders, employees, or otherwise for a period of five (5) years within a radius of twenty (20) miles from the location of the present "THE SURF" * * *Finally, part 14 of the agreement contained an agreement between the parties under which Sabanty agreed to employ both Laziskys at $ 200 per person per week from the closing date until June 1, 1971. The Laziskys in turn agreed to "assist the BUYER to June 1, 1971 by remaining in their present posts and performing their present *107 duties * * * it being understood that the said Albert A. Lazisky is in poor health and is unable to work a full day."A copy of the bill of sale, dated April 1, 1971, was included in the record. The bill of sale incorporated the agreement's covenant not to compete by reference. Old Surf was liquidated and all its assets distributed to the Laziskys within the calendar year 1971. At no time have the Laziskys included any amount in their income as consideration received in exchange for their covenant not to compete.The agreement anticipated that Sabanty would form at least one new corporation to be named Magnolia Surf, Inc. (New Surf). In fact two new Massachusetts corporations were subsequently formed, i.e., New Surf and Sabanty Realty Corp. Both these entities were incorporated in March of 1971 with Sabanty being the sole stockholder of each. Sabanty Realty Corp. was formed to hold the real estate purchased from the Laziskys. New Surf was formed to hold the restaurant business itself. On both its returns for its taxable years ended March 31, 1972 and 1974, New Surf allocated $ 65,000 of the $ 67,000 Sabanty paid for Old Surf's "Name, business and Good-Will" to the Laziskys' covenant *108 not to compete. Amortizing this $ 65,000 over the covenant's 5-year useful life, New Surf deducted $ 13,000 in its taxable year ended March 31, 1972, and $ 12,799.92 in its taxable year ended March 31, 1974. The Laziskys have conceded respondent's determination that if the $ 65,000 was not ordinary income to *500 them, it was includable in their income as a distribution in liquidation of Old Surf.In January 1975, Sabanty and his attorneys approached Lazisky to request his consent to the correction of a so-called "mistake" in the agreement with respect to how the covenant not to compete was treated. Lazisky refused to alter the agreement because, in his view, it already reflected his intention with respect to the treatment of the covenant.OPINIONThis is another in a long line of cases involving the proper allocation of a business' sales price between goodwill and a covenant not to compete. The tax stakes are obvious and well settled. If an amount is paid for a covenant not to compete, then the payment generates an intangible asset of value to the covenantee in his business for a definitely fixed period of time. Such an asset is clearly amortizable over its life. Sec. 1.167(a)-3, Income Tax Regs.*109 The covenantor, on the other hand, is deemed to have received an amount in respect of his agreement not to perform services -- which is ordinary income includable in his income upon receipt.Goodwill is a capital asset which, conventional wisdom tells us, does not waste. Thus, its purchase is a nonamortizable capital investment and its sale generates capital gain.This simple statement of the law belies the great body of litigation revolving around the question of whether, in any particular case, a proper, or at least tax-enforceable, allocation between a covenant not to compete (covenant) and goodwill has been made. The reports are replete with cases in which one or both parties have resorted to the courts in their effort to be held to a contract other than the one they made, or prove the contract that they would have made had they thought of it.The courts have reacted in a predictable fashion to this flood of litigation. Pulled in opposite directions by two powerful axioms of law, (1) that a person should be free to contract and that, once made, contracts should be enforced as made (absent certain enumerated exceptions), and (2) that in the tax law, substance must prevail over form, *110 the courts have tended to base their decisions on theories incorporating elements of both these principles. Equally predictable has been the distribution of opinions along a continuum according to the emphasis given any *501 one of these principles in the various jurisdictions. Thus, the so-called "Danielson rule" of the Third Circuit tends to emphasize form. Yet the rule in that circuit also provides for the court's right to look to the substance of the transaction in certain situations:a party can challenge the tax consequences of his agreement as construed by the Commissioner only by adducing proof which in an action between the parties to the agreement would be admissible to alter that construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc. [Commissioner v. Danielson, 378 F.2d 771">378 F.2d 771, 775 (3d Cir. 1967).]On the other side of the continuum are such cases as Wilson Athletic Goods Mfg. Co. v. Commissioner, 222 F.2d 355 (7th Cir. 1955). In that case the parties had failed to provide a specific allocation of part of the purchase price to the covenants -- which clearly possessed some value. The Seventh Circuit, using purely substance over form *111 reasoning, reversed our holding that the covenant was nonseverable from the goodwill and that, therefore, no amortizable deduction was allowable saying:But in tax matters we are not bound by the strict terms of the agreement; we must examine the circumstances to determine the actualities and may sustain or disregard the effect of a written provision or of an omission of a provision, if to do so best serves the purpose of the tax statute. * * * Therefore, it was the duty of the tax court and is our duty here to ascertain the true intent, insofar as tax consequences are concerned. Consequently, it is immaterial whether the contract did or did not define a specified amount as the value of the covenant. * * * In view of the silence of the contract in this respect, it became necessary to determine then from the other evidence whether the covenant had a value, and if so the amount thereof. Where realistically and actually the covenant has a discernible value, the purchaser, of course, may amortize the price paid for it and claim annual deductions pro rata during the life of the covenant. [Wilson Athletic Goods Mfg. Co. v. Commissioner, supra at 357.]The rule in this Court has tended to *112 fall somewhat between rules of these two cases. In general we prefer to apply the so-called "strong-proof" rule -- or more precisely the "economic significance" or "economic reality" version of strong proof as that rule is stated in the oft-cited case of Schulz v. Commissioner, 294 F.2d 52">294 F.2d 52, 55 (9th Cir. 1961), affg. 34 T.C. 235">34 T.C. 235 (1960):we think that the covenant must have some independent basis in fact or some arguable relationship with business reality such that reasonable men, genuinely concerned with their economic future, might bargain for such an agreement. [Schulz v. Commissioner, 294 F.2d at 55.]Our test is designed to (1) produce predictability (and therefore *502 reduce litigation) by generally enforcing agreements as made, and (2) assure at the same time that the Court is not hamstrung into enforcing obviously substanceless allocations.The First Circuit, to which an appeal in this case would normally lie, has adopted its own version of "strong proof." See Leslie S. Ray Insurance Agency, Inc. v. United States, 463 F.2d 210">463 F.2d 210 (1st Cir. 1972); Harvey Radio Laboratories, Inc. v. Commissioner, 470 F.2d 118">470 F.2d 118 (1st Cir. 1972), affg. a Memorandum Opinion of this Court. 3 In Harvey Radio*113 the First Circuit explained its version of strong proof as follows:our belief is that the "economic reality" rule is not appropriate, and that Leslie Ray states the correct test. Leslie Ray states a rule of intention. If the parties to a sale have affirmatively agreed to an allocation, they should not be able to state, later, to the Commissioner, that their agreement was meaningless. [Harvey Radio Laboratories, Inc. v. Commissioner, supra at 119-120.]We have bound ourselves to apply this "rule of intention" to the case before us. Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742, 757 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971).We interpret the First Circuit's strong-proof/intent rule as leaning more heavily on form than does our economic significance standard, but not so much as the Third Circuit's Danielson rule. We believe that the First Circuit would ask only whether the agreement as drawn truly represented the intention of the parties at the time it was signed -- not whether that intention itself conforms with "economic reality." 4 This standard is very close to the Danielson standard because the primary ways in which *114 a party can challenge his intent with respect to a sales agreement is to plead fraud, undue influence, duress, or mutual mistake -- all contract defenses that go to the original existence of a contractual intent. On the facts before us we have no difficulty in concluding that the parties intended to make exactly the agreement they did and no other. We conclude, therefore, that New Surf has failed to adduce strong proof that the parties' intent was other than is shown in their agreement. Our conclusion does not mean that we believe that the covenant was not bargained for or that it had no value. We hold rather that within the First Circuit, these other factors are not determinative in our inquiry with respect to *503 intent. We hold that it was the intent of the parties to the agreement to allocate none of the purchase price to the covenant.In this connection we believe the following facts are important. First, the $ 67,000 at issue herein was paid to the corporation, not to the Laziskys. The amount was paid for the corporation's "Name, business and Good-Will." Since the money was paid to the corporation it must have been paid for something *115 the corporation owned. The corporation did not own a right to Lazisky's services for 5 years into the future. In this connection we reject New Surf's request that we interpret "business" to include the Laziskys' covenant not to compete. We read "business" to be in para materia with "name" and "goodwill." We believe that when the parties used the word "business" in conjunction with "name" and "goodwill" they were referring to The Surf's going-concern value. Going-concern value is, of course, a valuable property right.Second, we note that all parties were represented by experienced counsel. Presumably counsel would have allocated part of the purchase price to the covenant if they so intended. Yet, they did not. Instead, they inserted what New Surf has emphasized was a long and detailed covenant into a part of the agreement totally separate from the asset allocation sections.Third, we note the importance attached to the covenant by the purchaser. At the trial herein, Sabanty testified that he would not have purchased The Surf if he had not received Lazisky's covenant not to compete. Obviously an element so important to the purchaser would not be haphazardly dealt with in the purchase *116 contract.Fourth, we find of some importance the fact that it was Sabanty's attorneys who contacted Lazisky after the last payment on Sabanty's $ 60,000 note was made, over 5 years after the purchase date, to ask Lazisky for his consent to an amendment to the agreement allocating part of the purchase price to the covenant. Obviously such a move would not have been necessary if Sabanty had believed the contract already made such an allocation.Finally, and most importantly, we note that there was never any discussion about allocating any part of the purchase price to the covenant not to compete and that the agreement itself assigns no value to the covenant. These considerations lead us *504 almost necessarily to the conclusion that no such allocation was intended. See Annabelle Candy Co. v. Commissioner, 314 F.2d 1">314 F.2d 1, 7 (9th Cir. 1962).In sum, we hold that New Surf has failed to show by strong proof that the parties intended any allocation other than that contained in the agreement itself. At best, the evidence shows that the parties had no intention at all with respect to the allocation of any of the purchase price to the covenant. In either case, the contract must be enforced as made. *117 We find that none of the $ 67,000 paid for "Name, business and Good-Will" was paid for the covenant. 5 The final issue with which we must deal involves New Surf's claimed investment credit. This claim is based on its purchase from Old Surf of all that corporation's "furniture, fixtures and equipment" to which the agreement allocated $ 170,000. New Surf alleges, and respondent concedes, that all the personalty purchased had remaining useful lives of 7 years as of the purchase date. New Surf's "qualified investment" in the personalty is, therefore, equal to 100 percent of the property's cost (sec. 46(c)(1)(B) and (c)(2)), subject to the $ 50,000 limitation contained in section 48(c)(1). New Surf's claimed investment tax credit is, thus, 7 percent of $ 50,000. Sec. 46(a)(1).The controversy with respect to the investment issues relates to provisions of section 50(a)(2), and primarily the proper interpretation of the word "order" as it was used in section 50: SEC. 50. RESTORATION OF CREDIT.(a) General Rule. -- *118 Section 49(a) (relating to termination of credit) shall not apply to property --* * * * (2) which is acquired by the taxpayer --* * * *(B) after March 31, 1971, and before August 16, 1971, pursuant to an order which the taxpayer establishes was placed after March 31, 1971.Preliminarily, New Surf argues, and respondent concedes, that its section 50 "acquisition" of the personalty occurred after March 31, 1971, i.e., that acquisition occurred on April 1, 1971, when the bill of sale was delivered and title to the personalty transferred. New Surf then goes on to argue that there was no "order" for the goods before March 31, 1971, because neither it nor Sabanty, its predecessor in interest, had made "an outright *505 commitment to purchase the asset" on or before that date and an "order" requires such a commitment. Armed with this definition of "order," New Surf goes on to argue that the agreement of February 24, 1971, i.e., the only other writing executed before March 31, 1971, was not an "order" because it was subject to several conditions, such as Sabanty's obtaining adequate mortgage financing. Implicit in New Surf's argument is the claim that no "order" is necessary to the successful *119 application of section 50(a)(2)(B). In New Surf's view, section 50(a)(2)(B) requires only that if an order was placed, it must have been placed after March 31, 1971.Respondent argues that the requirements of section 50(a)(2)(B) are twofold: (1) That an "order" be placed for the goods after March 31, 1971, and (2) that the acquisition of the goods occur after the "order" and before August 16, 1971. He then goes on to argue that the word "order" as used in section 50 was used in its normal commercial sense to mean "offer." Since the agreement of February 24, 1971, was not an offer but a contract of sale, the "offer" required by section 50(a)(2)(B) must have occurred before February 24, 1971. Thus, petitioner's claim must fail.We agree with respondent. While the word "order" is not defined in section 50 or its regulations, we do not believe that Congress intended any meaning for that word other than that ascribed to it in normal commercial practice. Thus, an "order" is something in the nature of an offer which may be accepted in the several ways described in article 2 of the Uniform Commercial Code. See U.C.C. sec. 2-206(1)(b); see also Menendez v. Faber, Coe & Gregg, Inc., 345 F. Supp. 527">345 F. Supp. 527, 563 (S.D. N.Y. 1972), *120 modified on other grounds sub nom. Menendez v. Saks & Co., 485 F.2d 1355">485 F.2d 1355 (2d Cir. 1973), revd. sub nom. Alfred Dunhill of London, Inc. v. Republic of Cuba, et al., 425 U.S. 682">425 U.S. 682 (1976). The agreement of February 24, 1971, was certainly more than an "offer." It was an actual contract subject to certain conditions subsequent which conditions did not, of course, invalidate the contract itself. Since the goods at issue were acquired on April 1, 1971, pursuant to a contract made on February 24, 1971, *506 it is reasonable to assume that the "order," therefore, must have been placed before March 31, 1971.Decision will be entered under Rule 155 in docket No. 11004-76.Decision will be entered for respondent in docket No. 170-77. Footnotes1. We note that petitioners in docket No. 11004-76 have not contested any of respondent's proposed adjustments as enumerated in his statutory notice of deficiency except those relating to the question of whether or not they had received $ 65,000 as ordinary income in respect of the covenant not to compete. Petitioners in docket No. 11004-76 are, therefore, deemed to have conceded these other adjustments to the extent that they do not involve the covenant not to compete issue.↩2. This $ 427,000 figure does not include any amount with respect to Old Surf's inventory of food, liquors, and supplies.↩3. Harvey Radio Laboratories, Inc. v. Commissioner, T.C. Memo. 1972-85↩.4. See Danehy v. Commissioner, T.C. Memo. 1974-281↩.5. For cases reaching the same conclusion on similar facts see Lucas v. Commissioner, 58 T.C. 1022">58 T.C. 1022 (1972); Rich Hill Insurance Agency, Inc. v. Commissioner, 58 T.C. 610↩ (1972). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619474/ | DANIEL J. CRADY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCrady v. CommissionerDocket No. 25705-84.United States Tax CourtT.C. Memo 1987-274; 1987 Tax Ct. Memo LEXIS 274; 53 T.C.M. (CCH) 971; T.C.M. (RIA) 87274; June 2, 1987. Daniel J. Crady, pro se. James A. Nelson, for the respondent. SHIELDSMEMORANDUM OPINION SHIELDS, Judge: Respondent determined deficiencies in and additions*275 to petitioner's income taxes as follows: Additions to taxSectionsectionSectionYearDeficiency6651(a)(1) 16653(a)(1), (2) 26654(a)1980$6,708$1,054$335$228 19813,144786$157 plus 50%243of interest onunderpayment of$3,144198224,9445,716$1,247 plus 50%2,176of interest onunderpayment of$24,944After concessions, the issues in this fully stipulated case are (1) whether petitioner has an overpayment of $1,982 within the meaning of section 6511 and section 6512 for the year 1980, and (2) whether respondent properly determined that there are additions to tax due from petitioner under sections 6651(a)(1), 6653(a)(1) and (2), and 6654(a) for the years in issue. The stipulation of facts and exhibits associated*276 therewith are incorporated herein by reference. Petitioner resided in Anchorage, Alaska at the time he filed his petition. For each of the years 1980, 1981 and 1982, petitioner filed a Porth-type income tax return in which he set forth Fifth Amendment arguments and did not supply sufficient information from which his income tax liability could be computed. After filing the returns, petitioner failed or refused to cooperate with respondent's agents in their attempts to determine his correct tax liability. Consequently, on May 7, 1984, respondent mailed the notice of deficiency from which petitioner filed his timely petition. Thereafter, petitioner supplied one of respondent's appeals officers with his books and records and with these the parties have computed and agree that his correct income tax liabilities for the years in issue are as follows: YearIncome Tax1980$55319814,335198211,209The parties further agree that for 1980 the total income tax withheld from petitioner's wages exceeded his correct income tax liability by $1,982 (withholding tax totaling $2,535 less his correct tax liability of $553). Both parties also realize that in a proceeding*277 before this Court an overpayment cannot be determined unless a timely claim for the refund of the overpayment had been filed or could have been filed under section 6511 at the time the deficiency notice was mailed to the taxpayer by respondent. Section 6512(b)(2)(B) and (C). Petitioner, however, contends that his 1980 Porth-type return which was timely filed constituted a valid return and, therefore, we should determine that he is entitled to an overpayment. Respondent contends that petitioner's return for 1980 did not constitute a valid return and, consequently, under section 6511(a) no claim for refund had been filed or could have been filed on May 7, 1984, the date of the deficiency notice, because that date was more than two years after April 15, 1981, the last date for filing the 1980 return. Section 6511(a), (b)(2)(B) and (C). 3Unfortunately for misguided taxpayers such as petitioner in this case a return which merely raises Fifth Amendment assertions and does not supply sufficient information from which the taxpayer's tax can be computed, does not constitute a valid income tax return. Edwards v. Commissioner,680 F.2d 1268">680 F.2d 1268 (9th Cir. 1982);*278 United States v. Klee,494 F.2d 394">494 F.2d 394 (9th Cir. 1974), cert. denied 419 U.S 835 (1974); United States v. Porth,426 F.2d 519">426 F.2d 519 (10th Cir. 1970), cert. denied 400 U.S. 824">400 U.S. 824 (1970). Consequently, the recovery of his 1980 overpayment is barred. Respondent determined that petitioner is liable under sections 6651(a)(1), 6653(a)(1) and (2) and 6654(a) for additions to tax for failure to file a timely return, negligence, and underpayment of estimated tax, respectively. Petitioner has the burden of proof on this issue. Benn v. Commissioner,366 F.2d 778">366 F.2d 778 (5th Cir. 1966), affg. a Memorandum Opinion of this Court, cert. denied 389 U.S. 833">389 U.S. 833 (1967); Neubecker v. Commissioner,65 T.C. 577">65 T.C. 577, 586 (1975); Enoch v. Commissioner,57 T.C. 781">57 T.C. 781, 802 (1972). On brief he has conceded liability for the addition to tax under section 6654(a) but argues with respect to the other additions that he filed valid income tax returns. As previously stated, a Porth-type return is no return at all. Furthermore, the "refusal to file any return at all has never been protectable by a taxpayer's privilege*279 against self-incrimination," [United States v. Carlson,617 F.2d 518">617 F.2d 518, 523 (9th Cir. 1980), cert. denied 449 U.S. 1010">449 U.S. 1010 (1980)] and "[m]erely relying upon [his] own uninformed beliefs that [he was] excused from answering such questions is clearly insufficient to constitute reasonable cause for failure to file." Thompson v. Commissioner,78 T.C. 558">78 T.C. 558, 563 (1982). On this record we are unable to find that petitioner has established reasonable cause for failing to file timely valid returns or that his conduct with respect to his tax liabilities did not constitute negligence. Respondent's determinations with respect to the additions to tax are sustained. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect during the years in issue, unless otherwise indicated. All rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise provided. ↩2. Section 6653(a)(2) provides for an additional 50 percent of the interest due on the underpayment due to negligence.↩3. See also Nason v. Commissioner,T.C. Memo. 1984-534↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619476/ | NORTHWEST LUMBER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Northwest Lumber Co. v. CommissionerDocket Nos. 10650, 15310.United States Board of Tax Appeals9 B.T.A. 1111; 1928 BTA LEXIS 4295; January 9, 1928, Promulgated *4295 Average unit value of petitioner's interest in standing timber at March 1, 1913, determined for depletion purposes. John E. Hughes, Esq., Forrest E. Ferguson, Esq., and E. J. Miner, Esq., for the petitioner. Granville S. Borden, Esq., for the respondent. LANSDON *1111 In this proceeding petitioner seeks a redetermination of the income and profits taxes for the years 1919 to 1921, inclusive, for which the Commissioner has determined deficiencies of $9,350.63, $33,337.85, and $1,410.88, respectively. The petitioner alleges error on the part of the Commissioner: (1) In determining inadequate amounts for depreciation and obsolescence; (2) In determining inadequate amounts as deductions for depletion of standing timber; (3) In increasing net income in the year 1919 by $1,253.90 by disallowing said amount as a deduction for bad debts; and (4) In disallowing a portion of the loss claimed on a sale of sawmill machinery in the year 1920. In accordance with a stipulation of the parties which the Board accepts, issues (1), (3), and (4) have been settled by the following determinations: *1112 (1) The deduction for depreciation*4296 of railroad equipment for the years in question is as follows: 1919$62,842.04192085,723.08192141,135.14These deductions are computed on a unit rate of $2,245 per thousand feet of timber cut during each of the respective years. The basis for computing the rate is the economic life of the railway construction. (2) The determination of depreciation and obsolescence on all other items as determined by the Commissioner is correct. (3) The amount of $1,253.90 was incorrectly added to the petitioner's net income and is an allowable deduction therefrom. (4) The loss sustained on the sale of sawmill machinery in the year 1920, as determined by the Commissioner, is correct. FINDINGS OF FACT. The petitioner is a State of Washington corporation, with its principal office at Seattle. Its business is the ownership of timber and timber lands and the manufacture and marketing of the products thereof. In 1907 the petitioner purchased certain lands, timber, timber rights and plant and equipment for a consideration of $2,000,000, payable as follows: $1,200,000 cash; $405,451.53 notes with 6 per cent interest; $300,000 cash; $94,548.47 payable without interest*4297 as timber is cut. Of this amount, $50,000 was allocated to the sawmill and other personal property. At the time of purchase a cruise of the standing timber in which petitioner acquired an interest showed a quantity of 663,839,000 feet. Between that date and March 1, 1913, there was cut from the property 89,591,000 feet, and it was determined from the experience gained in cutting this timber that there remained merchantable timber uncut at March 1, 1913, amounting to 388,654,000 feet. From March 1, 1913, the amount of timber cut each year was as follows: Feet191316,657,0001914502,0001915none191615,463,00019179,471,000191823,317,000191927,992,000192038,184,000192118,323,000192244,068,000192341,147,000192441,347,000192533,099,000192623,433,000All the property acquired by the petitioner and owned by it at March 1, 1913, was located in the County of King, State of Washington, about 35 miles from the City of Seattle, and was traversed by *1113 the main line of the Northern Pacific Railway. It consisted of the fee of 960 acres of lands, the right to cut and remove timber from 1,680 acres of land in*4298 conformity with contracts acquired from the vendor, and the right to cut and remove the timber from 6,480 acres of land owned by the Northern Pacific Railway. The topography of the terrain involved is normal for the Cascade mountain country. The stand of timber averaged between 70,000 and 80,000 board measure feet per acre, which is about double the average stand of similar timber on other lands tributary to the Puget Sound market. By the terms of the contract under which the petitioner acquired the right to all the merchantable timber from 6,480 acres of land owned by the Northern Pacific Railway it agreed to pay 70 cents per thousand feet as this timber was cut and further agreed to deliver to the railroad company for transportation at least 20,000,000 feet of logs or the manufactured product thereof each year until all of the merchantable timber had been removed from the railroad company's lands and the lands of the petitioner tributary to the railroad, and also agreed to ship all tools, materials, and supplies required by it and all manufactured products over the lines of the railroad company and pay freight at the regular tariff rates of the railroad company. The railroad*4299 company agreed to ship all logs cut by the petitioner from the lands owned by the railroad company or from its own lands or the lands of the Northwestern Improvement Co. from certain specified points to Seattle or Tacoma, at a charge of $1.50 per thousand feet board measure. At March 1, 1913, the petitioner's timber averaged 62 per cent fir, 18 per cent cedar, 4 per cent spruce and 16 per cent hemlock. Fir, cedar, and spruce are considerably more valuable than hemlock. The fir, cedar, and spruce owned by the petitioner was of higher quality than that on any other land tributary to the Puget Sound market and logs produced therefrom sold readily on such market at premiums that averaged $2 per 1,000 board measure feet. About 75 per cent of the logs produced cut into clear grade of timber. The price of timber on the Puget Sound market averages not less than $1 per 1,000 board measure feet above prices for similar timber sold in the Columbia River market. Between the date of acquisition and March 1, 1913, the timber here involved increased in average value from 50 to 75 cents per 1,000 board measure feet. The average value of the several species of standing timber in question at*4300 March 1, 1913, was $4.75 per 1,000 board measure feet and the average value of the petitioner's interest therein was $4.15 per 1,000 board measure feet. OPINION LANSDON: Issues 1, 3, and 4, as set forth in our preliminary statement, having been settled by a stipulation of the parties which we *1114 have accepted, the only matter left for our consideration is the correct amount of annual deductions from its gross income for each of the taxable years to which the petitioner is entitled for depletion of its timber reserves due to its annual logging operations. The parties have stipulated the quantities of timber cut in each of the taxable years and it remains only for us to determine the basis for the computation of depletion for each of such years. The respondent and petitioner are in substantial agreement that the timber lands and timber rights in question were acquired in 1907 at a cost of $1,950,000, the mill and other depreciable assets at a cost of $50,000, and that the land so acquired had no value. The respondent determined the deficiencies here in controversy on the basis of a value at March 1, 1913, which is less than cost and in support of such action relies*4301 on the provisions of section 234(a)(9) of the Revenue Acts of 1918 and 1921, which are as follow: (a) That in computing the net income of a corporation subject to the tax imposed by section 230 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 improvements, according to the peculiar conditions in each case, based upon cost including cost of development not otherwise deducted: Provided, That in the case of such properties acquired prior to March 1, 1913, the fair market value of the property (or the taxpayer's interest therein) on that date shall be taken in lieu of cost up to that date: * * * The petitioner contends, first, that the market value of its timber at March 1, 1913, was greater than cost, and, second, that if we should find that the value at the basic date was less than cost, it is entitled to have its annual depletion deductions determined on the basis of cost. We shall first consider the petitioner's contention that at March 1, 1913, the average unit value of its timber was in excess of the cost thereof. In support of its*4302 contention of value greater than cost the petitioner adduced evidence upon which we have found as fact that its timber was of a higher quality than the average in the Puget Sound district; that logs produced therefrom sold at premiums that averaged $2 per 1,000 board measure feet; that it was located on the main line of a railway and was distant only 35 miles from market; that the timber stand per acre averaged nearly double that of the district tributary to the Puget Sound market; that all but 16 per cent of the timber stand consisted of the most valuable species found in that territory; that about 75 per cent of the fir, spruce and cedar cut into the better grades of lumber; that the prices for the products of the petitioner averaged $1 more per 1,000 board measure feet on the Puget Sound lumber market than were paid for similar grades of lumber in the *1115 Columbia River market; and that between 1907 and 1913 stumpage in the Puget Sound district increased in value from 50 to 75 cents per 1,000 board measure feet. In further support of its contention, the petitioner introduced a number of experienced lumber and timber operators as expert witnesses. All were familiar with*4303 lumbering conditions in the State of Washington, well acquainted with the tract and timber in question and conversant with the processes of logging, manufacturing and marketing timber. The expert opinions of value of the petioner's timber at March 1, 1913, varied from $4.75 to $5.25 per 1,000 board measure feet. The respondent proved some sales of alleged similar timber lands at prices that support his contention of an average unit value of $3.25 at March 1, 1913. Upon cross-examination it appeared, however, that such sales were of small and isolated tracts and that the prices obtained were not a fair measure of the value of large timber areas easily accessible for logging and located on lines of transportation to nearby markets. In his brief, counsel for the respondent calls attention to the weakness of opinion evidence, although it is obvious that his determination of these deficiencies and the record that he made at the hearing rest almost entirely on such evidence. A careful study of all the evidence adduced by the parties convinces us that the petitioner has sustained the burden of proving that the average unit value of the standing timber in which it owned an interest*4304 at March 1, 1913, was greater than cost and was $4.75 per 1,000 board measure feet. Inasmuch as the record discloses that approximately 72 per cent of such timber was subject to a royalty charge of 70 cents per 1,000 board measure feet, it is obvious that the total value and the corresponding unit value of all the timber in question must be reduced by the amount of such royalty charge before the value of the petitioner's interest therein can be ascertained. The evidence shows that the petitioner owned 960 acres of the tract in question in fee, the right to cut and remove without further payment all the timber on 1.680 acres owned by various persons, and the right to cut and remove all the timber on 6,840 acres owned by the Northern Pacific Railway subject to a royalty charge of 70 cents per 1,000 board measure feet. It is also established by proof that the average stand of timber throughout the tract was uniform. We conclude that the royalty due the Northern Pacific Railway for cutting the timber on its lands, if applied to the entire tract, would result in an average charge of 60 cents per 1,000 board measure feet. We are of the opinion, therefore, that the average unit value*4305 of the petitioner's interest in the standing timber in question at March 1, 1913, was $4.15 per 1,000 board measure feet, which we hold is a reasonable basis for the computation of the annual deduction from gross income *1116 to which the petitioner is entitled on account of depletion. Cf. ; . In addition to the royalty charge of 70 cents per 1,000 board measure feet, the Northern Pacific contract imposes a considerable body of obligations on each of the parties thereto. We assume that their reciprocal undertakings were mutually advantageous and so have no bearing on the value of the timber. Since the parties are in substantial agreement that the land owned by the petitioner has no market value after the removal of the timber we do not regard such land as a factor in determining the reasonable deductions for depletion to which the petitioner is entitled. A part of the purchase price of the property in the amount of $94,548.47 was payable without interest as the timber was cut. We regard this amount as part of the original capital investment and not as a royalty*4306 charge. It is not a factor in the determination of the value of the petitioner's interest in the standing timber at March 1, 1913. Having decided that the March 1, 1913, value of the petitioner's interest in the standing timber was greater than cost thereof, it is not necessary to decide the question of law upon which the parties disagree. Judgment will be entered on 20 days' notice, under Rule 50.Considered by STERNHAGEN, GREEN, and ARUNDELL. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619478/ | LOUIS R. GRILLIOT AND KATHLEEN M. GRILLIOT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentGrilliot v. CommissionerDocket No. 10411-80.United States Tax CourtT.C. Memo 1981-100; 1981 Tax Ct. Memo LEXIS 643; 41 T.C.M. (CCH) 1045; T.C.M. (RIA) 81100; March 3, 1981. Louis R. Grilliot and Kathleen M. Grilliot, pro se. Jane T. Dickinson and Christina Burkholder, for the respondent. DAWSONMEMORANDUM OPINION DAWSON, Judge:*644 This case was assigned to Speical Trial Judge Francis J. Cantrel for the purpose of conducting the hearing and ruling on respondent's motion for summary judgment filed herein. After a review of the record, we agree with and adopt his opinion which is set forth below. 1OPINION OF THE SPECIAL TRIAL JUDGE CANTREL, Special Trial Judge: This case is presently before the Court on respondent's motion for summary judgment filed on December 31, 1980, pursuant to Rule 121, Tax Court Rules of Practice and Procedure.2*645 Respondent, in his notice of deficiency issued to petitioners on April 4, 1980, has determined the following deficiency in, and addition to, petitioners' 1976 Federal income tax: Addition to Tax, 1954 CodeDeficiencySection 6653(a)$ 696.04$ 34.80Petitioners' address on the date they filed their petition herein was R.R. 2, Box 580, Melrose, Florida. They timely filed a joint 1976 Federal income tax return with the Internal Revenue Service Center at Cincinnati, Ohio. On that return petitioners claimed deductions for "depreciated" Federal reserve notes, which respondent has disallowed. In paragraph 4 of the petition it is alleged that respondent erred in his determination of the tax set forth in his notice of deficiency for the following reasons: (a) The determination was willful, wanton, malicious, and intentional, all in violation of petitioners' rights secured by the U.S. Constitution, the Declaration of Independence, the Magna Carta, the Northwest Ordinnance, and the common law. (b) The disallowance of expenses in excess of income is arbitrary and a direct result of the agent's malice, incompetence, ignorance, and prejudice against petitioners. *646 (c) Petitioners did not earn sufficient income in "dollars" to warrant the amounts determined by respondent. (d) The statute of limitations is a complete defense as to any tax or penalties for any year over six years old. (e) Affirmative defenses asserted by petitioners are, namely, the statute of frauds, laches, estoppel, waiver, failure of jurisdiction over petitioners and the subject matter, accord and satisfaction, and reliance on prior notifications of the I.R.S. stating "No Tax Due". Proceeding on to paragraph 5 of the petition, we are advised of the facts upon which petitioners rely to sustain their allegations of error described above. They are: (1) Petitioners do not waive their constitutional rights guaranteed by Article 1 of the U.S. Constitution, as more fully set forth in the Bill of Rights and, further, those rights will not be waived in order to be in obedience to unconstitutional administrative laws, rules, a number of statutory provisions and "the entire Internal Revenue Code and others". (2) Doctrines derived from various enumerated statutes are completely unconstitutional and, thus, violate petitioners' constitutional rights under the First, *647 Fourth, Fifth, Sixth, Seventh, Eighth, Ninth, Tenth, and Thirteenth Amendments to the U.S. Constitution. (3) Petitioners' claims are based upon he Bible, the U.S. Constitution, the Bill of Rights, the Declaration of Independence, the Magna Carta, the Northwest Ordinance, the Constitution of the state of Florida, the common law, the Declaration of Resolves, the Federalist Papers, the Mayflower Compact, the Articles of Confederation of 1778, and the Declaration of Rights of 1765 and 1774. (4) Respondent has the burden of proof with respect to the adjustments in the notice of deficiency. (5) Respondent and/or his agents have violated the Administrative Procedure Act and section 7214. (6) Petitioners are entitled to a jury trial and damages against respondent in the amount of five million dollars general damages and five million dollars punitive damages payable in gold and silver coin. (7) Petitioners demand that they be given "counsel of their choice", not a member of any licensed "Bar Association" and licensed by no one but themselves to speak for them as guaranteed by the First Amendment to the U.S. Constitution. Rule 34(b) provides in pertinent part that the petition*648 in a deficiency action shall contain "clear and concise assignments of each and every error which the petitioner alleges to have been committed by the Commissioner in the determination of the deficiency or liability" and "clear and concise lettered statements of the facts on which petitioner bases the assignments of error." No justiciable error (with a possible exception as to the addition to the tax) has been alleged in the petition with respect to the Commissioner's determination of the deficiency. In any event, it is certain that no justiciable facts in support of any error asserted in paragraph 4 of the petition are extant in paragraph 5 of the petition. Rather, petitioners consume their entire petition raising, in the main, a plethora of constitutional arguments. It is clear beyond doubt that the many constitutional arguments advanced by petitioners are frivolous and without merit. All of the contentions they have raised have been fully discussed (adversely to petitioners' contentions) in numerous prior opinions of this and other courts. 3 On this very point, which is totally pertinent to this case, in Hatfield v. Commissioner,68 T.C. 895">68 T.C. 895, 899 (1977),*649 we had this to say-- *650 In recent times, this Court has been faced with numerous cases, such as this one, which have been commenced without any legal justification but solely for the purpose of protesting the Federal tax laws. This Court has before it a large number of cases which deserve careful consideration as speedily as possible, and cases of this sort needlessly disrupt our consideration of those genuine controversies. Moreover, by filing cases of this type, the protesters add to the caseload of the Court, which has reached a record size, and such cases increase the expenses of conducting this Court and the operations of the IRS, which expenses must eventually be borne by all of us. 4There is no adjustment in this case on which the burden of proof is placed by statute or the rules of this Court upon respondent. Hence, petitioners bear the burden of proof thereon. Rule 142(a). Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). This is so not only with respect to the income tax deficiency but also in regard to*651 the addition to the tax. See Mensik v. Commissioner,T.C. Memo. 1979-4 and the cases there cited. Petitioners' assertion of the statute of limitations as a defense is baseless. Their 1976 Federal income tax return was due to be filed on or before April 15, 1977. Respondent's notice of deficiency was mailed to petitioners on April 4, 1980, which date was within the three-year period provided by section 6501, Internal Revenue Code of 1954, as amended. The balance of petitioners' contentions are equally baseless. 5*652 Rule 121(b) provides that a motion for summary judgment shall be granted if the "pleadings * * * and any other acceptable materials * * * show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law. * * *" Here, petitioners have refused to submit any information which contradicts respondent's factual determinations. On the basis of the pleadings and the exhibit attached to respondent's motion, respondent has demonstrated to our satisfaction that there is no genuine issue as to any material fact present in this record and, thus, that respondent is entitled to a decision as a matter of law. In such posture, summary judgment is a proper procedure for disposition of this case. Respondent's motion for summary judgment will be granted. 6*653 An appropriate order and decision will be entered.Footnotes1. Since this is a pretrial motion and there is no genuine issue of material fact, the Court has concluded that the post-trial procedures of Rule 182, Tax Court Rules of Practice and Procedure↩, are not applicable in these particular circumstances. This conclusion is based on the authority of the "otherwise provided" language of that Rule. The parties were afforded a full opportunity to present their views on the law at the hearing at Washington, D.C., on February 18, 1981. Petitioners did not appear. However, on February 9, 1981, they filed a "Written Opposition to Summary Judgment" with attachment.2. All rule references herein are to the Tax Court Rules of Practice and Procedure.↩3. Richardson v. Commissioner,72 T.C. 818">72 T.C. 818 (1979) (Fourth, Fifth, Ninth, and Tenth Amendments); Wilkinson v. Commissioner,71 T.C. 633">71 T.C. 633 (1979) (Fifth Amendment); Cupp v. Commissioner,65 T.C. 68">65 T.C. 68 (1975), affd. in an unpublished order 559 F.2d 1207">559 F.2d 1207 (3d Cir. 1977) (First, Fourth, Sixth, Seventh, and Sixteenth Amendments); Roberts v. Commissioner,62 T.C. 834">62 T.C. 834 (1974) (Fourth, Fifth, Fourteenth, and Sixteenth Amendments); Porth v. Brodrick,214 F.2d 925">214 F.2d 925 (10th Cir. 1954) (Thirteenth Amendment); Bowser v. Commissioner,T.C. Memo. 1980-483 (Thirteenth Amendment); Poen v. Commissioner,T.C. Memo. 1979-226 (Thirteenth Amendment); Lyon v. Commissioner,T.C. Memo. 1978-347 (Thirteenth Amendment). See also Edens v. Commissioner,T.C. Memo. 1981-66; Voelker v. Commissioner,T.C. Memo 1981-67">T.C. Memo. 1981-67; Meyers v. Commissioner,T.C. Memo. 1980-579; Fleck v. Commissioner,T.C. Memo 1980-281">T.C. Memo. 1980-281; Ross v. Commissioner,T.C. Memo. 1978-203; Johnson v. Commissioner,T.C. Memo. 1979-313; Armstrong v. Commissioner,T.C. Memo. 1979-210; Babcock v. Commissioner,T.C. Memo 1979-161">T.C. Memo. 1979-161; Babcock v. Commissioner,T.C. Memo. 1979-160↩.4. The Court's language in Hatfield,↩ so true when stated on September 12, 1977, is all the more impelling today because of the ever increasing caseload of this Court.5. Federal reserve notes constitute legal tender--"money"--which must be reported on a taxpayer's return in accordance with his method of accounting. Cupp v. Commissioner,supra;Gajewski v. Commissioner,67 T.C. 181">67 T.C. 181 (1976), affd. in an unpublished opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978). A taxpayer is not entitled to a trial by jury in the U.S. Tax Court. Sec. 7453, 1954 Code. See Swanson v. Commissioner,65 T.C. 1180">65 T.C. 1180 (1976); Cupp v. Commissioner,supra;Gajewski v. Commissioner,supra; and Wilkinson v. Commissioner,supra.The constitutionality of the Federal income tax laws passed since the enactment of the Sixteenth Amendment has been upheld judicially on too many occasions for us presently to rethink the underlying validity thereof. See, e.g., Brushaber v. Union Pac. R.R. Co.,240 U.S. 1">240 U.S. 1 (1916); Stanton v. Baltic Mining Co.,240 U.S. 103">240 U.S. 103 (1916); Cupp v. Commissioner,supra; and Klir v. Commissioner,T.C. Memo. 1979-259↩.6. Although we considered imposing damages against petitioners pursuant to sec. 6673, 1954 Code, we did not do so since, in our view, no showing has been made in this case that the petition was filed merely for delay. But see and compare Sydnes v. Commissioner,74 T.C. 864">74 T.C. 864 (1980), on appeal 8th Cir., Nov. 1980; Greenberg v. Commissioner,73 T.C. 806">73 T.C. 806 (1980); and Wilkinson v. Commissioner,supra,↩ where damages were imposed. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619480/ | David E. Starrett and Grace I. Starrett, Petitioners, v. Commissioner of Internal Revenue, RespondentStarrett v. CommissionerDocket No. 2957-62United States Tax Court41 T.C. 877; 1964 U.S. Tax Ct. LEXIS 129; March 26, 1964, Filed *129 Decision will be entered for the petitioners. Held, where psychoanalysis is obtained for the purpose of diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any function of the body, the amount spent therefor is for medical care even though a further and additional benefit is obtained thereby such as qualification for admission to a school of psychoanalytic training. Arnold Namrow, 33 T.C. 419">33 T.C. 419 (1959), distinguished. Howard W. Rea, for the petitioners.Arthur B. Bleecher, for the respondent. Withey, Judge. Hoyt, J., concurs in the*130 result. Tietjens, J., concurring. Mulroney, Train, Drennen, Scott, and Dawson, JJ., agree with this concurring opinion. WITHEY*877 Deficiencies in the income tax of petitioners for the taxable years 1958 and 1959 have been determined by the Commissioner in the respective amounts of $ 737.85 and $ 1,064.95. The sole issue presented is whether amounts paid for the professional services of a psychoanalyst are deductible medical expense.FINDINGS OF FACTFacts which have been stipulated are found accordingly.Petitioners' income tax returns for the taxable years 1958 and 1959 were timely filed with the district director of internal revenue, Denver, Colo.David E. Starrett, hereinafter referred to as petitioner, has engaged in professional training and practice as follows:a. 1948-1952 -- Medical School, Washington University School of Medicine, St. Louis, Mo., M.D., 1952.b. 1951 -- Special work in Comprehensive Medicine Clinic, 1 year.c. 1951 -- Acting Assistant Resident Psychiatry, McMillan Hospital, St. Louis, 3 months.d. 1952-1953 -- Rotating Intern, Highland-Alameda County Hospital, Oakland, Calif.e. 1953-1954 -- Assistant Resident Internal Medicine, Highland-Alameda*131 County Hospital, Oakland, Calif.f. 1954 -- Resident in Medicine, Samuel Merritt Hospital, Oakland, Calif.*878 g. 1954-1955 -- Junior Resident in Psychiatry, University of Colorado Medical Center, Colorado Psychopathic Hospital, Denver.h. 1955-1956 -- Intermediate Resident in Psychiatry, University of Colorado Medical Center.i. 1956-1957 -- Senior Resident in Psychiatry, University of Colorado Medical Center.j. 1957-1960 -- Instructor in Psychiatry, Staff Psychiatrist, Adult Psychiatric Clinic, University of Colorado Medical Center.k. 1957-1960 -- Lecturer in Psychiatry, VA Hospital, Denver, Fort Lyon, Colo and Sheridan, Wyo.l. 1957-1961 -- Attending Staff, Denver VA Hospital and Denver General Hospital.m. 1957-1963 -- Attending Staff, Colorado General Hospital and Colorado Psychopathic Hospital, Denver.n. 1957-1963 -- Consultant in Psychiatry, Colorado State Hospital, Pueblo, Colo., and Craig Rehabilitation Center, 1599 Ingalls, Lakewood, Colo.o. 1959 -- Certified by American Board of Psychiatry and Neurology in Psychiatry.p. 1960-1963 -- Assistant Professor of Psychiatry, University of Colorado Medical Center, Department of Psychiatry.q. 1960-1961 -- Director, Division*132 of Psychiatric Services, Denver Department of Health and Hospitals.r. 1960-1963 -- Psychiatric Consultant to Denver Department of Welfare.s. 1961-1963 -- Associate Chief of Staff for Psychiatry, Denver VA Hospital.t. 1961-1963 -- Chief of Psychiatric Training, Denver VA Hospital.u. 1962-1963 -- Member of Governor's Advisory Board on Commitment and Transfer Laws.v. 1962-1963 -- Vice President, Board of Directors, Denver Mental Health Center.w. 1963 -- Member, board of directors, Metropolitan Mental Health Association.x. 1963 -- Secretary-Treasurer, Colorado District Branch, American Psychiatric Association.y. 1952 -- Licensed to practice medicine in Missouri.z. 1953 -- Licensed to practice medicine in California.aa. 1958 -- Licensed to practice medicine in Colorado.From 1957 to 1963, inclusive, petitioner was a candidate at the Chicago Institute for Psychoanalysis.During his entire adult life petitioner has suffered from a specific psychoneurosis known and classified by the American Medical Association1 as anxiety reaction. Anxiety reaction is a specific disease characterized by emotional imbalance, an indication of which is the lack of proportionate relevance between*133 the fears, anxieties, and sense of impending doom experienced with actual known factual situations. To the lay sufferer the disease is disabling. To petitioner, a practicing psychiatrist, the disease became increasingly disabling as he, through his practice, was brought into close contact with the emotional imbalance and the resulting symptomatic problems of his patients. This condition caused petitioner to believe that his professional abilities *879 were being or were in danger of being impaired to the detriment of his patients.In April of 1957 petitioner had determined to obtain training from the Chicago Institute for Psychoanalysis, hereinafter referred to as the institute, with the intention that, upon completion thereof, he would practice as a psychoanalyst. To that end, on April 22, 1957, he made written application to the institute to be admitted to its training courses. Prior to his acceptance as a student, petitioner was*134 required to and did submit to interview and examination by a committee of the institute charged with determining an applicant's scholastic and professional qualifications and also to determine whether or not the applicant was sufficiently mentally and emotionally healthy or stable to be able to absorb the institute's courses of instruction and to psychoanalyze patients without danger of harm either to the patient or himself. The committee refused to accept petitioner as a student and advised him to obtain a psychoanalysis.In January or February of 1957, petitioner had, by mail, requested Dr. Rene A. Spitz to accept him as a patient to undergo psychoanalysis. Dr. Spitz was then in Europe, but was expected to arrive in Denver in July of 1957 to take up his duties as a newly appointed professor of psychiatry. Dr. Spitz was a "training analyst" appointed by the institute. His duties, as such, included the psychoanalysis of student-applicants of the institute. All of the applicants for training at the institute were required to undergo psychoanalysis with a "training analyst." A psychoanalysis undergone prior to acceptance as a student was acceptable by the institute provided it *135 was conducted by one of its appointed "training analysts." During the years 1957 and 1958 the term "training analyst" was not descriptive of the function performed by one bearing that appellation in that it had become an accepted principle in the field of psychoanalytic education that no portion of the psychoanalysis of a student should be devoted to the education of the student, but that the entire process should be therapeutic. Petitioner's psychoanalysis was performed for the purpose of so altering his character and personality that he would become sufficiently stable emotionally to relieve him of his prior symptoms of anxiety reaction and for the purpose of compliance with the prerequirement of the institute for admission to its training courses in psychoanalysis.During the course of his treatment by Dr. Spitz, petitioner made some progress in the correction of his anxiety reaction, but not sufficient to satisfy Dr. Spitz. An accepted theory of psychoanalysis is that, where unsatisfactory progress is made by the patient being treated by a male psychoanalyst, further treatment by a female analyst is indicated. In pursuance of this theory Dr. Spitz, in September of 1958, advised*136 that petitioner retain the services of Dr. Eleanor Steele, *880 a female psychoanalyst, resident and practicing in Denver, who was also a "training analyst" appointed by the institute. Petitioner followed this advice and continued his psychoanalysis with Dr. Steele throughout the remainder of 1958 and the entire year 1959. Dr. Steele notified the institute of the fact that petitioner had begun treatment with her.Petitioner underwent psychoanalysis during 1958 and 1959 at the rate of 5 hours per week, with the exception of holidays or other occasions when for one reason or another he or his doctor could not be available. Petitioner paid for the services of Dr. Spitz and Dr. Steele $ 3,260 in 1958 and $ 4,390 in 1959.ULTIMATE FINDINGPetitioner's purpose in obtaining psychoanalytic treatment was dual and of equal weight -- (1) to obtain so far as possible a cure of a specific disease from which he suffered and (2) to qualify for admission to the training curriculum of the institute.OPINIONThe law controlling deductibility of the expenses here sought to be deducted is section 213 (a) and (e) of the Internal Revenue Code of 1954. 2 The interpretation of the law by respondent*137 is found in section 1.213-1(e)(1)(i) and (ii), Income Tax Regs.3*138 *881 Petitioner takes the position herein that because the reason why he underwent psychoanalysis was for the diagnosis of his emotional condition, cure of a specific emotional disease classified as anxiety reaction, mitigation of the effects upon him of such disease, treatment of the underlying causes of his anxiety reaction, and thereby the prevention of further suffering therefrom, his expenses in obtaining his psychoanalysis must be held to have been paid for "medical care" under the statute and therefore the deduction thereof must be permitted. He takes the further position that even though his psychoanalysis was undergone also for the reason that it was a necessary preliminary qualification for his acceptance as a student by the institute, this fact cannot detract from the statutory deductibility of the expense thereof as being for "medical care."Respondent, on the other hand, takes the position that petitioner's psychoanalysis was obtained by him primarily for the purpose of obtaining an education in psychoanalysis thus rendering the expense thereof nondeductible because of the portion of the above-cited regulation which provides that --Deductions for expenditures*139 for medical care allowable under section 213 will be confined strictly to expenses incurred primarily for the prevention or alleviation of a physical or mental defect or illness. * * *We think petitioner must prevail here. The evidence is clear, believable, and uncontradicted that, whatever other reason petitioner had for undergoing psychoanalysis, he certainly had the intention, as soon as he could afford the treatment, to be thereby relieved of the physical and emotional suffering attendant upon the specific disease from which he had suffered throughout his adult life. In the words of section 213(e)(1)(A), the amounts paid Drs. Spitz and Steele for their services during the years at issue are clearly "amounts paid for the diagnosis, cure, mitigation, treatment," and "prevention" of a specific "disease" classified by the American Medical Association as anxiety reaction and which amounts were clearly also spent "for the purpose of affecting" the "function of the (petitioner's) body" which controlled the equilibrium of his emotions.Respondent's use of the word "primarily" in his regulation cannot be extended to the point where an expense, clearly for medical care, may nevertheless*140 become nondeductible merely because the end result thereby sought to be achieved might include an advantage or benefit to the taxpayer in addition to cure or mitigation of a disease, and we *882 think other language contained in the same paragraph of the regulation indicates no such result was intended. Immediately following that portion of the regulation appears the following language which we read to denote the purpose for which the word "primarily" is used --Thus, payments for the following are payments for medical care: hospital services, nursing services (including nurses' board where paid by the taxpayer), medical, laboratory, surgical, dental and other diagnostic and healing services, X-rays, medicine and drugs (as defined in subparagraph (2) of this paragraph, subject to the 1-percent limitation in paragraph (b) of this section), artificial teeth or limbs, and ambulance hire. However, an expenditure which is merely beneficial to the general health of an individual, such as an expenditure for a vacation, is not an expenditure for medical care.Clearly the word "primarily" was used with reference to those types of expenditure which by their nature have no more than*141 a remote or general relationship to health or the maintenance thereof. A bill for physicians' services rendered for any of the enumerated statutory purposes is not such.Our decision in Arnold Namrow, 33 T.C. 419">33 T.C. 419 (1959), affd. 288 F. 2d 648 (C.A. 4, 1961), certiorari denied 368 U.S. 914">368 U.S. 914 (1961), is not controlling of the issue here presented. There, this issue was presented as an alternative and decision was for the respondent on the ground of the failure of taxpayer to establish that he was suffering from an illness or disease or that he underwent treatment for the cure, mitigation, etc., of such disease or illness. Here, all of the factual elements necessary under both the statute and the regulations to constitute "medical care" have been proven and found as fact.Decision will be entered for the petitioners. TIETJENSTietjens, J., concurring: I would simply find that petitioner's payments to the doctors were for the alleviation or cure of a mental illness and accordingly are deductible as medical expenses, and let the case end there. Footnotes1. Standard Nomenclature of Diseases and Operations (A.M.A., 5th ed., 1961).↩2. SEC. 213. MEDICAL, DENTAL, ETC., EXPENSES.(a) Allowance of Deduction. -- There shall be allowed as a deduction the expenses paid during the taxable year, not compensated for by insurance or otherwise, for medical care of the taxpayer, his spouse, or a dependent (as defined in section 152) --* * * *(e) Definitions. -- For purposes of this section -- (1) The term "medical care" means amounts paid -- (A) for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body (including amounts paid for accident or health insurance) * * *↩3. Sec. 1.213-1 Medical, dental, etc., expenses.(e) Definitions -- (1) General. (i) The term "medical care" includes the diagnosis, cure, mitigation, treatment, or prevention of disease. Expenses paid for "medical care" shall include those paid for the purpose of affecting any structure or function of the body, for accident or health insurance, or for transportation primarily for and essential to medical care. Amounts paid for hospitalization insurance, for membership in an association furnishing cooperative or so-called free-choice medical service, or for group hospitalization and clinical care are expenses paid for medical care. However, premiums paid by a taxpayer under an insurance contract which provides reimbursement for loss of earnings due to accident or illness do not constitute amounts expended for medical care. In the case of a policy providing reimbursement for both loss of earnings and medical expenses, only the pro rata portion of such premium payments which is properly attributable to the coverage for medical expenses will constitute an expense paid for medical care.(ii) Amounts paid for operations or treatments affecting any portion of the body, including obstetrical expenses and expenses of therapy or X-ray treatments, are deemed to be for the purpose of affecting any structure or function of the body and are therefore paid for medical care. Amounts expended for illegal operations or treatments are not deductible. Deductions for expenditures for medical care allowable under section 213↩ will be confined strictly to expenses incurred primarily for the prevention or alleviation of a physical or mental defect or illness. Thus, payments for the following are payments for medical care: hospital services, nursing services (including nurses' board where paid by the taxpayer), medical, laboratory, surgical, dental and other diagnostic and healing services, X-rays, medicine and drugs (as defined in subparagraph (2) of this paragraph, subject to the 1-percent limitation in paragraph (b) of this section), artificial teeth or limbs, and ambulance hire. However, an expenditure which is merely beneficial to the general health of an individual, such as an expenditure for a vacation, is not an expenditure for medical care. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/2024595/ | 117 Ill. App.3d 869 (1983)
454 N.E.2d 39
SANDOR SZABO, Plaintiff-Appellee and Cross-Appellant,
v.
THE BOARD OF EDUCATION OF COMMUNITY CONSOLIDATED SCHOOL DISTRICT 54, COOK COUNTY, et al., Defendants-Appellants and Cross-Appellees.
No. 82-2729.
Illinois Appellate Court First District (5th Division).
Opinion filed September 2, 1983.
*870 Wesley A. Wildman, John A. Relias, and Andrea R. Waintroob, all of Vedder, Price, Kaufman & Kammholz, of Chicago, for appellants.
Peter M. Katsaros and Wayne Schwartzman, both of Hirsh & Schwartzman, of Chicago, for appellee.
Affirmed in part, and reversed in part and remanded.
PRESIDING JUSTICE WILSON delivered the opinion of the court:
Sandor Szabo, a tenured physical education teacher assigned to the MacArthur Elementary School, was dismissed from his position by the Board of Education of School District 54, Schaumburg, Illinois (Board). The Illinois State Board of Education upheld plaintiff's discharge on the ground that in 1979 and 1980 Szabo misused the school district's sick leave and business leave policies. On administrative review (Ill. Rev. Stat. 1981, ch. 110, par. 264 et seq.), the trial court reversed and ruled that plaintiff's conduct was remediable and that he should not have been discharged. The case was remanded to the Board to impose an alternative penalty.
The Board appeals the trial court's decision that plaintiff's conduct was remediable, that discharge was too harsh a penalty and that the cause should be remanded. Plaintiff alleges in his cross-appeal that he did not misuse leave policies and that the Board need not impose a lesser penalty. For the reasons that follow, we affirm in part *871 and reverse in part.
From 1969 until November 1980, Szabo taught health and physical education at MacArthur Elementary School. During the last two years of his employment his teaching duties were performed between 8:15 a.m. and 3:30 p.m. He also held a part-time job in the late afternoon as a soccer coach at Harper Community College (Harper). Soccer was a varsity sport at Harper with regularly scheduled games against other teams. In addition to his coaching duties, Szabo was responsible for establishing the team's soccer match schedule. He decided which colleges would be placed on the schedule, the times that the games would be played and the bus schedules. Szabo received $1,062 for each season that he coached.
In 1979, Harper College participated in five soccer matches, four of which Szabo allegedly either took a personal business day or sick day to attend. On November 9, the team made the midwest regional playoffs and a game was scheduled. Departure time from the college was 11 a.m. Since November 9 was a Friday, Szabo had to give a reason for seeking personal leave. (No reasons were required for personal leave on Tuesday through Thursday.) On November 6, Szabo submitted a written request for personal business leave for November 9. He stated that he would be absent because he had a court appearance in the morning and a tournament in the afternoon. The assistant superintendent of personnel, Ronald Ruble, and the school principal, Roy Johnson, informed Szabo that one-half day of personal business leave would be allowed for the court hearing but that Szabo would be docked a half day's salary for his attendance at the soccer tournament. For the 1979 school year, Szabo was absent from his teaching duties at the elementary school five times. Each day of absence corresponded to a day that the Harper College team participated in a soccer competition that was not played on its campus.
During the 1980 school year, Szabo was absent seven times. Again, the absences corresponded to the days that the soccer team played an away game. Szabo either called in sick or took these absences as personal business days and as a result, his salary was never docked. The only date for which Szabo had taken time off at a salary deduction was, as previously stated, November 9, 1979.
School principal Roy Johnson reported Szabo's absences to the administrator of personnel relations, Curtis Casey. Casey compared Szabo's absences during 1979 and 1980 with the Harper soccer team schedule and discovered that with the exception of one occasion, Szabo had never been present at the elementary school on an afternoon when Harper played an away game. Casey notified the Board *872 and based on his report, it voted to discharge Szabo. Subsequently a hearing was held before a hearing officer of the State board of education. Although unable to dispute the unfailing correlation of his sick and personal leave days to Harper College's away game schedule, Szabo maintained that he had not abused the school district's leave policy and that on each of the days in question he either had legitimate personal business or had been too ill to teach but not too ill to coach soccer. He denied that he had taken the afternoons off in order to arrive at Harper College earlier than his normal quitting time at the elementary school of 3:15 p.m. would have permitted. Szabo alleged that although he had scheduled the departure times for the games, the team buses never left before 3:30, which is when he said he would have arrived at Harper had he worked a full school day.
The hearing officer did not find Szabo's explanations to be credible and concluded, as had the Board, that Szabo had wilfully abused the school district's personal and sick leave policies in order to avoid pay deductions for time spent coaching soccer. The hearing officer upheld the Board's determination that Szabo's conduct was an irremediable cause for discharge and explained that Szabo's conduct had deprived his students of his services, that he had taken the school district's money under false pretenses and that he had committed a breach of trust which reflected badly on the other faculty members and on the school system. The officer ruled that since Szabo's offense involved cheating and dishonesty, no notice of remediation was required.
Szabo filed a complaint in the circuit court of Cook County alleging that the hearing officer's decision was contrary to the manifest weight of the evidence. The court ruled that although it was apparent that Szabo had lied about the reasons for his absences, his conduct was remediable. The case was remanded to the Board with instructions to impose a penalty other than discharge. This appeal followed. Plaintiff cross-appealed the court's ruling that he misused leave policies and that a lesser penalty should be imposed.
OPINION
The controlling issue for our consideration is whether sufficient cause for plaintiff's dismissal is shown by the record to be irremediable. The determination of whether causes for dismissal are remediable or irremediable is a question of fact which initially lies within the discretion of the Board. A reviewing court will not interfere with the Board's decision unless the Board has acted in an arbitrary or capricious manner or the reasons formulated for the dismissal were against *873 the manifest weight of the evidence. Gilliland v. Board of Education (1977), 67 Ill.2d 143, 153, 365 N.E.2d 322; Lowe v. Board of Education (1979), 76 Ill. App.3d 348, 355-56, 395 N.E.2d 59.
We note at the outset that in order to encourage teachers to work within the educational system and to assure teachers of experience and ability that rehiring will be based upon merit rather than upon reasons that are political, partisan or capricious, the School Code provides that a tenured teacher may only be discharged for cause. (Ill. Rev. Stat. 1981, ch. 122, par. 24-12; Morris v. Board of Education (1981), 96 Ill. App.3d 405, 410-11, 421 N.E.2d 387.) In furtherance of the goal of protecting tenured teachers, the School Code provides that:
"Before setting a hearing on charges stemming from causes that are considered remedial, a board must give the teacher reasonable warning in writing, stating specifically the causes which, if not removed, may result in charges." (Emphasis added.) Ill. Rev. Stat. 1981, ch. 122, par. 24-12.
If charges against a teacher are remediable but the teacher is not given proper notice in writing, the failure to provide the warnings required by the School Code deprives the Board of jurisdiction. Aulwurm v. Board of Education (1977), 67 Ill.2d 434, 442-43, 367 N.E.2d 1337.
1 A written warning is not required when the teacher's conduct is irremediable, however. The test in determining whether a cause for dismissal is irremediable is whether damage has been done to the students, faculty or school, and whether the conduct resulting in the damage could have been corrected had the teacher's superiors warned her. (Gilliland v. Board of Education (1977), 67 Ill.2d 143, 153, 365 N.E.2d 322.) Where causes which are remediable in nature continue for a long enough period of time and where the teacher refuses or fails to remedy them, they may be considered to be irremediable. McCutcheon v. Board of Education (1981), 94 Ill. App.3d 993, 998, 419 N.E.2d 451.
2 In our opinion, the manifest weight of the evidence reveals that because Szabo's pattern of improperly taking days off with pay could have been rectified upon proper notice, his conduct was remediable. Although he was informed of the applicable leave policy by the principal, Roy Johnson, and the assistant superintendent of personnel, Ronald Ruble, these conversations occurred before either administrator was aware that a violation had transpired. Similarly, Johnson's remarks to Szabo that he must adhere to the proper channels to take time off to coach was not given in a context which indicated that he *874 was aware of a repeated violation. Szabo was, therefore, never admonished to correct his conduct. Arguably, Szabo was put on notice that a salary deduction was the only acceptable means to account for the time he took for his coaching responsibilities; however, a written warning stating the consequences of Szabo's absenteeism and failure to adhere to Board policy should have been issued. (Ill. Rev. Stat. 1981, ch. 122, par. 24-12.) There is nothing in the record to suggest that Szabo would not have corrected his modus operandi of taking sick leave and personal business days to coach had he been forewarned. The evidence presented therefore falls short of sustaining a charge of irremediability. The absence of a warning is fatal to the Board's appeal, for, as previously explained, it deprives the Board of jurisdiction of this matter. Aulwurm v. Board of Education (1977), 67 Ill.2d 434, 442-43, 367 N.E.2d 1337.
As to the second cause of dismissal, we again find no evidence in the record of any detrimental consequences suffered by the students, school or faculty as the result of Szabo's conduct. The Board has failed in this regard as well to justify not giving the required statutory warning. Moreover, we are unpersuaded by the cases cited by the Board on this issue as those cases are distinguishable from the facts before us. The teacher in Christopherson v. Spring Valley Elementary School District (1980), 90 Ill. App.3d 460, 462, 413 N.E.2d 199, stated in advance that she would disregard the board's denial of her request for a five-day business leave to attend an education convention. Accordingly, the court held that the teacher's wilful violation could not be remedied. (90 Ill. App.3d 460, 462.) In Yuen v. Board of Education (1966), 77 Ill. App.2d 353, 222 N.E.2d 570, the court upheld the board's discharge of a teacher who, after having expressly been denied a request for absence, was found to have intentionally and wilfully violated the board's ruling by leaving work and attending a teacher seminar. As in Christopherson, the court ruled that once the wilful violation had occurred, the damage was done and could not be remedied. 77 Ill. App.2d 353.
Clearly, the distinguishing factor in each of the above cited cases is that the teacher's conduct could not have been corrected even if a written warning had been given. In each case the teacher announced in no uncertain terms his and her intention to defy the board's denial of a request for leave. Such is not the case here. Szabo did not exhibit hostile defiance of his employer and did not erode the disciplinary authority of the Board. We therefore hold that defendants were not irremediably harmed and that the Board's decision was against the manifest weight of the evidence.
*875 We are compelled to next address the question of Szabo's alleged cheating the school district of money by taking leave with pay under false pretenses. In this regard, the hearing officer noted that to classify Szabo's conduct as theft would be overly harsh:
"Where outright theft of school property is concerned, the thief would probably find it impossible to justify his action either to himself or to others. Where sick leave or personal leave is concerned, some teachers begin to think in terms of `Those days are coming to me. They are mine.' and it becomes very easy to justify to one's self that there is nothing wrong with taking the day off even though one is not sick or engaged in an activity covered by the business leave provision. This is, of course, wrong, and may well constitute taking money under false pretenses, but the same social stigma does not commonly apply, although logically perhaps it should."
The trial court also noted that the abuse of leave policies" * * * is not unusual under the maladies of our system. The lack of scrupulousness in the serving of one's employer is pervasive * * *."
3 These observations raise the question of whether a teacher's use of his sick or personal business days to engage in part-time employment is, ipso facto, an irremediable act. We are of the opinion that in order to justify a dismissal for that reason alone, the Board must clearly articulate the restrictions placed on this privilege. In the case at bar, plaintiff was never expressly informed of any such restrictions, he was not instructed to refrain from working part-time nor was he warned in writing that to use his sick and business leave days to coach would result in his termination. In the absence of such warnings, we hold that plaintiff's conduct was not an irremediable cause for dismissal.[1]
4 Finally, we note that plaintiff and defendants agree that the school code has, in effect, an all or nothing policy which does not permit a lesser disciplinary penalty other than discharge in cases which have been adjudicated by the trial or appellate court. The pertinent portion of the code provides that "[i]f a decision of the hearing officer is adjudicated upon review or appeal in favor of the teacher, then the *876 trial court shall order reinstatement and shall determine the amount for which the board is liable including but not limited to loss of income and costs incurred therein. Any teacher who is reinstated * * * shall be assigned by the board to a position substantially similar to the one which that teacher held prior to that teacher's suspension or dismissal." (Emphasis added.) Ill. Rev. Stat. 1981, ch. 122, par. 24-12.
The language cited above indicates that a reviewing court is empowered to make only one of two decisions: to reinstate the teacher with no loss in pay or, to uphold the order of dismissal with no award of back pay. There is no language in the statute which suggests that a disciplinary penalty other than discharge is available. Accordingly, we find that the trial court erred in remanding this case to the Board.
For the reasons indicated, the trial court's order reversing the Board's order of dismissal is affirmed; the order remanding the case to the Board is reversed. The case is remanded to the circuit court to proceed in a manner consistent with the views expressed herein.
Affirmed in part; reversed in part and remanded.
LORENZ and MEJDA, JJ., concur.
NOTES
[1] We note that the record includes copies of pamphlets entitled "Agreement between the Schaumburg Education Association and the Board of Education" for 1979-80 and 1980-81. Under a section entitled "Business Leave," the agreement explains the procedure to be used to request time off and lists 10 common uses for business leave. These include religious holidays, legal hearings and weddings. Restrictions on the use of business leave or sick leave days are not addressed, however. | 01-04-2023 | 10-30-2013 |
https://www.courtlistener.com/api/rest/v3/opinions/4619483/ | GEORGE T. DOERRIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDoerries v. CommissionerDocket No. 32366-88United States Tax CourtT.C. Memo 1991-396; 1991 Tax Ct. Memo LEXIS 461; 62 T.C.M. (CCH) 484; T.C.M. (RIA) 91396; August 13, 1991, Filed *461 Decision will be entered under Rule 155. Nick A. Moschetti Jr., for the petitioner. J. Michal Nathan, for the respondent. RUWE, Judge. RUWEMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies and additions to tax in petitioner's Federal income taxes as follows: Additions to TaxYearDeficiencySec. 6653(a)(1) 1Sec. 6653(a)(2)Sec. 66611984$ 54,349.00$ 2,717.0050 percent of$ 5,933.00the interest dueon $ 23,370.001985$ 1,152.00$ 58.0050 percent of --the interest dueon $ 1,152.00After concessions by the parties, the issues for decision are: (1) Whether petitioner is entitled to a deduction for a loss incurred on the disposition of real property; (2) whether petitioner is entitled to deduct, *462 under either section 162(a) or section 212, mortgage interest, property taxes, and other expenditures incurred with respect to real property; (3) whether petitioner is liable for the 5-percent addition to tax under section 6653(a)(1) for negligence or intentional disregard of rules or regulations; (4) whether respondent's post-trial Motion for Leave to File Amendment to Answer regarding additions to tax should be granted; (5) whether petitioner is liable for additions to tax under section 6653(a)(2); and (6) whether petitioner is liable for the addition to tax under section 6661 for substantial understatement of income tax. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner resided in Reno, Nevada, at the time he filed his petition in this case. Petitioner timely filed his Federal income tax returns for each of the taxable years in issue. In 1980, petitioner became interested in purchasing property in a subdivision known as Lakeview Estates in Carson City, Nevada. Lakeview Estates had previously been part of a planned development, which was originally intended*463 to include a golf course and a tennis club. The development, as initially planned, failed. Prior to abandoning its initial plan, the developer constructed a "clubhouse" for the golf course and tennis club. It was the clubhouse and the lot upon which it was situated that petitioner was interested in purchasing. The clubhouse was a single-story 1400 square-foot structure which was functionally divided into 3 areas. At one end of the building there was a large room for entertaining which contained a fireplace and a bar. In the center of the structure were men's and women's locker rooms, and at the other end of the building was a small apartment. This small apartment was originally intended as quarters for a tennis pro. Petitioner was informed that the clubhouse was for sale subject to the requirement that it be remodeled in order to meet minimum square footage requirements. The seller also disclosed that the property had been damaged by a fire. It was further represented to petitioner that the damage was limited to a small alcove off the large room, that had since been repaired. On June 22, 1980, petitioner entered into a contract to purchase the property. The contract provided*464 that petitioner took the property "as is." The contract further specified that the required remodeling had to be done within 3 years. This was the first time petitioner had ever purchased real estate. The purchase price was $ 140,000. Petitioner made a $ 20,000 downpayment and obtained a loan for the remaining $ 120,000. Petitioner moved into the clubhouse in 1980 and used it as his principal residence until March 1984. Petitioner listed the property as his personal residence on his Federal income tax returns for the years 1980, 1981, 1982, and 1983. Petitioner claimed home mortgage interest and real estate taxes for the property as itemized deductions on Schedule A of his returns in each of those years. On September 22, 1983, more than 3 years after petitioner began using the property as his personal residence, he obtained remodeling plans from a residential designer he had hired. The plans provided for remodeling of the original clubhouse, as well as the construction of a detached garage. In order to finance the remodeling, petitioner applied to the Valley Bank of Nevada (the bank) for a construction loan. In making his loan application, petitioner told the loan officer*465 that he intended to use the remodeled property as his personal residence. The bank had petitioner's property appraised. The appraiser estimated the property's value upon completion of remodeling at $ 310,000. On November 23, 1983, petitioner obtained a construction loan from the bank in the amount of $ 180,000 for a term of 6 months. Part of the loan proceeds were used to pay off the original loan of $ 120,000. The balance of the proceeds was used to finance the remodeling. Remodeling began in March 1984, at which time petitioner moved his residence from the clubhouse to a rented condominium in Reno, Nevada. He maintained his residence at this condominium from March 1, 1984, through October 31, 1984. In May 1984, during the course of the remodeling, petitioner discovered that the fire damage to the clubhouse was more extensive than originally disclosed to him by the seller. The costs of repairing this damage were estimated at $ 16,660.80. Petitioner sought an additional loan of $ 15,000.00 from the bank to cover these costs. The bank again had the property appraised. This time, the appraiser estimated its value at approximately $ 200,000.00. 2 The bank made the loan to*466 petitioner and the proceeds were used for the repair of the fire damage. After the 1984 discovery of the additional fire damage, petitioner obtained legal representation. In November 1984, petitioner agreed to release the seller of the property of all claims in return for the receipt of $ 3,500. On September 14, 1984, petitioner's contractor notified petitioner and the Nevada Contractor's Board that he was unable to complete his contract with petitioner and that his license should be suspended. The contractor filed for Chapter 7 bankruptcy relief in November 1984 and, in April of 1985, discharge was entered. At the time the contractor stopped work, the garage which had been planned had not been built, but the *467 main structure was complete and liveable except for minor matters. Petitioner resumed use of the clubhouse as his residence in November of 1984. Petitioner ceased making payments on the outstanding construction loan after October 1984. Ultimately, in March 1985, petitioner transferred the property to the bank in cancellation of petitioner's outstanding $ 195,000.00 loan. In addition to the $ 195,000.00 borrowed to finance the purchase and remodeling, petitioner had made an initial cash down payment of $ 20,000.00 and expended $ 21,831.63 of his own funds for remodeling. On Schedule C of his 1984 Federal income tax return, petitioner claimed a business loss of $ 63,581 with respect to the property. This loss consisted of $ 41,622 representing the excess of cost of goods sold over gross receipts reported from the disposition of the property plus claimed expenses for interest, bank service charges, escrow fees, and property taxes totalling $ 21,959. Petitioner also claimed deductions related to the property on his 1985 Federal income tax return totaling $ 2,304. In his notice of deficiency, respondent determined that petitioner was not entitled to the claimed real estate expense*468 deductions in 1984 and 1985. Respondent determined that petitioner realized $ 3,500 of unreported income in 1984 when he received that amount in settlement of his claim against the seller of the property. Respondent determined that petitioner was not entitled to a 1984 deduction for the $ 41,622 which petitioner claimed was the excess of costs over receipts upon disposition of the clubhouse property. Finally, respondent determined that petitioner was required to report capital gains of $ 55,000 in 1984 (i.e., the difference between the original purchase price of the subject property and the amount of the indebtedness discharged upon conveyance of the property to the bank). The notice of deficiency reflected these adjustments in the following manner: Adjustments to IncomeYear:1984 Year:1985SCHEDULE C REAL ESTATE EXPENSES$ 21,959$ 2,304DAMAGE SETTLEMENT3,500COST OF GOODS SOLD41,622 * * *CAPITAL GAINS AND LOSSES3 22,000*469 In his notice of deficiency, respondent also determined additions to tax under sections 6653(a)(1) and (2) for 1984 and 1985 and 6661(a) for 1984. With respect to the sections 6653(a)(2) and 6661.(a) additions, respondent determined that the adjustments to which these additions apply were: 1.SCHEDULE C REAL ESTATE EXPENSES$ 21,9592.DAMAGE SETTLEMENT3,5003.GAIN FROM SALE OF RESIDENCE55,000Respondent did not base the additions to tax under sections 6653(a)(2) or 6661(a) on the adjustment for "cost of goods sold" regarding the disposition of the clubhouse property. Prior to trial, the parties entered into the following stipulation. 26. The following deficiency adjustments assessed in Joint Exhibit 3-C, Statutory Notice of Deficiency, are hereby abated and settled: a. 1984 Adjustment 1A, disallowing $ 21,959.00 in Schedule C Real Estate Expenses is offset by allowing Petitioner $ 15,964.00 as an interest deduction and $ 1,084.00 as a real estate tax deduction on his 1984 Schedule A and $ 4,911.00 as additional basis in the subject property, to the extent the Court may find the subject property to be Petitioner's 1984 personal residence. b. 1984 Adjustment*470 1B, damage settlement of $ 3,500.00, was treated as a return of capital and reduction in Petitioner's basis in the subject property rather than income. c. 1984 Adjustment 1E, capital gains of $ 22,000.00 based upon 40% of the difference between $ 195,000 in cancellation of bank debt and the original purchase basis of $ 140,000, is eliminated in its entirety based upon Petitioner's actual loan basis of $ 195,000 in the subject property. d. 1984 Adjustment 16, penalties, if any, are to be recalculated based upon Subparagraphs a, b, and c immediately above. 4Two months after the trial of this case, respondent made a motion for leave to amend his answer. Respondent now, for the first time, seeks new additions to tax under sections 6653(a)(2) and 6661(a) based on the understatement of tax attributable to the disallowed "cost of goods sold." OPINION The first issue for decision is whether petitioner*471 may deduct the loss on disposition of his property under section 165(c)(2). Petitioner argues that the loss occurred in 1984 and that his 1985 conveyance of the property to the bank in lieu of foreclosure was only a ministerial act. In the alternative, he argues that he is entitled to deduct the loss in 1985. In light of our conclusion regarding the nature of the loss, we need not determine the year in which the loss occurred. Section 165(c)(2) provides that an individual may take a deduction for losses incurred in any transaction entered into for profit even if not connected with a taxpayer's trade or business. On brief, petitioner's sole argument was that he is entitled to a deduction under section 165(c)(2) for the loss on the disposition of the subject property since he held the property primarily for sale for profit. Respondent contends that the property was petitioner's personal residence and, as a result, petitioner may not deduct the loss. Respondent's determinations are presumed correct and petitioner bears the burden of proving otherwise. Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 78 L. Ed. 212">78 L. Ed. 212, 54 S. Ct. 8">54 S. Ct. 8 (1933); Rule 142(a). In order for the loss on disposition of the property*472 to be deductible, we must find that either (1) petitioner selected and purchased the subject property primarily for sale for profit rather than primarily for a personal residence; or (2) despite the fact that the initial acquisition was primarily for a residence, petitioner later appropriated the property to income-producing purposes. Austin v. Commissioner, 35 T.C. 221">35 T.C. 221, 225-226 (1960), affd. 298 F.2d 583">298 F.2d 583 (2d Cir. 1962). Determining petitioner's primary objective at the time of purchase is a factual inquiry. In making this determination, greater weight is given to objective facts than petitioner's statements as to his intent. Fox v. Commissioner, 82 T.C. 1001">82 T.C. 1001, 1022 (1984) (citing Siegel v. Commissioner, 78 T.C. 659">78 T.C. 659, 699 (1982) and Engdahl v. Commissioner, 72 T.C. 659">72 T.C. 659, 666 (1979)). At the time of purchase, petitioner had never before purchased real estate for either personal use or investment. Petitioner did not seek or obtain professional advice regarding the profit potential of the property. While petitioner eventually obtained an appraisal of what the property's estimated value*473 would be after remodeling, that appraisal was made 3 years after purchase and at the initiative of the lending bank. Petitioner resided in the clubhouse for over 3 years after purchase. During those years, he treated it as his personal residence for income tax purposes. On his income tax returns for 1980 through 1983, he deducted interest and taxes on the property as itemized deductions rather than business expenses. Petitioner did not live in the clubhouse during remodeling, but once work on the property stopped, petitioner moved back into the clubhouse. He continued to live there until he conveyed the property to the bank. Petitioner relies on his acquisition of remodeling plans in September 1983, his construction loan in November 1983, and the actual remodeling work in 1984, to demonstrate that he held the property primarily for profit. However, we find that all of these actions, taken over 3 years after becoming a resident, are consistent with the use of the property as petitioner's residence. We find that petitioner has failed to prove that his primary intent at the time of purchase was to hold the property for sale for profit. Despite the fact that a taxpayer acquires*474 property intending to use it primarily as his personal residence, he may deduct losses with respect to that property if it has subsequently been appropriated to income-producing purposes. Neave v. Commissioner, 17 T.C. 1237">17 T.C. 1237, 1243 (1952). This Court has set forth a nonexclusive list of five factors to be considered in determining whether an individual has converted his residence to property held for the production of income. These factors are: (1) The length of time the house was occupied by the individual as his residence before placing it on the market for sale; (2) whether the individual permanently abandoned all further personal use of the house; (3) the character of the property (recreational or otherwise); (4) offers to rent; and (5) offers to sell. Grant v. Commissioner, 84 T.C. 809">84 T.C. 809, 825 (1985), affd. in an unpublished opinion 800 F.2d 260">800 F.2d 260 (4th Cir. 1986); Newcombe v. Commissioner, 54 T.C. 1298">54 T.C. 1298, 1300-1301 (1970). After consideration of these factors, we are not persuaded that such a conversion took place. In fact, the only evidence suggesting that petitioner had a profit objective was his own testimony*475 that he believed that the property was a good investment. We accept the fact that petitioner hoped to realize a gain on any eventual sale of his residence. However, the mere hope or expectation of gain does not automatically result in a conversion of a personal residence into property held for the production of income. Jasionowski v. Commissioner, 66 T.C. 312">66 T.C. 312, 323 (1976). There is also affirmative evidence that petitioner never intended to convert the property from residential use. When petitioner obtained construction financing in 1983, he was required by the bank to reveal his intended use of the property. Petitioner told the bank that his intention was to use the remodeled property as his personal residence. Petitioner has failed to prove that the subject property was purchased for, or subsequently appropriated to, income-producing purposes. As a result, the loss on disposition of the property is not deductible under section 165(c). 5*476 The next issue for decision is whether petitioner is entitled to deduct amounts paid for interest, real estate taxes, escrow fees, and other bank service charges relating to the subject property in the amounts of $ 21,959 6 in 1984 and $ 2,304 in 1985 as either business expenses under section 162 or expenses incurred in the production of income under section 212. Section 162(a) provides for the deduction of ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. To be engaged in a trade or business, the taxpayer's primary purpose for engaging in the activity must be for income or profit. Commissioner v. Groetzinger, 480 U.S. 23">480 U.S. 23, 35, 94 L. Ed. 2d 25">94 L. Ed. 2d 25, 107 S. Ct. 980">107 S. Ct. 980 (1987). We have already found that petitioner's primary objective was not profit at the time of acquisition of the subject property or anytime thereafter. Therefore, petitioner was not engaged in a trade or business and is not entitled to deduct his expenses under section 162 in either 1984 or 1985. For the same reason, petitioner may not deduct his real estate expenses for 1984 or 1985 under section 212(2) as expenses incurred for the production of income. See Dean v. Commissioner, 83 T.C. 56">83 T.C. 56, 73 (1984);*477 Jasionowski v. Commissioner, supra at 318-319. The next issue for decision is whether petitioner is liable for the 5-percent addition to tax for negligence under section 6653(a)(1) for 1984 and 1985. Section 6653(a)(1) provides that if any part of any underpayment of tax is due to negligence or intentional disregard of rules or regulations, there shall be added to the tax an amount equal to 5 percent of the underpayment. For the purposes of this section, negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Respondent's determination of negligence is presumed correct, and petitioner*478 bears the burden of proving otherwise. Hall v. Commissioner, 729 F.2d 632">729 F.2d 632, 635 (9th Cir. 1984), affg. a Memorandum Opinion of this Court; Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791 (1972). Petitioner deducted a loss and expenses related to the clubhouse property that could only be deducted if he held that property primarily for profit. We have found that the property was held primarily for use as his personal residence. Petitioner has not presented any credible evidence as to why the negligence addition should not be imposed. Therefore, we hold that petitioner is liable for the addition to tax for negligence under section 6653(a)(1) for 1984 and 1985. The next issue concerns respondent's motion to amend his answer. Respondent asks this Court to allow him to amend his answer so that he may assert further additions to tax under sections 6653(a)(2) and 6661(a). Rule 41(a) allows for amendment of the pleadings "when justice so requires." In making this determination, we focus on whether petitioner would be prejudiced thereby. Waterman v. Commissioner, 91 T.C. 344">91 T.C. 344, 349 (1988); see Estate of Horvath v. Commissioner, 59 T.C. 551">59 T.C. 551, 555 (1973).*479 Respondent asserts that the proposed amendment does not prejudice petitioner as it merely corrects a mathematical error. Petitioner contends that respondent is not merely seeking a correction, but is attempting to assert completely new additions to tax. Respondent determined four adjustments to income for 1984 in his notice of deficiency. He specifically based the additions to tax under sections 6653(a)(2) and 6661(a) on three of these adjustments (the Schedule C real estate expenses adjustment, the damage settlement adjustment, and the adjustment for gain on sale of a residence). No additions were determined with respect to the adjustment for the claimed loss on disposition of the property (the "cost of goods sold" adjustment). Prior to trial, the parties stipulated that they had "abated and settled" the three adjustments upon which the sections 6653(a)(2) and 6661(a) additions to tax had been asserted. With respect to the additions to tax, the stipulation provides that the 1984 additions to tax, if any, are to be recalculated based upon this stipulation. Petitioner argues that at the time of trial, the only additions to tax at issue were related to the Schedule C real estate*480 expenses claimed in 1984. It is petitioner's position that neither respondent's statutory notice, the pleadings, nor the stipulation gives any notice that respondent was claiming additions to tax with respect to the $ 41,622 which petitioner claimed as a loss on the disposition of the property. We agree. In order to find that the effect of respondent's motion is merely a mathematical correction, we would have to find that the parties had agreed that the sections 6653(a)(2) and 6661(a) additions to tax would apply to any understatement resulting from the disallowance of "cost of goods sold" in the amount of $ 41,622. There is no basis for us to make such a finding. The stipulation language regarding recalculation of additions to tax is limited to the adjustments discussed therein which does not include the $ 41,622 adjustment. We find respondent is attempting to assert new additions to tax under sections 6653(a)(2) and 6661(a) with respect to the $ 41,622 adjustment. Respondent has failed to persuade us that justice requires that we allow him to amend his answer. In light of the stipulation of the parties, the additions to tax under sections 6653(a)(2) and 6661(a) which were*481 in issue at the time of trial were relatively insignificant. Petitioner presented little evidence on these issues. To allow respondent to raise a new issue under these circumstances would be unfair. Respondent's motion will therefore be denied. The next issue is whether petitioner is liable for the addition to tax under section 6653(a)(2) as determined in the notice of deficiency. Section 6653(a)(2) provides that if any part of an underpayment of tax is due to negligence or intentional disregard of rules and regulations, there shall be added to the tax, in addition to the 5 percent addition provided in section 6653(a)(1), an amount equal to 50 percent of the interest payable under section 6601 with respect to the portion of such underpayment which is attributable to negligence. We have already found that petitioner failed to prove that he was not negligent. In light of our denial of respondent's motion to amend his answer, only that portion of the underpayment of tax attributable to the adjustments which were designated in the notice of deficiency as being due to negligence is to be considered in computing the section 6653(a)(2) underpayment. The underpayment to which section*482 6653(a)(2) applies should also be computed in accordance with the previously mentioned stipulation. The final issue for decision is whether petitioner is liable for an addition to tax pursuant to section 6661(a) for substantial understatement of income tax for 1984. This addition to tax is equal to 25 percent of the amount of any underpayment of tax attributable to such understatement. Petitioner has not established that he falls within any of the statutory exceptions in section 6661(a); however, as previously mentioned, the notice of deficiency did not determine that this addition to tax applied to any of the understatement of tax related to the "cost of goods sold" adjustment. An understatement of income tax is considered substantial if it exceeds the greater of $ 5,000 or 10 percent of the tax required to be shown for the taxable year. Sec. 6661(b)(1). In light of our disposition of respondent's motion to amend his answer and the aforementioned stipulation of the parties, it is not clear whether there is a substantial understatement. This will have to be determined in the Rule 155 computation. However, the understatement to which section 6661(a) might apply should not include*483 any understatement of tax resulting from the $ 41,622 "cost of goods sold" adjustment. Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The evidence in the record is not clear as to whether this figure represents the value at the time of appraisal or upon completion of remodeling. However, it would be consistent with the previous transaction between petitioner and the bank, that the property be appraised at its value upon completion.↩3. This adjustment for capital gains is 40 percent of the determined gain of $ 55,000. See sec. 1202.↩4. Adjustment 16 in the notice of deficiency includes all of the additions to tax determined by respondent.↩5. At trial, petitioner argued in the alternative that he would be entitled to deduct the loss as a casualty loss under sec. 165(c)(3)↩. Petitioner raised this argument for the first time at trial. Petitioner failed to amend his petition to include this issue and explicitly abandoned it on brief.6. As previously indicated, the parties have agreed that if this amount is not allowed as a business expense or an expense incurred for the production of income, then $ 15,964 in interest and $ 1,084 in real estate taxes will be allowed as itemized deductions for 1984.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619484/ | LYLE W. AND SUE K. BRITT AND LAW OFFICE OF LYLE W. BRITT, CHARTERED, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBritt v. CommissionerDocket No. 663-87United States Tax CourtT.C. Memo 1988-419; 1988 Tax Ct. Memo LEXIS 437; 56 T.C.M. (CCH) 56; T.C.M. (RIA) 88419; September 6, 1988*437 After receiving an extension of time within which to file, petitioner prepared a 1983 joint Federal income tax return on behalf of himself and his wife shortly before the August 15, 1984, due date. The return was not received by respondent, who on August 20, 1985, filed a "dummy" return on petitioner's behalf which designated petitioner's filing status as married filing separately. Thereafter, petitioner tendered a joint return to respondent which we ordered filed. Held: based on deemed admitted facts, sec. 6653 (b). Held further: the purported return individually is not a valid return and not a separate return for purposes of sec. 6013(b). Held further: petitioner is entitled to elect to file a joint return under sec. 6013(b)(1). Lyle W. Britt, pro se. Juandell D. Glass, for the respondent. WHITAKERMEMORANDUM FINDINGS OF FACT AND OPINION WHITAKER, Judge: By three separate notices of deficiency, each dated October 7, 1986, respondent determined deficiencies in and additions to petitioners' Federal income taxes for the years and in the amounts as follows: LYLE W. BRITTAdditions to TaxSection 1*438 SectionSectionSectionYearDeficiency6653(b)(1)6653(b)(2)665466611983$ 34,357$ 17,178 50% of interest$ 2,103$ 3,436 due on $ 34,357LYLE W. AND SUE K. BRITTAdditions to TaxSectionSectionSectionYearDeficiency6653(b)(1)6653(b)(2)66611981$ 10,857$ 5,428 ----19826,0923,046 50% of interest$ 609 due on $ 6,092LYLE W. BRITT CHARTEREDAdditions to TaxSectionSectionYearDeficiency6653(b)(1)6653(b)(2)1981$ 3,613.73$ 1,806.87 --19822,677.421,338.71 50% of interest due on $ 3,677.4219838,670.054,335.02 50% of interest due on $ 8,670.05Petitioners, who have been most uncooperative in all their dealings with respondent, were not permitted to present evidence concerning corporate expenditures on behalf of the individual petitioners, as facts pertaining to these matters were deemed admitted pursuant to Rule 90(c). 2 Petitioners were however allowed to present evidence pertaining to whether they filed a joint 1983 Federal income tax return and whether a 1969 Jaguar automobile was received by Lyle Britt in 1983 as payment for services. Accordingly, requests for admissions concerning these items are not deemed admitted. 3 Respondent has since *439 conceded the issue regarding the automobile. The remaining issues are whether petitioners are liable for an addition to tax for fraud under section 6653(b) and whether petitioners' 1983 Federal income tax liability is to be computed on the basis of the rates applicable to a husband and wife filing a joint return. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation and attached exhibits are incorporated herein by this reference. Additionally, some of the facts have been deemed admitted pursuant to Rule 90(c). Respondent's request for admissions is incorporated herein by reference. At the time their petitions were filed, the individual petitioners 4*440 were residents of Derby, Kansas, and Lyle W. Britt, Chartered (Chartered), had its principal place of business in Wichita, Kansas. Petitioner filed timely joint Federal income tax returns with his wife for the years 1981 and 1982. Chartered filed timely Federal income tax returns for all years at issue. Chartered is wholly owned and controlled by petitioner, who practiced law through it as a sole practitioner. Petitioner supervised the maintenance of the corporate books and records and also the preparation and filing of the corporate tax returns. He personally prepared the personal income tax returns for himself and his wife. At various times during the years in issue, Chartered paid petitioner's FICA taxes, deducting those payments as both business expenses and petitioner's salary. Chartered also paid part or all of the Federal, state, local, and personal property taxes of petitioner and his wife for those years. Finally, Chartered paid for many of the personal expenses of petitioner and his wife. In many cases, Chartered took deductions for these expenditures, although they were not reflected on petitioner's Form W-2, nor did he otherwise report those sums as income. These expenditures, as well as whether they were paid from Chartered's operating or trust account, are set forth with more specificity in Appendix A. On April 14, 1984, petitioner *441 and his wife filed an application for an automatic extension of time within which to file their 1983 Federal income tax return. That request for extension showed no taxes to be due. In the few days before August 15, 1984, when the automatic extension was to expire, petitioner prepared a 1983 joint Federal income tax return for himself and his wife which they both duly executed. Petitioner placed the return in an envelope provided by the Internal Revenue Service which accompanied petitioner's Form 1040 packet. Petitioner then took the return to his office where the return was mailed along with the regular office mail. An audit of petitioner's 1983 tax year was begun on November 30, 1984, by revenue agent Steven J. Glotzdach, who was the first to inform petitioner that he had no 1983 Federal income tax return on file. Petitioner provided agent Glotzdach with an unsigned photocopy of the 1983 return which he had previously prepared, asking him to accept it then for filing. Agent Glotzdach refused to accept the return, telling petitioner that a return could not be filed once an audit had begun. Petitioner made no further effort to file his 1983 Federal income tax return until after *442 trial when, at the Court's suggestion, petitioner prepared, executed, 5 and delivered to respondent's counsel a 1983 joint Federal income tax return utilizing the married filing jointly rates. The return was based upon the income and deductions determined by respondent in the statutory notice modified only by respondent's concession with respect to the automobile. That return was ordered filed with respondent by this Court by order dated June 3, 1988, as amended on June 22, 1988. Respondent's Certificate of Official Record, made part of the record herein, reflects the filing on April 15, 1984, of petitioner's request for an extension of time within which to file a 1983 joint return. That Certificate also reflects respondent's filing of a substitute for return on August 20, 1985. That unsigned return consisted of only the front page of a Form 1040 containing petitioner's name and address, taxpayer identification number, and number of dependency exemptions, and designated his filing status as married filing separately. The Certificate does not reflect the filing of a joint return for 1983. OPINION The vast majority of facts describing *443 the transactions of Chartered and petitioner are based upon respondent's request for admissions which are deemed admitted under Rule 90(c). Respondent relies upon these deemed admitted facts in support of his determination that petitioners are liable for the addition to tax for fraud pursuant to section 6653(b); respondent bears the burden of proof on this issue. Sec. 7454(a); Rule 142(b). We held in Marshall v. Commissioner,85 T.C. 267">85 T.C. 267 (1985), that when facts deemed admitted under Rule 90(c) are sufficient to carry the burden of proof imposed upon respondent, no further evidence need be introduced.6We find that petitioner diverted corporate funds for his personal use, with Chartered in many instances claiming deductions under section 162. However, petitioner never reported the expenditures as income, nor were they reflected on his W-2 forms. In Meyers v. Commissioner,21 T.C. 331">21 T.C. 331 (1953), we sustained respondent's determination of fraud under similar circumstances. *444 Although the taxpayer in Meyers had entered a plea of guilty in criminal tax proceedings, we found the proof presented to us would have sustained respondent's determination even in absence of such a plea. In this regard, we stated that: It is sufficient to point out that the evidence discloses a plan of petitioner * * * to obtain earnings of the Corporate under the guise of corporate expenses and capital outlays, and not include the distributions in returns for tax purposes. The scheme and the effort made to conceal the actualities contain all of the essential earmarks of a determination to evade income taxes by false and fraudulent means.Meyers v. Commissioner, supra at 348. Meyers is also instructive on the issue of the determination of fraud against Chartered. In that regard, we stated that: The plan, as conceived by petitioner, required participation by the corporation, which was no obstacle in view of his complete ownership of its stock * * *. The intent of the individuals under the circumstances is to be imputed to the Corporation. Auerbach Shoe Co.,21 T.C. 191">21 T.C. 191. The amounts were deducted in the returns of the corporation as salary, with knowledge that no services had been *445 performed for the payments and that the deductions were nothing more than a detail in a general scheme to withdraw profits of the enterprise for the account of petitioner under the guise of legitimate operating expenses. Such action discloses fraudulent returns with intent to evade tax. Coast Carton Co.,3 T.C. 676">3 T.C. 676, affd. 149 F.2d 739">149 F.2d 739. [Meyers v. Commissioner, supra at 348-349.]We therefore find petitioner and Chartered liable for an addition to tax under section 6653(b). We do not, however, find that Sue Britt shares in petitioner's and Chartered's liability for fraud. The complete control exercised by Britt over Chartered which is a persuasive element in Chartered's liability for the penalty makes it less likely that she "intended to evade taxes known to be owing by conduct intended to conceal, mislead or otherwise prevent the collection of such taxes." Rowlee v. Commissioner,80 T.C. 1111">80 T.C. 1111, 1123 (1983). While the deemed admissions contain some indicia of her acquiescence, they reveal that it was petitioner who had sole responsibility for the preparation of Chartered's tax returns and personally prepared those for himself and his wife. In the absence of evidence other than that *446 found in the request for admissions, respondent has not proven fraud on the part of Sue Britt by clear and convincing evidence. Sec. 7454(a); Rule 142(b). Petitioner next contends that his testimony establishes that he and his wife filed a timely 1983 joint Federal income tax return by mail on or before the date on which their automatic extension expired in 1984. Respondent has no record of such a return being filed and argues that petitioner's testimony is insufficient to prove mailing. Further, respondent argues that he filed a separate return on petitioner's behalf pursuant to section 6020(b), and that since petitioner has filed a petition with this Court he is prohibited by section 6013(b) (2) (C) from now electing to file a joint return. Section 7502 provides procedures whereby timely mailing of a document required by any internal revenue law shall be considered timely filing. However, that section is inapplicable when, as here, the document is not delivered. Sec. 301.7502-1(d), Proced. & Admin. Regs. The risk of nondelivery rests upon petitioner, Walden v. Commissioner,90 T.C. 908">90 T.C. 908 (1988). However, in a case not concerning section 7502, this Court has recognized a presumption *447 of filing based on oral proof of mailing, Mitchell Offset Plate Service Inc. v. Commissioner,53 T.C. 235">53 T.C. 235 (1969). While the majority of the parties' effort at trial was directed toward this issue, we find that its resolution is not necessary in reaching our decision. Respondent did not determine an addition to tax pursuant to section 6651 for failure to file a timely return. 7 The date the return was filed is therefore irrelevant for that purpose. However, respondent did determine an addition to tax for fraud pursuant to section 6653(b) for 1983. That addition is imposed on any underpayment for that year. Section 6653(c) defines an underpayment as a deficiency defined in section 6211. However, in determining the amount of underpayment, the actual tax due is reduced by the tax shown on the return only if that return is timely filed, taking into account any extensions. Therefore, in the absence of a timely filed return, an underpayment is the amount of tax imposed (in this case by subtitle A of the Code). Sec. 301. 6653-1(c) (1) (ii), Proced. & Admin. Regs. If petitioner proves that he filed a timely 1983 joint return, the underpayment would be reduced by the amount of tax shown *448 on that return. However, an unsigned photocopy of the joint return which petitioner purportedly mailed to respondent shortly before August 1, 1984, and which petitioner tendered to agent Glotzdach upon audit, was a stipulated exhibit and shows no tax due. Therefore, even were we to assume that return to have been timely filed, the amount of the underpayment would be unchanged. Neither does petitioner's assertion that he is entitled to utilize the married filing jointly rates require us to determine whether petitioner filed a timely 1983 joint return. In Phillips v. Commissioner,86 T.C. 433">86 T.C. 433, 440 (1986), affd. in part and revd. in part [Illegible Word] 51 F.2d 1492">51 F.2d 1492 (D.C. Cir. 1988) (Phillips I), we held that a "dummy return such as the one filed by respondent in this case does not constitute a separate return for purposes of section 6013(b). 8 We stated that "Where as here, no return was filed prior to the return on which joint return status is claimed, the limitations of paragraph (2) of subsection (b) of *449 section 6013 are inapplicable." We also noted that the legislative history did not suggest that an election to file a joint return where none had been filed previously was precluded by section 6013(b) (2). A different result is not required by the Tenth Circuit's holding in Smalldrige v. Commissioner,804 F.2d 125">804 F.2d 125 (10th Cir. 1986), in which the Court found that the commissioner filed a valid return on behalf of the taxpayer pursuant to section 6020(b). The "return" filed by respondent on petitioner's behalf contains no more than petitioner's name, address, taxpayer identification number, number of dependency exemptions, and his filing status, which respondent designated as married filing separately. That document does not contain sufficient data to calculate tax liability. See Beard v. Commissioner,82 T.C. 766">82 T.C. 766, 777 (1984), affd. per curiam 793 F.2d 139">793 F.2d 139 (6th Cir. 1986). In this case the return filed by respondent for petitioner was incomplete and was unsigned. It consisted of the front page of a Form 1040, and contained only petitioner's name, address, identification number, number of dependency exemptions, and designated *450 filing status as married filing separately. Such a document does not comply with section 6020(b) and does not constitute a valid return. Phillips v. Commissioner,86 T.C. 433">86 T.C. 433 (1986)Phillips I). Thus, Smalldrige v. Commissioner is not in point. That case is "based upon the conclusion that respondent filed valid returns pursuant to section 6020(b)." Phillips v. Commissioner,88 T.C. 529">88 T.C. 529, 534 n. 8 (1988). Since no separate return was filed for purposes of section 6013 (b) (1), we hold that petitioner is entitled to file a joint Federal income tax return with his wife for 1983, and that the return filed pursuant to this Court's order of June 3, 1988, as amended, is such a return. Decision will be entered under Rule 155.APPENDIX A On November 16, 1987, respondent filed with the Court his request for admissions as follows: 1. During the taxable years 1981 , 1982 and 1983, Britt was a practicing attorney who practiced for his wholly-owned and controlled corporation, Lyle W. Britt Chartered, of which he was the president and sole officer. 2. Britt was the sole attorney practicing for Chartered during the years 1981 through 1983 (hereafter years in issue). 3. In his capacity as president *451 and sole officer of Chartered, Britt was solely and directly responsible for and controlled the day-to-day operations of Chartered. 4. Britt personally directed, controlled and supervised the employees of Chartered in the maintenance of the corporations books and records during the years in issue. 5. Britt prepared or caused to be prepared Chartered's income tax returns for each of the years in issue, and Britt signed and filed or caused those returns to be filed for each of the years in issue. 6. During the years in issue, Chartered was engaged in the business of providing legal services for which income was received. 7. Britt personally maintained the books and records of Lyle and Sue Britt for the taxable years 1981 and 1982. 8. Britt personally prepared the 1981 and 1982 income tax returns of Lyle and Sue Britt, which returns were examined, signed and filed by them for those years. 9. Britt was personally responsible for maintaining books and records of his income, deductions and liability for taxes for the taxable year 1983. * * * 11. During the years 1981, 1982 and 1983, Chartered paid Britt's F.I.C.A. taxes in the amounts of $ 1,975.05, $ 2,171.80 and $ 2,3091.90, *452 respectively, without deducting those from his salary and without including those amounts as income on Britt's Forms W-2. 12. In 1982 and 1983, Chartered paid from its account no. XX2763 the personal federal income tax liabilities of the Britts for the taxable years 1981 and 1982 in the amounts of $ 1,551.00 and $ 4,146.00, respectively, and those payments were not included in the income shown on Britt's Forms W-2 or reported on the income tax returns for the respective years. 13. Payments were made to GMAC on Britt's Camaro from Chartered's account no. XX2763 in 1981 and 1982 in the amounts of $ 1,857.08 and $ 1,370.90, respectively. 14. In 1982, payments were made from Chartered's account no. XX2763 for (a) the Britt's income tax penalties for 1981 in the amount of $ 119.15, (b) the Britt's Kansas income tax liability for the year 1981 in the amount of $ 297.56, (c) personal property tax, tag and penalty for Britt's Camaro in the amount of $ 209.25, and (d) on Britt's loan no. 108549 at Valley State Bank in a total amount of $ 5,959.74. 15. In 1983, payments were made from Chartered's account no. XX2763 for the items and amounts as follows: ItemAmounta. Britt's Kansas Income Tax for 1982$ 471.26b. Jaguar insurance$ 63.23c. Sue Britt travel (check no. 2165)$ 608.00d. IRA for 1982$ 2,250.00e. Carl Heidolph-home improvements(check nos. 1911 and 1887)$ 1,100.00f. Valley State Bank -- Loan Nos.1085406 and 1085417$ 1,730.00*453 16. In 1981, payments were made from Chartered's Trust Account no. XX3174 as follows: ItemAmounta. Britt (check no. 319)$ 1,000.00b. Jewelry-Sue Britt (check no. 357)$ 1,000.00c. Britt (check no. 358)$ 1,100.0017. In 1983, the following payments were made from Chartered's Trust Account No. XX3174 on Valley State Bank loans nos. XXX5403 and XXX5416 of which $ 1,740.04 and $ 1,313.00, respectively, represented personal loan payments. 18. In 1983, the payment of $ 6,456.32 was made to Wichita State Bank on a loan of World of Rodeo from Chartered's Trust account no. XX3174. 19. World of Rodeo is wholly-owned by Lyle and Sue Britt. 20. Britt reduced an invoice to the Britts from Mike Turpin for $ 1,016.00 by $ 350.00 for professional services in 1982. 21. During 1981, 1982 and 1983, unidentified deposits were made to the Britt's personal checking account no. 331449 at Valley State Bank in the total amounts of $ 2,750.05, $ 1,320.68 and $ 3,911.83, respectively, as is more specifically set out by date and amount on Exhibit A. 22. In 1983, the Britts made currency deposits of $ 870.00 and $ 4,100.00 to their Valley State Bank account no. XX1449. 23. During 1981, 1982 and 1983, *454 Chartered paid medical expenses for the Britts in the total amounts of $ 2,047.64, $ 2,457.23 and $ 3,476.85, respectively. 24. Chartered did not pay medical expenses for other full time employees, other than premiums for medical insurance. 25. On June 22, 1983, currency in the amount of $ 5,500.00 was deposited to the bank account of World of Rodeo. * * * 27. In 1983, Britt expended $ 15,714.47 more than he had available from known and reported sources of income as shown on Exhibit A-1 to the statutory notice of deficiency. 28. In 1983, Britt received wages from Chartered in the amount of $ 52,161.60. 29. Title to the 1969 Jaguar referred to in paragraph 26 above was applied for in April 1984 in the name of Sue Britt and was conveyed from Mike Rogge on July 5, 1983. 30. Rodeo Publishing Corporation, Inc., did not file a Federal income tax return, Form 1120-S, for the taxable year 1983. 31. In 1983, Rodeo Publishing Corporation, Inc., sustained an ordinary loss due to business operations of $ 22,915.63 and Schedule D losses of $ 46,623.07. 32. Lyle and Sue Britt claimed a $ 28,901.00 medical deduction on their Form 1040 for 1980 for costs of a pool, spa (jacuzzi) and *455 pool house, which amount included the excess of the Britts' claimed cost of $ 59,126.00 over their claimed increase in the fair market value of the property of $ 29,800.00. 33. In 1981, the Britts claimed the following items as medical expense deductions and those same items were claimed by the Britts as 1980 medical expense deductions. ItemAmounta. Superior Plumbing$ 606.40b. Current Electric$ 104.88c. Aggregate Sand$ 403.87d. Metz Lumber$ 80.02e. Jack's Tile$ 2,045.00f. Mike's Air & Heating$ 412.00Total$ 3,652.1734. In 1981, the Britts claimed payments to Executive Pool of $ 2,000.00 and $ 2,720.00 as medical expense deductions and also claimed those amounts as part of the 1980 medical expense deductions. 35. The Britts claimed the $ 1,133.00 cost of a spa/hot tub heater on their 1981 return as a casualty loss and also claimed that amount as a medical expense, and they were reimbursed $ 883.00 by the insurance company for this spa/hot tub heater. 36. In 1981, the Britts claimed additional medical expenses deductions in the amounts of $ 3,573.94 and $ 8,998.20 as more specifically set forth at items 1 and 2 of Exhibit B. 37. In 1982, Chartered received repayments *456 of client advances which had been previously deducted as business expenses in the amount of $ 2,469.70 which amount was not recorded on the corporate records as income or as a deduction of business expenses. 38. In 1982 and 1983, Chartered deducted as business tax expense corporate payments of personal income tax and property tax of Britt. 39. During the years 1981, 1982 and 1983, Chartered deducted as business tax expenses payments of trust fund taxes for F.I.C.A., state income tax and Federal income tax and also deducted those same amounts as expenses for salaries or wages. 40. Chartered claimed an independent contractor expense of $ 1,020.00 on its 1983 return and also claimed the same payment as a janitor expense on its books and 1983 return. 41. Chartered claimed the full cost of an automobile acquisition as a business expense on its 1981 return. 42. In 1982 and 1983, Chartered claimed loan repayments in the amounts of $ 5,959.74 and $ 3,458.99 as corporate business expenses. 43. In 1983, Chartered paid $ 300.00 to Jeff DeHon and $ 160.00 to Bill Buck for services in the adoption of Adrienne by the Britts and charged those payments off as corporate business expenses. *457 44. In 1982, Chartered deducted a $ 1,000.00 loan to James Britt, Britt's father, as a business expense. 45. The Britts owned a 1982 Chevy Van which was used 100 percent for personal use. 46. Chartered claimed equipment expense of $ 4,834.42 in 1982, but has not produced any documentary evidence to substantiate this expenditure, its nature or purpose. 47. In 1981, Chartered paid $ 6,357.08 for two automobiles, consisting of $ 4,500.00 to Miller for a 1977 Corvette and $ 1,857.08 to GMAC for a 1981 Camaro, all of which was deducted as corporate expenses. 48. During the years 1981, 1982 and 1983, Chartered had a medical reimbursement plan; however, the employees other than Britt were not notified of that and employees other than Britt were not reimbursed for any medical, drug or doctors cost. 49. In 1983, Chartered deducted a $ 700.00 payment to Carl Heidolph as a corporate legal expense; however, the expense was for home improvement work on Britts' personal residence. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. 2. Respondent's request for admissions is attached to this opinion as Appendix A. ↩3. These requests are not included in Appendix A. ↩4. Sue Britt is not a petitioner with respect to 1983, having been issued no statutory notice of deficiency for that year. For convenience all further references to petitioner are to Lyle Britt. 5. Petitioner's wife also executed this return. ↩6. See also Doncaster v. Commissioner,77 T.C. 334">77 T.C. 334↩ (1981), where facts in respondent's answer deemed admitted under Rule 37(c) were held to be sufficient to carry respondent's burden regarding the addition to tax for fraud. 7. Pursuant to section 301.6653-1(b) (2) (i)↩, Proced. & Admin. Regs., an addition to tax for late filing is not assessed in cases where an addition to tax for fraud is assessed. 8. On appeal, respondent abandoned his argument to the contrary. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619485/ | NIAGARA FALLS BREWING CO., AND PAUL SCHOELLKOPF, CHARLES E. HAEBERLE, FRED H. KRULL, EDSON P. PFOHL, ALBERT T. MAYLE, FREDERICK CHORMANN, RUDOLF V. ROSE, AND GEORGE F. NYE, AS DIRECTORS AND TRUSTEES IN DISSOLUTION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Niagara Falls Brewing Co. v. CommissionerDocket No. 7952.United States Board of Tax Appeals13 B.T.A. 1040; 1928 BTA LEXIS 3115; October 16, 1928, Promulgated *3115 1. Held, that the petitioner is not entitled to a deduction for obsolescence for intangible assets, including good will. 2. Where prior to enactment of war-time and permanent prohibition the petitioner had been engaged in the manufacture and sale of beer and "near beer" and after October 28, 1919, ceased to manufacture and sell beer but continued to make and sell "near beer," using the same machinery and process as had been previously used in the manufacture of beer with the exception of dealcoholization before bottling, held, that the petitioner is not entitled to a deduction for obsolescence on such property. 3. Evidence held insufficient to determine the amount of obsolescence sustained by the petitioner as a result of having abandoned the lower floor of one of its buildings as a result of having ceased to make beer. 4. Losses claimed as a result of the decrease in value of tangible assets continued in use denied. Basil Robillard, Esq., and Edward C. Gruen, C.P.A., for the petitioners. M. E. McDowell, Esq., for the respondent. TRAMMELL *1040 This is a proceeding for the redetermination of deficiencies in income*3116 and profits taxes of $20,975.05 for 1918 and income tax of $5,013.65 for 1919. The deficiencies result principally from the respondent's having disallowed for 1918 a deduction of $110,047.52 and for 1919 a deduction of $57,139.99. The deductions were taken by the petitioner in its returns for the respective years as obsolescence on tangible assets resulting from the enactment of war-time prohibition legislation and the ratification of the Eighteenth Amendment. It was admitted by the respondent at the hearing that he had failed to allow as a deduction an amount of $5,000 representing a part of a loss sustained on the sale of certain property in 1918. From the pleadings, a stipulation, documentary evidence and depositions, we make the following - FINDINGS OF FACT. The petitioner, a New York corporation, was organized February 26, 1902, and had its office and place of business at Niagara Falls. The business of the petitioner prior to the incidence of the Eighteenth Amendment to the Constitution of the United States and the Acts of Congress in the enforcement thereof, was the manufacture, production, distribution and sale of a malt and spirituous *1041 liquor known as*3117 beer, containing more than one-half of one per cent of alcohol by volume. The petitioner's business and good will were created by the manufacture and sale of such beverage. In 1902 the petitioner purchased the buildings and equipment of the Niagara Falls Brewing Co., a joint stock association existing in Niagara Falls, N.Y., and assumed the current liabilities of the association. The petitioner thereafter constructed some new buildings and purchased and installed some additional machinery, fixtures and equipment, all of which were specially constructed, designed or adapted to the petitioner's business of manufacturing beer, and were not available or practicably or readily adaptable to other uses. This property and equipment were devoted solely to the business of the petitioner in making beer and "Pep" beer, containing less than one-half of one per cent of alcohol by volume prior to the incidence of war-time prohibition and the Eighteenth Amendment and the statutes in enforcement thereof. About July 1, 1918, the petitioner commenced the manufacture of soft drinks in a separate building, with machinery distinct from that used in the manufacture of beer or cereal beverages and*3118 which was carried in a separate account on petitioner's books. The making and sale of beer and malt and spirituous liquors was discontinued because of the incidence of the Eighteenth Amendment and the statutes in enforcement thereof, but the making and sale of soft drinks and of beer of an alcoholic content of less than one-half of one per cent continued after the incidence of such amendment and statutes. Petitioner continued to make "near beer" after it had discontinued the manufacture of beer, in order to see if the plant could be made to pay by making this product, and also to keep the plant in action and save the machinery. No part of the obsolescence or extraordinary depreciation taken by the petitioner for the years in question was computed upon or taken on account of the depreciation of buildings, machinery and equipment used for the manufacture of soft drinks other than dealcoholized beer. The investment in equipment for the manufacture of soft drinks other than dealcoholized beer, and the depreciation accrued thereon were as follows: YearInvestmentDepreciation1918$5,033.0919198,175.98$553.3119209,027.541,448.4919219,200.791,448.49*3119 The buildings, machinery and equipment for the manufacture of beer and malt and spirituous liquors were acquired for the most *1042 part prior to March 1, 1913, and the cost, accrued depreciation, and depreciated cost thereof on March 1, 1913, were: CostAccrued depreciationDepreciated costLand$100,000.00$100,000.00Buildings196,667.97$48,475.79148,192.18Machinery71,769.6811,111.3360,658.35Casks and tanks27,643.006,668.5420,974.46Horses, wagons, etc8,988.50948.878,039.63Office furniture and fixtures2,238.90302.251,936.65Auto trucks4,900.00703.004,197.00Signs500.00125.00375.00Small cooperage2,576.502,576.50Saloon furniture and fixtures22,852.066,961.5215,890.54Outside property38,128.5538,128.55Total476,265.1675,296.30400,968.86On March 1, 1913, the plant and buildings had a value equal to the amount at which they were set up on the books. The cost, accrued depreciation and depreciated cost of the buildings, machinery and equipment on December 31, 1917, were as follows: CostAccrued depreciationDepreciated costLand$100,000.00$100,000.00Buildings229,999.32$80,851.25149,148.07Machinery117,618.0723,524.5894,093.49Casks and tanks40,399.357,855.7632,543.59Horses, wagons, etc8,643.501,391.767,251.74Office furniture and fixtures3,091.24878.502,212.74Auto trucks13,073.945,934.107,139.84Small cooperage18,497.7817,595.56902.22Saloon furniture and fixtures27,758.1419,414.988,343.16Outside property76,719.591,299.8475,419.75Total635,800.93158,746.33477,054.60*3120 At the end of 1917 petitioner's buildings and machinery had a value fully equal to that at which they were carried on its books. The book cost and net depreciated book cost of the fixed assets of the petitioner at December 31, 1918, and December 31, 1919, were: Dec. 31, 1918Dec. 31, 1919Book costNet depreciated costBook costNet depreciated costLand$100,000.00$100,000.00$100,000.00$100,000.00Buildings229,999.32108,057.31229,999.3263,008.03Machinery:Beer131,675.2132,500.00134,542.6319,966.71Soft drink4,533.094,533.097,400.186,946.87Casks and tanks40,399.355,000.0040,399.352,000.00Horses, wagons, etc8,638.501,000.008,570.50932.00Office furniture and fixtures3,101.74600.003,173.87400.00Auto trucks:Beer15,283.853,000.0015,568.603,284.75Soft drink500.00500.00775.80675.80Small cooperage2,632.71500.002,232.71100.00Saloon furniture and fixtures28,383.06100.0028,733.060Outside property38,128.5538,128.5538,147.2732,500.00Total603,275.38293,918.95609,543.29229,814.16*1043 The above items of cost, accrued*3121 depreciation, nd depreciated cost were determined by the respondent and accepted by the petitioner. In determining the depreciated cost there has been used a rate of depreciation fixed by the respondent. During 1917 and 1918 the petitioner's officers and directors were aware, through brewers' associations and other agencies, of the enactment of state and national legislation affecting its business as well as of the proposal and progress toward ratification of the Eighteenth Amendment. At different times during these years recently enacted or pending legislation regarding the brewing of malted liquors and the future prospects of the business as well as the future of the petitioner were discussed or considered by the executive committee of the board of directors, the board of directors, and the stockholders. The board of directors of the petitioner at a meeting held November 26, 1918, authorized the president and auditor of the company to investigate and make a report on the question of lawful depreciation to be taken on the plant, property and equipment of the company, in view of the pending prohibition legislation, in an amount which in the judgment of the president and auditor*3122 was just, lawful and proper. The charges against earnings for the year 1918 for depreciation and obsolescence as recorded on the petitioner's books and deducted in its return for that year were as follows: Regular depreciationObsolescenceBuildings$4,597.63$27,014.33Machinery5,389.9359,430.22Casks and tanks2,019.8116,912.87Horses, wagons, etc862.981,268.56Office furniture and fixtures152.48532.42Autos and trucks$2,611.26$2,204.40Small cooperage650.002,132.71Saloon furniture and fixtures833.21522.01Total17,117.30110,047.52The amount of the deduction for obsolescence was determined after discussions between the president, secretary, auditor, and brewmaster of the petitioner and after they had made surveys of the plant and machinery. The obsolescence taken was only on property that had been used to brew beer. The deduction for obsolescence represented the amount necessary to be written off the assets to bring them down to an amount which the petitioner's directors thought could be realized on them at a forced or liquidaion sale after the imminent prohibition legislation should become effective. The amount*3123 of the deduction taken was determined after inquiries by the president of the petitioner as to what the brewing machinery would bring in the case of prohibition. The deductions for depreciation and obsolescence were approved by the board of directors on February 5, 1919, and by the stockholders of the petitioner on February 11, 1919. *1044 During 1919 in addition to regular depreciation there were written off on petitioner's books additional amounts for obsolescence of property for which deductions for obsolescence had been taken for the prior year. The amounts written off in 1919 were based, among other things, on the fact that the assets of a similarly situated brewing company at Niagara Falls which had taken greater deductions for obsolescence than the petitioner had been sold in 1919 for only a fractional part of the amount at which the assets remained on the books. Other considerations were that the petitioner had to curtail the brewing of beer considerably more than theretofore, and that in the event that it attempted to dispose of its machinery it would not find any market because of so much of that kind of machinery being offered for sale. The charges against*3124 earnings of the year 1919 for depreciation and obsolescene as recorded on the books of the petitioner and deducted in its return for that year were: Regular depreciationObsolescenceBuildings5,049.28$40,000.00Machinery5,854.0210,000.00Casks and tanks2,071.52928.48Office furniture and fixtures157.89114.24Auto trucks100.000Small cooperate$400.000Saloon furniture and fixtures0$450.00Outside property05,647.27Total13,632.7157,139.99In a determination of the deficiencies herein involved the respondent disallowed the deductions taken by the petitioner for obsolescence and allowed deductions for depreciation and losses as follows: Claimed on original returnAllowed by respondentDifference1918Regular depreciation$17,117.30$20,552.05$+3,434.75Obsolescence110,047.52-110,047.52Loss, casks and tanks18,210.16+18,210.16127,164.8238,762.21-88,402.611919Regular depreciation13,632.7120,983.05+7,350.34Obsolescence57,139.99-57,139.9970,772.7020,983.05-49,789.65The petitioner gave up and abandoned the manufacture and sale of beer in 1919*3125 on account of the restrictions imposed by statute. The petitioner's officers considdered selling or converting its buildings and machinery into a plant for a dairy, cold storage, ice cream manufacturing, dry storage, ice manufacturing, fruit storage, semicold storage, machine shop and chemical plant. The president of the petitioner, who was familiar with the use of buildings for industrial *1045 purposes, could find no use for the buildings and machinery except for the purpose of brewing beer or making cereal beverages. Because of the buildings being damp, the floor levels uneven, and there being no elevators and but few openings for light, they were not readily adaptable for storage, manufacturing or industrial purposes. The buildings were zoned under the city zoning law in an industrial or manufacturing zone. Much of the brewing machinery could not be removed from the buildings without tearing out the walls of the buildings or dismantling the machinery, and some of the machinery could not be dismantled to the extent that it could be removed without tearing out a side of the building. Sales of the petitioner's products for the years 1912 to 1921, inclusive, were*3126 as follows: BarrelsBeerCereal beverageSoft drinks191233,177191337,581191432,756191530,681191638,388191737,19616191830,204327$6,092.35191917,823822,451.35192007,92121,507.43192102,85215,343.77The sale of beer was discontinued October 29, 1919. The first sale of cereal beverage, dealcoholized beer, was November 27, 1917, under he name of "Pep." The first sale of soft drinks was July 1, 1918. After the Eighteenth Amendment became effective the petitioner's sales of soft drinks and "near beer" declined, although the petitioner used as great effort to sell "near beer" and soft drinks as it had done theretofore. Up to the time of the hearing, the petitioner had used its best efforts to sell the premises and the highest offer was $35,000 cash, made by the president of a paper company which owns the adjoining premises. About December 27, 1921, the petitioner sold to the paper company whose premises adjoined those of the petitioner 1.39 acres of the 3.53 acres of its land for $20,000. The land, which was sold free of buildings, had a frontage of 197 feet and depth varying from 282 to 334 feet. *3127 The petitioner's lands, buildings, machinery and equipment were at all times mentioned herein owned by it absolutely and without encumbrances. *1046 The value of the property of the petitioner as determined by the city assessor of Niagara Falls for the assessment of property tax for the years indicated was as follows: Land value, exclusive of buildingsFull value of property less exemption, if any1917$47,900$223,460191847,990223,460191947,990183,460192029,360164,830(18,630)(18,630)1921$29,360$129,760(18,630)(18,630)192429,360104,760(18,630)(18,630)The amounts shown in parenthesis for the years 1920, 1921, and 1924 represent the values placed by the assessor on the property sold by the petitioner in 1921 to the paper company. The reduction in the values for the years 1919, 1921, and 1923 was made by the city assessor because the petitioner's buildings which had been constructed and used for brewing beer could no longer be used for that purpose on account of prohibition and because of the unsuitableness of the buildings for manufacturing purposes. Assessments on nonbrewery property generally*3128 were increased during the same period. The reductioin in the value was not made entirely prior to the year 1923 for the reason that prior thereto the city assessor had not as thoroughly gone into the question of the value of the property as he had at that time. When the petitioner ceased manufacturing beer on October 28, 1919, it abandoned the lower floor, consisting of storage space in a building on its premises designated in the evidence as Building No. 4. The space so abandoned had been used for the storage and aging of beer, but its use was not required in making the beverage containing less than one-half of one per cent of alcohol by volume. The cost of Building No. 4 to December 31, 1917, was $67,913.74, and the depreciation accrued to that date was $23,875.37, making a depreciated cost of $44,038.37. The cost of Building No. 4 to March 1, 1913, was $67,913.74, and depreciation accrued to that date amounted to $16,538.70, making a depreciated cost of $51,375.04. One of the petitioner's buildings, designated in the evidence as Building No. 3, was divided into two parts - easterly and westerly. About 1917, the petitioner rebuilt the inside of the easterly part of the*3129 building and installed a storage cellar and new filtering and bottling machinery. The cost of Building No. 3 to December 31, 1917, was $70,938.89, and the depreciation accrued to that date was $24,934.52, leaving a depreciated cost of $46,004.37. The cost of Building No. 3 to March 1, 1913, was $53,083.13, and the depreciation accrued to that date was $13,088.46, leaving a depreciated cost of $39,994.67. *1047 The cost to December 31, 1917, of the machinery in Building No. 3 was $27,453.09, and the depreciated cost at that date was $24,707.79. After October 28, 1919, and until about January, 1922, the easterly part of Building No. 3, with the equipment therein, was used about once every two weeks in making "near beer" or cereal beverage, and aside from this it was not used for any other purpose. Prior to October 28 1919, the easterly part of the building and the equipment therein were used about three or four times a week in making and bottling beer. Inasmuch as the petitioner could not operate its business at a profit after prohibition, it dissolved under voluntary consent of the stockholders by certificate to such effect filed with the Secretary of State of the State*3130 of New York on December 1, 1921, its affairs in dissolution being administered by its directors as trustees in dissolution. Under a lease dated January 31, 1922, and effective from January 15, 1922, the petitioner leased all its buildings, plant, and equipment, including its soft-drink equipment, under a lease running for a period of three months renewable at three-month intervals at the option of the lessee, and this lease at the time of the hearing was still in operation at an annual rental of $5,000, plus taxes, insurance, and repairs. This was the highest and only rental offered at any time to officers and agents of the petitioner for the property. The lessee was not a stockholder or director of the petitioner and had no financial connection with the petitioner at the time the lease was made. Although he was never a stockholder of the petitioner, he formerly had been its secretary, resigning in February, 1922, and a number of years prior thereto had been a director for one year. The value of petitioner's machinery in 1918 and 1919 after prohibition became reasonably certain was not in excess of $10,475, which was less than its book value either on December 31, 1918, or*3131 December 31, 1919, after deducting the amounts for obsolescence taken by the petitioner for the respective years. At the end of 1918 and 1919, the petitioner's land had a value of about $46,000, whereas the buildings had a value of about $34,000. The value of the land and buildings at the end of the respective years was less than their book value after deducting for obsolescence the amounts taken by the petitioner for these years in its returns. The difference between the value in 1918 and 1919 and depreciated cost of petitioner's machinery, buildings and land at December 31, 1917, was due to the imminence and incidence of war-time and permanent prohibition legislation. There was no material change in the value of land and buildings in the vicinity of those of the petitioner used for purposes other than brewing. *1048 In making the cereal beverage containing less than one-half of one per cent of alcohol by volume manufactured and sold by the petitioner after October 28, 1919, the same machinery and the same process, except the dealcoholizing before bottling, was used as had been used in making beer. This cereal beverage had the same appearance as the beer manufactured*3132 by the petitioner prior to October 28, 1919, but did not resemble it in taste, nor did it have the same popularity. In 1918, the petitioner sold certain property located at Main and Niagara Streets, Niagara Falls, N.Y., and the loss determined by the respondent was understated by $5,000 due to the respondent in his computation having overstated the amount of depreciation previously taken. OPINION. TRAMMELL: The errors assigned in the original petition were that the respondent failed to allow the petitioner as deductions in computing its net income, (1) "a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business of the taxpayer, including a reasonable allowance for obsolescence;" (2) "losses sustained during the taxable year and not compensated for by insurance or otherwise incurred in the trade or business of the taxpayer." With respect to the first assignment of error, it does not appear from the record that there is any controversy concerning deductions for the exhaustion, wear and tear of the property, but only as to the allowance of deductions for obsolescence. In its brief the petitioner states that the contention for an allowance*3133 of a deduction on account of the obsolescence of intangible assets, including good will, is not pressed in view of the Board's decisions following the case of Red Wing Malting Co. v. Willcuts, 15 Fed.(2d) 626. In view of the petitioner's statement and of our holding in Manhattan Brewing Co.,6 B.T.A. 952">6 B.T.A. 952, we must hold that the petitioner is not entitled to a deduction for either year on account of obsolescence of intangible property including good will. With respect to the assignment of error relating to obsolescence there remains to be considered the question of whether the petitioner is entitled to the deductions taken by it for obsolescence of tangible property as set out in our findings of fact. Prior to September 5, 1917, the petitioner's business was the manufacture, production, sale and distribution of beer containing more than one-half of one per cent of alcohol by volume. In November, 1917, the petitioner began to make and sell dealcoholized or "near beer." About the first of July, 1918, it began making and selling soft drinks. Since obsolescence is not claimed on assets used in the *1049 manufacture of soft drinks, no further*3134 consideration will be given to these. The petitioner continued to manufacture and sell these three products until October 28, 1919, when on account of wartime and permanent prohibition legislation and the ratification of the Eighteenth Amendment it ceased to manufacture beer. The petitioner continued until about the time of its dissolution in December, 1921, to manufacture and sell dealcoholized or "near beer," using the same machinery and the same process that were used in the manufacture of beer, with the exception of dealcoholization before bottling. Immediately after dissolution the petitioner's plant was rented to a former officer and continued in use for making "near beer." The assets used in the manufacture and sale of beer were continued in use in the manufacture of "near beer," except that the lower floor of Building No. 4 was no longer used. In manufacturing "near beer" the easterly part of Building No. 3, with the equipment therein, was used less frequently than in manufacturing beer. We have heretofore considered the question of the allowance of deductions for obsolescence of tangible assets due to prohibition legislation where the assets were continued in use after*3135 prohibition became effective and have denied such deductions. Yough Brewing Co.,4 B.T.A. 612">4 B.T.A. 612; Star Brewing Co.,7 B.T.A. 377">7 B.T.A. 377. We think our decisions in those cases are applicable and controlling here. With respect to Building No. 4, the petitioner contends that since in 1919 it abandoned the lower floor therein, it is entitled to a deduction for obsolescence of at least $17,125.01, representing one-third of the depreciated cost of the building on March 1, 1913, of $51,375.04. If we were disposed to hold that obsolescence were allowable on account of abandonment of a part of a building, we do not have sufficient evidence to determine whether the amount contended for by the petitioner is correct or what the allowance should be. The contention, therefore, must be denied. The petitioner also contends that on account of the reduced use of the machinery in Building No. 3 as well as the reduced use of the building itself from an average of four times a week to once every two weeks after it had ceased making beer, it is entitled to a deduction of obsolescence of $59,398.22. The petitioner determines this amount by taking 84 per cen of $70,712.16, *3136 which was the total of the depreciated cost of $46,004.39 of the building and $24,707.79 of the machinery at December 31, 1917. This contention must be denied, in view of our holding that a deduction may not be taken for obsolescence where the assets were continued in use in the business. The second error assigned in the original petition is that the respondent failed to allow deductions for losses sustained during the *1050 taxable year and not compensated for by insurance or otherwise incurred in the trade or business of the petitioner. With the exception of a loss to be considered presently, we are unable to tell from the record what losses if any this assignment of error relates to unless the petitioner intended to raise the issue that if the deductions taken for obsolescence on tangible property are not allowable as obsolescence, then the petitioner is entitled to deduct as losses the amounts representing the decline in value of property resulting from prohibition legislation. While the evidence shows that the value of the petitioner's assets during the years involved in this proceeding experienced a great decline on account of prohibition legislation, yet they were*3137 continued in use during succeeding years. In George Wiedemann Brewing Co.,9 B.T.A. 792">9 B.T.A. 792, we had occasion to consider the question of the allowance as losses of deductions representing decreases in value of assets which were used in subsequent years, and there held that such deductions are not allowable. We think our decision in that case is applicable here. At the hearing the petitioner amended its petition to allege that the respondent in determining a loss from the sale of certain property in 1918 had understated the amount of the loss by $5,000 as a result of having determined that the petitioner had previously taken depreciation of $5,000 more than it actually had. Inasmuch as the respondent admitted the correctness of the petitioner's allegation, the petitioner is entitled to have its net income reduced by the amount of $5,000. Judgment will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619486/ | Velma W. Alderman, Petitioner v. Commissioner of Internal Revenue, RespondentAlderman v. CommissionerDocket No. 5935-68United States Tax Court55 T.C. 662; 1971 U.S. Tax Ct. LEXIS 200; January 11, 1971, Filed *200 Decision will be entered for the respondent. Held: 1. Under sec. 357(c), I.R.C. 1954, petitioner had a taxable gain to the extent that her and her deceased husband's liabilities assumed by newly formed corporation A exceeded the adjusted basis of assets transferred in a sec. 351 exchange.2. A promissory note executed and contributed to corporation A by the shareholders had a zero basis for determining whether the liabilities transferred exceeded the basis of the assets transferred.3. The entire excess of liabilities over basis was allocable to depreciable property and therefore the gain is taxable as ordinary income under sec. 1239, I.R.C. 1954. Bernard F. Bednarz, for the petitioner.Vivian T. Martinez, Jr., for the respondent. Dawson, Judge. DAWSON*662 OPINIONRespondent determined a deficiency of $ 4,568.42 in petitioner's Federal income tax for the year 1963. There are two issues for decision: (1) Whether section 357(c), I.R.C. 1954, 1 applies when property is transferred pursuant to section 351(a) and the transferor issues a promissory note equal to the amount by which the liabilities assumed by the transferee exceed the adjusted basis of the assets transferred; and (2) whether the excess of the liabilities over basis of the assets is taxable as ordinary income to the transferor under section 1239.*204 This case was submitted under Rule 30, Tax Court Rules of Practice. All of the facts are stipulated and they are adopted as our findings. The facts deemed pertinent are summarized below.Velma W. Alderman (herein called petitioner) was a legal resident of Idanha, Oreg., at the time she filed her petition in this proceeding. She and her husband, Marion F. Alderman, who died on October 15, 1968, filed their joint Federal income tax return for the year 1963 with the district director of internal revenue at Portland, Oreg. Petitioner and Marion F. Alderman (hereinafter referred to collectively as the Aldermans) were calendar year accrual basis taxpayers.*663 Prior to February 13, 1963, the Aldermans conducted a lumber-trucking business as a sole proprietorship. On February 13, 1963, the business was transferred to a newly formed corporation, Alderman Trucking Co., Inc. (hereinafter referred to as the Alderman Corp.).The Aldermans transferred all of the assets of the sole proprietorship to the Alderman Corp. in exchange solely for 99 shares of the outstanding stock of the corporation and the assumption by the corporation of all of the liabilities pertaining to the sole proprietorship. *205 At all relevant times herein the corporation had 100 shares of no-par common stock outstanding and this constituted the only class of stock issued by the corporation. One share of stock was issued to Mrs. Rilla Schaffer, the corporation's bookkeeper.The following opening journal entry was made in the books of the Alderman Corp. on the date of the transfer:DebitCreditTrucks and trailers (adjusted basis)$ 62,782.20Note receivable -- Alderman10,229.59Accounts payable$ 24,420.14Notes payable:1st National Bank7,595.52Barrett Bros1,920.73International Harvester15,475.40U.S. National Bank14,000.00U.S. National Bank8,600.00Capital stock1,000.00The assets transferred from the sole proprietorship to the Alderman corporation consisted solely of depreciable trucks and trailers used in the business.All liabilities assumed by the Alderman Corp. were subsequently paid by the corporation with its own funds. The accounts payable assumed ($ 24,420.14) were liabilities incurred on open account. All the remaining liabilities assumed ($ 47,591.65) were encumbrances on the trucks and trailers transferred on the exchange.At the time*206 of the transfer on February 13, 1963, the liabilities of the business assumed by the Alderman Corp. exceeded the adjusted basis of the assets transferred to it by $ 9,229.59. In order that the assets shown on the balance sheet of the corporation would exceed the liabilities assumed, the Aldermans agreed to make up this difference by executing a personal promissory note payable to the corporation with a face amount of $ 10,229.59, creating a capital stock account of $ 1,000.In his notice of deficiency dated September 20, 1968, respondent *664 gave the following explanation for his $ 9,229.59 adjustment to the Alderman's income for 1963:(a) It is determined that you realized income from the February 13, 1963, transfer of assets and liabilities to Alderman Trucking Co., Inc., which must be recognized under section 357(c) of the Internal Revenue Code of 1954 in the amount of $ 9,229.59. In that transfer, which qualified as a section 351 exchange, the sum of the amount of liabilities assumed by Alderman Trucking Co., Inc., plus the amount of the liabilities to which the property transferred was subject exceeded the total of the adjusted basis of the property transferred by $ 9,229.59. *207 Further, the entire gain is taxable as ordinary income pursuant to section 1239 of the Internal Revenue Code of 1954 since you owned more than 80 per cent in value of the outstanding stock of Alderman Trucking Co., Inc., at the date of the transfer and only depreciable property was transferred to that corporation. Accordingly, your taxable income for the taxable year ending December 31, 1963, is increased by $ 9,229.59.The parties agree that the transfer qualified as a section 351 2 exchange. The requirements of section 368(c) were satisfied on the transfer of the assets of the sole proprietorship to the Alderman Corp. because the Aldermans owned 99 percent of all the corporation's stock after the transfer.*208 Section 351(e)(1) provides that where another party to the exchange assumes a liability or acquires property subject to a liability, reference must be made to section 357.Section 357(a) provides, in part, that where the transferor's liabilities are assumed by another party to the exchange, such assumption shall not prevent the transferor from benefiting from the nonrecognition provisions of section 351.Section 357(c) provides as follows:(c) Liabilities in Excess of Basis. -- (1) In general. -- In the case of an exchange -- (A) to which section 351 applies, or(B) to which section 361 applies by reason of a plan of reorganization within the meaning of section 368(a)(1)(D),if the sum of the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceeds the total of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be.(2) Exceptions. -- Paragraph (1) shall not apply to any exchange to which -- (A) subsection (b)(1) of this section applies, or*209 (B) section 371 or 374 applies.*665 In Peter Raich, 46 T.C. 604">46 T.C. 604, 608 (1966), this Court said:A literal interpretation of sections 351(d)(1) [now 351(e)(1)] and 357(c) compels the application of section 357(c) to the transaction in question. If, as the respondent contends, the trade accounts receivable in the hands of petitioner's sole proprietorship had an adjusted basis of zero at the time of their transfer to the corporation, the liabilities assumed by the corporate transferee ($ 45,992.81) would exceed the adjusted basis of the transferor's property ($ 11,251.73) by the amount of $ 34,741.08, which amount, under section 357(c), must be recognized as gain to petitioners.See also N. F. Testor, 40 T.C. 273">40 T.C. 273 (1963), affd. 327 F.2d 788">327 F.2d 788 (C.A. 7, 1964).In arriving at the amount of recognizable gain on the transaction here involved it is necessary to determine the basis of the promissory note. Section 1012 provides that the basis of property is its cost except as otherwise provided in the Code. Section 362(a) provides as follows:(a) Property Acquired by Issuance of Stock or as Paid-In*210 Surplus. -- If property was acquired on or after June 22, 1954, by a corporation -- (1) in connection with a transaction to which section 351 (relating to transfer of property to corporation controlled by transferor) applies, or(2) as paid-in surplus or as a contribution to capital,then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain recognized to the transferor on such transfer.The Aldermans incurred no cost in making the note, so its basis to them was zero. The basis to the corporation was the same as in the hands of the transferor, i.e., zero. Consequently, the application of section 357(c) is undisturbed by the creation and transfer of the personal note to the corporation.Since the personal promissory note in the hands of the Aldermans had an adjusted basis of zero at the time of its transfer to the Alderman Corp., the liabilities assumed ($ 72,011.79) by the corporation as transferee exceeded the adjusted basis ($ 62,782.20) of the transferor's property by $ 9,229.59. Such amount, under section 357(c), must be recognized as gain to the Aldermans. To conclude otherwise, as petitioner contends, 3 would effectively*211 eliminate section 357(c) from the Internal Revenue Code. It would be a relatively simple matter to execute a note so that the adjusted basis would always exceed liabilities. See Rev. Rul. 68-629, 2 C.B. 154">1968-2 C.B. 154.Section 1239 provides, in part, that "in the case of a sale or exchange, directly or indirectly, of property * * * which in the hands of the transferee is subject to the allowance for depreciation," between *666 an individual and his controlled corporation, any gain recognized to the transferor from the sale or exchange shall be considered as a gain from the sale or exchange of property which is neither a capital asset*212 nor property described in section 1231.The Aldermans transferred only depreciable property, the trucks and trailers, to the corporation. These assets are therefore property subject to section 1239.We agree with respondent's contention that since the application of section 357(c) is undisturbed by the transfer of the personal note to the corporation, section 1239 is applicable to the gain recognized. Since a limited gain may be recognized under section 357(c), even though there is an otherwise tax-free exchange, the Aldermans realized ordinary income to the extent of $ 9,229.59. See Rev. Rul. 60-302, 2 C.B. 225">1960-2 C.B. 225.Decision will be entered for the respondent. Footnotes1. All statutory references herein are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. SEC. 351. TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.(a) General Rule. -- No gain or loss shall be recognized if property is transferred to a corporation (including, in the case of transfers made on or before June 30, 1967, an investment company) by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation. For purposes of this section, stock or securities issued for services shall not be considered as issued in return for property.↩3. Alderman contends that "since he has given his note to the corporation for this amount and subsequently has paid this note from his personal funds, the corporation has not borne the burden of paying this excess amount." The evidence of record, which is fully stipulated, does not show that the Aldermans paid the note with their personal funds.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619488/ | DAVID C. ALTENBURG and MARIANNE ALTENBURG, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentAltenburg v. CommissionerDocket No. 1469-81.United States Tax CourtT.C. Memo 1982-402; 1982 Tax Ct. Memo LEXIS 345; 44 T.C.M. (CCH) 495; T.C.M. (RIA) 82402; July 19, 1982. Gloria T. Svanas, for the petitioners. Cynthia J. Olson, for the respondent. NIMSMEMORANDUM OPINION NIMS, Judge: This case is before the Court on respondent's motion for partial summary judgment filed pursuant to Rule 121. 1 Respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows: Addition to TaxYearDeficiencySec. 6653(a) 21974$44219771,617$8119784,075204The issues raised by the motion are 1) whether petitioners failed to report as income certain amounts received by a family trust in 1977 and 1978 and 2) whether petitioners are liable for the*347 additions to tax asserted by respondent. Respondent has presented the following uncontroverted evidence in support of his motion: a "Declaration of Trust" for the "David Altenburg Trust," executed February 9, 1977; petitioners' joint Federal income tax returns for the years 1974, 1977 and 1978; and copies of the Forms 1041 filed by the David Altenburg Trust for the years 1977 and 1978. These documents, together with undenied allegations of the pleadings, establish the following facts: Petitioner David Altenburg worked as an independent insurance salesman during 1977 and 1978. Petitioner Marianne Altenburg, David Altenburg's wife, operated a poodle grooming business during the same years. On February 9, 1977, a document entitled "Declaration of Trust" was executed by David Altenburg (as creator and trustor) and Marianne Altenburg and Don Nye (as co-trustees). The trust was created for the purpose of receiving certain real and personal property from the trustor. Beneficial certificates were issued by the trust to David Altenburg, Marianne Altenburg and Irene M. Scoccia in relative proportions of 1: 4: 2. These beneficial certificates entitled their holders to receive a*348 pro rata portion of any income distributed by the trust and a pro rata portion of the corpus on the trust's termination. The trustees were given complete discretion to accumulate or distribute trust income. The trust further provided: This Trust shall continue for a period of twenty-five years from date, unless the Trustees shall unanimously determine upon an earlier date when they may at their discretion, because of threatened depreciation in values, or other good and sufficient reason necessary to protect or conserve trust assets, liquidate the assets, distribute and close The Trust at any earlier date determined by them. On their 1977 joint income tax return Schedule C for David Altenburg's insurance sales business, petitioners reported gross commissions of $23,478, but subtracted therefrom $20,194 as commissions paid out. On its 1977 Fiduciary Income Tax Return, the David Altenburg Trust reported the receipt of $20,057 of insurance commissions by way of David Altenburg, its "nominee." On their 1978 joint income tax return, petitioners did not include any Schedules C for either David Altenburg's insurance sales business or Marianne Altenburg's poodle grooming business. *349 Instead, the David Altenburg Trust 1978 Fiduciary Income Tax Return included a Schedule C for David Altenburg's insurance business, reporting total income of $30,098. (David Altenburg was again listed as nominee recipient of this income.) The Trust return also included, as other income, $1,555 from "Dog Grooming." In 1977 and 1978, the trust reported earning interest income of $65 and $123, respectively. In his statutory notice of deficiency, respondent determined that petitioners were required to include in their 1977 taxable income the $20,057 of commission income and $65 of interest income reported by the trust that year. For 1978, respondent determined that petitioners were required to include in income the $30,098 of commissions, $1,555 of dog grooming income and $123 of interest income reported by the trust that year. Respondent argues that the petitioners' conveyance of their property and lifetime services to the David Altenburg Trust was ineffective to shift the incidence of taxation of income earned by petitioners either under the assignment of income doctrine, the grantor trust rules of sections 671 through 677, or the doctrine of sham transactions. Respondent*350 further argues that petitioners are liable for the addition to tax under section 6653(a) for negligence or intentional disregard of rules and regulations because a prudent person would know or would discover on consulting an independent person knowledgeable in the tax law that income taxes may not be avoided simply by assigning income and property to a trust. Petitioners, on the other hand, argue 1) that the trust was a legal, taxpaying entity which must be respected as the true earner of the income herein, and 2) that a motion for for summary judgment in the instant case is inappropriate because there are factual issues is dispute. Petitioners have not furnished the Court with any specifics upon which they rely to rebut respondent's factual allegations and have merely relied on the general denials of their pleadings to put the factual matters in issue. Rule 121 (d) provides, in part: When a motion for summary judgment is made and supported as provided in this Rule, an adverse party may not rest upon the mere allegations or denials of his pleading, but his response, be affidavits or as otherwise provided in this Rule, must set forth specific facts showing that there is a genuine*351 issue for trial. * * * Petitioners have simply failed to demonstrate a genuine issue for trial. Consequently, this case is ripe for partial summary adjudication. Rule 121(b). With regard to the petitioners' commission income and dog grooming income reported by the trust both in 1977 and 1978, numerous cases in this Court have held that such income may not be simply assigned away to a family trust. ; ; . There is no evidence herein to show that the trust had any control whatsoever over the earning of this income. Consequently, and for the reasons stated in the above opinions, petitioners were required as a matter of law to report the commission and dog grooming income on their joint 1977 and 1978 tax returns. With regard to the interest income reported by the trust, we hold that petitioners must also report these amounts because the trust created by David Altenburg runs afoul of the grantor trust rules of sections 671 through 677. In particular, the trust violates section 677(a) which provides*352 that "[t]he grantor shall be treated as the owner of any portion of a trust * * * whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be -- (1) distributed to the grantor of the grantor's spouse; (2) held or accumulated for future distribution to the grantor of the grantor's spouse * * *." For purposes of this section, neither Marianne Altenburg nor Don Nye is an adverse party. Section 672(a); . Finally, we uphold respondent's assertion of the negligence addition. Petitioners, who bore the burden of proof, have not made any factual allegations regarding the degree of care they exercised before deciding to set up the instant family trust. They merely deny they were negligent. This is an insufficient showing to avoid the imposition of the addition. . 3An appropriate order will be entered.Footnotes1. All references to Rules are to the Tax Court Rules of Practice and Procedure.↩2. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as in effect during the years before the Court.↩3. See also .↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619491/ | Ralph A. Skilken and Loretta Skilken, Petitioners v. Commissioner of Internal Revenue, RespondentSkilken v. CommissionerDocket No. 6302-66United States Tax Court50 T.C. 902; 1968 U.S. Tax Ct. LEXIS 66; September 17, 1968, Filed *66 Decision will be entered for the Commissioner. A-M, a partnership which owned and operated a vending-machine business, purchased the assets of several other such businesses including certain oral agreements for vending-machine locations terminable at the will of either party. Held, A-M could not deduct as a loss under sec. 165, I.R.C. 1954, any amounts which it allocated to the oral location agreements that were terminated during the taxable year. Hugh E. Wall, Jr., for the petitioners.Robert A. Roberts, for the respondent. Tietjens, Judge. TIETJENS*903 The Commissioner determined deficiencies in income tax for the taxable years ending December 31, 1962, and December 31, 1963, in the amounts of $ 5,742.18 and $ 4,887.71, respectively. The only question is whether the partnership of which the petitioner is a partner may deduct certain amounts as losses under section 165, I.R.C. 1954, 1 due to loss of certain locations for the vending machines of the partnership.FINDINGS OF FACTSome of the facts have been stipulated. The stipulation and exhibits attached thereto are incorporated herein by *67 this reference.Petitioners Ralph A. Skilken (herein referred to as petitioner or Ralph) and his wife Loretta Skilken, resided in Dayton, Ohio, at the time their petition to this Court was filed. For the taxable years 1962 and 1963, petitioner and his wife filed joint Federal income tax returns with the district director of internal revenue, Cincinnati, Ohio.Petitioner was a member of a partnership known as Acme-Miami Vending Service, hereinafter referred to as Acme-Miami or the partnership, with its principal place of business in Dayton, Ohio. Petitioner owned a 33 1/3-percent interest in the partnership with the remaining 66 2/3-percent interest owned by the Sam W. Klein Co., a partnership which consisted of Sam W. Klein, Freda Klein, and Rose Miller.Acme-Miami was engaged principally in the business of selling cigarettes, candy, and other items through the use of vending machines. For each of the taxable years ending December 31, 1962, and December 31, 1963, the partnership filed its U.S. Partnership Return of Income.During the taxable year 1962, Acme-Miami acquired the going businesses of seven competitor companies. The following schedule reflects the businesses acquired, the *68 dates of their acquisition, the recorded costs of each business, and the fair market value of the tangible assets acquired: *904 Business acquired byDate ofRecorded cost ofFair market valueAcme-Miami Vendingacquisitionacquisitionof tangibleServiceproperty acquiredA-1 Custom Vending Co1- 1-62$ 18,296.81$ 18,296.81Ohio Music Service1- 1-6253,137.6143,855.00Fisher Vending Co4-30-6220,000.009,750.00Commercial Music Co2-28-6235,000.0027,967.89Snack Vending Service, Inc2-28-6245,000.0034,400.40Miami Cigar & Tobacco Co1- 1-621 303,105.0084,940.00Acme Merchandise Vending Co1- 1-622 445,068.12259,825.16Total919,607.54479,035.26For each of the companies purchased, the partnership examined the books and records of the company about to be purchased in determining the value of the company. As a rule of thumb, the partnership determined the average number of cases of cigarettes sold per week by the machines of the company and multiplied this number by $ 3,000 to calculate the maximum *69 price to be paid for the business. Petitioner was president of one of the corporations, Miami Cigar & Tobacco Co., whose assets were purchased by the partnership.The several businesses acquired by Acme-Miami owned and operated vending machines in approximately 922 locations principally in the area of Dayton, Ohio. The following schedule reflects the breakdown by business of the types of products sold by the vending machines:Number of locations for --BusinessCigarettesFull line 1TotalA-1 Custom Vending Co8412Ohio Music Service4747Fisher Vending Co448Commercial Music Co42428Snack Vending Service, Inc94352Miami Cigar & Tobacco Co27220292Acme Merchandise Vending Co306177483Total603319922In total, the purchase price paid for the various businesses exceeded the fair market value of the tangible property acquired by the partnership. This excess ($ 377,716.30) was capitalized and charged to "location costs" on the books of the partnership. Immediately after each acquisition the location cost was allocated on the partnership books among the various vending-machine locations acquired by the business in proportion to the prior sales *70 volume of each location.*905 The following schedule illustrates the partnership's method of apportioning this cost:CigaretteFactorSellerpack unitSales volumeCost ofapplied tosalesbaselocationsunits ordollarsAcme Merchandise Vending Co.:Cigarettes at 30 cents224,061$ 67,218.30$ 93,445.63$ 41705Full-line vending23,641.3532,865.831.3901890,859.65126,311.46Miami Cigar & Tobacco Co.:Cigarettes at 30 cents190,41557,124.50207,962.631.09215Full-line vending1,724.456,277.893.6405158,848.95214,240.52Snack Vending Service, Inc.:Cigarettes at 30 cents3,6271,088.102,168.91.59799Full-line vending4,229.498,430.691.99335,317.5910,599.60Commercial Music Co.:Cigarettes at 30 cents3,9161,174.801,751.85.44736Juke-box sales3,540.955,280.261.49124,715.757,032.11Ohio Music Service:Juke-box sales1,928.949,282.61.48122Fisher Vending Co.:Cigarettes at 30 cents9,1472,744.104,625.32.50566Full-line vending3,337.045,624.681.685556,081.1410,250.00Total cost of locations377,716.30Cigarette location costs$ 309,954.34Full-line location costs53,199.09Music location costs14,562.87377,716.30 In each of the acquisitions, the trade name, trademark, and goodwill were transferred to the partnership along with the tangible assets *71 of the purchased company. However, the partnership did not use the name of the former owners, but began to operate the machines under the partnership's name. In some instances, the owners of the premises where the vending machines of the acquired companies were located, did not know the vending business had been sold. The majority of the employees of the several businesses acquired by Acme-Miami became employees of the partnership.During the taxable years in question, the partnership employed two men for the purpose of obtaining new locations for Acme-Miami's vending machines.Except in a few instances, insignificant for our purpose, there were no leases or other agreements in effect which guaranteed the partnership *906 the continued use of the vending-machine locations. The agreements were oral, terminable at the will of either party, and provided that the partnership pay over to the owners of the locations a certain portion of the receipts of the machines for the partnership's use of the premises in placing machines. During the taxable years 1962 and 1963, Acme-Miami lost 150 and 102 vending-machine locations, respectively. Whatever rights there were to these locations were acquired *72 by the partnership when it purchased the other companies. The following table sets forth the number of locations lost, the taxable year in which the locations were lost, and not reacquired, and the purchased businesses from which the locations were acquired:Number ofSource of locationlocationslost in --19621963Acme Merchandise9159Miami Cigarette5038Snack Vending35Commercial & Ohio5Fisher1Total150102For the taxable years in question, the location costs allocated by the partnership to the various locations which were lost and not reacquired amounted to $ 35,885.86 for 1962 and $ 29,943.54 for 1963. These amounts were deducted as losses in the partnership's tax returns for the 2 years.In the statutory notice of deficiency, the Commissioner disallowed deduction for these lost locations as partnership expenses with the following explanation:Explanation of Adjustment, Year Ended Dec. 31, 1962It is held that the amount of $ 35,885.86 [$ 29,943.54 for 1963], deducted on the return of Acme-Miami Vending Service, a partnership, as "lost locations," is not allowable under section 165 of the Internal Revenue Code. Accordingly, your distributive share of the partnership net income is increased *73 by $ 11,961.65 [$ 9,981.19 for 1963].OPINIONThe only issue for our determination is whether the partnership may deduct as losses under section 165, 2 amounts which it allocated to *907 certain oral location agreements which were terminated during the taxable years. Ralph is the petitioner in this case because as a partner in Acme-Miami, he must recognize as income his distributive share of the partnership's taxable income or loss under section 701 3*74 and 702(a) (9). 4 In general, section 703(a) 5 provides that the taxable income of the partnership shall be computed in the same manner as that of an individual, thus making section 165 losses deductible in computing the partnership's income.The partnership purchased the location agreements along with the other assets of several companies and unilaterally allocated a portion of the aggregate purchase price to each of the agreements based upon the sales made at the particular location covered by the agreement. These agreements, 922 in number, were terminable either at the will of the partnership or the owner of the premises and provided that the partnership could own and operate certain vending machines there in the meantime. The machines were located and operated on the premises of others and the partnership agreed to pay the *75 owner of the premises a portion of the receipts from the machines for the privilege of operating them there.It is petitioner's position that these agreements were separate individual "leases" which the partnership purchased and to which an allocable share of the purchase price is attributable. The argument continues, that because the contracts were terminable at will by either party, the partnership properly refrained from amortizing or depreciating the location costs, but properly could write off the purchase price allocated to each location in the year in which the agreement for that location was terminated, as a deduction under section 165.The Commissioner disallowed deduction to the partnership for the claimed "losses." He contends that these agreements are similar to "customer lists" and as such should not be accounted for separately, but lumped together as a single asset and treated as goodwill. Accordingly, he argues that no deduction is allowable for partial losses, but must await the final disposition or termination of all the rights under these agreements.*908 In support of his argument, the Commissioner quotes the following from Thrifticheck Service Corporation, 33 T.C. 1038">33 T.C. 1038, 1047 (1960):The *76 cancellation of a [particular] contract would not destroy the value of the larger asset of which it was a part, but would merely reduce its value, which might be restored by the acquisition of new customers * * * in our opinion the petitioner will not be entitled to deduct any cost of the contracts which it purchased until its customer structure becomes worthless or is disposed of.We think the Commissioner's determination is correct. As we see the transactions involved, the partnership purchased going businesses with tangible assets (the vending machines, etc.) and intangible assets (the location rights). No question about the tangible assets is involved. The Commissioner argues that there is no substantial difference between this case and the so-called customer-list cases where we have disallowed deductions either for depreciation of the lists or as "losses" when particular customers of the former owners of a business canceled their contracts or ceased to do business with the new owners, as in Thrifticheck Service Corporation, supra.We agree. Unlike David Hoffman, 48 T.C. 176">48 T.C. 176 (1967), this is not a case where the partnership acquired subsisting leases for definite periods. Concededly *77 the right to place and operate machines in this case was simply at sufferance of either party. These rights are not depreciable, which petitioner admits. The partnership took a chance it would be allowed to continue to operate at the locations listed; or in the alternative, could itself move out of any location. That in acquiring the businesses, the partnership arrived at its overall purchase price by allocating a certain amount to each location based on previous business done at that location does not change the picture. Anchor Cleaning Service, Inc., 22 T.C. 1029">22 T.C. 1029 (1954).Nor do we give validity to petitioner's argument that this is not a "customer list" or "customer structure" case because the owners of the locations were not themselves "customers" of petitioner, i.e., the location owners did not buy from the partnership any goods or services; rather the "customers" of the partnership were those who came to the locations to trade either with the owner or to buy from the vending machines. We think that at least this is a vicarious customer-list case. The partnership bought the opportunity to continue the former vending-machine businesses of the sellers of those businesses. Whether *78 the lists purchased were "location" lists (lists of places where machines could be placed and customers reached), or "customer lists" (the naming of particular customers who put money in the slot of a particular machine) makes no difference.Neither do we think this is a case like Metropolitan Laundry Co. v. United States, 100 F. Supp. 803">100 F. Supp. 803 (N.D. Cal. 1951), where the taxpayer who operated two laundries, one in San Francisco and one in *909 Oakland, lost the San Francisco business when the U.S. Government seized its plant there and the District Court allowed a deduction for the cost of the San Francisco laundry routes which the taxpayer abandoned because of the seizure. In effect, petitioner here argues that each of the 922 locations acquired was a separate business and as each location was lost or abandoned, a deductible loss was sustained. We do not accept this argument.Decision will be entered for the Commissioner. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated.↩1. Includes $ 3,924.48 for prepaid licenses.↩2. Includes $ 58,931.50 for other assets, such as accounts receivable, prepaid cigarette stamps, licenses insurance, interest, deposits, and cash value of life insurance policy.↩1. Candy, drinks, and food -- any product other than cigarettes.↩2. SEC. 165. LOSSES.(a) General Rule. -- There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.* * * *(c) Limitation on Losses of Individuals. -- In the case of an individual, the deduction under subsection (a) shall be limited to --(1) losses incurred in a trade or business;↩3. SEC. 701. PARTNERS, NOT PARTNERSHIP, SUBJECT TO TAX.A partnership as such shall not be subject to the income tax imposed by this chapter. Persons carrying on business as partners shall be liable for income tax only in their separate or individual capacities.4. SEC. 702. INCOME AND CREDIT OF PARTNER.(a) General Rule. -- In determining his income tax, each partner shall take into account separately his distributive share of the partnership's --* * * * (9) taxable income or loss, exclusive of items requiring separate computation under other paragraphs of this subsection.↩5. SEC. 703. PARTNERSHIP COMPUTATIONS.(a) Income and Deductions. -- The taxable income of a partnership shall be computed in the same manner as in the case of an individual except that --↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619493/ | Joyce T. Haft v. Commissioner. Alfred Lewis Haft v. Commissioner.Haft v. CommissionerDocket Nos. 3966-69 SC., 4172-69 SC.United States Tax CourtT.C. Memo 1970-38; 1970 Tax Ct. Memo LEXIS 322; 29 T.C.M. (CCH) 124; T.C.M. (RIA) 70038; February 12, 1970, Filed. Joyce T. Haft, pro se, in Docket No. 3966-69 SC. Alfred Lewis Haft, pro se, in Docket No. 4172-69 SC. A. Mills McCawley, for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: In these consolidated cases respondent determined the following Federal income tax deficiencies aginst the petitioners: PetitionerYearDeficiencyJoyce T. Haft1964$402.48Alfred Lewis Haft1964918.21At the trial of these cases Joyce T. Haft and respondent conceded*323 that Alfred L. Haft is entitled to the deduction for the dependency exemption for Christine, the petitioners' eldest daughter. Respondent agrees that if Joyce T. Haft is entitled to the dependency exemption deduction for Alfred L. Haft, Jr., she is also entitled under section 214, Internal Revenue Code of 1954, 1 to deduct $600 for child care expenses. Alfred L. Haft has conceded that respondent correctly disallowed $150 he claimed as contributions. Thus, the only issue remaining for decision is which of the petitioners provided more than half of the total support of their three minor children, Cathy, Constance and Alfred, Jr., in the year 1964 for dependency exemption deduction purposes under sections 151(e) and 152(a). Findings of Fact Some of the facts were stipulated by the parties and are found accordingly. Joyce T. Haft was a legal resident of New York, New York, when she filed her petition in this proceeding. Her individual Federal income tax return for the year 1964 was filed with the district director of internal revenue in Brooklyn, New*324 York. Alfred Lewis Haft was a legal resident of Mount Vernon, New York, when he filed his petition in this proceeding. His individual Federal income tax return for the year 1964 was filed with the district director of internal revenue for the Manhattan District. Alfred and Joyce are the parents of four children. In 1964 the children, Christine (age 17), Cathy (age 14), Constance (age 11) and Alfred, Jr. (age 6), were all minors. On July 11, 1962, petitioners were separated pursuant to a judgment entered by the Supreme Court of the State of New York for Nassau County. The judgment provided, in part, that Joyce would have custody of the children subject to Alfred's visitation rights, and that Alfred would pay to Joyce for the support of the children the sum of $125 per week. During 1964 Cathy, Constance and Alfred Jr. resided with their mother. Christine attended a boarding school for over 8 months and resided with her mother during the summer. Alfred exercised his visitation rights during that year. 125 In 1964 Alfred was a salesman whose gross income was $18,701.23. Joyce was a school teacher whose gross income was $6,895.58. In 1964 she received tax refunds totaling*325 $816.01, and her mother, Mrs. Caroline F. Tamres, gave her about $3,000. Joyce also withdrew about $1,000 from savings accounts. Pursuant to the Court judgment, Alfred paid $125 per week in 1964 as child support. These totaled $6,500. In addition, he took three children on a summer vacation for 10 days to 2 weeks at a cost of about $60 per child, and he gave each child gifts of $100 during the year. He provided $1,785 for each of these children. The total amount spent for the support of the three children in 1964 was approximately $10,652.19, as follows: CathyConstanceAlfred Jr.Lodging$ 586.82$ 586.82$ 586.82Utilities182.93182.93182.93Summer camp377.63377.63377.63Private school948.10Medical and dental287.45287.4530.00Drugs25.00100.0010.00Hospitalization insurance30.0030.0030.00Clothes550.00400.00300.00Food600.00600.00600.00Child care217.35217.35217.35Gifts200.00200.00150.00Vacation60.0060.0060.00Recreation and miscellaneous 350.00350.00300.00Total$3,467.18$3,392.18$3,792.83Alfred L. Haft provided more than half of the total support for*326 Cathy and Constance in 1964. Joyce T. Haft provided more than half of the total support for Alfred Jr. in 1964. Opinion The only issue we must decide is which of the petitioners, Joyce or Alfred, is entitled under section 151(e) to the dependency deductions claimed by each of them for Cathy, Constance and Alfred Jr. in 1964. To protect the revenue, respondent originally disallowed the claimed exemptions to both petitioners. However, he now takes a neutral position, contending that the Court should decide on the evidence presented which petitioner is entitled to the exemptions. Section 152(a) defines the term "dependent" as meaning a daughter or son of the taxpayer "over half of whose support, for the calendar year in which the taxable year of the taxpayer begins, was received from the taxpayer." It is quite apparent from the testimony of Joyce and Alfred that they fulfilled their parental responsibilities by providing a substantial amount for the support of each child. The figures are close. We believe some of the claimed expenditures of both are inflated. Consequently, we have reduced some of them that were based on estimates. In Alfred's case, we have reduced the claimed*327 vacation expenses and gifts, and eliminated all amounts he claimed for purchases of clothing for the children. In Joyce's case, we have substantially reduced the estimate of $100 per month per child for food. In our opinion her estimate of food costs is grossly inflated. We have allowed only $600 per child for food in the year 1964. 2After considering and weighing all of the evidence presented, we have concluded and found as a fact that Alfred provided more than half of the support for Cathy and Constance in 1964, and that Joyce*328 provided more than half of Alfred Jr.'s support in such year. Joyce is also entitled to a $600 child care expense deduction for Alfred Jr. To reflect these conclusions and the concessions made by the parties, Decisions in both dockets will be entered under Rule 50. 126 Footnotes1. All statutory references herein are to the Internal Revenue Code of 1954 unless otherwise indicated.↩2. This figure appears to be reasonable. It is more than the estimated food costs per week under a "liberal plan" for children, as released by the United States Department of Agriculture, Consumer and Food Economics Research Division. For example, in April 1964, the "U.S.A. Average" under a "liberal plan" was $6 90 per week for children 4 to 6 and $10.10 per week for children 13 to 15. Moreover, the amount we have allowed compares favorably to a figure of $2,330 for food for a family of four with a moderate standard of living, residing in New York in 1967. See U.S. Bureau of Census, Statistical Abstract of the United States, 1969 (90th Ed.), p. 348.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619494/ | FRANK E. LUNN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentLunn v. CommissionerDocket No. 44989-85.United States Tax CourtT.C. Memo 1987-435; 1987 Tax Ct. Memo LEXIS 432; 54 T.C.M. (CCH) 356; T.C.M. (RIA) 87435; August 27, 1987. Frank E. Lunn, pro se. David S. Reid, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: Respondent determined deficiencies in and additions to petitioner's Federal income tax as follows: ADDITIONS TO TAXSectionSectionYearDeficiency6653(b) 166541978$ 9,574.64$ 4,787.32$ 304.7619794,826.712,413.36201.1619804,218.472,109.99254.99The sole issue is whether respondent's determination of additions to tax pursuant to section 6653(b) should be sustained. FINDINGS OF FACT Petitioner resided in Belleville, Illinois, at the time the petitioner herein was filed. Petitioner was employed by the Metropolitan Life Insurance Company ("Met Life") as a district sales*434 manager, a sales manager, and a sales representative during the years in issue. Petitioner was married during the years at issue, but his wife is not a party to this case. Petitioner received income during the years at issue as indicated below. Income Sources197819791980W-2 wages from Met Life$ 27,305.00$ 22,523.00$ 21,239.00Dividends294.00512.50425.50Interest190.00131.50--Capital Gains94.25167.20255.20Pensions4,084.00----Total$ 31,967.25$ 23,334.20$ 21,919.70For Federal income tax, Met Life withheld from petitioner's annual compensation $ 21.91 in 1978, $ 0 in 1979; and $ 179.99 in 1980. Such obviously low amounts were withheld because petitioner had completed a W-4 Form claiming 35 allowances. Respondent introduced at trial Forms 4340, Certificate of Assessments and Payments, which clearly indicate that petitioner failed to file returns for each of the years at issue. Nonetheless, petitioner steadfastly but unconvincingly claims to have filed returns for the years at issue. Attached to petitioner's brief are documents which he claims are copies of such returns. These documents do*435 not indicate petitioner's address or social security number. Two of the documents indicate that no tax or refund is due and one of the documents indicates that a refund of $ 179.99 is due. Petitioner filed returns for 1977 and 1981. 2Petitioner has not provided respondent's agents with any documents, records, receipts, or any other information pertaining to the years at issue and has been uncooperative. OPINION At trial the Court dismissed petitioner's case as to all issues for which petitioner bore the burden of proof. 3 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. , affg. a Memorandum Opinion of this Court; .*436 Respondent bears the burden of proving fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b); ;. The presence of fraud is a factual question to be determined by an examination of the entire record. . Petitioner's testimony that he filed returns was incredible and self-serving and is accordingly given no weight. See . The documents attached to petitioner's memorandum brief do not contain petitioner's address or social security number. Thus, even if the documents were sent to respondent, there is a serious question as to whether they even constitute returns. See , affd. .*437 See also secs. 6011(a) 4 and 6109(a)(1). 5 At any rate, based on the Forms 4340, 6 we hold that petitioner filed no returns for the years at issue. 7*438 Failure to file returns, without more, is not sufficient to prove fraud. . Failure to file may, however, be considered in connection with other facts in determining whether an underpayment is due to fraud. . Respondent has proven that petitioner failed to file returns for the years in issue; had substantial income for the years in issue; filed false W-4 Forms claiming 35 allowances, thus reducing to zero or near zero his withholding for income tax; and refused to cooperate with respondent's agents. Petitioner had filed returns for years prior and subsequent to the years at issue and was thus aware of his Federal income tax obligations. On these facts, we readily hold that respondent has met his burden of proving fraud by clear and convincing evidence for each of the years at issue. 8 Respondent's determination of additions to tax for fraud is sustained. *439 Decision will be entered for the respondent.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. Petitioner claimed five exemptions on both of these returns. ↩3. Petitioner argues that the notice of deficiency was not timely sent by respondent. Since we ultimately hold, inter alia, that petitioner failed to file returns for the years at issue, petitioner's statute of limitations argument is meritless. See sec. 6501(c)(3). ↩4. Section 6011(a) provides: When required by regulations prescribed by the Secretary any person made liable for any tax imposed by this title, or for the collection thereof, shall make a return or statement according to the forms and regulations prescribed by the Secretary. Every person required to make a return or statement shall include therein the information required by such forms or regulations. ↩5. Section 6109(a)(1) provides: When required by regulations prescribed by the Secretary: * * * Any person required under the authority of this title to make a return, statement, or other document shall include in such return, statement, or other document such identifying number as may be prescribed for securing proper identification of such person. ↩6. See , on appeal (7th Cir. May 18, 1987); and . We also draw to some extent on petitioner's own incredible story of how he and a friend filed their returns together. The story was so unbelievable that it (1) indicates clearly that returns were not filed as described in the story and (2) allows the inference to be drawn that since returns were not filed as described, returns were simply not filed. ↩7. In another case before this Court, docket No. 1838-87, petitioner brazenly indicated his willingness to attempt to mislead this Court to accommodate his needs. On October 17, 1986, respondent issued to petitioner and his wife a notice of deficiency with respect to 1982. On January 16, 1987, 91 days after the issuance of the notice of deficiency, petitioner and his wife filed a petition with this Court commencing the case at docket No. 1838-87. Attached to the petition was the original of the notice of deficiency which clearly indicated its date of issuance was October 17, 1986. Respondent moved to dismiss the petition because it was not filed within 90 days from the issuance of the notice of deficiency as is required by section 6213. Petitioner responded to the motion to dismiss by filing a copy of the notice of deficiency with its date clearly altered to read October 18,↩ 1986. The Court granted respondent's motion to dismiss. Petitioner's modus operandi in docket No. 1838-87 suggests that it is not unlikely that petitioner created the documents attached to his memorandum brief solely for purposes of this trial. 8. See (fraud is established where respondent proves that a taxpayer failed to file returns and filed false W-4 Forms eliminating income tax withholding). ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619495/ | WILLIAM G. CAMPBELL AND NORMA T. CAMPBELL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCampbell v. CommissionerDocket No. 22367-83United States Tax CourtT.C. Memo 1990-162; 1990 Tax Ct. Memo LEXIS 144; 59 T.C.M. (CCH) 236; T.C.M. (RIA) 90162; March 27, 1990Lewis H. Mathis, James M. Saxton, and B. Gray Gibbs, for the petitioners. Matthew A. Lykken, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in petitioners' Federal income tax for the calendar years 1979 and 1980 in the amounts of $ 186,670 and $ 295,318, respectively. In an amendment to answer, respondent*147 alleged that petitioners were liable for additions to tax under section 6653(a) in the amounts of $ 9,333.50 and $ 14,765.90 for the years 1979 and 1980, respectively, and made claim for these amounts. 1Some of the issues raised by the pleadings have been disposed of by agreement of the parties, leaving for our decision: (1) whether the value of interests in certain partnerships received by William G. Campbell in 1979 and 1980 for services performed has an ascertainable value the amount of which is includable in petitioners' income, and if so, what that value is, and (2) whether petitioners were negligent in failing to include the value, if any, of the partnership interests received in their gross income or in claiming deductions to which they were not entitled. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners, husband and wife, who resided in Little Rock, Arkansas at the time they filed their petition in this case, filed joint Federal*148 income tax returns for the calendar years 1979 and 1980 based on the cash method of accounting. The 1980 return was timely filed pursuant to extensions granted. During 1979 and 1980, and for some years prior thereto, William G. Campbell (petitioner or Mr. Campbell) was employed by the Summa T. Group, a collection of affiliated entities which were primarily engaged in the formation and syndication of limited partnerships. Mr. Campbell performed most of his services for, and received compensation from, Summa T. Realty, Inc. (Summa T. Realty), a real estate brokerage and consulting firm which was a member of the Summa T. Group. Mr. Campbell served as vice president and director of most members of the Summa T. Group, including Diversified Financial Services Corporation of America (Diversified Financial Services), Summa T. Realty, Summit Mortgage Company, Summa T. Corporation, and Summa Management Company. Mr. Campbell also served as vice president of Realty Properties Company (Realty Properties), a corporation organized under the laws of the State of Delaware which was also a member of the Summa T. Group. A man named David R. Kane served as the president of Realty Properties. Summa*149 T. Realty and Realty Properties were subsidiaries of a common parent, Summa T. International. Prior to 1979, Mr. Campbell, in partnership with a man named Jim Nettles (Mr. Nettles), packaged and sold interests in "transactions" to prospective investors on behalf of Mr. Campbell's employer, Summa T. Realty. If Mr. Nettles, who was primarily responsible for selling the interests, was unable to sell all of the interests in a particular transaction, other salesmen who worked for Mr. Campbell's employer would sell the remainder. The arrangement between Mr. Campbell and Mr. Nettles concluded in early 1979 after Mr. Nettles terminated his employment arrangement with Summa T. Realty. After Mr. Nettles left, Mr. Campbell's responsibilities and duties changed. He became predominately responsible for locating suitable properties for Summa T. Realty, negotiating the acquisition of those properties, obtaining the financing necessary to acquire the properties, organizing the partnerships which would eventually acquire those properties, and assisting in the preparation of offering materials in connection with the syndication of those partnerships. Mr. Campbell also helped promote the sale*150 of partnership interests to prospective investors. After Mr. Nettles' departure, Mr. Campbell negotiated a new compensation arrangement with his employer. Under the new arrangement, he was to receive 15 percent of the proceeds from each limited partnership syndication. In addition, for his services, Mr. Campbell was to obtain a "special limited partnership interest" in partnerships which he helped form and finance. Mr. Campbell consulted with Mr. Donald Turlington, a tax attorney, about the tax consequences of his receipt of the special limited partnership interests in exchange for services. Mr. Turlington was an associate with a New York law firm and taught partnership tax law at New York University. Mr. Turlington told Mr. Campbell that there was little or no chance that he would be taxed on the receipt of such interests but would, instead, be taxed as he received distributable shares of income and gains from the partnerships. Mr. Campbell also consulted with Mr. George Hardin, a tax attorney, about the tax consequences to petitioners of Mr. Campbell's receipt of special limited partnership interests. Both Mr. Hardin and Mr. Campbell were aware of the case of Diamond v. Commissioner, 530">56 T.C. 530 (1971),*151 affd. 492 F.2d 286">492 F.2d 286 (7th Cir. 1974), in which this Court held that a similar interest was taxable upon receipt. However, Mr. Hardin advised Mr. Campbell that the facts of Diamond v. Commissioner, supra, were distinguishable and that the value of the interests Mr. Campbell received need not be included in income. Although the interests provided immediate tax benefits to petitioners, Mr. Campbell was also enthusiastic about the residual value these interests might have. Pursuant to this new compensation arrangement, Mr. Campbell received, in 1979, a 2-percent special limited partnership interest in Phillips House Associates, Ltd. (Phillips House or the partnership) in exchange for services he had rendered in the formation and syndication of the partnership. In 1980, petitioner received a 1-percent special limited partnership interest in The Grand, Ltd. (The Grand) and a 1-percent special limited partnership interest in Airport 1980, Ltd. (Airport) in exchange for services he had rendered in the formation and syndication of those partnerships. Realty Properties was the sole general partner of Phillips House, The Grand, and Airport. Mr. Kane also became a special*152 limited partner in these three partnerships. Phillips HousePhillips House was organized in October 1979 under the laws of the State of Missouri for the purpose of acquiring, restoring, and operating a 20-story hotel in downtown Kansas City, Missouri (the Hotel) with a view toward obtaining certain tax benefits, distributing cash to potential investors at a rate of 10 percent of their net cash investments, and realizing a gain upon the eventual sale or refinancing of the Hotel. The Hotel was to be acquired from a group of sellers unrelated to the Summa T. Group. The total purchase price of the hotel was $ 1,600,000. The total cost of restoring and furnishing the Hotel was projected to be $ 6,675,000. Permanent financing for acquisition and restoration of the Hotel was to be obtained by the Land Clearance For Redevelopment Authority of Kansas City, Missouri (the Authority) primarily through the issuance of $ 8 million in tax-exempt revenue bonds. "Bond closing" was to take place on or before January 29, 1980, by which time it was expected that the Authority would have obtained permanent financing by the issuance of its tax-exempt revenue bonds. The Authority could not*153 obtain permanent bond financing by January 29, 1980. However, the Authority subsequently resolved to obtain permanent financing through the issuance of a secured nonrecourse promissory note and units of participation rather than through the issuance of bonds. On March 1, 1980, the Authority executed a $ 1,136,000 nonrecourse promissory note in favor of the sellers. The Authority obtained permanent financing in April 1980 when Parham and Company, Inc. agreed to underwrite the sale of $ 8 million in units of participation. The Hotel was renovated and opened for business in May 1981. Upon its organization in October 1979, the sole general partner of Phillips House was Realty Properties. The sole limited partner was Mr. Campbell. Mr. Campbell was required to contribute $ 100 to the capital of Phillips House in return for his limited partnership interest and was not required to make any further contributions. According to the original certificate of limited partnership, Mr. Campbell, as sole limited partner, was to receive 95 percent of the profits and losses of Phillips House. According to the original limited partnership certificate, no limited partner could sell or assign*154 any part of his interest without the consent of the general partner. The general partner was authorized to admit, in its sole discretion, additional limited partners. Pursuant to this authorization, 35 Class A limited partnership units in Phillips House were offered for sale to "suitable" investors through a nonpublic offering memorandum. The minimum recommended investment was one Class A limited partnership unit and the purchase price for each Class A limited partnership unit was $ 99,250. Diversified Financial Services was the sales agent for the offering and was to receive a placement commission of up to 8 percent of investor subscriptions to be paid out of the general partner's separate funds. In addition, the partnership was to pay Diversified Financial Services a nonaccountable expense allowance of 3 percent of the offering proceeds as reimbursement for its direct expenses and overhead expenses it incurred as a result of the offering. The maximum amount Diversified Financial Services could receive as an expense allowance was $ 104,213 (35 partnership units multiplied by $ 99,250 multiplied by 3 percent). Mr. Campbell and Mr. Kane were denominated as "special limited partners"*155 in the Phillips House offering memorandum. According to the offering memorandum, total capitalization of Phillips House was projected to be $ 3,504,050, assuming all Class A limited partnership units offered for sale were actually sold. Of this amount, the Class A limited partners were to contribute a total of $ 3,473,750, the special limited partners were to contribute a total of $ 300, and the general partner was to contribute $ 30,000. Approximately 41.5 percent of the proceeds of the offering were to be set aside as a bond debt service reserve fund and to make principal payments on the second mortgage note, while another 16 percent of the proceeds were set aside for working capital and professional services (i.e., legal and tax advice). The remaining 42.5 percent of the proceeds were to be paid, in the form of expense allowances, consulting fees, and management fees, to the general partner, Realty Properties, and other members of the Summa T. Group. According to the Phillips House offering memorandum, 94 percent of the profits and losses of the partnership were to be allocated to the Class A limited partners, 2 percent of the profits and losses were to be allocated to the*156 general partner, and 2 percent of the profits and losses were to be allocated to each of the special limited partners. Any cash available from the operations of Phillips House was to be allocated first to the Class A limited partners to the extent of 10 percent of their capital contributions per year. This "priority return" was subject to a special allocation to Realty Properties of all operating receipts of Phillips House prior to January 1, 1981. However, the general partner was obligated to advance up to $ 100,000 in working capital, which would be repaid without interest, if the partnership's cash flow was insufficient to cover its operating expenses and debt service payments. After January 1, 1981, any cash available from operations would be allocated first to satisfy the Class A limited partners' priority return and second to pay each of the special limited partners $ 7,391 per year as a "special priority return." If any cash from operations was available after satisfaction of both the priority return and special priority return, the general partner would be paid $ 7,391 per year. Any cash available after satisfaction of the priority return, the special priority return, *157 and the general partner's return was to be distributed to all of the partners in accordance with their ratio for sharing profits and losses. According to projections contained in the offering memorandum, Phillips House was expected to show a loss for Federal income tax purposes in each of the years 1979 through 1985. For example, in 1979, the partnership projected an overall loss of $ 1,937,000. Each Class A limited partner's share of the partnership's overall loss in 1979 was projected to be $ 52,022 resulting in a tax benefit of approximately $ 26,011 (assuming each Class A limited partner purchased a single Class A limited partnership unit and was taxed at a combined Federal/state rate of 50 percent). According to the figures contained in the offering memorandum, the remaining partners (i.e., Mr. Campbell, Mr. Kane, and Realty Properties) could expect to receive approximately $ 38,740 in tax losses from Phillips House in 1979. A good deal of the 1979 loss was attributable to the partnership's expected deduction of the substantial fees payable to Realty Properties and its affiliates. The partnership also intended to donate a perpetual easement on the exterior portion or facade*158 of the Hotel to the Historic Kansas City Foundation. The easement was expected to reduce the value of the Hotel by approximately $ 1,200,000 and, thus, the projection was stated to reflect a charitable deduction in the amount of $ 1,200,000. Each Class A limited partner's distributive share of the charitable deduction was projected to be $ 32,229. The distributive share of such deduction would be $ 24,000 each for the three remaining partners. The partnership's overall loss for 1980 was projected to be $ 1,150,000 and each Class A limited partner's distributive share of such loss was projected to be $ 30,886. Each Class A limited partner's projected tax benefit was expected to be $ 29,075. This amount includes investment tax credits totaling $ 13,632 per Class A limited partner attributable, in part, to rehabilitation costs which the partnership would assert were entitled to investment tax credit treatment. According to the figures contained in the offering memorandum, in 1980 the remaining partners could expect to receive a tax loss of approximately $ 23,000 each, as well as investment tax credits in the approximate amount of $ 10,151. Over the next four years (1982 through*159 1985), the overall projected loss of the partnership and, therefore, the tax benefits available gradually decreased until 1986 when the partnership expected to pass through taxable income to the Class A limited partners for the first time. During 1986 and for the next three years thereafter, the partnership was expected to pass through a total of $ 35,076 in taxable income to each Class A limited partner. The offering memorandum warned that the partnership intended to take positions with respect to certain deductions and allocations that were not based on settled interpretations of tax law and that, if the Internal Revenue Service were to audit the returns of the partnership and its Class A limited partners, some or all of the deductions and allocations would probably be disallowed. Nevertheless, the offering memorandum projected that each Class A limited partner would receive a total of $ 172,261 in tax losses from his investment in Phillips House and save approximately $ 82,225 in Federal income taxes (assuming his income from other sources was taxed at a rate of at least 50 percent) over the 11 taxable years for which projections were available (1979 through 1989). The Class*160 A limited partners could also expect tax savings from utilizing the $ 13,632 in investment tax credits passed through from Phillips House in 1980. According to the figures contained in the offering memorandum, from 1979 through 1989, the remaining partners (i.e., Mr. Campbell, Mr. Kane, and Realty Properties) could each expect to receive tax losses totaling $ 128,280, taxable income totaling $ 26,120, and investment tax credits totaling approximately $ 10,151. Mr. Campbell and Mr. Kane were each allocated a basis in the partnership based on the amount of nonrecourse indebtedness of the partnership. The projections also reveal that, after 1979, the partnership did not anticipate a positive cash flow again until 1982 and did not expect to have cash available for distribution to the Class A limited partners until that year. It did not expect to have cash available for distribution to the special limited partners and the general partner until 1984. In 1984, the partnership expected to have $ 358,000 in cash available for distribution to the Class A limited partners and $ 23,000 in cash available for distribution amongst the special limited partners and the general partner. In 1985, *161 the partnership expected to have $ 459,000 in cash available for distribution to the Class A limited partners and $ 29,000 in cash available for distribution amongst the special limited partners and the general partner. From 1986 through 1989 (the last year for which projections were made), the partnership expected in each year to have approximately $ 460,000 in cash available for distribution to the Class A limited partners and $ 29,000 in cash available for distribution amongst the special limited partners and the general partner. According to the offering memorandum, the Class A limited partners could expect total cash distributions in the amount of $ 91,372 over the ten years for which projections were available. In addition to a share in the profits and losses of Phillips House, both the general partner, Realty Properties, and the special limited partners, Mr. Campbell and Mr. Kane, were entitled to share in any proceeds which might become available from the sale or refinancing of the Hotel. The net proceeds from the sale or refinancing of the Hotel were to be distributed first to the Class A limited partners in accordance with their respective "capital investments" plus any*162 accrued deficiency in the priority return for the year of sale or refinancing. Next, the general partner would be entitled to a return of his $ 30,000 capital contribution. Thereafter, 5 percent of the net proceeds were to be distributed first to each of the special limited partners to the extent available and then 5 percent to the general partner. Finally, any remaining proceeds were to be distributed in a ratio of 85 percent to the Class A limited partners, 5 percent each to the special limited partners, and 5 percent to the general partner. According to the offering memorandum, the partnership units were intended to be long-term investments only. The sale of the partnership units was not being registered under state or Federal securities laws nor did the limited partners have any right to require such registration. The offering memorandum provided that the sale or exchange of a unit in the partnership would not be permitted without the consent of the general partner. According to the offering memorandum and sample certificate of limited partnership attached thereto, the general partner could arbitrarily withhold its consent to such a transfer. The offering memorandum also*163 noted that the resale value of the units would probably decline due to the ultimate exhaustion of the tax benefits which would be available in earlier years. The general partner was solely responsible for the management of the affairs of the partnership and was not required to obtain the consent of the limited partners except under certain specifically enumerated circumstances. For example, the general partner was empowered to borrow money on behalf of the partnership or lend money to the partnership without the consent of the limited partners. However, in order to sell, dispose of, mortgage, lease, demolish, or substantially alter the Hotel, the general partner was required to obtain the consent of a majority in interest of the Class A limited partners. The special limited partners did not have to be consulted. The day-to-day management of the Hotel itself was delegated to Sunn Management, Inc. (Sunn), a professional hotel and management company. By December 31, 1979, 20 Class A limited partnership units in Phillips House had been sold and 15 remained outstanding. By the time an amended certificate of limited partnership for Phillips House was filed on May 28, 1980, 30.5 Class*164 A limited partnership units had been sold. By December 31, 1980, all 35 Phillips House Class A limited partnership units had been sold. A second amended certificate of limited partnership, dated April 29, 1981, listed the names and addresses of all participants in Phillips House, including Realty Properties, Mr. Campbell, and Mr. Kane. Phillips House filed a Form 1065, "U.S. Partnership Return of Income" for its tax year ending December 31, 1979 (the 1979 partnership return), on which it reported an ordinary loss in the amount of $ 5,049 attributable to travel, printing, postage, bank charges, amortization of organizational expenditures under section 709, and miscellaneous expenses. The partnership's return was prepared by the accounting firm of Baird, Kurtz and Dobson and executed by the general partner on April 15, 1980. As noted, the partnership was obligated to pay Diversified Financial Services 3 percent of the offering proceeds as a nonaccountable expense allowance (up to a maximum of $ 104,213 if it sold all 35 of the Class A partnership units). In computing its amortization deduction under section 709, the partnership included the full $ 104,213 in organizational expenses*165 even though only 20 partnership units had been sold by the end of 1979. In addition, the partnership reported a charitable contribution in the amount of $ 1,200,000. The partnership attached to the partnership return a Schedule K-1, "Partner's Share of Income, Credits, Deductions, etc. -- 1979" (the 1979 Phillips House K-1), for each Class A limited partner, both special limited partners, and the general partner. The 1979 Phillips House K-1 for Mr. Campbell indicated that, on December 28, 1979, he acquired a 2-percent interest in the profits and losses of the partnership and a .01-percent interest in the capital of the partnership. The 1979 Phillips House K-1 also indicated that Mr. Campbell's share of the partnership's nonrecourse debt was $ 31,680, that his share of the partnership's ordinary loss was $ 102, and that his share of the partnership's charitable contribution was $ 24,000. Finally, the 1979 Phillips House K-1 indicated that, as of December 31, 1979, Mr. Campbell's capital account had a negative balance of $ 23,952. On its partnership return for the tax year ending December 31, 1980 (the 1980 partnership return), Phillips House reported an ordinary loss in the amount*166 of $ 1,818,678. A 1980 Schedule K-1 (1980 Phillips House K-1) for Mr. Campbell, which had been attached thereto, indicated that, as of December 31, 1980, Mr. Campbell owned a 2-percent interest in the profits and losses of Phillips House and in addition, owned a 2-percent interest in the capital of Phillips House. According to the 1980 Phillips House K-1, Mr. Campbell's share of the partnership's nonrecourse debt was $ 182,760 and his distributive share of the partnership's ordinary loss was $ 36,374. The 1980 Phillips House K-1 also indicated that, as of December 31, 1980, Mr. Campbell's capital account had a negative balance of $ 60,326. The GrandThe Grand was organized under the laws of South Carolina in November 1980 for the purpose of acquiring, improving, and operating a Howard Johnson's Motor Lodge (the Motel) which was located in Myrtle Beach, South Carolina with a view toward obtaining certain tax benefits. The Grand was to acquire the Motel, which was already in operation, from Summit Mortgage Company, a member of the Summa T. Group, for approximately $ 11,125,000. Approximately $ 350,000 of the total purchase price of the Motel was allocated by The Grand to*167 a "covenant-not-to-compete," under which Summit Mortgage Company and certain of its affiliates agreed not to acquire, for a period of six months from the date of closing, any ownership interest in any venture which was within a five-mile radius of the Motel and which would compete directly with the Motel. Approximately $ 547,347 of the total purchase price was due at closing while a payment of $ 312,500 was due on January 21, 1982, and again on January 21, 1983. In addition, The Grand was required to assume liability for repayment of two preexisting notes which had a combined principal balance of approximately $ 602,500. Finally, The Grand was to issue a nonrecourse "Wrap Note and Mortgage" for the balance of the purchase price, $ 9,347,500, and precomputed capitalized interest in the amount of $ 28,716,750. 2 Interest was computed at a rate of 9.99 percent, utilizing the "Rule of 78's." The wrap note was executed on November 2, 1980, by Mr. Campbell on behalf of the general partner, Realty Properties, and by Mr. Kane on behalf of Summit Mortgage Company. *168 Summit Mortgage Company had purchased all of the stock of a corporation which owned the Motel in July 1980 for approximately $ 10,448,509 and planned to liquidate such corporation so that it could convey direct title to the Motel to The Grand in December 1980. By virtue of the transaction Summit Mortgage Company would also become liable for approximately $ 350,000 in Federal income taxes it would incur upon liquidation of the corporation. Summit Mortgage Company secured a profit of approximately $ 326,614 upon completion of the transaction ($ 11,125,000, including $ 350,000 for the covenant not to compete, reduced by $ 10,448,509, the purchase price of the corporation's stock, and further reduced by $ 350,000, the Federal income taxes due upon liquidation). According to the original certificate of limited partnership, which had been filed on October 24, 1980, upon formation of The Grand, the sole general partner was Realty Properties and the sole limited partner was Mr. Campbell. Mr. Campbell, as sole limited partner, was to be allocated 97 percent of the profits of The Grand. Mr. Campbell was required to contribute $ 150 in cash to The Grand in exchange for his interest. Mr. *169 Campbell was not required to make any further capital contributions. According to the certificate of limited partnership, no limited partner (including Mr. Campbell) had the right to assign his interest except under specified conditions, one such condition being the agreement of the general partner, Realty Properties, to the assignment. The general partner was given the right, in its sole discretion, to admit additional limited partners. Pursuant to this authorization, 35 Class A limited partnership units in The Grand were offered for sale to investors through a nonpublic offering memorandum. The purchase price of each partnership unit was $ 99,750 and the minimum recommended investment was one unit. Diversified Financial Services was the sales agent for the Class A limited partnership units and was to receive a placement commission of up to 8 percent of Class A limited partnership subscriptions plus a nonaccountable expense allowance equal to 3 percent of the proceeds from the sale of the units (up to a maximum of $ 104,738 if all 35 units were sold). Mr. Campbell and Mr. Kane were denominated as "special limited partners" in The Grand offering memorandum. Total capitalization*170 of The Grand was projected to be $ 3,521,250, of which $ 3,491,250 was expected to be raised through sale of Class A limited partnership units in The Grand, $ 50,000 was to be contributed by Realty Properties, and $ 150 was to be contributed by each special limited partner. According to the offering memorandum, 62 percent of the capital contributed was to be used for equity payments, prepaid debt service, loan assumption payments, and project improvements. Approximately 2.1 percent of the contributed capital was to be used to pay legal and accounting fees, while 5.7 percent of the contributed capital would serve as the working capital for The Grand. The remaining 30.2 percent of contributed capital would be paid, in the form of expense allowances, consulting fees, management fees, and financing fees, to Realty Properties and its affiliates, Summa T. Realty and Diversified Financial Services. Realty Properties was to receive a fee of $ 209,475 for providing a system of cost controls and market survey for The Grand. In addition, Realty Properties was to develop a marketing plan for The Grand which would focus on the sale of golf and tennis packages during the Motel's slow months. *171 Realty Properties was also entitled to a management fee equal to 1/24th of 1 percent of the total value of The Grand's assets. Summa T. Realty was to receive a total of $ 900,025 in consulting fees from The Grand, including a fee of $ 687,275 for financial and tax consulting services which were to be rendered over the first 37 months of the Motel's operation. The tax consulting services related mostly to the design, organization, and coordination of the offering so as to provide significant tax benefits. Mr. Campbell participated in the provision of these tax services but was primarily involved in the provision of financial services (i.e., the selection and acquisition of properties). According to the offering memorandum, 97 percent of the profits and losses of The Grand were to be allocated to the Class A limited partners, 1 percent of the profits and losses were to be allocated to Realty Properties, and 1 percent of the profits and losses were to be allocated to each of the special limited partners, Mr. Campbell and Mr. Kane. Any cash available from the operations of The Grand was to be used first to pay all sums due on partnership obligations, second to establish reasonable*172 reserves, and third to make distributions to the partners. Any cash available for distribution was to be paid first to the Class A limited partners to the extent of 10 percent of their capital contributions per year (the priority return). Any cash available after payment of the priority return was to be used to pay the special limited and general partners a return of $ 3,599 each per year. Thereafter, any remaining cash was to be allocated and distributed in accordance with the partners' ratio for sharing profits and losses. According to projections contained within the offering memorandum, The Grand was expected to incur a taxable loss in each of the years 1980 through 1989. For example, in the taxable year ending December 31, 1980, The Grand was expected to incur a taxable loss in the amount of $ 1,173,072. This loss was, in large part, attributable to the deduction of consulting and management fees and amortization of the covenant not to compete. In addition, the projection reflects large deductions for interest expense and depreciation. Each Class A limited partner's distributive share of The Grand's 1980 loss was projected to be $ 32,511 with a resulting tax benefit (assuming*173 his income from other sources was taxed at a rate of at least 50 percent) of $ 16,255. Each Class A limited partner would also be entitled to claim an investment tax credit in the amount of $ 494. According to the figures contained in the offering memorandum, each of the remaining partners' (i.e., Mr. Campbell, Mr. Kane, and Realty Properties) distributive share of The Grand's 1980 loss would be approximately $ 11,737 and their distributive share of investment tax credit would be $ 178 each. The offering memorandum for The Grand warned, as did the offering memorandum for Phillips House, that the partnership's positions with respect to certain deductions and credits were not based on settled interpretations of the tax laws and that the Internal Revenue Service might disallow any of the various deductions and credits claimed. Nevertheless, the offering memorandum projected that each Class A limited partner would receive $ 246,259 in tax losses from his investment in The Grand and save approximately $ 123,128 in Federal income taxes (assuming his income from other sources was taxed at a rate of at least 50 percent) over the 10 taxable years for which projections were available (1980*174 through 1989). The Class A limited partners could also expect tax savings from utilizing $ 989 in investment tax credits passed through from The Grand. According to the figures contained in the offering memorandum, the remaining partners (i.e., Mr. Campbell, Mr. Kane, and Realty Properties) could each expect to receive tax losses totaling $ 88,902 and investment tax credits totaling $ 357. According to the offering memorandum, The Grand did not project a positive cash flow from operations until 1982. The general partner was obligated to advance up to $ 100,000 in working capital, which would be repaid without interest, if the partnership's cash flow was insufficient to cover its operating expenses and debt service payments. The Grand anticipated sufficient cash flow in 1982 to distribute to each Class A limited partner $ 1,322. The Grand projected cash distributions to the Class A limited partners in the amounts of $ 4,130, $ 6,527, and $ 8,295, in 1983, 1984, and 1985, respectively. However, it was not until 1986 that The Grand expected to have sufficient cash flow to enable it to make cash distributions to the general and special limited partners. In 1986, and each year thereafter*175 for which projections were made, The Grand was expected to have sufficient cash flow to enable it to distribute $ 12,312 per year to each Class A limited partner, $ 4,443 per year to each special limited partner, and $ 4,443 per year to the general partner. In addition to a share in the profits and losses of The Grand, the special limited partners and the general partner were entitled to share in any proceeds which might become available from the sale or refinancing of the Motel. The net proceeds from a sale or refinancing of the Motel were to be used first to pay all sums due on partnership obligations and second to establish reasonable reserves for the partnership. Any proceeds in excess of such amounts were to be used first to repay each Class A limited partner the greater of his original capital contribution (less any amounts previously distributed as a return of capital) or 80 percent of the net proceeds from the sale or refinancing. In addition, the general partner was to be repaid its original capital contribution of $ 50,000 (less any amounts previously distributed as a return of capital). After return of the original capital contributions, 10 percent of the net proceeds*176 from a sale or refinancing was to be paid to each of the special limited partners before any further amounts could be paid to the Class A limited partners or the general partner. Thereafter, 10 percent of the net proceeds (less the amount paid as a return of capital) was to be paid to the general partner. Finally, any remaining proceeds were to be distributed in a ratio of 80 percent to the Class A limited partners, 5 percent to each of the special limited partners, and 10 percent to the general partner. Primary responsibility for management of The Grand partnership was vested with the general partner, Realty Properties. The day-to-day management of the Motel itself was delegated to Summa-Sunn Strand, a joint venture between Summa Management Company, a member of the Summa T. Group, and Sunn Management Company. Summa-Sunn Strand was to receive a management fee equal to 4.25 percent of the gross revenues of the Motel in return for its management services. The offering memorandum and the certificate of limited partnership provided that no limited partner could transfer his interest in The Grand without the consent of the general partner and that the general partner could arbitrarily*177 withhold such consent. The sale of the units was not being registered under Federal or state securities laws and, according to the offering memorandum, the limited partners had no rights to require such registration. The offering memorandum warned that no market existed or would develop for resale of the units. By December 31, 1980, 18.5 Class A limited partnership units in The Grand had been sold and 16.5 units remained outstanding. By December 31, 1981, all 35 Class A limited partnership units in The Grand had been sold. An amended certificate of limited partnership, which listed the names and addresses of all participants in The Grand (including Mr. Campbell), was executed on June 15, 1981. The Grand filed a Form 1065, "U.S. Partnership Return of Income" for its tax year ending December 31, 1980 (the 1980 return) on which it reported an ordinary loss in the amount of $ 811,582. The return was prepared by the accounting firm of Baird, Kurtz and Dobson and bears the date April 11, 1981. On its 1980 return, The Grand allocated a basis of $ 8,287,153 to the buildings and components thereof (i.e., the Motel) that it had purchased and calculated a deduction for depreciation*178 based on this amount. The Grand allocated a basis of $ 285,400 to nondepreciable real property (i.e., the land on which the Motel stood). On April 20, 1981, Appraisal Consultants, Inc., an independent appraisal firm, submitted a report to The Grand valuing the Motel and the land on which it stood at $ 12,200,000 as of April 1, 1981. The firm allocated $ 1,500,000 of the total estimated value to nondepreciable real estate and $ 10,700,000 of the total estimated value to the Motel, its components, and accompanying personalty. The Grand also reported a basis in amortizable intangible assets (including the covenant not to compete) of $ 357,793 and calculated a deduction for amortization based on this amount. The Grand attached a Schedule K-1, "Partner's Share of Income, Credits, Deductions, etc. -- 1980" for each Class A limited partner, each special limited partner, and the general partner. The Schedule K-1 issued to Mr. Campbell (1980 The Grand K-1) indicated that, on November 2, 1980, Mr. Campbell received a 1-percent interest in the profits, losses, and capital of The Grand. According to Mr. Campbell's K-1 from The Grand for 1980, his share of The Grand's nonrecourse debt was*179 $ 99,522 and his distributive share of The Grand's 1980 ordinary losses was $ 8,115. In addition, Mr. Campbell's K-1 from The Grand for 1980 indicates that The Grand passed through a loss of $ 55 as a separately accounted-for item. Finally, Mr. Campbell's K-1 from The Grand for 1980 indicates that, as of December 31, 1980, his capital account in The Grand had a negative balance of $ 8,020. AirportAirport was formed under the laws of the State of Missouri in July 1980 for the purpose of acquiring, improving, and operating the Northwest Airport Inn (the Inn) which was located in St. Louis County, Missouri with a view toward obtaining certain tax benefits. Airport was to acquire the Inn, on or before October 20, 1980, from S.T. Properties Corporation (S.T.), an affiliate of Realty Properties, for approximately $ 6,250,000. In addition, Airport agreed to pay S.T. $ 250,000 in return for a covenant by S.T. and certain of its affiliates not to compete within a five-mile radius of the Inn for a period of 12 months. S.T. had contracted to acquire the Inn from an unrelated seller in July 1980 for a total purchase price of $ 5,500,000 and, thus, stood to earn a profit of approximately*180 $ 1,000,000 (including the $ 250,000 paid for the covenant not to compete) upon completion of the transaction. Of the total purchase price of $ 6,500,000, $ 400,000 was due in cash upon closing and $ 400,000 was due on March 15, 1981. In addition, Airport issued a "Wrap-around Purchase Mortgage Note" (the wrap note) to S.T. for the balance of the purchase price, $ 5,700,000. The wrap note bore interest at a rate of 9.01 percent, payable monthly and computed under the "Rule of 78's." The sole general partner of Airport was Realty Properties. Mr. Campbell and Mr. Kane were the sole special limited partners of Airport. Mr. Campbell was required to contribute $ 150 in cash to Airport in exchange for his interest therein. Mr. Campbell was not required to make any further capital contributions. According to an amended certificate of limited partnership, which was filed on September 24, 1981, no limited partner (including Mr. Campbell) had the right to assign his interest except under specified conditions, one such condition being the agreement of the general partner, Realty Properties, to the assignment. The general partner was given the right, in its sole discretion, to admit*181 additional limited partners. Pursuant to this authorization, 35 Class A limited partnership units in Airport were offered for sale to investors through a nonpublic offering memorandum. The purchase price of each Class A limited partnership unit was $ 57,500 and the minimum recommended investment was one unit. Diversified Financial Services was, once again, the sales agent for the offering and was to receive a placement commission of up to 8 percent of Class A limited partner subscriptions plus a nonaccountable expense allowance equal to 3 percent of the proceeds from the sale of the units up to a maximum of $ 60,375 if all 35 units were sold. Total capitalization of Airport was projected to be $ 2,032,800 of which $ 2,012,500 was to be raised through sale of Class A limited partnership units, $ 20,000 was to be contributed by Realty Properties, and $ 150 was to be contributed by each special limited partner. The offering memorandum described the projected use of these capital contributions. According to the memorandum, approximately 39.3 percent (or $ 800,000) of contributed capital was to be paid to S.T. as an equity payment. Another 12.3 percent of contributed capital ($ 250,000) *182 was to be used for improvements to the Inn. Approximately 7.5 percent of the proceeds of the offering would be used as working capital and 2.4 percent would go towards legal and accounting fees. The remaining 38.5 percent of contributed capital would be paid, in the form of expense allowances, consulting fees, management fees, and financing fees, to Realty Properties and its affiliates, Summa T. Realty and Diversified Financial Services. In this instance, Summa T. Realty was to receive a total of $ 550,000 in consulting fees, including a fee of $ 357,500 for financial and tax consulting services which were to be rendered over the first 37 months of the Inn's operation. The tax consulting services related mostly to the design, organization, and coordination of the offering so as to provide significant tax benefits. Mr. Campbell participated in the provision of these tax services but was primarily involved in the provision of financial services (i.e., the selection and acquisition of properties). In addition, Realty Properties was to receive a total fee of $ 170,000 for arranging financing and providing a marketing and management plan. According to the offering memorandum, 97*183 percent of the profits and losses of Airport were to be allocated to the Class A limited partners, 1 percent of the profits and losses were to be allocated to Realty Properties, and 1 percent of the profits and losses were to be allocated to each of the special limited partners, Mr. Campbell and Mr. Kane. Any cash available from the operations of Airport was to be used first to pay all sums due on partnership obligations, second to establish reasonable reserves, and third to make distributions to the partners. Prior to January 1, 1981, all cash available for distribution was to be paid to the general partner, Realty Properties. However, the general partner was obligated to advance up to $ 75,000 in working capital, which would be repaid without interest, if the partnership's cash flow was insufficient to cover its operating expenses and debt service payments. After January 1, 1981, any cash available for distribution was to be used first to pay annually to the Class A limited partners an amount equal to 10 percent of their capital contributions (the priority return). If cash was still available after annual distribution of this priority return, an amount equal to $ 2,075 would*184 be distributed annually to the general partner and each special limited partner. Thereafter, any remaining cash was to be allocated and distributed in accordance with partners' ratio for sharing profits and losses. According to projections contained within the offering memorandum, Airport was expected to incur a taxable loss in each of the years 1980 through 1987. In 1988 and 1989, Airport was expected to show taxable income. In the taxable year ending December 31, 1980, Airport was expected to incur a taxable loss in the amount of $ 738,585. This loss was, in large part, attributable to the deduction of consulting and management fees and amortization of the covenant not to compete. In addition, the projection reflects large deductions for interest expense and depreciation. According to the offering memorandum, Airport intended to allocate $ 210,000 of the total price it paid for the Inn to land and the remainder, $ 6,040,000, of the purchase price to buildings and other depreciable assets. Each Class A limited partner's distributive share of Airport's 1980 loss was projected to be $ 20,469 with a resulting tax benefit (assuming his income from other sources was taxed at rate*185 of at least 50 percent) of $ 10,235. In addition, each Class A limited partner would be entitled to claim an investment tax credit, passed through from the partnership, in the amount of $ 700. According to the figures contained in the offering memorandum, the remaining partners' (i.e., Mr. Campbell, Mr. Kane, and Realty Properties) distributive share of Airport's 1980 loss would be approximately $ 7,390 each and their distributive share of investment tax credit would be approximately $ 253 each. The offering memorandum for Airport warned, as did the offering memorandum for Phillips House and The Grand, that the partnership's positions with respect to certain deductions and credits were not based on settled interpretations of the tax laws and that the Internal Revenue Service might disallow any of the various deductions and credits claimed. Nevertheless, the offering memorandum projected that each Class A limited partner would receive $ 107,764 in tax losses from his investment in Airport but would also be charged with taxable income in the amount of $ 2,394. Each Class A limited partner would save approximately $ 52,686 in Federal income taxes (assuming his income from other*186 sources was taxed at a rate of at least 50 percent) over the 10 taxable years for which projections were available (1980 through 1989). Each Class A limited partner could also expect tax savings from utilizing $ 1,280 in investment tax credits passed through from Airport. According to the figures contained in the offering memorandum, the remaining partners (i.e., Mr. Campbell, Mr. Kane, and Realty Properties) could each expect to receive tax losses totaling approximately $ 38,904, taxable income totaling approximately $ 864, and investment tax credits totaling approximately $ 462. According to the offering memorandum, Airport did not project a positive cash flow from operations until 1982. In 1982, Airport anticipated sufficient cash flow to distribute $ 2,322 to each Class A limited partner. Airport did not anticipate sufficient cash flow to enable it to make distributions to the special limited partners and general partner until 1983. In 1983, Airport anticipated sufficient cash flow to enable it to distribute $ 7,316 to each Class A limited partner, $ 2,644 to each special limited partner, and $ 2,644 to the general partner. In 1984, Airport anticipated sufficient cash flow*187 to enable it to distribute $ 8,853 to each Class A limited partner, $ 3,194 to each special limited partner, and $ 3,194 to the general partner. In 1985, Airport anticipated sufficient cash flow to enable it to distribute $ 11,292 to each Class A limited partner, $ 4,079 to each special limited partner, and $ 4,079 to the general partner. In 1986, and each year thereafter for which projections were made, Airport was expected to have sufficient cash flow to enable it to distribute $ 10,965 per year to each Class A limited partner, $ 3,952 per year to each special limited partner, and $ 3,952 per year to the general partner. In addition to a share in the profits and losses of Airport, Mr. Campbell, Mr. Kane, and Realty Properties were entitled to share in any proceeds which might become available from the sale or refinancing of the Inn. The net proceeds from a sale or refinancing of the Inn were to be used first to pay all sums currently due on partnership obligations and second to establish reasonable reserves for the partnership. Any proceeds in excess of such amounts were to be used first to repay each Class A limited partner his original capital contribution (less any amounts*188 previously distributed as a return of capital). In addition, the general partner was to be repaid its original capital contribution ($ 20,000) less any amounts previously distributed as a return of capital. After return of the original capital contributions, 10 percent of the net proceeds from a sale or refinancing was to be paid to the special limited partners before any further amounts could be paid to the limited or general partners. Thereafter, 5 percent of the net proceeds, less $ 20,000 (the amount paid as a return of capital), was to be paid to the general partner. Finally, any remaining proceeds were to be distributed in a ratio of 85 percent to the Class A limited partners, 5 percent to each special limited partner, and 5 percent to the general partner. The general partner, Realty Properties, bore primary responsibility for management of Airport. The day-to-day management of the Inn itself was delegated to Summa-Sunn St. Louis, a joint venture between Summa Management Company, a member of the Summa T. Group, and Sunn Management Company. Summa-Sunn St. Louis was to receive a management fee equal to 4.25 percent of the gross revenues of the Inn in return for its management*189 services. As was the case with units in Phillips House and The Grand, there were restrictions placed on the transfer of limited partnership units in Airport. The offering memorandum and the certificate of limited partnership provided that no limited partner could transfer his interest in Airport without the consent of the general partner and that the general partner could arbitrarily withhold such consent. The sale of the units was not being registered under Federal or state securities laws and, according to the Airport offering memorandum, the limited partners would have no rights to require a registration. The offering memorandum also warned that no market existed or would develop for resale of the units. According to the Form 1065, "U.S. Partnership Return of Income," filed by Airport for its calendar year ending December 31, 1980, all 35 Class A limited partnership units in Airport had been sold by December 31, 1980. The return was prepared by the accounting firm of Baird, Kurtz and Dobson and bears the date April 11, 1981. An amended certificate of limited partnership, which listed the names and addresses of all participants in Airport (including Mr. Campbell), was recorded*190 on September 24, 1981. On its 1980 partnership return, Airport reported an ordinary loss in the amount $ 602,424. On its 1980 return, Airport reported a basis of $ 6,051,170 in buildings and other depreciable assets (i.e., the Inn) and calculated a deduction for depreciation based on this amount. Airport reported a basis of $ 210,000 in nondepreciable real property (i.e., the land on which the Inn stood). On March 25, 1981, Appraisal Consultants, Inc. submitted an appraisal report to Airport valuing the Inn and the land on which it stood at $ 6,250,000 as of March 12, 1981. Appraisal Consultants, Inc. allocated $ 400,000 of the total estimated value to nondepreciable real estate and $ 5,850,000 of the total estimated value to the Inn, its components, and accompanying personalty. Finally, Airport reported a basis in amortizable intangible assets (including the covenant not to compete) of $ 741,595 and calculated a deduction for amortization based on this amount. Airport attached a Schedule K-1, "Partner's Share of Income, Credits, Deductions, etc. -- 1980" for each Class A limited partner, each special limited partner, and the general partner. The Schedule K-1 issued to Mr. *191 Campbell (the 1980 Airport K-1) indicated that, on September 29, 1980, Mr. Campbell received a 1-percent interest in the profits, losses, and capital of Airport. According to the 1980 Airport K-1, Mr. Campbell's share of Airport's nonrecourse debt was $ 57,000 and his distributive share of Airport's ordinary losses was $ 6,024. In addition, the 1980 Airport K-1 indicates that Airport passed through a loss of $ 105 to Mr. Campbell as a separately accounted-for item. Finally, the 1980 Airport K-1 indicates that, as of December 31, 1980, Mr. Campbell's capital account in Airport had a negative balance of $ 5,979. On April 15, 1980, petitioners received an automatic extension to June 15, 1980 of the time in which they were required to file their joint Federal income tax return for their tax year ending December 31, 1979. On their 1979 return, petitioners deducted $ 102 as their share of ordinary losses passed through from Phillips House. Petitioners also reported a charitable contribution in the amount of $ 24,000 attributable to their interest in Phillips House. They were only able to deduct $ 4,089 of this amount on their 1979 return. The remainder, $ 19,911, was to be carried*192 over to their 1980 tax year. Petitioners did not report the receipt of the special limited partnership interest in Phillips House on their 1979 Federal income tax return. On April 15, 1981, petitioners filed for an automatic two-month extension to June 15, 1981 of the time in which they were required to file their joint Federal income tax return for their tax year ending December 31, 1980. On July 2, 1981, the time in which petitioners were required to file their 1980 return was further extended to August 15, 1981. On their joint Federal income tax return for their tax year ending December 31, 1980, petitioners deducted $ 36,374 as their share of ordinary losses passed through from Phillips House. They did not utilize any of the $ 19,911 carryover attributable to the 1979 charitable contribution by Phillips House. Petitioners also deducted $ 8,115 as their distributive share of losses from The Grand and $ 6,024 as their distributive share of losses from Airport. Petitioners did not report any income representing the value of the receipt of the special limited partnership interests in Phillips House, The Grand, or Airport on their 1980 Federal income tax return. In his notice*193 of deficiency, dated May 10, 1983, respondent determined that petitioners' 1979 and 1980 income as reported on their return overstated their distributive share of losses and understated their distributive share of income from the numerous partnerships in which they held an interest. With respect to their 1979 return, respondent determined that the correct amount of the 1979 charitable deduction to which petitioners were entitled as a result of their interest in Phillips House was $ 1,920 and that any carryover should be eliminated. Respondent also determined that petitioner's distributive share of losses from Phillips House for 1979 was zero. In addition, respondent determined that petitioners should have included in income the value of the 2-percent partnership interest they received in Phillips House which respondent valued at $ 42,084. With respect to their 1980 return, respondent determined that no amount of the $ 36,374 loss deducted by petitioners as their distributive share of loss from Phillips House was allowable. Respondent determined that, instead, Phillips House had taxable income for 1980 and that petitioners' distributive share of such income was $ 9,324. Respondent*194 further determined that petitioners were entitled to a specially allocated interest deduction of $ 1,881 from Phillips House. Respondent determined that petitioners' share of ordinary loss from The Grand for 1980 was $ 3,815, instead of the $ 8,115 deducted by petitioners on their 1980 return. Respondent further determined that petitioners' distributive share of ordinary loss from Airport was $ 1,148 rather than $ 6,024 as reported on their 1980 return. Respondent also determined that petitioners should have included in their 1980 income the value of the partnership interests Mr. Campbell received in The Grand and Airport. Respondent determined that the fair market value of these interests were $ 16,968 and $ 20,683, respectively. In an amendment to answer, respondent alleged that petitioners were also liable for additions to tax under section 6653(a) for the taxable years 1979 and 1980. Respondent alleged that petitioners, and particularly Mr. Campbell, were negligent in failing to include the value of the special limited partnership interests Mr. Campbell received in income in 1979 and 1980. Respondent also alleged that petitioners were negligent in deducting partnership*195 losses on their joint return which were unjustified and, in some cases, highly inflated. Prior to trial, the parties reached agreement on many of the issues raised in the petition. The parties stipulated that the correct amount of petitioners' share of the Phillips House charitable contribution was $ 6,000 and that the correct amount of petitioners' distributive share of loss from Phillips House for 1979 was zero. The parties also stipulated that petitioners' distributive share of loss from Phillips House for 1980 was zero. The parties stipulated that the correct amount of petitioners' distributive share of losses for 1980 from The Grand and Airport were $ 4,247.94 and $ 1,304.55, respectively. The parties have not reached agreement on whether petitioners were required to include in income the value of the partnership interests Mr. Campbell received or if so, the value of such interests and have reached no agreement with respect to the additions to tax asserted by respondent in his amendment to answer. OPINION Petitioners take the position that the interests Mr. Campbell received in Phillips House, The Grand, and Airport were merely interests in the profits of such partnerships*196 and, as such, the value, if any, of these interests should not be included in petitioners' income in the year of receipt. Petitioners base their arguments, in part, on section 721(a) (and the regulations thereunder) which provided for nonrecognition of income upon the receipt of a partnership interest under certain circumstances. Petitioners further argue that, even if section 721(a), and the regulations thereunder, are inapplicable to the present situation, the receipt of each partnership interest is governed by section 83 which provides the time of recognition of income where property is transferred to a taxpayer in exchange for his performance of services. Petitioners argue that, under section 83, they are permitted to defer recognition of income because the partnership interests were never "transferred" to them within the meaning of section 83 or, in the alternative, that the interests were subject to a substantial risk of forfeiture and thus were not taxable upon receipt even if they were transferred. Finally, petitioners argue that, even if the partnership interests were transferred to Mr. Campbell in return for the performance of services and such interests were not subject*197 to a substantial risk of forfeiture, the value of such interests was so speculative that the most which should be included in their income under either section 61 or section 83 is $ 1,000 per partnership interest. Section 61(a) stated the general rule that: Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation for services, including fees, commissions, and similar items; * * * Thus, unless nonrecognition is provided for elsewhere, petitioners must include the value of the partnership interests which Mr. Campbell received in their income immediately upon receipt. Section 721(a) provides that no gain or loss is recognized to a partnership or the contributing partners, "in the case of a contribution of property to the partnership in exchange for an interest in the partnership." (Emphasis supplied.) Despite the fact that section 721, by its own terms, applies only where the recipient of a partnership interest contributes property in exchange for such interest, petitioners argue that the regulations issued under section 721 have enlarged the scope of*198 that section to also provide nonrecognition in situations where the contributing partner has contributed services, rather than property, in exchange for his partnership interest. Specifically, petitioners point to the language of section 1.721-1(b)(1), Income Tax Regs., which provides that: Normally, under local law, each partner is entitled to be repaid his contributions of money or other property to the partnership * * *. To the extent that any of the partners gives up any part of his right to be repaid his contributions (as distinguished from a share in partnership profits) in favor of another partner as compensation for services (or in satisfaction of an obligation), section 721 does not apply. * * * [Emphasis supplied.] Petitioners seize upon the language we have emphasized in the above-quoted regulation to support their argument that a distinction has been intentionally drawn in such regulation between situations in which a partner receives an interest in the capital of a partnership and situations in which a partner receives a mere profits interest. Petitioners argue that the former situation has been clearly excluded from nonrecognition treatment under section 721(a) *199 while the latter situation has, by negative implication, been clearly singled out for nonrecognition treatment by the regulations. We have previously addressed and rejected this same argument in Diamond v. Commissioner, 530">56 T.C. 530 (1971), affd. 492 F.2d 286">492 F.2d 286 (7th Cir. 1974), a case with facts similar to those in the instant case. In the Diamond case, the taxpayer, who was a mortgage broker, arranged financing for an individual who owned a right to purchase an office building. In exchange for his services in arranging the loans necessary for the purchase of the building, the taxpayer was given a 60-percent interest in the profits and losses of a partnership which was subsequently formed to exploit the property. In the Diamond case, the individual for whom the taxpayer arranged financing was to contribute all cash needed in excess of the loan proceeds. In addition to an interest in the profits and losses of the partnership, the taxpayer was entitled to 60 percent of the proceeds from any sale of the office building, but only after repayment to the other individual of all cash advanced by him. Less than three weeks after acquiring his partnership*200 interest, the taxpayer sold his interest for $ 40,000. The taxpayer failed to include the value of the interest he received in income, but reported the gain from sale of the interest as short-term capital gain. The taxpayer in the Diamond case, argued, as do the petitioners in this case, that if a taxpayer receives an interest in partnership capital in exchange for the performance of services, he is required to recognize ordinary income immediately upon receipt of such interest but, if he merely receives an interest in the future partnership profits and losses in exchange for services, he may defer recognition of income under section 1.721-1(b)(1), Income Tax Regs. Without determining the exact nature of the partnership interest received by the taxpayer, we noted that, although the origin and effect of the parenthetical language in the regulation was by no means clear, nothing in section 1.721-1(b)(1), Income Tax Regs., explicitly required the application of section 721(a) to the situation before the Court. We further reasoned that the application of section 721 to a partnership interest which was received in exchange for a contribution of services would result in an impermissible*201 distortion of the language of the statute. In light of the fact that the taxpayer sold his interest for $ 40,000 just three weeks later, we rejected the taxpayer's argument that the interest he received was worthless. We therefore concluded that, under the general rule of section 61, the taxpayer was required to include the value of the interest he received in gross income immediately upon receipt. Diamond v. Commissioner, 530">56 T.C. at 545. On appeal, the Circuit Court of Appeals for the Seventh Circuit, which proceeded on the theory that the taxpayer had received a profits interest in the partnership, affirmed our decision. Diamond v. Commissioner, 492 F.2d 286">492 F.2d 286, 291 (7th Cir. 1974), affg. 56 T.C. 530">56 T.C. 530 (1971). The court suggested that regulations be issued to clarify the proper treatment of the receipt of a profits interest in exchange for services. The court concluded, however, that, in the absence of such regulations, it was best to sustain the decision of this Court. Petitioners state that our decision in the Diamond case, and to a lesser extent, the decision of the Seventh Circuit Court of Appeals in that case has been the*202 subject of much criticism (e.g., 1 A. Willis, Partnership Taxation, p. 125 (2d ed. 1976); Cowan, "Receipt of an Interest in Partnership Profits: The Diamond Case," 27 Tax Law Review 161 (1972)) and urge that, in light of this criticism, we reverse our holding in that case. Petitioners argue that in rejecting our position in the Diamond case, we should conclude, as a matter of law, that section 1.721-1(b)(1), Income Tax Regs., precludes the inclusion in gross income of the value of a profits interests received in exchange for services which have been rendered to a partnership. We reject petitioners argument that we should no longer follow our decision in the Diamond case and reaffirm our holding that section 721(a) and the regulations thereunder are simply inapplicable where, as in the Diamond case and the instant case, a partner receives his partnership interest in exchange for services he has rendered to the partnership. In order to invoke the benefits of nonrecognition under section 721(a), the taxpayer must contribute "property" to the partnership in exchange for his partnership interest. United States v. Stafford, 727 F.2d 1043">727 F.2d 1043, 1048 (11th Cir. 1984).*203 The Stafford case makes it clear that services are not "property" for purposes of section 721(a). The considerations which underlie section 721(a) nonrecognition treatment where a taxpayer receives a partnership interest in exchange for property are vastly different from those reasons advanced by petitioners in favor of section 721(a) nonrecognition treatment where a taxpayer receives a partnership interest in exchange for services. In the former situation, there has been no disposition of the contributed property. The partnership interest such partner receives represents a mere change in the form of an asset which the taxpayer already owns. Archbald v. Commissioner, 27 B.T.A. 837">27 B.T.A. 837 (1933), affd. 70 F.2d 720">70 F.2d 720 (2d Cir. 1934). In the latter situation, it represents compensation for services, the value of which has not previously been reported as income. In providing nonrecognition treatment, section 721(a) makes no distinction between the receipt of a capital interest and a profits interest. Therefore, it is inconsistent that petitioners, while conceding that a service partner who receives an interest in partnership capital is not relieved from*204 immediate taxation by section 721(a), argue that a service partner's receipt of a profits interest should be afforded nonrecognition treatment under section 721(a). After reexamining our holding in Diamond v. Commissioner, supra, we are convinced that section 721(a) is inapplicable to the receipt of any type of partnership interest in exchange for services. Putting aside for the moment the question of whether respondent could, by the issuance of regulations, significantly enlarge the scope of this clearly worded statute, we conclude that the language of section 1.721-1(b)(1), Income Tax Regs., does not lead to the result advanced by petitioners. As we noted in Diamond, section 1.721-1(b)(1), Income Tax Regs., is unartfully drafted, but this fact does not require an interpretation of the statute contrary to its clear words. In the instant case, we conclude from the evidence that petitioner received his interests in Phillips House, The Grand, and Airport in exchange for prior services. Those services included locating suitable properties for his employer, negotiating the acquisition of those properties, organizing the limited partnerships which would eventually acquire*205 those properties, and assisting in the preparation of offering materials in connection with the syndication of these limited partnerships. The records of the partnerships as shown in their respective returns of income show that Mr. Campbell acquired his interest in each partnership after the rendering of these services. Clearly, on this record, the listing of Mr. Campbell as the sole limited partner at formation in two of the partnerships was a matter of form and convenience and his substantive interest was not acquired until his services had been rendered as shown on the partnership records. In our view, the instant transaction is not within the scope of section 721(a). In our view, the determination of when Mr. Campbell should be required to include in income the value of the partnership interests he received in Phillips House, The Grand, and Airport is governed by section 83. Hensel Phelps Construction Co. v. Commissioner, 74 T.C. 939">74 T.C. 939, 952 (1980), affd. 703 F.2d 485">703 F.2d 485 (10th Cir. 1983). Under section 83 3, if property is transferred to any person in connection with the performance of services, the person who performed the services is required to*206 include in income the fair market value of such property (less any amounts which were paid for such property) in the first taxable year in which such property becomes transferable or is not subject to a substantial risk of forfeiture, whichever occurs first. Thus, the operation of section 83 requires inclusion in income of the value of property transferred if three factors are present. *207 First, the thing transferred in connection with the performance of services must be "property" as that term is used in section 83. In our view, it cannot be seriously questioned that the interests which Mr. Campbell received in Phillips House, The Grand, and Airport were "property" within the meaning of section 83. Section 1.83-3(e), Income Tax Regs., provides that, "the term 'property' includes real and personal property other than either money or an unfunded and unsecured promise to pay money or property in the future." Under section 701 of the Uniform Limited Partnership Act (ULPA), as well as the corresponding laws of both Missouri and South Carolina, any partnership interest is personal property. Uniform Limited Partnership Act section 701, 9 U.L.A. (1976); Mo. Ann. Stat. section 359.401 (Vernon 1989); S.C. Code Ann. section 33-42-1210 (Law. Co-op. 1976). We see no reason why a different rule should obtain for Federal income tax purposes. Respondent argues that a pure profits interest in a partnership might be considered an unfunded and unsecured promise to pay money in the future and, therefore, excluded from the*208 definition of "property" within the meaning of section 83. Respondent reasons that, if the interests Mr. Campbell received are found to be pure profits interests, section 83 would not apply and the question of whether petitioners are taxable upon the receipt of such interests should be determined under the more general provisions of section 61. We need not discuss whether section 61 would be applicable in this case since we conclude that the interest transferred to Mr. Campbell in each of the partnerships was "property" within the meaning of section 83, so that section 83 governs its receipt. State law makes no distinction between an interest in partnership profits and an interest in partnership capital. Uniform Limited Partnership Act sections 101(10) and 701, 9 U.L.A. (1976); Mo. Ann. Stat. sections 359.011(10) and 359.401 (Vernon 1989); S.C. Code Ann. sections 33-42-20(10) and 33-42-1210 (Law. Co-op. 1976). Both are classified as personal property and, therefore, are literally within the terms of section 83. But see section 1.721-1(b)(1), Proposed Income Tax Regs., 36 Fed. Reg. 10799 (June 3, 1971). Furthermore, *209 a partnership profits interest is not a "promise to pay." The recipient of a promise to pay is generally entitled only to a fixed amount of money that is not specifically geared to the profits of a business. This is the case even though no funds have been set aside to secure payment of the fixed amount so that the payment may in fact be affected by the success of the business. In contrast, the holder of a profits interest in a partnership is not promised a fixed amount of money but, rather, is subject to the exigencies of the partnership's business. He may receive a windfall or he may receive nothing at all. Furthermore, in the instant case, the interest received by Mr. Campbell in each partnership was in profits and losses so that he was entitled to share in the partnership deductions. In fact, any partner, whether he holds a capital or a profits interest, will generally be allocated a distributive share of his partnership's losses and charitable deductions as was Mr. Campbell in this case. Because of the differences in the interests received by Mr. Campbell and a "promise to pay," we consider it immaterial whether the bundle of rights Mr. Campbell received in such partnership*210 is denominated as a profits interest or a capital interest. In either event, they bear no resemblance to "an unfunded and unsecured promise to pay money or property in the future" which, along with money, is excluded from the definition of property within the meaning of section 83 by section 1.83-3(e), Income Tax Regs. Therefore, we conclude that the interest transferred to Mr. Campbell in each of the partnerships was property within the meaning of section 83. The second factor which must be present for section 83 to govern the inclusion in income of the value of property is that such property must be transferred in connection with the performance of services. Section 1.83-3(a)(1), Income Tax Regs., provides that, "For purposes of section 83 and the regulations thereunder, a transfer of property occurs when a person acquires a beneficial ownership interest in such property * * *." Petitioners argue that a section 83 "transfer" in connection with the performance of services never took place with respect to Mr. Campbell's interests in Phillips House and The Grand. They argue that he acquired his original limited partnership interests, upon formation of the partnerships, in exchange*211 for a capital contribution of $ 100 and $ 150, respectively. Petitioners argue that there is nothing in the record which would indicate that the amount contributed by Mr. Campbell did not accurately reflect the true value of the partnership interests at the time of the contributions. Petitioners further argue that any increase in the value of such interests after this initial contribution was "sweat equity" which accrued as a result of Mr. Campbell's efforts in bringing the partnership's business to fruition. Petitioners argue that they are no more liable for taxes on such increase than they would be if Mr. Campbell had owned stock that increased in value as a result of his efforts. Thus, petitioners contend that there was never a "transfer" in connection with performance of services from Phillips House and The Grand within the meaning of section 83. Instead, petitioners argue, Mr. Campbell acquired valuable interests in such partnerships as a result of his capital contributions and his own hard work. It is elementary that, for purposes of Federal taxation, the substance of a transaction, rather than its form, will control. Diedrich v. Commissioner, 457 U.S. 191">457 U.S. 191 (1982);*212 Crane v. Commissioner, 331 U.S. 1">331 U.S. 1 (1947); Old Colony Trust Co. v. Commissioner, 279 U.S. 716">279 U.S. 716 (1929). While it may be true that, in form, Mr. Campbell was the original limited partner in both Phillips House and The Grand and that he purchased these partnership interests for a nominal amount of cash, it is apparent that, upon formation, these partnerships were nothing more than empty shells awaiting syndication. The interests he acquired were not intended to create a substantive partnership interest, but were used only as a means of syndicating the partnerships in order to sell limited partnership interests to investors at substantial prices. Mr. Campbell in substance had no beneficial interest in either of these partnerships upon its formation. We conclude that, in substance, Mr. Campbell acquired a beneficial interest in these partnerships at a later date in connection with the performance of services for his employer and as part of his renegotiated compensation package. The limited partnership interests Mr. Campbell received in return for his nominal capital contributions bear little resemblance to the special limited partnership interests he was*213 to eventually receive. Under the original certificates of limited partnership for Phillips House and The Grand, Mr. Campbell was entitled to limited partner status along with all the rights which accompanied such status (an insubordinate right to partnership profits, limited statutory voting rights, etc.). Yet, in the offering memorandums and amended certificates of limited partnership, he had been "demoted" to the status of special limited partner. Furthermore, although Mr. Campbell (as sole limited partner) was originally entitled to the vast majority of partnership profits (95 percent in the case of Phillips House and 97 percent in the case of The Grand), he ended up with only a 1- or 2-percent beneficial interest. These facts make it clear that, from the outset it was contemplated that the beneficial interests which Mr. Campbell eventually would receive were to be quantitatively and qualitatively different from those he in form received in exchange for his nominal capital contributions. The Schedules K-1 issued by Phillips House and The Grand indicate that Mr. Campbell did not, in fact, acquire the interests in such partnerships upon formation. According to the original certificate*214 of limited partnership for Phillips House, the partnership was formed in October 1979 with Mr. Campbell as the sole limited partner. However, Mr. Campbell's 1979 Phillips House K-1 indicates that he acquired his beneficial interest in Phillips House on December 28, 1979, the same day on which the other special limited partner, Mr. Kane, and the general partner, Realty Properties, acquired their interests in the partnership. Similarly, the 1980 Schedules K-1 issued by The Grand indicate that Mr. Campbell, Mr. Kane, and Realty Properties all acquired their respective interests in The Grand on November 2, 1980, nearly a month and a half after the original certificate of limited partnership (by which Mr. Campbell in form was the sole limited partner) was filed. The treatment of these transactions on the Schedules K-1, while not controlling, indicates that the parties considered the transfers as taking place after formation of the partnerships and the rendering of services by Mr. Campbell. In any event, as is clear from the record, the nominal amount Mr. Campbell purportedly paid for each of the two partnership interests bore no relation to the value of the different interests he received*215 for his services. Finally, as respondent points out, the special limited partnership interest in Airport, which petitioners admit was transferred to Mr. Campbell in connection with his performance of services, is virtually identical to the interests which Mr. Campbell contends he retained in Phillips House and The Grand. To tax the receipt of the former, but not the receipt of the latter, merely because Mr. Campbell was required by his employment to become in form the original limited partner in these shell limited partnerships, would be to ignore reality. According to his own testimony, Mr. Campbell received interests in such partnerships pursuant to his renegotiated compensation package. It is undisputed that Mr. Campbell's beneficial interest in Airport was transferred to him in connection with the performance of services for his employer. We hold that valuable and beneficial special limited partnership interests in Phillips House and The Grand, as well as Airport, were transferred to Mr. Campbell in 1979 and 1980 in connection with the syndication activities which he performed for his employer. Thus, Mr. Campbell's receipt of special limited partnership interests in Phillips*216 House, The Grand, and Airport, falls squarely within the receipt of property for services within the meaning of section 83. A final factor which must be present before section 83 will require inclusion in income of the value of property transferred in connection with the performance of services is that either the property transferred must be transferable by the recipient or the property transferred must not be subject to a substantial risk of forfeiture. Both parties apparently recognize that there were restrictions on Mr. Campbell's rights to transfer his interests in Phillips House, The Grand and Airport. However, petitioners contend that section 83 does not require petitioners to include in income the value of the interests which Mr. Campbell received in Phillips House, The Grand, and Airport because such interests were subject to a substantial risk of forfeiture. In support of their contention that Mr. Campbell's interests were subject to substantial risk of forfeiture, petitioners cite section 83(c)(1) which provides that for purposes of section 83, "The rights of a person in property are subject to a substantial risk of forfeiture if such person's rights to full enjoyment*217 of such property are conditioned upon the future performance of substantial services by any individual." (Emphasis supplied.) Petitioners also quote section 1.83-3(c)(2), Income Tax Regs., which they contend is directly applicable to the interests Mr. Campbell received. Petitioners liken the special limited partnership interests which Mr. Campbell received to so-called "earn-outs" under which the purchase price paid to the seller of a business interest is dependent upon the future performance of the business. Petitioners point out that Mr. Campbell would not receive any cash distributions from the partnerships until their earnings had increased to the point where the Class A limited partners could be paid an annual 10-percent return on their investments. Also, since each of the partnerships incurred substantial indebtedness in financing and acquiring their primary asset, Mr. Campbell would not participate in any proceeds from the sale or refinancing of these assets unless there was a substantial increase in their value. Petitioners apparently conclude that Mr. Campbell would receive nothing from the partnerships until their economic performance improved and, therefore, his*218 full enjoyment of the special limited partnership interests was conditioned on his future performance of substantial services in improving the economic performance of the partnerships. There are several fatal flaws in petitioners' arguments. In arguing that the performance levels of the partnerships would affect whether Mr. Campbell is required to include the value of the special limited partnership interests in income, petitioners incorrectly focus on the value of such interests rather than the fact of their receipt. It is true that, if the partnerships did not reach certain performance levels, Mr. Campbell might never receive cash distributions or participate in the proceeds from the sale or refinancing of the partnerships' primary assets. In such case, Mr. Campbell's interests in such partnerships might turn out to be worth only the value of the tax benefits he was to receive. However, this speculative aspect of the special limited partnership interests does not render them subject to a substantial risk of forfeiture. Section 1.83-3(c)(1), Income Tax Regs. It merely affects their value, not the fact of their receipt or the requirement that their value, if any, be included*219 in income. The instant case is akin to a situation in which an employee receives, in connection with his performance of services, unrestricted common stock in his corporate employer which is subordinated to preferred stock in both dividends and liquidation proceeds. Even though the corporation may eventually go bankrupt resulting in the worthlessness of the transferred stock, even though the corporation's board of directors may choose to never declare dividends, even though such corporation's economic performance may never allow the employee's participation in a dividend declaration, and even though the liquidation of such corporation may not result in sufficient proceeds to allow a distribution to the employee, it is clear that the employee has received property in the form of stock, the value of which must, under section 83, be included in income upon receipt. There is no sound reason why a different result should obtain merely because the interest received is a partnership interest rather than stock. We also conclude that petitioners' substantial reliance on section 1.83-3(c)(2), Income Tax Regs., is misplaced. That regulation provides in part that, "Where an employee receives*220 property from an employer subject to a requirement that it be returned if the total earnings of the employer do not increase, such property is subject to a substantial risk of forfeiture." (Emphasis supplied.) Section 1.83-3(c)(2), Income Tax Regs. Petitioners conclude, without discussion, that it is unnecessary for a transferor to actually recover possession of the property rights transferred as long as such rights are extinguished (i.e., through bankruptcy) if the total earnings of the employer do not increase. Petitioners' position ignores the requirement that the forfeited property be returned to the employer when increased earnings do not materialize. Such requirement may have been inserted in the regulations to cover precisely the situation present here (e.g., where an employer transfers an interest in a business to an employee and relinquishes any right to a return of such interest even if earnings do not increase). Petitioners have presented no employment contract or other evidence which would indicate that Mr. Campbell's right to retain the special limited partnership interests transferred was contingent on the future economic performance of the partnerships or*221 that his employer would require the return of such interests if certain performance levels were not met. Section 83 taxes the transfer of "property" in connection with the performance of services. The "property" transferred to Mr. Campbell was the special limited partnership interest he received in each partnership. These interests became vested, at the very latest, when each partnership reached the minimum subscription amounts necessary for the partnership to become operational. Once such amounts were obtained, there was no substantial risk that Mr. Campbell would be required to forfeit his special limited partnership interests to his employer, or otherwise forfeit such interests. Petitioners must, therefore, include the value of such interests in income upon receipt. Since we conclude that this value of the special limited partnership interests which Mr. Campbell received in connection with his performance of services for his employer should have been included in petitioners' income under section 83, it is necessary to determine the fair market value of such interests. In his notice of deficiency, respondent valued Mr. Campbell's 2-percent special limited partnership interest*222 in Phillips House at $ 42,084, his 1-percent special limited partnership interest in The Grand at $ 16,818, and his 1-percent special limited partnership interest in Airport at $ 20,683. Respondent based his valuations on three factors: 1) the size of Mr. Campbell's interest in each partnership; 2) the amount the Class A limited partners had paid per unit for their interest in each partnership; and 3) the number of Class A limited partnership units outstanding for each partnership as of the end of the taxable year at issue. On brief, respondent has asserted that the special limited partnership interests which Mr. Campbell received in Phillips House and The Grand are worth more than the values determined in the notice of deficiency and that the special limited partnership interest he received in Airport is worth less. Respondent did not call an expert witness at trial nor did he submit any expert reports to support the values he asserts on brief. Instead, respondent determined the value of each special limited partnership interest by discounting the future value of the tax benefits and cash distributions which, according to the projections contained in each partnership's offering*223 memorandum, Mr. Campbell would be entitled to receive from the inception of the partnerships until liquidation. In determining the present value in 1979 of the tax and cash benefits which Mr. Campbell was projected to receive through his interest in Phillips House, respondent utilized an overall discount rate of 17.9 percent. Respondent obtained this rate by determining the discount rate necessary to reduce the future value of the projected tax and cash benefits which a Class A limited partner, owning a single Class A limited partnership unit, would receive from the partnership to a present value which was equal to the amount paid by such partner for such unit. Similarly, respondent obtained and utilized an overall discount rate of 14.35 percent in determining the present value of the tax and cash benefits which Mr. Campbell was to receive from his interest in The Grand and an overall discount rate of 26.8 percent in determining the present value of the tax and cash benefits Mr. Campbell was to receive from his interest in Airport. By applying the discount rates he obtained, respondent assigned a present value of approximately $ 16,665, $ 5,757, and $ 6,536 to the projected cash*224 distributions to Mr. Campbell from Phillips House, The Grand, and Airport, respectively. Respondent contends that the balance of the value of each partnership interest is attributable to the present value of the tax benefits which Mr. Campbell was projected to receive. For purposes of determining the tax and cash benefits available to Mr. Campbell and the Class A limited partners, respondent assumed that each partnership would liquidate or sell its primary asset in 1989 when the tax benefits available to each partnership would decline dramatically. In the case of all three partnerships, respondent determined that Mr. Campbell would not be entitled to any proceeds if each partnership sold or liquidated its primary asset in 1989 and, therefore, the value of Mr. Campbell's special limited partnership interests should not reflect this component of the bundle of rights he received. On brief, respondent asks that we find as ultimate facts that, as of the time the interests which Mr. Campbell received had vested, his interest in Phillips House had a fair market value of approximately $ 67,000, his interest in The Grand had a fair market value of approximately $ 30,000, and his interest*225 in Airport had a fair market value of approximately $ 19,000. Petitioners object to respondent's valuations. Initially, petitioners claim that the value of each of the special limited partnership interests was so speculative that the interests should not be included in their income at all. In support of their claim, petitioners cite Diamond v. Commissioner, 492 F.2d 286 (7th Cir. 1974), affg. 56 T.C. 530">56 T.C. 530 (1971), discussed previously, in which the Seventh Circuit stated that: There must be a wide variation in the degree to which a profit-share created in favor of a partner who has or will render service has a determinable market value at the moment of creation. Surely in many if not the typical situations it will have only speculative value, if any. Diamond v. Commissioner, supra at 290. Petitioners further contend that, even if the special limited partnership interests are capable of valuation, their value is far less than the values advanced by respondent in his notice of deficiency or on brief. In support of this contention, petitioners point to the testimony and appraisal reports of Mr. Steven Blumreich, an expert on*226 valuation of intangible assets, who appraised each of Mr. Campbell's interests and testified on petitioners' behalf at trial. Mr. Blumreich based his computations on the same factors which entered into respondent's computations, namely the value of the projected tax and cash benefits inherent in each interest. However, Mr. Blumreich evaluated these factors differently from respondent. Mr. Blumreich also computed the present value of the cash benefits which Mr. Campbell was to receive by computing and applying a discount rate to the projected cash distributions from each partnership. Mr. Blumreich obtained the discount rates he utilized by multiplying the 1979 Baa Corporate Bond Rate of 12.22 percent and the 1980 Baa Corporate Bond Rate of 15.19 percent by a factor of 2.5. Thus, Mr. Blumreich determined that the present value of the projected cash distributions of Phillips House, The Grand, and Airport were $ 8,407, $ 1,692, and $ 4,207, respectively. Although Mr. Blumreich acknowledged the existence of substantial tax benefits, he assigned no value to these tax benefits because, according to the partnership offering memorandums, there was a substantial risk that such benefits*227 would be eliminated if the partnerships were audited by respondent. Like respondent, Mr. Blumreich assigned no value to the possibility that Mr. Campbell might receive proceeds upon the sale or liquidation of each partnership's primary asset. However, unlike respondent, Mr. Blumreich also took into account separately factors such as restrictions on transfer of the special limited partnership interests and lack of participation in the management of the limited partnerships. Taking into account these various factors, Mr. Blumreich without further explanation determined that each of the special limited partnership units was worth no more than $ 1,000 upon its receipt. According to section 83, a taxpayer must include in income the fair market value of property transferred in connection with services (determined without regard to any restriction other than a restriction which by its terms will never lapse). The restriction on transferability of the limited partnership interest was clearly not a restriction which by its terms would never lapse and, therefore, we need not take such restriction into account in determining "fair market value." Section 83(a). The term "fair market value"*228 generally refers to the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Hamm v. Commissioner, 325 F.2d 934">325 F.2d 934, 937 (8th Cir. 1963), affg. a Memorandum Opinion of this Court; Estate of Gilford v. Commissioner, 88 T.C. 38">88 T.C. 38, 48 (1987); section 1.170A-1 (c) (2), Income Tax Regs.; section 1.20.2031-1 (b), Estate Tax Regs. The determination of fair market value is an inherently imprecise process. Estate of Gilford v. Commissioner, supra at 50; Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C. 441">74 T.C. 441, 452 (1980). While the criteria to be applied in determining an asset's fair market value are a matter of law, the determination itself is essentially a matter of fact. Morris v. Commissioner, 761 F.2d 1195">761 F.2d 1195, 1200 (6th Cir. 1985), affg. a Memorandum Opinion of this Court; Estate of Gilford v. Commissioner, supra at 50; Parker v. Commissioner, 86 T.C. 547">86 T.C. 547, 562 (1986). The testimony of experts on valuation may well assist the*229 trier of fact in making this determination. Fed. R. Evid. 702. However, such evidence must be weighed in light of all evidence in the record. Carland v. Commissioner, 90 T.C. 505">90 T.C. 505, 550 (1988); Parker v. Commissioner, supra at 561. Although we may not, without sound reason, disregard expert testimony on the question of valuation, we may reject all or a portion of the opinion of any expert which it is contrary to our sound judgment. Carland, Inc. v. Commissioner, supra at 550; Parker v. Commissioner, supra at 561. In the instant case, the testimony of petitioners' expert, Mr. Blumreich, is in some respects not based on sound reasoning. We reject Mr. Blumreich's suggestion that the value of the interests which Mr. Campbell received was speculative at best. There were sales of similar interests at concrete prices shortly before, shortly after, and on the very same day that Mr. Campbell received his special limited partnership interests. Thus, even if the dictum petitioners quote from Diamond v. Commissioner, 492 F.2d 286 (7th Cir. 1974), affg. 56 T.C. 530">56 T.C. 530 (1971),*230 could be interpreted as allowing the exclusion from income of the value of partnership interests where such value is speculative, such dictum has no application in the instant case. We also reject outright Mr. Blumreich's characterization of the value of each partnership interest as merely de minimis. Mr. Blumreich committed several errors in evaluating the benefits to which petitioners were entitled. For example, Mr. Blumreich erred in failing to assign any value at all to the tax benefits inherent in each special limited partnership interest, even though he clearly recognized that the tax benefits comprised a major portion of the benefits which Mr. Campbell, as well as the limited partners who purchased their interests, received. In 1979 and 1980 alone, petitioners utilized on their returns approximately $ 54,704 in tax losses distributed to them from the partnerships. It is true that some of the items that generated these losses were questionable. However, the Class A limited partners were willing to pay substantial amounts for these very same tax losses despite the chance that some of them might be disallowed. In the instant case, respondent in his notice of deficiency*231 did not disallow all the charitable deductions and tax losses claimed by petitioners from the partnerships or the investment tax credits distributed to petitioners from the partnerships. Mr. Blumreich's disregard of these benefits indicates to us that his evaluation of this factor is incorrect. Mr. Blumreich's conclusion that the value of each partnership interest is $ 1,000 is equally unfounded. The business and economic position of each limited partnership, the purchase price of interests in each limited partnership, the projected cash distributions, and the projected tax benefits of each partnership varied widely. Despite the wide variations in those components which admittedly make a venture risky, Mr. Blumreich determined that each special limited partnership interest had exactly the same value, $ 1,000. Although valuation is an inherently imprecise process, we are not required to accept an expert valuation which is unreasonable, without basis, and quite obviously plucked out of thin air. Tripp v. Commissioner, 337 F.2d 432">337 F.2d 432, 434 (7th Cir. 1964), affg. a Memorandum Opinion of this Court; Carland, Inc. v. Commissioner90 T.C. 505">90 T.C. 505, 550 (1988);*232 Parker v. Commissioner, 86 T.C. 547 (1986). On the other hand, we also find respondent's valuation of Mr. Campbell's special limited partnership interests to be flawed primarily by the discount rate he used. Respondent obtained the discount rate which he applied to Mr. Campbell's tax and cash benefits by determining the rate necessary to discount the future value of the cash and tax benefits attributable to a single Class A limited partnership unit to the price paid by such Class A limited partners in substantially contemporaneous transactions. Two assumptions underlie respondent's discount rate calculations: first, that the partnerships would be liquidated in 1989 upon the exhaustion of the tax benefits associated with the Class A limited partnership units and, second, that the Class A limited partners would receive nothing upon the sale or liquidation of the partnership's primary asset. However, there is little basis for either assumption in this record. It is true that the tax benefits available to a Class A limited partner quite obviously played a major role in his decision to invest. However, this does not support an inference that the Class A limited*233 partners and the partnership would be willing to abandon future distributable cash from operations, as well as their substantial capital investment, in a year where liquidation or sale would result in little or no distributable proceeds. Both parties appear to agree that there was very little realistic chance that a disposition would result in enough proceeds to repay the general partner's capital contributions or make a distribution to the special limited partners. However, it does appear likely that, within the foreseeable future, there would be sufficient proceeds to repay at least a portion of the Class A limited partners' capital contributions. Even if the partnerships did liquidate in 1989 as projected by respondent, the limited partners could expect to receive some return of their capital investment in The Grand and Airport. Thus, we conclude that respondent erred in failing to include any post-1989 potential cash distributions or disposition proceeds in the cash benefits which a Class A limited partner would receive. As a result of this failure, the discount rate which respondent obtained was artificially low and, thus, the values which he assigned to the special limited*234 partnership interests were too high. Respondent and petitioners' expert used the same method of valuing the interests petitioners received except for respondent's use of too low a discount rate and petitioners' failure to include in the value of the interests the tax benefits which petitioners anticipated receiving. We accept the method used by the parties. We conclude that the value of the tax benefits should be included in making the valuation but that the discount rate used by petitioners' expert should be applied since it is more realistic than the discount rate used by respondent. In our view since financing of the acquisitions of the properties of The Grand and Airport had been completed in 1980 as of the date of valuation of petitioners' special limited partnership interests, the valuation of petitioners' interests in The Grand and Airport on the basis used by both parties but including the value of tax benefits and using petitioners' discount rate results in the fair market value of these interests. The computation for The Grand results in approximately the value for petitioner's interest in that partnership determined in the notice of deficiency or $ 16,818. We therefore*235 sustain respondent's determination as set forth in the notice of deficiency as to the value of petitioner's interest in The Grand. Our computation of the fair market value of petitioner's interest in Airport as of the time it was received in 1980 on the basis set forth above is approximately $ 15,000. We therefore hold that petitioners should include in their income for 1980 the amount of $ 15,000 as the value of the interest Mr. Campbell received in Airport for services rendered. The situation as to Phillips House is quite different. Petitioner received his 2-percent interest at the end of 1979 when the principal financing had not been completed. Certainly the limited partners who had paid $ 99,250 each for their limited partnership interests valued their interests at the amount they paid. However, they have superior rights to petitioner especially if a liquidation became necessary. The prospect of completion of the funding of the partnership appeared good at the end of 1979 but it was not certain. In our view, this fact as of the end of 1979 would have resulted in a willing buyer of petitioner's interest demanding a further discount. When we compute the value of petitioner's*236 interest in Phillips House, as we did his interest in The Grand and Airport, the value of his interest comes out to be approximately $ 50,000. While in our view the evidence does not support a conclusion that the uncertainties at the end of 1979 caused the value of petitioner's interest in Phillips House to be only $ 1,000 as petitioners' expert concluded, it would require a substantial reduction of the $ 50,000 computed value. At the same time petitioner received his 2-percent special limited partnership interest for services in 1979, the general partner paid $ 30,000 for a 2-percent interest with approximately the same tax benefits and distribution rights as petitioner's interest had. We recognize that a general partnership interest has rights and liabilities which differ from those of a limited partner. However, the $ 30,000 payment by the general partner for a financial interest quite comparable to petitioner's special limited partnership interest is persuasive evidence that petitioner's 2-percent special limited partnership interest in Phillips House had much more than a nominal value at the end of 1979. Considering the evidence as a whole, we conclude that an additional*237 50-percent discount on the $ 50,000 computed as set forth above is appropriate to determine fair market value of the interest petitioner received in Phillips House in 1979. We hold that the fair market value of the interest petitioner received in Phillips House in 1979 for services was $ 25,000 at the time of its receipt and that this amount is includable in petitioners' income for 1979. The final issue for decision is whether petitioners are liable for additions to tax under section 6653 (a). Respondent bears the burden of proof on this issue since he first asserted the additions to tax in an amendment to answer. Rule 142 (a). During the years at issue, section 6653 (a) provided that: If any part of any underpayment * * * is due to negligence or intentional disregard of rules and regulations (but without intent to defraud), there shall be added to the tax an amount equal to 5 percent of the underpayment. Negligence is generally defined as a failure to exercise due care or a failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Forseth v. Commissioner, 845 F.2d 746">845 F.2d 746, 749 (7th Cir. 1988), affg. 85 T.C. 127">85 T.C. 127 (1985);*238 Neely v. United States, 775 F.2d 1092">775 F.2d 1092, 1095 (9th Cir. 1985); Crocker v. Commissioner, 92 T.C. 899">92 T.C. 899, 916 (1989). If any portion of an underpayment in any one year is due to negligence or intentional disregard of the rules and regulations, then the 5-percent addition to tax under section 6653 (a) will be computed on the basis of the entire underpayment for such year. Commissioner v. Asphalt Products Co., 482 U.S. 117">482 U.S. 117 (1987); Crocker v. Commissioner, supra at 916-917. Respondent alleges that a portion of petitioners' underpayments for both 1979 and 1980 was due to negligence or intentional disregard of the rules and regulations. In support of his allegations, respondent first claims that Mr. Campbell was intimately involved in the structuring, syndication, financing, and management of each partnership. He also notes that Mr. Campbell was a sophisticated businessman who, as an employee of Summa T. Realty, provided financial and tax consulting services to the partnerships. Respondent then points to several instances of abusive deductions, which were passed through from the partnerships and deducted by petitioners*239 on their joint return, which he claims demonstrates petitioners' negligence and intentional disregard of the rules and regulations. With respect to 1979, respondent claims that petitioners were negligent in deducting $ 102 in losses passed through from Phillips House because such loss included startup and organizational expenses which should not have been deducted until the Hotel opened for business in 1981. In addition, as respondent points out, the partnership's amortization deduction was artificially inflated due to inclusion of the entire nonaccountable expense allowance of $ 104,213, even though Diversified Financial Services had sold only 20 partnership units by the end of 1979. Furthermore, respondent states that the nonaccountable expense allowance, because it was calculated strictly as a percentage of the offering proceeds, was actually a disguised sales commission and thus a nondeductible cost of syndication under section 709. With respect to 1980, respondent states that the large consulting fees paid to Realty Properties, Summa T. Realty, and other members of the Summa T. Group by all three partnerships were also disguised sales commissions or other syndication costs*240 which should not have been reported as amortizable organizational expenses on the partnership's 1980 return and should not have been deducted on petitioners' 1980 return. Respondent also claims that The Grand and Airport abusively allocated too little of the purchase price of each property to nondepreciable land in order to increase their depreciation allowances for buildings and equipment. Respondent claims that petitioners were negligent in claiming these increased depreciation deductions on their joint return which was filed after the partnerships had received appraisal reports indicating that a much greater portion of the purchase prices should have been allocated to nondepreciable land. Respondent further claims that the purchase price of the Inn which Airport purchased from S.T. Properties, another member of the Summa T. Group, was abusively inflated by $ 1,000,000 in order to increase depreciation deductions and that the basis of such property should have been limited to its fair market value. Finally, respondent claims that the covenants not to compete for which The Grand and Airport paid $ 350,000 and $ 250,000, respectively, were shams because there was no realistic possibility*241 that the Summa T. Group would compete with the partnerships anyway and were merely designed to increase the partnerships' losses through amortization deductions. Respondent concludes that, given Mr. Campbell's contacts with the partnerships and his position within Realty Properties as well as the other members of the Summa T. Group, he must have been aware that these deductions were abusive and, therefore, petitioners were negligent in deducting their distributive share of these amounts on their returns. The parties disposed of the issues respecting the deductions and credits petitioners claimed in 1979 and 1980 by agreement at substantially lesser amounts than claimed by petitioners so that it was unnecessary for us to determine the correct amount of these items. However, the documentary evidence of record shows that the amounts of such deductions claimed by petitioners on their returns for 1979 and 1980 were greatly in excess of the allowable amounts. Petitioners do not appear to dispute this fact. They primarily argue that respondent has failed to show that Mr. Campbell was aware of this fact. We conclude that respondent has met his burden of proving that a portion of petitioners' *242 underpayment for 1979 and 1980 was due to negligence or intentional disregard of the rules and regulations. As noted by respondent, Mr. Campbell was an experienced businessman and the vice president of many of the Summa T. Group entities, including Realty Properties (the general partner of each partnership), Diversified Financial Services (the selling agent for each partnership offering), Summa T. Realty (the tax and business consultant to each partnership), Summit Mortgage Company (the entity from which The Grand purchased its primary asset), and Summa Management Company (the co-manager of The Grand's and Airport's lodging facilities). By his own admission, he was intimately involved in the structuring, organization, promotion, and financing of the partnership syndications. Mr. Campbell also testified that he was involved in the preparation of the offering memorandums for each partnership. Thus, he knew (or should have known) that the tax benefits which the partnerships intended to claim were questionable and, in some cases, just plain abusive. For example, with respect to 1979, the offering memorandum projects that Phillips House will claim a deduction of approximately $ 2,000*243 attributable, in part, to the partnership's amortization of organizational expenses, and that the partnership's amortization deduction included a nonaccountable expense allowance of $ 104,273 applicable to the sale of 35 limited partnership interests. Petitioner was familiar with the tax benefits each memorandum advertised. These projections were prepared, as Mr. Campbell knew, on the assumption that all 35 Class A limited partnership units would be sold. Given his intimate involvement in the sale, promotion, and financing of Phillips House, he also knew that, as of December 31, 1979, only 20 limited partnership units had been sold. Therefore, even assuming that a nonaccountable expense allowance that is calculated strictly as a percentage of syndication proceeds is a cost of organization rather than syndication, petitioners were patently negligent in claiming a deduction for expenses which they were well aware had not yet been incurred. Under such circumstances, it is irrelevant that Mr. Campbell may not have been directly involved in the preparation of the partnership's tax return. We conclude that an addition to tax under section 6653 (a) is appropriate for petitioners' 1979*244 tax year. Similarly, with respect to losses passed through and deducted by petitioners on their 1980 tax return, Mr. Campbell knew through his involvement in the promotion, sale, and financing of each partnership, that the basis for these deductions was, at best, questionable. In the case of both The Grand and Airport, the primary asset of each partnership was acquired from a related entity at a price which reflected a substantial and completely unjustified mark-up over the price paid by such related entity to an unrelated party just a few months before. In the case of The Grand, the price of the Motel was inflated by approximately $ 326,614. The mark-up represented a covenant on the part Summit Mortgage Company and other members of the Summa T. Group not to compete for six months which the parties valued at approximately $ 350,000. Given the fact that the length of the covenant was extremely short, that the likelihood of competition was very small, and that the parties were related and, therefore, not adverse, we consider it clear that the covenant had no economic substance. We consider it more than a mere coincidence that the price of the covenant exactly equalled the amount*245 of Federal income taxes due on liquidation for which Summit Mortgage Company had assumed responsibility. Petitioners' own expert witness found no evidence of appreciation in the property purchased by The Grand between the date of acquisition from the unrelated seller to the date of sale to The Grand and, thus, disregarded the covenant not to compete in valuing Mr. Campbell's interest. In the case of Airport, the purchase price of the Inn was inflated by approximately $ 1,000,000, $ 250,000 of which was also attributable to a questionable covenant not to compete. Once again, petitioners' own expert could find no evidence of appreciation between July 1980, the month in which a related entity, S.T. Properties, acquired the property from an unrelated seller, and the date on which S.T. Properties sold the Inn to Airport. By his own admission, Mr. Campbell was intimately involved in the acquisition and financing of these properties and must have been aware of these gross inflations of purchase price. We are certain that, given his involvement, Mr. Campbell was also aware that the allocation of these purchase prices between depreciable and non-depreciable real property was questionable. *246 The appraisal which each partnership received prior to the filing of petitioners' return conclusively demonstrated that the allocations chosen were incorrect. Given his position in the Summa T. Group and his intimate involvement in the acquisition of the partnerships' properties, it is reasonable to assume that Mr. Campbell would have seen these appraisals prior to the time petitioners filed their joint Federal income tax returns for 1980. We, therefore, conclude that petitioners were negligent in 1980 in claiming deductions based on the inflated purchase prices of the partnerships' primary assets and the misallocation of such purchase prices between depreciable and nondepreciable property. Since we have concluded that the part of the deficiencies due to petitioners' claiming excessive deductions and credits in each year here involved was due to negligence, we need not discuss whether petitioners' failure to include in each year any amount as the value of a partnership interest received for services rendered was negligent. Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The total purchase price of the Motel, $ 11,125,000, exceeds the combined total of these payments, assumed notes, and issued notes, $ 11,122,347, by approximately $ 2,653. However, this discrepancy is not relevant to our determination herein.↩3. Section 83 provides: (a) General Rule. -- If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of -- (1) the fair market value of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over (2) the amount (if any) paid for such property, shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable. * * *↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619496/ | Cedarburg Canning Company v. Commissioner.Cedarburg Canning Co. v. CommissionerDocket No. 31233.United States Tax Court1953 Tax Ct. Memo LEXIS 323; 12 T.C.M. (CCH) 325; T.C.M. (RIA) 53097; March 27, 1953Carl B. Rix, Esq., 833 Wells Building, Milwaukee, Wis., for the petitioner. Paul Levin, Esq., for the respondent. MURDOCKMemorandum Findings of Fact and Opinion The Commissioner determined deficiencies and additions thereto as follows: DeficiencyPersonal HoldingAddition underYearCompany SurtaxSection 291(a)1941$1,148.33$ 287.0819421,147.11286.7819431,687.57421.8919445,180.451,295.1119456.501.631946671.83167.96Income Tax194586.80 The Commissioner concedes that the addition to the income tax for 1945 was improperly determined and is not due. The only issue raised by the pleadings which is urged for decision is whether the failure of the petitioner to file personal*324 holding company tax returns for the taxable years was due to reasonable cause and not to willful neglect. Findings of Fact The petitioner is and was during the taxable years a Wisconsin corporation. The Commissioner, in a notice of deficiency dated March 18, 1942, determined a deficiency in personal holding company surtax against the petitioner for 1938 in the amount of $6,798.33, and an addition thereto of 25 per cent, or $1,699.58. He explained the 25 per cent addition as follows: "Inasmuch as you failed to file a personal holding company return within the time prescribed by law, twenty-five per centum of the tax has been added thereto in accordance with the provisions of Section 291 of the Revenue Act of 1938." Cedarburg Canning Company on June 11, 1942, filed a petition with the Board of Tax Appeals contesting that determination. That petition was signed and verified on behalf of Cedarburg Canning Company by James J. Wittenberg, its Secretary. That proceeding came to trial on May 25, 1943, at which time James Wittenberg testified. The Tax Court decided in March, 1944, that the Cedarburg Canning Company was a personal holding company, liable for personal holding company*325 surtax and also for the addition of 25 per cent under section 291 for failure to file a personal holding company return on Form 1120H. That decision was affirmed on appeal to the Court of Appeals for the Seventh Circuit. James Wittenberg was Secretary and Treasurer of the petitioner prior to his election as President of the company in 1946. His brother, Theodore, had been President up to the time of his death on May 1, 1942. James Wittenberg took over the management of the affairs of the petitioner, including the supervision of its books and records and the filing of income tax returns after the death of his brother on May 1, 1942. Counsel for the petitioner in this case told James Wittenberg, at some time not disclosed by the record, that he should file a personal holding company return for the petitioner on Form 1120H. The petitioner was a personal holding company during all of the taxable years but it did not file a personal holding company return for any of the taxable years. Its failure to file a personal holding company return for each of the taxable years was not due to reasonable cause but was due to willful neglect. All facts stipulated by the parties are incorporated*326 herein by this reference. Opinion MURDOCK, Judge: The petitioner is presumed to know the law, including that requiring it to file a personal holding company return. Furthermore, this requirement was known to it and to its officer, James Wittenberg, by reason of the determination of the Commissioner as to 1938 and the proceedings unsuccessfully contesting that determination. Furthermore, at some time not disclosed by the record the attorney for the petitioner in the present proceeding called to the attention of James Wittenberg, the officer of the petitioner who supervised the filing of the returns, the need or advisability of filing such returns. Yet none were filed. No adequate excuse for failing to file such a return in each taxable year appears. The Commissioner determined that the failure of the petitioner to file such returns was not due to reasonable cause but was due to willful neglect. The evidence not only fails to show that the Commissioner erred in that respect but shows affirmatively that he was right. Counsel for the petitioner after the hearing in this case, with the permission of the Court and the cooperation of counsel for the respondent, filed a stipulation of*327 facts which counsel for the petitioner apparently felt would entitle the petitioner to some relief under section 504 (e) (2) of the Internal Revenue Code as enacted by section 349 of the Revenue Act of 1951. However, no issue relating to that provision is raised in the pleadings and no effort has been made to amend the pleadings to include any such issue. Consequently, no such issue is properly before the Court. Nevertheless, the Court has examined the evidence before it, including the stipulation, and has concluded that there is no merit in the contention in any event because section 504 (e) (2) has no application under the facts here present. That section provides for an amount to be subtracted in computing "undistributed subchapter A net income." The amount to be subtracted is the amount by which the undistributed subchapter A net income, determined without reference to the subsection, exceeds the amount which could be distributed on the last day of the taxable year as a dividend not subject to a lien in favor of the United States. The argument of counsel for the petitioner in this connection relates to the year 1944. He states correctly that there was no*328 lien at the end of that year in favor of the United States against any income of the petitioner. The stipulation shows that the earned surplus at the end of that year was $86,631.82, all of which could have been distributed on the last day of that year as a dividend. The undistrbuted subchapter A net income determined without reference to subsection (e) did not exceed, but was less than one-tenth of, that amount. Therefore, nothing could be subtracted by reason of the application of (e). Decision will be entered for the respondent except for a concession that no addition to the income tax for 1945 is due under section 291 (a). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619497/ | EDMOND C. RECTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRector v. CommissionerDocket No. 3634-84.United States Tax CourtT.C. Memo 1985-617; 1985 Tax Ct. Memo LEXIS 13; 51 T.C.M. (CCH) 141; T.C.M. (RIA) 85617; December 18, 1985. *13 Edmond C. Rector, pro se. Dean H. Wakayama, for the respondent. COHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined a deficiency of $8,279.81 in petitioner's 1980 Federal income taxes and an addition to tax of $414 under section 6653(a)(1). 1 The issues for decision are (1) whether petitioner or a certain corporation must report interest income resulting from a sale of property and (2) whether the failure to report interest income is due to negligence or intentional disregard of rules or regulations. FINDINGS OF FACT Some of the facts have been stipulated. The stipulated facts and attached exhibits are incorporated herein by this reference. Petitioner was a resident of Kenai, Alaska, at the time his petition was filed. He filed a 1980 Federal income tax return with the Internal Revenue Service Center in Ogden, Utah. Petitioner was a shareholder and president of Rectors, Inc., a corporation engaged in the real estate rental business. On August 15, 1977, petitioner, *14 his brother Frederick C. Rector, also a shareholder of Rectors, Inc., and Frederick C. Rector's wife, Dolores Faye Rector, (the Rectors) executed an agreement on behalf of Rectors, Inc. to purchase a parcel of real estate (the property) from George M. and Belva J. Nelson (the Nelsons). To finance the purchase, Rectors, Inc. acquired a loan secured by other property owned by Rectors, Inc. and known as the Marysville Apartment property. The sales agreement restricted assignment or transfer of the property; however, the same parties executed a subsequent agreement allowing the Rectors to sell the property provided certain conditions were met. Shortly thereafter, petitioner executed an agreement on behalf of the Rectors to sell the property to Zack Construction for $250,000, including a down payment of $50,000. Petitioner also executed an Escrow Letter of Instruction on behalf of the Rectors regarding payment of the remaining principal balance. For 1980, the Escrow Letter of Instruction required no payments reducing the unpaid principal balance; however, interest only installment payments of $1,500 were to be deposited monthly with an escrow agent, Pacific National Bank of Washington. *15 The net proceeds would then be transferred to a Seattle First National Bank checking account belonging to Rectors, Inc. Below the sellers' signatures, petitioner's social security number was handwritten on a line designated for "SOCIAL SECURITY OR TAX IDENTIFICATION NUMBER OF SELLER." During 1980, Pacific National Bank recorded on a collection ledger card the receipt of each month's $1,500 interest payment, a total of $18,000. Rectors, Inc. referred to the 1979 sale of the property on a Schedule of Installment Sales in its corporate tax return for the taxable year ended December 31, 1980. That schedule reflected a $20,000 gain realized in 1979 on the down payment and reported no gain realized in 1980. The return reported shareholdings of the corporation as follows: Time DevotedPercent of CorporateShareholdersto BusinessStock Owned, CommonFrederick C. Rector45%Edmond C. Rector(petitioner)5%38%Grorge E. Rector10%Ralph G. Rector7%100%The return reported total interest income of $29,250 in 1980, and the balance sheet portion of the return reported receivables of $321,824 as the only corporate assets as of December 31, 1980. *16 Respondent examined petitioner's 1980 tax return and determined increases to petitioner's income of $18,000 for interest payments deposited with Pacific National Bank of Washington as a result of the sale of the property and $18 for additional interest received from Wells Fargo. Also, respondent determined an addition to tax of $414 under section 6653(a)(1) on the ground that petitioner's underpayment of tax was due to negligence or intentional disregard of rules or regulations. OPINION Petitioner contends that Rectors, Inc., not he, owned and subsequently sold the property, that the Rectors were only acting as agents for Rectors, Inc.; and that therefore the interest income associated with the sale is not his for tax purposes. Alternatively, petitioner argues that if respondent is correct in determining that petitioner was owner of the property, only one-third of the interest income is attributable to him. Respondent's position is that petitioner owned the property and attempted to assign the income from the sale of the property to Rectors, Inc. Petitioner bears the burden of proving that respondent's determination is incorrect. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933);*17 Rule 142(a), Tax Court Rules of Practice and Procedure.The escrow agreements and other documents in evidence relating to the purchase and sale of the property indicate that title was vested in the Rectors, not Rectors, Inc. Title standing alone, however, is not conclusive of ownership. Rupe Investment Corp. v. Commissioner,266 F.2d 624">266 F.2d 624, 629-630 (5th Cir. 1959), affg. 30 T.C. 240">30 T.C. 240 (1958). Title and beneficial ownership are often split, and taxation is more concerned with actual command over the property than with formalities of title. Griffiths v. Helvering,308 U.S. 355">308 U.S. 355, 357 (1939); Mayer v. Donnelly,247 F.2d 322">247 F.2d 322 (5th Cir. 1957). Based upon careful consideration of petitioner's testimony and the scant record, we conclude that Rectors, Inc. was the beneficial owner of the property and that the Rectors were merely acting as agents for Rectors, Inc. Petitioner testified that Rectors, Inc. financed the purchase of the property by acquiring a loan against the Marysville property, which was owned by Rectors, Inc.; that the property was sold as Rectors, Inc. was being liquidated; that Rectors, Inc. received and reported*18 in its 1980 tax return the interest payments in 1980 resulting from the sale of the property; and that petitioner did not realize that he should have put the corporation's tax identification number in the escrow letter instead of his social security number. Petitioner's testimony is neither incredible nor impeached. Further, petitioner's testimony is consistent with the 1980 tax return for Rectors, Inc.In that return, Rectors, Inc. reported interest income in 1980 of $29,250. Although the source of that interest is not specified, no other assets that would earn as much interest are shown on the balance sheet portion of the return. Total receivables shown on the balance sheet as of December 31, 1980, were $321,824, of which $200,000 would appear to be the balance due on the sale of the property to Zack Construction. Respondent argues that one of the Rectors, Dolores Faye Rector, was not a shareholder of Rectors, Inc. and that she could not represent Rectors, Inc. without proof or authority of an agency relationship. An express agreement is not necessary for an agency relationship; it may be implied circumstantially. See Rupe Investment Corp. v. Commissioner,supra.*19 The facts and circumstances of this case, as heretofore discussed, satisfy us that all three of the Rectors were acting as agents for Rectors, Inc. The presence of petitioner's social security number below the sellers' signature in the Escrow Letter of Instruction is unfortunate, as is the form of title, but it is not controlling. Petitioner executed the Escrow Letter of Instruction as the only agent present, and according to his testimony, was unaware of the significance of the use of his social security number. Because we hold for petitioner on this issue, we do not address petitioner's alternative argument. Because petitioner has presented no evidence or arguments to refute respondent's $18 increase in interest income from Wells Fargo or to explain the omission of that item from his returns, that determination and the addition to tax with respect thereto are sustained. We caution petitioner that we regard this as a close case on the primary issue, and he should take care in the future that record title to property with which he is involved reflects beneficial ownership. 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 year in issue.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619499/ | RICHARD W. LIVELY and VERONICA LIVELY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentLively v. CommissionerDocket No. 22233-80.United States Tax CourtT.C. Memo 1982-590; 1982 Tax Ct. Memo LEXIS 157; 44 T.C.M. (CCH) 1351; T.C.M. (RIA) 82590; October 6, 1982. Thomas J. Carley, for the petitioners. Rona Klein, for the respondent. FAYMEMORANDUM OPINION FAY, Judge: Respondent determined a deficiency of $6,173.00 and an addition to tax of $308.65 in petitioners' 1977 Federal income tax. The issues are whether (1) wages are income and (2) any part of petitioners' underpayment was due to negligence. This case is before us on respondent's motion for summary judgment as to the deficiency and the addition to tax. All the facts are stipulated to or are deemed admitted pursuant to an order of this Court dated April 23, 1982. Petitioners, Richard W. Lively and Veronica Lively, resided in Mandan, N.Dak., when they filed their petition herein. *158 Petitioner Richard Lively received wages in 1977, as reflected in W-2 Forms from three different corporations totaling $30,659.65. On their 1977 Federal income tax return, petitioners included this amount in their gross income. Petitioners also claimed a variety of deductions totaling $23,442. In his notice of deficiency, respondent disallowed the claimed deductions. He also asserted an addition to tax under section 6653(a) 1 for negligence. Petitioners do not dispute the disallowed deductions. In any event, they presented absolutely no evidence to support these deductions. Petitioners claim, however, that compensation received in exchange for labor is not subject to Federal income tax. They reason that there is no way to measure "income" and therefore, it is not subject to tax. We disagree. Section 61(a)(1) specifically includes compensation for services within the meaning of income. See also sec. 1.61-2(a), Income Tax Regs. The courts have consistently held that income subject to Federal taxation includes compensation for services. Commissioner v. Duberstein,363 U.S. 278">363 U.S. 278 (1960);*159 United States v. Buras,633 F.2d 1356">633 F.2d 1356 (9th Cir. 1980). 2 While the tax laws do not purport to answer all questions, nothing is clearer than the proposition that wages are income. 3Petitioners bear the burden of proof that any underpayment of tax was not due to negligence. Enoch v. Commissioner,57 T.C. 781">57 T.C. 781 (1972). Petitioners offered no evidence on this issue. Moreover, petitioners' frivolous claim that compensation is not subject to tax is insufficient to rebut respondent's assertion of negligence. We sustain the addition to tax. As we are presented with no genuine issue as to any material fact, Rule 121(b), Tax Court Rules of Practice and Procedure, we hold respondent is entitled to summary judgment on all issues. Accordingly, An appropriate*160 order and decision will be entered.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended.↩2. See also Hebrank v. Commissioner,T.C. Memo. 1982-496; Lopez v. Commissioner,T.C. Memo. 1982-7↩. 3. At trial, petitioners' motion for summary judgment alleging the Federal income tax is unconstitutional was denied. Petitioners' frivolous constitutional claims are totally without merit. See Wilkinson v. Commissioner,71 T.C. 633">71 T.C. 633↩ (1979). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619500/ | Robert Leslie Bowlin, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ann W. Bowlin, Petitioner, v. Commissioner of Internal Revenue, RespondentBowlin v. Comm'rDocket Nos. 55571, 65486United States Tax Court31 T.C. 188; 1958 U.S. Tax Ct. LEXIS 48; October 27, 1958, Filed *48 Decisions will be entered for the respondent. 1. Petitioner Robert Leslie Bowlin, for each of the years 1942 through 1947, failed to report substantial portions of his income in the returns filed by him, and his books and records are wholly inadequate for the determination of and do not reflect his income for those years. Held, that his returns were false and fraudulent with intent to evade tax, and the statute of limitations has not run for the years in question. Held, further, that the petitioners have failed to show error in the deficiencies for the said years as determined by the respondent, and that a part of the deficiency for each of the said years was due to fraud with intent to evade tax.2. After the investigation of Bowlin's income tax liability by respondent's agents had been made, Bowlin made transfers of property, including all of the incidents of ownership in certain insurance policies on his life, to his wife, Ann W. Bowlin, which transfers rendered him insolvent. Held, that petitioner Ann W. Bowlin is liable, as transferee, for the deficiencies in income tax and additions to tax for fraud determined against Robert Leslie Bowlin for each of the years*49 1942 through 1947. Ward Hudgins, Esq., and Richard H. Frank, Jr., Esq., for the petitioners.James R. Harper, Esq., for the respondent. Turner, Judge. TURNER *189 In Docket No. 55571, the respondent determined deficiencies in income tax and additions to tax for fraud against petitioner Robert Leslie Bowlin, as follows:Addition to taxYearDeficiencySec. 293(b)1942$ 725.64$ 362.8219431 2,402.831,201.4219444,449.682,224.8419457,965.703,982.8519465,076.862,538.4319474,027.082,013.54*50 In Docket No. 65486, the respondent determined transferee liability against petitioner Ann W. Bowlin for the above deficiencies in income tax and additions to tax.The questions for determination are: (1) Whether the statute of limitations has run for the taxable years 1942 through 1947; (2) whether the respondent erred in his determination of deficiencies in income tax against petitioner Robert Leslie Bowlin for the years 1942 through 1947; (3) whether petitioner Robert Leslie Bowlin is liable for additions to tax for fraud, under section 293 (b) of the Internal Revenue Code of 1939, for each of the said years; and (4) whether petitioner Ann W. Bowlin is liable, as transferee, for deficiencies in income tax and additions thereto due from Robert Leslie Bowlin for such years.FINDINGS OF FACT.Some of the facts have been stipulated and are found as stipulated.The petitioners are husband and wife, and are residents of Memphis, Tennessee. Robert Leslie Bowlin filed individual income tax returns for the years involved with the collector of internal revenue for the district of Tennessee.Robert Leslie Bowlin, hereafter referred to as Bowlin, was a practicing*51 physician in Memphis. He had offices in the Exchange Building. They consisted of a reception room, a room used for examining and treating patients, and an office. All of the rooms were small, and economically maintained. He had no medical assistant. He employed a woman who acted as receptionist and did odd jobs, including some bookkeeping.In the latter part of 1948, a special agent, in association with a revenue agent of the Internal Revenue Bureau, began an investigation of Bowlin's books and records, covering the years 1942 through 1947. The investigation was completed in 1950. The books and records *190 examined were a large transfer binder, containing closed or old patient ledger cards, a binder containing current patient ledger cards, canceled checks and bank statements. The agents were advised by Bowlin and his employee that all records had been made available to them.The agents transcribed from the patient ledger cards all credits that had been entered thereon during the period 1942 through 1947, listing, by years, each individual payment according to the date received. It was found that except for 1942 the total ledger figures for each of the years were less*52 than the gross receipts reported on Bowlin's returns.Bowlin reported gross income, deductions, net income, and income tax due on his returns for the years in question, as follows:194219431944Gross income:Compensation for personal services$ 5,992.85$ 8,564.55$ 10,101.06Interest12.14Total6,004.998,564.5510,101.06Deductions:Contributions82.50203.50338.00Taxes895.78251.87258.66Business expenses2,758.103,911.583,656.68Total3,736.384,366.954,253.34Net income2,268.614,197.605,847.72Income tax reported122.92636.79856.93194519461947Gross income:Compensation for personal services$ 11,876.43$ 11,736.56$ 10,970.75InterestTotal11,876.4311,736.5610,970.75Deductions:Contributions429.00358.00426.00Taxes205.48230.60218.50Business expenses4,342.173,943.563,610.18Total4,976.654,532.164,254.68Net income6,899.787,204.406,716.07Income tax reported1,135.941,095.48974.87On his returns for each of the years herein, Bowlin claimed a dependency exemption credit for his wife, Ann.Bowlin maintained an individual*53 checking account at the National Bank of Commerce in Memphis, which was also used as a business checking account. All canceled checks for the years under investigation were obtained and listed by the agents. They also found all but two of the deposit slips for the period.Bowlin usually prepared his own deposit slips, listing the amount of each individual check deposited. During the years 1942 and 1943 currency was shown on some of the deposit slips, but no currency was shown on any of the deposit slips for the years 1944, 1945, 1946, and 1947.The items on the deposit slips could not be identified by name, but the agents compared the individual amounts of the checks deposited with those shown on Bowlin's records. Where amounts as shown on the deposit slips could not be found at the approximate dates on the records, they were considered payments received but not recorded by Bowlin.The totals of the checks that appeared on the deposit slips and could not be traced on Bowlin's records, are as follows: *191 YearAmount1942$ 614.2819432,897.5919443,191.3919455,643.2819461,980.7419473,532.16The agents found substantial disbursements of currency which*54 could not be traced from the bank account and which did not appear on Bowlin's records. Bowlin's bank deposits, plus his currency expenditures, were greatly in excess of his income as shown by his returns and by his books and records.Bowlin's gross receipts as reported on his returns, the gross receipts as shown by his books, and the deposits he made in his checking account, properly adjusted for items of deposit which did not clear the bank, for the years 1942 through 1947, and the bank balance at the end of each of the years 1941 through 1947, were as follows:GrossGrossDeposits NationalBankYearreceiptsreceiptsBankbalancereportedper booksof CommerceDecember 311941$ 667.351942$ 5,992.85$ 6,052.30$ 3,042.48381.4419438,564.557,473.975,095.341,943.17194410,101.069,643.106,010.403,088.03194511,876.439,136.717,875.123,619.50194611,736.5610,900.074,904.241,871.26194710,970.759,142.506,117.66804.19A report from the National Bank of Commerce to the Federal Reserve Bank for the district in which the National Bank of Commerce is located disclosed a currency transaction between the said*55 bank and Bowlin in the amount of $ 7,000, on July 31, 1945. Pursuant to the requirements of the Federal Reserve Bank, banks were required to report currency transactions involving bills of large denominations, and a transaction covered by such a report would represent either a deposit or withdrawal of currency, or an exchange of currency for other currency. Taking into account the amount of the transaction, namely, $ 7,000, the balance in Bowlin's account with the National Bank of Commerce at December 31, 1944, the deposits in the account during 1945, the balance in the account at December 31, 1945, and the withdrawals from the account during the year for other purposes, as shown by the record herein, the currency transaction of July 31, 1945, was neither a deposit nor a withdrawal, but would have to have been an exchange.On December 31, 1955, Bowlin's bank balance in his checking account at the National Bank of Commerce was $ 662.37.On September 16, 1948, Bowlin opened a checking account with the Union Planters Bank in Memphis, and at the end of each of the years 1952 and 1953 the balance in the account was $ 506. This account was closed November 15, 1954.*192 Bowlin maintained*56 a savings account, No. X5082, at the First National Bank of Memphis, which account had balances at the end of the years 1941 through 1947 as follows:December 31Bank balance1941$ 961.181942975.721943985.491944194519461947Ann W. Bowlin maintained a savings account, No. X4512, at the First National Bank of Memphis during the years 1943 through 1947. The deposits in the account during each year and the balance in the account at the end of each year, were as follows:BankbalanceDecemberYearDeposits311943$ 247.00$ 225.001944124.00251.071945100.00353.44194660.14417.04194790.00511.50During the year 1945 a savings account, No. XXXX, was opened at the Union Planters Bank in the name of "Mrs. R. L. Bowlin," and in that year two separate deposits in the aggregate amount of $ 500 were made in the account. The balance in the account at December 31, 1945, was $ 502.22, and on July 31, 1946, the entire balance, which was then $ 504.73, was withdrawn. No deposits were made in the account during 1946 and 1947, and the account had no balance at December 31, 1946, or 1947.During 1945, Ann also had a checking account at*57 the Union Planters Bank, under the name of "Mrs. R. L. Bowlin." During that year four deposits were made in the account in the total amount of $ 920.68.On November 9, 1951, Ann opened a savings and loan account with the Leader Federal Savings & Loan Association of Memphis, under the name of "Mrs. R. L. Bowlin." At the end of each of the years 1952 through 1955, the account had the following balances:December 31Bank balance1952$ 3,988.2119535,073.2519546,004.3219557,212.80An installment investment contract was issued on March 10, 1936, in the name of Ann W. Bowlin, by the Investors Syndicate of Minneapolis, Minnesota. The contract called for payments of $ 5.25 monthly, $ 15.50 quarterly, $ 30.50 semiannually, or $ 60 annually, for a period of 15 years, and had a maturity value of $ 1,250. By the end of 1941, an aggregate amount of $ 352.25 had been paid on the contract. During the years 1942 through 1947, Bowlin had paid *193 the following amounts on the contract, by checks drawn on his personal checking account:DateAmountMay 6, 1942$ 30.50Nov. 12, 194260.00Dec. 6, 194360.00Dec. 20, 194460.00Dec. 19, 194560.00Dec. 14, 194660.00*58 Nothing was paid on the contract in 1947, but $ 60 was paid on it in 1948.The following schedule, taken from the records of the Bureau of the Public Debt of the United States Treasury Department, is a list of United States War Bonds, Series E, showing to whom they were issued, their dates of issue, the issuing agents, their denominations, and the dates they were cashed (the serial numbers being omitted):InscriptionIssue dateIssuing agent 1DenominationDate ofpaymentMrs. Robt. L.BowlinMay 1942The John Gerber Co.$ 25May 25, 1944816 AvalonMemphis,TennesseePayable ondeath toMrs. Jno. W.QuenichetPine Bluff,Arkansaw [sic]Dr. Robert L.BowlinSept. 1942Union Planters25May 18, 1953or Mrs. AnnNational Bank &BowlinTrust Co.816 AvalonMemphis,TennesseeDec. 1942National Bank ofCommerce500Sept. 9, 1952500500500100100100100100100100100100100500500500500[Robert or Ann] 2May 1943National Bank ofCommerce50Sept. 9, 19521001005001,000Sept. 6, 19521,0001,0001,000Sept. 1943Union PlantersNational Bank &50Sept. 9, 1952Trust Co.100100[Ann or Robert] 2National Bank ofCommerce1,0001,0001,0001,0001,000Sept. 6, 1952[Robert or Ann 2Jan. 19441,0001,0001,0001,000Union PlantersNational Bank &Trust Co.1,000[Ann or Robert] 2June 19441,000July 2, 1952July 1944First Natl. Bank ofDec. 1944Memphis Union1,000Planters National1,000Bank & Trust Co.1,0001,000[Robert or Ann] 2June 1945First Natl. Bank ofMemphis1,000July 2, 19531,0001,0001,0001,000Mrs. Oburn B.QuenichetNov. 1945Union Plantersor Mrs. Ann W.National50Dec. 19, 1950BowlinBank & Trust Co.6832 StevensCleveland StreetDallas, TexasBranch[Ann or Robert] 2Dec. 1945First Natl. Bankof Memphis1,000July 2, 19531,0001,0001,0001,000Mrs. Oburn B.QuenichetJan. 1946Union Planters6832 StevensNational25Dec. 19, 1950Dallas, TexasBank & Trust Co.or Mrs. Ann W.Cleveland StreetBowlinBranch816 AvalonMemphis,TennesseeJuly 19465001005025Oct. 194625100100100*59 *194 The agents found only two amounts used in the purchase of the bonds above which were traceable to any of the foregoing bank accounts. One check in the amount of $ 375, dated December 31, 1942, was drawn on Bowlin's account at the National Bank of Commerce. With respect to the other item, the records of the Bureau of the Public Debt disclosed the purchase, during July 1946, of war bonds costing $ 506.25, and finding that $ 504.73 had been withdrawn from Ann's savings account, No. XXXX, at the Union Planters Bank under date of July 31, 1946, it was assumed that the said withdrawal was applied to the July purchase of bonds costing $ 506.25.The agents computed the expenditures for bonds out of currency on the basis of the cost of the bonds being 75 per cent of the face value, as follows:YearTotal faceTotal costLess amountPaid by cashamountpaid by check1942$ 5,050$ 3,787.50$ 375.00$ 3,412.50194310,0007,500.007,500.00194410,0007,500.007,500.00194510,0507,537.507,537.5019461,025768.75504.73264.02Totals36,12527,093.75879.7326,214.02*60 During the years involved, Bowlin made payments by check on insurance premiums to the following companies, as follows: *195 Company194219431944Massachusetts Protection Association$ 33.00$ 130.30$ 120.28Pacific Mutual Life Insurance Company141.00141.00141.00Central Life Assurance Company22.2634.6234.54Commercial Casualty Company75.0075.0075.00Mutual Life Insurance Company of NewYork20.99283.28Mutual Benefit Life & Accident InsuranceCo98.00Company194519461947Massachusetts Protection Association$ 120.28$ 120.28$ 120.28Pacific Mutual Life Insurance Company141.00141.00141.00Central Life Assurance Company34.46Commercial Casualty Company74.0074.0074.00Mutual Life Insurance Company of NewYorkMutual Benefit Life & Accident InsuranceCoAt all times material herein, Pan-American Life Insurance Company, New Orleans, Louisiana, had 11 life insurance policies in effect upon Bowlin's life. Clyde Berryhill had been the company's branch manager in Memphis for a number of years prior to his death on November 11, 1956. When he moved to Memphis in 1930 or 1931, Bowlin was the*61 medical examiner for the company. He sold Bowlin some insurance as early as 1932. He made additional sales to Bowlin during the years 1942 through 1947. Bowlin paid some of the premiums by check, but usually paid discounted premiums by cash. Berryhill deposited the payments received in the personal joint checking account maintained by him and his wife at the Commercial & Industrial Bank in Memphis. He would then issue a check to the company for the amount due it. If Berryhill was entitled to any commissions, they were deducted. He was not entitled to any commission on payments of discounted premiums, his commissions being based on first annual or annual premiums.The following schedule shows the policy number of each policy Bowlin carried with the Pan-American Life Insurance Company on his life, the amount of the individual payments on premiums and the date paid, for the years 1942 through 1947:Number ofannual premiumsAmount paidDate paidpaid$ 84.22Apr. 31, 19421Policy No. 231-21684.22May 10, 19431618.93Apr. 15, 1944884.22Apr. 13, 19421Policy No. 231-21784.22May 10, 19431618.93Apr. 15, 1944884.22Apr. 13, 19421Policy No. 231-21884.22May 10, 19431618.93Apr. 15, 19448190.28May 19, 19441Policy No. 386-9182,305.81Mar. 29, 194514190.28June 4, 19441Policy No. 388-2892,269.19June 12, 194414190.28June 12, 19441Policy No. 388-3392,269.19June 12, 1944141,028.80Apr. 3, 19451Policy No. 398-4714,899.15Mar. 22, 194656,898.10Apr. 14, 19478Policy No. 398-4726,168.20Apr. 3, 1945Paid up1,028.80May 15, 19451Policy No. 400-1124,899.15Mar. 22, 19465514.40May 15, 19451Policy No. 400-1135,835.87Apr. 9, 1946131,347.40Dec. 26, 19471Policy No. 445-0376,260.02Dec. 31, 19475*62 *196 The total premiums paid on the above insurance policies in each of the said years were in the following amounts:YearAmount1942$ 252.661943252.6619446,966.01194511,046.01194615,634.17194714,505.52Bowlin paid cash on some of the above insurance premiums in the following amounts:YearAmount194219431944$ 4,921.3819459,502.81194615,634.17194714,505.52Bowlin also carried an insurance policy with the Pan-American Life Insurance Company on the life of Cleo S. Moulsher, and during the years 1942 through 1947 issued checks in payment of the premiums as follows:Date of checkAmountPayeeOct. 26, 1942$ 7.33Pan-American Life Insurance Co.Mar. 6, 194340.59Clyde BerryhillJan. 14, 194435.25Pan-American Life Insurance Co.Apr. 20, 194527.92Pan-American Life Insurance Co.Mar. 13, 194627.92Pan-American Life Insurance Co.Mar. 24, 194727.92Pan-American Life Insurance Co.Payments made by Bowlin for life insurance and war bonds, either in currency or by check, compared to his reported net income, for the years 1942 through 1947, are as follows:Reported netInsurance premiumsU.S. warYearincomepaidbondspurchased1942$ 2,268.61$ 531.25$ 3,787.5019434,197.60793.167,500.0019445,847.727,655.367,500.0019456,899.7811,443.677,537.5019467,204.4015,997.37768.7519476,716.0714,868.72Total33,134.1851,289.5327,093.75*63 *197 In 1941, Bowlin acquired a two-door Ford automobile at a cost of $ 935, and a two-door Chevrolet sedan for $ 886.10. On April 6, 1946, he traded the 1941 Ford for a 1946 Ford sedan which cost $ 1,210, paying a difference of $ 421.56 by check. Bowlin obtained no license for the 1941 Chevrolet after 1945.On November 20, 1946, Bowlin purchased a 1946 Pontiac Streamliner 6 sedan coupe for $ 1,751.04 "cash on delivery."At a conference with the agents in his office, Bowlin estimated that prior to 1946, his household furniture was worth around $ 4,000. In 1946 and 1947, he made additions to the furniture in his residence by the purchase of certain articles from an appliance dealer, for which he issued checks in the following amounts: October 30, 1946, $ 157; April 26, 1947, $ 100 and $ 259.50; July 28, 1947, $ 100; and August 21, 1947, $ 262.05.At the same conference, Bowlin also estimated that his office furniture and fixtures were worth about $ 800, prior to 1946. During 1947 he issued checks for additional office furniture and fixtures in the following amounts: January 4, 1947, $ 250.85; January 28, 1947, $ 100; and April 7, 1947, $ 190.The following is an analysis of*64 ad valorem, realty, and personal taxes, including automobile licenses, Bowlin claimed on his returns and paid by check or cash during the years 1942 through 1947:YearTaxes claimedTaxes paid byTaxes paid byon returnscheckcash1942$ 331.33$ 221.05$ 110.281943243.27180.5262.751944258.63176.1882.481945205.48165.0740.411946214.97162.9052.071947200.50165.1835.32The following is a similar analysis of contributions claimed by Bowlin on his returns and paid by check or cash:ContributionsContributionsContributionsYearclaimed onpaid by checkpaid by cashreturns1942$ 82.50$ 82.501943203.50$ 33.00170.501944338.0075.00263.001945429.00263.50165.501946358.0088.00270.001947426.00144.00282.00The following is an analysis of the business expense claimed by Bowlin on his returns and paid by check or currency:YearClaimed onPaid by checkPaid by currencyreturns1942$ 2,758.10$ 454.94$ 2,303.1619433,911.58758.603,152.9819443,656.68678.372,978.3119454,342.171,508.492,833.6819463,943.561,822.932,120.6319473,610.182,296.041,314.14*65 *198 Bowlin's records failed to show the names of certain patients he attended in local hospitals. During the years 1942 through 1947, he attended 662 patients in three Memphis hospitals, but the names of only 271 appeared on his records. A summary of the cases on the hospital records and on Bowlin's records is as follows:Cases per hospital recordsYearMethodistSt.BaptistTotalJosephs1942205373194372501221944101311321945134132149194660238319476835103Total4552052662Cases per Bowlin's recordsYearOmittedMethodistSt.BaptistTotalJosephs194211283934194335185369194442135577194538543106194636104637194725103568Total18784271391During the years 1942 through 1947, Bowlin maintained a safe-deposit box, No. 3349, at the First National Bank. According to the records of the bank, Bowlin entered the box on the following dates during that period:YearDates1942April 14 and December 301944January 271945July 311946April 2 and June 151947March 3*66 On January 21, 1949, the special agent obtained permission to enter the lock box, and on January 28, 1949, he inventoried its contents. At that time it contained, among other things, $ 5,000 in currency.At a conference with Bowlin on January 5, 1950, the agents tried to ascertain what funds, if any, and also any liabilities he had at the beginning of the year 1942. They did not discuss his actual tax liabilities with him, and after Bowlin employed counsel in 1950, the agents dealt with his attorneys. The only liabilities the agents found were in some checks that were outstanding, amounting to $ 44.94.Later in 1950, they received from Bowlin's counsel an undated statement Bowlin made with respect to his lock box, which statement was as follows:After considering the matter carefully I am able to state positively that I had approximately the sum of $ 5,000.00 in my lock box in 1942. Some years previous to that I started putting money in a lock box from a fund of $ 1200.00 which I collected as a result of an automobile accident and I added to this amount from time to time by small amounts that I was able to save, or that I acquired through various means. The result was that my*67 lock box in 1942 was not entirely empty, but contained about $ 5,000.00. I cannot state this exact amount, nor can I give *199 you a full history of this whole sum, inasmuch as it was accumulated over a period of some ten or twelve years.This statement is made at the request of the Intelligence Unit of the Bureau of Internal Revenue, and is the best estimate that I am able to make.Prior to October 11, 1954, all of the incidents of ownership in the insurance policies on Bowlin's life with the Pan-American Life Insurance Company were owned by Bowlin. On October 11, 1954, at the request of Bowlin, all of the incidents of ownership in those insurance policies were transferred to Bowlin's wife, petitioner Ann W. Bowlin.The transfers were made without consideration.The following schedule sets out the face amount of the policies, the cash surrender value of each policy when transferred, and the outstanding loan on each insurance contract when transferred:Date transferredFace amountCash surrenderLoan on insurancePolicy No.of policyvalue whenwhentransferredtransferred231-216Oct. 11, 1954$ 2,000$ 2,161.46(1) 231-217Oct. 11, 19542,0002,161.46(1) 231-218Oct. 11, 19542,0002,161.46(1) 386-918Oct. 11, 19542,0001,992.00(1) 388-289Oct. 11, 19542,0001,992.00(1) 388-339Oct. 11, 19542,0001,992.00(1) 398-471Oct. 11, 195410,0009,670.00(1) 398-472Oct. 11, 195410,0006,540.00$ 5,292.87400-112Oct. 11, 195410,0009,670.001,094.44400-113Oct. 11, 19545,0004,835.00(1) 445-037Oct. 11, 195410,0008,480.00(1) Total51,655.386,387.31*68 At the time the incidents of ownership were transferred to Ann Bowlin, premiums had been paid in advance on the following policies in amounts as follows:Policy No.Amount386-918$ 728.71388-289728.71388-339728.71398-4713,947.74400-1131,970.008,103.87On December 20, 1954, at the request of Ann, the Pan-American Life Insurance Company issued a check to her for the advance premiums in the amount of $ 8,103.87.On the same date, December 20, 1954, Ann negotiated loans on the various life insurance policies with the Pan-American Life Insurance Company. The following schedule shows the policies and the amounts of the loan proceeds paid to her: *200 Policy No.Loan proceeds231-216$ 2,124.00231-2172,124.00213-2182,124.00386-9181,957.47388-2891,957.47388-3391,957.47398-4719,553.96398-4721,228.21400-1128,426.91400-1134,751.19445-0379,462.0745,666.75On April 29, 1936, at a cost of $ 4,500, Bowlin acquired a piece of real estate located at 816 Avalon Street in Memphis, which has been the home of the petitioners up to the present time. On April 21, 1949, he made a transfer of an interest in the*69 property to his wife so as to create a tenancy by the entirety.In 1940 the petitioners, by quitclaim deed executed by Ann's mother, Lizzie Wadley, and other members of the Wadley family, acquired a residence at 887 North 7th Street in Memphis. The recited consideration was "the sum of Ten ($ 10.00) Dollars, and other good and valuable consideration." On his returns for 1944 through 1947, Bowlin claimed his mother-in-law, Lizzie Wadley, as a dependent, and on his 1944 and 1945 returns, he claimed Clara Wadley, his sister-in-law, as a dependent.On November 21, 1953, Bowlin transferred his interests in both of the above properties to his wife through one warranty deed, the consideration being recited as "Ten ($ 10.00) Dollars, love and affection, and other good and valuable consideration, and as a gift." At the time of the transfer, the property at 816 Avalon Street had a fair market value of $ 11,000, and the property at 887 North 7th Street, $ 6,500. There was no adequate consideration for the transfer of these properties.Bowlin became insolvent and unable to pay his debts as a result of making the transfers of his interests in the real properties and the insurance policies on*70 his life. His assets and liabilities, including the deficiencies in income tax and additions to tax involved herein, on November 1, 1954, were as follows:Fair marketAssets:valueCash$ 1,082.82Accounts receivable8,412.11Notes receivable50.00Furniture and fixtures2,000.00Total assets$ 11,544.93Liabilities:Loans on insurance6,387.31Income tax liabilities -- including additions totax -- 1942-194736,971.69Total liabilities43,359.00Excess of liabilities over assets31,814.07*201 Beginning with the year 1924 and extending to the first taxable year herein, Bowlin paid income taxes as follows:19241926192819291941Income tax$ 7.631 $ 1.23$ 2.14$ 1.72$ 12.14During the other years in that period, he paid no tax and none was assessed.Bowlin's books and records being wholly inadequate to reflect income clearly, the respondent made a computation in accordance with a method which in his opinion clearly reflected Bowlin's income. His computation was based on bank deposits and currency expenditures, and he determined Bowlin's unreported *71 income for the years 1942 through 1947, as follows:194219431944Gross receipts deposited inbank$ 3,042.48$ 5,342.34$ 6,134.40Gross receipts not deposited:Currency expenditures for --U.S. war bonds3,412.507,500.007,500.00Life insurance premiums4,921.38Automobile purchasedBusiness expenses2,303.163,152.982,978.31Contributions82.50170.50263.00Taxes paid110.2862.7582.48Personal items8.60Total gross receiptscorrected8,950.9216,237.1721,879.57Gross receipts reported5,992.858,564.5510,101.06Unreported income2,958.077,672.6211,778.51194519461947Gross receipts deposited inbank$ 9,395.80$ 4,964.38$ 6,207.66Gross receipts not deposited:Currency expenditures for --U.S. war bonds7,537.50264.02Life insurance premiums9,502.8115,634.1714,505.52Automobile purchased1,751.04Business expenses2,833.682,120.631,314.14Contributions165.50270.00282.00Taxes paid40.4152.7035.32Personal items15.0018.00Total gross receiptscorrected29,475.7025,071.9422,362.64Gross receipts reported11,876.4311,736.5610,970.75Unreported income17,599.2713,335.3811,391.89*72 On September 10, 11, 12, and 15, 1952, Bowlin was criminally prosecuted for violation of section 145 (b) of the Internal Revenue Code of 1939, for some of the taxable years herein, in the United States District Court for the Middle District of Tennessee, Nashville Division, which resulted in a mistrial. He was similarly tried in the same court on January 14, 15, 16, and 19, 1953. The result of that trial is not shown.The notice of deficiency was mailed to petitioner Robert Leslie Bowlin on September 24, 1954. In his determination of deficiencies herein, the respondent took into consideration the report of examination dated January 6, 1950, and the protest executed by Bowlin on November 27, 1953.Notice of transferee liability was mailed to petitioner Ann W. Bowlin on October 15, 1956. The respondent had made jeopardy assessments of the deficiencies involved herein on October 5, 1956.For each of the taxable years 1942 through 1947, petitioner Robert Leslie Bowlin filed a false and fraudulent return with intent to evade tax.*202 A part of the deficiency determined against petitioner Robert Leslie Bowlin for each of the taxable years 1942 through 1947 is due to fraud with*73 intent to evade tax.Petitioner Robert Leslie Bowlin made transfers of real property and insurance contracts for the purpose of defrauding his creditors.Petitioner Ann W. Bowlin is liable as transferee of the assets of her husband, Robert Leslie Bowlin, for the full amount of the deficiencies in income tax and additions thereto for fraud due from him for the taxable years 1942 through 1947.OPINION.The respondent has determined deficiencies in income tax and additions thereto for fraud against petitioner Robert Leslie Bowlin for the years 1942 through 1947, and his determination of such deficiencies is presumptively correct. The parties are agreed, however, that in the absence of proof that Bowlin's returns for the said years were false and fraudulent with intent to evade tax, the statute of limitations has run as to all years, and the burden of proving fraud is on the respondent.In their reply brief, the petitioners admit that Bowlin's books and records did not reflect all of the receipts from his medical practice and that they were inadequate for the determination of his taxable income. They also admit that the income tax returns filed by him did not show his entire income. *74 Classifying Bowlin's underreporting of his income has "undeniable" negligence, they contend that the respondent has failed to meet his burden of proving that the returns were false and fraudulent with intent to evade tax.From the evidence of record and the facts shown thereby, we are convinced that Bowlin's returns for all of the years herein were false and fraudulent with intent to evade tax, and we have so found.Taking into account the expenditures from Bowlin's checking account for the taxable years, together with the insurance premiums admittedly paid in cash and not from the bank account, the items of expense claimed on his returns which were not traceable to the bank account, and the amounts expended for United States war bonds not traceable to either Bowlin's or Ann's bank account, there is an indicated total of expenditures for each of the years in question greatly in excess of reported gross income, and for each of the years 1944, 1945, 1946, and 1947, of more than twice the reported gross income, and for each of the last 3 such years, quite substantially more than twice the gross income reported.Furthermore, there can be no doubt, we think, that such indicated excess*75 of expenditures over reported gross income represented unreported *203 income in substantial part, if not in toto, as the respondent has determined. In response to an inquiry by the special agent assigned to the case, made at a conference on January 5, 1950, as to whether Bowlin had any funds on hand at the beginning of 1942, it was Bowlin's best estimate, subsequently made in writing, that in 1942 he had about $ 5,000 in a lock box, which, beginning with $ 1,200 collected as a result of an automobile accident some years previously, had from time to time been saved in small amounts. The evidence further shows that when opened in 1949, the lock box then contained $ 5,000 in currency. It would thus appear, and the petitioners, in effect, so acknowledge in their reply brief, that Bowlin did not draw the money to cover the very substantial expenditures in excess of reported gross income during the taxable years from any funds accumulated in prior years. It is to be noted also that none of the returns reflect any sale or liquidation of property, from which such funds could have been derived. Furthermore, the petitioners have both alleged, in verified petitions herein, that throughout*76 the period in question, income from the practice of medicine, plus "certain" interest and dividends, constituted Bowlin's sole source of income. In that connection, it is to be noted that $ 12.14, reported in 1942, constituted the only item of interest reported for the taxable years, and that whatever the amount of dividends received, they were wholly unreported.When considered with other facts of record, it is of significance, we think, that for each of the years the unreported income is fully accounted for by nondeductible expenditures for United States war bonds and insurance premiums, considerable portions of the latter being premiums paid in advance, and that these expenditures were, except for negligible amounts, made in cash from income received in cash or, possibly to some extent, from the proceeds of checks which did not clear through Bowlin's bank account. Bond purchases increased from $ 3,787.50 in 1942, $ 3,412.50 of which was in currency, to $ 7,500 for 1943, all of which was in currency. Insurance premiums, on the other hand, were $ 531.25 for 1942, and $ 793.16 in 1943, all of which were paid by check. In 1944, the bond purchases remained at $ 7,500, all of which*77 was in currency, whereas insurance premiums paid jumped to $ 7,655.36, of which $ 4,921.38 was in currency. On each of 3 policies, 8 annual premiums were paid, of which 7 were advance premiums, as compared with the payment of current premiums only in each of the 2 years preceding, while on 2 other policies 14 annual premiums were paid, in addition to the current premiums. For 1945, the expenditures for bonds were $ 7,537.50, all of which was in currency, while insurance premium payments increased to $ 11,443.67, of which $ 9,502.81 was in cash. On 1 policy, 13 annual premiums *204 were paid in advance, in addition to the current premium, and by a payment of $ 6,168.20 1 policy became a paid-up policy. For 1946, only $ 768.75 was expended for bonds, as against $ 15,997.37 for insurance premiums, only $ 363.20 of which was paid by check, and of the premiums so paid, 4 on 1 policy, 5 on another, and 12 on a third were advance premiums. For 1947, there were no bond purchases, as compared with the payment of $ 14,868.72 for insurance premiums, of which $ 14,505.52 was in currency.It is to be noted also, and is not without significance, we think, that as greater portions of Bowlin's*78 income bypassed his books and his income tax returns, similarly there were noticeable increases in the amounts of his currency transactions, which likewise were not reflected by his records, and that whereas his deposit slips for 1942 and 1943 indicated that he did make deposits of cash on occasions, no cash was included in any of his deposits in 1944, 1945, 1946, and 1947.Patently, the source of some substantial part of Bowlin's unreported income represented fees from patients treated by him in Memphis hospitals during the taxable years. In fact, most of his hospital cases were never recorded on his books. A check of the records of Memphis hospitals disclosed that for the years 1942 through 1947 Bowlin's hospitalized patients were 662 in number, 391, or approximately 59 per cent, of which do not appear in Bowlin's accounts. Also, just as there had been a steady increase in Bowlin's income and in his non-deductible currency expenditures from a low in 1942 to a peak in 1945, there was a corresponding increase in the number of hospital patients. And particularly noticeable is the fact that there was a corresponding rise, from year to year, in the percentage of such patients which*79 were never carried by Bowlin into his accounts. In 1942, 34 of 73, or 46.5 per cent, of Bowlin's hospital patients were omitted by him from his books. Sixty-nine of 122, or 56.5 per cent, were omitted in 1943; 77 of 132, or 58.3 per cent, in 1944; and 106 of 149, or 71.1 per cent, in 1945. In 1946, however, when the number of Bowlin's hospital patients dropped to 83, which was only 10 above the number for 1942, and the number omitted by him from his accounts was 37, the percentage of omissions was 44.75, and was likewise somewhat comparable to the percentage omitted for 1942. But in 1947, when the number of such patients increased to 103, 68, or 66 per cent, were omitted by Bowlin from his books.On brief, petitioners seek to discount the facts with respect to hospital patients, with the contention that the respondent, who had the burden of proof, has not shown that any income was received from any of the patients omitted from Bowlin's books of account. The argument, in our opinion, is without merit on its face. It would be most unrealistic and incredible to believe and conclude that there was an *205 absence of income from 59 per cent, or 391 of 662, of Bowlin's hospital*80 patients during the taxable years, and that the lack of income from those patients was the reason for their omission from his accounts and records.It is argued for the petitioners that the respondent in his determination of Bowlin's income for the various years herein was in error in including the amounts deposited in the two savings accounts and the checking account of Ann Bowlin and in including the amounts represented by the expenditures for United States war bonds which were issued in the names of Bowlin and Ann Bowlin, especially those purchased "at Mrs. Bowlin's bank and clearly indicating her as primary payee with Doctor Bowlin as alternate payee," and that if these amounts be eliminated from the total income for the respective years as determined by the respondent, a substantially different picture is presented, so as to demonstrate error in the respondent's determination of fraud.A mere glance at the facts will disclose that the deposits in Ann Bowlin's two savings accounts and her checking account were so small that their inclusion or exclusion from consideration, insofar as the fraud determination is concerned, would be of no moment. Neither is there any significance*81 in the fact that a goodly portion of the bond purchases were made at the First National Bank and the Union Planters Bank where, during all of the taxable years in one instance, and some of the taxable years in other instances, Ann had small amounts on deposit. As a matter of fact, most of the bonds purchased at the Union Planters Bank were purchased prior to 1945, which was the year in which Ann's two accounts in that bank were opened. Furthermore, Bowlin likewise had a savings account at the First National Bank, in which there were balances at the beginning of the years 1942, 1943, and 1944 which were at least three times greater than the balances on those dates in Ann's savings account at that bank. But even in the case of those balances, they were so small as to be insignificant when related to the amounts of the bond purchases, and it is patent that the deposits in Ann's savings account at the First National Bank were in no way related to the bond purchases made. In short, it is not the place of purchase, or even the identity of the person who physically made the purchase, which is significant, but the course of the funds used in making the purchase. And with respect to Ann, *82 the evidence strongly indicates that she was without any substantial funds and had little, if any, income. In fact, the record is persuasive that her income was limited to such small amounts of interest as might have accrued on her two small savings accounts. Support for such a conclusion is to be found in the fact that Bowlin, on his income tax returns, claimed Ann as a dependent for all of the years herein, and in *206 the further fact that during the taxable years all payments on an investment contract in Ann's name with the Investors Syndicate of Minneapolis were made by checks drawn on Bowlin's personal checking account.In contrast, Bowlin, during the taxable years, did have a source for such income, and from such source he was earning income substantially in excess of that being reported by him. And not without significance, we think, is the fact that the bond purchase program ran concurrently with the war years, reaching a level of $ 7,500 in 1943 and continuing at that level through 1945, whereas the buildup of the insurance program on a substantial scale, particularly the payment of advance premiums, began in 1944, increased very substantially in 1945, the year the*83 war ended, and was approximately doubled in 1946 and 1947, in the latter of which years it had wholly superseded the bond-buying program. That the insurance premiums were paid by Bowlin and from his funds is a stipulated fact. We are satisfied and convinced by the facts of record that most, if not all, of the bonds were purchased by Bowlin and out of his income, as the respondent has determined, but even if on some occasions Ann might from some undisclosed source have supplied funds for a bond, the picture as to fraud on the part of Bowlin would not, in our opinion, be changed.As indicating that Bowlin's failure to report all of his income was due to negligence, not fraud, counsel for petitioners, on brief, strongly rely on Wiseley v. Commissioner, 185 F. 2d 263, the tenor of the argument being that "[as] is well known to everyone," there was a shortage of doctors in the war years, and the available doctors were compelled to work long hours and to care for an unusually large number of patients; that Bowlin's "office was sparsely furnished, and staffed solely by a woman employee who did odd jobs, kept the books, and acted as receptionist"; and *84 that "[the] entire picture painted by the record is that of a harried physician attempting to minister to those who needed him to the neglect of his books and records."A major difficulty with that contention is that petitioners' counsel seek to apply to the record in this case evidence which was of record in the Wiseley case but which is wholly absent from the record here. The record does show that Bowlin's office was not an elaborate one and that he had only the one employee, and we not only do not doubt, but accept as true, that during the war years the number of patients attended by Bowlin increased substantially over the number of such patients in the years preceding, but unlike the record in the Wiseley case, wherein the picture painted by the evidence was that of a "harried physician attempting to minister to those who needed him to the neglect of his books and records," the record here is wholly devoid of any evidence to that effect, or to the effect that increase in the *207 number of patients attended by Bowlin had anything to do with his substantial underreporting of his income. Both of the petitioners in the instant case were present throughout the trial, *85 but neither took the stand to testify in refutation of any part of the respondent's determination, or in refutation or explanation of the facts which are shown of record, and which have been found as above set forth. Facts which are of record are not overcome or refuted by argument for which there is of record no factual basis, and this is all the more evident in a case where any such explanatory or refuting facts would particularly be within the possession and knowledge of the party making the argument. See in that connection Katz v. Commissioner, 188 F. 2d 957, and Cohen v. Commissioner, 176 F. 2d 394, affirming 9 T.C. 1156">9 T. C. 1156.After considering the evidence and the facts shown thereby, including the comparatively very substantial amounts of income which bypassed both Bowlin's books and records and his income tax returns, the very large portions of his income received in cash or by checks which did not clear through his bank account, the substantial portions of his expenditures which were made in currency from such income and not recorded on any of his records, and the practice, after*86 the first 2 taxable years, of withholding all cash from his bank account, the deposit slips for which were all prepared by him, the pattern of his nondeductible expenditures in the form of investments in bonds up through the war years and the prepayment of insurance premiums which reached large proportions as the war was drawing to a close and continued in comparable amounts through the remaining taxable years, and which in themselves for most of the taxable years exceeded his total reported income, we are convinced that Bowlin did most, if not all, of these things for the deliberate purpose of avoiding income tax and his income tax returns for all of the years before us, namely, 1942 through 1947, were false and fraudulent with intent to evade tax. We have so found, and so hold. In reaching our conclusions as to fraud, we have given no weight to the criminal proceedings against Bowlin.As to the deficiencies in tax, the respondent's determination is presumptively correct, and the burden of proving error therein is on the petitioners. In their briefs, the petitioners have, as indicated above, contended that the respondent erred in his determination of deficiencies in certain respects. *87 Not only is there an absence of proof to support or sustain those claims of error, but most of the various elements going to make up the deficiencies are admitted by the petitioners. The respondent's determination of the deficiencies in tax for the years 1942 through 1947 is accordingly sustained.With respect to the additions to tax for fraud for the said years, what has been said above in determining that the returns filed were false and fraudulent with intent to evade tax, is equally applicable and *208 forceful in showing that a part of the deficiency determined by the respondent for each of taxable years is due to fraud with intent to evade tax. We have so found.The remaining question is whether petitioner Ann W. Bowlin is liable as transferee for the deficiencies in tax and additions thereto in question.The burden of proving transferee liability is on the respondent. Sec. 1119 (a), I. R. C. 1939. He must show that there was a gratuitous transfer of assets from Bowlin to his wife and that Bowlin was either insolvent at the time of the transfer, or was rendered insolvent by such transfer. Mary Stoumen, 27 T. C. 1014, 1018. Respondent*88 must also show the value of the assets at the time they were transferred. R. E. Burdick, 24 B. T. A. 1297. Moreover, where it has been asserted that an addition to tax for fraud is due from the transferor, it is necessary for the respondent to prove that a part of the deficiency is due to fraud with intent to evade tax. What has been said with respect to fraud on the part of Bowlin is equally applicable here.A determination of the liability of Ann Bowlin as the transferee of Bowlin under Tennessee law is in turn a determination of her transferee liability here. Commissioner v. Stern, 357 U.S. 39">357 U.S. 39.With respect to what constitutes a fraudulent conveyance sufficient to impose liability upon a transferee, Tennessee Code Annotated section 64-312 (1954) provides as follows:Conveyances by insolvent without fair consideration declared fraudulent. Every conveyance made and every obligation incurred by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to his actual intent, if the conveyance is made or the obligation is incurred without a fair consideration.The Tennessee*89 Code further provides that assets of a debtor means property not exempt from liability for his debts; that a person is insolvent when the present fair salable value of his assets is less than the amount that will be required to pay his probable liability on his existing debts as they become absolute and matured; and that a defrauded creditor may disregard the conveyance and attach or levy execution upon the property conveyed. Tenn. Code Ann. secs. 64-308, 64-309, and 64-317 (1954).The transferee-petitioner has not attempted to show that the deficiencies determined against her husband-transferor are not due from him. In fact, she has offered no evidence, but relies on the argument that the respondent has failed to prove that she is liable as transferee.The evidence shows that after the investigation of Bowlin's income tax liability was begun and the examining agent had made his report on January 6, 1950, Bowlin started disposing of his assets. In 1950, *209 Bowlin and Ann owned war bonds that had maturity values in the aggregate amount of $ 36,100, for which $ 27,075 had been paid. In December 1950, 10 bonds, having a maturity value of $ 1,075, issued in the name of Ann *90 and a third party were cashed. The bonds had accrued interest over a period ranging from 3 to 5 years. On September 6, 1952, 10 bonds issued to Bowlin and Ann, having a maturity value of $ 10,000, were cashed. Interest had accrued on these bonds over a period of 8 to 9 years. Three days later, on September 9, 1952, 29 bonds issued to both Bowlin and Ann, and having a face value in the aggregate amount of $ 10,000, were cashed. Interest had accrued on these bonds over a period of 9 to 10 years. In May 1953, a $ 25 bond which had been issued in both of their names in September 1942, was cashed. In July 1953, 15 of their bonds, having a total maturity value of $ 15,000, were cashed. Interest had accrued on these bonds over a period ranging from 7 1/2 to 9 years. Thus, the entire $ 27,075 that had been put into the $ 36,100 face amount of bonds had been received back, plus the interest that had accrued thereon. All of the bonds had been disposed of before Bowlin had executed his protest to the proposed deficiencies on November 27, 1953. During their investigation of Bowlin's tax matters, the agents had discussed some matters with Bowlin, the last discussion having been on January*91 5, 1950. It is noted that Bowlin was criminally prosecuted in September 1952, in a Federal District Court, for violation of section 145 (b) of the Internal Revenue Code of 1939, with respect to some of the tax years herein, and because of a mistrial, was again tried in the same court for the same offense in January 1953. He was fully aware of the additional taxes he owed the Government when he conveyed his interests in the home property at 816 Avalon Street and the property at 887 North 7th Street to his wife on November 21, 1953. At the time of the transfers the fair market value of the said properties was $ 11,000 and $ 6,500, respectively.Furthermore, on October 11, 1954, which was less than 3 weeks after the deficiency notice had been mailed to Bowlin on September 24, 1954, Bowlin transferred to his wife, without consideration, all of his incidents of ownership in his life insurance policies having cash surrender values in the net aggregate amount of $ 45,268.07. At the time of their transfer, premiums had been paid in advance on some of the policies in the aggregate amount of $ 8,103.87. The transfers resulted in Bowlin's becoming insolvent and being unable to pay his debts. *92 On November 1, 1954, Bowlin admitted to the Government that he was insolvent and unable to pay the deficiencies in income tax and additions thereto for fraud. Adjustments made for income tax liability, including the addition to tax for fraud, are proper in determining insolvency, though the definite amounts may not be known *210 at the time of the transfers. Vestal v. Commissioner, 152 F.2d 132">152 F. 2d 132; J. P. Quirk, 15 T.C. 709">15 T.C. 709, affirmed per curiam 196 F.2d 1022">196 F. 2d 1022.Under the Tennessee statute, when Bowlin made the transfers without consideration to his wife, he made fraudulent conveyances. Furthermore, it is significant that within a short time after the transfer of the insurance policies to her, she requested payment of the advance premiums in the amount of $ 8,103.87, and negotiated loans on the various insurance policies in the net aggregate amount of $ 45,666.75, receiving checks for the respective amounts from the company on December 20, 1954. It thus appears that she was assisting in a plan to prevent the Government from reaching any assets of her husband in the satisfaction of his*93 tax obligations. In Tennessee, when a grantee joins in a fraudulent conveyance, a creditor of the grantor may recover the value of the property fraudulently conveyed from the grantee. Hartnett v. Doyle, 16 Tenn. App. 302">16 Tenn. App. 302, 64 S. W. 2d 227.Ann Bowlin contends that under the laws of Tennessee1 Bowlin's life insurance policies, including the cash surrender values thereof, were not property which would be reached by the creditors of the insured.*94 In support of that contention, she cites and relies on Stern v. Commissioner, 242 F.2d 322">242 F. 2d 322, reversing a Memorandum Opinion of this Court, and Rowen v. Commissioner, 215 F.2d 641">215 F. 2d 641.After the filing of briefs herein, the Supreme Court of the United States affirmed the Circuit Court of Appeals in the Stern case, Commissioner v. Stern, supra, and on the same date, rendered its decision in a companion case, United States v. Bess, 357 U.S. 51">357 U.S. 51. In the Stern case, the Supreme Court applied the applicable Kentucky State law, and held that the widow-beneficiary was not liable as a transferee, because under the statute a beneficiary of a life insurance policy is not liable to the insured's creditors where the premiums had not been paid in fraud of creditors.In the Bess case, it was held that the insured did have rights in the policy cash surrender value which he could demand and receive during his lifetime and which he could borrow against, assign, or pledge, and under the facts of that case, the beneficiary of the life insurance policy was*95 liable for income taxes owed by the insured at the time of his death.*211 In both the Stern and Bess cases the transfers were made by the deaths of the insured, and there was no evidence indicating that the premiums were paid with intent to defraud creditors, or that the insured was insolvent at any time prior to their deaths.In the instant case, Bowlin made inter vivos transfers to his wife voluntarily, without consideration, and which not only rendered him insolvent, but were made with intent to hinder and defraud the Government. On the facts here, the Tennessee statute with respect to fraudulent conveyances is, in our opinion, clearly applicable and decisive. Bowlin's conveyances to his wife were fraudulent, and she thereby became liable as transferee, and we so hold. The cash she received from the insurance policies alone was more than sufficient to pay the income tax deficiencies and the additions thereto as determined by the respondent.Decisions will be entered for the respondent. Footnotes1. Income and Victory tax.↩1. All issuing agents were located in Memphis Tennessee.↩2. First names used for brevity.↩1. None.↩1. Includes interest of 15 cents.↩1. Tennessee Code, Annotated (1954) :Sec. 56-1110. Life insurance or annuity for or assigned to wife or children or dependent relatives exempt from claims of creditors↩. -- The net amount payable under any policy of life insurance or under any annuity contract upon the life of any person made for the benefit of, or assigned to, the wife and/or children, or dependent relatives of such persons, shall be exempt from all claims of the creditors of such person arising out of or based upon any obligation created after January 1, 1932, whether or not the right to change the named beneficiary is reserved by or permitted to such person. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619501/ | Marva Trotter Barrow Spaulding, et al., 1 Petitioners, v. Commissioner of Internal Revenue, RespondentSpaulding v. CommissionerDocket Nos. 50395, 52050, 52055United States Tax Court27 T.C. 479; 1956 U.S. Tax Ct. LEXIS 16; December 12, 1956, Filed *16 In Docket Nos. 52050 and 52055 decisions will be entered under Rule 50.In Docket No. 50395 decision will be entered for the petitioner. An individual, who had large unpaid deficiencies in income tax, paid certain sums to his wife, pursuant to an agreement between them that 50 per cent of such sums would be used by her to create trusts for their children. The wife created two trusts for the children in accordance with her obligation. At the time of each transfer to the trusts, the husband was insolvent. Held, that, under the provisions of section 311, I. R. C. 1939, the trustee of each of said trusts is liable as a transferee of the property of the husband in respect of his delinquent income taxes, to the extent of the value of the property transferred to such trustee, together with interest thereon as provided by law. The values of the transfers are determined. Held, further, that the period of limitation for assessment of the liability of each trustee-transferee had not expired at the time when such liability was determined and the notice of such liability was issued. Held, further, that the wife was not the actual donor of either of the trusts, or the actual transferor of *17 the property with which they were created; and that she is not liable for gift taxes in respect of the transfers, or for additions to tax for failure to file gift tax returns. Arthur J. Wilson, C. P. A., for the petitioner in Docket No. 50395.Aaron H. Payne, Esq., and Julian B. Wilkins, Esq ., for the petitioners in Docket Nos. 52050 and 52055.Thomas J. Donnelly, Jr., Esq., and John E. Owens, Esq., for the respondent. Pierce, Judge. PIERCE *480 The respondent determined transferee liabilities in respect of income taxes, and also deficiencies in gift tax and additions to gift tax for failure to file returns, as follows:Transferee Liability.YearType of taxDeficiency of transferorTransferee liabilityDocket No. 52055 11946Income tax$ 246,055.79$ 30,773.041947Income tax3,555.51444.67Docket No. 52050 21946Income tax246,055.7915,835.831947Income tax3,555.51228.831948Income tax209,737.5813,498.441949Income tax85,596.235,508.86Gift Taxes.YearType of taxDeficiencyAddition to tax under sec. 3612 (d) (1), I. R. C. 1939Docket No. 50395 1*18 1947Gift tax$ 2,250.00$ 562.501949Gift tax5,855.421,463.86All the cases identified by the above-mentioned docket numbers were consolidated for trial.The issues for decision are:(1) Whether, in the case of each of the trusts here involved, the trustee is liable as a transferee of assets of Joe Louis Barrow, for certain portions of the latter's undisputed delinquent income taxes, on the ground that Barrow was the actual donor of the corpus of each of said trusts; and, if so, whether assessment of such transferee liabilities is barred by the statute of limitations.(2) In the alternative, whether the petitioner Marva Trotter Barrow Spaulding, the former wife of Joe Louis Barrow, was the actual donor of the corpus of each of said trusts and is, by reason thereof, liable for gift taxes on the transfer of such corpus and also for additions to tax for failure to file gift tax returns.FINDINGS OF FACT.The petitioner the First National Bank of Chicago, as trustee, is, in the case of each of the two trusts here involved, the alleged transferee of assets of Joseph Louis Barrow, also known as Joe Louis Barrow and as Joe Louis (hereinafter called Louis). Louis was the heavyweight boxing champion of the world for a period of about *19 11 years beginning in June 1937. He filed an individual income tax return for each of the years 1946, 1947, and 1948, with the collector of internal revenue for the third district of New York; and he also *481 filed such a return for the year 1949 with the collector of internal revenue for the first district of Illinois. None of the above-mentioned unpaid deficiencies in his income taxes for said years (as distinguished from transferee liabilities concerning the same) is here in dispute.The petitioner Marva Trotter Barrow Spaulding (hereinafter called Marva), is the former wife of Louis. She filed no gift tax return for either of the years 1947 or 1949.Marva and Louis were twice married and twice divorced. Their first marriage, on September 24, 1935, ended in divorce on March 27, 1945. Thereafter, they were remarried in 1946; and were divorced for the second time on February 15, 1949. During their first marriage, a daughter, Jacqueline Barrow, was born to them on February 8, 1943. And during their second marriage, a son, Joseph Louis Barrow, Jr. (hereinafter called Joe Louis, Jr.), was born to them on May 28, 1947.Facts re Trust No. 36358, Dated November 21, 1947.Louis entered *20 the Army in 1942, and he continued to serve in the Armed Forces until about October 1, 1945. In the early part of 1945, while he was so serving, Marva filed suit for divorce from him. During the pendency of this suit, Louis told Marva that he was not financially able to make a substantial property settlement with her; and they executed concurrently, under date of March 26, 1945, two written agreements (hereinafter called, respectively, the settlement agreement and the manager's contract).The settlement agreement provided in substance and so far as here material:That, whereas the parties had agreed upon a settlement of all their marital rights and obligations, each of the parties accepted the provisions of such agreement in lieu of all dower rights; in lieu of all claims of each against the other for alimony, maintenance, and support; and also in full satisfaction of other claims and demands of each against the other, except the obligations imposed by such agreement;That Louis relinquished to Marva all his right, title, and interest in the household furnishings and effects, other than his personal effects, and also in all bank accounts standing in Marva's name;That Marva acknowledged *21 that she had no right, title, or interest whatsoever in any property held in the name of Louis; or in any property or money held in the name of any person, firm, or corporation, as trustee for him;That Marva would have the care and custody of their minor daughter Jacqueline, subject to certain consultation and visitation rights in Louis; and that Louis would pay her $ 200 per month for the child's support;*482 That, in lieu of any further provision for the maintenance, support, and alimony of Marva, Louis would execute simultaneously with such settlement agreement, the manager's contract, of which a copy was attached and made a part of the settlement agreement; andThat Marva, in the event she were granted a decree of divorce in the pending divorce proceeding, would, in consideration of said covenants and agreements, agree:To create a trust fund in a suitable Chicago Bank or Trust Company, to be mutually agreed upon, to be in the name of Joe Louis Barrow and Marva Trotter Barrow for the benefit of JACQUELINE BARROW, the minor child of the parties hereto, and to pay into the said trust fund a sum equal to fifty per cent (50%) of all monies received by the said MARVA TROTTER BARROW growing *22 out of the manager's contract, heretofore referred to and made a part hereof.It was further mutually agreed that, if at any time during the term of such manager's contract there should be any breach or default by Marva in performing the above-mentioned provisions relating to the minor child, then such manager's contract could, at the option of Louis, be immediately revoked and terminated by him.The said manager's contract, which was physically attached to and made a part of the settlement agreement, provided in substance and so far as here material:That Louis engaged Marva as his business manager, or co-manager, for a period of 5 years to commence when Louis received his discharge from the Army, but in any event not earlier than June 1, 1945;That Marva agreed to exert herself for the profit, benefit, and advantage of Louis, and to perform such duties as are generally required of a manager of a professional boxer;That Marva understood that Louis was then indebted to the Government of the United States and to other named creditors in an aggregate amount which might exceed $ 200,000; and that no money should be deemed earned, due, and owing to her under the manager's contract until after *23 the aggregate amount of said indebtedness had first been deducted and paid from the moneys derived by Louis from professional boxing contests and other sources in connection therewith;That Louis agreed to pay Marva 25 per cent of all sums derived by him from any services rendered in professional boxing contests during the term of the manager's contract, and from radio broadcasting, motion pictures, and television pictures in connection therewith; provided, however, that such percentage would be payable only after deduction from the proceeds of the foregoing of a sum sufficient to pay all the above-mentioned indebtedness of Louis to the extent of $ 200,000, and also after deduction of all expenses incurred by Louis in connection with any boxing contest in which he engaged during the term of such manager's contract;*483 That the manager's contract could not be sold or assigned without Louis's written consent;That Marva would not be required to devote her entire time and attention in and about the business of Louis;That Louis might, without cost or expense to Marva, engage a co-manager to render the same services which she was required to render under the manager's contract; andThat said *24 manager's contract would, at all times, be subject to the terms of a prior existing agreement between Louis and one Michael S. Jacobs, under which the latter had exclusive promotional rights of all boxing interests in which Louis might engage.On March 27, 1945, which was the day following the execution of said settlement agreement and said manager's contract, Louis and Marva were divorced by the Superior Court of Cook County, Illinois. Under the terms of the divorce decree, Marva was given custody of the minor daughter, Jacqueline, and the settlement agreement between the parties was approved.In June 1946, Louis won a championship fight with Billy Conn; and, shortly thereafter, he paid Marva the sum of $ 60,000 in cash, out of his proceeds of said fight, pursuant to the provisions of the above-mentioned manager's contract. Marva deposited this sum in her personal account at the Drexel National Bank in Chicago; and thereafter she placed approximately half of this amount in a separate account which was called the Jacqueline Barrow account. She thereupon proceeded to investigate various banks and trust companies, with a view to selecting a suitable trustee for the trust which was *25 to be created for the daughter, Jacqueline, pursuant to the settlement agreement. Marva, in her income tax return for 1946, did not include any of said $ 60,000 in her gross income.On November 21, 1947, an irrevocable trust for the benefit of Jacqueline was created with the petitioner the First National Bank of Chicago, as trustee, which was known on the records of the trustee as Trust No. 36358. Marva was described therein as the "Donor"; and she, on the above date, delivered to the trustee as the initial corpus of the trust the sum of $ 30,000. This payment was made by a cashier's check of the Drexel National Bank in which she had previously deposited the $ 60,000 received from Louis; and all or substantially all of said $ 30,000 was obtained from the so-called Jacqueline Barrow account which she had established at said bank.The preamble of said trust agreement read as follows:Under date of March 26, 1945, the Donor entered into a property settlement agreement with JOSEPH LOUIS BARROW, under the terms of which it was provided that she should establish a trust with a bank or trust company in Chicago, Illinois, of one-half (1/2) the net proceeds received by her under the manager's *26 contract referred to in said agreement for the benefit of her daughter, *484 JACQUELINE BARROW. Said agreement was approved by the Superior Court of Cook County, and this trust is established in pursuance of that agreement. Accordingly, the Donor does hereby assign, transfer and pay over to the Trustee the sum of $ 30,000, and the Trustee acknowledges receipt thereof and hereby agrees to hold, manage and distribute the same and all subsequent additions that may be made thereto as a Trust Estate upon the following terms and conditions:Prior to the creation of said trust and under date of November 1, 1947, the trustee procured from Louis a letter which read as follows:Gentlemen:This is to advise you that I have seen and approved the trust agreement with you created by my wife, Marva Trotter Barrow for the benefit of our daughter, Jacqueline, and agree that the same is in compliance with the terms of my property settlement agreement with Mrs. Barrow.(Signed) Joe Louis BarrowLater, under date of December 20, 1950, the trustee (petitioner in Docket No. 52055) wrote a letter to the respondent, in which it described the circumstances under which the trust was created and the reasons for procuring *27 the above-quoted statement from Louis. This letter stated, in part, as follows:At the time this trust was negotiated, Mrs. Spalding exhibited to us a property settlement agreement with her former husband, Joseph Louis Barrow, and a certified copy of a Decree of the Superior Court of Cook County approving that settlement.Under the terms of that settlement agreement, Mrs. Spalding received certain monies from Mr. Barrow, charged with the obligation of establishing an irrevocable trust for the benefit of their daughter, Jacqueline Barrow.Because the monies had previously been paid to Mrs. Barrow and it was necessary that there be a Donor of the trust, she was designated in the agreement in that capacity.In order to be sure that Mr. Barrow accepted the proposed agreement as being in satisfaction of this part of Mrs. Spaulding's obligation under the terms of the property settlement agreement, he delivered to us a letter approving the agreement and stating that it was in compliance with the terms of his property settlement agreement with her.We asked for and secured this letter because we considered Mrs. Spaulding was not, as in the normal case, making a gift by way of trust of funds which *28 she was free to keep or give away, but because we understood that she was required to create the trust and wanted assurance that the trust she proposed to create was satisfactory to the other party to the contract from whom the funds going into the trust had, we were told, originally been received.We understand that Mrs. Spaulding's counsel has shown you the agreement and Decree on which this trust was based and this letter is merely to confirm our understanding as Trustee under the agreement that this trust was, as appears on the first page thereof, executed pursuant to that agreement and was not accepted by us without knowledge of the background.Because the law imposes a definite obligation on any trustee who receives money in an irrevocable trust to file a Donee's information return, we did file such a return in the name of Marva Trotter Barrow. This was not intended to be construed as a conclusion on our part that she was, or was not, a Donee subject to gift tax liability under the terms of the Internal Revenue Code.*485 Marva did not file a gift tax return for the year 1947, in respect of the above-mentioned $ 30,000 which she had delivered to said trustee. In creating the trust, *29 she regarded Louis to be the actual donor, and herself to be merely his agent; and accordingly she thought, and was advised by her attorney, that it was unnecessary for her to file a gift tax return respecting the transfer.Marva was not licensed to act as a manager of Louis in connection with his boxing activities; and she at no time, either in 1946 or in any subsequent year, performed any substantial service for him as manager. The $ 30,000 which she delivered, on November 21, 1947, to the First National Bank of Chicago, as trustee of Trust No. 36358, was all received by her from Louis without consideration, out of his personal funds, for the specific purpose of establishing such a trust; and she delivered said sum to the trustee in fulfillment of that obligation. Said $ 30,000 was at no time owned or held by Marva for her own benefit or as her own personal property. Louis was the actual donor of said trust; and he was the actual transferor of said $ 30,000 to the trustee on November 21, 1947. The trustee did not pay or deliver any consideration for the transfer to it of said amount.Facts re Trust No. 38328, Dated July 7, 1949.In December 1947, Louis organized an Illinois corporation *30 known as Joe Louis Enterprises, Inc., with capital stock of $ 50,000 divided into 500 shares. Four hundred and ninety-eight of these shares were issued to Louis, and were held by him at all subsequent times here material; and the 2 remaining shares were issued, respectively, to two of Louis's attorneys, in order to qualify them as directors. The principal purposes of the corporation were to market motion pictures of Louis's fights, and also to assist Louis in liquidating his personal liabilities out of his anticipated earnings from prize fights and from said motion pictures; but, beginning in the latter part of 1948, the corporation also operated a trade school for automobile mechanics. Shortly after its organization, the corporation purported to "assume" $ 115,635.36 of Louis's personal debts and obligations, including about $ 82,000 of his Federal income tax liabilities; and, in addition, it purported to "take on" the above-mentioned manager's contract between Louis and Marva. The opening balance sheet of the corporation was as follows: AssetsLiabilitiesCash$ 5,000.00Accounts payable$ 115,635.36Contracts and franchises165,635.36Stockholders' loans5,000.00Capital stock50,000.00Total assets$ 170,635.36Total liabilities$ 170,635.36The *31 asset described as "Contracts and franchises" purported to represent an anticipatory assignment of Louis's future earnings from *486 prize fights and motion pictures thereof; but actually the corporation paid nothing therefor, and such "asset" was conceded to be merely a balancing entry employed to equalize the purported assets and the purported liabilities.During the year 1948, the corporation did liquidate, out of the moneys which it received from Louis's fights and from the motion pictures, substantial portions of Louis's personal debts and income tax liabilities, and made payments to Marva on account of the manager's contract; and it also permitted Louis to withdraw funds for his personal use when moneys were available. Louis controlled the corporation. The respondent, in his examination of the income tax returns of Louis and of the corporation for the year 1948, determined that approximately $ 104,000 of the corporation's purported income for said year was actually personal income of Louis; and this determination was not contestsd.In December 1947 Marva was unable to collect amounts which she believed to be due her from Louis; and she therefore instituted legal proceedings and attached *32 Louis's share of the purse from his fight with Joe Wolcott. As the result of such attachment, she received $ 27,000. She regarded this amount to bein repayment of loans and advances which she had theretofore made to Louis; and she did not report any of the same as taxable income.In the year 1948, Marva received the following amounts from proceeds of Louis's fights and related activities:From Joe Louis Enterprises, Inc. This was one of Louis'sobligations which the corporation liquidated, as above stated$ 36,780.20From proceeds of Louis's fights which were allocated to hismanagers, John Roxborough and Marshall Miles, and to MarvaBarrow31,781.74Total$ 68,561.94All the above amounts were paid by or on behalf of Louis, pursuant to the above-mentioned settlement agreement and manager's contract; and Marva delivered no consideration therefor. It was understood between Louis and Marva that the terms of said agreement and contract, as executed on March 26, 1945, continued in full force and effect, except as modified by a supplemental agreement between them that 50 per cent of the amounts paid by Louis to Marva would be used to create trusts not only for the daughter, Jacqueline, but also *33 for Joe Louis, Jr., who was born subsequent to the execution of the original agreements. Said supplemental agreement was given recognition also in connection with Marva's second divorce from Louis in February 1949, at which time Louis informed her that he had nothing else to give in settlement. Marva reported only half of the above-mentioned $ 68,561.94, or $ 34,280.97, as personal income to her for the year 1948.*487 The said amounts which Marva received from Louis in 1948, including the portion thereof which was to be used by her in creating trusts for the children, were expended by her in rehabilitating and improving certain apartment house real estate in Chicago, which she owned personally. After completing such improvements, she conveyed the title to said real estate to the Trust Company of Chicago, as trustee for her benefit; and she then obtained from such trustee its negotiable promissory note made payable to bearer in the amount of $ 34,000. Said trustee's note was dated January 10, 1949; was payable on or before January 10, 1959, with interest at the rate of 4 per cent per annum, payable semiannually; and was secured by a trust deed executed by said Trust Company of Chicago, *34 as trustee, on the apartment house real estate above mentioned. After obtaining said promissory note, Marva, on the same date of January 10, 1949, filed a verified petition in the Probate Court of Cook County, Illinois, in a proceeding entitled "In the Matter of the Estate of Jacqueline Louis Barrow and Joe Louis Barrow, Jr., Minors," in which she made the following representations:Your Petitioner, MARVA TROTTER BARROW, Guardian of JACQUELINE LOUIS BARROW and JOE LOUIS BARROW, JR., respectfully represents to the Court that she is the acting Guardian of the minor children involved herein, duly appointed by the Probate Court of Cook County.Your Petitioner further represents that all funds that have been received under an agreement between herself and her husband, JOE LOUIS BARROW for the year 1948 were placed in trust for the benefit of the minor children herein as provided.Your Petitioner further represents that during the year 1948 certain properties described as 4320 South Michigan Avenue in trust with the Trust Company of Chicago, as Trustee, were rehabilitated and improved at an outlay of upwards of $ 69,000.00; and that revenue from the said building has been increased from approximately *35 $ 350.00 per month to $ 1000.00 and upwards per month.About 6 months later, under date of July 7, 1949, Marva delivered and transferred the above-mentioned $ 34,000 promissory note, together with the trust deed securing the same, to the petitioner, the First National Bank of Chicago, as trustee of Trust No. 38328, to provide the corpus for an irrevocable trust for the benefit of Joe Louis, Jr. The trust agreement, like that of the trust previously created for the benefit of the daughter, Jacqueline, designated Marva as the "Donor"; and the terms thereof were substantially the same as those of the prior trust agreement for the benefit of Jacqueline. The trustee delivered no consideration for the transfer of it of said promissory note.The value of the apartment house real estate, which was mortgaged to secure said trustee's promissory note for $ 34,000, was at least $ 50,000; and the value of said note at the time of its delivery and transfer to the First National Bank of Chicago, as trustee, was $ 34,000 plus accrued and unpaid interest thereon from January 10, *488 1949, to July 7, 1949, in the amount of $ 668.67, making a total value of $ 34,668.67. This total value was determined *36 also by the trustee after appraisal of the security for the note and was entered in its trust accounts; and this also was the value which the First National Bank of Chicago, as trustee, assigned to the gift on its donee's information return of gifts in respect of said trust for the year 1949.Prior to the creation of the above-mentioned trust for Joe Louis, Jr., Marva discussed the same with Louis; and he indicated that he had confidence in her and that whatever arrangements she made would be satisfactory to him. Also Marva later told Louis that the trust had been created, and informed him of the source from which the corpus had been obtained. Louis told Marva that he would pay the gift tax on the transfer by which the trust had been created. At the time the trust was created, Marva considered Louis to be the actual donor thereof.Said trust for the benefit of Joe Louis, Jr., was created pursuant to the terms of the settlement agreement and manager's contract between Louis and Marva, as modified by their supplemental agreement as to Joe Louis, Jr. The promissory note of the Trust Company of Chicago, which was used to provide the corpus of said trust, represented a segregated investment *37 of $ 34,000, which had been paid by Louis to Marva in accordance with said agreements and for the specific purpose of creating such a trust. Marva at no time owned or held such funds, or such promissory note, for her own benefit; and Louis retained the beneficial interest therein until the note was delivered and transferred to the First National Bank of Chicago, as trustee of the irrevocable trust for Joe Louis, Jr., on or about July 7, 1949. Louis, and not Marva, was the actual donor of said trust; and he was the actual transferor of the corpus thereof.Facts re Solvency of Louis.At the time when Louis was discharged from the Army on about October 1, 1945, he had no substantial assets, and had liabilities of more than $ 240,000, including loans and advances of: $ 131,976.93 from the 20th Century Sporting Club; about $ 60,000 from Michael S. Jacobs, the fight promoter mentioned in the above-described manager's contract; about $ 40,000 from John Roxborough, who was one of Louis's managers and representatives; and about $ 11,000 from Marshall Miles, who was another manager. Louis retired as heavyweight boxing champion of the world in the fall of 1948 or the early part of 1949. During *38 1946 through 1949, he engaged in several fights which yielded large purses; but only 50 per cent of his share thereof was retained by him personally, and the remaining 50 per cent was disbursed for managers and training expenses. During the *489 same years, substantially all of his income came from his boxing activities; he received no gifts or inheritances; and his personal living expenses were about $ 58,000 per year. During said years, he made numerous gifts to friends and members of his family; and he also made several investments which proved to be improvident. In 1948 the corporation, Joe Louis Enterprises, Inc., which he organized, assisted in managing his income and in liquidating portions of his indebtedness; but by July 1949 part of said indebtedness was still unsatisfied, and this corporation made no further payments thereon during the remainder of that year. At the time of Marva's first divorce from Louis, the only thing that he was able to give her in settlement was the agreement to share his potential future earnings; and, at the time of their second divorce in February 1949, he again told her that he had nothing to give her except the continuance of such agreement.At *39 the end of the calendar year 1946, Louis had at least the following liabilities:Unpaid deficiency in income tax for 1946$ 246,055.79Due Marshall Miles, approximate minimum balance on personalloan14,000.00Due John Roxborough, approximate minimum balance on personalloan20,000.00Total$ 280,055.79His only substantial assets on that date (exclusive of his heavyweight boxing championship which had no value that may be used in determining his solvency) consisted of: (1) Real estate in Detroit that was improved with a house occupied by members of his family, which he represented as of May 31, 1950, to have a fair market value of $ 10,000; (2) an annuity which paid him $ 52 per month, and which had an alleged value of $ 10,000; (3) his beneficial interest in the $ 30,000 which he had theretofore paid to Marva for use in creating the trust for Jacqueline; (4) cash claimed to have been in the amount of $ 5,000; and (5) stock of Supreme Life Insurance Company acquired at a cost of $ 500. The maximum total value of such assets was $ 55,500.Between December 31, 1946, and November 21, 1947, the date on which the trust for Jacqueline was created, none of the above liabilities were discharged, and *40 additional liabilities were incurred as follows: A loan from the 20th Century Sporting Club in the amount of $ 59,362.37, and accrued interest on the 1946 income tax deficiency. During this same period, there was no substantial increase in the value of Louis's assets. He testified that when Joe Louis Enterprises, Inc., was organized on December 1, 1947, he was not financially able to satisfy his liabilities.*490 Louis was insolvent on November 21, 1947, when the trust for the benefit of the daughter, Jacqueline, was created, and when the $ 30,000 was transferred to the trustee of said trust, as the initial corpus thereof.At the end of the calendar year 1948, Louis had at least the following liabilities, exclusive of accrued interest:Unpaid deficiency in income tax for 1946$ 246,055.79Unpaid portion of returned income tax for 194757,067.48Unpaid deficiency in income tax for 19473,555.51Unpaid deficiency in income tax for 1948209,737.58Due 20th Century Sporting Club on personal loan20,896.47Due Marshall Miles on personal loan14,000.00Total (exclusive of interest on above tax liabilities)$ 551,312.83 As of the same date, his only substantial assets consisted of the following:Real estate in Detroit (as above described)$ 10,000Annuity (as above described)10,000Stock of Supreme Life Insurance Company (as above described)500Beneficial interest in the $ 34,000 which he had theretofore paid to Marva for use in creating the trust for Joe Louis, Jr34,000Stock in All-American Drinks Corporation, manufacturer of Joe Louis 35,000Total$ 89,500Louis *41 testified that he knew of no additional assets held by him as of said date.As of July 7, 1949, the date on which the trust for Joe Louis, Jr., was created, the amount of Louis's liabilities were the same as those at the end of the year 1948, except that his loan from the 20th Century Sporting Club had been reduced to $ 19,591.14, and the amount of the accrued interest on his tax liabilities had increased. As regards his assets on said date, he still had the real estate in Detroit, the $ 10,000 annuity policy, the stock of the Supreme Life Insurance Company, and the beneficial interest in the money paid to Marva for creation of the trust for Joe Louis, Jr., all as above mentioned. 2*42 Louis stated in his testimony that, in July 1949 and also at the time of the trial, he did not have $ 400,000 which could be applied against his Federal tax liabilities.Louis was insolvent on July 7, 1949, when the trust for the benefit of Joe Louis, Jr., was created and the $ 34,000 note was transferred to the trustee of said trust, as the initial corpus thereof.*491 On October 4, 1948, respondent issued a notice and demand to Louis for payment of his delinquent income taxes for 1947; and upon Louis's failure to make payment, a warrant for distraint was issued and a lien was filed, both under date of December 7, 1949. The only amounts collected from Louis pursuant to such action were $ 2,983.76 on December 7, 1949, and $ 1,000 on January 4, 1950.In about December 1949, Louis's attorneys decided that the only way for him to meet his delinquent tax liabilities was for him to file an offer in compromise. The first such offer was filed on June 20, 1950; and amended offers in compromise were thereafter filed on October 2, 1950, January 9, 1951, February 4, 1952, and March 24, 1953. None of these offers were at any time accepted.Prior to filing the first of said offers in compromise, Louis submitted to the respondent a verified statement of his financial condition as *43 of May 31, 1950, in which he represented that the total fair market value of all his assets as of said date was $ 35,950, and that his total liabilities as of said date, exclusive of his Federal tax liabilities, were $ 96,500. In subsequently filed statements of the same character, he represented his assets and liabilities to be as follows:Effective dateAssetsLiabilitiesJune 30, 1950$ 35,950.001 $ 96,000Nov. 30, 195118,090.001 41,000Jan. 20, 195517,633.332 545,100Mar. 1, 195563,753.143 478,300In about December 1950, a representative of the respondent commenced an investigation of Louis's financial condition, and he completed such examination on or about April 3, 1953. After examining the nature and value of Louis's assets and consulting with Louis regarding the same, he determined that the total forced sale value of Louis's assets as of the last mentioned date (exclusive of potential earning power) was $ 71,635.41, and that Louis's total Federal tax liabilities as of said date were $ 639,319.73, exclusive of interest.The notices *44 of transferee liability here involved were both issued to the First National Bank of Chicago, as trustee of Trust No. 36358 and Trust No. 38328, on December 3, 1953. On said date, and at all subsequent times to and including the time of the trial herein, the excess of the amount of Louis's liabilities over the amount of his assets was substantially greater than the aggregate amount of the transferee liabilities determined in said notices.Facts re Statute of Limitations .The Commissioner of Internal Revenue and Louis consented in writing (on Treasury Form 872) to extensions of the period of *492 limitation on assessment of Louis's income taxes for his taxable years ended December 31, 1946 to 1949, inclusive, as follows:Taxable yearLimitation per returnConsent datedLimitation per consent1946Mar. 15, 1950Jan. 24, 1950June 30, 1951Apr. 6, 1951June 30, 1952Apr. 25, 1952June 30, 1953Mar. 11, 1953June 30, 19541947Mar. 15, 1951Nov. 15, 1950June 30, 1952Apr. 25, 1952June 30, 1953Mar. 11, 1953June 30, 19541948Mar. 15, 1952Jan. 30, 1952June 30, 1953Mar. 11, 1953June 30, 19541949Mar. 15, 1953Mar. 11, 1953June 30, 1954All of the above-mentioned consents were signed by Louis personally, except that *45 which was executed on November 15, 1950, in respect of the taxable year 1947; and this was signed in the name of Louis by Truman K. Gibson, Jr. Such consent was executed by Gibson under a power of attorney which he then held, which Louis had theretofore signed, verified under oath, and delivered to the respondent. Said power of attorney read as follows:State of IllinoisssCounty of CookPOWER OF ATTORNEYKnow all men by these presents, that I, JOE L. BARROW, of the City of Chicago, County of Cook and State of Illinois, DO BY THESE PRESENTS, Make, Constitute and Appoint, THEODORE A. JONES, Certified Public Accountant, and TRUMAN K. GIBSON, JR., Attorney At Law, of the City of Chicago, County of Cook and State of Illinois my true and lawful agents to appear for me and represent me before the Treasury Department in connection with my Federal Tax for the year 1946-7, with full power of substitution and revocation, giving my said agents full power to do everything whatsoever requisite and necessary to be done in the premises, and to receive refund checks, execute waivers of the statute of limitations, and to execute closing agreements, as fully as I might do if personally present, at any *46 time subsequent to the date hereof and prior to the revocation hereof.In witness whereof, I have hereunto set my hand and seal this 21st day of June, A. D. 1950./s/ Joe L. Barrow [seal]Joe L. BarrowSubscribed and sworn to before me this 21st day of June, A. D. 1950/s/ Delores A. MannNotary Public[notary seal]Signed, Sealed andDelivered in presence of:Witnesses*493 At the time of the issuance of each of the notices of transferee liability here involved, the period of limitation for assessment of Louis's income tax for each of the years 1946 through 1949, and also the period of limitation for assessment of the liability of a transferee in respect of such taxes, had not expired.OPINION.I.The basic issue, in each of the two trust cases here involved, is whether the trustee is liable as a transferee of assets of Joe Louis Barrow (herein called Louis), for certain portions of the latter's undisputed delinquent income taxes. The determination of such issue, in each case, requires an answer to the following questions:(1) Was Louis the actual donor and transferor of the property transferred to the trustee as the initial corpus of the trust? And, if he was, what was the value of such property *47 at the time of its transfer?(2) Assuming that Louis was the donor, was he insolvent at the time of the transfer, or did the transfer render him insolvent?(3) At the time when the two notices of transferee liability here involved were issued, did Louis's liabilities exceed his assets by an amount which was greater than the aggregate of the transferee liabilities determined in said notices?All the foregoing questions are factual. A detailed statement of the facts upon which the answers depend, as well as our ultimate conclusions regarding such facts, have been set forth above in our findings.The burden of proving that the trustee is liable as a transferee of assets of Louis is on the respondent. Sec. 1119 (a), I. R. C. 1939. It is our opinion that the respondent has sustained such burden.In Docket No. 52055, involving the trust created for the daughter, Jacqueline, we have found as a fact that Louis delivered to his wife, Marva, without consideration and out of his own personal funds, the sum of $ 60,000; and that 50 per cent (or $ 30,000) of such sum was, under an agreement between them, to be applied by Marva in creating a trust for their daughter. Marva deposited said $ 30,000 *48 in a separate bank account of hers, which she called the Jacqueline Barrow account. Thereupon, after investigating various potential trustees, she caused an irrevocable trust to be created with the First National Bank of Chicago, as trustee for the benefit of Jacqueline; and she, at the same time, delivered to the trustee without consideration, said $ 30,000 which she had received for such purpose. Marva at no time had any personal beneficial interest in the $ 30,000; she considered that, in *494 creating the trust, she was acting merely as Louis's agent; and the trustee not only had knowledge that she was so acting, but also sought and obtained Louis's approval before accepting the trust. We have heretofore found as a fact, and we here hold, that Louis was the actual donor of said trust known as Trust No. 36358, and that he was the actual transferor of said $ 30,000 to the trustee on November 21, 1947.In Docket No. 52050, involving the trust created for Joe Louis, Jr., the facts are similar, except that the funds which Louis delivered to Marva for the purpose of creating this trust were first invested by her in income-producing real estate, in respect of which she obtained a corporate *49 trustee's interest-bearing note, secured by a trust deed covering such real estate; and she then delivered such note to the First National Bank of Chicago, as trustee, to provide the initial corpus of the trust for Joe Louis, Jr. The trustee, after receiving the note and obtaining an appraisal of the collateral security therefor, determined that the note had a value equal to its face amount, plus the accrued interest thereon; and we, likewise, have found that such was its value. Also, we have found as a fact, as in the case of the other trust, that Louis was the actual donor and the actual transferor of the property which constituted the initial corpus of this second trust, known as Trust No. 38328. We here adopt said findings as our holding.As regards the solvency of Louis, we have heretofore found as a fact, and here hold, that he was insolvent at the time when each of the two above-mentioned transfers to the trustee was made; and we have further found as a fact, and here hold, that on December 3, 1953, when the two notices of transferee liability here involved were issued, and also at all subsequent times up to the date of the trial herein, Louis's liabilities exceeded his assets *50 by an amount which was substantially greater than the aggregate transferee liabilities determined in said notices.In making these holdings regarding Louis's insolvency, we have not overlooked the substantial amounts of income which he derived from his boxing activities. The evidence does not disclose precisely where this income went; and it is not for us to conjecture. A letter of Louis's attorneys, attached to a statement of his financial condition which was filed with the respondent on about January 21, 1950, states in part as follows:As the enclosed schedules show, Louis has no quick assets of any consequence. He has made large sums and he has spent them. Where and how we do not completely know because Louis himself doesn't have this knowledge. At an early age he was schooled in profligacy instead of thrift. From the age of 19 on, he was surrounded by men of wealth who made money quickly and easily and spent it the same way. During his championship period, no brakes were applied to his spending. To the contrary large sums were constantly advanced him by the 20th Century Sporting Club, the promoting organization which held an exclusive services contract.*495 There are certain *51 other contentions of counsel for the trustee which require consideration. One of these is that Marva was not obligated to create the trusts, because her contract to create them was executed in connection with her divorce from Louis in 1945, whereas one of the trusts was created after their remarriage, and the other was created after their second divorce. We think such contention is without merit. Although the remarriage may have terminated any obligation to pay alimony, it did not terminate the obligation, which the parties mutually agreed should continue in full force and effect, that Marva would apply 50 per cent of the moneys paid to her by Louis for the specific purpose of creating trusts for their children. This mutual agreement prevented Marva from obtaining any personal interest in that portion of the moneys, and subjected such portion to a charge that it would be applied for the purpose for which it was paid. The parties themselves continued to recognize, both after their remarriage and after their second divorce, that such obligation was still binding; and Marva stated in her testimony that both of the trusts were created pursuant to the same. Louis and Marva recognized *52 also, in connection with their second divorce, that the agreement was to continue. Moreover, as we have heretofore pointed out, the trustee accepted the first trust, after the remarriage of Louis and Marva, with knowledge that it was being created in fulfillment of Marva's obligation; it sought and obtained Louis's written acknowledgment of that fact; and it executed the trust instrument which recited, in its preamble, that the trust was established in pursuance of the 1945 agreement.The objection is made that the deficiency in Louis's 1946 income tax had not been determined or assessed at the time when the trust for Jacqueline was created and the transfer to the trustee thereof was made. In J. Warren Leach, 21 T.C. 70">21 T. C. 70, 75, we said:The transferee is retroactively liable for transferor's taxes in the year of transfer and prior years, and penalties and interest in connection therewith, to the extent of the assets received by him even though transferor's tax liability was unknown at the time of the transfer. Scott v. Commissioner, 117 F.2d 36">117 F. 2d 36; [and other authorities].We here follow that decision.It is argued that the transferee liabilities were determined after the expiration of *53 the applicable period of limitation, on the ground that the waivers or consents which were executed by or on behalf of Louis are not effective against the transferee. Such argument reflects a misapprehension of the limitation provisions of the Internal Revenue Code (1939). Sections 275 (a) and 276 (b) of the Code provide, in substance, that the period of limitation upon assessment of income taxes shall be 3 years after the return was filed, plus such additional periods as the Commissioner and the taxpayer have agreed upon in *496 writing. Section 311 (b) of the Code provides further that the period of limitation for assessment of any liability of an initial transferee of the property of a taxpayer shall be within 1 year after the expiration of the period of limitation for assessment against the taxpayer. In the instant case, the liabilities of the transferee were determined, without use of the additional 1-year period, within the period of limitation upon assessment against the taxpayer, Louis.Finally, it is contended that the initial waiver or consent respecting Louis's 1947 income tax, which was executed on behalf of Louis by Truman K. Gibson, Jr., under date of November 15, 1950, *54 is invalid on the ground that Gibson was only one of the two agents named in Louis's power of attorney; and hence that Gibson alone had no authority to execute the consent. Said power of attorney, which has been set forth in our Findings of Fact, contains no requirement that the two agents named therein must act jointly. We have heretofore held that, in such circumstance, any of the designated agents may act alone under the power, in executing a waiver or consent. J. E. Hample, 12 B. T. A. 342, 347.After consideration of the foregoing authorities and all the evidence herein, we hold that, under the provisions of section 311 of the 1939 Code, the trustee of each of the trusts here involved, designated as Trust No. 36358 and Trust No. 38328, is liable as a transferee of property of Louis, in respect of his delinquent income taxes, to the extent of the value which we have determined for the property transferred to such trustee as the initial corpus of such trust, together with interest on the amount of such liability as provided by law.II.In Docket No. 50395, we have heretofore found as a fact, and we here hold, that the petitioner Marva Trotter Barrow Spaulding was not the actual *55 donor of either of the trusts here involved, or the actual transferor of the property which became the corpus of either of said trusts. Accordingly, we hold that she is not liable either for the deficiencies in gift tax, or for the additions to tax, which the respondent determined against her.In Docket Nos. 52050 and 52055 decisions will be entered under Rule 50.In Docket No. 50395 decision will be entered for the petitioner. Footnotes1. The cases of the following petitioners are consolidated herewith: Docket No. 52050. The First National Bank of Chicago, Trustee of a Trust created by Marva Trotter Barrow by an Agreement dated July 7, 1949, and known on the records of the Trustee as Trust Number 38328; Docket No. 52055, The First National Bank of Chicago, Trustee of a Trust created by Marva Trotter Barrow by an Agreement dated November 21, 1947, and known on the records of the Trustee as Trust Number 36358.↩1. First National Bank of Chicago, Trustee of Trust Number 36358 (dated November 21, 1947), as transferee of Joe Louis Barrow.↩2. First National Bank of Chicago, Trustee of Trust Number 38328 (dated July 7, 1949) as transferee of Joe Louis Barrow.↩1. Marva Trotter Barrow Spaulding.2. Louis also held, on July 7, 1949, his shares of stock of Joe Louis Enterprises, Inc. This stock, however, is deemed to have had no value as of said date; for, after eliminating the above-mentioned balancing asset entry of $ 165,635.36, the corporation's liabilities greatly exceeded its assets. In July 1949 it had not yet paid all of Louis's debts; and there was no liquidation of the same during the balance of said year.1. Exclusive of tax liabilities.↩2. Including estimated income and gift tax liabilities of $ 500,000.↩3. Including estimated income tax liabilities of $ 400,000.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619502/ | A. J. Mandt v. Commissioner. A. J. Mandt and Ola Fae Mandt v. Commissioner.Mandt v. CommissionerDocket Nos. 45656, 45657.United States Tax CourtT.C. Memo 1955-226; 1955 Tax Ct. Memo LEXIS 111; 14 T.C.M. (CCH) 909; T.C.M. (RIA) 55226; August 12, 1955*111 1. Held: The individual return filed by A. J. Mandt for the year 1944 and the joint return filed by A. J. Mandt and Ola Fae Mandt for the year 1945 were not false or fraudulent returns with intent to evade tax. Held, further, the statute of limitations having run with respect to both such years, assessment and collection of any deficiencies therefor are barred. Section 275, Internal Revenue Code of 1939. 2. Correct amount of ordinary income realized by Mandt in each of the years 1946 through 1949 with respect to payments received by him on a promissory note executed in 1945 by Lowell Hunter, determined. Richard L. Shook, Esq., 1026 Sixteenth Street, N.W., Washington, D.C., for the petitioners. O. P. Stevens, Esq., for the respondent. VAN FOSSAN *112 Memorandum Findings of Fact and Opinion Respondent determined deficiencies in income tax of A. J. Mandt and an addition thereto for fraud for years and in amounts as follows: 50 Per CentAdditionYearDeficiencyfor Fraud1944$10,154.85$5,077.431946194.10194784.801948600.771949804.00Respondent also determined a deficiency in income tax of A. J. Mandt and Ola Fae Mandt with an addition thereto for fraud for the year 1945, as follows: 50 Per CentAdditionYearDeficiencyfor Fraud1945$1,793.04$896.52The parties have made mutual concessions, all of which concessions will be reflected in the Rule 50 recomputation consequent hereon. The issues remaining to*113 be resolved are: (1) Whether the taxable income of petitioner in Docket No. 45656 was understated for the year 1944, as determined by respondent, and, if so, (2) Whether any part of the resulting deficiency was due to fraud with intent to evade tax, (3) Whether the taxable net income of petitioners in Docket No. 45657 was understated for the year 1945, as determined by respondent, and, if so, (4) Whether any part of the resulting deficiency was due to fraud with intent to evade tax, (5) Whether amounts collected during each of the years 1946 through 1949 in payment of a certain note held by petitioner in Docket No. 45656 constituted ordinary income or are to be allocated between ordinary income and return of capital, (6) Whether petitioner in Docket No. 45656 is to be allowed a capital loss carryover from the year 1945 to the years 1946 through 1949. Findings of Fact The stipulation of facts filed by the parties, with exhibits attached, is adopted, and, by this reference, made a part hereof. The petitioner in Docket No. 45656 is A. J. Mandt, who now resides in Lexington, Kentucky, and who filed his individual income tax returns for the years involved herein with the*114 collector of internal revenue for the district of Kentucky. The returns for the years 1946 through 1949 included a profit and loss statement reflecting inventories and expenses incurred in connection with the operation of a retail package liquor store; otherwise such returns were prepared on a cash receipts and disbursements basis. The petitioners in Docket No. 45657 are A. J. Mandt and his wife, Ola Fae, who filed a joint return for the year 1945 with the collector of internal revenue for the district of Kentucky. Such return was prepared on a cash receipts and disbursements basis. For convenience, A. J. Mandt will hereinafter be referred to as petitioner. Petitioner's father, W. F. Mandt, Sr., who will sometimes hereinafter be referred to as Mandt, Sr., began working in coal mines in 1884 at the age of 13. In or about 1919, he and his family moved to eastern Kentucky where he became associated with various coal mining concerns. During the early 1920s, he was made the general manager of Dudley Coal Company (hereinafter called Dudley), which conducted a coal mining operation at Letcher, Letcher County, Kentucky. Mandt, Sr. remained in charge of mining operations on the Dudley property*115 until the fall of 1932. In 1918, when he was about 14 years old, petitioner began to work around the mines over which his father had charge. He continued to work under his father's supervision during summer vacations until 1924. In 1924, at the age of 19, petitioner obtained a second class certificate from the Commonwealth of Kentucky permitting him to perform the duties of a mine foreman for a coal mining concern which operated in Perry County, Kentucky. He received a base wage of $200 per month and lived in a room over the commissary near the mine. In 1926, petitioner returned to Dudley where he was employed as a foreman at the same base wage. During this period, he lived with his parents at the Dudley mine. In addition to the base wages as foreman, he received bonuses which were based on production. During unspecified periods in the 1920s, petitioner supplemented his income by selling automobiles. He profited as much from this business as he did from working in the coal mines. Some time during the 1920s, Mandt, Sr. acquired a number of shares of Dudley stock. Petitioner also purchased 25 shares of stock of Dudley at some time prior to January 29, 1929. In 1922, Mandt, Sr. purchased*116 75 shares of stock in Marian Coal Company (hereinafter called Marian). Marian operated coal mines on lands situated near the Dudley property. In April 1923, Marian declared a 100 per cent stock dividend. On the same date, Mandt, Sr. transferred 38 of the 75 shares so received to his daughter Virginia Mandt and the remaining 37 to his other daughter Marguerite Mandt. Thereafter no Marian stock was transferred of record within the Mandt family. During the 1920s, Mandt, Sr. and his wife acquired additional bonuses in both Dudley and Marian. The certificates evidencing much of the stock thus acquired were signed in blank by the vendor and the shares were never formally transferred on the books of the issuing corporation. From time to time during the 1920s and early 1930s, petitioner acquired an aggregate of 100 shares of Dudley stock and 75 shares of Marian stock from his father, and some 40 shares of Dudley stock from various other persons in the community. None of the shares so acquired were transferred of record. Petitioner paid the par value, or $100 per share, for all of the Dudley and Marian stock acquired by him. Effective March 1, 1927, Dudley conveyed its leasehold rights in*117 and to the property in which it conducted its mining operations to South Chicago Coal & Dock Companp (hereinafter called South Chicago). South Chicago, a financially responsible company, was obligated to pay Dudley a minimum royalty of $30,000 per year. By the fall of 1932, South Chicago had exercised its option to extend the lease for an additional five year period ending in 1937. Dudley paid dividends during the later 1920s and early 1930s, usually at the rate of $6 per share. During the early 1930s, Dudley stock was considered a sound investment because the coal lands could be operated very profitably. During January 1933, the Dudley stock, which had a par value of $100 per share, also had a fair market value of $100 per share. At the time that South Chicago was negotiating for a lease on the Dudley property, it also gave serious consideration to leasing the Marian property. In 1929 or 1930, Marian encountered a fault in the main producing portion of its mine. After cutting into the fault approximately 3,000 feet without running into a mineable seam of coal, Marian abandoned its mine. It was common knowledge in the area that Marian had struck the fault. That fact reduced the*118 value of its stock. The elder Mandt and his associates, with full knowledge of the fault, offered to purchase Marian stock at $75 per share. During 1941 petitioner organized the Jeanne Francis Coal Company, which concern acquired the old Marian lease, as well as a lease to adjoining coal lands. By connecting the two properties underground, the fault was avoided. During the early 1940s Jeanne Francis Coal Company removed substantial tonnage from the old Marian property. During January 1933 the Marian stock had a fair market value of $75 per share. In the late fall of 1932, petitioner and his first wife and the elder Mandt and his family moved from Letcher to Alphoretta, Floyd County, Kentucky, where the elder Mandt planned to organize a coal mining company which was to be owned and controlled by him and members of his family. The Mandt family was very closely knit and was dominated by Mandt, Sr. at all times. The elder Mandt had the reputation of being a very capable and successful coal mine operator. He kept complete personal control of his business operations. From November 1932, until the latter part of January 1933, the Mandts removed coal from the properties at Alphoretta. *119 On January 27, 1933, Stephens Elkhorn Fuel Corporation (hereinafter called Stephens Elkhorn) filed its Articles of Incorporation with the Secretary of State of the Commonwealth of Kentucky and took over the business at Alphoretta. Pursuant to Article 4 of the charter, the capital stock of Stephens Elkhorn was $20,000 and was divided into 200 shares valued at $100 each. The three incorporators subscribed for the stock as follows: W. F. Mandt, Sr., 100 shares; petitioner, 50 shares; and Virginia Mandt, 50 shares. Upon the organization of Stephens Elkhorn, petitioner acquired 40 shares of the capital stock thereof. Petitioner transferred to his father all of the stock of Dudley and Marian which he had previously acquired, worked for one year without current compensation, and paid in some cash. With respect to the item of current compensation, it was agreed between petitioner and his father that the services of each were worth approximately $5,000 per year. As to the cash paid in, such amount was raised through the sale of an automobile, by means of loans on insurance policies of the petitioner and his wife, and by borrowing from petitioner's brother John. Petitioner also borrowed*120 an additional $500 from John to be used to pay for the initial inventory for the commissary which was subsequently taken over by Stephens Elkhorn. Petitioner's 40 shares of Stephens Elkhorn's stock were issued to him quite some time after the incorporation of the company. During the spring of 1951, at petitioner's place of business at Lexington, Kentucky, the examining revenue agent inquired of petitioner as to the cost of the 40 shares of Stephens Elkhorn stock, and was informed that such stock had cost $100 per share. Petitioner did not at that time mention his having transferred any Dudley or Marian stock, nor did the agent inquire as to the fact. On June 1, 1943, petitioner borrowed $7,999.92 from Stephens Elkhorn. The obligation, which he secured by posting his 40 shares of Stephens Elkhorn stock as collateral, was represented by a promissory note of that date. On June 1, 1943, Stephens Elkhorn issued two checks payable to petitioner, one for $4,000 and the other for $3,999.92. On June 2, 1943, he endorsed the $4,000 check and loaned the proceds to Jeanne Francis Coal Company (hereinafter called Jeanne Francis) by depositing the check to its credit at the First National Bank*121 of Pikeville, Kentucky (hereinafter some times called Pikeville National). On June 5, 1943, he cashed the $3,999.92 check and placed the money in a safe deposit box at the Pikeville National, which was registered in the name of his brother. On June 10, 1943, petitioner took the $3,999.92 from the safe deposit box and loaned same to Jeanne Francis by depositing such amount to its credit at the Pikeville National. Some time between June 1, 1943, and June 18, 1943, petitioner executed a series of notes for $222.22 each, one of which was due each month over the following three years. He gave the notes to Stephens Elkhorn in substitution for the original note of $7,999.92. Subsequent to June 18, 1943, Stephens Elkhorn requested petitioner to return to it the original note dated June 1, 1943, for $7,999.92 which Stephens Elkhorn had mailed to petitioner on June 18, 1943. Before complying, he defaced the note by tearing off his signature. As of December 31, 1943, three of the 36 notes had been paid, leaving a balance of $7,333.26 due Stephens Elkhorn. As of December 31, 1943, Jeanne Francis owed the petitioner $7,333.26. During February, 1944, petitioner borrowed an additional $10,000 from*122 Stephens Elkhorn. Shortly thereafter he transferred his Stephens Elkhorn shares to L. B. Brashear and his wife. The Brashears gave petitioner $20,000 in notes and in addition, Stephens Elkhorn canceled his indebtedness of $17,333.26. Some time prior to March 15, 1945, petitioner conferred with Arthur Dixon in his office in the Letcher County Court House, Whitesburg, Kentucky, regarding the preparation and filing of his Federal income tax return for the taxable year 1944. Dixon has served as judge pro tem and as Judge of the County Court of Letcher County for an aggregate of eight years. He also has served as secretary to the county attorney, and, at the time of the hearing herein, was doing clerical work in the office of the sheriff of such county. To supplement his income, Dixon, in the early 1930s, began filling out income tax returns in his spare time. He had prepared petitioner's returns in previous years. Prior to his conference with Dixon, petitioner prepared a detailed memorandum with respect to his acquisition and disposition of the 40 shares of Stephens Elkhorn stock, which memorandum he took with him to Dixon. Petitioner went over all of the information with Dixon to some*123 extent, and left all of the data with Dixon for the latter's consideration and preparation of a return. A few days following the conference, petitioner returned to Dixon's office. Dixon told petitioner of having discussed the matter with a man, with whom he often discussed such matters, and that this party was, like he was of the opinion that the transaction involving the disposition of the Stephens Elkhorn stock need not be reported because no profit had been realized therefrom. Pursuant to Dixon's recommendation, petitioner filed a Form W-2 for the taxable year 1944 in which was reported his salary from Jeanne Francis. During August 1944, petitioner entered into a contract with Hugh French for the purchase of a farm located in Woodford County, Kentucky (hereinafter called Woodford County farm) for $43,000, of which $10,000 was to be paid in cash and the balance was to be represented by a mortgage note. By March 1, 1945, petitioner completed the cash payment and on or about that date received the deed. Between March 1, 1945, and July 31, 1945, petitioner paid French a total of $1,000 principal and $543.33 interest on the $33,000 mortgage note. No deduction was claimed with respect*124 to the interest on the return for the taxable year 1945. During July 1945, petitioner sold the Woodford County farm to Lowell Hunter. Hunter paid petitioner $10,000 cash, gave him an installment note for $8,000 (hereinafter called Hunter note), and assumed the remaining balance of $32,000 due French on the mortgage note. The Hunter note, which had an agreed fair market value of only $1,000 as of December 31, 1945, was paid by Hunter as follows: YearAmount1946$2,00019471,00019481,00019494,000During 1945 petitioner paid $300 as attorney fees for searching the title to the Woodford County farm. On March 1, 1945, he purchased 14,000 tobacco sticks which were used on the farm. The sticks, which cost $350, went with the farm when he resold it to Hunter. Petitioner paid $200 in expenses in connection with operating the farm while he owned it. No deduction was claimed for the attorney fees, the tobacco sticks, or the farm expenses on the return for the taxable year 1945. Petitioner reported no gain from the sale until the taxable year 1949 during which year he received the final payment from Hunter. In filing his return for 1949, petitioner reported*125 a long-term capital gain of $6,525 with respect to the sale. The gain, which was computed on the basis of a gross sale price of $51,000 and a cost basis of $44,475, was explained as follows on the 1949 return: "Taxpayer entered into a contract for the sale of farm on 10/11/45 which was not finally consummated until 6/4/49 when final payment was made. Therefore taxpayer is reporting profit on transaction in taxable year 1949." In determining the deficiency asserted against petitioner for the taxable year 1949, respondent included $4,500 as ordinary income with respect to the Hunter note and eliminated the long-term capital gain of $3,262.50. The adjustments were explained as follows: "[Inclusion] "(c) It is held that you realized ordinary income in the year 1949 on the collection of $4,500 on a note of Lowell Hunter. This sum was included in the gross salesprice of the long-term capital gain reported by you on your return for 1949. The long-term capital gain on the sale of a farm to Lowell Hunter has been excluded from income in the year 1949. (See explanation (e) following). "[Elimination] "(e) It has been determined that the long-term capital gain reported on your*126 return for the year 1949 in the amount of $3,262.50 on the sale of a farm to Lowell Hunter represented a short-term capital gain in the year 1945, limited to $1,000 of the fair market value at time of the sale of a second mortgage note in the amount of $8,000. Taxable net income for the year 1945 has been adjusted accordingly." The net income adjustment for the taxable year 1945, referred to above, was made by including the Hunter note in the net worth of petitioner and Ola Fae Mandt as of December 31, 1945, at $1,000. In determining the deficiency asserted against petitioner for the taxable year 1948, respondent included $2,500 as ordinary taxable income with respect to the Hunter note, which adjustment was explained as follows: "* * * It is held that you realize ordinary taxable income in the year 1948 on the collection of $2,500 on a note of Lowell Hunter, none of which was reported by you for this year. This note for $8,000 was received as part of the consideration on sale of farm by you in 1945, and it has been determined to have had a fair market value at that time of $1,000." During 1943 petitioner purchased a house in Hazard, Kentucky, for $2,400. The house was sold*127 in August 1944 for $3,000 at which time its adjusted cost basis was reduced to $2,340 by reason of allowable depreciation. Petitioner's first wife, from whom he was divorced a month earlier, received the entire proceeds from the sale. Petitioner did not report any portion of the $660 long-term capital gain for the taxable year 1944. The Jeanne Francis debt of $7,333.26 became worthless in 1945. No deduction was claimed therefor on the return for such year. In addition to this short-term capital loss 1 in 1945 and in addition to the short-term capital loss sustained in such year on the sale of the Woodford County farm, petitioner realized long-term capital gains and losses in 1945, as follows: Gain or (Loss)Adjustedto Be TakenItemPropertyCost BasisSales PriceGain or (Loss)Into Account1.125 shares capital stock of JeanneFrancis$12,500.002.50 shares capital stock of Commu-nity Fuel Co.5,000.003.Garage building - Blackey, Ky.746.70$10,000 2($9,571.70)($4,785.85)4.Half interest Wyatt Mining Equip-ment1,325.00 3$19,571.705.Mine equipment1,325.001,500175.0087.506.G.M.C. truck1,100.001,000(100.00)(50.00)*128 The $87.50 taxable gain was not reported on the return for the taxable year 1945. No deduction was claimed*129 with respect to any portion of the allowable loss. In making his determination for the years 1944 and 1945, respondent determined cash on hand, total assets, total liabilities, and net worth as follows: TotalLiabilitiesCashand De-As ofonTotalpreciationNetDec. 31HandAssetsReserveWorth1943$2,500$39,335.17$13,441.59$25,893.5819442,50068,056.272,386.6565,669.6219452,50083,440.9716,911.5666,529.41 In computing petitioner's net worth as of December 31, 1943, respondent included as a liability petitioner's debt to Stephens Elkhorn. 4 He did not include, as a corresponding asset, the amount of the receivable owed petitioner by Jeanne Francis. Petitioner's 40 shares of Stephens Elkhorn stock were included in total assets as of December 31, 1943, at $4,000. The total assets and total liabilities as of December 31, 1944, included only those of petitioner, while those as of December 31, 1945, included his as well as Ola Fae's. Included among the total assets as of December 31, 1945, was an item in the amount of $4,702.50 representing household furniture. Of this amount, approximately $2,000 represented*130 new furniture purchased with funds which Ola Fae had derived from the sale of personal assets prior to her marriage to petitioner. Respondent determined petitioner's living expenses for the years 1944 and 1945, as follows: MaintenanceIncome TaxofPaidand Gifts toLivingYear(Refunded)ChildrenExpenses1944$1,165.81$ 750$3,000.001945(244.91)1,2004,408.03After eliminating 50 per cent of the long-term capital gains which he determined were derived from the sale of a house in Hazard, Kentucky, and from the sale of the 40 shares of Stephens Elkhorn stock, respondent added the above tax payment, maintenance costs of children, and living expenses, and then by use of the net worth method determined unreported income for the year 1944, as follows: ReportedUnreportedCorrectNet IncomeNet IncomeNet Income$4,914$22,781.18$27,695.18Petitioner was first married on February 17, 1930. At that time, petitioner was working on a straight salary. During the first two years of their marriage their standard of living was moderate rather*131 than luxurious. They were unable to save much money. Three children were born of that marriage. On or about December 30, 1942, petitioner and his first wife were separated. Thereafter, the first wife's attorney, Rodney Haggard of Winchester, Kentucky, wrote petitioner relative to alimony and a property settlement. Petitioner mentioned his marital difficulties to John M. Yost, an official of Pikeville National, whereupon Yost recommended petitioner consult with the bank's attorney, O. T. Hinton, of Pikeville. On April 8, 1943, petitioner had a conference with Hinton at which he informed Hinton of the nature and scope of his wife's demands. It was Hinton's opinion that these demands were unreasonable. Being cognizant of the law of Kentucky allowing a wife, under the circumstances, to attach her husband's property, including any bank accounts, without giving bond, Hinton advised petitioner to take such steps as were possible to preclude the possibility of such action by his wife's attorney. During the conference, petitioner called the Pikeville National to inquire as to the amount of the balance in his personal checking account and immediately withdrew $750 cash therefrom. Shortly thereafter*132 petitioner rented a safe deposit box at the Pikeville National in the name of his brother, W. F. Mandt, Jr., to which box petitioner had access. On December 31, 1943, petitioner had an account with the Peoples Bank of Hazard, Kentucky with a balance of $824.68. Petitioner possessed negotiable government bonds with an approximate value of $5,000 until on or about September 3, 1943, when they were liquidated. Petitioner's first wife never attempted to learn what petitioner's assets were nor did she authorize her attorney to do so. At the time of their divorce, petitioner and his first wife were both represented by a law firm in Lexington, Kentucky. Prior to his death in October, 1943, petitioner's father had, from time to time, made gifts of money to petitioner, which gifts aggregated approximately $12,000. During part of 1943 and 1944, petitioner kept substantial cash in a safe at his office, as well as in one which he had at his home. In December 1950, petitioner and his accountant were questioned by the examining revenue agent in connection with the computation of respondent's net worth statements. At that time the agent asked as to what amount they considered as cash on hand*133 at December 31, 1943 and 1944, and was informed by them that such amount was approximately $2,500. From January 1, 1944, to about the middle of April 1945, petitioner resided at Letcher, Letcher County, Kentucky, near the Jeanne Francis mine. Letcher, a small mining community in the mountainous area of eastern Kentucky, is approximately 18 miles from Whitesburg, Kentucky, and approximately 32 miles from Hazard, Kentucky, the County Seat of Perry County. Except for Blackey, Kentucky, which had a population of about 450 at that time and was about 2 miles from Letcher, Whitesburg and Hazard were the only towns or cities of any substantial size within a radius of approximately 90 miles. During 1944-1945 Whitesburg and Hazard had populations of about 3,000 and 8,000, respectively. Each served as a trading center for its surrounding mining community. Except for moving picture theatres, restaurants, and a roadside establishment near Hazard which offered metals, soft drinks, and music furnished by a nickelodeon, there were no places of amusement or entertainment readily available. From January 1, 1944, to about the middle of April 1945, petitioner put in from 10 to 12 hours per day in*134 and around the Jeanne Francis mine. Prior to his second marriage of February 8, 1945, petitioner lived alone. On the days which he spent at or around the mine, he followed the practice of eating breakfast, which he prepared himself, and an evening meal which he purchased for about $1.25. Due to gasoline rationing, his traveling was principally in connection with Jeanne Francis' business. After his divorce in July 1944, and prior to his second marriage, petitioner and his future wife had dinner together on many occasions at one of the restaurants in Hazard. The meals cost him about $1.25 per person. Occasionally during that period he and she patronized the roadside establishment referred to above, which was the only place in the Hazard-Whitesburg area offering music. On one occasion petitioner, his future wife, and friends spent a week end in Cincinnati, Ohio, and on another, they and relatives spent a week end in Frankfort, Kentucky. From time to time, petitioner entertained his friends and neighbors at his home. Respondent determined that petitioner realized a long-term capital loss of $7,371.70 during the taxable year 1945 from the sale of the G.M.C. truck, the mine equipment, *135 the Blackey garage building, the 125 shares of Jeanne Francis stock, and the 50 shares of Community Fuel Co. stock, and a shortterm capital gain of $1,000 from the sale of the Woodford County farm. Respondent increased the alleged increase in net worth for 1945 ($859.79) by (a), 50 per cent of the $7,371.70 long-term capital loss, (b), maintenance costs for the children, and (c), living expenses, and subtracted the income tax refund. He then determined unreported income for the taxable year 1945 under the net worth method, as follows: ReportedUnreportedCorrectNet IncomeNet IncomeNet Income$2,551.55$7,357.21$9,908.76After their marriage on February 8, 1945, petitioner and Ola Fae lived at Letcher until April 12, 1945, when they moved to Lexington where they owned their own home. The house was a brick colonial residence costing $14,500, of which about $9,161.56 was raised by a mortgage thereon. Petitioner's eldest child came to live with them in May 1945. On June 26, 1947, petitioner purchased premises known as 234-236 East Shore Street, Lexington, Kentucky, for $35,000, of which $15,000 was attributable to the land and $20,000 to the building. *136 The building, which he used in connection with his business beginning July 1, 1947, had a useful life of 40 years from and after July 1, 1947. Petitioner claimed no deduction for depreciation with respect to such building on his Federal income tax return for the taxable year 1947, nor was any amount allowed with respect thereto in determining the deficiency for that year. Although petitioner did not receive any regular salary for his services for the first year after Stephens Elkhorn was formed, he and his family did receive all their living expenses, including, among other things, living quarters, food, and doctor's expenses, from Stephens Elkhorn or its operator, Mandt, Sr. The tax returns filed by petitioner in 1944 and by petitioner and Ola Fae in 1945 were not false or fraudulent with intent to evade tax. Opinion VAN FOSSAN, Judge: Assessment and collection of any deficiencies for the years 1944 and 1945 are barred by the statute of limitations, see section 275, Internal Revenue Code of 1939, unless prior to the running of such statute, valid waivers thereof were executed or unless the returns filed by petitioner for the year 1944, and by petitioner and Ola Fae for the*137 year 1945, were false or fraudulent with intent to evade tax. See section 276, Internal Revenue Code of 1939. It appears that no waivers were executed. Thus, we consider first the question of fraud. Fraud connotes bad faith, a deliberate and calculated intention at the time the returns in question were prepared and filed to defraud the Government of taxes legally due. E. S. Iley, 19 T.C. 631">19 T.C. 631. The existence of such an intent is never to be presumed. Nor is a mere suspicion or doubt as to the intentions of a taxpayer sufficient to justify the imposition of the so-called fraud penalty. L. Glenn Switzer, 20 T.C. 759">20 T.C. 759. The presence of fraud must be proven by clear and convincing evidence, and the burden of producing such proof is, by statute, placed upon the respondent. See section 1112, Internal Revenue Code of 1939. Involving as it does the personal intent of the taxpayer, and intent being a state of mind, seldom can one isolated act or omission be singled out as evidencing*138 a fraudulent intent. Such intent is to be found by viewing a taxpayer's entire course of conduct. Thus, the existence, or absence, of a fraudulent intention on the part of the taxpayer at any particular time is a fact, and like any other fact, is to be deduced from all the evidence of record and any inferences properly to be drawn therefrom. Charles E. Mitchell, 32 B.T.A. 1093">32 B.T.A. 1093, affd. sub nom. Helvering v. Mitchell, 303 U.S. 391">303 U.S. 391. If, after studying the record with the care a case of this nature requires, and with due consideration for the inferences, there remains a conviction, based on clear and convincing evidence, that any part of the deficiency was due to fraud with an intent to evade tax, only then may imposition of the so-called fraud penalty provided in section 293(b) of the Code of 1939 5 be sustained. *139 In the instant case, respondent argues that the record is replete with evidence from which inferences of fraud may be drawn. Specifically, respondent decries petitioner's failure to keep satisfactory records or memoranda concerning his financial transactions in 1944 and 1945, which transactions involved the sale of certain capital assets. Respondent points out that petitioner was an experienced businessman, and maintains that such omission, when contrasted with petitioner's practice of maintaining a complete set of double entry books in 1946 and thereafter, presents a factor from which may be drawn an inference of his fraudulent intention to evade taxes in 1944 and 1945. We disagree. It would appear that petitioner began his practice of keeping a complete set of records at the time he became the owner of a liquor dispensary in Lexington. This apparently occurred sometime in 1946. Prior to that time, it seems, petitioner was a salaried employee, all of whose income, except that derived from the sale of the assets here in question, consisted of such salary. While it be true that all taxpayers, *140 except farmers and those whose income is derived solely from salary, wages, or similar compensation for personal services rendered, are required to keep such permanent books and records as will enable respondent correctly to determine the amount of income subject to tax, see also Regulations 111, section 29.54-1, the failure to comply with such requirement followed by the installation of the proper procedures, in our opinion, does not, without more, clearly and convincingly evidence a fraudulent design to evade taxes during the prior period. This is true in the present case regardless of whether or not we consider petitioner to have been an experienced businessman. Substantially all of the deficiency, as determined by respondent for the year 1944, springs from the transaction involving petitioner's sale in that year of his Stephens Elkhorn stock. In this connection, the specific question is in regard to the proper basis to be ascribed to such stock in petitioner's hands for determining gain. We have found facts on this record tending to support a higher basis therefor than that determined by respondent. Such finding is for the most part based upon the sworn testimony of petitioner. *141 After viewing and hearing petitioner when such testimony was given, and after considering all the evidence bearing upon the point and the attendant circumstances, including petitioner's admission against interest regarding the amount paid therefor, we see no reason to discredit such testimony. But, even if we were to do so, his mere failure to report income, standing alone, is insufficient to establish fraud. James Nicholson, 32 B.T.A. 977">32 B.T.A. 977; L. Glenn Switzer, supra.Petitioner sought what he believed to be competent advice in the preparation of his return for 1944. Further, the party consulted was apprised of sufficient data appertaining thereto to make possible his becoming cognizant of the entire transaction. That the advice given by this party and acted upon by petitioner was erroneous, is obvious. Of course, petitioner's act of seeking consultation does not relieve him of his duty to render an accurate and honest accounting of his income. But, all of the facts considered, we feel that petitioner's failure to file a proper return and to report thereon the transactions in dispute does not evidence a calculated attempt to evade taxes. The most that can*142 be said is that petitioner was seriously negligent in determining the proper basis at which he held the stock in question. William W. Kellett, 5 T.C. 608">5 T.C. 608, 618. The stipulation on file herein shows that petitioner also derived a gain in 1944 from a sale of a house in Hazard, Kentucky, in the approximate amount of $660. The evidence shows, and petitioner admits, that such gain was not reported. No other facts attending this transaction are shown. As pointed out above, such evidence falls short of establishing fraud. Regarding the year 1945, the record made is completely devoid of proof of the degree and character necessary to establish fraud. In fact, on most of the transactions involving the sale by petitioner in that year of the assets in controversy, petitioner sustained a loss, which losses were not claimed as deductions. In the few transactions from which gain was realized, such gain was wholly derived from, and equal to, the amount of depreciation allowed or allowable. Finally, no additional sources of income other than as reported by petitioner and Ola Fae in their 1945 return are shown. Thus we conclude that the tax returns filed by petitioner in 1944, and*143 by petitioner and Ola Fae in 1945, were not false or fraudulent with intent to evade tax. We have, accordingly, so found as a fact, and here so hold. It follows, therefore, that the assessment and collection of an income tax deficiency in either year, if any there be, are barred by the statute of limitations. The next question involves the proper tax treatment to be accorded the amounts collected by petitioner during each of the years 1946 through 1949 in payment of the Hunter note above referred to. The parties now agree that the note in question had a fair market value of $1,000 as at the end of the year 1945, during which year it was received by petitioner as part consideration for the sale by him of the Woodford County farm. Also, they further agree that, this being true, petitioner sustained a short term capital loss in 1945 of $650 on such transaction. They disagree as to the tax consequences of petitioner's subsequent collection of the full $8,000 face amount of the note. In this regard, both parties realize that of the amount so collected, $1,000, the fair market value of the note when received, constitutes a nontaxable return of capital. Victor B. Gilbert, 6 T.C. 10">6 T.C. 10;*144 A. B. Culbertson, 14 T.C. 1421">14 T.C. 1421. Respondent, however, argues that the remaining payments, aggregating $7,000, constitute ordinary income in the years in which respectively received. Petitioner, on the other hand, contends that these amounts should be prorated in such years between ordinary income and return of capital since no tax benefit was derived from the $650 short term capital loss sustained upon the sale of the farm in 1945, citing Dobson v. Commissioner, 320 U.S. 489">320 U.S. 489; Birmingham Terminal Co., 17 T.C. 1011">17 T.C. 1011, and cases cited therein. We disagree with the premise upon which petitioner's argument is based. That is to say, during 1945 petitioner sustained net capital losses in the aggregate of $17,479.96, of which $1,000 was properly allowable pursuant to section 117(d)(2) of the 1939 Code. 6 No authority exists, so far as we have been able to ascertain, for breaking down the total capital losses sustained in one year into component transactions, or for applying thereto a procedure such as the first in first out rule to determine which loss or losses are represented in the $1,000 deduction so determined. To the contrary, some portion of*145 every capital loss so sustained, minute though it may be, is properly allocable thereto. Thus, we sustain respondent's position and hold that the payments in controversy are taxable as ordinary income in the years in which they were respectively received. Since, as pointed out above, petitioner's net capital losses in 1945 amounted to a total of $17,479.96, only $1,000 of which was properly allowable in that year, petitioner is entitled to a net capital loss carryover of the remainder pursuant to section 117(e) of the 1939 Code. 7*146 Decisions will be entered under Rule 50. Footnotes1. Petitioner concedes that the debt constituted a nonbusiness debt within the purview of section 23(k)(4), Internal Revenue Code of 1939↩. 2. Items 1-4 were sold to F. S. McComas during February, 1945 for $10,000. Respondent determined that Items 1 and 2 (stocks) were sold for $10,000 and that Item 3 (garage building) was sold for $800. Respondent did not take the sale of Item 4 (interest in Wyatt mining equipment) into account. ↩3. The petitioner acquired his half interest in the Wyatt mining equipment on August 31, 1944 for $1,500. He sold his interest therein during February, 1945. The other mine equipment (Item 5) was acquired in September, 1944 and sold to Hallon during October, 1945. Respondent allowed depreciation in the amount of $175 with respect to the other mine equipment (Item 5). The adjusted cost basis of $1,325 for the Wyatt equipment was computed by allowing $175 as depreciation. Since the Wyatt equipment was held by petitioner for a shorter period than the other equipment (Item 5), an allowance of $175 as depreciation for the Wyatt equipment seems ample.↩4. The debt was included at the erroneous amount of $7,333.34.↩5. SEC. 293. ADDITIONS TO THE TAX IN CASE OF DEFICIENCY. * * *(b) Fraud. - If any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be so assessed, collected, and paid, in lieu of the 50 per centum addition to the tax provided in section 3612(d)(2).↩6. SEC. 117. CAPITAL GAINS AND LOSSES. * * *(d) Limitation on Capital Losses. - * * *(2) Other Taxpayers. - In the case of a taxpayer other than a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges, plus the net income of the taxpayer of [or] $1,000, whichever is smaller. * * *↩7. SEC. 117. CAPITAL GAINS AND LOSSES. * * *(e) Capital Loss Carry-Over. - (1) Method of Computation. - If for any taxable year beginning after December 31, 1941, the taxpayer has a net capital loss, the amount thereof shall be a short-term capital loss in each of the five succeeding taxable years to the extent that such amount exceeds the total of any net capital gains of any taxable years intervening between the taxable year in which the net capital loss arose and such succeeding taxable year. For purposes of this paragraph a net capital gain shall be computed without regard to such net capital loss or to any net capital losses arising in any such intervening taxable years.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619503/ | RONALD L. BARBER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBarber v. CommissionerDocket No. 5823-76.United States Tax CourtT.C. Memo 1980-39; 1980 Tax Ct. Memo LEXIS 546; 39 T.C.M. (CCH) 1026; T.C.M. (RIA) 80039; February 12, 1980, Filed John J. Hentrich, for petitioner. David P. Fuller, for respondent. QUEALYMEMORANDUM FINDINGS OF FACT AND OPINION QUEALY, Judge: Respondent determined a deficiency in income tax due from the petitioner for the taxable year 1972 in the amount of $147,682 together with the addition to the tax under section 6653(b) 1 in the amount of $73, 841. At the trial, respondent conceded that the determination should be reduced on account of respondent's overstatement of unreported income attributable to the petitioner. The issue to be decided is whether petitioner is chargeable with income in the amount of $206,566 for the taxable year 1972 on account of his participation in a burglary of the Laguna Niguel branch*547 of the United California Bank and, if so, whether petitioner's failure to include such income in his individual income tax return for that year constituted a fraudulent omission of income on account of which the penalty is applicable under section 6653(b). FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. The petitioner, Ronald L. Barber, resides in Anaheim, California. During the taxable year 1972 he resided at 9803 San Carols Avenue, South Gate, California. Petitioner filed a timely United States Individual Income Tax Return, Short Form 1040A, for the taxable year 1972. Said return, and the accompanying Form W-2, reported taxable wage income received from Paramount General Hospital in the amount of $1,599.75 for 1972. The return disclosed no other income from any source for 1972. At the time the petition herein was filed, the petitioner was confined at the Medical Center for Federal Prisoners, Springfield, Missouri. During the weekend of March 24-27, 1972, certain individuals entered the vault of the United California Bank's Laguna Niguel branch and stole and*548 contents of numerous safe deposit boxes and a sum of bank cash. The total cash and value of the property taken from the bank was determined to be $2,155,531. Some of this property was later recovered in a filed in Ohio. As of the date of the trial of this case, the total unrecovered property from the above-mentioned robbery of the United California Bank's Laguna Niguel branch was $1,445,961, computed as follows: Lost bank cash$ 45,256.00Lost boxholder property1,400,705.00TOTAL$1,445,961.00An indictment was filed on July 3, 1972, in the United States District Court for the Central District of California (No. 10652CD). Said indictment charged Charles Albert Mulligan, Ronald Barber, Harry James Barber, Philip Bruce Christopher and Amil Alfred Dinsio with conspiracy, bank burglary, larceny of a national Bank, and receiving property stolen from a national bank. Charles Broeckels, also known as G. Richards, was named as an unindicted co-conspirator. The indictment in No. 10652CD was later dismissed as to Ronald Barber and Harry James Barber on March 19, 1973. Amil Alfred Dinsio, Charles Albert Mulligan and Philip Bruce Christopher were tried on the above*549 charges and found guilty of conspiracy in violation of 18 U.S.C. sec. 371; bank burglary in violation of 18 U.S.C. sec. 2113(a); and larceny of a national bank in violation of 18 U.S.C. sec. 2113(b). On January 31, 1973, another indictment was filed in the United States District Court for the Central District of California with respect to the aforesentioned robbery of the United California Bank's Laguna Niguel branch (No. 11874CD). This indictment charged Ronald Barber, Harry James Barber, and James Frank Dinsio with conspiracy, bank burglary, and larceny of a national bank. Charles Broeckels, also known as G. Richards, was again named as an unindicted co-conspirator. Ronald Barber, the petitioner herein, and James Frank Dinsio was tried on the above charges and found guilty of conspiracy in violation of 18 U.S.C. sec. 371, and larceny of a national bank in violation of 18 U.S.C. sec. 2113(b). Harry James Barber fled before trial and remains a fugitive. The defendants in Nos. 10652CD and 11874CD appealed their convictions on the aforementioned charges to the United*550 States Court of Appeals for the Ninth Circuit. On January 4, 1974, and June 4, 1974, respectively, the Ninth Circuit entered orders affirming the judgments of the district court in Nos. 10652CD and 11874CD. The proof adduced at the trials of the petitioner and other defendants convicted as participants in the burglary of the Laguna Niguel branch of United California Bank was included as follows: Harry James Barber was the petitioner's brother. Amil Alfred Dinsio and James Frank Dinsio were the petitioner's uncles. Charles Albert Mulligan was the brother-in-law of either Amil or James Dinsio. Harold Dawson was a friend of Albert Mulligan from the Marine Corps. Philip Bruce Christopher and Charles Broeckels were unrelated to the petitioner. On February 17, 1972, Amil Dinsio and Charles Mulligan flew from Cleveland, Ohio, to Los Angeles. On February 18, Amil Dinsio and Mulligan registered at the Jubilee Motor Inn in Lynwood, California. The registration cards listed a Ford LTD with California license plates. This vehicle was registered to the petitioner. On February 29, 1972, a person using a fictitious name and address purchased a 1962 Oldsmobile from a private seller, *551 William Sublett, in Long Beach, California. Mr. Sublett had received a phone call earlier in the day from a prospective buyer. Petitioner Ronald Barber's telephone records showed a phone call to Mr. Sublett on February 29, 1972. On March 5, 1972, James Dinsio made a down payment of $1,000.00 in cash on a 19-foot ski boat sold by a private owner in Downey, California. On March 7, 1972, petitioner Ronald Barber and Harry Barber rented a condominium apartment in Laguna Niguel, California, located approximately 1-1/2 miles from the United California Bank's Laguna Niguel branch. The lease was for a term of three months at a rental rate of $300.00 per month. The lease was executed the following day, March 8, by petitioner Ronald Barber, and he took possession on that date. The same date, Amil Dinsio and Charles Mulligan checked out of the Jubilee Motor Inn in Lynwood, California. On Saturday, March 25, 1972, during the day-time, James Dinsio completed the purchase of the ski boat by paying the seller $4,200.00 in cash and having the boat delivered to the "Barber" residence in South Gate. On Monday morning, March 27, 1972, after the burglary, but before it had been discovered, *552 Charles Mulligan and Amil Dinsio stopped by the house of Harold Dawson. A few minutes later, the petitioner arrived. The three men stayed for approximately 30 minutes. Shortly after the weekend of March 24-27, 1972, the petitioner's brother, his uncles, Charles Mulligan, Philip Christopher and Charles Broeckels all returned to Ohio. In early April 1972, the petitioner drove from California to Youngstown, Ohio, towing the ski boat. The petitioner remained in Ohio for about four days and while there met with his brother, Harry Barber, and his uncles, Amil and James Dinsio. A neighbor who lived directly above the condominium apartment described above observed four to five men and a woman move into the apartment in March of 1972. The same neighbor saw the same individuals leave the apartment carrying luggage a few days later. One of the persons seen living at the apartment was the petitioner. The petitioner told the neighbor that he was from Ohio, and that he and his brother were looking for work in the construction field. The neighbor also saw a man resembling James Dinsio at the apartment. Both the woman who rented the condominium apartment to the petitioner, and the*553 owner, entered the apartment on a number of occasions after its rental. They found that the apartment appeared to be unoccupied most of the time. On June 7, 1972, after the three-month lease had expired, the owner retook possession of the condominium apartment. During the cleaning of the apartment, the owner discovered five work gloves covered with white powder. The same type of work gloves had been found near the bank during the crime scene search and also in the Oldsmobile described above. Fingerprint lifts from glasses and dishes left in the Laguna Niguel condominium disclosed the fingerprints of petitioner Ronald Barber, as well as those of Amil Dinsio, Albert Mulligan, Philip Christopher and Harry Barber. On June 2, 1972, a search warrant was issued authorizing the search of the 1962 Oldsmobile now parked in Harold Dawson's garage. A search pursuant to the warrant disclosed that the Oldsmobile was equipped with a false-bottom compartment in the trunk area. Below the false bottom were several blue "AWOL" bags containing numerous burglary tools. Among the items seized from the Oldsmobile were a custom-made sledge hammer similar to the tool used to punch out the lock*554 devices of safe deposit boxes at the Laguna Niguel bank; three gold coins in a container or holder (both the coins and the holder were substantially similar to those removed from one of the safe deposit boxes broken into at the bank; a flashlight which bore a fingerprint of Amil Dinsio on one of its two batteries; a Jersey Maid ice cream bag which bore a fingerprint by petitioner Ronald Barber; walkie-talkies; a Department of Motor Vehicles suspense report which bore the fingerprints of Harry Barber; and a Tilden brand concrete core drill bit identical to one found at the bank and to another one found during the search of the apartment of James Dinsio and Harry Barber in Boardman, Ohio, on June 27, 1973. On June 28, 1972, FBI agents, armed with a search warrant, searched the petitioner's South Gate apartment. The agents seized a short-wave radio capable of picking up police frequencies. Shortly after Charles Mulligan's arrest on June 2, 1972, the petitioner left his apartment in South Gate, California, and traveled to Rochester, New York. He was arrested on January 15, 1973, in an apartment in Rochester. In his notice of deficiency, the respondent determined that petitioner*555 had realized income during the taxable year 1972 as a result of the burglary of the Laguna Niguel branch of the bank in the amount of $307,933, being one-seventh of the total value of cash and property of $2,155,531 originally taken from the bank. Upon subsequent recovery of a portion of the stolen property, respondent now claims that the amount taxable to the petitioner was $206,566, or one-seventh of the unrecovered cash and property valued at $1,445,961. ULTIMATE FINDINGS OF FACT Upon consideration of the evidence presented at the trial of this case, including the testimony of the petitioner, the Court finds as ultimate findings of fact the following: (1) The petitioner had prior knowledge of and was a participant in the burglary of the Laguna Niguel branch of the United California Bank between March 24 and March 27, 1972, as a result of which property having a value of $2,155,531 was taken from that bank. (2) As a result of the petitioner's participation in the burglary of the Laguna Niguel branch of the United California Bank on March 24-27, 1972, petitioner either received or would ultimately be entitled to receive one-seventh of the proceeds of the burglary. (3) *556 The failure of petitioner to report any income from the proceeds of the burglary of the Laguna Niguel Branch of the United California Bank on March 24-27, 1972, in petitioner's individual income tax return for the calendar year 1972 was not due to fraud with intent to evade tax within the meaning of section 6653(b). OPINION During the weekend of March 24-27, 1972, the Laguna Niguel branch bank was broken into and cash and property valued at $2,155,531 was taken from that bank. Petitioner was found guilty of conspiracy in violation of 18 U.S.C. sec. 371 and larceny of a national bank in violation of 18 U.S.C. sec. 2113(b). The conviction was affirmed by the U.S. Court of Appeals for the Ninth Circuit. Respondent thereupon argues that the petitioner is collaterally estopped from denying his felonious involvement in the burglary. Rule 39 of the Tax Court Rules of Practice and Procedure provides that the party seeking to invoke collateral estoppel must set forth such matter in his pleading. In view of respondent's failure to comply with Rule 39, the Court will not invoke collateral estoppel to prevent the petitioner from denying his*557 participation in the burglary. 2 However, considering the evidence, the Court is convinced that petitioner knew of the plans to burglarize the bank and participated therein. On behalf of petitioner, counsel also argues that the notice of deficiency in this case is arbitrary and capricious in that respondent had no basis for determining that the "loot" was divided equally among the seven participants. Accordingly, counsel argues that no presumption of correctness should attach to the respondent's determination with respect to the amount of income taxable to petitioner. Since the appeal from a decision in this case will lie in the U.S. Court of Appeals for the Ninth Circuit, we will be guided by the recent decision of that Court in Weimerskirch v. Commissioner,596 F.2d 358">596 F.2d 358 (9th Cir. 1979), revg. 67 T.C. 672">67 T.C. 672 (1977). In the Weimerskirch case, the respondent determined that the taxpayer had unreported income from the sale of narcotics. Respondent had no proof that the taxpayer had actually been engaged in such activities during the taxable year. Because of the absence of*558 such proof, the appellate court held that the notice of deficiency was not entitled to the presumption of correctness. Implicit in that decision, was the premise that if respondent had proof of the illegal activity on the part of the taxpayer, the resulting determination of the income realized from the illegal activity on the basis of the best information available to the respondent would be entitled to the presumption of correctness. In other words, as we interpret the Weimerskirch case, once the respondent can show that a taxpayer was engaged in an illegal activity, the inability of the respondent to determine with exactitude the income from such activity does not destroy the presumption which attaches to the notice of deficiency. See also Jackson v. Commissioner, 73 T.C. (Nov. 28, 1979). At the trial before this Court, petitioner testified that he had no knowledge of the plans to rob the Laguna Niguel branch of the bank, was unaware at the time that such robbery had taken place and did not at any time receive any of the proceeds thereof. On brief, petitioner's attorney argued that petitioner's role in the robbery was "minor" and it was unreasonable to assume that*559 the petitioner shared equally with the other participants in the proceeds of the robbery. In this case, the Court has found as a fact that petitioner was a participant in the burglary of the Laguna Niguel branch bank. Simply stated, the Court does not accept the petitioner's denial of any involvement in the burglary. In the absence of any other basis for allocating the "loot" between the participants, respondent was justified in assuming that all shared equally. Petitioner offered no proof to rebut this assumption, except for his bare denial of having participated to any degree. Although except for one--petitioner's brother, who was a fugitive from justice--the other participants had likewise been convicted and presumably could have testified in refutation of the respondent's determination without risk of further criminal prosecution, petitioner did not offer such testimony. Not only do we find that respondent's determination that the "loot" was shared equally is entitled to the presumption, but on the basis of the present record, independently of that presumption the Court would have no recourse except to reach the same conclusion. Finally, respondent contends that petitioner's*560 failure to report any income from the burglary of the Laguna Niguel branch bank in his individual income tax return for the taxable year 1972 constituted "fraud" within the meaning of section 6653(b). With respect to this issue, respondent has the burden of proof by "clear and convincing evidence." Section 7454(a); Tax Court Rule 142(b). While the record in this case will support a finding that petitioner was a participant in the burglary of the Laguna Niguel branch bank, and was thereby entitled to a share in the "loot" taken from that bank, the respondent has not shown that petitioner has received his share. Petitioner testified with respect to his limited financial resources and we have no reason to doubt that testimony. It is equally clear that the proceeds from the burglary, except possibly for a relatively small amount of cash, were transported to Ohio. A portion of the proceeds was found buried in a field there. It can be only assumed that there had been no division of the proceeds prior to the petitioner's arrest for the burglary on January 15, 1973. In fact, before there could be a division of the "loot", and prior to the close of the taxable year 1972, petitioner*561 had every reason to believe that he would soon be apprehended for his part in the burglary. Under such circumstances, his failure to report his share, which might never be received, does not constitute proof of fraud by "clear and convincing evidence" within the meaning of section 6653(b). Respondent has clearly failed to sustain this burden. Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended.↩2. See Fahey v. Commissioner,T.C. Memo 1979-20">T.C. Memo 1979-20↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619505/ | Anstes V. Agnew (Formerly Anstes V. Carr), Petitioner, v. Commissioner of Internal Revenue, RespondentAgnew v. CommissionerDocket No. 25373United States Tax Court16 T.C. 1466; 1951 U.S. Tax Ct. LEXIS 140; June 29, 1951, Promulgated *140 Decision will be entered for the respondent. Commissions collected by trustee from corpus upon termination of trust and distribution of principal, held not deductible by petitioner remainderman upon receipt of the trust property. Matthew F. Dorsey, Esq., and Robert C. Lea, Jr., Esq., for the petitioner.Lester H. Salter, Esq., for the respondent. Opper, Judge. OPPER*1466 OPINION.Income taxes in the amount of $ 293.45 for the year 1946 are in controversy. The question is whether commissions paid *1467 to trustees of a trust of which petitioner was the remainderman can be taken as a deduction by her in the year of receipt of the trust property, the trustee having collected the commission from trust assets before distribution to petitioner.All of the facts have been stipulated and are hereby found accordingly. *141 Petitioner resided in Pennsylvania during the taxable year and filed her return for that period on the cash basis with the collector for the first district of Pennsylvania.Petitioner's grandfather, who died a resident of Missouri in 1915, created a testamentary trust in which he provided:I give, devise and bequeath to the St. Louis Union Trust Company, of the City of St. Louis, Missouri, the remaining two parts in trust, one for my daughter Anstes [petitioner's mother] and the other for my son Henry.Said trustee shall keep my said property invested and may change the investments as often as it may see fit, that is to say, it may sell any real estate, stock, bonds, notes or other securities, and invest and reinvest the funds as often as in its judgment the interests of said estates shall so demand.I direct that my trustee shall retain complete control of one portion thereof for the use and benefit of my daughter Anstes during her lifetime, and likewise shall retain complete control of the other portion for the use and benefit of my son Henry during his lifetime.I direct that my daughter Anstes and my son Henry is each to be the beneficial owner of her or his respective portion, *142 but neither is to have the power of disposition of the same by deed, will or otherwise, and neither is to be able to mortgage, anticipate, or in any way alienate or encumber the said principal or income from said respective portions, but each shall simply have the right to receive the income therefrom in person, which income from the respective portions I direct my trustee to pay to her or him, respectively, during her or his natural life and at regular and frequent intervals, upon her or his own respective personal acquittance and receipt.Upon the death of my daughter Anstes leaving issue or their descendants her surviving, I direct the said trustee to convey, deliver or assign to said issue or their descendants, per stirpes and not per capita, the principal of the estate so held in trust by it for my said daughter Anstes. If my said daughter Anstes die leaving no issue or their descendants her surviving, then the said trustee is to divide her portion of my said estate into two equal parts, one of which I direct my said trustee to forthwith deliver to my son Wilson P. H., or in the event of his death, to his heirs, per stirpes and not per capita, according to the law of descent*143 and distribution at that time existing in the State where my said son Wilson P. H. may have been legally domiciled at the time of his death.The trustee so appointed charged commissions of 5 per cent on income collected during the pendency of the trust and 5 per cent on the principal distributed upon its termination. Petitioner's mother, life beneficiary of one of the two parts in trust, died on May 19, 1945, survived by petitioner and one other child. During 1945 and 1946 the trustee distributed income accrued prior to her death to petitioner's mother's estate and distributed income subsequently accrued to petitioner and her brother. On February 11, 1946, petitioner's *1468 share of the principal was distributed to her in cash and securities in the amount of $ 40,975.93. This amount was arrived at by deducting from the "Total Market Value of Assets," $ 86,716.56, the amount of $ 4,335.82, denominated "Trustee's commission on distribution," as well as another small item, and by dividing the balance in half.Petitioner deducted one-half of the above-stated commission in computing her individual income for the taxable year. This deduction was disallowed by respondent.The *144 reason why these trustee's commissions are not deductible by this petitioner who was a beneficiary of the trust is that at no time were they her personal obligation, even though the payments may have been deducted from the corpus of the trust before distribution to her. See . "In the absence of any contrary testamentary directive, administration expenses are chargeable against principal." . See Bogert, "Trusts," § 805 n. 72 (a). "Compensation for services rendered after the death of the life tenant is payable out of capital." . The commissions were not paid by petitioner directly and the suggestion that they were paid out of her property loses sight of the essential proposition that she owned, and was entitled to, only so much of the trust property as was left after satisfaction of its prior obligations. See ; ;*145 .A trust is a juristic person separate from its beneficiaries. . And commissions are an obligation of the trust and deductible by it, even where the trust term has ended and distribution is in process. . There is no showing of any such agreement by petitioner to pay the commissions as would have made it possible to enforce payment from her personally. See . If she had paid them, she would have been a mere volunteer. Under these facts, she cannot claim the expenses were necessary payments by her, ; , so as to entitle her to a deduction.Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619507/ | T. V. LARSEN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Larsen v. CommissionerDocket No. 12685.United States Board of Tax Appeals14 B.T.A. 160; 1928 BTA LEXIS 3023; November 13, 1928, Promulgated *3023 The right of petitioner and wife to report in separate returns the income derived from a partnership in the State of Oregon, in which the petitioner had invested certain funds belonging to himself and wife by virtue of the community property laws of the State of Washington, denied where the evidence does not afford any basis for allocation of the partnership income from capital investment and from personal services of the petitioner and others. Walter E. Barton, Esq., and Lawrence T. Harris, Esq., for the petitioner. Clark T. Brown, Esq., and Carl D. Eshelman, Esq., for the respondent. SMITH *160 This appeal is for the redetermination of a deficiency in income tax for the year 1923 in the amount of $1,842.79. The question at issue is whether the petitioner and his wife are entitled to file separate returns for the taxable year. FINDINGS OF FACT. The petitioner is a resident of the State of Oregon. He was married in that State in 1904. In 1906 the petitioner and his wife moved to the State of Washington. At that time they had practically no money or other property of value. On moving to the State of Washington the petitioner*3024 began working for the Oakdale Lumber Co. at wages of $3 per day. The Oakdale *161 Lumber Co. was a Washington corporation in which the petitioner's father-in-law, O. S. Moe, owned a one-third interest. In 1907 the petitioner terminated his employment with the Oakdale Lumber Co. and, together with M. R. Rashford and George E. Forcia, organized a corporation known as the Star Lumber Co. to engage in the sawmill and lumber business. The Star Lumber Co. was capitalized at $100,000, not all of which was ever paid in. At that time the petitioner had less than $200 in cash and no other property of material value. To pay for his subscription of stock in the Star Lumber Co. he borrowed $200 from his father-in-law, O. S. Moe, which he later repaid out of his dividends and salary from the company. The petitioner owned a one-third interest in the Star Lumber Co. and held the office of secretary. He received a salary of $5 per day. The Star Lumber Co. operated until the year 1910, when it was liquidated and the proceeds divided among the stockholders. During its existence the petitioner had received from the company $3,121.45 in wages, $4,473.67 in dividends, and $2,066.67 on*3025 liquidation. In October, 1910, the petitioner and others organized another corporation under the laws of the State of Washington, known as the Star Mill Co. which took over the equipment of the Star Lumber Co. The stockholders were George E. Forcia, M. R. Rashford, B. T. Anderson, S. Fenning, P. T. Meaney, O. S. Moe, and the petitioner. The petitioner subscribed for and had issued to him stock of the Star Mill Co. of the par value of $7,000, $3,500 of which was his own and $3,500 of which belonged to his father-in-law, O. S. Moe. The petitioner and his wife signed a memorandum stating that they held $3,500 par value of said stock for O. S. Moe. The petitioner paid for his stock at par value out of the wages, salary and dividends which he had received from the Star Lumber Co. in the State of Washington prior to the organization of the Star Mill Co. The petitioner was secretary of the Star Mill Co. and kept the books of the company. He was paid a salary of $130 per month, except at times when the mill was not operating regularly when he received daily wages instead of the monthly salary. The Star Mill Co. operated until December, 1921, when it discontinued operations. Its*3026 surplus at December 31, 1921, was $20,371.31. The personal property, consisting mostly of equipment and lumber, was converted into cash in the year 1921. The petitioner and his wife and Forcia and his wife purchased the mill equipment. During *162 the years 1910 to 1922, inclusive, the petitioner received the following wages, salaries, and dividends from the Star Mill Co.: YearWages and salaryDividends1910$491.25None.19111,047.50None.19121,085.00None.1913953.00$3,500.001914689.97None.1915564.171,400.001916555.00None.19171,643.70None.1918$2,191.30$1,750.0019193,000.001,750.0019203,000.003,500.0019213,000.007,000.0019222,800.00Total18,220.8921,700.00About the first of January, 1922, the petitioner and Forcia went to the State of Oregon to look for some timber land with a view of starting another lumber business. About this time they organized, under a verbal agreement, a copartnership known as Forcia and Larsen. Soon thereafter Forcia and Larsen entered into a contract with the Elmira Lumber Co. for the purchase of certain timber and timber lands. In 1926 the Elmira*3027 Lumber Co. gave to the petitioner and his wife and Forcia and his wife a deed to the property. Forcia and Larsen also entered into a contract with E. B. McLean and I. B. McLean, his wife, for the purchase of certain timber lands. After acquiring the aforesaid timber lands Forcia and Larsen began the construction of a sawmill thereon, which was completed and ready for operation in February, 1923. No income was received from the business prior to February, 1923. The petitioner's wife did not move to the State of Oregon from the State of Washington until about the middle of the year 1923. The petitioner had consulted with his wife about entering the copartnership with Forcia and entering into the aforesaid agreements. On entering the aforesaid contract with the Elmira Lumber Co. Forcia and Larsen paid to the Elmira Lumber Co. $10,750 cash and prior to the end of 1923 they paid $12,600 additional. On entering the contract with E. B. McLean and his wife Forcia and Larsen paid to them $2,000 and prior to the end of the year 1923 they paid $2,000 additional. The petitioner invested in the lands, timber and sawmill equipment of Forcia and Larsen $15,662.21 in cash which had been*3028 derived entirely from the wages, salaries and dividends from the Star Lumber Co. and the Star Mill Co. while the petitioner was a resident of the State of Washington, and $10,000 in cash which the petitioner and his wife had borrowed from O. S. Moe on their joint note. During the year 1923 the partnership of Forcia and Larsen operated the sawmill and sawed a portion of the timber which they had purchased as aforesaid. The income from the operation of the *163 mill was $51,027.19, after deducting $5,000 salary paid to the petitioner and $5,000 salary paid to Forcia. A partnership return was filed for the year 1923 showing a net income of $51,027.19. In this return it was stated that one-half of the said income belonged to the petitioner and one-half to Forcia. While residents of the State of Washington, petitioner and his wife were cognizant of the community property laws of that State and they believed, upon taking up their residence in Oregon, that similar community property laws prevailed in that State. Petitioner and his wife filed separate income-tax returns for the year 1923 upon the so-called community basis in which each reported one-half of their total income*3029 for the taxable year. The Commissioner has required the petitioner to file a single return reporting the entire amount of his distributable earnings of the partnership of Forcia and Larsen. OPINION. SMITH: The petitioner now concedes that since the community property laws do not prevail in the State of Oregon the filing of returns for the taxable year 1923 by himself and wife upon the community property basis was unauthorized and erroneous. He contends, however, that one-half of the income derived during the taxable year from the investment of their community property was the separate income of his wife which she was entitled, irrespective of community property laws, to report in a separate return. He contends that he was a trustee for his wife as to her half of the community property which they had accumulated while resident in the State of Washington, and was likewise her trustee for the income from the investment of her property. He further contends that one-half of the petitioner's distributable income of the partnership of Forcia and Larsen, except for the salary of $5,000 which the petitioner received for his personal services, was income to his wife through her investment*3030 in the partnership. The petitioner on leaving the State of Washington in 1922 invested in the partnership of Forcia and Larsen the sum of $25,662.21 in timber lands and sawmill equipment in the State of Oregon. Of the amount so invested $15,662.21 was cash belonging to the petitioner and his wife jointly and $10,000 was borrowed by the petitioner and his wife from the latter's father, O. S. Moe. There was never any separate agreement between the petitioner and his wife in respect of the investment of their joint property. Both the petitioner and his wife thought that community property laws similar to those of the State of Washington prevailed in the State of Oregon and that the status of their community property would not *164 be changed by their change of residence from the State of Washington to the State of Oregon. We held in , that the wife's interest in community property under the laws of the State of Washington is regarded as a present vested right. We also held in *3031 , that the removal of property from one State to another does not affect the rights vested therein by the laws under which it was acquired. In the latter case a husband and wife, residents of Oklahoma, filed separate returns for the year 1923, in which each reported one-half of the income received from property acquired while residents of the State of Texas. In the opinion we said: It accordingly follows that the stock in the Oklahoma banks [which the petitioner owned at the time of marriage] at all times remained his separate property and that upon his removal to the State of Oklahoma the income from said stock was his separate income and properly so returnable. The remainder of the income is derived from the estate that was built up during the period of residence in Texas, in which State the income from personal property was community income. See . The principle laid down in the Phillips case is that the vested rights of the parties of the community attached to the income from their separate property as well as to the property itself, notwithstanding that the property*3032 has been removed from the State and that such income may be reported by the parties in separate returns. In the case at bar it is not to be disputed that the petitioner's wife had a vested interest in one-half of the total amount of capital that the petitioner acquired in the State of Washington. This capital was used by the petitioner with the consent of his wife in the partnership which the petitioner formed with Forcia. There is no evidence and no claim made that the petitioner's wife was a member of this partnership. There is nothing to indicate that the situation is different from what it would have been if the petitioner and his wife had always been residents of Oregon and the wife had allowed the petitioner to use in the sawmill business a part of her capital. Under the taxing act a partner is required to account for his pro rata share of the distributable profits of the partnership. This is all that the Commissioner is requiring the petitioner to account for in the instant proceeding. In support of the claim that the petitioner invested community property and the proceeds of a joint note in the lands, timber, and sawmill plant of Forcia and Larsen, one-half thereof*3033 for himself and the other one-half thereof in trust for his wife, the petitioner relies upon a line of decisions wherein the courts have held that where a husband took money belonging to his wife and purchased real estate therewith the husband was a trustee for his wife. ; ; ; . Those cases are to be sharply differentiated from the present one. In the proceeding at bar it is clear that the community property was invested by the petitioner with the full consent of his wife. Furthermore, the question here is not the right of the wife to claim an interest in the capital invested in the partnership by the petitioner but the right of the petitioner to escape tax liability on a portion of his pro rata share of the profits of the partnership for the year 1923. Presumably those profits were obtained in part from the investment of money and in part from services and skill in the management of the business. No claim is made that the petitioner's wife contributed to any portion of the profit which may be ascribed to the services performed*3034 by the husband. Even if there might be merit in the claim of the petitioner that a part of the profits representing a fair return upon his wife's invested capital was income of the wife, we can not determine what such amount would be. Upon the record the determination of the Commissioner must be and is sustained. Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619508/ | APPEAL OF MAX D. STEUER.Steuer v. CommissionerDocket No. 4430.United States Board of Tax Appeals3 B.T.A. 489; 1926 BTA LEXIS 2645; January 28, 1926, Decided Submitted October 28, 1925. *2645 The March 1, 1913, value of property determined. Sidney Ehrlich, Esq., for the taxpayer. George G. Witter, Esq., for the Commissioner. SMITH *489 Before SMITH, LITTLETON, and TRUSSELL. This appeal is from the determination of a deficiency in income tax for 1921 in the amount of $16,052.89, only a part of this amount being in controversy. The question in issue is the loss sustained on property sold in 1921. FINDINGS OF FACT. The taxpayer is a resident of New York City. In 1903 he purchased the premises at 225 East Fifty-third Street, New York City, at a cost of Land$31,000Building45,000Total76,000He sold the premises in 1921 at a net price of $56,133.77. In his income-tax return for the year he determined his loss upon the transaction as follows: Cost and March 1, 1913, value$76,000.00Selling price56,133.77Loss19,866.23The Commissioner has computed the cost at $76,000, less depreciation for 18 years on $45,000 - $16,200 - balance $59,800; and on that basis fixed the deductible loss at $3,666.23. From the same data he *490 computed March 1, 1913, value at $67,000 - *2646 $76,000 less depreciation for 10 years, $9,000 - less depreciation to date of sale $7,200; loss on sale $3,666.23. The March 1, 1913, value of the property in question was $67,000 and the depreciation sustained thereon from March 1, 1913, to the date of sale in 1921 was $7,200. The net loss resulting from the sale was $3,666.23. DECISION. The determination of the Commissioner is approved. OPINION. SMITH: In his appeal the taxpayer claims a loss upon the sale of the premises at 225 East Fifty-third Street, New York City, in 1921 of $12,666.23. He waives any question as to the correctness of the determination of the Commissioner that depreciation in the amount of $7,200 was sustained from March 1, 1913, to the date of sale, and that such depreciation should be taken into account in the determination of the profit from the sale. He contends, however, that the March 1, 1913, value was $76,000 instead of the amount allowed by the Commissioner, which is found to have been $67,000. In support of a March 1, 1913, value of $76,000 the taxpayer has submitted an appraisal made by an expert appraiser of New York City. This appraiser keeps careful record of sales of property*2647 in New York City. He states that, in his opinion, the fair market value of the property on March 1, 1913, was: Land$31,000Building45,000Total76,000He further states that the following sales should be relevant: Sale February, 1906.No. 219 East 53rd Street, north side, 391.8 feet west of Second Avenue. Size 16.8 X 100.5. Building three (3) story brick tenement sold for $11,100. Sale April, 1906.No. 224 East 53rd Street, south side, 260 feet east of Third Avenue. Size 20 X 100.5. Building three (3) story dwelling sold for $12,000. Sale November, 1906.Nos. 226-228 East 53rd Street, south side, 299 feet west of Second Avenue. Size 40 X 100.11. Building six (6) story brick tenement sold for $64,900. Sale July, 1913.No. 234 East 53rd Street, south side, 230 feet west of Second Avenue. Size 20 X 100.5. Building three (3) story dwelling sold for $10,750. *491 Judging from these sales alone, it appears that the property located at 234 East Fifty-third Street sold in July, 1913, for $1,250 less than the property located at 224 East Fifty-third Street did in April, 1906. The size of each lot was the same and*2648 the improvements were the same, so far as the record discloses. These sales indicate a decline in values of the property in the neighborhood of taxpayer's property from 1906 to 1913. We think that such evidence is entitled to as much weight as the estimate of an appraiser made in 1924 or 1925 of the value of property in New York City in 1913. At any rate, we do not consider that the evidence is strong enough to overrule the determination of the Commissioner as to the value of the property on March 1, 1913. The property was tenement property and was subject to wear and tear during the entire period 1903 to 1913. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619509/ | HENRY TURRISH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Turrish v. CommissionerDocket No. 44742.United States Board of Tax Appeals24 B.T.A. 913; 1931 BTA LEXIS 1567; November 25, 1931, Promulgated *1567 In the circumstances herein the petitioner's tax liability should be settled in conformity with section 206 of the Revenue Act of 1926. Frank W. Wilson, C.P.A., for the petitioner. C. H. Curl, Esq., for the respondent. LANSDON *913 OPINION. LANSDON: The respondent asserts a deficiency in income tax for the year 1926, in the amount of $2,714.04. All errors alleged by petitioner are abandoned except the claim that certain losses sustained in 1924 and 1925 were net losses within the meaning of section 206 of the Revenue Act of 1926, and, therefore should be carried forward to reduce taxable income for the year 1926. The amounts of such losses have been proved or stipulated. In 1925 petitioner sustained a loss in the sale of the stock of the Potlatch Lumber Company, in the amount of $209,160, and other losses in 1924 and 1925, in the respective amounts of $40,016.46 and $118,290.33. The only question at issue is whether he was engaged in a trade or business regularly carried on for profit. The petitioner is an individual residing at Duluth, Minn., where he maintains an office through which his business affairs are conducted. Before he*1568 was twenty-one years old he became interested in the timber and lumber business and for about forty years has been engaged in buying and selling timber lands and, to some extent, in the production of lumber, as disclosed by the following excerpt from his testimony at the hearing: I started in on the Chippewa River when I was 18, at $15 a month and they paid me off in scrip which I had to discount when I got through at 25 per cent, and I worked in logging camps on a salary for several years on the Chippewa Indian Reservation. Then I went into business myself on a small scale. My means were limited and I speculated a little in land, and I worked in that *914 way and had quite a thorough knowledge of the woods, and lumber and logging and everything pertaining to the operation and I did not seem to have much difficulty in getting capital to go into it. I started in that way and I was in the woods a great deal and had men employed in the woods, and we had to look over a great deal of country, several times before we purchased anything. It required very close designation as to quality and quantity of timber. Often times we would find the quantity and the location would not*1569 be accessible and there were a great many things taken into consideration, and I acquired a great deal of the timber and formed corporations, and I formed corporations in other places, and I was called in as an advisor and always took stock in the corporations. I was always a stockholder and I made it a rule early in life that I never took a salary or a commission. I never got a commission for buying or selling stock or timber in my life. The largest salary I ever got was $100 a month when I worked in the office. I worked up to $100 a month and then I went into operating myself. I operated in wisconsin, Minnesota, Idaho, Washington and Oregon, and also was interested in Florida in two lumber companies - in three lumber companies. One was a lumber company and the other was a timber company. I was a stockholder and an officer in two. The Putnam Lumber Company I was the largest stockholder in. That is in existence yet, that is in Florida. That covers the ground pretty fairly. Petitioner was a stockholder in every company that he organized and, in most instances, was a director and officer. He controlled and directed the policies of each corporation that he formed. He never*1570 received any salary for his services and depended for his profits on the dividends received from the corporations and the gains realized from disposing of the same and subsequent liquidation of his stockholdings. In almost every instance he financed the corporation which he formed either by the endorsement of corporate paper or direct advances of capital secured on his personal credit. In the years 1924 and 1925 he paid interest on money borrowed to finance his corporations in the respective amounts of $93,825.99 and $155,169.03, and such payments, far in excess of any receipts from interest due him, resulted in the losses sustained in those years. In our opinion, this interest was paid in connection with the petitioner's regular business. The record here is convincing that during his entire business life the petitioner has operated in timber and lumber properties individually and through corporations organized by him for that purpose, and he has had no other major business interest. Timber and lumber operations have been his vocation and this is the test very early applied by the Board. *1571 . We are of the opinion that the losses sustained by the petitioner in 1924 and 1925 were incurred in the operation of a business regularly carried on and that his tax liability for 1926 should be settled by the application of such losses to his income for that year in conformity with section 206 of the Revenue Act of 1926. ; ; Harvey H. Ostenberg et*915 al.,; ; ; ; ; and . Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619510/ | CORMAN COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Corman Co. v. CommissionerDocket No. 6227.United States Board of Tax Appeals13 B.T.A. 75; 1928 BTA LEXIS 3318; July 26, 1928, Promulgated *3318 Personal service classification allowed. Charles B. Rogers, Esq., for the petitioner. Maxwell E. McDowell, Esq., for the respondent. ARUNDELL*75 This proceeding was instituted for the purpose of obtaining a redetermination by the Board of deficiencies in income and profits taxes of $3,513.90, $3,945.03, and $2,552.07 for the years 1919, 1920, and 1921, respectively. The question presented for decision is whether the petitioner is entitled to be classified as a personal service corporation. FINDINGS OF FACT. The petitioner, a New York corporation, with principal offices in New York City, is an advertising agency, and a member of the American Association of Advertising Agencies. It was incorporated December 21, 1912, under the name of Cheltenham Advertising Service, Inc. In 1916, the corporate name was changed to "Corman-Cheltenham Company," and on or about September 5, 1918, when S. W. Corman acquired the interest of the principal stockholder, Corman changed the corporation's name to "The Corman Company." During the years 1919, 1920, and 1921, the petitioner had a capital stock of $50,000, divided equally between common and preferred. *3319 Corman held all of the preferred stock and never had less than 240 of the 250 shares of common stock. The remainder of the common stock was held by Anna M. Corman, wife of S. W. Corman, and E. N. Wilkinson, treasurer and office manager of the petitioner. At the time of the organization of the corporation, $15,000 was paid in for stock. The balance of the stock was issued for alleged good will. No additional money has been invested in the business. From 1895 until the summer of 1916, Corman was engaged in various branches of advertising work, including eight years as "superintendent of business getting," and general manager of N. W. Ayer & Son, an advertising agency, Philadelphia. Corman has been president and general manager of the petitioner since October, 1918. During the taxable years Corman was the principal stockholder of the petitioner and devoted all of his time to the affairs of the corporation. The clients of the petitioner, particularly during the years 1919, 1920, and 1921, were intentionally limited in number to carry out *76 Corman's policy of giving his personal attention to the business of each client. Corman solicited all of the business of*3320 the petitioner requiring solicitation; obtained all of the clients who spent in excess of $25,000 annually for advertising placed through the petitioner; kept in contact with clients; discussed merchandising problems with clients and with their assistance determined their advertising policies; dictated to his assistants the kind and character of advertising required for each client and personally directed and supervised the preparation of advertisements. Corman also made, or directed, trade investigations for clients in order to obtain first-hand information about their merchandising problems, and selected, with the approval of the advertiser, the publications to be used for advertising. Wilkinson took care of the financial affairs of the petitioner, including the collection of bills rendered clients, and managed its office. The objective of the petitioner was to form business connections with commercial concerns as a counselor of merchandising, and as the merchandising counsel of a firm, to study its peculiar marketing problems and assist it in developing a selling plan for its product. The petitioner styled itself "Merchandising Counsel-Advertising Service," on its business*3321 cards, letterheads and other official paper. An example of the petitioner's manner of conducting its business is shown in the case of a varnish company, which, when Corman solicited its advertising business, was selling its product in bulk without satisfactory results. After a thorough investigation by the petitioner of the client's advertising expenditures, the Company decided to sell its product in packages rather than bulk. As a result of this decision, Corman prepared a new selling system for the company; traveled throughout the country collecting data for his client; made a study of competitors' products; addressed jobbers' conventions; attended salesmen's conventions; organized and attended a sales convention of the company, and selected labels for the tin cans in which the product was marketed. Corman also selected, with the approval of the varnish company, a list of publications for advertisements, and directed negotiations with publishers for advertising space. Advertisements were drafted by employees of the petitioner under the constant supervision of Corman. After a proof of the advertisement to be run had been approved by the client, the necessary drawings were*3322 completed, and the petitioner had the required electrotypes, zinc etchings or half tones manufactured by outside concerns. Upon the approval by the client of a proof of the finished advertisement, the petitioner had a plate made and forwarded it to the publisher to be run in the space reserved for the advertisement. *77 The petitioner did not produce any of the illustrations, art work, engravings, electrotypes, stereotypes, and matrices used in connection with its business. All of such work and material was, however, procured under the direction of the petitioner. The method followed by the petitioner in getting out booklets was to first write a description of the booklet and present it to a prospective client with a statement of the maximum cost to him. If the client authorized the petitioner to proceed with the work, the latter would make up a dummy and have a printing establishment produce a rough copy. The petitioner then roughed up the pages, sketched the proposed illustrations, and wrote the text, and if the proposed booklet was approved by the client, the petitioner gave the client an estimate of the cost. The petitioner's clients during the taxable years*3323 were, and the amount billed each, were, with some exceptions, as follows: 191919201921Mennen Co$252,468.42$203,844.03$256,001.17Wallach Bros178,807.97309,722.02290,936.48Torbensen Axle Co96,722.3934,494.48National Bank of Commerce in New York62,270.19161,427.85149,849.55Murphy Varnish Co52,637.4370,891.8770,409.96Gordon Tire & Rubber Co43,551.26207.83Hardman, Peck & Co33,152.9134,189.9741,622.31L. A. Young Industries, Inc19,407.04745.20Allen Corporation9,840.2816,361.10Haviland China Co., Inc10,308.213,605.105,475.52Phenix Cheese Co9,568.9238,529.3924,053.75Pictorial Review861.70Powrlok Co9,554.721.50Brooks Brothers7,000.517,987.2112,906.74Lincoln Trust Co5,204.393,911.662,836.31Dominick & Dominick4,319.693,674.386,270.32Sexton Manufacturing Co4,015.0541,716.4634,246.89Alex D. Shaw Co3,561.15707.48W.J.B. Motor Truck Co., Inc2,907.35Triangle Film Corporation2,721.91A. J. Coccaro & Co2,034.4830.00National Thrift Bond Corporation1,539.90185.33Leslie-Judge Co1,007.443,105.99George D. Sykes Co1,248.33Astoria Mahogany Co946.588,413.71858.42Lionel Corporation685.801,283.08Central Talking Machine Co1,560.69American Hard Rubber Co262.76Total816,606.78945,035.64897,028.11*3324 The total billings each year were: 1919, $820,632.55; 1920, $1,012,820.71; 1921, $954,791.73. The contracts entered into between the petitioner and its clients for the services of the former, read as follows: The CORMAN COMPANY, INC., New York City.We hereby appoint you to act as our advertising agent with the understanding that you will not lend your services to another organization to advertise a product competitive with the product you are advertising for us without our consent and that all your books, bills, papers and orders pertaining to our business are subject to our inspection at any time. *78 Upon our specific authorization you are to contract for advertising space for us in magazines, newspapers, street cars, on bill boards or elsewhere, such space to be billed to us at the gross rates charged you, the differential allowed you as a recognized advertising agent to be retained by you as compensation for your service to us. Where no differential is allowed you are to charge us 15%. We agree to pay bills for space within the period specified on such bills with the understanding that you will allow us the full amount of all cash discounts allowed*3325 you. In the preparation of advertisements you are to make no charge for the writing of copy; composition is to be charged at cost to you; illustrations, engravings, electrotypes, stereotypes and matrices are to be charged at net cost to you, plus 15%. For mail, express or telegraph charges in connection with the placing of our advertising, you are to charge us the cost to you. For the writing of booklets, catalogues, circulars, and follow-up letters or the production of store advertising such as countertrims, window cutouts, etc., you are to charge us a reasonable price for the services rendered and materials supplied and are, upon request, to furnish us in advance an estimate of the cost of such work before incurring any expense chargeable to our account. When in our mutual judgment extended market or trade investigations are essential, specific provision will be made as to the basis upon which they are to be undertaken and an estimate of the maximum cost approved by us before proceeding with the work. This engagement of your services may be terminated by you or us upon ninety days' written notice. The petitioner never bought space in publications for sale to clients. *3326 After the client had ordered the reservation of space, the petitioner arranged for the space, using the following form of order blank: Publisher (Name of publication) Please enter our order for space to be used for the advertising of (Name of advertiser) For this service you are to charge us (amount) Less Commission Cash Discount. Space reserved in the name of a particular advertiser was not transferable by the petitioner to another advertiser. It was a common practice for publishers to communicate directly with advertisers concerning their accounts and advertising. The gross income and expenses of the petitioner during each taxable year, were as follows: 1919 BusinessGROSS INCOME:Per centCommissions earned90.72$94,237.09Production profits7.287,560.19Art and copy.48502.48Interest on bank deposits and discounts earned1.421,475.14Interest on Liberty bonds.10103.65Total100103,878.55EXPENSES:Advertising$136.87General office expense5,182.88Insurance151.74Postage498.87Rent4,330.03Salary71,974.04Stationery and office supplies1,341.21Telegraph104.89Telephone732.42Traveling expenses2,223.32Depreciation on F. & O.E365.00Depreciation on improvement745.87Bad debts742.26Taxes187.13Total$88,716.53Net income15,162,02*3327 1920 BusinessGROSS INCOME:Per centCommissions earned91.87$119,884.54Production profits6.408,356.64Art and copy.29373.11Interest on bank deposits and discounts earned1.231,601.76Interest on Liberty bonds.21273.44Total100130,489.49EXPENSES:Advertising$237.09General office expense4,232.33Insurance147.01Postage445.20Rent4,439.99Salary95,409.82Stationery and office supplies1,933.60Telegraph93.03Telephone1,084.87Traveling expense2,758.88Depreciation on improvement663.33Taxes - New York State738.32Taxes - Federal32.00Bad debts1,069.45Total expenses113,284.92Net income17,204.571921 BusinessGROSS INCOME:Per centCommissions earned93.09$116,517.51Production profits4.315,399.33Art and copy.53660.72Interest on bank deposits and discounts earned1.732,165.65Interest on Liberty bonds.34427.85100125,171.06EXPENSES:General office expense$4,204.88Insurance118.88Postage370.43Rent4,440.00Salary94,661.51Stationery and office supplies915.91Telegraph52.90Telephone872.31Traveling expense5,065.13Depreciation on F. & O.E855.25Depreciation on improvement663.32Taxes - New York State765.27Total expenses$112,985.79Net income12,185.27*3328 *80 The account "Commissions Earned" represents fees charged advertisers on the basis of 15 per cent of the cost of the space used and the differential allowed the petitioner by publishers as a recognized advertising agent. The totals shown in the account "Production Profits" represent the 15 per cent allowed the petitioner on the cost of engravings, electrotypes, stereotypes, and matrices. The account "Art and Copy" covers charges made for small jobs performed by members of the petitioner's staff. The item of $742.26 charged to bad debts in 1919 represents the total of small sums loaned to employees of the petitioner prior to the time Corman acquired an interest in the business. The bad debt item of $1,069.45 in the statement for 1920 covers an account against an advertiser charged off as worthless. Between 90 and 95 per cent of petitioner's gross income was earned through services performed in connection with advertisements, and the remainder, with the exception of interest earned on bank deposits and liberty bonds, and cash discount taken on bills payable, was derived from the preparation and production of booklets, store trims, and engravings and the like. Of*3329 the latter per cent, less than one per cent was earned through the writing of booklets. The balance sheets of the petitioner on the first day of the years 1919 to 1922, inclusive, were: Jan. 1, 1919Jan. 1, 1920Jan. 1, 1921Jan. 1, 1922ASSETSCash$23,493.58$33,481.72$39,892.53$54,885.29Accounts receivable25,079.8242,777.2936,718.9324,334.73Bills receivable2,142.874,200.00Art and engraving305.232,158.851,223.791,320.06Liberty loan employeesaccount538.60224.84Furniture and officeequipment2,025.002,428.602,393.353,454.85Improvements2,302.331,824.461,161.13497.81Insurance unexpired74.58Good will$35,000.00$35,000.00$35,000.00$35,000.00Loss and gain1,015.924,699.099,205.199,214.39Liberty loan investmentTotal91,995.93126,794.85125,594.92128,707.13LIABILITIESAccounts payable40,495.9363,566.0356,286.5353,921.17Surplus3,603.8212,808.3924,744.96Capital stock50,000.0050,000.0050,000.0050,000.00Reserve for dividends1,500.009,625.006,500.00Total91,995.93126,794.85125,594.92128,707.13*81 The item "Accounts*3330 Receivable" represents the unpaid amount of bills rendered clients for advertising space. The account "Bills Receivable" represents money loaned to employees of the petitioner. The amounts set up in the account "Art and Engraving," represent charges for art work and engravings which had not been allocated to a particular job. The figures in the account "Liberty Loan Investment" represent the amount of money invested in Liberty bonds. The item "Accounts Payable" represents the amount owing to, but not due, publishers for advertising space. Concurrently with the completion of arrangements for advertising space, book entries were made charging the advertiser and crediting the publisher for the cost of the space. Bills rendered by the petitioner to clients for advertising space had to be paid not less than five days in advance of the last cash discount day of the publisher's bill in order to entitle the advertiser to the discount allowed by the publisher for prompt payment of bills. The petitioner did not allow a cash discount on its own account and passed on to its clients any discount allowed it. Every invoice sent out by the petitioner indicated the time within which the debtor*3331 would have to pay the account in order to obtain the cash discount allowed by the publisher. During a period of twelve years, including the taxable years in question, all of petitioner's bills, with a few exceptions, were paid by the client sufficiently in advance of the due date of the publisher's bill to enable the petitioner to pay the publisher with funds paid in by the advertiser. The bank balance of the petitioner on the first day of each month of the years 1919, 1920, and 1921, was: 191919201921January$28,573$43,876$46,768February31,12736,26064,206March31,22433,68849,383April48,32536,83669,276May65,55038,63761,064June64,82261,52784,059July$64,316$65,341$75,441August69,11061,30478,625September46,04055,97369,394October41,38451,74575,862November40,88654,56267,782December52,01547,34266,919*82 Most of the money in bank represented funds paid in by clients and being held for the payment of publisher's bills. None of it was borrowed money. The officers and employees of the petitioner during the years in question, were, together with the compensation*3332 paid them, as follows: 191919201921GROUP 1S. W. Corman, president$29,000.00$36,000.00$36,000.00Adams, writer6,536,119,840.4710,888.51Milne, writer2,573,344,660.004,580.00Benet, writer1,300.16Jones, writer3,528.964,556.004,801.83Palmer, artist4,080.004,923.065,004.97Goldman, assistant1,061.83Coffrain, media3,581.314,506.004,629.59Roth1,040.491,409.67Crowe, writer4,550.00GROUP 2E. H. Wilkinson, treasurer4,812.505,987.666,674.76Cummings1,295.933,356.803,965.00Knapp842.001,086.671,036.40Ganz631.00959.001,130.22Fagan1,287.511,421.251,480.05Fleming1,809.462,073.10In addition, the petitioner had a total of nine, six, and eight stenographers, telephone operators, lobby attendants, file clerks, and messengers in the respective years. All of the employees in group one assisted Corman in so-called "plans work," conducting investigations and writing, and otherwise preparing, advertisements. Adams was the petitioner's head writer and wrote or finished writing most of the text in advertisements handled by the petitioner. Palmer was proficient*3333 in making visuals or layouts for use by outside artists in producing a completed picture. His chief value to the petitioner was his ability to purchase art from outside artists, and the purchase of art was his principal duty. Goldman was an assistant to Palmer. The employees in group two were engaged in accounting work and checked advertisements in publications. Cummings had charge of "media work," assisted the bookkeeper and Wilkinson and conferred with clients concerning business matters. Knapp kept the petitioner's books and Ganz and Fagan assisted others in accounting work. None of the employees did executive work or took any part in the management of the business. All of the employees were selected by Corman. OPINION. ARUNDELL: It is clear from the evidence that the petitioner was not engaged in trading as a principal. It is equally evident, and we have so found as a fact, that Corman, who never held less than 96 per cent of the petitioner's capital stock, was the principal stockholder *83 and was regularly engaged in the active conduct of the affairs of the corporation. The elimination of these requirements of the statute in favor of the petitioner leaves*3334 for our consideration and determination the two remaining questions of (1) whether capital, invested or borrowed, is a material income-producing factor, and (2) whether the income of the petitioner is to be ascribed primarily to the activities of its principal stockholders. Although the respondent appears to have disallowed personal service classification on the ground that capital was a material income-producing factor, we have found no difficulty in reaching a contrary conclusion from the evidence submitted. The only cash paid in for stock was $15,000, the balance of the capital stock of $35,000 having been issued for alleged good will. In 1920 the petitioner had a surplus of $3,603.82, and in 1921, $12,808.39. Of the total of these amounts, there was invested in furniture and office equipment, improvements and Liberty bonds, the sum of $4,327.33 in 1919, $8,952.15 in 1920, and $12,768.87 in 1921, leaving the amounts of $10,672.67, $9,651.67, and $15,039.52 in the corporation during the the respective years available for transacting business. Notwithstanding the small cash capital investment and the large amount of advertising handled each year, and the other business*3335 transacted, which in 1920 exceeded a million dollars, the petitioner was able to conduct its affairs without the use of borrowed money. This was possible because of its ability to collect amounts due from clients before the cash discount maturity date of the publisher's bill, thereby enabling it to pay these bills with funds provided by the client. The record does not show whether the petitioner was legally liable to the publisher for his advertising charges, but the question is immaterial here since all of such bills, with a few possible exceptions, were paid by the client before the due date of the publisher's invoice. As we said in , "The actual method of operation and not the theoretical or legal liability is what controls." See , and . As to the other requirement of the statute, that of whether the corporation's income is to be ascribed primarily to the activities of the principal stockholder, we find an abundance of evidence to sustain the claim of the petitioner. *3336 After a client had contracted to place his advertising through the petitioner, Corman, the principal stockholder, with the assistance of a few employees of his selection, proceeded to make an investigation into the particular marketing problems of the client, and after a plan of operation had been *84 agreed to, to prepare the necessary advertisements and arrange, in the name of the advertiser, for space in publications acceptable to the client for the running of advertisements. For the completion of art work necessary in connection with the manufacture by others of a plate for the advertisement, the petitioner employed outside artists and charged the advertiser 15 per cent of the cost to it. A similar situation existed in other proceedings wherein we held that that fact was not fatal to the claim being made if the petitioner met the other requirements of the statute. See ;, and . The commissions received on art work never exceeded about 7 per cent of the petitioner's gross income and in 1921 were approximately*3337 4 per cent. Substantially all of the petitioner's gross revenue was derived by way of commissions and fees for preparing and placing advertisements and work incidental thereto. The percentage to gross income approximated 90 per cent in 1919, 92 per cent in 1920, and 93 per cent 1921. The interest received on Liberty bonds never amounted to one-half of 1 per cent of gross income. Corman was the only solicitor of the petitioner and actually obtained all of its clients excepting those whose billings each year were less than $25,000. The balance of the clients were obtained by employees or came to the petitioner unsolicited. The petitioner did not trade in the sale of advertising space and did not reserve space until after a particular publication had been approved by the advertiser. The only thing it had for sale, and did sell, was its services. Corman was the only person connected with the corporation who had had experience in all branches of advertising work and it was due to his qualifications to successfully carry out a publicity campaign that the petitioner obtained its business in the first instance and it was to him, rather than petitioner's employees, that clients looked*3338 for results. The employees merely carried out ideas formulated by and under the direction of Corman. While they may have produced some of the petitioner's income the statute did not require that all the income be traceable to the principal stockholders. It is sufficient if the income is primarily due to their activities. We are satisfied from all the evidence before us in this proceeding that the income of the petitioner is to be ascribed primarily to the activities of Corman, the principal stockholder. Judgment will be entered for the petitioner. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619511/ | Harry A. Kinney and Betty W. Kinney, Petitioners v. Commissioner of Internal Revenue, RespondentKinney v. CommissionerDocket No. 2935-68United States Tax Court58 T.C. 1038; 1972 U.S. Tax Ct. LEXIS 54; September 26, 1972, Filed *54 Decision will be entered under Rule 50. In 1962, P sold his insurance agency. The contract of sale included a covenant not to compete and provided for the transfer of the agency's insurance expirations. No allocation was made in the contract between the amount paid for the expirations and the amount paid for the covenant not to compete. Held: (1) Under the circumstances, the covenant not to compete had substantial value, and a portion of the purchase price is allocable to it; (2) the amount to be allocated to the covenant has been determined. Charles W. Hall and Augustus T. Blackshear, Jr., for the petitioners.Leslie A. Plattner, for the respondent. Simpson, Judge. SIMPSON*1038 The respondent determined a deficiency of $ 49,200.34 in the petitioners' 1962 Federal income tax. The only issue for decision is what portion, if any, of the amount paid for an insurance agency is allocable to the covenant not to compete.*1039 FINDINGS OF FACTSome of the facts have been stipulated, and those facts are so found.The petitioners, Harry A. and Betty W. Kinney, are husband and wife and maintained their residence in Houston, Tex., at the time the petition*55 was filed in this case. They filed their 1962 joint Federal income tax return with the district director of internal revenue, Austin, Tex. Mr. Kinney will sometimes be referred to as the petitioner.For over 20 years prior to March 1962, Mr. Kinney was licensed by the State of Texas as a local recording agent to sell insurance (Tex. Ins. Code Ann. art. 21.14 (1963)), and during that period, he maintained an office in the area of southwest Houston. As a local recording agent, he was authorized by insurance companies to sell insurance to the public, and he was required to maintain an office and records of all insurance transactions which occurred in his office. Tex. Ins. Code Ann., supra.On March 23, 1962, the petitioner executed a memorandum of agreement in which he agreed to sell his insurance agency for an amount equal to 1 1/2 times the agency's annual insurance commissions, or approximately $ 125,000, plus $ 5,000 for the furniture and fixtures of the agency. The memorandum of agreement also provided that Mr. Kinney would not "compete in the insurance business in Harris County, Texas, for a period of five years other than working for the purchaser." The purchaser was *56 the Gem Insurance Agency, a three-man partnership.On May 1, 1962, the purchaser took over operational control of the business, and on May 26, 1962, an agreement and bill of sale were executed, which were effective as of May 1, 1962. Under the terms of the agreement, Mr. Kinney transferred to the purchaser the office furniture and fixtures, the goodwill of the agency, the exclusive right to use the name "Kinney Insurance," the exclusive property right in and to the expirations of all insurance policies written by the agency, and "the exclusive property right to control and solicit renewals of all said policies." An expiration is a copy of a portion of an insurance policy, not including the insuring provisions, but setting forth all the statistical information, including the names of the parties, the property covered, the premium, and the expiration date. In the agreement, Mr. Kinney also promised not to compete in the insurance business within a 50-mile radius of Houston for a period of 5 years (except as a solicitor for the purchaser), and he also promised, for a period of 10 years, not to solicit (except as a solicitor for the purchaser) the "sale of a renewal or replacement" or*57 any other policy to any person holding, on May 1, 1962, a policy written by the agency. The purchaser agreed to pay Kinney $ 5,000 for the office furniture, *1040 fixtures, and equipment; $ 10 for goodwill; $ 10 for use of the name "Kinney Insurance"; and $ 125,000 as "the balance of the amount payable by the Purchaser." The agreement also provided that the consideration would be paid concurrently with the execution of the agreement, but the $ 20 check for goodwill and use of trade name was dated June 8, 1962.No amount was allocated to the covenant not to compete because the parties could not agree on the amount to be allocated, and the purchaser signed the agreement without allocation against the advice of tax counsel. The agreement was drafted by the purchaser or its counsel, and the only change which Mr. Kinney requested was to reduce the area included within the covenant not to compete from 100 miles to 50 miles. He requested this change because he was considering the possibility of moving to Austin, Tex. The purchaser would not have purchased the agency without Mr. Kinney's covenant not to compete. The bank, which financed the purchase, required the purchaser to obtain*58 a covenant not to compete and verification of the authenticity of the policies written by the agency.At the time of the sale, Mr. Kinney was deeply involved in the work of the Gideons and desired to spend more time in such work. He was financially able to live in the style to which he was accustomed without the income from the agency, and his physician had advised him that he had hypertension and should avoid stress. Mr. Kinney told the purchaser that he desired to spend more time working with the Gideons, but he did not inform the purchaser that he was suffering from hypertension.When the agency was sold, it had some 2,500 to 3,000 customers and some 4,000 policies in force. Mr. Kinney could recognize 300 to 400 of his customers and remember the names of approximately 100. None of the customers were related to Mr. Kinney by blood or marriage, and most were individuals as opposed to commercial enterprises. The largest commercial customer accounted for 3 to 4 percent of the commission income of the agency, and all the large commercial accounts combined accounted for only 7 to 8 percent of such income. Fire and windstorm insurance accounted for 70 percent of the commission income*59 of the agency, automobile insurance accounted for 20 percent of the income, and miscellaneous insurance accounted for 10 percent.In addition to Mr. Kinney, the agency had approximately five female employees doing various types of work, a female telephone solicitor, and a male solicitor. A solicitor is a licensed insurance agent who is not required to maintain an office or records, and who must work for a local recording agent. Tex. Ins. Code Ann., supra. At the time of the sale of the agency, Mr. Kinney was personally soliciting 35 to 40 *1041 percent of the agency's new business and 10 to 15 percent of the agency's renewal business. Most of the agency's business was renewal business.Approximately one-half of the agency's new business was acquired through use of 3- and 5-year-old copies of the Daily Record, a legal newspaper, which listed real estate transfers and the names of the parties involved. Because home insurance is usually acquired on or near the date of the real estate transfer and because the policies were generally for 3 or 5 years, it could be approximated when a policy was about to expire. One of the female employees would call the homeowner, and if *60 the owner was interested in being insured by the agency, a solicitor or Mr. Kinney could contact him. About 2 to 3 percent of the persons called purchased insurance from the agency.The solicitation of renewals was based on the expirations. The agency filed its expirations in order of the date of the expiration of the policy, and when a policy was about to expire, a staff member telephoned the policyholder and inquired whether he desired to have the policy renewed. Generally, 90 to 95 percent of the policies were renewed, and 95 percent of these renewals were done solely by telephone without the need of a personal visit.The purchaser sought to retain the services of Mr. Kinney and his staff. However, the male solicitor formed his own agency, and at least 40 policyholders switched to his agency. Mr. Kinney maintained an office at the agency. Although he did not necessarily work a full business day, he did go to the office each business day, and he did produce business for the purchasers. On February 25, 1963, he signed a contract with the purchaser in which he agreed to be a solicitor for the agency; yet, prior to that time, some disagreements had arisen between Mr. Kinney and*61 the purchaser, and at about this time, he moved his furniture from the office. He allowed his local recording license to expire in March 1963, and he never obtained another insurance license.The petitioner allocated $ 125,000 of the sale price to the expirations and reported the entire gain on the sale of the agency as a long-term capital gain. The respondent determined that $ 125,000 of the sale price was attributable to the covenant not to compete and taxable as ordinary income.The members of the Gem partnership allocated $ 125,000 of the sale price to the covenant not to compete and claimed amortization deductions for the years 1962 through 1966. The respondent disallowed the deductions and such action is presently being contested by the partners in the District Court.OPINIONThe issue to be decided is what portion of the $ 125,000, if any, is allocable to the covenant not to compete. The petitioners contend that *1042 no amount can be allocated to the covenant because it is not severable from the assets and goodwill of the agency which were transferred to the purchaser. Alternatively, the petitioners contend that only a nominal amount is allocable to the covenant. *62 The respondent contends that the covenant not to compete has independent significance and that a major portion of the purchase price is allocable to it.In Balthrope v. Commissioner, 356 F. 2d 28, 31 (C.A. 5, 1966), affirming a Memorandum Opinion of this Court, the Fifth Circuit evaluated the severability test upon which the petitioner relies and stated that:The "severability" test, if it does not beg the question, has been criticized as ignoring the relationship between a covenant not to compete and the sale of goodwill. * * * Any covenant not to compete must to some degree protect the reputation and customer loyalty transferred with the goodwill of the business. Indeed, the covenant is unenforceable if intended for purposes other than protecting goodwill. 6 Corbin, Contracts § 1387. The only covenant that would not to some degree protect goodwill would be a covenant that had no basis in economic reality. Since directly determining whether a covenant has economic reality is the threshold inquiry in all of these cases, the indirect "severability" test for the same purpose has little probative value and less utility. * * *See Barran v. Commissioner, 334 F. 2d 58, 63*63 (C.A. 5, 1964), affirming on this issue 39 T.C. 515">39 T.C. 515 (1962); Schulz v. Commissioner, 294 F. 2d 52, 55, 56 (C.A. 9, 1961), affirming 34 T.C. 235">34 T.C. 235 (1960).The petitioner argues, however, that Balthrope does not apply in the present case because it involved a situation where there had been an allocation to the covenant and because in earlier cases, where there had been no allocation, the Fifth Circuit utilized the severability test. Commissioner v. Killian, 314 F. 2d 852 (C.A. 5, 1963), affirming a Memorandum Opinion of this Court; Masquelette's Estate v. Commissioner, 239 F. 2d 322 (C.A. 5, 1956), reversing a Memorandum Opinion of this Court. However, nothing in Balthrope indicates that the court intended to look at economic reality when there was an allocation and not look at it when there was no allocation. Indeed, the reasoning of Balthrope would seem to be equally applicable in both situations, and in Barran v. Commissioner, supra at 63, the Fifth Circuit pointed out that the*64 court would have reached the same result in Commissioner v. Killian, supra, by applying the economic reality test as by applying the severability test. In view of the court's statements in Balthrope, we are convinced that, when a covenant has substantial value, the Fifth Circuit will allocate a portion of the purchase price to it, irrespective of whether or not the parties have allocated any value to it. Since this case arose in the Fifth Circuit, we shall carefully consider the law of that circuit. See John T. Dodson, 52 T.C. 544">52 T.C. 544 (1969).Moreover, after reviewing the decisions of this Court, we are convinced *1043 that they are consistent with our understanding of the position of the Fifth Circuit. This Court has refused to allocate any part of the purchase price to a covenant when it found that the covenant lacked value. See, e.g., Howard Construction, Inc., 43 T.C. 343">43 T.C. 343, 355 (1964); North American Loan & Thrift Co. No. 2, 39 T.C. 318">39 T.C. 318, 326 (1962), affirmed per curiam 319 F. 2d 132 (C.A. 4, 1963); Edward A. Kenney, 37 T.C. 1161">37 T.C. 1161, 1169 (1962);*65 Aaron Michaels, 12 T.C. 17">12 T.C. 17, 19-20 (1949). However, those opinions indicate that if the covenant had independent value, a part of the purchase price would be allocated to it, at least in the absence of an agreement between the parties to allocate no amount to the covenant.We have found that Mr. Kinney and the purchaser failed to allocate any of the consideration to the covenant not to compete because they could not agree on the amount to be allocated. The witnesses disagreed as to whether there was any discussion of the amount to be allocated to the covenant. The three members of the partnership that purchased the agency all testified, and although they were excluded from the courtroom when not testifying, their accounts of the conversations were substantially consistent. In addition, we found credible their testimony that as businessmen acting with the advice of counsel, they were aware of the need to have an amount allocated to the covenant and sought to secure such an allocation. Since the failure to allocate was due to such disagreement between the seller and purchaser, the absence of the allocation does not indicate that they considered the *66 covenant to have no value. Compare Rich Hill Insurance Agency, Inc., 58 T.C. 610 (1972). Furthermore, inasmuch as the parties did not agree that nothing should be allocated to the covenant, we do not reach the question of whether, or under what circumstances, a party could set aside such an agreement and contend that some amount should be allocated to the covenant based on its value. Compare Yates Industries, Inc., 58 T.C. 961 (1972). As a party is not attempting to vary the language of the agreement, we do not have a situation in which the "strong proof" test is applicable. See Glen W. Lucas, Jr., 58 T.C. 1022">58 T.C. 1022 (1972).The covenant not to compete in the present case had substantial value. Mr. Kinney had been in the Houston insurance business for over 20 years, and during that time, he had built a large and successful business. At the time of the sale, he was personally soliciting 25 to 35 percent of the agency's new business and 10 to 15 percent of its renewal business. Through his Gideon activities, he had the opportunity to meet many people. In view of his past success, we are convinced*67 that if Mr. Kinney had undertaken to continue in the insurance business in Houston after the sale, he would have attracted a substantial number of his former customers. At the age of 55, he was not at the *1044 end of his working life, even though he was suffering from hypertension. Indeed, he continued to work for the agency on a daily basis through February 1963. He even signed a solicitor's agreement with the agency, and at one time, considered the possibility of soliciting in Austin, Tex. The members of the partnership who purchased the agency all testified that they considered the covenant to be essential in order to protect their investment, and we found such testimony to be convincing. Furthermore, the bank financing the purchase required the purchaser to obtain a covenant not to compete. Under these circumstances, we hold that Mr. Kinney's desire to reduce his business activities and his ability to live without the income from the insurance agency affect the value to be allocated to the covenant not to compete, but they fail to show that the covenant lacked substantial value.The parties agree that the expirations had value, and on the basis of the record before*68 us, we must now determine what part of the $ 125,000 to allocate to the expirations and what amount to allocate to the covenant. As stated by the court in Levine v. Commissioner, 324 F.2d 298">324 F. 2d 298, 302 (C.A. 3, 1963), affirming a Memorandum Opinion of this Court:It [the Tax Court] did agree that both items [goodwill and a covenant not to compete] were valuable. In those circumstances to allow nothing for the good will or for the covenant or for both would have been at the least inconsistent. At the same time one hundred per cent accuracy in fixing the respective amounts was impossible. So the court made the closest approximation it could. See Cohan v. Commissioner, 39 F. 2d 540, 543-544 (2 Cir. 1930). * * *Those words are precisely applicable to the task that we must now perform.The record does show that the purchaser had acquired several insurance agencies, and that in these acquisitions approximately 65 percent of the consideration was allocated to the covenant not to compete. It also shows that there are several factors which indicate that the covenant in this case was of less value than in the other situations. *69 The Kinney agency was the largest of those purchased, and without the expirations, it would have been very difficult for Mr. Kinney to remember a large percentage of the agency's customers. In addition, Mr. Kinney wanted to devote more time to the Gideons, and he communicated this intent to the purchaser. Although his health did not preclude his competing for business, it was such that Mr. Kinney might not desire to pursue the insurance business full time. Furthermore, he could live in the style to which he was accustomed without the income from the insurance business. However, for the reasons discussed in examining the reality of the covenant, it is apparent that Mr. Kinney was an able and experienced man who could successfully compete with the agency. Based on a careful examination of the evidence, we hold that *1045 33 percent of $ 125,000 should be allocated to the covenant not to compete. See Cohan v. Commissioner, 39 F. 2d 540 (C.A. 2, 1930).The petitioner contends, however, that all of his witnesses stated that the expirations themselves had a value of $ 125,000. Although the testimony of these witnesses is not completely consistent, *70 it is apparent that they were treating the covenant and the expirations as a unit and that the $ 125,000 figure was the value of such unit.The petitioner further argues that the covenant has little value because the transfer of the expirations included the transfer of the property right "to control and solicit renewals." However, such property right clearly does not apply to soliciting the business of new customers or old customers who desire additional insurance. In addition, there is substantial doubt as to whether it would apply to selling a different policy to an old customer in place of his present policy. Indeed, the covenant not to compete contains different provisions relating to replacement and renewal policies, while the property right refers only to renewal policies. The petitioner's argument that there is no showing that the agency has a substantial replacement insurance business is not responsive. Whether such business existed or not, Mr. Kinney, without the covenant, apparently could have drawn old customers away from the agency through the use of replacement policies.Finally, the petitioner seems to suggest that we should take into account the fact that he did*71 not understand the tax consequences of the sale and that the purchaser had tax counsel. We are not altogether convinced that the petitioner was ignorant of the tax consequences of the sale. In any event, we do not believe that such knowledge alters the value of the covenant. Edmond A. Maseeh, 52 T.C. 18">52 T.C. 18 (1969).Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619512/ | Geoli Investment Company v. Commissioner. Eccdor Investment Company v. Commissioner.Geoli Inv. Co. v. CommissionerDocket Nos. 6466-66 and 6486-66.United States Tax CourtT.C. Memo 1970-77; 1970 Tax Ct. Memo LEXIS 282; 29 T.C.M. (CCH) 349; T.C.M. (RIA) 70077; March 31, 1970, Filed Stephen H. Anderson and Alonzo W. Watson, Jr., Suite 400 Deperat Bldg., 79 South Main St., Salt Lake City, Utah, for the petitioners. Charles W. Nyquist, for the respondent. SCOTT Memorandum Findings of Fact and Opinion SCOTT, Judge: Respondent determined deficiencies in petitioners' income taxes for the years and in the amounts as follows: 350 Docket No.PetitionerFiscal yearDeficiencyAddition toTotalendedtax underSec. 531,I.R.C. 19546466-66GeoliApril 30, 1962$20,734.63$13,985.69$34,720.32Investment CoApril 30, 196324,877.3616,744.4841,621.84April 30, 196430,066.2519,923.1149,989.366486-66EccdorSept. 30, 19615,807.795,981.4611,789.25Investment CoSept. 30, 196218,665.6913,276.0331,941.72Sept. 30, 196325,705.6717,397.4343,103.10May 31, 196422,306.9314,449.0836,756.01*283 Some of the issues, including the issue relating to the accumulated earnings tax imposed by section 531, I.R.C. 1954, 1 have been disposed of by agreement of the parties leaving for our decision the following: Whether respondent properly disallowed, under the provisions of section 269, to each petitioner the deduction for dividends received provided for by section 243. Findings of Fact Some of the facts have been stipulated and are found accordingly. Geoli Investment Co. (hereinafter referred to as Geoli), a corporation organized under the laws of Utah on April 28, 1958, had its principal place of business on the date its petition in this case was filed in Salt Lake City, Utah. Eccdor Investment Co. (hereinafter referred to as Eccdor), a corporation organized under the laws of Utah on September 2, 1958, had its principal place of business on the date its petition in this case was filed at Salt Lake City, Utah. Geoli and Eccdor each filed its Federal corporate income tax return for each of the years here in issue with the district director of internal revenue at Salt Lake City, Utah. *284 George S. Eccles (hereinafter referred to as Eccles) was the organizer of each of the corporations and has been the beneficial owner of all of the stock of Eccdor and Geoli since their incorporation. 2 Each of the corporations issued at the date of its incorporation 100 shares of $10 par value stock for total cash of $1,000. During 1957 and 1958 Eccles was a director and shareholder of Utah Construction Company which was engaged in construction of large projects. The Company would build a commercial building, obtain a tenant on a long-term lease for the building and then offer the building for sale. In 1957 and 1958 Utah Construction Company was engaged in developing an industrial park in South San Francisco, California. At one of*285 the meetings of its board of directors held in the latter part of 1957, each of the directors was offered the opportunity to purchase, upon their completion and leasing but prior to their being offered to the public, some of the commercial buildings in the industrial park. The prices at which the buildings were offered to the directors were the same as the prices at which the buildings were to be offered to the public. Eccles committed himself to purchase two of the buildings when they were completed and leased and some of the other directors agreed to purchase some of the properties upon their completion. The properties which Eccles agreed to purchase were the Par-T-Pak Building and the Cleveland Cap-Screw Building. Prior to agreeing to purchase the properties, Eccles considered the estimated return from investment in real properties as compared to other investments as well as the fact that a substantial portion of the cost could be financed by mortgages at comparatively low interest rates. After committing himself to purchase the two properties, Eccles consulted his lawyer with respect to carrying out his agreement to purchase the properties. The lawyer who Eccles consulted had*286 represented Eccles personally and had represented the banks of which 351 Eccles was an officer and director for over 30 years. This attorney advised Eccles not to take title to the properties in his personal capacity but to acquire them through a corporation. He pointed out to Eccles that taking title to the properties in a corporation would relieve him of personal liability with respect to the buildings and any aspect of their operation, would be better from the standpoint of estate planning if the properties were located outside of Utah and would enable Eccles to borrow money to finance the purchase from his own banks. Eccles and his lawyer also discussed the tax aspects of taking title to the buildings in a corporate name. Eccles then requested his attorney to proceed with the organization of Geoli. After Eccles agreed to purchase the two California properties upon their completion he considered other possible real estate acquisitions in Idaho and Utah. In March of 1958 he began to negotiate for the purchase of the El Paso Natural Gas Building in Salt Lake City, (later named the Pacific Northwest Pipeline Co. Building) and the J.C. Penney Building in Twin Falls, Idaho. The*287 offering prices of the El Paso Natural Gas Building and the J.C. Penney Building were $270,000 and $280,000, respectively. In April 1958 Eccles entered into negotiations for the purchase of the Eccles Hotel Bank Building 3 in Logan, Utah for a price of $105,000. Eccles was successful in purchasing the J.C. Penney property and on May 9, 1958, completed the transaction having title to the property taken in the name of Geoli which as heretofore noted had been incorporated on April 28, 1958. Prior to the incorporation of Geoli, Eccles was aware of the fact that by incorporating a business he was relieved of personal liability. Eccles was an officer and director of the First Security Bank of Utah and the First Security Bank of Idaho, both national banks. Eccles knew even before being so advised by his attorney that he was not permitted to borrow money from these banks in his own name, but that a corporation owned by him would be permitted to do so with proper security. Eccles also knew that because he was a director of these banks he*288 would be required to report any personal borrowing from other sources to the board of directors of the banks, thereby disclosing his personal affairs to other businessmen and associates. Eccles was of the opinion that a corporation owned by him would not be required to make such a report. Eccles also was aware that if he contributed stock to his wholly owned corporation to enable it to have security upon which to borrow the money to purchase real estate that the corporation would be entitled to a deduction for dividends received of 85 percent of the dividends received. Eccles was aware that California and Idaho were community property states and was of the opinion that confusing problems might develop in the probation of his estate if he personally owned real property in those states. In January of 1958 Eccles and his wife purchased a long-term lease for $32,000 on a cottage located on the grounds of the El Dorado Country Club. The El Dorado Country Club is a golf club located at Riverside, California of which Eccles was a member. Its membership includes many prominent people. In June of 1958 Eccles and his wife assigned the lease to Geoli. Eccles occupies the cottage from 4 to 12*289 weeks each year and at all other times the cottage is available for renting by other club members in accordance with the club's rules. When the buildings Eccles had agreed to purchase from Utah Construction Company were completed and leased, Eccles decided it would be advisable to form another corporation to hold title to these California properties and therefore had his attorney arrange the organization of Eccdor. On September 4, 1958, 2 days after the organization of Eccdor on September 2, 1958, Eccles had title to the Par-T-Pak Building in South San Francisco taken in its name. Petitioners actually purchased from the sellers with whom Eccles had made arrangements the various properties they owned. Petitioners would give a mortgage on the property and borrow the remaining money needed for the purchase on a demand note secured by stock transferred by Eccles to petitioners. The following chart shows all the real property purchased by each petitioner from its incorporation to the time of trial of this case together with the purchase prices, mortgages given, notes given in connection with the purchase, and terms of the leases on the properties when they were purchased: 352 GeoliEccdorDatepurchasepurchaseOriginalPropertyacquiredpricepricemortgageJ. C. Penney Bldg. TwinMay 9, 1958$280,000.00$165,302.55Falls, IdahoEl Dorado CottageJune 17, 195832,000.00---Riverside, Calif.Par-T-Pak Bldg., South SanSept. 4, 1958$145,901.5595,500.00Fran- cisco, Calif.Cleveland Cap- Screw Bldg.Nov. 11,1958204,982.49135,000.00South San Fran- cisco,Calif.Zeno Hydraulic Corp. Bldg.June 19, 1959185,000.0096,897.59Salt Lake City, UtahB.F. Goodrich Bldg. SaltDec. 19, 1960246,300.00160,000.00Lake City, UtahSkaggs Drug Center Bldg.Sept. 16, 1961350,464.67225,000.00Ogden, Utah*290 OriginalApproximatenoteDate ofTerm ofmonthlyPropertypayableleaseleaserentalJ. C. Penney Bldg. Twin$114,900.00March 24,20 yrs.2.75 % ofFalls, Idaho1954monthlysalesEl Dorado CottageRiverside, Calif.Par-T-Pak Bldg., South San48,000.00Sept. 1,15 yrs.$1,076.00Fran- cisco, Calif.1958Cleveland Cap- Screw Bldg.68,000.00Nov. 1,15 yrs.1 1,625.00South San Fran- cisco,1958Calif.Zeno Hydraulic Corp. Bldg.90,000.00April 15,15 yrs.1 1,260.00Salt Lake City, Utah1958B.F. Goodrich Bldg. Salt90,000.00Dec. 1,15 yrs.1 1,642.00Lake City, Utah1960Skaggs Drug Center Bldg.124,000.00April 1,20 yrs.1 2,333.34Ogden, Utah19611*291 On December 31, 1964, petitioners each purchased for $478,710 a one-fourth ownership in the Shoshone Pipeline Ltd., a partnership. In July 1968, the Shoshone Pipeline interest was sold and petitioners each acquired one-fourth ownership in the Cheyenne Pipeline Co. for $400,000. In order to enable petitioners to finance their real estate purchases, Eccles transferred certain stock which he owned to each petitioner. These stocks were carried on petitioners' books as "paid-in surplus" at their basis to Eccles. The following charts show for each Geoli and Eccdor the dates of transfer of the stocks, the number of shares transferred, and the bases of the stocks in Eccles' hands which is the same bases at which they were carried on the corporate books: GeoliInvestment CompanyNumber ofsharesName of companyEccles' basesDatetranferredissuing stockin the stocks1958May 166,000First Security$71,721.67CorporationMay 26200Mountain Fuel Supply16,011.00CompanyMay 272,333Farmers Underwriters72,552.70AssociationMay 281,000Utah Construction Company25,023.80June 133,000Amalgamated Sugar Company86,429.77- commonBalance April271,738.9430,19591959Sept. 105,000Amalgamated Sugar Company20,027.99- commonBalance April291,766.9330,19601962March 15,000Eccles Investment Company12,128.15Balance April$303,895.0830,1964Eccdor Investment Company1958Sept. 55,000First Security$42,646.19CorporationNov. 288,000First Security56,005.29CorporationNov. 281,500Amalgamated Sugar Company29,799.87- commonBalance Sept.128,451.3530,19591962March 110,000Eccles Investment Company24,256.30Balance Sept.152,707.6530,19621963Jan. 24.5,000Eccles Investment Company12,128.15Balance Apr.$164,835.8030,1964*292 Eccles is president of the First Security Corpo Eccles is president of the First Security Corporation. He had owned the 19,000 shares of stock in that company which he contributed to Geoli and Eccdor since 1928. The market value of these shares of stock in 1958 was substantially in excess of Eccles' bases in the stock. Eccles Investment Company is a personal holding company, the assets of which are almost entirely stock. Eccles had owned the 20,000 shares of this stock which he contributed to Geoli and Eccdor since 1912. The market value of this 20,000 shares of stock on April 30, 1964, was approximately $700,000. None of the Eccles Investment Company stock was pledged by Geoli or Eccdor as security for bank borrowing. Most of the stocks contributed to Geoli and Eccdor were held and not sold by them. The only stocks contributed by Eccles to petitioners which were sold by them were 150 shares of common stock of Amalgamated Sugar Company, 900 shares of the First Security Corporation, and 380 shares of Mountain Fuel Supply Company. Petitioners did purchase and sell stocks during the years here in issue. The following chart shows such purchases and sales by petitioners: Geoli Investment CompanyDate ofNumber of sharespurchasepurchasedCompanyAmountJuly 7, 19585Permanente Cement$5.10CompanyJan. 22, 195910Amalgamated Sugar400.00Co. - CommonFeb. 10, 195935Amalgamated Sugar1,400.00Co.Sept. 4, 1959400Morrison-Knudsen14,475.00CompanyOct. 8, 19591,411Amalgamated Sugar12,699.00Co. - PreferredOct. 1, 19593,000Lucky Mae Uranium14,981.40Oct. 8, 19593,000Lucky Mae Uranium14,400.00Nov. 5, 1959900Aubrey G. Lanston9,000.00and CompanyApril 22, 1960700Union Pacific19,001.90Railroad CompanyFeb. 23, 1961900Aubrey G. Lanston9,000.00and Co. - Class AJuly 21, 19612,500Hidden Splendor24,884.96Mining Co. - 6%preferredFeb. 16, 1962200Husky Oil Company -20,000.006-1/2% preferredMay 4, 1962205Husky Oil Company -20,500.006-1/2% preferredMay 21, 1962500Union Pacific16,049.40Railroad CompanyMay 23, 1962400Utah Power and Light10,260.00Company - $1.18cumulative preferredBSept. 21, 19621,000Cyprus Mines23,750.00CorporationAug. 23, 1963600Husky Oil Company -60,000.006-1/2% preferredTotal stocks$270,806.76purchasedStocks paid in303,895.08Total$574,701.84Less stockssold:Apr. 20, 1960200Amalgamated Sugar$5,658.00Co. CommonApr. 22, 1960300Morrison Knudsen Co.10,875.00Apr. 22, 1960380Mt. Fuel Supply Co.7,948.50March 16, 1961500First Sec. Invest.376.18Co.Feb. 2, 1962400First Sec. Invest.334.88Co.Aug. 22, 1962400Utah Power and Light10,260.00Co. $1.18 cumulativepfd.Sept. 20, 19622,500Hidden Splendor24,884.96Mining Co. -PreferredJuly 29, 19631,000Cyprus Mines Corp.23,750.00July 29, 1963100Morrison Knudsen Co.3,600.00Total stocks sold87,687.52Balance April$487,014.3230, 1964Eccdor Investment CompanySept. 4, 1959900Morrison-Knudsen$32,606.27CompanyNov. 5, 1959900Aubrey G. Lanston &9,000.00CompanyApr. 20, 1959200Amalgamated Sugar9,800.00Company - CommonJuly 21, 19612,500Hidden Splendor24,884.96Mining CompanyFeb. 16, 1962200Husky Oil Company -20,000.006-1/2% pfd.May 4, 1962200Husky Oil Company -20,000.006-1/2% pfd.May 21, 1962500Union Pacific16,036.83Railroad CompanyMay 23, 1962400Utah Power & Light10,260.00Company - $1.18cumulative preferredSept. 21, 19621,000Cyprus Mines23,750.00CorporationJuly 3, 1963400First Security20,000.00CorporationAug. 23, 1963600Husky Oil Company -60,000.006-1/2% pfd.Total stocks$246,338.06purchasedStocks paid in164,835.80Total$411,173.86Less stockssold:Feb. 27, 1961906Aubrey G. Lanston &$9,000.00CompanyApr. 30, 1962100First Security In-60.44vestment CompanyAug. 28, 1962400Utah Power & Light10,260.00Co. - $1.18cumulative pfd.Sept. 20, 19622,500Hidden Splendor24,884.96Mining Co.July 29, 1963750Cyprus Mines17,812.50CorporationJuly 29, 1963400Morrison-Knudsen Co.14,500.00Total stocks sold76,517.90Balance April$334,655.9630, 1964*293 Under the lease on the J.C. Penney Building the landlord is liable for taxes, insurance, painting, and redecorating every 5 years, and exterior and structural maintenance and heating and air conditioning repairs and replacement. The monthly rent is computed by a formula of 2.75 percent of the gross monthly sales with a provision that if the annual sales exceed $1,400,000, the lessee may require the landlord to build a second floor according to the specifications set out in the lease. By 1964 only $582 had been added to Geoli's basis in the J.C. Penney Building for capital improvements. The following chart shows the expenses in connection with the J.C. Penney lease and the rents received by Geoli: FireLiabilityPropertyYearinsuranceinsurancetaxMiscellaneousRent1958$459.52$227.27$ 831.23$ 169.29Not shown inthe record1959404.3822.475,734.801,519.26Not shown in(Paint-glass)the record1960404.385,848.10Not shown inthe record1961$404.38$205.89$5,681.26$ 106.49$ 29,238.73(Front door)1962404.385,687.9934,541.771963739.855,916.22100.0037,789.97*294 In each of the other leases on petitioners' buildings the lessee paid a stated monthly rental and was liable for property taxes, fire and liability insurance, interior repairs and maintenance, and with the exception of the B.F. Goodrich Building for the exterior maintenance and repairs. The lease on the Skaggs Drug Building limited the responsibility of the lessee to $1,000 annually for each interior and exterior repair. The record does not contain the lease on the Par-T-Pak Building. The following charts show petitioners' expenses in connection with each building and the rents received from each building for the years indicated: YearProperty taxInsuranceMiscellaneousRentZeno HydraulicBuilding195911111960$1,693.32119611,758.20$ 49.69$16,878.2019621,908.0673.2517,028.0619631,970.58$25.071B.F. GoodrichBuilding19612,615.7180.5522,319.7119622,858.9922,562.9919632,952.6823.9222,636.68El DoradoCottage1958$1,000.00 per1contract19592,341.50 per1contract19602,994.93 per1contract19613,261.65 per4,930.00contract19623,173.92 per4,069.00contract19633,885.97 per2,121.50contract19593,525.682 80.201Par-T-PakBuilding19582 80.21$119.79119592,188.022 80.21119602,155.282 80.21119612,421.762 80.21119622,431.142 73.2415,931.2619632,656.882 163.2310,412.24Cleveland CapScrew Building1958185.642 80.20186.00119603,418.802 80.20119613,146.502 73.20n2/ 116.06119623,146.662 73.2019,993.1319633,439.522 150.2313,000.00(short)Skaggs DrugCenter Building1960119613,794.082 116.06119624,999.6237,656.9319635,773.722 190.1031,260.91(short year)*295 During the years ending April 30, 1959, through 1964, Geoli's total rental income was as follows: Year ended April 30Rents1959$26,778.02196045,369.96196160,029.56196273,366.64196378,201.82196479,658.73During the years ending September 30, 1959 through 1963 and the short year October 1, 1963 through May 31, 1964, Eccdor's rental income was as follows: Year ended September 30Rents1959$31,325.00196035,255.54196149,959.40196267,710.97196373,581.32October 1, 1963 throughMay54,673.1531, 1964Neither Eccdor nor Geoli acquired any real estate subsequent to September 1961. Subsequent to the year 1964 Geoli sold the property which was under lease to J.C. Penney Company, and Eccdor sold the properties which were under lease to Cleveland Cap Screw Company and Par-T-Pak. Eccles' personal office is located in the Deseret Building in Salt Lake City. Geoli and Eccdor used this address as their business address. They had no office space separate from Eccles' personal office space and their names are not listed on*296 the building directory. There were no telephone listings for either of petitioners. Neither Geoli nor Eccdor had printed or engraved business stationery. Correspondence carried on in the name of Geoli and Eccdor was on Eccles' letterhead with the name of Geoli or Eccdor always typed below the closing of the letter and often typed at the top. Neither petitioner paid any amounts designated as wages or salaries from the time of its incorporation through the years here in issue. At all times since their formation each petitioner has maintained separate and complete books of account and an active bank account. Regular shareholders and directors meetings have been held by the directors and shareholders of each petitioner and corporate minutes of these meetings have been kept. Each petitioner has entered into various contracts in its own name. From the time of its incorporation to the close of the years here in issue neither petitioner has paid any dividend. During 1958, 1959, and early 1960 Eccles entered into negotiations for the purchase of the Pacific Northwest Pipeline Company Building in Salt Lake City for $270,000. Eccles contemplated purchasing this building for either Geoli*297 or Eccdor. There was a merger between Pacific Northwest Pipeline Company and El Paso Gas and the building was withdrawn from the market. In 1961 Eccles made an offer of $800,000 for the purchase of the W.T. Grant Building and an offer of $800,000 for the Eccles 358 Building in Ogden, Utah. Both of these properties were sold to higher bidders for $850,000 and $1,000,000, respectively. Between 1960 and 1965 Eccles investigated the possibility of purchasing the Strevell Paterson Building, Addressograph Building, Merrill Lynch, Pierce, Fenner & Smith Building and the Blair Motor Company Building, all of Salt Lake City, and the Seattle Garage, Seattle, Washington. For various reasons all five of these buildings were withdrawn from the market. In 1964 Geoli negotiated for the acquisition of a water system in Mexico, but the system was not sold because of its being financed by a local bond issue. The dividend income reported in each of the joint Federal income tax returns filed by Eccles and his wife for the years 1957 through 1964 and the highest income bracket applicable to the income reported on each of these returns are as follows: DividendsHighest taxYearreportedbracket applicable1957$139,409.0675 percent1958140,764.8284 percent1959124,386.0175 percent1960156,451.9378 percent1961207,342.6384 percent1962197,411.9685 percent1963197,112.501964225,872.68*298 Petitioners on their Federal corporate income tax returns for the years in issue reported dividends received and claimed deductions for dividends received in the following amounts:DividendsDividends receivedPetitionerFiscal year endedreported-deductions claimedGeoliApril 30, 1962$58,624.81$49,831.09GeoliApril 30, 196363,464.6253,944.93GeoliApril 30, 196472,010.5661,208.96EccdorSept. 30, 196132,106.4019,359.32EccdorSept. 30, 196254,431.0043,716.35EccdorSept. 30, 196364,765.1055,041.84EccdorSept. 30, 196452,712.1044,805.29The highest tax bracket applicable to the income reported on the corporation returns filed by each petitioner for its taxable years 1959 through 1963 was 30 percent. The 52 percent bracket was applicable to some of the income reported by each petitioner for the taxable year ended in 1964. Changes in the personal holding company law caused Eccles to have Geoli and Eccdor each purchase an interest in the Shoshone Pipelines, Ltd. After this purchase by petitioners, Shoshone purchased another pipeline, a gasoline plant, producing wells and a small pipeline in New Mexico and*299 Texas. Each of petitioners also acquired an interest in the Cheyenne Pipeline Co., a general partnership operating a gathering and transmission system covering many states. Eccles was active on behalf of both petitioners in negotiating the acquisition of these interests and in the management of both Shoshone and Cheyenne. Eccles was so active in the management of Shoshone on behalf of petitioners that the general partner, Nielsen Enterprises, considered petitioners also to be general partners and inquired of Eccles' attorney whether a change in documentation was necessary. The following show the balance sheets and income statements for Geoli for the years 1959 through 1964: 359 Geoli Investment CompanyComparative Balance Sheet -- April30, 1959 through April 30, 1964195919601961ASSETSCash$ 3,037.88$ 8,884.58$ 17,928.25Stocks at cost273,544.04353,647.83362,271.65Stocks-apprec. to market value388,000.21667,140.30993,975.10Automobile4,452.804,452.80Less: Accum. depreciation(311.68)(2,092.84)Furniture & fixtures236.821,567.26Less: Accum. depreciation(78.91)Real estate312,000.00497,000.00743,882.00Less: Accum. depreciation(9,901.34)(24,785.50)(45,172.61)Total Assets$966,680.79$1,506,265.15$2,076,732.70LIABILITIESMortgage notes payable$158,945.19$ 241,365.60$ 383,737.53Com. notes payable122,700.00243,500.00297,800.00Total liabilities$281,645.19$ 484,865.60$ 681,537.53CAPITAL & RETAINED EARNINGS:Cap. stock; auth. 1,000 shares of1,000.001,000.001,000.00$10 par val. each issued &outstand. 100 sharesPaid-in surplus271,738.94291,766.93291,766.93Surp. aris. from apprec. of stocks388,000.21667,140.30993,975.10to market val.Retained earnings24,296.4561,492.32108,453.14Total capital and retained685,035.601,021,399.551,395,195.17earningsTOTAL$966,680.79$1,506,265.15$2,076,732.70Geoli Investment CompanyComparative Statement of Incomeand Retained EarningsFor the Fiscal Years Ended April30, 1959, through April 30, 1964Dividends$22,664.24$38,393.11$ 44,945.45Rents26,778.0245,369.9660,029.56InterestGain on sale of securities3,861.109,088.77Gain on sale of automobileTotal income$49,442.26$87,624.17$114,063.78ExpensesInterest12,377.0622,430.0329,163.57Insurance686.79500.10568.32Property taxes831.235,859.917,618.97Other taxes20.00912.282,022.37Depreciation9,901.3415,195.8422,247.18Automobile49.05180.28Business expense115.001,622.03650.00Repairs and maintenance1,169.292,349.503,023.93Miscellaneous45.10Total expenses25,145.8148,918.7465,474.62Income before Federal income taxes24,296.4538,705.4348,589.16Provision for Federal income tax1,509.561,628.34(of prior yr.)Net income$24,296.45$37,195.87$ 46,960.82Retained earningsBeginning$24,296.45$ 61,492.32Ending$24,296.45$61,492.32$108,453.14*300 Geoli Investment CompanyComparative Balance Sheet -- April30, 1959 through April 30, 1964196219631964ASSETSCash$ 12,339.59$ 3,324.92$ 31,320.03Stocks at cost418,949.88454,364.32487,014.32Stocks-apprec. to market value1,078,648.891,398,449.081,280,752.43Automobile4,611.704,611.704,611.70Less: Accum. depreciation(768.64)(2,301.69)(3,164.04)Furniture & fixtures1,567.262,301.984,613.87Less: Accum. depreciation(235.63)(409.67)(725.81)Real estate743,882.00743,882.00748,467.96Less: Accum. depreciation(71,884.32)(97,067.41)(120,937.63)Total Assets$2,187,110.73$2,507,155.23$2,431,952.83LIABILITIESMortgage notes payable$ 361,732.32$ 331,966.01$ 296,488.15Com. notes payable277,100.00241,400.00245,700.00Total liabilities$ 638,832.32$ 573,366.01$ 542,188.15CAPITAL & RETAINED EARNINGS:Cap. stock; auth. 1,000 shares of1,000.001,000.001,000.00$10 par val. each issued &outstand. 100 sharesPaid-in surplus303,895.08303,895,08303,895.08Surp. aris. from apprec. of stocks1,078,648.891,398,449.081,280,752.43to market val.Retained earnings164,734.44230,445.06304,117.17Total capital and retained1,548,278.411,933,789.221,889,764.68earningsTOTAL$2,187,110.73$2,507,155.23$2,431,952.83Geoli Investment CompanyComparative Statement of Incomeand Retained EarningsFor the Fiscal Years Ended April30, 1959, through April 30, 1964Dividends$ 58,624.811 $ 64,302.12$ 72,010.56Rents73,366.6478,201.8279,658.73Interest200.00Gain on sale of securities6,062.563,676.08245.03Gain on sale of automobile1,654.16Total income$139,708.17$146,180.02$152,114.32ExpensesInterest34,952.0932,805.9429,247.10Insurance543.22404.38788.84Property taxes10,155.5710,539.7910,906.05Other taxes2,197.092,697.143,243.79Depreciation28,191.1926,890.1825,048.71Automobile436.47267.00522.17Business expense644.991,248.91894.26Repairs and maintenance3,574.033,247.173,985.97MiscellaneousTotal expenses80,694.6578,100.5174,636.89Income before Federal income taxes59,013.5268,079.5177,477.43Provision for Federal income tax2,732.222,368.893,805.32(of prior yr.)Net income$ 56,281.30$ 65,710.62$ 73,672.11Retained earningsBeginning$108,453.14$164,734.44$230,445.06Ending$164,734.44$230,445.06$304,117.17*301 The following show the balance sheet and income statement for Eccdor for the years 1959 through April 30, 1964: Eccdor Investment CompanyComparative Balance Sheet -- Fiscalyears ended September 30, 1959through September 30, 1963 andApril 30, 1964195919601961ASSETSCash in bank$ 6,065.54$ 4,573.24$ 6,513.55Stocks at cost161,057.62179,857.62195,742.58Stocks-apprec. to market value730,817.38852,529.881,549,982.42Automobile1,703.351,703.35Less: Accum. depreciation(551.54)(1,153.22)Real estate347,734.50348,109.21698,948.59Less: Accum. depreciation(12,795.84)(25,630.95)(51,618.23)Other assets Accrued interestTotal assets$1,232,879.20$1,360,590.81$2,400,119.04LIABILITIESMortgage notes payable224,283.14216,989.90432,809.31Commercial notes payable118,000.00105,000.00209,000.00Lease deposits2,466.002,466.002,466.00Total liabilities$ 344,749.14324,455.90644,275.31CAPITAL & RETAINED EARNINGS:Cap. stock: auth. 1,000 shares of$10 par va. each issued & outstand.100 shares1,000.001,000.001,000.00Paid-in surplus128,451.35128,451.35128,451.35Surp. aris. from apprec. of stocks730,817.38852,529.881,549,982.42to market valueRetained earnings27,861.3354,153.6876,409.96Total capital and retained earnings888,130.061,036,134.911,755,843.73TOTAL$1,232,879.20$1,360,590.81$2,400,119.04Eccdor Investment CompanyComparative Statement of Income andRetained EarningsFor the Fiscal Years EndedSeptember 30, 1959 throughSeptember 30, 1963, andFor the 7 Months Ended April 30,1964195919601961IncomeDividends$24,725.00$31,311.25$32,108.40Rents31,325.0035,255.5449,959.40Gain (loss) on sale of securitiesInterestTotal income56,050.0066,566.7982,067.80ExpensesInterest14,691.5017,804.0324,587.06Insurance160.235,713.70160.23Property taxes185.64160.235,597.94Other taxes20.001,033.111,293.02Depreciation12,795.8413.386.6526,588.96Automobile464.92Business expense600.00Miscellaneous335.46123.20Total expenses28,188.6738,220.9259,292.13Income before Federal income taxes27,861.3328,345.8722,775.67Provision for Federal income tax2,053.52519.39(of prior year)Net income$27,861.33$26,292.35$22,256.28Retained earningsBeginning27,861.3354,153.68Ending$27,861.33$54,153.68$76,409.96*302 Eccdor Investment CompanyComparative Balance Sheet -- Fiscalyears ended September 30, 1959through September 30, 1963 andApril 30, 1964196219631964ASSETSCash in bank$ 21,908.20$ 9,871.71$ 71,655.74Stocks at cost274,840.31334,655.96334,655.96Stocks-apprec. to market value1,445,362.191,925,622.791,779,631.04Automobile1,703.351,703.351,703.35Less: Accum. depreciation(1,203.35)(1,203.35)(1,203.35)Real estate699,748.63700,548.67701,348.71Less: Accum. depreciation(73,217.09)(98,450.46)(112.392.61)Other assets Accrued interest487.50Total assets$2,369,142.24$2,873,236.17$2,775,398.84LIABILITIESMortgage notes payable417,775.53402,615.79394,727.35Commercial notes payable219,000.00184,000.00184,000.00Lease deposits2,466.002,466.002,466.00Total liabilities639,241.53589,081.79581,193.35CAPITAL & RETAINED EARNINGS:Cap. stock: auth. 1,000 shares of$10 par va. each issued & outstand.100 shares1,000.001,000.001,000.00Paid-in surplus152,707.65164,835.80164,835.80Surp. aris. from apprec. of stocks1,445,362.191,925,622.791,779.631.04to market valueRetained earnings130,830.87192,695.79248,738.65Total capital and retained earnings1,729,900.712,284,154.382,194,205.49TOTAL$2,369,142.24$2,873,236.17$2,775,398.84Eccdor Investment CompanyComparative Statement of Income andRetained EarningsFor the Fiscal Years EndedSeptember 30, 1959 throughSeptember 30, 1963, andFor the 7 Months Ended April 30,196419621963April 30,1964IncomeDividends$51,431.00$64,755.10$52,712.10Rents67,710.9773,581.3251,972.15Gain (loss) on sale of securities5,215.00(1,663.89)Interest400.00Total income124,356.97136,672.53105,084.25ExpensesInterest35,690.9932,347.9215,986.72Insurance378.59146.47146.47Property taxes9,382.4210,593.0511,880.64Other taxes973.992,252.112,636.63Depreciation21,648.9925,233.3713,942.15Automobile176.17126.6075.26Business expense660.00850.00850.00MiscellaneousTotal expenses68,911.1571,549.5245,517.87Income before Federal income taxes55,445.8265,123.0159,566.38Provision for Federal income tax1,024.913,258.093,523.52(of prior year)Net income$54,420.91$61,864.92$ 56,042.86Retained earningsBeginning76,409.96130,830.87192,695.79Ending$130,830.87$192,695.79$248,738.65*303 361 Each petitioner claimed on its Federal income tax return for each of the years here in issue the deduction provided under section 243 for 85 percent of the dividends received by it from other corporations. Respondent in his notice of deficiency disallowed to each petitioner this claimed deduction for each year here in issue. The explanation given in the notice of deficiency to Geoli was that it had been determined that a principal purpose for your formation was to obtain the benefit of the dividend received deduction on dividends paid on stock contributed to the corporation. Accordingly, the dividend received deductions claimed on your return * * * have been disallowed under the authority of Section 269 of the 1954 Internal Revenue Code. The same explanation was given in the notice of deficiency to Eccdor except that the words "under the authority of Section 269 of the 1954 Internal Revenue Code" were not contained in the statement of explanation of adjustments. Opinion Petitioners take the position that section 2694 does not authorize respondent to disallow to a corporation the deduction for dividends received*304 provided for under section 243. Petitioners further contend that if respondent is authorized to disallow such a deduction under the provisions of section 269, his disallowance of the claimed deduction to each of petitioners in this case was erroneous since the principal purpose of Eccles in the formation and the acquisition of the stock of each petitioner was not evasion or avoidance of Federal income tax by securing the benefits of the dividends received deductions for each of the corporations. *305 Respondent contends that he is authorized under section 269 to disallow to a corporation a deduction for dividends received and that his disallowance in the instant case was proper since the evidence fails to show that the principal purpose for which Eccles formed each petitioner and acquired its stock was not the evasion or avoidance of Federal income tax by securing the benefit of the deduction for dividends received allowed by section 243. At the outset it might be noted that respondent in his notice of disallowance stated that "a principal purpose" of the formation of each petitioner was to obtain the benefit of a deduction for dividends received. No point is made by petitioners of the use by respondent in his notice of deficiency of the word "a" and not the word "the" which is the word used in section 269. However, petitioners call attention to the fact, and respondent does not contend to the contrary, that in order for respondent's disallowance to each petitioner of the deductions for dividends received to be sustained "the" principal purpose for the acquisition by Eccles of the stock of each petitioner must be tax avoidance. As we stated in Bush Hog Manufacturing Co., 42 T.C. 713">42 T.C. 713, 729 (1964),*306 "under section 269 petitioner need prove only that the evasion or avoidance of tax was not the 'principal purpose' in forming" the corporation. 362 The requirement of section 269 of acquisition of control by a person or a corporation after October 8, 1940, is, of course, met in this case since Eccles became the beneficial owner of all the stock of each petitioner at its formation in 1958. It is now settled that section 269 is applicable whether the contested tax benefit is claimed by the corporation control of which is acquired or by the person who acquired that control. Bush Hog Manufacturing Co., supra. Therefore, if the deduction for dividends received provided for under section 243 is a type of deduction encompassed within the provisions of section 269, the factual determination which must be made in this case is whether the principal purpose of Eccles in forming the two corporate petitioners was to secure the benefit of the deduction for dividends received. From the facts*307 in this case we do not doubt that at the time Eccles was planning the formation of each of petitioners, he considered the advantages which would result from transferring stocks greatly appreciated in value to these corporations as a contribution to capital so that the corporations would be able to borrow funds to finance real estate dealings on the basis of the appreciated values of the stock contributed to them even though Eccles would not have made a disposition of the stock in such a manner as to result in capital gains taxable to him. We do not doubt that in considering the formation of the corporations Eccles also considered the fact that the corporations would be entitled to deductions for 85 percent of the dividends received on the stocks which he contributed to them. In our view the fact that the corporations would be able to use the appreciated value of the stocks as security for amounts borrowed to finance the purchase of real properties under long-term leases was at least as important to Eccles in considering the formation of petitioners as was the fact that the corporations would have available to them the deduction for dividends received. However, in our view of the*308 facts the reason for the formation of Geoli was that Eccles had committed himself to acquire from Utah Construction Company two buildings which were then under construction by that company at such time as the building had been completed and leased for a long term. Eccles testified specifically that he committed himself to acquire the buildings prior to considering how title to the buildings would be taken and that after making the commitment to acquire the buildings he discussed that problem with his attorney. The attorney's testimony substantiated the testimony of Eccles. While the other benefits which might be derived by taking title to the properties in a corporation owned by Eccles were discussed by Eccles and the attorney prior to the actual incorporation of Geoli, our conclusion from the facts is that the advantages of holding income properties which were under long-term leases in a wholly owned corporation as distinguished from holding such property as an individual was a factor in Eccles' decision to form Geoli which was of at least equal weight to any other factor. The fact that the corporate acquisitions could be financed by borrowing on stocks which had appreciated in value, *309 thereby having Eccles personally in no way required to personally guarantee loans so as to be required to disclose his financial affairs to other directors of the banks of which he was an officer and director, was in our view likewise a factor of equal weight to any other factor influencing Eccles' formation of Geoli. The deduction for dividends received which the corporations would obtain with respect to the dividends paid on the stock transferred to them by Eccles was only one factor considered and it was only one of several of Eccles' purposes in forming Geoli. We therefore conclude that the evidence in this case does not support a finding that a tax avoidance purpose exceeded in importance any other purpose in the formation of Geoli and Eccdor. For this reason we hold that a tax avoidance purpose did not constitute the "principal purpose" of the acquisition by Eccles of control of Geoli and Eccdor. Commodores Point Terminal Corporation, 11 T.C. 411">11 T.C. 411, 418 (1948). We have considered the fact that prior to the completion of buildings which Eccles had originally committed himself to purchase, Eccles had agreed to purchase other property and the J.C. Penney Company Building*310 had been purchased by Geoli. However, this does not cause us to change our conclusion that a primary purpose in Eccles' formation of Geoli was to have that corporation take title to the properties he had agreed to purchase from Utah Construction Company. This fact merely shows that prior to the time that the purchase from Utah Construction Company 363 had been consummated, Eccles had arranged to have Geoli purchase other real property which was under long-term lease. It is not completely clear in the record why Eccles formed a second corporation to purchase the two California properties which he had agreed to purchase from Utah Construction Company. Eccles' testimony was to the effect that since these two properties were in California, he considered there to be some advantage in forming Eccdor and having these properties held by a separate corporation from Geoli which had by that time acquired properties in other States. He further testified that he later decided that there was no advantage in having Eccdor hold only California properties. Whatever the motivating factor in the formation of Eccdor about 5 months after Geoli was formed, there was no purpose of tax avoidance by obtaining*311 a deduction for dividends received since such a deduction could have been obtained as well by placing all the rental properties and all the contributed stocks in one as distinguished from two corporations. We therefore conclude that the principal purpose in the formation of Eccdor was not the avoidance of tax by receipt of a deduction for dividends received. Having concluded on the basis of the evidence in this case that the principal purpose of the formation of Geoli and Eccdor was not the avoidance or evasion of Federal income tax by securing the benefit of deductions for dividends received which would not have been available had those corporations not been formed, it is unnecessary for us to discuss whether a deduction for dividends received is within the purview of section 269. It might be noted that this issue has been inherent in two prior cases decided by this Court. 5 In both of these cases we concluded that the principal purpose of the acquisition was not tax avoidance and did not reach the question of the applicability of section 269 to disallow a deduction for dividends received, if any such issue was raised by the parties in either case. *312 Decision will be entered under Rule 50. Footnotes1. All references are to the Internal Revenue Code of 1954.↩2. While both respondent and petitioner requested the finding that George S. Eccles owned or was the sole beneficial owner of all of petitioners' stock, the chart of outstanding stocks found in the stipulation showed the 100 shares owned as follows: ↩NameNumber of sharesAmountGeorge S. Eccles96$ 960Delores Dore Eccles110S. J. Quinney110C. U. Benzley110Grace F. Madison110Total100$1,0003. The Eccles Hotel Bank Building is not a hotel but derives its name because it had been a hotel owned at an earlier date by the Eccles' family.↩1. The monthly rental rates are subject to adjustments based on increases in taxes or insurance when paid by petitioners. In all leases, except J.C. Penney, the lessee is liable for all property taxes, assessments, insurance, interior repairs and maintenances and exterior repairs and maintenances. [Petitioners are liable for exterior repairs and maintenance in the B.F. Goodrich lease and for the excess of $1,000 annually for interior and exterior repairs in the Skagg Drug Center Bldg. lease.] The terms of the lease for the Par-T-Pak Bldg. are not shown by the evidence.↩1. Individual figure not shown in the record. ↩2. Estimate from Eccdor's tax returns.↩1. The income tax return for 1963 shows dividends income in the amount of $63,464.62. The statutory notice of deficiency required that $837.50 be included in the dividend income. This adjustment was conceded by petitioner.↩4. SEC. 269. ACQUISITIONS MADE TO EVADE OR AVOID INCOME TAX. (a) In General. - If - (1) any person or persons acquire, or acquired on or after October 8, 1940, directly or indirectly, control of a corporation, or (2) any corporation acquires, or acquired on or after October 8, 1940, directly or indirectly, property of another corporation, not controlled, directly or indirectly, immediately before such acquisition, by such acquiring corporation or its stockholders, the basis of which property, in the hands of the acquiring corporation, is determined by reference to the basis in the hands of the transferor corporation, and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then the Secretary or his delegate may disallow such deduction, credit, or other allowance. For purposes of paragraphs (1) and (2), control means the ownership of stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote or at least 50 percent of the total value of shares of all classes of stock of the corporation.↩5. Commodores Point Terminal Corporation 11 T.C. 411">11 T.C. 411↩ (1948) and Armais Arutunoff, T.c. Memo. 1963-192. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619513/ | LOUIS COSTANZO, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. OLIVER MONACO, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Costanzo v. CommissionerDocket Nos. 21045, 21046.United States Board of Tax Appeals16 B.T.A. 1294; 1929 BTA LEXIS 2421; June 29, 1929, Promulgated *2421 1. The petitioners, on the dissolution of a corporation of which they were the principal stockholders, received liquidating dividends in excess of the amount of additional taxes subsequently assessed against the dissolved corporation. Held that the petitioners are transferees within the meaning of section 280 of the Revenue Act of 1926. 2. Where the period of limitation for assessment of taxes against the taxpayer did not expire until after the enactment of the Revenue Act of 1926, and the liability for unpaid taxes of the taxpayer was asserted against petitioners, as transferees, within one year after the expiration of such period, collection of the taxes is not barred. W. B. Francis, Esq., and Sion B. Smith, Esq., for the petitioners. Harold Allen, Esq., and W. R. Lansford, Esq., for the respondent. ARUNDELL*1294 These proceedings, which were consolidated for hearing and decision, involve the redetermination of the liability of the petitioners, as transferees, for unpaid income and excess-profits taxes of the Stellar Coal Mining Co., in the amount of $1,940.01 for the year 1919 and $4,601.72 for the year 1920. The issues*2422 are whether the petitioners are transferees within the meaning of section 280 of the Revenue Act of 1926, and whether collection of the taxes *1295 against the petitioners is barred by the statute of limitations. The cases were submitted on the pleadings and stipulation of facts. FINDINGS OF FACT. Oliver Monaco of Adena, Ohio, and Louis Costanzo of Wheeling, W. Va., were the principal stockholders, and president and vicepresident, respectively, of the Stellar Coal Mining Co., a corporation organized in February, 1918, with a capital stock of $70,000, to engage in the business of mining coal. Each petitioner owned approximately $26,000 of the corporation's stock. In June, 1920, the corporation sold its assets to the Woodward Coal Co. at a profit of $30,837.39. It was then liquidated and the stockholders thereof received their pro rata share of its assets. The sum received by each petitioner was in excess of the amount of the deficiencies proposed against them as transferees. The corporation was legally dissolved in April, 1921. The income-tax returns of the Stellar Coal Mining Co. for the years 1919 and 1920 were filed on March 13, 1920, and March 15, 1921, respectively. *2423 The tax disclosed by the returns was duly paid. On October 24, 1923, the respondent mailed to the Stellar Coal Mining Co. a letter, which read, in part, as follows: You will be given ten days from the date of this letter in which to verify computations at the end of which time the additional tax stated above will be assessed. The tax liability referred to for the year 1919 was $1,940.01, and for the year 1920, $4,601.72. The said additional taxes were assessed against the Stellar Coal Mining Co. on January 10, 1924, the assessments appearing on page 44 of the January, 1924, assessment list. No part of the additional taxes assessed has been paid. The notices forming the basis of these proceedings were mailed by respondent to the petitioners on September 7, 1926. The petitions were filed on November 4, 1926. No consent agreements have ever been filed by the petitioners. It has been stipulated that the assessment of $1,940.01 of the amount of the deficiencies determined against the petitioners is barred by the statute of limitations. OPINION. ARUNDELL: Petitioners contend that the term "transferee," as used in section 280 of the Revenue Act of 1926, is limited*2424 to heirs, legatees, devisees and distributees, the four classes named in subsection (f) of section 280. The statute does not define the meaning of the word *1296 "transferee." The language of section 280 (f) was not intended, as we held in , to limit the meaning of the term to the classes mentioned, but was inserted to eliminate any doubt that it included those four classes. On the dissolution of the Stellar Coal Mining Co., petitioners, as stockholders thereof, received liquidating dividends on their stock in excess of the amount of the liability the respondent has asserted against them for unpaid taxes of the dissolved corporation. The petitioners are clearly transferees of property of the Stellar Coal Mining Co. ; certiorari denied, ; ; . The respondent concedes that collection of the deficiency asserted for unpaid taxes of the taxpayer for the year 1919 is barred by the provisions of sections 277(a)(2) and 278(d) of the Revenue Act*2425 of 1924. The question is also governed by . The taxpayer's return for the year 1920 was filed March 15, 1921, and the statutory period for assessment against it for taxes for that year did not expire until March 15, 1926. Section 250(d) of the Revenue Act of 1918 and section 277(a)(2) of the Revenue Act of 1924. The additional tax of $4,601.72 asserted against the taxpayer for the year 1920 was assessed January 10, 1924, a date within the five-year period allowed by the statute for assessment. The provisions of section 280(b)(1) of the Revenue Act of 1926, enacted February 26, 1926, extended the period of limitation for assessment of any liability of the petitioners, as transferees, for unpaid taxes of the taxpayer, one year after the expiration of the period of limitations for assessment against the taxpayer, or to March 15, 1927. The deficiency notices were mailed to the petitioners on September 7, 1926, a date prior to the expiration of the statutory period for assessment against them. The petitions instituting these proceedings were filed on November 4, 1926. Section 280(d) of the Revenue Act of 1926 suspends the*2426 running of the period of assessment against transferees until the decision of the Board becomes final, and for 60 days thereafter. Section 278(d) of the Revenue Act of 1926 reads, in part, as follows: Where the assessment of any income, excess-profits or war-profits tax imposed by this title or by prior Act of Congress has been made (whether before or after the enactment of this Act) within the statutory period of limitation properly applicable thereto, such taxes may be collected by distraint or by a proceeding in court (begun before or after the enactment of this Act), but only if begun (1) within six years after the assessment of the tax * * *. *1297 This section of the Act is retroactive to taxes payable under the Revenue Act of 1918, and applies to the transferees. . It follows that the period within which collection may be made from the transferees has not expired. The liability of each petitioner is $4,601.72, plus interest from February 26, 1926, at the rate of 6 per cent per annum. *2427 . Judgment will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619515/ | SHELDEN LAND COMPANY, A MICHIGAN CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Shelden Land Co. v. CommissionerDocket No. 93196.United States Board of Tax Appeals42 B.T.A. 498; 1940 BTA LEXIS 993; August 8, 1940, Promulgated *993 1. Where the taxpayer corporation, nearly all of whose stock was held directly or beneficially by relatives of the same family, sold certain land to a second corporation whose stock was entirely owned by a trust for the benefit of two members of the family, and there was no option or agreement for reacquisition of the land by the taxpayer and it was sold at the market price, Held, a deduction in full for loss on the sale is not prevented by the provisions of section 24(a)(6) of the Revenue Act of 1934 and, since the sale was bona fide, must be allowed. 2. Losses suffered by petitioner as a result of foreclosure of properties owned by it are deductible in the year in which the equity of redemption expires. Ferris D. Stone, Esq., and Edward S. Reid, Esq., for the petitioner. Philip M. Clark, Esq., for the respondent. LEECH*498 This is a proceeding to redetermine a deficiency in income tax of $22,249.67 and a deficiency in excess profits tax of $8,059.54 for the calendar year 1934. There are two issues: Whether petitioner is entitled to deduct a loss on the sale of certain land to another corporation, and whether certain losses*994 suffered by petitioner as the result of foreclosures of properties owned by it are deductible in the year of foreclosure or in the year in which the equity of redemption expired. *499 FINDINGS OF FACT. Petitioner is a corporation, organized under the laws of Michigan. On December 26, 1934, its outstanding capital stock, of a total par value of $100,020, was owned as follows: Alger Shelden$22,666.67Henry Shelden40,666.67Allan Shelden trust10,666.66Allan Shelden III trust10,000.00William Warren Shelden trust10,000.00Squire trust$2,000.00Bronson trust2,000.00Alger Shelden trust2,000.00Hiram E. Hees10.00Fred E. Klockow10.00H. D. Shelden is the father, and Caroline A. Shelden, now deceased, was the mother of Alger Shelden, Henry Shelden, and Allan Shelden. Elizabeth Warren Shelden was the wife of Allan Shelden (now deceased), and Allan Shelden III and William Warren Shelden are their children. Hiram E. Hees and Fred E. Klockow are not related, either by blood or marriage, to any of the above named persons. The Allan Shelden trust was created March 10, 1920, the trustees being H. D. Shelden, Alger Shelden, and Henry*995 Shelden, and the settlor being Caroline A. Shelden. It provided that the trust income should be paid in such amounts as the trustees might deem advisable to Allan Shelden during his life, the remainder to be accumulated, that the corpus was to be paid to Allan Shelden upon his reaching 45, that if he died before then the trust estate was to be delivered to his children 21 years after his death, and that if none of them were then surviving, the distribution was to be made to other persons upon terms and conditions not here material. The Allan Shelden III trust was created December 30, 1916, with Allan Shelden as trustee and Elizabeth Warren Shelden as settlor. Its provisions were that the trust income was to be paid over to Allan Shelden III during his minority for his support and education, that the corpus was to be delivered to him upon his reaching 50, but that if he died before then, the income was to be paid over to his widow and children in the trustee's discretion, and the corpus distributed to them 21 years after his death. The William Warren Shelden trust was created December 22, 1919, with Allan Shelden as trustee. Elizabeth Warren Shelden succeeded to the trusteeship*996 upon the death of Allan Shelden. This trust was identical in its terms with the Allan Shelden III trust, except that William Warren Shelden was the beneficiary. The Squire trust was created on April 23, 1923, with Allan Selden as trustee and H. D. Shelden as settlor. Subsequently, Alger Shelden succeeded to the trusteeship. This trust provided that its income was to be paid to the children of Allan Shelden in such amounts as the trustee might deem advisable for their best interests, and that the *500 corpus was to be delivered to them when the oldest child should reach 40. Alternative dispositions of the corpus, upon terms and conditions not here material, were prescribed in the event that none of the children survived. The Bronson trust was created on April 13, 1923, with Alger Shelden as trustee and H. D. Shelden as settlor. Henry Shelden later succeeded to the trusteeship. Its terms were the same as those of the Squire trust, except that the beneficiaries were the children of Alger Shelden. The Alger Shelden trust was created on March 10, 1920, with H. D. Shelden, Allan Shelden, and Henry Shelden as trustees, and with Caroline A. Shelden as settlor. Its terms*997 were the same as those of the Allan Shelden trust, except that the beneficiary was Alger Shelden. The Warren Corporation is a corporation organized under the laws of Michigan. On December 24, 1934, its capital stock, consisting of 100 shares, was owned as follows: Elizabeth Warren Shelden51 sharesAllan Shelden III trust25 sharesWilliam Warren Shelden trust24 sharesOn December 24, 1934, the above stockholders transferred all their stock in the Warren Corporation to the Harrington trust, for which they received sums aggregating $403.32. The Harrington trust thus owned all the capital stock of the Warren Corporation on December 26, 1934. The Harrington trust was created December 21, 1923, with Allan Shelden as trustee and Allan Shelden, H. D. Shelden, and Caroline A. Shelden as settlors. Elizabeth Warren Shelden later succeeded to the trusteeship. It provided that its income should be paid to the children of Allan Shelden and Elizabeth Warren Shelden, in such amounts as the trustee might deem advisable for their best interests, and that the corpus was to be delivered to them when the oldest child should reach 40. Alternative dispositions, upon terms*998 not here material, were prescribed in case no child should survive. On December 24, 1934, the Harrington trust loaned the Warren Corporation $33,000. Several days prior to December 26, 1934, Allan Shelden made a gift of all his stock in petitioner to his brother, Henry Shelden. At the same time H. D. Shelden amde a gift of all his stock in petitioner in equal shares to Alger Shelden, Henry Shelden, and the Allan Shelden trust. On December 26, 1934, petitioner was the owner of 160 acres of land located in Wayne County, Michigan, which it had acquired in 1925 at a cost of $268,212.93. The acreage consisted of undeveloped farm land. Contiguous property, also owned by petitioner, had been developed *501 and subdivided. A number of houses had been erected on this contiguous property, which was known as Rosedale Gardens. Nearby properties had been sold for various prices, ranging from $150 to $195 an acre. On December 26, 1934, petitioner sold the above described land to the Warren Corporation for $32,446.79. On that day, the fair market value of this land was $200 per acre. The deeds of conveyance were duly recorded on December 27, 1934. Said acreage has never*999 been reconveyed to petitioner, nor has any agreement or option ever been entered into for petitioner's reacquisition of this acreage. Before making the sale, petitioner, through its agents, investigated the fair market value of the land in order to ascertain what was the best price that could be obtained. At the time of the sale, petitioner needed cash, since it owed about $100,000 in debts on land contracts, past due taxes, and various obligations. On December 31, 1934, petitioner retired certain of its outstanding bond issues for $250,031.45 less than their face value. On February 11, 1932, petitioner bought, for $500, certain premises in Detroit known as 585 Newport Avenue from Frederick M. Alger and wife. It acquired the premises subject to a mortgage running to the Detroit & Security Trust Co. as mortgagee. During 1932 the mortgage was foreclosed, the sheriff's deed being dated, January 13, 1933. The equity of redemption expired January 13, 1934, and petitioner surrendered possession of the premises on that date to the purchaser at the foreclosure sale. During the period of redemption petitioner collected the rents, issues, and profits of the property. On February 11, 1932, petitioner*1000 bought, for $307, certain premises in Detroit known as 15838 Normandy Avenue from Frederick M. Alger and wife. It acquired the premises subject to a mortgage running to the Detroit Trust Co. as mortgagee. During 1932 the mortgage was foreclosed, the sheriff's deed being dated January 13, 1933. The equity of redemption expired January 13, 1934, and petitioner surrendered possession of the premises on that date to the purchaser at the foreclosure sale. During the period of redemption petitioner collected the rents, issues, and profits of the property. On February 20, 1932, petitioner bought, for $2,100, certain premises in Detroit known as 4890 Yorkshire Avenue from John Rattenbury and wife. It acquired the premises subject to a mortgage running to the Detroit Trust Co. as mortgagee. During 1933 the property was foreclosed, the sheriff's deed being dated April 11, 1933. The equity of redemption expired April 11, 1934, and on that date petitioner surrendered possession of the premises to the purchaser at the foreclosure sale. During the period of redemption petitioner collected the rents, issues, and profits of the property. *502 On April 2, 1931, petitioner bought, *1001 for $2,268, certain premises in Detroit known as 9316 Stoepel Avenue from Nina W. Van Tifflin. It acquired the premises subject to a mortgage running to the Northwestern State Bank as mortgagee. The property was foreclosed during 1933, the sheriff's deed being dated July 27, 1933. The equity of redemption expired July 27, 1934, and on that day petitioner surrendered possession of the premises to the purchaser at the foreclosure sale. It is stipulated that petitioner is not entitled to a loss of $700 in respect of certain other property, known as 15793 Mendota Avenue, also foreclosed. The total foreclosure loss in issue is thus $5,175. OPINION. LEECH: The first issue arises out of respondent's disallowance of a loss of $235,766.14 which petitioner claims as a result of the sale of land made by it to the Warren Corporation. Respondent's action is predicated on two propositions, first that the sale falls within section 24(a)(6) of the Revenue Act of 1934, and, second, that the interfamily character and other circumstances of the transactions in connection with the sale contradict its bona fides and render the sale a nullity for tax purposes. Section 24(a)(6) disallows*1002 any deduction for "loss from sales or exchanges of property, directly or indirectly, (A) between members of a family, or (B) except in the case of distributions in liquidation, between an individual and a corporation in which such individual owns, directly or indirectly, more than 50 per centum in value of the outstanding stock. For the purpose of this paragraph - (C) an individual shall be considered as owning the stock owned, directly or indirectly, by his family; and (D) the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants." The net result of the sale here was that petitioner, the greater part of whose stock was held directly or beneficially by various relatives of the Shelden family, transferred certain property to the Warren Corporation, all of whose stock was held in trust for the benefit of the two children of Allan and Elizabeth Warren Shelden. Considering the factual situation against the provisions of the statute, we do not think the section can be applied. Subsection (A) of the quoted statutory provision specifies sales, directly or indirectly, between members of a family. *1003 To hold that this was a sale between members of the same family would require not only the disregard of several trust entities, as well as two corporate entities, but also the specific language of subsection (D) of the same statute. *503 It is true that, in determining the number of $5,000 exclusions in connection with gifts to trusts, it has been held that such exclusions apply separately to each beneficiary rather than, as formerly, to the trust itself. . "But the very doubt which has affected the question as to trusts strengthens the conclusion that a gift to a corporation may not be treated as a group of gifts to its shareholders." . Here the seller and purchaser are both bona fide corporations. And, no such circumstances are discernible as would warrant our disregard of the entities of these two corporations. ; ; *1004 . But, even if the separate entities of the several trusts and corporations here involved be ignored, the sale was not between "members of a family", as that term is defined in section 24(a)(6)(D), supra. The individuals owning the stock of the buying corporation, under the provisions of section 24(a)(6)(C), supra, were William Warren Shelden and Allan Shelden III. But, in the petitioner, the seller, these individuals owned, both actually and constructively, as described in subsection 24(a)(6)(C), supra, only the stock held in the Allan Shelden III trust, the William Warren Shelden trust, the Allan Shelden trust and the Squire trust. The aggregate of the par value of all of this stock is $32,666.66, which is substantially less than the 50 percent ownership which section 24(a)(6)(B), supra, requires. The majority stock of the seller, i.e., $63,333.34 in par value, is owned by their uncles, Alger and Henry Shelden, who are not "brothers and sisters, spouses, ancestors, or lineal descendants" of William Warren and Allan Shelden III. The controlling statute does contain the ambiguous expression "directly or indirectly.*1005 " (Emphasis supplied.) But there appears to be no legislative history resolving that uncertainty or, at least, none that can give respondent any encouragement here. 1 We, therefore, refuse to construe it as including the present situation. See Subsection (B) of section 24(a)(6) singles out sales between an individual and a corporation in which the individual owns more than 50 percent in value of outstanding stock. This provision is clearly inapplicable here, since petitioner, the vendor, is a corporation. Congress amended section 24(a)(6), supra, in several respects in section 301 of the Revenue Act of 1937. That section, as thus amended, disallows losses, in addition to the instances already covered by section 24(a)(6), in exchanges between corporations where more than 50 percent of the value of the outstanding stock in each of which is owned *504 by or for the same individual, provided either one of such corporations is a personal holding company. The section, as amended, also provides that where a trust is involved, the beneficiaries*1006 shall be considered as owners of stock held by the trust, and where a corporation is involved, a person shall be considered as owning stock owned by members of his "family." Assuming that the Warren Corporation is a personal holding company, section 301 of the 1937 Act would nevertheless not apply here, even if it were, as argued by respondent, a mere clarification of existing law. As already discussed, under the specific terms of the statute, the individuals owning the stock of the Warren Corporation, the purchaser, owned less than 50 percent of the stock of the taxpayer, the selling corporation. We therefore conclude that the deduction of the loss on the present transaction is disallowed by neither the 1934 nor the 1937 Revenue Act. Cf. . Petitioner needed the money, arising from the transaction, to meet pressing obligations. The fair market value of the land was subjected to an investigation, from which it was determined that $32,446.79 was the best price that could be obtained for the acreage. Petitioner proved by an expert witness, whose testimony was unchallenged, that the fair market value of the land sold was $200*1007 per acre, or a total of $32,000. The consideration for the purchase was not furnished by the seller, petitioner, nor any of its stockholders. There was no agreement or option for reacquisition by the petitioner, nor was the property ever reconveyed to the petitioner. Consequently, we think, the second premise, upon which respondent denied any loss on this sale, is likewise without merit. ; affd., , and ; ; ; ; ; ; ; ; affd., ; ; ; ; *1008 . Respondent contends that petitioner's loss on the sale to the Warren Corporation, if otherwise allowable, is allowable only to the extent of $2,000 under section 117 of the Revenue Act of 1934 because the property was a capital asset. This contention was made neither in the deficiency letter nor in the pleadings and is raised for the first time on brief. Respondent has thus made no determination that the property in question was a capital asset, and no presumption to that effect can properly be entertained. Indeed, since contiguous property had been developed, subdivided and sold, it is likely that petitioner was merely awaiting a favorable time to accord this tract of land the same *505 treatment and that this fact could easily have been shown had the issue been timely raised. In any event, we will not consider the question now, especially since petitioner, not having been apprised in advance of the hearing of respondent's reliance on this ground, would thereby be seriously prejudiced and robbed of an opportunity to offer proof on the point. *1009 , and cases therein cited. Accordingly, we hold that the loss suffered by petitioner upon the sale of its property to the Warren Corporation may be deducted in full. This conclusion is not affected by the fact that petitioner may have made the sale in order to reduce its tax liability on account of retirement of bonds at less than face value. Without now deciding whether petitioner realized income by reason of such retirement, it is well settled that a transaction is not vitiated because motivated by a desire to reduce taxes. ; ; . Respondent disallowed petitioner's foreclosure loss on the sole ground that the loss occurred in the year of foreclosure rather than the year in which the equity of redemption expired. It is settled, however, that it is the expiration of the period of redemption which is the indentifiable event fixing such a loss. *1010 ; ; affd., . See also . The case of , upon which respondent relies, is distinguishable in that there an abandonment of worthless property occurred in the year of foreclosure. Here, far from abandoning the property, petitioner remained in possession and collected rents, issues, and profits during the period of redemption. We hold that petitioner is entitled to deduct a loss of $5,175 by reason of the foreclosures of its properties. In view of the stipulation of the parties that petitioner is not entitled to a loss of $700 in respect of certain other property which was foreclosed, Reviewed by the Board. Decision will be entered under Rule 50.Footnotes1. See Seidman, Legislative History of Federal Income Tax Laws, pp. 316, 317. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619662/ | William T. Wheeling and Antonette L. Wheeling v. Commissioner.Wheeling v. CommissionerDocket No. 3468-62.United States Tax CourtT.C. Memo 1964-128; 1964 Tax Ct. Memo LEXIS 206; 23 T.C.M. (CCH) 778; T.C.M. (RIA) 64128; May 7, 1964Charles J. Higson, for the petitioners. Michael P. McLeod, for the respondent. FAYMemorandum Findings of Fact and Opinion FAY, Judge: The Commissioner determined deficiencies of $931.12 and $588.25, respectively, in petitioners' income tax for the calendar years 1958 and 1959. The sole issue remaining for decision is whether William T. Wheeling correctly reported certain amounts received by him as long-term capital gains arising from the sale of a partnership interest pursuant to section 741 1 or whether these amounts represented his distributive share of partnership income taxable as ordinary income under*208 section 736(a). All other issues raised by the pleadings have been settled by agreement between the parties. Findings of Fact Some of the facts have been stipulated, and the stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference. William T. Wheeling (hereinafter referred to as petitioner) and Antonette L. Wheeling are husband and wife and filed their joint income tax returns for the calendar years 1958 and 1959 with the district director of internal revenue at Los Angeles, California. Petitioner has been a certified public accountant since 1946 and a public accountant since 1928. He engaged in the practice of public accounting in the Los Angeles area as a sole proprietorship from 1928 until sometime in the latter part of 1953. During 1953 petitioner, who was then 62 years of age, began to consider the possibilities of retirement. In connection therewith be ran an advertisement in a local professional journal indicating that he was interested in combining his practice with that of a younger accountant so that*209 he could eventually dispose of it. At that time petitioner had approximately 100 clients, 60 to 75 of which had been with him for over 20 years. In response to his advertisement petitioner was contacted by John W. Sunderman (hereinafter referred to as Sunderman) who was also an accountant with a substantial practice in the Los Angeles area. Sunderman was interested in combining his practice with that of petitioner's for the principal purpose of increasing the volume of his operations and obtaining petitioner's clients upon petitioner's retirement. Sunderman had an associate named Stanley L. Miller (hereinafter referred to as Miller). After some preliminary negotiations between these three individuals, they decided to combine their practices by entering into a partnership. As a fundamental condition to the formation of the partnership, it was agreed that petitioner would terminate his association with the partnership after a relatively short period of time and that he would be paid for his practice. It was further agreed that the amount petitioner would receive for his partnership interest would be determined by reference to a percentage of the gross fees received by Sunderman and*210 Miller from petitioner's former clients during the three years following petitioner's retirement. There was some disagreement between petitioner and Sunderman as to the exact percentage that would be used in determining the amount to be paid to petitioner. Nevertheless, petitioner, Sunderman and Miller commenced their partnership on November 1, 1953, pursuant to an oral agreement, despite the fact that they had not agreed upon the specific amount petitioner would receive upon his withdrawal from the firm. On October 28, 1954, when these three individuals had finally resolved this dispute and the press of their accounting work permitted them to do so, they entered into a written partnership agreement which was made retroactive to November 1, 1953. The partnership agreement provided initially that the partnership would be known as Sunderman, Wheeling and Co., and that after specified monthly salaries, Sunderman and Miller would receive 85 percent of the partnership profits and petitioner would receive 15 percent. By amendment dated December 2, 1955, petitioner's interest was increased to 20 percent. Paragraph 10 of the partnership agreement set forth the terms and conditions for the*211 sale of petitioner's partnership interest. It provided as follows: 10. On August 31, 1956, WHEELING agrees to retire from the partnership and sell his interest therein to SUNDERMAN and MILLER upon the terms hereinafter set forth, and SUNDERMAN and MILLER jointly and severally agree to purchase on August 31, 1956, the interest of WHEELING upon the terms hereinafter set forth. It is the intention of SUNDERMAN and MILLER to continue as partners after August 31, 1956, upon the terms and conditions herein set forth until such time as one of them retires or dies or terminates the partnership upon reasonable notice to the other. Reasonable notice shall be a minimum of sixty (60) days. None of the partners shall have the right to terminate the partnership prior to August 31, 1956. The terms of the purchase and sale to take place on August 31, 1956 are as follows: Of the gross fees billed Wheeling's clients for each of the three year periods beginning September 1, 1956, Wheeling is to receive 25% thereof payable quarterly as collected e.g., $20,000 fees billed the first year Wheeling is to receive $5,000; 2nd year gross fees billed $22,000 Wheeling is to receive $5,500; 3rd year gross fees*212 billed $24,000 Wheeling is to receive $6,000; Sunderman and Miller must purchase accounts that, for the six month period from March 1, 1956 to August 31, 1956, have been billed to clients at $5.00 or more per hour. On February 28, 1956, or as soon after as is practicable, Wheeling's accounts are to be reviewed. Sunderman and Miller are to then advise Wheeling which accounts that are yielding less than a $5.00 per hour charge to client they do not wish to purchase at above figure of 25% per year for three years. Wheeling may then offer these accounts for sale to any other accountants. Sunderman and Miller are to have right of first refusal at highest price offered. During the life of this contract Sunderman and Miller, and each of them, will at all times exercise due care and caution in the integration of Wheeling's practice with their own to see that harmonious relations are maintained with Wheeling's clients and to insure Wheeling of their agreement and their best efforts to keep Wheeling's clients, purchased by them, satisfied with their services and to do everything possible to insure collection of accounts. * * *In the event of a breach of this contract the partner*213 or partners in default shall be liable, in addition to any and all damages and liabilities legally collectible or enforceable, for court costs and reasonable attorneys' fees incurred by the aggrieved party. As aforesaid, the liability to purchase the interest of Wheeling on August 31, 1956 shall be joint and several. Wheeling agrees that on and after August 31, 1956 he will not compete with Sunderman and Miller in the County of Los Angeles, State of California, so long as this contract is not in default. The moneys collected from Wheeling's clients beginning September 1, 1956, to the extent of the percentage thereof payable to Wheeling, shall be deemed to be held by the purchasers for the benefit of Wheeling. Complete records shall be kept with respect to all matters in connection with this agreement and Wheeling and/or his appointed representative shall have the right at all reasonable times to inspect and copy any or all of said records. A subsequent portion of the partnership agreement dealt with the division of partnership profits and capital upon the retirement or death of any partner or the termination of the partnership. It provided as follows: 12. On the retirement of*214 Wheeling on August 31, 1956 and/or upon any termination of the partnership or upon the death or withdrawal of any partner then, in addition to the other divisions or payments provided for herein, all uncollected charges for services rendered by the partnership shall be tabulated and each partner given credit for his share of the profits thereon. A copy of this tabulation shall be furnished each partner. Such share of the profits shall be payable as and when collected from each of the clients. Any and all accumulated profits which have not been added to the capital account shall be divided among the partners according to the division provided in this agreement. The capital account represented by cash invested or office furniture and equipment invested and/or profits added thereto shall be payable within thirty (30) days according to the proportions of the capital contributions of the partners. Because the operation of the partnership, as thus constituted, proved successful, it was decided that the date upon which petitioner was required to withdraw from the partnership, August 31, 1956, would be postponed. Therefore, by instrument dated December 2, 1955, the partnership agreement*215 was amended so that petitioner would not have to sever his connection with the partnership until August 31, 1957. In February 1957, the partners, pursuant to the terms of the partnership agreement, prepared two schedules, one setting forth all of the clients petitioner had brought to the partnership and the other setting forth a portion of these clients (essentially, but not exclusively, those which fees averaged less than $5.00 per hour) which were to be retained by petitioner upon his withdrawal. The purpose of these schedules was to record specifically the accounts with regard to which the amounts payable to petitioner would be determined. During the period petitioner was a member of the partnership, he used his best efforts to introduce his clients to Sunderman and Miller. As of August 1957, all of the accounts which were to be transferred to Sunderman and Miller were being serviced by them and had been so serviced for the preceding six months. On August 31, 1957, petitioner severed his association with Sunderman, Wheeling and Co. He took his files and working papers relating only to the clients he was to retain after that date. He left the files and working papers relating*216 to his former clients with Sunderman and Miller. On September 20, 1957, petitioner, Sunderman and Miller entered into an agreement (hereinafter referred to as the settlement agreement) which was in the nature of a settlement of the partnership accounts up to and including August 31, 1957. Essentially, the agreement provided for the payment to petitioner of his share of the partnership capital and the uncollected fees of the firm as of the date of petitioner's withdrawal. More specifically, the settlement agreement, in pertinent part, provided: 2. The capital account of William T. Wheeling, as evidenced by the attached Exhibit "A", is in the sum of $4241.93. Concurrently herewith J. Wm. Sunderman and Stanley L. Miller shall pay said sum to William T. Wheeling whose execution hereof shall acknowledge receipt of said sum. 3. Each party hereto has received a list of accounts receivable due to Sunderman, Miller and Wheeling as of August 31, 1957, and aggregating $16,307.64. Under the terms of the agreement between the parties William T. Wheeling is entitled to receive twenty percent (20%) of all monies collected from the clients designated on said list of accounts receivable. J. Wm. *217 Sunderman and Stanley L. Miller agree to pay to William T. Wheeling a sum equal to twenty percent (20%) of all sums hereafter collected in connection with the aforementioned accounts receivable. Payment shall be made to William T. Wheeling on the 10th day of each month hereafter commencing October 10, 1957, and continuing for so long as payments continue to be received in connection with said accounts. Each payment shall cover the period of the immediately preceding calendar month. Each payment shall be accompanied by a brief statement setting forth the names of the clients and the amount of payment received from such clients during the calendar month in question. The settlement agreement concluded with the following paragraphs: 4. The parties hereby ratify all of the provisions of the agreement of October 28, 1954, and the supplements and amendments of December 2, 1955, and February 2, 1957. The partnership heretofore existing between the parties by reason of said agreements is dissolved as of August 31, 1957. 5. This agreement shall be binding upon the parties, their respective heirs, executors and assigns. The schedule attached to the settlement agreement showed that petitioner*218 was entitled to 20 percent of the partnership profits up to and including August 31, 1957, or $7,851.23, of which $3,261.53 represented accounts receivable not yet collected as of that date. Petitioner was paid in cash for his share of the partnership capital and his share of the partnership profits which had been collected. Subsequently, he received 20 percent of amounts collected upon the firm's accounts receivable owed as of August 31, 1957. Petitioner reported his share of the firm's profits, including the receivables, as ordinary income. Upon petitioner's withdrawal from the partnership, Sunderman and Miller continued as partners pursuant to the provisions of the partnership agreement of October 28, 1954. Pursuant to the terms of the partnership agreement, the petitioner received for his partnership interest $4,593.88 in 1958 and $5,132.65 in 1959, which amounts were determined with reference to a percentage of the gross fees billed to petitioner's former clients. In 1958 Sunderman and Miller furnished petitioner with a Form 1099 indicating that the $4,593.88 received by him in 1958 constituted a "Payment on purchase of practice." That portion of the gross fees billed to petitioner's*219 former clients, payable to petitioner, was credited to the gross income. Then, when paid to petitioner, it was debited directly against the firm's gross income. Thus, these amounts were never included in the taxable income of the partnership at the end of its taxable year. Respondent, in his notice of deficiency, determined that the $4,593.88 and $5,132.65 reported by petitioner as long-term capital gains for the years 1958 and 1959 actually should have been included in petitioner's income in full as his share of partnership income. Opinion On August 31, 1957, petitioner's association with the partnership came to an end. Petitioner contends that he sold his partnership interest to Sunderman and Miller pursuant to section 741 and realized long-term capital gain in connection therewith. 2 In the alternative, petitioner argues that, in essence, what actually occurred was that he sold the goodwill of his accounting practice to Sunderman and Miller; that the partnership was merely a temporary conduit to facilitate the transfer of petitioner's accounting practice to Sunderman and Miller; that the partnership was liquidated on August 31, 1957; and that the sale of the goodwill attaching*220 to his accounting practice had nothing to do with the termination of the partnership. Respondent, on the other hand, contends that all the amounts received by petitioner were paid by the partnership in liquidation of petitioner's interest therein pursuant to section 736. 3 Respondent, furthermore, maintains that the $4,593.88 and $5,132.65 received by petitioner during 1958 and 1959 were in liquidation of his goodwill in the partnership, and since the partnership agreement did not specifically provide for a payment with respect to goodwill, these amounts constitute petitioner's distributive share of partnership income under section 736(a). *221 It is clear that a partnership interest may be sold to one or more members of the partnership. David A. Foxman, 41 T.C. 535">41 T.C. 535 (1964). Respondent's regulations specifically cover this point. Thus, section 1.741-1(b) of the Income Tax Regulations provides: Section 741 shall apply whether the partnership interest is sold to one or more members of the partnership or to one or more persons who are not members of the partnership. * * * In such instances, the provisions of section 736 relating to the liquidation of a partnership interest are not applicable. See section 1.736-1(a)(1)(i) of the Income Tax Regulations: Sec. 1.736-1 Payments to a retiring partner or a deceased partner's successor in interest. (a) Payments considered as distributive share or guaranteed payment. (1)(i) Section 736 and this section apply only to payments made to a retiring partner or to a deceased partner's successor in interest in liquidation of such partner's entire interest in the partnership. See section 761(d). * * * Section 736 and this section apply only to payments made by the partnership and not to transactions between the partners. *222 Thus, a sale by partner A to partner B of his entire one-fourth interest in partnership ABCD would not come within the scope of section 736. The fundamental question for decision, therefore, is whether petitioner sold his partnership interest to Sunderman and Miller as individuals or whether the arrangement was merely that the surviving partnership of Sunderman and Miller would "buy out" petitioner's interest therein. As this Court has recently noted, the real controversy, in situations similar to the one now before us, is between the withdrawing partner and the remaining partners. 4David A. Foxman, supra. See also Karan v. Commissioner, 319 F. 2d 303 (C.A. 7, 1963), affirming a Memorandum Opinion of this Court; V. Zay Smith, 37 T.C. 1033">37 T.C. 1033 (1962), affd. 313 F. 2d 16 (C.A. 10, 1962); and Jackson Investment Company, 41 T.C. - (February 26, 1964). Congress, in enacting sections 736 and 741, intended to permit partners to control the tax results, inter sese, upon the withdrawal of a partner. Because of this policy, we must carefully examine the arrangements which the partners have made among themselves. Since the practical differences*223 between (1) a sale of a partnership interest and (2) a liquidation by the partnership of such interest are slight, if such differences exist at all, the resolution of this issue often turns upon the specific wording of the partnership agreement and the rights and liabilities created thereby. An examination of the various instruments involved herein, as well as of the other relevant evidence in the record, leads us to*224 conclude that petitioner sold his interest in the partnership to Sunderman and Miller, as individuals. The partnership agreement of October 28, 1954, indicates the petitioner intended to sell his partnership interest, and Sunderman and Miller intended to purchase it. Thus, the agreement, in paragraph 10 thereof, provides that [PETITIONER] agrees to retire from the partnership and sell his interest therein to SUNDERMAN and MILLER upon the terms hereinafter set forth, and SUNDERMAN and MILLER jointly and serverally agree to purchase * * * the interest of [PETITIONER] * * *. After setting forth the purchase price for petitioner's partnership interest, namely 25 percent of the gross fees billed petitioner's former clients during the three years subsequent to petitioner's withdrawal, the partnership agreement again provides: As aforesaid, the liability to purchase the interest of [petitioner] * * * shall be joint and several. * * * The partnership formed by petitioner, Sunderman and Miller was formed in California and engaged in business in that State. Therefore, it is subject to the laws of California. Under California law, the liability of a partner is joint and several*225 only for the wrongs or torts committed by a partner (Cal. Corp. Code, § 15013) or the misapplication by a partner of money or property of a third party (Cal. Corp. Code § 15014). For all other partnership liabilities their obligation is merely joint. See section 15015, Cal. Corp. Code. 5 Therefore, it is clear that the obligation to purchase petitioner's partnership interest was an individual obligation of both Sunderman and Miller. We find nothing in any of the instruments relating to the arrangements between petitioner and Sunderman and Miller nor anywhere else in the record that is inconsistent with our conclusion that petitioner's interest in the partnership was sold to Sunderman and Miller as individuals. The fact that the purchase price for petitioner's interest was to be determined on the basis of a percentage of the gross*226 fees charged petitioner's former clients does not alter this conclusion. For this merely amounted to a method for valuing petitioner's partnership interest. In no way does it detract from the fact that Sunderman and Miller were each individually obligated to pay petitioner, for his partnership interest, an amount equal to 25 percent of the gross fees billed petitioner's former clients for the three-year period beginning upon petitioner's withdrawal from the firm. 6Moreover, there is nothing in the settlement agreement of September 20, 1957, which is inconsistent with our conclusion. The settlement agreement merely ratifies all of the provisions of the partnership agreement, as amended, and more specifically implements*227 the provisions thereof concerning the payment to petitioner of his share of the partnership capital and earned profits, including accounts receivable for fees earned, but uncollected as of August 31, 1957. In fact, if anything, the particular language of the settlement agreement suggests that Sunderman and Miller are individually obligating themselves to make the payments therein described. Thus, in pertinent part, the settlement agreement provides: 2. The capital account of [petitioner] * * * is in the sum of $4241.93. Concurrently herewith J. Wm. Sunderman and Stanley L. Miller shall pay said sum to [petitioner] whose execution hereof shall acknowledge receipt of said sum. 3. Each party hereto has received a list of accounts receivable as of August 31, 1957, and aggregating $16,307.64. Under the terms of the agreement between the parties [petitioner] is entitled to receive twenty percent (20%) of all monies collected from the clients designated on said list of accounts receivable. J. Wm. Sunderman and Stanley L. Miller agree to pay to [petitioner] a sum equal to twenty percent (20%) of all sums hereafter collected in connection with the aforementioned accounts receivable. *228 * * * 7The fact that petitioner was paid for his interest in the partnership with a check drawn on the account of the remaining partnership can in no way alter the liabilities of the individuals, Sunderman and Miller, arising from the partnership agreement, as amended. Nor can the individual liabilities of these two individuals be altered by the bookkeeping transactions employed by their partnership to reflect the amounts paid to petitioner. For if the partnership of Sunderman and Miller had not paid these amounts to petitioner, Sunderman and Miller, each, would have been individually liable to pay the full amount. On the basis of the evidence before us, it is our conclusion that the transaction before us falls within the language of section 741. Karan v. Commissioner, supra.Moreover, it is also our opinion*229 that it comes within the purpose of section 741. It is not a mere device to convert ordinary income to capital gains. Cf. Roth v. Commissioner, 321 F. 2d 607 (C.A. 9, 1963), affirming 38 T.C. 171">38 T.C. 171 (1962). The sale of an accounting practice has upon numerous occasions been held to constitute the sale of a capital asset. Rodney B. Horton, 13 T.C. 143">13 T.C. 143 (1949); Richard S. Wyler, 14 T.C. 1251">14 T.C. 1251 (1950); and Malcolm J. Watson, 35 T.C. 203">35 T.C. 203 (1960). In view of our decision as to petitioner's first contention, it is not necessary for us to consider his alternative argument. Decision will be entered under Rule 50. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended.↩2. SEC. 741. RECOGNITION AND CHARACTER OF GAIN OR LOSS ON SALE OR EXCHANGE. In the case of a sale or exchange of an interest in a partnership, gain or loss shall be recognized to the transferor partner. Such gain or loss shall be considered as gain or loss from the sale or exchange of a capital asset, except as otherwise provided in section 751 (relating to unrealized receivables and inventory items which have appreciated substantially in value.) ↩3. SEC. 736. PAYMENTS TO A RETIRING PARTNER OR A DECEASED PARTNER'S SUCCESSOR IN INTEREST. (a) Payments Considered as Distributive Share or Guaranteed Payment. - Payments made in liquidation of the interest of a retiring partner or a deceased partner shall, except as provided in subsection (b), be considered - (1) as a distributive share to the recipient of partnership income if the amount thereof is determined with regard to the income of the partnership, or (2) as a guaranteed payment described in section 707(c) if the amount thereof is determined without regard to the income of the partnership. (b) Payments for Interest in Partnership. - (1) General Rule. - Payments made in liquidation of the interest of a retiring partner or a deceased partner shall, to the extent such payments (other than payments described in paragraph (2)) are determined, under regulations prescribed by the Secretary or his delegate, to be made in exchange for the interest of such partner in partnership property, be considered as a distribution by the partnership and not as a distributive share or guaranteed payment under subsection (a). (2) Special Rules. - For purposes of this subsection, payments in exchange for an interest in partnership property shall not include amounts paid for - (A) unrealized receivables of the partnership (as defined in section 751(c)), or (B) good will of the partnership, except to the extent that the partnership agreement provides for a payment with respect to good will.↩4. If the transaction is found to be a sale, any gain reported by the withdrawing partner would be taxable as a capital gain (in the event none of the gain was attributable to unrealized receivables or substantially appreciated inventory as defined in section 751). If the transaction was found to constitute a liquidation pursuant to section 736, the amounts received by the withdrawing partner (to the extent they are not received in exchange for his partnership property pursuant to section 736(b)(1)) would constitute ordinary income. Moreover, to the extent the amounts received by the withdrawing partner are treated as payments pursuant to section 736(a), such amounts would not be included in the distributive share of partnership income of the remaining partners.↩5. § 15015. Joint and several liability of partners. All partners are liable (a) Jointly and severally for everything chargeable to the partnership under Sections 15013 and 15014. (b) Jointly for all other debts and obligations of the partnership; but any partner may enter into a separate obligation to perform a partnership contract. * * *↩6. The fact that the amount payable to petitioner is determined by reference to the fees paid by merely a portion of petitioner's former clients is not inconsistent with our conclusion that petitioner sold his entire partnership interest to Sunderman and Miller. The consideration for the remaining portion of petitioner's partnership agreement could be regarded as the relinquishment by Sunderman and Miller of whatever rights they had in petitioner's remaining clients.↩7. Petitioner reported his share of the partnership accounts receivable as ordinary income when received by him. This fact is consistent with our determination that sec. 741 is applicable to the disposition of petitioner's partnership interest; for the amounts collected upon the receivables would appear to be taxable as ordinary income under sec. 751.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4669054/ | In The
Court of Appeals
Seventh District of Texas at Amarillo
No. 07-19-00427-CV
TOMORROW TELECOM, INC. AND TOMORROW WEST, LLC, APPELLANTS
V.
JEREMY JOHNSON, APPELLEE
On Appeal from the 237th District Court
Lubbock County, Texas
Trial Court No. 2017-527,516, Honorable Les Hatch, Presiding
March 11, 2021
MEMORANDUM OPINION
Before QUINN, C.J., and PIRTLE and PARKER, JJ.
This appeal results from a judgment rendered on a Rule 11 agreement between
the parties to this suit, appellants Tomorrow Telecom, Inc. (Telecom) and Tomorrow
West, LLC (West), and appellee Jeremy Johnson. By their appeal, Telecom and West
challenge the finality of the trial court’s judgment and urge four alternative issues. We
reverse the trial court’s judgment.
Background
Johnson sued Telecom and West for unlawful employment practices under the
Texas Labor Code, claiming violations on the basis of sex. The parties signed a Rule 11
agreement and agreed to settle “all claims between [Johnson] and [Telecom and West]”
and to “suspend all current settings in this cause for [d]epositions, [h]earings, or the like.”
The Rule 11 agreement called for a payment to Johnson no later than April 30, 2019, a
nonsuit with prejudice upon payment, and completion of a “separate settlement
agreement intended to be global in nature for the mutual purpose of settling all claims
between the [p]arties, whether pled or unpled.”
Disputes arose between the parties surrounding the separate agreement and
Johnson filed a motion to enforce the Rule 11 agreement, a motion for sanctions, and a
request for attorney’s fees. Telecom and West filed a notice of revocation and withdrawal
of consent of the Rule 11 agreement, citing an inability to resolve the settlement terms.
Johnson then filed a motion for partial summary judgment on his amended motion to
enforce the Rule 11 agreement, motion for sanctions, and request for attorney’s fees.
Telecom and West filed a response to both motions.
The trial court signed an order granting Johnson’s motion for partial summary
judgment, finding the Rule 11 agreement was valid and enforceable and that Telecom
breached the terms of the agreement. The trial court set a hearing on Johnson’s requests
for sanctions and attorney’s fees. After hearing, the trial court denied Johnson’s request
for sanctions by a separate order, and granted Johnson’s attorney’s fees and conditional
appellate attorney’s fees request. The trial court’s judgment incorporated the “findings
2
and orders” contained in the motion for partial summary judgment, ordered Telecom and
West’s compliance with the Rule 11 agreement by delivering the settlement funds of
$21,000 to Johnson’s counsel, and assessed attorney’s fees.
Telecom and West timely appealed the trial court’s judgment.
Discussion and Law
Final Judgment
Telecom and West initially contend that the judgment is not a final judgment for
purposes of appeal “because it relies solely upon a partial motion for summary judgment
and associated request for attorney’s fees, not the live pleadings of the parties or the Rule
11 Agreement.” They further allege that the judgment is interlocutory because it “fails to
afford [Telecom and West] any relief it should have received” from the Rule 11 agreement.
A final judgment is one that disposes of all parties and all issues in a lawsuit.
Lehmann v. Har-Con Corp., 39 S.W.3d 191, 205 (Tex. 2001). In determining whether the
judgment is final, different presumptions apply depending on whether the judgment
follows a conventional trial on the merits or results from summary judgment proceedings.
Id. When there has not been a conventional trial on the merits, “a judgment is not final
for purposes of appeal unless it actually disposes of every pending claim and party or
unless it clearly and unequivocally states that it finally disposes of all claims and all
parties.” Id. “Although no ‘magic language’ is required, a trial court may express its intent
to render a final judgment by describing its action as (1) final, (2) a disposition of all claims
and parties, and (3) appealable.” Bella Palma, LLC v. Young, 601 S.W.3d 799, 801 (Tex.
2020) (per curiam). The law does not require that a final judgment be in any particular
3
form. Lehmann, 39 S.W.3d at 195. A judgment that actually disposes of every remaining
issue in a case is not interlocutory merely because it recites that it is partial or refers to
only some of the parties or claims. Id. at 200.
The judgment here is titled, “Final Judgment.” The judgment references the
previously granted motion for partial summary judgment and incorporates “all findings and
orders contained in that ruling.”1 The decretal language in the judgment orders Telecom
and West to “comply with the terms of the Rule 11 agreement” and “deliver the settlement
funds of $21,000” to Johnson’s counsel, awards trial and appellate attorney fees,
assesses costs, and provides Johnson with writs and process necessary to enforce and
collect the judgment. The judgment concludes with a standard Mother Hubbard clause
that “all relief not expressly granted herein is denied,” and states, “[t]his judgment
disposes of all parties and all claims and is appealable.”
In this case, Johnson brought suit against Telecom and West only. The claims
pled by Johnson included sexual harassment; respondeat superior and ratification;
intentional infliction of emotional distress; negligence; negligent hiring, supervision,
training, and retention; retaliation; and alter ego. There were no counterclaims or cross-
claims asserted by Telecom or West. The parties reached an agreement on the merits
of the claims and addressed a final resolution of the claims in a Rule 11 agreement. The
trial court found the Rule 11 agreement to be enforceable. There is no evidence in this
record that Johnson has or had any claims or potential claims against Telecom and West
1
The order granting the motion for partial summary judgment found that the Rule 11 agreement is
valid and enforceable as a matter of law, and that West and Telecom breached the terms of the Rule 11
agreement as a matter of law. The court further ordered that Johnson’s motion for sanctions and attorney’s
fees would be determined at a subsequent hearing. The order granting the motion for summary judgment
is silent as to the “separate settlement agreement” referenced in paragraph three of the Rule 11 agreement.
4
other than those he asserted in this lawsuit. Because the language in the trial court’s
judgment in this case clearly evidences the trial court’s intent to dispose of all claims and
parties, we conclude that the judgment is a final judgment. See Bella Palma, LLC, 601
S.W.3d at 801.
Telecom and West also raise concerns that the judgment does not address “the
full relief negotiated in the Rule 11” agreement, specifically the relief afforded in paragraph
three. Paragraph three provides: “The parties have agreed to enter into a separate
settlement agreement intended to be global in nature for the mutual purpose of settling
all claims between the Parties, whether pled or unpled.”
The record indicates that the parties were at a standstill negotiating the provisions
of the “separate settlement agreement” in paragraph three. Although both parties
engaged in a “back-and-forth” regarding language of mutual release, non-disparagement,
indemnification, and a litany of claims to be included in the global agreement, no
agreement was reached on the terms of the separate settlement agreement. Notably,
there was no mention of release, non-disparagement, or indemnification in the Rule 11
agreement before the court. Although the parties contemplated a separate settlement
agreement, it was not characterized as a condition requisite to the formation of the Rule
11 agreement. West Beach Marina, Ltd. v. Erdeljac, 94 S.W.3d 248, 259 (Tex. App.—
Austin 2002, no pet.) (parties need not settle all pending issues for mediated settlement
agreement to be enforceable, but may agree on certain severable issues, while not
resolving the entire dispute); Oakrock Exploration Co. v. Killam, 87 S.W.3d 685, 690 (Tex.
App.—San Antonio 2002, pet. denied) (a binding settlement may exist when parties agree
5
upon some terms, understanding them to be an agreement, and leave other terms to be
made later).
It appears from the record that the trial court determined that the language in
paragraph three was not enforceable. As such, including language of release, non-
disparagement, or indemnification in the judgment would have impermissibly modified the
terms of the parties’ agreement. In re Marriage of Ames, 860 S.W.2d 590, 593 (Tex.
App.—Amarillo 1993, no writ) (a trial court judgment founded upon a settlement
agreement must be in strict compliance with the agreement.).
We overrule Telecom and West’s first issue.
Having determined that the trial court’s judgment is a final judgment, we next
address the alternative issues raised by Telecom and West.
Enforcement Procedure
In its second issue, Telecom and West challenge the procedure used by Johnson
in seeking enforcement of the Rule 11 agreement.
A Rule 11 agreement is considered contractual in nature. Coale v. Scott, 331
S.W.3d 829, 832 (Tex. App.—Amarillo 2011, no pet.). As such, a Rule 11 agreement is
interpreted in the same manner as are contracts in general. Golden Spread Elec. Coop.,
Inc. v. Denver City Energy Assocs., L.P., 269 S.W.3d 183, 190-91 (Tex. App.—Amarillo
2008, pet. denied). The elements of a breach of contract claim are (1) the existence of a
valid contract; (2) performance or tendered performance by the plaintiff; (3) breach by the
6
defendant; and (4) damages sustained by the plaintiff as a result of that breach. Domingo
v. Mitchell, 257 S.W.3d 34, 39 (Tex. App.—Amarillo 2008, pet. denied).
Rule 11 of the Texas Rules of Civil Procedure provides that “no agreement
between attorneys or parties touching any suit pending will be enforced unless it be in
writing, signed and filed with the papers as part of the record, or unless it be made in open
court and entered of record.” TEX. R. CIV. P. 11. A valid Rule 11 agreement must contain
all essential terms of the agreement and must be “complete within itself in every material
detail.” Padilla v. La France, 907 S.W.2d 454, 460 (Tex. 1995).
A trial court cannot render a valid agreed judgment after a party has withdrawn its
consent to a settlement agreement. Id. at 461; ExxonMobil Corp. v. Valence Operating
Co., 174 S.W.3d 303, 309 (Tex. App.—Houston [1st Dist.] 2005, pet. denied) (op. on
reh’g) (a party has the right to revoke consent to a Rule 11 agreement at any time before
the rendition of judgment). If a party revokes consent, the agreement might still be
enforceable, but only as a breach of contract action. Padilla, 907 S.W.2d at 461. An
action to enforce a Rule 11 agreement to which consent has been withdrawn must be
based on proper pleading and proof. ExxonMobil Corp., 174 S.W.3d at 309.
The record reflects that Johnson filed his first amended “Motion to Enforce Rule
11 Agreement, Motion for Sanctions, Request for Attorney[’]s Fees” after Telecom and
West withdrew their consent to the Rule 11 agreement. Johnson then filed his “Motion
for Partial Summary Judgment on Motion to Enforce Rule 11 Agreement, Motion for
Sanctions, and Request for Attorney[’]s Fees.” Within his motion for partial summary
judgment, Johnson asserts that “this is a Motion to Enforce a settlement agreement,
7
which also meets the heightened burden required of a Traditional Motion for Summary
Judgment in a true belt and suspenders approach.” Telecom and West argue that these
motions failed to give proper notice of a claim for breach of contract and that Johnson
was required to amend his pleadings to assert his breach of contract claim.
The first amended motion to enforce asserted that Johnson, Telecom, and West
reached an agreement to settle all of the claims in the underlying case, attached the Rule
11 agreement signed by the attorneys for the parties, recited the payment terms under
the agreement, and stated that Telecom and West breached the terms of the agreement
by failing to make the agreed-upon settlement payment by April 30, 2019. The motion
further stated that all conditions precedent to performance have been met and the
contractual obligations of Johnson have been substantially performed. The portion of the
document requesting attorney’s fees alleged that counsel had been retained to enforce
Telecom and West’s performance of the contract and to recover “all actual, incidental,
and consequential damages resulting from [Telecom and West’s] material breach of the
[c]ontract, including all fees necessary in the event of an appeal.” The document
concludes with a request for the court to find that Telecom and West breached the
settlement agreement, order payment of the amount contained in the settlement
agreement, grant the motion for sanctions, and grant attorney’s fees.
In his motion for partial summary judgment, Johnson asserts that he established
the Rule 11 agreement is enforceable as a matter of law and that Telecom and West
breached the agreement, and he “reserves his right to seek a later summary judgment on
his entitlement to attorney’s fees, the amount of attorney’s fees to be awarded, and the
appropriate sanctions to be assessed against [Telecom and West].” The motion further
8
alleges, in part, that the terms of the Rule 11 required Telecom and West to pay the
agreed-upon settlement amount not later than April 30, 2019, no action or performance
was required of Johnson prior to the payment of the settlement funds, Telecom and West
breached the agreement by failing to pay the agreed-upon settlement amount, all
conditions precedent to the performance of Telecom and West have been met, the
contractual obligations of Johnson have been substantially performed until payment is
made, Johnson was damaged by Telecom and West’s breach, and the trial court should
enforce the settlement agreement.
The amended motion for enforcement and the motion for partial summary
judgment stated the terms of the Rule 11 agreement, detailed Telecom and West’s breach
of that agreement, and identified the relief sought. By order of the trial court, a hearing
was conducted on the motion for partial summary judgment.2 See In re BBX Operating,
LLC, No. 09-17-00079-CV, 2017 Tex. App. LEXIS 3526, at *3 (Tex. App.—Beaumont Apr.
20, 2017, orig. proceeding) (mem. op.) (per curiam) (a judgment enforcing a settlement
agreement may only be rendered after a trial on the merits or by summary judgment).
Under these facts, assuming without deciding that a claim for breach of contract asserted
in a Rule 11 enforcement motion is sufficient to provide proper notice, Johnson’s motions
sufficiently notified Telecom and West of Johnson’s claim for breach of contract.3 See
2
In its order granting the partial motion for summary judgment, the court ordered a separate hearing
on Johnson’s motion for sanctions and request for attorney’s fees.
3 We conclude that it is unnecessary for us to determine whether the approach taken by Johnson
was sufficient to properly plead his cause of action for breach of contract because of our resolution of
Telecom and West’s remaining issues. However, we encourage practitioners to follow the better practice
of either bringing a separate cause of action (when the trial court no longer has jurisdiction) or amending
filed pleadings (when the trial court maintains jurisdiction). See Mantas v. Fifth Court of Appeals, 925
S.W.2d 656, 658 (Tex. 1996) (per curiam) (advocating amending pleadings when trial court has jurisdiction
or filing separate breach of contract claim when trial court does not); Twist v. McAllen Nat’l Bank, 248
9
Neasbitt v. Warren, 105 S.W.3d 113, 117 (Tex. App.—Fort Worth 2003, no pet.) (motion
to enforce settlement agreement can constitute a pleading raising a breach of contract
claim when it gives the opposing party proper notice of the claim); Roark v. Allen, 633
S.W.2d 804, 810 (Tex. 1982) (“A petition is sufficient if it gives fair and adequate notice
of the facts upon which the pleader bases his claim.”).
Telecom and West also contend that the procedure employed by Johnson in this
case interfered with Telecom and West’s ability to “assert appropriate defenses, conduct
discovery specifically for the alleged breach of contract or other requested relief, or submit
contested issues of fact.” We disagree.
The appellate record shows that Telecom and West filed a response and an
amended response to the motion to enforce and a separate response to the partial motion
for summary judgment. A party who contends that there has not been adequate time for
discovery before a summary judgment hearing must file either an affidavit explaining the
need for further discovery or a verified motion for continuance. Tenneco Inc. v. Enter.
Prods. Co., 925 S.W.2d 640, 647 (Tex. 1996). The appellate record does not contain
such an affidavit or motion. By failing to timely file a motion for continuance or affidavit,
Telecom and West have failed to preserve a complaint of trial court error on this issue.
We overrule issue two.
S.W.3d 351, 361 (Tex. App.—Corpus Christi 2007, no pet.) (identifying amending pleadings as the
“preferred method” of raising breach of contract claim based on settlement agreement).
10
Summary Judgment
Telecom and West’s third issue asserts that the trial court erred in granting
summary judgment because (1) the Rule 11 agreement was not enforceable as a
contract, (2) Johnson failed to perform, (3) Telecom and West did not breach the
agreement, and (4) Johnson presented no evidence of damages. Because we conclude
that Johnson failed to prove that he was damaged, we will confine our analysis to this
element.
An appellate court reviews a trial court’s decision to grant a traditional summary
judgment de novo. Valence Operating Co. v. Dorsett, 164 S.W.3d 656, 661 (Tex. 2005).
The party moving for a traditional summary judgment has the burden to establish there is
no genuine issue of material fact and it is entitled to judgment as a matter of law. TEX. R.
CIV. P. 166a(c). The movant must establish its right to summary judgment on the issues
expressly presented to the trial court by conclusively proving all elements of the movant’s
cause of action or defense as a matter of law. Rhone-Poulenc, Inc. v. Steel, 997 S.W.2d
217, 223 (Tex. 1999). If the movant meets his burden, then the burden shifts to the
nonmovant to raise a genuine issue of material fact precluding summary judgment. Id.
In reviewing a trial court’s ruling on summary judgment, we take as true all evidence
favorable to the nonmovant, and we indulge every reasonable inference and resolve all
doubts in the nonmovant’s favor. Provident Life & Accident Ins. Co. v. Knott, 128 S.W.3d
211, 215 (Tex. 2003).
As the movant, Johnson was required to establish that he was entitled to judgment
as a matter of law on each element of his breach of contract claim except the amount of
11
damages. TEX. R. CIV. P. 166a(c); see Domingo, 257 S.W.3d at 39 (elements of breach
of contract); Rivera v. White, 234 SW.3d 802, 805-07 (Tex. App.—Texarkana 2007, no
pet.) (exception that plaintiff need not show entitlement to prevail on damages applies
only to amount of unliquidated damages, not to existence of damages or loss).
As noted above, one of the elements of a breach of contract claim is damages.
Within the damage element of Johnson’s motion for partial summary judgment, he alleges
he “lost the use, enjoyment, and benefit of the funds to be paid,” but he offered no affidavit
or other testimony to support his damage claim except for the attorney’s fees incurred.4
Attorney’s fees incurred in a breach of contract action do not qualify as damages. Berg
v. Wilson, 353 S.W.3d 166, 182 (Tex. App.—Texarkana 2011, pet. denied). In order for
Johnson to recover attorney’s fees under section 38.001 for a breach of contract, he is
required to establish that he suffered damages, independent of attorney’s fees. TEX. CIV.
PRAC. & REM. CODE ANN. § 38.001(8) (West 2015) (allowing recovery of attorney’s fees in
addition to the amount of a valid claim). Here, Johnson did not seek damages
independent of attorney’s fees and costs and none were awarded to him. Because
Johnson did not produce evidence of damages, he failed to meet his burden to establish
his entitlement to partial summary judgment on his breach of contract claim.
Consequently, we sustain Telecom and West’s third issue and reverse the trial court’s
grant of partial summary judgment.
4 The affidavit of Matthew Harris states, “I make this affidavit for the sole purpose of showing that
[Johnson] has incurred attorney’s fees in this case, and therefore has suffered damages, as a result of
[Telecom and West’s] breach of the Rule 11 agreement. This affidavit is not tendered to show the amount
of the attorney’s fees incurred as this amount has yet to be determined.”
12
Attorney’s Fees
In its fourth issue, Telecom5 urges that the trial court erred in the award of
attorney’s fees because (1) fees were not proper and (2) if an award of fees was proper,
Johnson’s fees for the enforcement were not properly proven. Having determined that
Johnson did not meet his burden to establish that he was entitled to partial summary
judgment as a matter of law, we conclude that Johnson was not entitled to recover
attorney’s fees. Green Int’l, Inc. v. Solis, 951 S.W.2d 384, 390 (Tex. 1997) (to recover
attorney’s fees under section 38.001, “a party must (1) prevail on a cause of action for
which attorney’s fees are recoverable, and (2) recover damages.”).6 We sustain this issue
and reverse the trial court’s award of attorney’s fees.
Conclusion
Having concluded that the trial court erred in granting the motion for partial
summary judgment and in awarding attorney’s fees to Johnson, we reverse and remand
this cause for further proceedings in the trial court.7
Judy C. Parker
Justice
5 The trial court awarded Johnson a judgment for attorney’s fees solely against Telecom.
6 In his appellate brief, Johnson contends that he sought “expectation damages, meaning he sought
the benefit of the bargain that he made.” However, Johnson did not submit evidentiary proof of any
damages related to the breach of the Rule 11 agreement separate and apart from his claim for attorney’s
fees.
7 Telecom and West’s fifth issue is pretermitted. See TEX. R. APP. P. 47.1.
13 | 01-04-2023 | 03-18-2021 |
https://www.courtlistener.com/api/rest/v3/opinions/4619554/ | The Connecticut Light and Power Company, Petitioner, v. Commissioner of Internal Revenue, RespondentConnecticut Light & Power Co. v. CommissionerDocket No. 49321United States Tax Court40 T.C. 597; 1963 U.S. Tax Ct. LEXIS 92; June 26, 1963, Filed *92 Decision will be entered under Rule 50. 1. Sec. 722. -- Held, the respondent failed to establish error in his partial allowance of relief because of numerous affirmatively alleged contra-adjustments to the reconstruction. Held, further, that petitioner established (b)(4) base period changes in the character of the business consisting of a difference in capacity for production or operation entitling it to application of the 2-year pushback rule. The amount of the CABPNI determined.2. Sec. 722. -- Held, that petitioner is entitled to additional adjustment for base period abormality in interest and debt expense.3. Sec. 722. -- Held, that petitioner is not entitled to additional adjustment to eliminate alleged base period abnormality of excessive depreciation, under E.P.C. 6.4. Sec. 722. -- Held, that petitioner's sales promotion activities and voluntary inducive rate reductions are not qualifying (b)(4) changes in the character of the business.5. Sec. 722. -- Held, that under the (b)(4) commitment rule the word "taxpayer" limits the applicability of such rule and, further, that a committed-for change in capacity by another taxpayer corporate entity*93 is not equally committed for by petitioner because of an interchange agreement respecting the use of the energy to be produced by the new facility.6. Jurisdiction -- Standard Issues. -- Held, that this Court will no longer follow its decision in Mutual Lumber Co., 16 T.C. 370">16 T.C. 370, and, on authority of the decisions of the various circuit Courts of Appeal reversing the Tax Court on this issue, we take jurisdiction of the standard issues properly raised herein.7. Statute of Limitations. -- Held, that the assessment and collection of additional excess profits taxes are not barred for the years 1941 and 1942, but are barred for the years 1943, 1944, and 1945.8. Pleadings. -- Petitioner's motion to strike amended answers raising standard issues relative to 1940, for carryover purposes, and taxable years 1941 and 1942 is denied. Further, petitioner's motion to strike all of paragraph 11 of second amended answer raising standard issues relative to taxable years 1943, 1944, and 1945 is granted in part but denied as to that portion raising an alternative issue as to the correct excess profits credit for purpose of determining whether there is an actual*94 overpayment for those years.9. Unused Credit Carryover. -- Held, that the respondent erred in computing the amount of any unused excess profits credit for 1940 for purposes of carryover to 1941.10. Excess Profits Credit Based on Income, Sec. 713. -- Adjustment for Net Capital Addition or Reduction as Defined in Subsec. (g). -- Held, that in adjusting excess profits credit under section 713(a)(1)(A), (B), and (C) and for purposes of the capital reduction under section 713(g)(4), the respondent properly reduced the taxable year's earnings and profits available for distribution by the amount of accrued taxes for that year in determining the amount of petitioner's distributions not out of earnings and profits. A B C Brewing Corp., 20 T.C. 515">20 T.C. 515, followed. Held, further, that respondent failed to establish error in not prorating available current earnings to each quarterly dividend distribution for purposes of the capital reduction for each year. Held, further, that respondent erroneously computed the amount of the capital reduction under section 713(g)(4) by failing to include therein the current year's distributions not out*95 of earnings and profits for the year 1940 for carryover purposes and the taxable years 1941 and 1942, and also the cumulative effect of such errors on the computations of the capital reduction for 1943, 1944, and 1945.11. Adjustment of Excess Profits Credit for 1943, 1944, and 1945 Despite Bar of Statute of Limitation. -- Held, that petitioner's excess profits credit for 1943, 1944, and 1945 must be recomputed to reflect the corrected capital reduction under section 713(g)(4) in redetermining petitioner's excess profits tax liability for those years for purpose of redetermination herein as to whether any overpayments actually exist for those years. Lewis v. Reynolds, 284 U.S. 281">284 U.S. 281, followed. J. Marvin Haynes, N. Barr Miller, and Arthur H. Adams, for the petitioner.Arnold I. Weber, for the respondent. Kern, Judge. Withey, J., dissents on Issues 6 and 7. Scott, J., did not participate in the consideration or disposition of this case. Opper, J., dissenting. KERN *96 *598 This proceeding involves the petitioner's appeal for redetermination of the respondent's partial disallowance of its applications for excess profits tax relief under section 722, I.R.C. 1939, 1 and related claims for refunds for the calendar years 1941 to 1945, inclusive. The year 1940 is also involved for purposes of excess profits credit carryover.*97 The respondent in his statutory notice determined that petitioner qualified for relief under section 722(b)(1) and (b)(4), and further determined a constructive average base period net income (CABPNI) resulting in overassessments for the years involved. The petitioner herein seeks a CABPNI substantially in excess of that determined by*98 respondent, based upon certain alleged errors in respondent's reconstruction and his partial disallowance of certain claims for relief under section 722(b)(4).This proceeding also involves the respondent's numerous affirmative allegations of error in his statutory notice which are denied by petitioner. Respondent alleges error in his partial allowance of section 722 relief and determination of overassessments on the ground that he failed to make certain so-called contra-adjustments which would cancel out the adjustments previously allowed in his reconstruction of a CABPNI and thereby preclude any section 722 relief and eliminate the overassessments determined in the statutory notice. Respondent further alleges errors in his determination of petitioner's *599 excess profits tax liability for the years 1941 to 1945, inclusive, and affirmatively asserts deficiencies for those years.The petitioner's excess profits tax liability and the overassessments as determined in the statutory notice for the years 1941 to 1945, inclusive, and also the excess profits tax deficiencies affirmatively asserted herein for those years are as follows:Excess Profits TaxYearLiabilityOverassessmentDeficiency1941$ 606,909.24$ 94,394.88$ 130,670.5619421,266,017.213,590.1394,550.901943470,491.8647,740.0618,081.60194419,779.9152,594.7226,212.311945988,478.5654,187.6833,274.69*99 The following major and subsidiary questions are presented for our determination as to which the first four major questions and subsidiary questions thereunder arise from petitioner's allegations that respondent erred in failing to reconstruct a fair and just amount representing normal earnings to be used as a CABPNI on the ground that he failed to allow certain additional adjustments in his reconstruction and the remaining major and subsidiary questions arise from the respondent's affirmative allegations of error in his statutory notice:1. Whether respondent erred in failing to allow for substantial reductions in interest expense and debt discount and expense.2. Whether respondent, having allowed reconstruction for cost savings resulting from more efficient electric generating facilities completed during the base period, erred in failing to allow for cost savings computed on the same basis for facilities completed after December 31, 1939, and committed for prior to January 1, 1940.3. Whether respondent erred in failing to eliminate abnormal depreciation deductions in the base period years under respondent's E.P.C. 6.4. Whether respondent erred in failing to reconstruct for an*100 increased level of sales and earnings under the 2-year pushback rule: A. For changes in capacity for producing electric energy (1) completed during the base period, and (2) completed after December 31, 1939, and committed for prior to January 1, 1940, andB. For base period extensions of rural distribution lines to furnish additional electric service and for further extensions which would have been made if all the base period changes in the character of the business had been made 2 years earlier.5. Whether in the statutory notice respondent erroneously determined the above-stated overassessments resulting, except in part for *600 1941, from the erroneous partial allowance of relief under section 722 on the ground that he failed to make contra-adjustments which would preclude the allowance of relief and more specifically that he erred: A. In failing to make contra-adjustments for increased insurance, property taxes, and depreciation which would be constructively incurred on the additional facilities completed in the base period, and also for increased interest and amortization of debt discount and expense on new capital required to finance such additional facilities. *101 B. In failing to make adjustment for increased welfare and pension expenses incurred after 1937.C. In failing to make adjustment for constructive loss of earnings in the base period arising from distributions in that period other than out of earnings and profits.D. In erroneously allowing petitioner an unused excess profits credit carryover, based on constructive earnings under section 722, from the year 1940 to the year 1941.E. In erroneously characterizing the Stamford Interchange Agreement as making available 15,000 kilowatt capacity.6. Whether, in computing petitioner's excess profits tax liability for the year 1941, the respondent's statutory notice erroneously determined that there was an unused excess profits credit carryover from the year 1940 in the amount of $ 257,021.36.7. Whether the petitioner is estopped from claiming an adjustment under section 722 for elimination of alleged abnormal depreciation deductions in the base period years.8. Whether respondent erroneously scheduled overassessments in excess profits taxes in the above-mentioned amounts for 1941 and 1942, and erroneously rebated (by refund and credit) such amounts to petitioner and, further, whether *102 respondent erroneously failed to make correct capital reductions in computing petitioner's net capital additions, and that there are excess profits tax deficiencies in the above-mentioned amounts for 1941 and 1942.9. Whether, as alleged by respondent, there is no statutory bar to the assessment and collection of the affirmatively asserted excess profits tax deficiencies for 1941 and 1942 because of alleged executed agreements extending the period of limitations.10. With respect to the years 1943, 1944, and 1945 as to which respondent has affirmatively asserted the above-mentioned deficiencies and petitioner has plead, inter alia, the statute of limitations, and in the event the Court should determine that petitioner is entitled to the additional adjustments claimed herein under section 722, then in the alternative whether the petitioner's net capital additions as corrected should be used in determining its excess profits tax liability *601 for the years 1943, 1944, and 1945 for the purpose of determining whether any net overpayments actually exist for those years.11. Whether the Court has jurisdiction over the "standard issues" raised herein.FINDINGS OF FACTSome of the*103 facts were stipulated by the parties. We incorporate herein by this reference the stipulation and supplemental stipulations and exhibits attached thereto.Petitioner is a corporation organized under the laws of the State of Connecticut. Its principal office is located at Berlin, Conn. During all times here material petitioner kept its books and filed its Federal tax returns on an accrual method of accounting for calendar years. Such tax returns were filed with the collector of internal revenue for the district of Connecticut.Petitioner duly filed its corporation income and excess profits tax returns for the years involved herein on the dates as shown by exhibits attached to the stipulation.In the returns filed for 1940 and 1941, petitioner computed its excess profits tax credit based on the invested capital method as provided in sections 714-720. Such credit, as adjusted by respondent, was as follows:1940$ 5,302,686.0119414,623.640.25On its returns for the years 1942 to 1945, inclusive, the petitioner determined its excess profits credit under the income method as provided in section 713. Its average base period net income under section 713(f), as adjusted*104 by respondent, for the years 1942 to 1945, inclusive, was $ 3,854,803.45.The petitioner's average base period net income under section 713(f) for the year 1941 is $ 3,844,849.70.In its timely filed applications and amendments thereto for relief and refunds under section 722, for the years 1941 to 1945, inclusive, the petitioner claimed relief on substantially the same grounds as set forth in its petition herein. Petitioner's claims include the carryover of unused excess profits credits, based upon a constructive average base period net income, from the year 1940 to 1941 and from 1944 to 1945, as well as the carryback of unused excess profits credits from 1943 to 1941 and 1942 and from 1944 to 1942.On March 18, 1953, the respondent issued the statutory notice by registered mail, pursuant to section 732, determining a partial allowance and a partial disallowance of petitioner's applications for relief. *602 Petitioner's actual average base period net income was $ 3,781,544. The statutory notice stated, in part, as follows:It is held that you are entitled to relief under Section 722(b)(1) by reason of a hurricane which resulted in an interruption of normal production and *105 operations, and under Section 722(b)(4) by reason of cost savings based on the additional 25,000 KW unit installed at Montville in 1937, and on the 15,000 KW capacity made available under the Stamford Interchange. The fair and just amount representing earnings to be used as a constructive average base period net income, has been determined to be $ 3,913,000.00 applicable to each of the years 1941 to 1945, inclusive, computed as follows:19361937Adjusted excess profits net income before sec.722 adjustments $ 3,509,048$ 3,980,965Add: Sec. 722 adjustments for hurricane lossesTotals 3,509,0483,980,965Deduct: Sec. 722 adjustments for flood losses3,55842Constructive net income per RAR dated Apr.26, 1950 3,505,4903,980,923Add: Sec. 722 adjustments for constructive costsavings 213,399189,021Constructive net income as adjusted3,718,8894,169,944AggregateCABPNI -- $ 3,912,730, rounded to19381939Adjusted excess profits net income before sec.722 adjustments $ 3,660,916$ 3,975,247Add: Sec. 722 adjustments for hurricane losses78,6547,558Totals 3,739,5703,982,805Deduct: Sec. 722 adjustments for flood losses10,69611,471Constructive net income per RAR dated Apr.26, 1950 3,728,8743,971,334Add: Sec. 722 adjustments for constructive costsavings 61,879Constructive net income as adjusted3,790,7533,971,334Aggregate15,650,920CABPNI -- $ 3,912,730, rounded to3,913,000*106 Accordingly, the claims for refund listed above are disallowed in part.The petitioner is a public utility. It was originally organized in 1902 as the Rocky River Power Co. and in 1917 changed its name to the Connecticut Light and Power Co. In 1925 petitioner began to acquire various small utility companies throughout the State of Connecticut. Also in 1925 the Connecticut Electric Service Co. was organized as the holding, or parent, company of petitioner and other companies. In 1935 the parent company, with all its subsidiaries and operating assets, was merged into petitioner. For a period of time immediately prior to the base period years, 1936-39, there was no significant change in the franchise territory, in the aggregate, of all the numerous companies ultimately merged into petitioner.At all times here material petitioner's business has consisted primarily of the production, purchase, transmission, distribution, and sale of electricity and gas. It also furnished steam heat to customers in the city of Bristol and water service for domestic and commercial purposes in five towns. Petitioner's sales of electrical energy during the base period and the excess profits tax years*107 are classified as follows: 1. Domestic (Including residential and rural)2. Commercial3. Industrial4. Other utilities*603 5. Municipal street lighting6. Railroad corporationsApproximately 81 percent of petitioner's total gross operating revenue was derived from the sale of electric energy, approximately 18 percent from the sale of gas, and the balance of about 1 percent from the sale of steam, water, and from other miscellaneous sources. As a public utility the petitioner is subject to regulation by the Connecticut Public Utilities Commission.The State of Connecticut is divided geographically into eight counties which are in turn subdivided into some 169 areas or civil divisions called towns. The various cities and boroughs are located within the geographical boundaries of the towns.At the beginning of 1936 the petitioner supplied electric service in 105 towns with a population of approximately 580,198. At the end of the base period petitioner supplied electric service in 107 towns with a population of approximately 660,000. The franchise territory served directly by retail sales by petitioner during the base period covered approximately 60 percent of the geographical*108 area of the State of Connecticut, embracing the major portion of the eastern half and a substantial portion of the western half of the State, and including the cities of Bristol, Meriden, New Britain, Norwalk, Putnam, Rockville, Waterbury, Willimantic, Winsted, and Greenwich. Rural and suburban areas constituted the greatest portion of the geographical territory served by petitioner. Of the total population of the territory served by petitioner at the end of the base period, approximately one-half lived in small cities and the other half lived in suburban communities and rural areas. Throughout the base period petitioner also supplied electric energy to four other utilities which purchased a substantial part of their electricity from petitioner for retail as the principal suppliers of electric service in 14 other towns. The remaining towns in the State were supplied by other utility companies which generated their own power.Electric generating capacity is expressed in terms of kilowatts (kw) and the capacity of a generating unit is expressed in the number of kilowatts of electric energy it is capable of producing in 1 hour of operation. Electric energy is sold in terms of kilowatt-hours*109 and the petitioner's sales herein are expressed in the number of kilowatt-hours (kw-hr) of electric energy distributed to its customers.A "transmission line" is a powerline of high voltage that transmits electric energy from a generating station to a transmission substation from which the electricity is transmitted to a distribution substation and thence over "distribution lines" to the customers' meters.A steam generating plant burns coal or oil to convert water to steam, which in turn spins the turbines and produces electric energy. *604 A hydroelectric generating plant uses the power produced by falling water to spin the turbines to produce electricity.The Glossary of Electric Terms prepared by the statistical committee of the Edison Electric Institute defines "name-plate rating (or manufacturer's guaranteed capacity)" as "The full-load continuous rating of a generator or other piece of electrical equipment under specified conditions as designated by the manufacturer. It is usually indicated on a name-plate attached mechanically to the individual machine or device. Name-plate rating is generally less than, but may be greater than, demonstrated gross capability of the*110 installed machine."Prior to and throughout the base period petitioner produced electric energy by both steam and hydroelectric generating facilities. Petitioner had two types of hydroplants, namely, the run-of-the-river or stream-flow type and the reservoir or pump-storage type. A stream-flow plant utilizes the power of falling water from the actual flow of a stream or river into a reservoir or pond and then over a dam, usually near the powerplant which is operated when there is sufficient water in the stream. A pump-storage plant utilizes water pumped from a stream or river into a reservoir from which the water is released as needed to generate electricity. In the latter type of hydroplant water can be stored for emergency use or against drought.Throughout the base period petitioner had steamplants located at Devon and Montville, one pump-storage hydroplant (nameplate capacity 24,000 kw), and a minimum of 11 stream-flow hydroplants (of varying capacity) at various locations. The following schedule shows the nameplate capacity, in killowatts, of the hydroplants and of the steamplants, respectively, owned by petitioner on December 31, 1935-39, inclusive, embracing changes made*111 in such facilities during the base period, and the ratio of each type of such generating capacity to total capacity:[In kilowatts]YearHydroplantsPercentSteamplantsPercentTotalPercent193558,19035107,50065165,690100193664,81538105,00062169,815100193766,81534130,00066196,815100193864,86533130,00067194,865100193964,62533130,00067194,625100In addition to the above-mentioned generating capacity of plants owned by petitioner, 15,000-kw capacity became available in March 1938, and 25,000-kw steam generating capacity became available in 1941, to both the petitioner and the Stamford Division of the Connecticut Power Co. by virtue of the interchange agreement, as hereinafter more fully described. From 1940 to 1945, inclusive, the only addition made by petitioner to its generating facilities was a 45,000-kw *605 steam unit installed at Devon in 1942 which resulted in a ratio of steam and hydro facilities of 73 and 27 percent, respectively.An electric utility company produces electricity as it is used. As a consequence the company must at all times maintain, "on the line," generating facilities*112 of sufficient capacity to meet the demands of its customers at any given time, including periods of peak loads. In addition, the company is required at all times to maintain a so-called spinning reserve of generating capacity equivalent to the nameplate capacity of its largest single generating unit. Such spinning reserve must be instantaneously available in the event of emergencies, such as picking up any "outages" that might occur in the breakdown or stoppage of other units. Such reserve or standby capacity is an essential part of a utility company's plant capability to meet the demands of its customers and as such is not idle capacity.Throughout the base period the petitioner's largest single generating unit had a nameplate capacity of 25,000 kw and petitioner therefore always maintained a spinning reserve of generating capacity equivalent to that amount. Such reserve was kept "hot on the line" thus carrying some of the load and was not standing idle. Petitioner used its various facilities in the manner which provided the most efficient operation under the circumstances obtaining at a given time, but always kept the equivalent of 25,000 kw in reserve.The so-called "dependable" *113 capacity of an electric generating unit is the maximum amount of energy in kilowatt-hours which the unit can produce under the most adverse conditions, and the dependable capacity of an entire electric generating system is the total amount of energy which the various units in the system can produce under the most adverse conditions and less the spinning reserve. During the base period petitioner used its hydroelectric facilities to the fullest possible extent, but the dependable capacity of those units was at times significantly below their nameplate capacity because of adverse waterflow conditions. The uncertainty of the waterflow in the streams used by petitioner and the great variation in flow during the year, and from year to year, limited the amount of hydro capacity petitioner could depend upon for carrying any substantial part of the steady long-hour load requirements. That load had to be carried primarily by steam-generating capacity which could deliver a definite amount of electric energy 24 hours a day every day in the year. The hydro capacity was available for carrying some part of the steady load and for carrying additional requirements for peak loads of short duration. *114 In view of the uncertain elements involved, petitioner could not rely on hydropower to meet the growing demand of its customers, and in 1939 petitioner determined and announced that future additions to its generating facilities would consist entirely of steam units.*606 Electric utilities operate around the clock, but the rate of production varies as the load varies at different hours of the day to meet the demand which is normally at the highest peak in the late afternoon and early evening hours.The maximum system peak load, in kilowatts, on petitioner's main system from 1935 to 1939, inclusive, and the time when such peak load occurred were as follows:1935 115,555 kw on November 155 to 6 p.m.1936 126,410 kw on December 225 to 6 p.m.1937 129,815 kw on September 1310 to 11 a.m.1938 131,301 kw on December 215 to 6 p.m.1939 148,612 kw on November 285 to 6 p.m.On August 27, 1936, petitioner completed and placed into service a new additional 8,000-kw nameplate capacity hydrounit at its Stevenson hydroelectric generating plant at a cost of $ 282,068. Provision for this unit had been made when the Stevenson plant was first constructed. On August 25, 1937, *115 at a cost of $ 172,661, petitioner completed and placed in service its new Scotland hydroelectric plant which had a 2,000-kw nameplate capacity. Such new plant replaced the old Scotland 1,200-kw hydrounit which had been destroyed in the 1936 flood. On August 23, 1937, petitioner completed and placed into service a new additional 25,000-kw nameplate capacity steam unit at its Montville steamplant at a cost of $ 1,892,577.The total sum spent by petitioner for the construction of the 25,000-kw addition to the Montville plant was from funds acquired as a result of the issue of series "F" bonds as of September 1, 1936, as hereinafter described, and from temporary bank loans. Construction expenditures were made over a 3-year period in the following amounts:1936$ 448,843.5819371,382,519.39193861,214.101,892,577.07During the base period petitioner ceased operation of several of its small hydro generating facilities as follows: The 175-kw plant at Stafford on March 19, 1936; the 760-kw plant at Quidnick on May 28, 1938; the 390-kw plant at Leesville and also the 800-kw plant at Dyer Dam on September 21, 1938. On April 8, 1939, petitioner ceased operation of a 240-kw*116 unit at its Mechanicsville plant but continued operating the remainder of that facility.In addition to the above-mentioned increases made during the base period to generating facilities owned by it, petitioner also increased the mileage and the voltage of its transmission and distribution lines, and increased the capacity of its transmission and distribution substations. *607 In 1938 petitioner completed and placed into service a new 66,000-volt, double circuit, steel tower transmission line from Norwalk to Stamford and also a similar 66,000-volt transmission line between Willimantic and Rockville, along with related substation equipment. Additional capacity was also provided in the Baldwin Street substation at Waterbury. In 1939 a new distribution center for petitioner's northeastern territory was provided through completion of the Tracy substation. Also in 1939 new high-tension lines were completed, resupplying certain communities which petitioner served. Increases in the voltage of transmission and distribution lines and enlargement of substations enabled petitioner to supply more electric current to customers without constructing new lines and new substations. New *117 construction was taken into petitioner's depreciable assets when the new equipment and facilities were placed into operation.Joint Exhibit 16-P, included herein by reference, is a schedule setting the amounts of expenditures made by petitioner from 1936 to 1945, inclusive, for additions and replacements to its electric distribution and transmission plants. The schedule also includes the amounts of the retirements from such plants during those years. The total cost of additions and replacements to petitioner's transmission and distribution plant during the base period was as follows:YearDistributionTransmissionTotalplantplant1936$ 1,320,011.01$ 11,652.89$ 1,331,663.9019371,787,305.3062,232.211,849,537.5119381,820,467.31287,566.262,108,033.5719391,540,510.67113,497.321,654,007.99Total 6,943,242.97The petitioner's retirements during the base period amounted to a total of approximately $ 1,988,039.The total cost of the 66,000-volt transmission line between Norwalk and Stamford, included in the total additions and replacements in the next preceding paragraph, was $ 473,810 including $ 40,000 for the cost of land. Of*118 such total cost the amount of $ 409,501 was paid in 1937.On December 16, 1936, the petitioner and the Connecticut Power Co. entered into an agreement (hereinafter referred to as the interchange agreement) which provided for an interchange of electric power through an interconnection between the main system of the petitioner and the Stamford Division of the Connecticut Power Co. Such agreement first became operative on March 17, 1938, when petitioner completed its above-mentioned 66,000-volt transmission line between its facilities at Norwalk and the Stamford generating facilities *608 of the Connecticut Power Co. The interchange agreement provided as follows:1. Such interconnection will make possible certain operating savings from the interchange of power and also investment savings through a reduction in the amount of generating capacity that would otherwise be required by the two companies.2. The facilities necessary for such interconnection will be provided as follows:a. The Connecticut Light and Power Company will construct, own, operate and maintain at its own expense a double circuit 66 kv line from its Norwalk Substation to the terminus of its existing line on the*119 New Haven Railroad right of way near South Street in Stamford.b. The Connecticut Power Company will construct, own, operate and maintain at its own expense a double circuit 66 kv connection, including transformers, tap changers, switches and other equipment, each suitable for not less than 15,000 kw of transfer capacity.3. As soon as the interconnection is completed the operation of the Stamford power plant will be coordinated with the operation of The Connecticut Light and Power Company's main system so as to obtain maximum overall operating economy, the day to day coordination of operations to be by agreement between the operating forces of the two companies.4. The net savings from such coordinated operation and interchange of power are to be calculated and divided equally between the two companies monthly. The Connecticut Light and Power Company is to act as the accounting agent for this purpose.5. Investment savings resulting from the reduction in the combined generating capacity will be divided equitably by the following method:When the maximum load for one hour of either Company exceeds such Company's total firm generating capacity less the capacity of its largest generating*120 unit such Company will be considered as having established a deficiency. In such event it will make payment to the other Company at the rate of $ 1.10 per kw per month for the maximum deficiency established to date until such deficiency is cancelled by the installation of additional generating capacity.6. The present total firm generating capacity of the Stamford power plant is 38,700 kw and its largest generating unit is 15,000 kw. The present total firm generating capacity of the main system of The Connecticut Light and Power Company is 185,000 kw (including the 25,000 kw unit now under construction at Montville) and its largest generating unit is 25,000 kw.7. Additions to the generating capacity of the two companies will be made only when required by the combined loads of the interconnected systems, and such additions will be so made in principle as to maintain a reasonably equal relation between loads and installed generating capacities of the respective systems.8. Emergency power supplied by either company to the other over the interconnection will be billed at the incremental rate of the supplying company as determined for regular interchange power.9. Each company will*121 designate a representative and these representatives will jointly handle all questions relating to this interchange of power between the two companies. In case of disagreement these representatives will select an arbitrator and if they cannot agree upon an arbitrator either company may call upon the Chairman of the Public Utilities Commission to select the arbitrator.*609 10. Such interchange of power is to be commenced as soon as the interconnection is completed ready for operation and is to be continued until January 1, 1947 and thereafter until the expiration of not less than twelve months written notice from one Company to the other, which notice may be given at any time after December 31, 1945.11. The entire arrangement to be subject to the acquisition and retention of the necessary rights of way for the interconnection facilities.The principal reasons which prompted the execution of the interchange agreement were the investment savings and the operating cost savings which would accrue to both companies as a result of operating the two previously independent systems as an integrated system over a period of years extending at least until January 1, 1947, and thereafter*122 until expiration of the agreement after due notice.Investment savings resulted from the interchange agreement because additional operating capacity was thereby made available for the integrated system, in that once the two systems were interconnected only one spinning reserve was required. The largest generating unit of the two systems, petitioner's 25,000-kw capacity unit, served as the spinning reserve capacity for the combined systems, and the necessity of maintaining the 15,000-kw reserve capacity of the Connecticut Power Co.'s Stamford Division was eliminated. The release of that reserve capacity provided an additional 15,000-kw capacity available for full use in carrying the daily load requirements of the combined systems without additional investment by either company for new generating facilities.Operating cost savings resulted from the interchange agreement because it required the power dispatchers of both companies to coordinate their operations so as to obtain the maximum overall operating economy in meeting the total daily consumer demand on the interconnected system. Savings in fuel costs were obtained by first putting on the line the most efficient generating units, *123 which consumed the least amount of fuel, regardless of which company's generating units were being used. As the demand on the integrated system increased the less efficient generating facilities of the combined systems were brought on the line.Under the interchange agreement both companies were obligated for a period of years, during and after the base period, to operate as an integrated system with an interchange of power from one another as that power was generated in the most economical manner on all of the facilities of both companies, regardless of who owned such facilities. In the event either company used power in excess of its total firm generating capacity less its largest generating unit, it would pay the other company for such power at a fixed rate so long as its generating *610 deficiency continued. Under the agreement additions to the generating capacity of the two companies were to be made only when required by the combined loads of the interconnected systems and so as to maintain a reasonably equal relation between loads and installed generating capacities of the respective systems.In connection with the interchange agreement and during 1937 the Connecticut*124 Power Co. undertook a major construction program at Stamford costing approximately $ 415,000 for certain new substation and transmission facilities. Included in that program was the building of a 66,000-volt substation immediately adjacent to the Stamford generating plant with a 66,000-volt transmission cable, completed early in 1938 at a cost of $ 282,400, and establishing an interconnection with the transmission system of the petitioner for the agreed interchange of power. In such undertaking it was determined that rather than invest in an additional steam-generating plant at Stamford it would be more economical to purchase from petitioner any increase in primary power needed at Stamford, and further that considerable fuel savings could be effected through the interchange of power with the petitioner.As of September 15, 1939, the petitioner's general engineer made a report entitled "Estimated System Capacities and Demands with Low Water Conditions and Maximum Hour Demands" setting forth various data to be used only in connection with operating problems. That report set forth, inter alia, the total rated installed generating capacity, the total net capacity, the estimated*125 maximum hour demand for the fall of 1939, and the surplus generating capacity, for the petitioner's main system, for the Connecticut Power Co.'s Stamford Division, and for the two combined systems, respectively, as follows:Petitioner'sStamfordCombinedmain systemdivisionsystemsKilowattsKilowattsKilowattsTotal rated installed generating capacity 194,12538,700 232,825Less largest unit25,00015,000 25,000Total net capacity 169,12523,700 207,825Estimated maximum hour demand138,00025,000 163,000Surplus (deficiency) netcapacity 31,125(1,300)44,825That report and the matter of experienced and anticipated loads of the combined systems were considered at a September conference of the two companies' representatives. They further noted that the Stamford Division load exceeded its net generating capacity by 1,300 kw and that it would, therefore, pay petitioner for such deficiency *611 until canceled by the installation of additional generating capacity as provided in the interchange agreement.During the fall of 1939 studies were made and conferences were held relative to the existing and immediate*126 future loads and the generating capacity of the combined systems. At a conference in October 1939 the representatives of petitioner and the Connecticut Power Co. agreed that a reasonably certain combined peak load of between 165,000 kw and 170,000 kw would be reached during the fall and winter of 1939; that the estimated 1942 combined peak load would be between 190,000 kw and 195,000 kw and additional capacity should be available for such peak load; and that an additional unit of not less than 25,000-kw capacity should be installed at Stamford.On November 27, 1939, the board of directors of the Connecticut Power Co. authorized the installation of a 40,000-kw steam-powered electric generator at Stamford, but after further consideration and on December 27, 1939, the board rescinded that action and in lieu thereof authorized the installation of a 25,000-kw steam-generating unit at Stamford at an estimated cost of $ 3,500,000. On December 26, 1939, the Connecticut Power Co. placed an order with the General Electric Co. for a turbine generator. Installation of the new 25,000-kw unit at Stamford was completed by October 1941 at a cost of $ 3,325,000 and, under the interchange agreement, *127 that additional capacity became available to both petitioner and Connecticut Power Co., and such unit was used along with the other generating units of the two companies to carry the daily load requirements of the integrated system in the most efficient manner.In its claims for relief (Form 991) for the years involved herein, the petitioner claimed constructive base period fuel cost savings resulting from (1) the new 25,000-kw capacity steam-generating unit which petitioner installed in 1937 at Montville; (2) the 15,000-kw capacity steam-generating unit at Stamford which was made available to the combined integrated system after March 17, 1938, under the interchange agreement; and (3) the new 25,000-kw capacity steam-generating unit which was ordered by the Connecticut Power Co. prior to December 31, 1939, and was completed and available to the combined integrated system in 1941 under the interchange agreement. Those units used less coal than petitioner's older less efficient facilities, and if such units had been in operation and available during the base period years they would have carried a substantial portion of petitioner's load resulting in substantial fuel cost savings. *128 The constructive base period fuel cost savings attributable to the Montville 25,000-kw unit and the Stamford 15,000-kw unit, as shown *612 in column A, and also to the 25,000-kw unit made available in 1941, as shown in column B, are as follows:Fuel cost savingsYearColumn AColumn B1936$ 213,399$ 56,1241937189,02152,446193861,87942,602193966,879In the reconstruction appearing in the statutory notice the respondent allowed adjustments for the claimed fuel cost savings in the amounts set forth in column A above and disallowed the claimed amounts set forth in column B above.In the first year of the base period petitioner produced approximately 80.93 percent of its electric energy requirements and in the last year of the base period it was producing approximately 80.23 percent. Most of the balance of petitioner's electric energy requirements was purchased from other Connecticut utility companies, and the remaining purchases were from municipalities and manufacturing companies with generating facilities. Joint Exhibit 14-N, included herein by reference, shows the sources of petitioner's total supply of electric energy from generation, *129 purchase, and interchange receipts, and also shows petitioner's disposition of electric energy for the years 1936 to 1945, inclusive. Such data for the base period years 1936-39 is as follows:[In thousands of kilowatt-hours]Sources and disposition of electric energy1936193719381939All sources:Generation 572,154609,044545,684625,919Purchases 105,059139,142126,068128,6961 Interchange receipts (gross) 29,80711,03931,361Total 707,020748,186682,791785,976Disposition:Sales 599,919646,693569,956667,342Interchange deliveries (gross) 6,91612,7625,868Used by company 5,9537,5837,3757,3782 Energy losses 94,23293,91092,698105,388Total 707,020748,186682,791785,976Joint Exhibit 21-V attached to the stipulation, included herein by reference, shows the petitioner's annual sales of electric power in kilowatt-hours, the total revenue therefrom, *130 and the total number *613 of petitioner's meters, by classes of customers for each of the years 1935 to 1945, inclusive. Such data for the years 1935 to 1939, inclusive, are set forth in the following three schedules (added to the first schedule is the index of kilowatt-hour sales, 1939=100):Total kilowatt-hour sales (in thousands)Class of customer19351936193719381939Domestic95,695110,695127,742140,203154,267Commercial40,00544,95250,66752,96657,881Industrial247,523292,647316,283237,034304,584Other utilities101,340108,335118,632110,976121,012Municipal street lighting10,07910,21810,57710,76911,087Railroad and street railwaycorporations 35,60133,07322,79218,00818,511Total 530,243599,920646,693569,956667,342Index 1939 = 100 79.489.996.985.4100Total revenue from kilowatt-hour salesClass of customer193519361937Domestic$ 5,417,876$ 5,694,824$ 6,171,760Commercial2,380,7892,498,8182,528,670Industrial3,920,1254,235,9284,477,432Other utilities1,024,7361,068,7741,162,698Municipal street lighting593,529607,361618,059Railroad and street railwaycorporations 437,419395,414253,283Total 13,774,47414,501,11915,211,902*131 Total revenue from kilowatt-hour salesClass of customer19381939Domestic$ 6,284,806$ 6,314,711Commercial2,583,5152,686,109Industrial3,762,1894,437,726Other utilities1,149,5621,246,011Municipal street lighting623,819640,785Railroad and street railwaycorporations 195,046194,839Total 14,598,93715,520,181Total number of petitioner's metersClass of customer19351936193719381939Domestic131,099135,940140,944143,708148,268Commercial17,17217,42517,76517,87718,152Industrial2,2612,2052,0841,9421,9311 Other utilities 14141414142 Municipal street lighting 17,89618,11718,33718,54318,710Railroad and street railway3 corporations 33211Total 168,445173,704179,146182,085187,076*132 The "domestic" classification embraced the residential users of electric energy, that is, persons living in the urban and suburban areas and also in the rural areas, including farms. The "commercial" classification embraced retail stores, offices, and business establishments of various kinds. The "industrial" classification included various kinds of industrial plants using electricity for lighting, *614 manufacturing, or production processes. The "other utilities" classification embraced other public utilities in the nature of wholesale customers supplied with energy for resale to their own customers. The "municipal street lighting" classification embraced the cities and municipalities in petitioner's franchise area. The "railroad and street railway corporations" classification embraced public transportation companies. The petitioner always had different rates for the electric service sold to each class of its customers. Also, petitioner's transmission and distribution costs varied as between classes of customers depending on the type of service and location of the customers.The reduction in the number of petitioner's industrial meters during the base period was due primarily*133 to a reclassification of various customers' meters and only a very few industrial concerns actually left the petitioner's franchise area. The Connecticut Public Utilities Commission required the reclassification of 175 meters at the University of Connecticut from industrial to domestic. About 100 customers, each of whom had two meters with one for lighting and another classified industrial, were persuaded by petitioner to use only one meter reclassified as commercial. In addition, various other customers were reclassified from industrial to commercial as required by governmental authority.During the base period petitioner experienced a substantial increase in its total kilowatt-hour sales, with a varying amount of increase for each class of its customers except railroad and street railway corporations which decreased. The greatest increase occurred in domestic customer kilowatt-hour sales which increased 61.2 percent as compared to such sales for 1935. During the same period and in addition to an increase of 17,169 in the number of domestic customers, the average kilowatt-hour use per domestic customer served by petitioner increased as follows:Average kw-hr useYearper domestic customer193573619368211937913193897719391,047*134 The substantial increase in the kilowatt-hour sales to petitioner's domestic customers, the increase in the number of domestic customers, and the increase in the average kilowatt-hour use per domestic customer during the base period were due to three principal factors, namely, (1) the extension of distribution lines into previously unserved rural and farm areas, (2) substantially increased electric appliance sales, and (3) inducive rate reductions to encourage greater use of electric energy. The increased sales of electricity to domestic *615 customers during the base period did not result, except to an insignificant degree, from the change by such customers from gas to electricity.Joint Exhibit 17-Q, included herein by reference, shows various data with respect to petitioner's rural extensions of its distribution lines for the years 1928 to 1945, inclusive. The number of rural customers added to petitioner's distribution system at the time the extension lines were built, the number of miles of rural distribution lines constructed, and the total cost thereof to petitioner for each of the years 1935 to 1939, inclusive, were as follows:Number ofMiles ofYearrural customerslines constructedTotal costadded193553193.70$ 189,1521936902177.85340,70219371,163235.34452,7991938786152.30278,3841939873168.45310,448*135 During the base period petitioner constructed a total of 733.94 miles of rural distribution lines and added a total of 3,724 new rural customers, or approximately 5 new customers per mile at the time such lines were built. At the end of 1939 there remained an estimated 1,099 miles of rural extension lines to be constructed to serve an estimated 4,472 new rural customers. Prior to and during the base period the petitioner carried out a rural electrification program of extending its distribution lines into previously unserved territory which was away from concentrations of population.The petitioner's franchise territory embraced a variety of farmers, such as poultry, dairy, tobacco, and various produce farmers, each of whom could benefit by the use of electrically operated labor-saving equipment. By 1936 petitioner's farm customers had begun to accept electricity as a stable and dependable source of energy because petitioner was able to supply more dependable rural electric service than in the earlier years of farm electrification. Throughout the base period years petitioner employed seven farm representatives who continually made an active survey of the farm population served *136 by petitioner, including customers and potential customers. Those sales representatives interviewed farmers and demonstrated the extent to which labor-saving farm equipment and home appliances could be used, and generally encouraged a greater use of electric energy on the farm.The petitioner's experience was that its average farm customer used a much greater amount of electric energy than its ordinary residential customer because of the farmer's use of electrically operated farm equipment (such as milkers, brooders, etc.) in addition to household *616 appliances. The following schedule shows the average kilowatt-hour use by such customers during the indicated years:Average kw-hrYearuse per customer19351,40419361,70019371,83719382,04119392,208In 1936 petitioner made a general survey of its domestic customers in order to determine the extent to which they were using electric appliances and to ascertain the potential market for the sale of new appliances. The survey showed that out of every 100 domestic customers only 40 had an electric refrigerator, only 5 had an electric range, and only 1 had an electric hot water heater. Installations of new *137 appliances constituted load-builders for the petitioner's system. During the base period petitioner conducted appliance sales-promotion campaigns which were directed primarily to the individual customers because they were widely scattered, with about one-half living in numerous small cities and the other half living in suburban communities and rural areas. Petitioner could not effectively employ mass group advertising such as that used in large metropolitan areas.At the beginning and during the base period petitioner regularly employed approximately 140 persons engaged in sales-promotion work, including supervisory personnel. In 1936 and 1937 petitioner temporarily employed an additional 50 specially trained young women who made surveys in practically every domestic customer's home to determine the extent to which customers were using adequate lighting equipment. During the base period petitioner conducted several aggressive appliance sales compaigns to increase the use of electricity through customers' purchases of electric refrigerators, ranges, and hot water heaters. Petitioner offered its customers special inducements such as very small downpayments with extended installments, *138 and special wiring required for ranges and water heaters free of charge, which saved customers approximately $ 45 per installation. Also petitioner introduced a plan for the rental of water heaters with three-fourths of the rental payments being applied to the purchase price if the customer subsequently bought such appliance.During the base period years the petitioner was a substantial seller of all types of electrical appliances. Its gross receipts from such sales amounted to $ 1,444,971 for 1936, $ 1,765,457 for 1937, $ 913,182 for 1938, and $ 996,739 for 1939. Petitioner maintained approximately 25 sales outlets and sold about twice as many electrical appliances as the dealers *617 within its franchised territory. During each year of the base period petitioner sold the following number of units of the indicated electrical appliances:Number of units soldAppliance1936193719381939Base periodtotalRanges1,8511,8761,3481,3446,419Refrigerators4,8365,7442,4852,87615,941Water heaters8411,0597807333,413Irons2,5402,5491,8881,9878,964Vacuum cleaners5286096639932,793Clocks7729659461,0473,730Washing machines1,1531,1466899953,9831 Other appliances 47,98951,54347,32545,900192,757Total -- all appliances 238,000*139 The following schedule shows the average annual kilowatt-hour consumption of electricity per unit by the indicated electric appliance, the total annual kilowatt-hour consumption for the total number of each type of appliance sold by petitioner during the base period years, and also the total normal annual kilowatt-hour consumption of the total number of other miscellaneous electrical appliances sold by the petitioner during the base period years:Number ofAnnualTotalApplianceunits soldkw-hrannualduring baseconsumptionkw-hrperiodper unitconsumptionRanges6,4191,2007,702,800Refrigerators15,9414006,376,400Water heaters3,4134,00013,652,000Irons8,9641201,075,680Vacuum cleaners2,7932467,032Clocks3,7302489,520Washing machines3,98348191,184Other appliances192,75729,154,6162,915,460Total all appliances sold by petitioner 32,070,076In addition, the total number of electric appliances sold by dealers in petitioner's franchised territory during the base period (about half as many as petitioner sold) *140 had an estimated total annual consumption of approximately 16 million kilowatt-hours.In addition to its base period efforts to increase sales of electric energy to domestic customers, the petitioner also engaged in efforts to increase sales of electric power to its commercial and industrial customers. During the base period petitioner's electric sales-promotion personnel included 21 commercial and industrial sales representatives, usually college engineering graduates, who continually *618 made surveys of petitioner's commercial and industrial customers to encourage the greater use of electric energy. The commercial sales representatives gave demonstrations and assisted commercial customers in planning improved interior lighting, window display lighting, air conditioning, etc., and worked with restaurants and hotels in planned use of electricity for cooking and water heating. The industrial sales representatives advised and encouraged more extensive use of electricity for various purposes in industrial establishments of petitioner's customers and they were instrumental in persuading a number of new industrial firms to locate in petitioner's franchised territory. At the beginning*141 of the base period, private industrial firms in petitioner's territory owned steam-generating capacity in excess of 40,000 kilowatts. Petitioner's industrial sales representatives made studies showing the cost of self-generated power as compared with the cost of power purchased from petitioner. By the end of the base period industrial firms with generating capacity of 2,500 kilowatts had switched to using petitioner's power. Such changeovers resulted in an estimated total annual consumption of not less than 5 million kilowatt-hours. Petitioner's commercial and industrial sales-promotion activities resulted in increased-per-customer use of electric energy, except for a decrease in industrial use in 1938.The following schedule shows the average annual kilowatt-hour use per commercial and industrial customer, respectively, served by petitioner during the years 1935 to 1939, inclusive:Average annual kw-hruse per --YearCommercialIndustrialmetermeter19352,338109,47519362,577132,72019372,861151,76719382,965122,05619393,202157,734As above mentioned, petitioner's electric sales-promotion activities embraced its domestic, commercial, *142 and industrial customers. The petitioner's total promotion expense (including supervision, salaries and commissions, demonstration, advertising, and miscellaneous sales expense); wiring and appliance expenses; income from merchandising, jobbing, and contract work; and the amounts denominated as net promotion expense for new electric service business, for each of the base period years, were as follows: *619 19361937Total promotion expense$ 522,757.11$ 637,478.04Wiring and appliance expense45,962.4149,672.56568,719.52687,150.60Less: Income from merchandise, jobbing, andcontract work 411,927.38538,171.93Net promotion expense156,792.14148,978.6719381939Total promotion expense$ 471,395.10$ 467,450.54Wiring and appliance expense29,529.7012,155.97500,924.80479,606.51Less: Income from merchandise, jobbing,and contract work 211,872.33245,303.29Net promotion expense289,052.47234,303.22During the base period petitioner made a number of "inducive" rate reductions for sales promotional purposes. They were entirely voluntary and in no way compelled by the Connecticut Public Utilities Commission. Also, *143 they were in pursuance of petitioner's established policy to make such reductions from time to time as warranted by general business conditions and petitioner's finances. Other Connecticut electric companies made similar reductions. The inducive-rate reduction gave customers an immediate flat reduction in the cost of electricity per kilowatt-hour regardless of the number of kilowatt-hours consumed as distinguished from the so-called objective-rate reduction which resulted in a lower cost per kilowatt-hour only if the customer's consumption increased above a certain minimum amount of usage. Petitioner's inducive-rate reductions were made for the purpose of stimulating greater consumption of electric energy by its existing customers and encouraging the connection of new customers to its lines. At the time inducive-rate reductions were made, petitioner widely advertised the resulting savings to its customers and urged them to increase their consumption of electric energy.In each of the years 1935 to 1939, inclusive, petitioner voluntarily reduced the rates on domestic, commercial, and industrial electric service. In one or two of those years petitioner made some reduction in the*144 rates for service to other electric corporations and to municipal street lighting. The estimated annual savings to petitioner's customers, generally computed on the volume of consumption at the effective date of the reduction, by principal classes of customers, for the years 1935 to 1939, inclusive, were as follows:Estimated annual savings to customersYearOtherMunicipalDomesticCommercialIndustrialelectricstreetTotalcorporationslighting1935$ 94,649$ 101,582$ 130,217$ 326,4481936249,666286,46764,522$ 19,649620,304193764,67924,40064,986$ 3,330157,3951938624,5542,94134,7401,944664,179193978,100331,4413,500413,041The following schedule shows the average rate in cents per kilowatt-hour and the average revenue per meter for petitioner's domestic *620 and commercial customers, respectively, and also shows petitioner's revenue in cents per kilowatt-hour and average revenue per meter for its industrial customers, for each of the years 1935 to 1939, inclusive:DomesticCommercialIndustrialYearAverageAverageAverageAverageRevenueAveragerate perrevenue perrate perrevenue perperrevenue perkw-hrmeterkw-hrmeterkw-hrmeterCents Cents Cents 19355.66$ 41.675.95$ 139.131.58$ 1,733.8019365.1442.265.56143.231.451,921.0519374.8344.114.99142.781.412,148.4819384.4843.814.88144.611.591,937.2719394.0942.864.64148.591.462,298.15*145 Petitioner's base period experience was that while inducive-rate reductions gave its customers an immediate savings on their cost per kilowatt-hour of electricity used, the loss of revenue to petitioner from kilowatt-hour sales was only temporary. Such loss was recovered within a limited period of time as the result of the greater consumption of electricity, especially by petitioner's domestic class of customers. Once petitioner's previous total level of revenue was recovered, the continued increase in the use of electric energy resulted in an increased level of operating revenue from kilowatt-hour sales for each base period year except 1938.During the base period years and for the electric department only petitioner's operating revenue and operating income increased in each base period year except 1938, and its operating income per kilowatt-hour decreased in each year as shown in Joint Exhibit 25-Y, as follows:19361937Operating Revenue:Sale of energy $ 14,501,119.06$ 15,211,902.31Other 4,275.743,311.24Total 14,505,394.8015,215,213.55Operating Expenses:Production 2,950,792.293,141,926.94Transmission 170,488.82162,206.37Distribution 1,443,184.951,439,370.81Customers' Acctg. & Col 444,857.15527,012.51Sales promotion 156,792.14148,978.67Adm. & General 1,008,930.171,067,793.91Total 6,175,045.526,487,289.21Depreciation2,044,176.622,144,151.51Taxes exclusive Federal Income Taxes1,071,865.251,135,456.30Rent-leased property393,883.18390,863.22Total 9,684,970.5710,157,760.24Utility operating income4,820,424.235,057,453.31Kw-hr. sold599,919,650646,693,398Operating income per kw-hr. sold.00804.00782*146 11939Operating Revenue:Sale of energy $ 14,598,936.87$ 15,520,181.07Other 4,420.364,383.25Total 14,603,357.2315,524,564.32Operating Expenses:Production 2,724,455.273,124,990.57Transmission 165,948.15150,430.11Distribution 1,762,953.171,419,455.29Customers' Acctg. & Col 503,749.70507,437.55Sales promotion 289,052.47234,303.22Adm. & General 1,140,985.151,155,847.61Total 6,587,143.916,592,464.35Depreciation1,980,409.472,151,632.66Taxes exclusive Federal Income Taxes1,218,184.141,270,413.57Rent-leased property389,558.35390,868.23Total 10,175,295.8710,405,378.81Utility operating income4,428,061.365,119,185.51Kw-hr. sold569,956,236667,341,535Operating income per kw-hr. sold.00777.00767During the base period years the petitioner was the largest electric utility in Connecticut in the number of customers and the franchised *621 territory served. Its total number of meters, total annual kilowatt-hour sales in one-thousandths, and average annual kilowatt-hours per meter with*147 respect to its domestic, commercial, and industrial classes of customers for each of the base period years may be compared with similar data for all Connecticut electric utilities other than the petitioner (including about nine principal private companies and also municipalities), as follows:Number of metersKw-hr. sold (1,000's)YearPetitionerAll othersPetitionerAll othersDOMESTIC CUSTOMERS1936135,940271,861110,695202,1241937140,944277,905127,742226,6791938143,708280,178140,203243,9811939148,268286,183154,267265,690COMMERCIAL CUSTOMERS193617,42539,97544,952152,484193717,76540,75250,667171,736193817,87740,77052,966181,356193918,15241,35757,881198,814INDUSTRIAL CUSTOMERS19362,2056,888292,647399,71019372,0846,588316,283432,67719381,9426,487237,034345,57819391,9316,295304,584438,1571 Average kw-hr. per meter YearPetitionerAll othersDOMESTIC CUSTOMERS19368217441937913816193897787119391,047928COMMERCIAL CUSTOMERS19362,5773,81519372,8614,21419382,9654,44819393,2024,807INDUSTRIAL CUSTOMERS1936132,72058,0301937151,76765,6771938122,05653,2721939157,73469,604*148 In its Federal income tax returns for the years 1936 to 1939, inclusive, the petitioner deducted the following amounts for depreciation:YearAmount1936$ 2,372,128.2119372,452,952.0919382,510,420.4419392,549,999.51The depreciable bases and the composite rates of depreciation used by petitioner in computing the above deductions were a continuation of the depreciable bases and the composite rates of depreciation which the respondent had determined for years prior to 1936. The composite depreciation rates which respondent had previously determined were 3.34 percent for the bulk of petitioner's depreciable assets and 4.255 percent for certain 1926 acquisitions. The annual depreciation charge of $ 114,616.25 for the 1926 acquisitions was only about 5 percent of the total depreciation deduction for each of the base period years.The above-mentioned composite depreciation rates, which were determined by respondent in or about 1930 with respect to the years 1926 and 1927, were allowed the petitioner for the years subsequent *622 to 1927 and up through 1939, except for certain 1935 acquisitions as hereinafter*149 set out.In 1935 petitioner acquired by merger additional depreciable assets from the Rockville-Willimantic Lighting Co., the Monroe Electric Light and Gas Co., and the Northern Connecticut Power Co. Composite rates of depreciation of 3.15 percent, 3.5 percent, and 2.57 percent, respectively, had been previously determined by the respondent and used in the computation of the depreciation deductions for each of these companies. In its Federal income tax return for 1935 petitioner added the depreciable bases of these additional assets to its prior depreciable base, and the depreciation deduction was computed by using petitioner's previously determined composite rate of 3.34 percent.In a report dated October 15, 1937, covering the year 1935, a revenue agent recommended that the petitioner be required to depreciate the assets acquired by merger by using the composite rates of depreciation which had been previously determined and used by the aforementioned three companies. The revenue agent's proposed adjustments with respect to depreciation related both to depreciable base and to depreciation rates, and he proposed disallowance of charges for excessive depreciation in the amount of*150 $ 163,488.23 for the year 1935.Under dates of February 12 and March 20, 1940, another revenue agent prepared reports on petitioner's income tax liability for the years 1936, 1937, and 1938. The revenue agent's reports for these 3 years recommended that the same depreciation adjustment as had been proposed for the year 1935, which was still open, be made in respect to the depreciable assets which had been acquired by petitioner by merger in 1935. The agent's reports proposed disallowance of excessive depreciation in the amounts of $ 44,246.70, $ 44,589.83, and $ 25,449.42 for the years 1936, 1937, and 1938, respectively.Under dates of November 29, 1937, March 4, 1939, February 26, 1940, and May 16, 1940, petitioner filed protests against the depreciation adjustments and other adjustments proposed in the agent's reports covering the years 1935 to 1938, inclusive. In each of these protests petitioner contended in respect to the depreciable assets acquired by merger, that its own composite rate of depreciation, which was 3.34 percent, should be used in the determination of the depreciation deductions instead of the rates of 3.5 percent, 3.15 percent, and 2.57 percent which had been*151 previously determined and used by the three merged companies prior to their merger with petitioner. Several conferences were held with regard to petitioner's protests but respondent did not take any conclusive action as to the years 1936-38 until 1942.In January 1942, Internal Revenue issued Bulletin "F" (revised January 1942) which superseded the preceding Bulletin "F" issued in 1931 and "Depreciation Studies" published in 1931. The 1942 edition *623 of Bulletin "F" sets forth estimated useful lives and rates of depreciation based on averages, and states they are not prescribed for use in any particular case but are for use solely as a guide in the determination of correct rates in the light of the experience of the particular property under consideration and all other pertinent evidence. During 1942 and thereafter Internal Revenue engaged in making reexaminations of previously determined depreciation rates of all utility companies as rapidly as its manpower would permit.On June 19, 1942, a conference was held in New Haven, Conn., with respect to the above-mentioned protests filed by petitioner and issues relating to depreciation and other adjustments for the years 1935*152 to 1939, inclusive. Engineer Revenue Agent Karl Schmitt, of the New York district office and a specialist in the field of electric utility depreciation problems, was requested to attend the conference primarily for advice in respect to an abandonment loss deduction of about $ 130,000 claimed by petitioner for 1938. During the conference Schmitt pointed out that, based on his experience, he thought the petitioner's depreciation deductions for the years 1935 to 1939, inclusive, were higher than those which would be produced by the rates indicated in the 1942 edition of Bulletin "F," but that a redetermination of petitioner's composite rates could not be made without a field examination of petitioner's properties and records. Such an examination could not be made for at least a year because Schmitt was investigating the depreciation rates of numerous other utility companies. The representatives for both the respondent and the petitioner desired to close the years 1935 to 1939, inclusive, and they reached an agreement in settlement of the several questions involved in those years.Under date of July 7, 1942, Engineer Revenue Agent Schmitt submitted a report covering the petitioner's*153 taxable years 1935 to 1939, inclusive, which was approved by Engineer Reviewer E. R. Ford. With respect to the question of depreciation that report stated, as follows:It is recommended that the previously established rate of 3.34 percent for this taxpayer be continued and applied in these years to the appropriate depreciable properties, including those acquired in merger October 31, 1935 from Rockville, Willimantic Lighting Company and Monroe Electric Lighting Company. However, for the depreciable property acquired in 1935 from ConnecticutElectric Service Company formerly belonging to Northern Connecticut Power Company, a rate of 2.75 percent is applicable to the gross cost in the hands of Northern Connecticut Power Company.In the same report it was stated that the matter of depreciation for 1935 to 1939, inclusive, was discussed and agreed to in conference with the taxpayer in New Haven on June 19, 1942, and, further, that:It is also understood that for the year 1940 a thorough study of the whole question of depreciation is to be made and proper rates and separate reserve established for the gas, electric and water departments.*624 On September 17, 1942, the respondent*154 sent to petitioner a notice of additional tax liability for the years 1935 to 1938, inclusive. On January 5, 1943, the respondent sent the petitioner a similar notice accompanied by a revenue agent's report covering the year 1939. The foregoing notices for the years 1935 to 1939, inclusive, adopted the depreciation adjustments for each year which had been recommended by Schmitt in his report dated July 7, 1942. The amounts of depreciation deductions allowed in determining such additional tax liabilities and the reductions in the above-mentioned amounts of depreciation claimed on the returns were as follows:YearDepreciationReduction inallowedamount claimed1936$ 2,339,945.77$ 32,182.4419372,421,402.0431,550.0519382,498,939.4011,481.0419392,537,631.8612,367.65The respondent's notices of September 17, 1942, and January 5, 1943, referred to the acceptance by petitioner of the total additional liabilities determined therein for the years 1935 to 1939, inclusive, of $ 43,118.56 resulting from various adjustments made for depreciation and other items in question.Thereafter waivers held by the respondent extending the statutory period for assessing*155 and collecting additional taxes for the years 1935 to 1938, inclusive, were permitted to expire on June 30, 1943, and the statutory period for 1939 expired automatically on March 15, 1943.In the summer of 1943 Karl Schmitt made a field examination of the petitioner's properties and records and made a valuation report covering depreciation and other items for the years 1940 and 1941, which was submitted on September 16, 1943, and approved by E. R. Ford, engineer reviewer. With respect to depreciation and "as a result of agreement" that report recommended adjustments to petitioner's depreciable base and the allowance of depreciation at a composite rate of 3.15 percent, and further the disallowance of excessive depreciation taken on the returns for each of the years 1940 and 1941. The report stated, in part, as follows:From a review and study made of such data as was available, which was far from complete, the previously established composite rate of 3.34 percent appeared higher than would ordinarily be found applicable to facilities such as are used in the taxpayer's business. An inspection was also made of the major units of the plant in September 1943. * * ** * * *The data*156 for the establishment of proper departmental rates and reserves not being available, it was decided to continue with the use of a composite rate. The total tax reserve as of December 31, 1939 does not appear to be out of line, being about 32 percent of the total depreciable assets.The question of an allowable rate was gone into at great length and was the subject of discussion in several conferences. It was brought out that deferred *625 maintenance due to war conditions is quite substantial. An estimate from a reliable analysis and study made by the research engineer showing an amount of about $ 850,000 for the years 1942 and 1943 was produced. In view of all the circumstances, giving due regard to incomplete data, undermaintenance and other factors, pertinent to this taxpayer, it was agreed that a reasonable allowance for depreciation at this time would be produced by the use of a rate of 3.15 percent. * * *The composite character of the petitioner's various depreciable facilities was essentially the same during the base period 1936-39 and the subsequent period 1940-45, except for the above-mentioned increases in the ratio of steam to hydro facilities made during each*157 of those periods, respectively. In the petitioner's industry the composite depreciation rate for steam generating plants is generally higher than for hydroelectric generating plants.The respondent used the composite depreciation rate of 3.15 percent in the determination of petitioner's excess profits net income for the years 1940 to 1945, inclusive, but in the determination of petitioner's excess profits net income for the base period years, which is used to compute the excess profits credit for the purpose of determining petitioner's excess profits tax liability for the years 1940 to 1945, inclusive, the respondent used the higher composite rates of depreciation set forth in Schmitt's report dated July 7, 1942.The application of the composite depreciation rate of 3.15 percent to petitioner's depreciable base during the base period years decreases petitioner's depreciation deductions and increases petitioner's excess profits net income in the following amounts:YearAmount1936$ 144,698.061937149,331.811938153,742.621939155,943.69Total 603,716.18Average increase 150,929.05The capital stock of petitioner outstanding in the hands of the public*158 as of December 31, 1935 through 1939, was as follows:Capital stockDec. 31, 1935Dec. 31, 1936-1939Preferred $ 100 par value:68,044 shares 5 1/2 percent $ 6,804,400$ 6,804,40065,000 shares 6 1/2 percent 6,500,000Common no par value:1,147,860 shares, 1935 1,148,126 shares, 1936-39 Stated value 46,206,60046,217,240Total 59,511,00053,021,640*626 In July 1935 petitioner issued its First and Refunding Mortgage 3 3/4 percent series E bonds, due July 1, 1965, in the amount of $ 10 million. Amortization of debt discount and expense with respect to these series E bonds amounted annually to $ 4,860.24 for tax purposes. The funds derived therefrom were used to call and redeem the series B 5 1/2 percent bonds of petitioner and the 5 percent bonds of the Eastern Connecticut Power Co., and for improvements to property.During the base period years 1936-39 petitioner refinanced a sizable amount of its long-term debt which resulted in reductions in costs and expenses for interest and amortization of debt discount and expenses. Such reductions were made possible by the retirement of old bonds, issued in some instances at a discount, *159 with the proceeds from the sale of new bonds sold at a premium and bearing a lower interest rate than the old bonds which were retired. In addition to such refinancing, petitioner retired other bonds and debentures through the operation of sinking funds.The petitioner's long-term indebtedness on January 1, 1936, and on December 31, 1936, 1937, 1938, and 1939, was as follows:Outstanding long-termJan. 1, 1936Dec. 31, 1936Dec. 31, 1937indebtednessBonds issued by petitioner:Series A, 7 percent, due May 1, 1951 $ 5,080,500$ 4,928,000$ 4,771,000Series C, 4 1/2 percent, due July 1, 1956 8,618,500Series D, 5 percent, due July 1, 1962 7,358,500Series E, 3 3/4 percent, due July 1, 1965 10,000,00010,000,0009,907,000Series F, 3 1/2 percent, due Sept. 1, 1966 7,000,0007,000,00020-year debentures, 3 1/2 percent due Sept. 1, 1956 7,500,0007,429,000Series G, 3 1/4 percent, due Dec. 1, 1966 16,000,00016,000,000Series H, 3 1/4 percent, due Dec. 1, 1968 Bonds assumed by mergers:Central Connecticut Power and Light Co., 5 percent, due Apr. 1, 1937 306,000298,000The Bristol and Plainville Tramway Co., 4 1/2 percent, due Nov. 1, 1945 540,000The Northern Connecticut Power Co., 5 1/2 percent, due Mar. 1, 1946 2,100,000The Northern Connecticut Light and Power Co., 5 percent, due Dec. 1, 1946 196,000195,000190,500The Windsor Locks Water Co., 5 percent, due June 1, 1951 45,000The Waterbury Gas Light Co., 4 1/2 percent, due Nov. 1, 1958 995,000The Rockville Gas and Electric Co., 5 percent, due May 1, 1936 300,000The Rockville-Willimantic Lighting Co., series D and E, 5 percent, due Dec. 1, 1971 375,000Total 35,914,50045,921,00045,297,500*160 Outstanding long-termDec. 31, 1938Dec. 31, 1939indebtednessBonds issued by petitioner:Series A, 7 percent, due May 1, 1951 $ 4,571,000$ 4,371,000Series C, 4 1/2 percent, due July 1, 1956 Series D, 5 percent, due July 1, 1962 Series E, 3 3/4 percent, due July 1, 1965 Series F, 3 1/2 percent, due Sept. 1, 1966 7,000,0007,000,00020-year debentures, 3 1/2 percent due Sept. 1, 1956 7,356,0007,280,000Series G, 3 1/4 percent, due Dec. 1, 1966 16,000,00016,000,000Series H, 3 1/4 percent, due Dec. 1, 1968 15,000,00015,000,000Bonds assumed by mergers:Central Connecticut Power and Light Co., 5 percent, due Apr. 1, 1937 The Bristol and Plainville Tramway Co., 4 1/2 percent, due Nov. 1, 1945 The Northern Connecticut Power Co., 5 1/2 percent, due Mar. 1, 1946 The Northern Connecticut Light and Power Co., 5 percent, due Dec. 1, 1946 189,000188,500The Windsor Locks Water Co., 5 percent, due June 1, 1951 The Waterbury Gas Light Co., 4 1/2 percent, due Nov. 1, 1958 The Rockville Gas and Electric Co., 5 percent, due May 1, 1936 The Rockville-Willimantic Lighting Co., series D and E, 5 percent, due Dec. 1, 1971 Total 50,116,00049,839,500*161 *627 The numerous outstanding short-term bank loans owed by petitioner for the years 1936, 1937, and 1938 are set forth in detail in joint Exhibit 54-BBB included herein by reference. Petitioner had no such loans during the years 1935 and 1939. For the year 1936 petitioner's loans at various times from June to September totaled $ 3,500,000, all at 1 1/4 percent interest, and such total amount was paid during October 1936. For the year 1937 petitioner's loans at various times from April to December totaled $ 2,660,000, all at 1 1/2 percent interest, and such total amount was paid as follows: $ 30,000 in October 1937; $ 50,000 in June 1938; and the balance in December 1938. For the year 1938 petitioner's loans at various times from June to September totaled $ 540,000, all at 1 1/2 percent, and such total amount was paid during December 1938.In October 1936 petitioner issued and sold the following bonds:$ 7,000,000First and Refunding Mortgage 3 1/2%, Series F, due September1, 1966. $ 7,500,000Twenty-year 3 1/2% Debentures, due September 1, 1956.Series F bonds of $ 7 million were sold to the public at 105 percent and, after underwriting commissions, net to*162 the petitioner at 103 percent. Petitioner's expenses in connection with the issue were $ 87,410, leaving a net of $ 7,122,590 for petitioner. The debentures of $ 7,500,000 were sold to the public at 102 percent and, after underwriting commissions, net to the petitioner at 100 percent. Petitioner's expenses in connection with the issue were $ 85,296, leaving a net of $ 7,414,704 for petitioner.The total net proceeds of $ 14,537,294 received from the sale of the series F 3 1/2 percent bonds and the 3 1/2 percent debentures was used by petitioner as follows:(a) To repay existing bank loans$ 3,000,000This amount had been used in part to redeem the following bonds on the dates indicated: May 1, 1936 -- $ 300,000 to pay the First Mortgage 5% bonds of The Rockville Gas and Electric Co., due May 1, 1936. September 1, 1936 -- $ 2,194,500 for the redemption price of $ 2,100,000 First and Refunding Mortgage 5 1/2% Gold Bonds of The Northern Connecticut Power Co., due March 1, 1946. (b) To pay the redemption price of the following bonds redeemedon the dates indicated: November 1, 1936 -- $ 995,000 of The Waterbury Gas Light Co., First Mortage 4 1/2% Gold Bonds, due November 1, 1958 1,044,750November 1, 1936 -- $ 540,000 The Bristol and Plainville Tramway Co. First Mortgage 4 1/2% Gold Bonds, due November 1, 1945 540,000December 1, 1936 -- $ 40,000 Windsor Locks Water Co. First Mortgage 5% Gold Bonds, due June 1, 1941 42,000December 1, 1936 -- $ 375,000 The Rockville-Willimantic Lighting Co. First Refunding Mortgage 5% Gold Bonds Series "D" and "E", due 12-1-1971 $ 393,750(c) To pay for the redemption price of the outstanding $ 6,500,000par value of petitioner's 6 1/2% Cumulative Preferred Stock, redeemed on December 1, 1936 7,475,000(d) To pay for additions, betterments, and improvements of theproperty during 1936 2,041,794Total 14,537,294*163 *628 In December 1936 the petitioner issued and sold its series G bonds in the principal amount of $ 16 million bearing interest at the rate of 3 1/4 percent per annum, due December 1, 1966. These bonds were sold to the public at 104 percent of their principal amount and, after underwriting commissions, net to the petitioner at 102 percent. The petitioner received from the sale of said bonds, net of expenses of $ 91,634, the amount of $ 16,228,366. The net proceeds from the sale of series G bonds were used by the petitioner on January 1, 1937, 2 as follows:(a) To pay for the redemption of petitioner's seriesC, 4 1/2-percent Sinking Fund Gold Bonds, principal amount $ 8,530,500 at 105 percent and accrued interest $ 8,957,025Less cash in sinking fund 92,675$ 8,864,350(b) To pay for the redemption of petitioner's seriesD, 5 percent Sinking Fund Gold Bonds, principal amount $ 7,287,000, at 105 percent and accrued interest 7,651,350Less cash in sinking fund 75,0007,576,350Total 16,440,700The balance required for the redemption of series C and D bonds above was obtained from the*164 current cash of petitioner.During 1937 petitioner reduced its bonded indebtedness in the amount of $ 623,500. This amount is accounted for by the payment at maturity, on April 1, 1937, of the Central Connecticut Power and Light Co. underlying bonds amounting to $ 298,000, and the retirement of other bonds and debentures through the operations of sinking funds.In December 1938 the petitioner sold at private sale $ 15 million of First and Refunding 3 1/4-percent Series "H" Bonds for 104.9137 percent of their principal amount. The petitioner received from the *629 issuance of said bonds, net of expenses of $ 87,038, the amount of $ 15,650,017. Part of the proceeds from the sale of the series H bonds was used to pay for redemption of $ 9,720,000 First and Refunding Mortgage Series "E" Bonds bearing an interest rate of 3 3/4 percent per annum. *165 The old bonds were redeemed at 105 percent of the principal amount of $ 10,206,000.After redemption of the series E bonds, there remained $ 5,444,017 of the proceeds from the series H bonds. Of such sum $ 3,120,000 was used in 1938 to repay bank loans. The remaining $ 2,324,017 was carried in the petitioner's cash balance on hand at December 31, 1938 and 1939, available for capital requirements or operational purposes, and resulted in those cash balances being in excess of the approximately $ 1 million cash balance normally maintained by petitioner.During 1939 petitioner reduced its bonded indebtedness by $ 276,500 through the operations of the sinking funds.In the determination of petitioner's base period net income the respondent allowed deductions for interest and amortization of bond discount and expenses on the bonds and bank loans outstanding during the years 1936 to 1939, inclusive, as follows:Deductions allowed19361937Interest on bonds$ 1,773,504.34$ 1,754,058.60Amortization of bond discount and expenses72,756.8118,553.28Stamp taxes paid30,500.00Interest on bank loans8,969.0016,860.00Total deductions 1,885,730.151,789,471.88*166 Deductions allowed19381939Interest on bonds$ 1,737,416.36$ 1,836,034.79 Amortization of bond discount and expenses1 13,119.86(13,037.01)Stamp taxes paid15,000.00Interest on bank loans42,766.00Total deductions 1,808,302.221,822,997.78 In addition to the deductions in the next preceding paragraph, the amounts of bond premium and unamortized bond discount and expenses incurred by petitioner in connection with the bond redemptions made in the years 1936 through 1939 were also allowed in the determination of petitioner's income tax liability for the years 1936 to 1939, inclusive, as follows:Amounts allowed in determiningYearincome tax liability1936$ 272,978.9319371,811,090.74193832,807.19 1939644,822.62 However, in the determination of petitioner's base period net income for the above years, these amounts were added to such net income under section 711 for the purpose of determining petitioner's excess profits tax credit under the income method.Joint Exhibit 46-TT, included*167 herein by reference, is a schedule entitled "Summary of Average Borrowed Capital and Interest Paid *630 in Base Period," which sets forth in detail with respect to each bond issue outstanding during the years 1936 to 1939, inclusive, the average outstanding, the interest rate, the interest paid, and also the total amounts thereof. Such totals for the indicated years are as follows:YearAverageInterestInterestoutstandingratepaid1936$ 37,786,9364.6934$ 1,773,504193745,535,4483.85211,754,058193845,280,7723.83701,737,416193950,055,4953.66801,836,035The petitioner's above-mentioned refinancing of a sizable amount of its long-term debt, by retirements of certain higher interest rate bond issues with the proceeds of lower interest rate series F, G, and H bond issues, resulted in reductions in interest and debt expense as to the portions of its long-term debt so refinanced. The higher interest and debt expense on the old bonds were reflected in petitioner's level of earnings up to the dates of their respective retirements. The reductions and/or savings in interest and debt expense were only partially reflected in petitioner's level*168 of earnings during the years 1936, 1937, and 1938, but were fully reflected therein for the last base period year 1939 and subsequent years.As of March 1, 1938, petitioner entered into group annuity contract No. GA-0177 with the Aetna Life Insurance Co. to provide annuities for petitioner's employees subscribing to the plan, payable when such employees reached age 65. The total premium for the retirement annuity of each employee was to be determined from a table in the contract on the basis of age and salary. Under the plan the employees contributed a percentage of their earnings and the petitioner contributed approximately 170 percent of the amount contributed by the employees. During the 10 months of 1938 in which the plan was effective, the employees contributed $ 75,528.42 and the petitioner contributed $ 124,898.40. During the year 1939 the petitioner contributed $ 135,955.20. Prior and subsequent to the above contract, petitioner had certain welfare and pension expenses other than the annuity plan. The total amounts of welfare and pension expenses incurred by petitioner, including amounts charged to expense and amounts capitalized on the books but deducted for tax purposes, *169 for the years 1936-39, were as follows:Total welfare and pension expenses1936193719381939Total charged to expenseon books $ 52,899.57$ 59,848.32$ 211,323.57$ 209,004.96Add: Additional pensionexpense capitalized on books but deducted for tax purposes 10,917.7612,788.31Total 52,899.5759,848.32222,241.33221,793.27*631 Included herein by reference are Exhibit 75, showing an allocation of total welfare and pension expenses between petitioner's electric and other departments, and Exhibit TTT, showing petitioner's operating payroll exclusive of payroll charged to construction and non-operating accounts, both for the years 1936 to 1939, inclusive. Construction of certain facilities was handled by petitioner's own employees. As between the beginning and end of the base period petitioner's deductions for welfare and pension expenses had reached a relatively permanent higher amount, and the latter was fully reflected in petitioner's level of earnings for the last base period year 1939.In each of the years from 1922 through 1939 the petitioner made dividend distributions, for tax purposes, not out of earnings, as shown*170 by Exhibit NNN, included herein by reference. After the payment of dividends petitioner had a surplus at December 31 of each of the years 1935 to 1939, inclusive, as shown by the condensed balance sheets in joint Exhibits 28-BB to 32-FF, included herein by reference. The petitioner's dividend distributions made in excess of earnings for tax purposes in each of the years 1935 to 1939, inclusive, and also its surplus at the end of those years were as follows:DistributionsYearin excess ofSurplus atearnings forDecember 31tax purposes1935$ 2,050,155.19$ 3,767,79619361,553,961.142,991,32619371,918,265.583,280,48719381,635,845.703,119,9101939190,291.193,353,748The petitioner's excess profits taxes for the years involved herein, computed without the benefit of section 722, are excessive and discriminatory in that its average base period net income is an inadequate standard of normal earnings because as provided in section 722(b)(1) normal production and operation of the business was interrupted by reason of a hurricane during the base period, and further, as provided in section 722(b)(4), the petitioner during the base period changed*171 the character of the business by a difference in the capacity for production or operation and the average base period net income does not reflect the normal operation for the entire base period of the business. The business of the petitioner did not reach, by the end of the base period, the earning level which it would have reached if petitioner had made the change in the character of the business 2 years before it did so. A fair and just amount representing normal earnings to be used as a constructive average base period net income is the amount of $ 4,300,000 for the purpose of computing an excess profits credit based on the income method for the years involved herein.*632 Standard IssuesAmong the numerous exhibits attached to the stipulation and supplemental stipulations, included herein by reference, are the petitioner's income and excess profits tax returns for the years involved, and also Exhibit BBBB -- certificates of assessments and payments covering the years 1941 through 1945; Exhibit CCCC -- certificates of overassessment covering the years 1941 and 1942; Exhibit DDDD -- worksheets with reference to Exhibit CCCC showing the underlying computations; Exhibit*172 EEEE -- waivers of restrictions on assessment and collection of deficiency in tax and acceptance of overassessment (Form 870) for the years 1941 and 1942 and petitioner's letters of transmittal; Exhibit FFFF -- notices of allowance of tentative amortization adjustment for the years 1942, 1943, and 1944; and Exhibits VVV through AAAA -- revenue agents reports and supplemental reports variously covering the years 1940 to 1942 and 1943 to 1945, respectively. It is stipulated that such revenue agents' reports shall be accepted as proof of data therein taken from petitioner's books and records, and as proof of adjustments made to petitioner's tax returns in arriving at tax liability as set forth in the statutory notice.The petitioner and respondent executed a series of agreements (Form 872) whereby the period of limitations for assessment and collection of additional taxes was extended to June 30, 1953, for each of the years 1941 and 1942, and extended to June 30, 1950, for each of the years 1943, 1944, and 1945. There were no further agreements executed by the parties extending the statutory period of limitation.The respondent's statutory notice of partial disallowance, mailed on *173 March 18, 1953, refers to petitioner's applications for section 722 relief and claims for refund; to the constructive average base period net income of $ 3,913,000 determined by the Excess Profits Tax Council on or about January 21, 1952, as applicable to the year 1940 for carryover purposes and to the taxable years 1941 to 1945, inclusive; to the supplemental revenue agent's report dated June 5, 1952, covering the years 1940, 1941, and 1942 (Exhibit XXX herein); and to the supplemental revenue agent's report dated July 18, 1952, covering the years 1943, 1944, and 1945 (Exhibit AAAA herein). Those reports refer to data and schedules contained in earlier revenue agents' reports.The petitioner had a deficit in its earnings and profits for tax purposes for each of the years 1939 to 1945, inclusive.The amounts of the petitioner's quarterly dividends on common stock paid on the 1st of January, April, July, and October and the amounts of its quarterly dividends on prefered stock paid on the 1st of *633 March, June, September, and December of each of the years 1940 to 1945, inclusive, are set forth in the revenue agents' reports, included herein by reference and particularly in Exhibits*174 VVV and YYY herein. The latter exhibit embraces schedules of respondent's computations showing the petitioner's net income and the various adjustments thereto, including deductions for income tax for 1940 and income and excess profits taxes for 1941 to 1945, inclusive, in arriving at petitioner's earnings and profits for tax purposes available for distribution. As therein computed, the petitioner made dividend distributions not out of earnings and profits for tax purposes during each of the years 1940 to 1945, inclusive.With respect to the year 1940 the supplemental revenue agent's report dated June 5, 1952 (Exhibit XXX herein), referred to in the statutory notice, embraces the computation which shows that petitioner had no excess profits tax liability for 1940, under the invested capital method, and no excess profits tax previously assessed for that year. The report further shows the computation of the excess profits credit for 1940 for carryover purposes only. In the computation under the invested capital method, the excess profits net income was adjusted by adding thereto the income tax of $ 995,100.92 for 1940, resulting in no unused excess profits credit for 1940. In the*175 computation under the income method, a similar adjustment for 1940 income tax was not made to petitioner's excess profits net income as set forth in the amount of $ 3,460,328.64, and respondent's allowance of an excess profits credit of $ 3,717,350 (or 95 percent of the CABPNI of $ 3,913,000 allowed by respondent under section 722) resulted in an unused excess profits credit of $ 257,021.36 for 1940, which was allowed as a carryover to 1941.In computing the excess profits credit for 1940 under the income method for carryover purposes only, mentioned in the next preceding paragraph, the respondent made no adjustment thereto for net capital reduction because of 1940 dividend distributions not out of earnings and profits for tax purposes, determined to be in the amount of $ 654,930.77. Briefly stated, the amount of such distributions was computed in revenue agent's report, Exhibit VVV, in the following manner: Petitioner's net income for 1940 as finally determined for tax purposes was $ 4,154,262.04, and after certain adjustments thereto including the deduction of $ 995,100.92 Federal income tax for 1940, the net 1940 income available for distribution for tax purposes was determined*176 to be $ 3,153,529.23, and petitioner's 1940 preferred and common dividend distributions amounted to a total of $ 3,808,460, exclusive of Treasury stock dividends.Attached to the statutory notice and included herein by reference is the statement setting forth the respondent's computation of petitioner's *634 excess profits tax liability and the amount of the overassessment at issue herein for each of the taxable years 1941 to 1945, inclusive. In connection therewith the computation, based on the income method for each taxable year, shows an excess profits credit (at 95 percent of the $ 3,913,000 CABPNI allowed by respondent under section 722) in the amount of $ 3,717,350 as further adjusted by either a plus or minus adjustment for net capital addition or reduction in arriving at petitioner's adjusted excess profits net income and its excess profits tax liability. The computation of the adjustment for net capital addition or reduction as made by respondent will be set forth for each taxable year.With respect to the excess profits credit for 1941, the respondent's minus adjustment for net capital reduction in the amount of $ 39,295.85 consisted of 6 percent of $ 654,930.77, *177 representing petitioner's 1940 dividend distributions not out of earnings and profits for tax purposes, arrived at as hereinabove set out. No similar adjustment was made for any such distributions made by petitioner during the taxable year 1941. Further, the respondent allowed an unused excess profits credit carryover from 1940 to 1941 in the amount of $ 257,021.38 arrived at as hereinabove set out.With respect to the excess profits credit for 1942, the respondent's plus adjustment for net capital addition in the amount of $ 668,436.40 consisted of 8 percent of $ 8,355,454.95 representing the difference between a capital addition of $ 10,750,660.90 (at 93.9726 percent of $ 11,440,208) from the sale of preferred stock on January 22, 1942, and capital reductions in the total amount of $ 2,395,205.95. The latter amount consisted of the amount of $ 936,077.10 (at 83.5616 percent of $ 1,120,224) resulting from retirement of preferred stock on March 1, 1942, and dividend distributions not out of earnings and profits for tax purposes determined to be in the amounts of $ 654,930.77 for 1940 and $ 804,198.08 for 1941. Respondent's adjustment for 1942 net capital addition did not take into*178 account any dividend distributions not out of earnings and profits for tax purposes, made by petitioner during the taxable year 1942.The respondent's plus adjustment to petitioner's excess profits credit for net capital addition amounted to $ 639,924.47 for 1943, $ 601,595.58 for 1944, and $ 537,737.43 for 1945. Those amounts represented 8 percent of the net capital addition for each year, respectively, computed as the difference between a capital addition of $ 11,440,208 resulting from the sale of preferred stock in 1942, and the total capital reductions determined for each year, respectively. The latter amount consisted of the preferred stock retired in 1942 and dividend distributions not out of earnings and profits for tax purposes determined to be in the amounts for the indicated years, as follows: *635 1943Preferred stock sold, 1942$ 11,440,208.00Preferred stock returned, 19421,120,224.00Dividend not out of earnings:1940 654,930.771941 804,198.081942 754,843.621943 106,955.671944 1945 Total capital reductions 3,441,152.14Net capital addition 7,999,055.8619441945Preferred stock sold, 1942$ 11,440,208.00$ 11,440,208.00Preferred stock returned, 19421,120,224.001,120,224.00Dividend not out of earnings:1940 654,930.77654,930.771941 804,198.08804,198.081942 754,843.62754,843.621943 428,998.16428,998.161944 157,068.67631,726.441945 323,569.02Total capital reductions 3,920,263.304,718,490.09Net capital addition 7,519,944.706,721,717.91*179 Exhibit CCCC, consisting of certificates of overassessments included herein by reference, shows that respondent allowed petitioner overassessments in excess profits tax in the amounts of $ 94,394.88 for 1941 and $ 3,590.13 for 1942 which have been rebated by refund or credited as payment for other unpaid assessments.OPINIONThe respondent, in his statutory notice, partially disallowed petitioner's applications for relief under section 722 of the Internal Revenue Code of 1939 and related claims for refund, and further partially allowed such application for relief. This partial allowance was based on respondent's determination of petitioner's qualification under sections 722(b)(1) and (b)(4) and a constructive average base period net income (CABPNI) of $ 3,913,000 applicable to each of the years 1941 to 1945, inclusive, resulting in relief to petitioner over that available under section 713(f) and in an overassessment of excess profits taxes for each of those years. In arriving at such CABPNI the respondent determined, for each base period year, the petitioner's adjusted excess profits net income without benefit of section 722, and reconstructed such net income for each year to the*180 extent affected by his partial allowance under both (b)(1) and (b)(4) and then took the average thereof for those years, as set out in our Findings of Fact.There is no issue herein raised by either party with respect to the correctness of respondent's determination that petitioner qualified under section 722(b)(1) by reason of a hurricane which resulted in an interruption of normal production and operation, or with respect to respondent's adjustment therefor in his reconstruction. However, in conjunction with his affirmative pleading that petitioner is not entitled to any relief under subsection (b)(4), respondent herein contends that any reconstruction based on the subsection (b)(1) qualifying factor standing alone results in a CABPNI which affords no relief.The petitioner seeks a CABPNI substantially in excess of that determined in respondent's statutory notice, based upon alleged errors *636 in respondent's partial disallowance of its subsection (b)(4) claims for relief, and also in respondent's reconstruction of the CABPNI determined for purposes of his partial allowance of relief.The respondent denies error in his partial disallowance. Further, respondent affirmatively*181 pleads that he erred in his statutory notice in determining a partial allowance of relief, alleging that he erroneously failed to make certain so-called contra-adjustments which would cancel out the subsection (b)(4) adjustments previously allowed and result in a CABPNI which would preclude any section 722 relief and eliminate the overassessments. Furthermore, respondent affirmatively pleads error in his determination of petitioner's excess profits taxes in matters involving so-called standard issues, whereby respondent seeks redetermination of a substantial increase in the excess profits tax liability from which the petitioner sought relief in initiating this proceeding.The section 722 issues involved herein arise only under subsection (b)(4). The applicable statutory provisions of the Internal Revenue Code of 1939 are set forth in the margin. 3The petitioner has the *637 burden of proving alleged qualifications in addition to those determined in respondent's statutory notice and of establishing a fair and just amount to be used as a CABPNI in excess of that determined by respondent. The respondent has the burden of proof as to each of his various affirmative allegations*182 of error in his partial allowance of relief. We will discuss the section 722(b)(4) issues involved in such order of arrangement and either separately or collectively as we deem appropriate for the purposes of this opinion.*183 In his statutory notice respondent determined that petitioner qualified under section 722(b)(4) by reason of cost savings based on the additional 25,000-kw steam generating capacity installed at petitioner's Montville plant in 1937 and on the 15,000-kw steam generating capacity made available to petitioner in March 1938 under the interchange agreement. In his pleadings the respondent alleged error in such determination only with respect to his characterizing the interchange agreement as making available an additional 15,000-kw capacity. There is no issue properly before the Court with respect to the correctness of respondent's determination as to the additional 25,000-kw capacity installed at Montville, and respondent's contention on brief that it was merely a normal routine change, not within the scope of subsection (b)(4), serves only to cloud an already complex case. In any event, the facts herein establish that the additional 25,000-kw steam generating facility installed at a cost of $ 1,892,577 constituted "a difference in the capacity for production or operation" (emphasis supplied) and thus a qualifying factor as a base period change in the character of the business within*184 the meaning of section 722(b)(4). With respect to the 15,000 kw made available to petitioner in 1938, we are of the opinion that respondent has failed to prove error in his statutory notice determination that it also constituted a similar (b)(4) qualifying factor. The facts establish that the terms of the Stamford interchange agreement and the petitioner's construction of a 66,000-volt transmission line between Norwalk and Stamford at a cost of $ 473,810, including $ 40,000 for the cost of land, made available to petitioner's system an additional 15,000 kw steam generating capacity in 1938. The record does not support the respondent's contention herein that there was merely a normal routine arrangement for petitioner's purchase of a supply of electric energy on a favorable basis instead of additional capacity for petitioner's production or operation.The above base period changes materially increased the petitioner's capacity by a total of 40,000 kw for the production of steam-generated electricity which was more dependable to meet daily load requirements than hydroelectric generating facilities, and lowered cost of production of electric energy which directly resulted in a higher*185 level of normal earnings. We conclude that the amounts of such cost savings *638 were properly allowed by respondent as adjustments in the reconstruction of base period income and determination of partial relief under section 722(b)(4). Cf. Bergstrom Paper Co., 26 T.C. 1167">26 T.C. 1167, petition for review dismissed (C.A. 7, Jan. 30, 1958), and authorities cited therein.Related to the next preceding issue is the petitioner's assignment of error that respondent, having allowed a reconstruction adjustment for cost savings resulting from base period changes in the character of the business, erred in failing to allow cost savings computed on the same basis for steam generating facilities completed after December 31, 1939, and alleged to have been committed for by petitioner prior to January 1, 1940. This pertains to the new 25,000-kw generating unit which was authorized and ordered prior to December 31, 1939, and the installation thereof completed at Stamford in October 1941 by the Connecticut Power Co. (not the petitioner herein) to provide additional generating capacity for the integrated system as contemplated by the interchange agreement. The petitioner*186 contends that this was a section 722(b)(4) commitment with respect to the Connecticut Power Co.; that under the interchange agreement such company was obligated to construct the new generating facility and make the additional capacity available to petitioner for production or operation; and that petitioner was obligated to use such additional capacity in its interchange operations with resulting cost savings and, accordingly, the change in capacity was equally committed for by petitioner within the meaning of subsection (b)(4). The respondent contends, inter alia, that to qualify for a subsection (b)(4) commitment the change in capacity consummated after December 31, 1939, must be "as a result of a course of action to which the taxpayer was committed prior to January 1, 1940" (emphasis supplied), and that petitioner, the taxpayer herein, never took any course of action on its own account to authorize, order, and install the new generating unit. The respondent further contends that even though upon completion the new unit was used along with the other generating units of the two companies to carry the daily load requirements of the integrated system under the interchange *187 agreement, nevertheless, a course of action to which another taxpayer was committed may not be imputed to petitioner for the purposes of section 722(b)(4) relief. We agree with the respondent's contention.The general rules of the relief section 722 contain broad phraseology which has been given liberal construction in determining the applicability of that section to various factual situations presented in claims for relief from alleged excessive and discriminatory excess profits taxes. However, in our opinion, where specific language of that statute denotes requisite requirements, the latter must be squarely *639 met by the taxpayer seeking relief. With respect to the subsection (b)(4) commitment rule, we have heretofore held that "capacity" is a word with specific limitations upon the applicability of that rule. Newburgh Transfer, Inc., 17 T.C. 841">17 T.C. 841. We are also of the opinion that the word "taxpayer" specifically limits the applicability of such rule to the taxpayer as the requisite entity which must be committed to making a change in capacity as such. See Barth Smelting Corporation, 30 T.C. 1073">30 T.C. 1073. It should*188 be noted that in the instant case the alleged commitment was not for the installation of machinery by or for the sole use of the taxpayer, did not result in the taxpayer obtaining any interest, leasehold, or otherwise in the property to be constructed, and did not create as to the taxpayer the right or obligation to receive a determinable amount of energy. Cf. Southern California Edison Co., 19 T.C. 935">19 T.C. 935. In any event, a (b)(4) qualification under the commitment rule applies only to a change in capacity, Newburgh Transfer, Inc., supra, and any other (b)(4) change in the character of the business must have occurred immediately prior to or during the base period. Corn Products Co., 36 T.C. 969">36 T.C. 969. Here there is no base period event to support the claimed adjustment for additional cost savings relating to the new Stamford 25,000-kw unit completed after December 31, 1939. We sustain the respondent's disallowance of any reconstruction adjustment on this issue.In addition to the above-mentioned increases made by petitioner in the capacity of its own generating facility during the base period, the*189 petitioner also substantially increased the mileage and the voltage of its transmission and distribution lines, and increased the capacity of its transmission and distribution substations during the base period as detailed in our Findings of Fact. Such base period additions to petitioner's transmission and distribution facilities at a total cost of $ 6,943,242.97, including some replacements, materially increased petitioner's capacity for operation and actual operation in delivery of electric energy not only to old customers but to new customers, particularly of the domestic category, which directly resulted in increased sales and a higher level of normal earnings. The petitioner alleges that the respondent, in his reconstruction, erred in failing to allow any adjustment to base period income for increased sales and level of earnings attributable to such changes. The respondent counters with the contention that they were merely normal routing changes not within the purview of section 722(b)(4). In our opinion, these base period changes, separately or certainly when considered altogether, constituted a qualifying (b)(4) base period change in the character of the business as "a *190 difference in the capacity for production or operation." Cf. Lansburgh & Bro., 30 T.C. 1114">30 T.C. 1114, 1118. We hold that respondent erred in failing to make any reconstruction adjustment on account thereof.*640 The petitioner's various sales-promotion activities and voluntary rate reductions during the base period, as detailed in our Findings of Fact, clearly did not constitute subsection (b)(4) changes in the character of the business, either as "a change in the operation or management of the business" or otherwise, but rather constituted intensified normal activities in petitioner's growing business.The petitioner alleges that the respondent, in his reconstruction, erred in failing to allow an additional adjustment to base period net income to reflect elimination of alleged abnormal deductions for depreciation in the base period years as compared to deductions for depreciation in the subsequent taxable years. It would serve no useful purpose to set forth the lengthy arguments of the parties. Briefly stated, petitioner contends that having qualified for relief the reconstruction of its normal earnings should eliminate an alleged base period abnormality*191 of excessive depreciation pursuant to respondent's E.P.C. 6, 2 C.B. 123">1946-2 C.B. 123, and respondent contends that the latter is not applicable to the facts in the instant case. We agree with respondent.In Southern California Edison Co., supra, the respondent in 1943 determined lower depreciation rates than were claimed by the taxpayer on its returns for each of the years 1936-39. The reduced rates were applied for tax purposes both prospectively to later years and retroactively to earlier years, but, because of the statute of limitations, they were given no effect prior to 1939. The reduced rates applied to 1939 were no less appropriate for the earlier base period years and if applied thereto the taxpayer's depreciation would have been reduced and net income increased by substantial amounts for each of the years 1936-38. For purposes of section 722 the reduced depreciation rates were applied by respondent in determining normal earnings for 1939 but not for the earlier years 1936-38. This Court held that, so far as concerned a reconstruction under section 722, the rates used for 1939 should be used in determining normal earnings*192 for the three earlier base period years as required by E.P.C. 6 for the correction of abnormal depreciation deductions in such earlier years. The date of the respondent's determination of the reduced depreciation rates was immaterial to the Court's holding because the actual application thereof to 1939 constituted the occurrence of a base period event. The Court further held that E.P.C. 6 required correction for abnormal interest deductions to the extent that base period net income did not reflect interest savings on long-term debt retirement and refunding which occurred at various times during the base period. However, with respect to the taxpayer's claim for adjustment for alleged abnormal base period interest deductions as compared to subsequent years where bonds outstanding at the close of 1939 were refunded in 1941 at a lower rate of interest, this Court held that no effect could be given to such transaction in reconstructing the taxpayer's *641 base period net income because reference to post-1939 events is prohibited by section 722(a). This last holding is, in our opinion, controlling in the instant case on petitioner's claimed adjustment for alleged abnormal or excessive*193 depreciation allowed for the entire base period as compared with the subsequent taxable years involved. The crux of the factual situation herein is that the petitioner and respondent agreed upon a composite depreciation rate of 3.34 percent as the appropriate rate applicable in determining a reasonable allowance for depreciation for tax purposes for all 4 base period years, and thus there was no abnormality as between any one or more of those years as was true in the Southern California Edison case. Thereafter as a result of inspection of the properties and conferences, the petitioner and respondent agreed to a lower composite depreciation rate of 3.15 percent as the appropriate rate applicable in determining a reasonable allowance for depreciation for different taxable years 1940-45. This was a post-1939 event, which incidentally involved a question of fact relating only to the years 1940-45, and pursuant to the prohibition of section 722(a) no regard shall be had to such event in reconstructing petitioner's base period net income. The respondent is sustained on his disallowance of the claimed additional adjustment for alleged abnormal depreciation deductions in the base *194 period years. Further, our conclusion on this issue obviates any necessity of passing on the question of whether petitioner is estopped from claiming an adjustment for abnormal depreciation as affirmatively pleaded by respondent.The petitioner alleges that the respondent, in his reconstruction of base period net income, erred in failing to allow an additional adjustment to reflect substantial reductions in interest expense and debt discount and expense. This is a claim for correction of a base period abnormality. Our Findings of Fact set forth in detail the petitioner's base period refunding of a sizable portion of its long-term bond indebtedness at lower interest and debt expense. The higher interest and debt expense on the old refunded bonds were reflected in petitioner's level of earnings up to the dates of the respective retirements of the old bonds. The reductions and/or savings in interest and debt expense were only partially reflected in petitioner's level of earnings during the years 1936, 1937, and 1938, but were fully reflected therein for the last base period year 1939. In Southern California Edison Co., supra, where the taxpayer retired*195 long-term indebtedness in each of the base period years thereby reducing the amount of interest payable, this Court said at page 998:Keeping in mind E.P.C. 6, we think petitioner's average base period net income is abnormally low for failure completely to reflect these reduced interest charges, and that this is an abnormality which requires correction. * * * Correction *642 is needed only to the extent that the actual earnings do not reflect the interest savings.And, further, where the taxpayer refunded a bond issue in the base period at reduced interest rates, this Court said at page 999:To the extent that petitioner's average base period net income fails to reflect this reduction in interest, we think it likewise contains an abnormality which requires correction under E.P.C. 6 for essentially the same reasons as obtain respecting the retired indebtedness. * * *In the instant case and on authority of the Southern California Edison case we hold that the claimed abnormality correction may be made but only to the extent that actual base period earnings do not reflect the petitioner's interest and debt expense savings.The petitioner alleges that the respondent, in*196 his reconstruction of base period net income, erred in failing to reconstruct for an increased level of sales and earnings under the 2-year pushback rule, and further claims application of that rule to certain enumerated events. Based upon a study of the record herein, we are convinced that "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 * * * made the change in the character of the business two years before it did so," and, accordingly, "it shall be deemed to have * * * made the change at such earlier time," but only in regard to petitioner's qualifying subsection (b)(4) changes. The petitioner is entitled to a reconstruction of an increased level of sales and earnings under the 2-year pushback rule as applied to the hereinbefore-determined qualifying changes in plant facilities completed by petitioner during the base period for increased capacity for production of electric energy, and also for increased capacity for operation of the business in transmission and distribution of electric energy. However, the petitioner is not entitled to the contended-for application of the 2-year pushback*197 rule to the claimed Stamford additional generating capacity as to which we have held petitioner was not committed, or the claimed additional extensions of rural distribution lines which would have been made if all the base period changes in the character of the business had been made 2 years earlier. Since neither of those alleged changes constituted a qualifying factor, there can be no push back thereof. Further, with respect to the additional extensions of rural distribution lines which petitioner claims it would have made with 2 more years' experience based on other qualifying factors, we are of the opinion that the record fails to establish what, if any, such lines might reasonably have been built. We think the record shows that petitioner's base period construction of transmission and distribution lines constituted the total that actual base period conditions warranted.As hereinbefore mentioned, the respondent's partial allowance was based upon a CABPNI arrived at through year-by-year reconstruction *643 of base period net income. We find the year-by-year method of reconstruction not only complex, but unnecessary in regard to certain aspects of this case. We find that*198 certain circumstances or matters for which adjustments are claimed by both parties herein were for all practical purposes fully reflected in petitioner's actual earning level for its last base period year. Accordingly, and based upon a consideration of the whole record, we conclude that the appropriate reconstruction of a CABPNI in the instant case should be made on the basis of ascertaining the earning level which petitioner would have reached by the end of 1939, after application of petitioner's section 722 qualifying factors (including the pushback rule where applicable) to its business operations under existing base period conditions, and backcast with an appropriate index to arrive at a base period average. See 7- Up Fort Worth Co., 8 T.C. 52">8 T.C. 52; Lansburgh & Bro., supra; and Copco Steel & Engineering Co., 31 T.C. 629">31 T.C. 629.Having reached the conclusion set forth in the next preceding paragraph and in connection with the reconstruction for the year 1939, we hold that no adjustments need be made for interest and debt expense savings occasioned by base period refunding of outstanding long-term *199 bonds at lower interest rates or cost savings resulting from more efficient steam-generating facilities which became available during the base period as claimed by petitioner, or for increased interest and debt expense on new additional borrowed capital required to finance base period additions to petitioner's plant facilities, or for increased insurance, property taxes, and depreciation incurred on such additional facilities, or for increased welfare and pension expenses incurred after 1937 as contra-adjustments claimed by respondent.Furthermore, in connection with respondent's claimed contra-adjustments, we conclude and hold that respondent has not established his affirmative plea of error in his determination in failing to make an adjustment for an alleged abnormality which would reduce reconstructed base period net income for alleged constructive loss of earnings arising from dividend distributions other than out of earnings and profits for tax purposes. On the record we conclude that respondent has failed to establish a sound factual basis in support of his theory of constructive loss of earnings and, in any event, that respondent's proposed computation of amounts (in terms *200 of interest on constructive additional borrowed capital in sums equivalent to such dividends), as representing alleged constructive loss of earnings in each base period year, fails to establish any justifiable amounts thereof. The record establishes that after payment of dividends, other than out of earnings for tax purposes, the petitioner had a substantial surplus in each base period year and there is no basis herein for a finding as to what amounts, if any, of constructive borrowings could be said to be attributable to petitioner's dividend policies. Furthermore, *644 this claimed abnormality adjustment for constructive loss of earnings would result in a double diminution of base period net income because, as above concluded, petitioner's level of earnings for 1939 reflects deductions for increased interest incurred on additional borrowed capital required to finance base period additions to petitioner's plant facilities. We hold against respondent on this issue, which has served only to add complexity to the instant case.The respondent affirmatively alleges error in his determination in allowing the petitioner an unused excess profits credit carryover, based on constructive*201 earnings under section 722, from the year 1940 to the year 1941, that is computed on the basis of the CABPNI of $ 3,913,000 determined by respondent under section 722. The burden of this affirmative allegation is simply that if respondent erred in allowing section 722 relief then he further erred in using the CABPNI as a basis for computing the excess profits credit for 1940 and the resulting carryover. This issue is dependent upon whether any relief is granted in this proceeding. Respondent's separate assignment of error, raising the question of the correct amount of any carryover from 1940, will be discussed hereinafter. The remaining so-called contra-adjustment, affirmatively claimed by respondent that he erroneously characterized the Stamford Interchange Agreement as making available an additional 15,000-kw capacity during the base period, has been hereinabove decided adversely to respondent.The petitioner's actual average base period net income is $ 3,781,544 while its average base period net income under the "growth formula" of section 713(f) as adjusted by respondent is $ 3,844,849 for 1941 and $ 3,854,803 for the years 1942 to 1945, inclusive. In his notice of partial*202 disallowance, the respondent determined that petitioner qualified for relief under section 722(b)(1) and (b)(4), and further determined a constructive average base period net income of $ 3,913,000 applicable to the taxable years 1941 to 1945 and also to 1940 for purpose of carryover of unused excess profits credit. Respondent has failed to establish his affirmative allegations that he erroneously allowed any relief. Petitioner claims a CABPNI of $ 5,032,811 based on a reconstruction embracing all the adjustments claimed herein, some of which have been hereinabove decided adversely to petitioner, and, accordingly, such claimed CABPNI is not substantiated. However, the petitioner has carried its burden of establishing a basis for determining a fair and just amount representing normal earnings to be used as a CABPNI in an amount in excess of its average base period net income computed without regard to section 722.We have found as a fact, and so hold, that petitioner's average base period net income is an inadequate standard of normal earnings and that petitioner's excess profits tax for the years involved herein, computed *645 without the benefit of section 722, results in *203 an excessive and discriminatory tax.We have given full consideration to all the facts in the voluminous record herein. We have applied the 2-year pushback rule to petitioner's (b)(4) base period changes in the character of the business embracing "a difference in the capacity for production or operation" and including increased capacity of generating facilities, high voltage transmission lines and substations, and also increased mileage of transmission and distribution lines, all of which directly resulted in increased sales of electric energy and a higher level of normal earnings. In applying the 2-year pushback rule we have given consideration to petitioner's own experience in expansion and growth of its business. We have used our best judgment in reconstructing a reasonable amount of increased sales and level of earnings which would have been reached as of December 31, 1939, in the light of petitioner's qualifying factors under base period circumstances. We have applied an appropriate index figure for the purpose of backcasting to obtain a base period average. In the exercise of our best judgment, we have determined that a fair and just amount representing normal earnings to*204 be used as a constructive average base period net income for the purpose of computing petitioner's excess profits credit based on the income method is $ 4,300,000 for the taxable years 1941 to 1945, inclusive. Such CABPNI is also applicable to the year 1940 for purposes of any carryover of unused excess profits credit based on the income method. A further adjustment for income taxes will be made for the year 1940 in the recomputation under Rule 50. Cf. Copco Steel & Engineering Co., supra, and Lansburgh & Bro., supra at 1121.Standard IssuesThe respondent's affirmative pleading that there are no overassessments and that there are deficiencies in petitioner's excess profits taxes for the years 1941 to 1945, inclusive, is premised upon allegations of error in his statutory notice.Respondent's alleged error in his allowance of any section 722 relief has been decided adversely to respondent in our determination of a CABPNI to be used in lieu of petitioner's average base period net income (otherwise computed without benefit of section 722) for purposes, inter alia, of computing petitioner's excess profits credit*205 in the recomputation to be made under Rule 50.Respondent's further allegations of error in the statutory notice, broadly stated for present purposes, pertain primarily to the computation of the allowable excess profits credit and relate to alleged requisite adjustments involving issues other than those arising under section 722, that is, so-called standard issues.*646 This proceeding was initiated under section 732 of the 1939 Code solely by reason of the petitioner's appeal from respondent's statutory notice of partial disallowance of its claims for relief under section 722 and for refund of excess profits taxes for the years involved. No deficiencies in such taxes were asserted in the statutory notice and the standard issues have been raised by respondent's amended answers to the petition herein.Both parties assert that the Court is squarely faced with the question of whether, under the circumstances herein, it has jurisdiction of the several so-called standard issues. Petitioner urges that this Court should continue to follow its position taken in Mutual Lumber Co., 16 T.C. 370">16 T.C. 370, that the Court lacks jurisdiction. Respondent urges that*206 this Court has been consistently reversed on this jurisdictional issue and that we should now follow the decisions of the various Courts of Appeals. CIBA Pharmaceutical Products, Inc. v. Commissioner, 297 F. 2d 77, reversing and remanding 35 T.C. 337">35 T.C. 337; Commissioner v. Seminole Mfg. Co., 233 F. 2d 395; Commissioner v. Blue Diamond Coal Co., 230 F. 2d 312; Commissioner v. S. Frieder & Sons Co., 228 F.2d 478">228 F. 2d 478; Commissioner v. Poe Manufacturing Co., 224 F. 2d 254, reversing and remanding T.C. Memo. 1954-158; Martin Weiner Corp. v. Commissioner, 223 F. 2d 444, reversing and remanding on this issue 21 T.C. 470">21 T.C. 470; Commissioner v. Pittsburgh & Weirton B. Co., 219 F.2d 259">219 F. 2d 259, reversing and remanding 21 T.C. 888">21 T.C. 888; Willys-Overland Motors v. Commissioner, 251">219 F. 2d 251; Packer Pub. Co. v. Commissioner, 211 F. 2d 612,*207 remanding 17 T.C. 882">17 T.C. 882; Claremont Waste Mfg. Co. v. Commissioner, unreported; City Machine & Tool Co. v. Commissioner, 194 F. 2d 535; H. Fendrich, Inc. v. Commissioner, 192 F. 2d 916.In Dixie Portland Flour Co., 31 T.C. 641">31 T.C. 641, and Air Preheater Corporation, 36 T. C. 982, both involving section 722 claims for relief and standard issues raised by the taxpayers, this Court said it preferred to bypass the controversial jurisdictional question of standard issues by disposing of the latter on the ground that they were without merit. In CIBA Pharmaceutical Products, Inc., 35 T.C. 337">35 T.C. 337, 355, 356, involving section 722 claims for relief and a claimed standard issue deduction, this Court followed Mutual Lumber Co., supra, in holding that it lacked jurisdiction of the standard issue, but further expressed the view that if we had jurisdiction to decide such issue we would decide it for the taxpayer. On appeal on the jurisdictional question the Tax Court was reversed, as*208 above noted.The circuit Court of Appeals, to which this case may go on appeal, has taken the position that the Tax Court has jurisdiction of standard issues raised in a section 722 relief case. Martin Weiner Corp., supra. In Dixie Portland Flour Co., supra, and Air Preheater Corporation, supra, this Court without taking jurisdiction nevertheless considered *647 the merits of the standard issues raised and determined them to be without merit. In the instant case the jurisdictional question may not be so bypassed. On the record herein we are persuaded that the standard issues not only have merit, but that the issues involving the correct computation of the allowable excess profits credit require consideration and decision on the merits in order that this Court may make the requisite redetermination of this proceeding.A further consideration herein, with respect to the jurisdictional issue, is that on the record we have concluded and found that petitioner is entitled to a CABPNI in an amount greater than that allowed by respondent which, if the only issue herein, would necessarily*209 result in larger excess profits credits and overassessments than those computed in respondent's statutory notice of partial allowance of relief. However, we are persuaded that the record discloses further error in the statutory notice in that it incorporates incorrect amounts on account of adjustments required by statute in arriving at the excess profits credit based on the income method. The CABPNI herein determined constitutes only a part of the basis for computation of petitioner's allowable excess profits credit. The petitioner is certainly not entitled to a decision, under Rule 50 recomputation, that there are excess profits tax overpayments in any amounts greater than actually overpaid.Upon reconsideration of the long controversial question of this Court's jurisdiction over standard issues raised in section 722 relief cases, we will no longer follow the rule announced in Mutual Lumber Co., supra. On authority of the decisions of the various circuit Courts of Appeals hereinabove cited, we take jurisdiction of the standard issues properly raised in this proceeding.The petition herein having been filed pursuant to section 732(a) of the 1939 Code, *210 4 the respondent's "notice of disallowance shall be deemed to be a notice of deficiency for all purposes relating to the *648 assessment and collection of taxes or the refund or credit of overpayments" and, further, pursuant to section 732(b), 4 if this Court "finds that there is no overpayment of tax" and "further finds that there is a deficiency" this Court "shall have jurisdiction to determine the amount of such deficiency."*211 Statute of LimitationsIt is stipulated herein that the petitioner and respondent executed waivers whereby the period of limitations for the assessment and collection of additional taxes for 1941 and 1942 was extended to June 30, 1953, and for the years 1943, 1944, and 1945 was extended to June 30, 1950. On the date of respondent's notice of disallowance, March 18, 1953, there was no bar to the assessment and collection of additional taxes for the years 1941 and 1942, and the respondent's affirmative assertion of deficiencies for those years, in his amended answers filed herein, is timely. See sec. 272(a). With respect to the asserted deficiencies for the years 1943, 1944, and 1945, as to which petitioner has pleaded the bar of the statute of limitations, it has been held that a deficiency asserted for the first time in respondent's answer to a petition filed with this Court, based upon a disallowance of a section 722 claim, is untimely if it was barred when the notice of disallowance was mailed. F. W. Poe Manufacturing Co., 25 T.C. 691">25 T.C. 691, affirmed on other grounds 245 F.2d 8">245 F. 2d 8; Commissioner v. S. Frieder & Sons Co., 247 F. 2d 834.*212 See section 275(a) period of limitation; section 276 (b) waivers; section 729(a) laws applicable to excess profits tax. In May Broadcasting Co. v. Commissioner, 299 F. 2d 84, the Court of Appeals for the Eighth Circuit distinguished that case from Commissioner v. S. Frieder & Sons, Co., supra, as follows: "Frieder deals with limitations as to the Government asserting a deficiency. Such issue brings into play statutes not directly involved in the taxpayer's claim for redetermination in the present case." If the recent case of Overland Corporation (formerly Willys-Overland Motors) v. Commissioner, 316 F. 2d 777, (C.A. 6, 1963) he considered as holding to the contrary, then, with due deference to the Court of Appeals for the Sixth Circuit, we adhere to the views expressed by us in Overland Corporation, 34 T.C. 1001">34 T.C. 1001, and in F. W. Poe Manufacturing Co., supra, and choose to follow the opinion of the Court of Appeals for the Third Circuit in Commissioner v. S. Frieder & Sons, Co., supra. Accordingly we decide that no deficiencies in tax*213 may be assessed or collected for those years. However, as we shall explain more fully later in this opinion, the correct amount of petitioner's excess profits credits for those years must be determined herein for the purpose of determining the amount, if any, of excess profits tax refunds to which petitioner is entitled, even though this determination requires a consideration of *649 tax liabilities otherwise not collectable by reason of the statute of limitations.PleadingsAt the hearing on this proceeding the Court denied petitioner's motion to strike those paragraphs of respondent's amended and second amended answers which relate to his affirmative allegations of errors raising standard issues for the taxable years 1941 and 1942 and for 1940 for unused credit carryover purposes, and also affirmative assertions for deficiences for 1941 and 1942. Petitioner's motion for reconsideration of such ruling was taken under advisement and, upon due reconsideration thereof, the denial of petitioner's motion to strike, as above set out, is reaffirmed.Further, at the hearing on this proceeding the Court granted the petitioner's motion to strike paragraph 11 of respondent's second*214 amended answer. Subparagraphs 11 (1) to (4), inclusive, set forth affirmative allegations of errors in failing to correctly compute petitioner's net capital additions with resulting errors in determining the amount of the excess profits credit for each of the years 1943, 1944, and 1945, and also affirmative assertions for deficiencies for those years. The Court took under advisement respondent's motion for reconsideration of such ruling with respect to the second amended answer subparagraph 11(5). The latter is an alternative plea, in the event it is determined herein that petitioner is entitled to section 722 relief, that the Court further determine that petitioner's corrected net capital additions be used in determining its excess profits tax liability for the purpose of determining whether there is an actual overpayment in excess profits tax for each of the years 1943, 1944, and 1945. Upon due reconsideration of the premises, we are of the opinion that the pleading in said subparagraph 11(5) should be considered and decided on its merits and, accordingly, petitioner's motion to strike is denied with respect thereto.Unused Credit CarryoverIn section 722 cases, where this*215 Court grants relief and determines a CABPNI and the year 1940 is involved, the adjustment for 1940 income tax has been ordinarily considered a matter for recomputation under Rule 50 rather than consideration on the merits in the opinion. Cf. Copco Steel & Engineering Co., supra, and Lansburgh & Bro., supra.In the instant case respondent affirmatively alleges, and petitioner denies, error in the statutory notice allowance of an unused excess profits credit carryover from 1940 to 1941 in the amount of $ 257,021.36 based on the income method. In his computation for carryover purposes respondent used petitioner's excess profits net income as determined *650 in the amount of $ 3,460,328.64 for 1940, and allowed an excess profits credit of $ 3,717,350 (or 95 percent of the CABPNI of $ 3,913,000 allowed by respondent under section 722) resulting in the amount of $ 257,021.36 as an unused excess profits credit for 1940.Respondent contends that such computation is erroneous in that it is made under the 1939 Code provisions applicable to 1940 instead of those applicable to 1941 which are controlling for carryover purposes*216 and, accordingly, that he erred in failing to adjust petitioner's excess profits net income as determined for 1940 by adding thereto the income tax of $ 995,100.92 for 1940, which would result in no unused excess profits credit carryover to the taxable year 1941.Section 711(a) of the 1939 Code, as amended by the Revenue Act of 1940, provided that the excess profits net income would be the normal-tax net income, as defined in section 13(a)(2), with certain adjustments and if the excess profits credit were computed under section 713 (income method) such adjustments included a deduction for income tax as provided in section 711(a)(1)(A). However, the Revenue Act of 1941 amended section 711(a)(1)(A) to eliminate any deduction for income tax. See S. Rept. No. 673, to accompany H.R. 5417 (Pub. L. 250), 77th Cong., 1st Sess., p. 14 (1941). The Revenue Act of 1941 also amended 1939 Code section 710(c)(2) which sets forth the definition of unused excess profits credit and provides, in part, that "For such purpose the excess profits credit and the excess profits net income for any taxable year beginning in 1940 shall be computed under the law applicable to taxable years beginning in 1941." *217 See also Regs. 112, sec. 35.710-3.In the instant case we have determined that petitioner is entitled to a CABPNI of $ 4,300,000 which is applicable to the year 1940 for carryover purposes only. The computation of any unused excess profits credit for 1940 for purposes of carryover to 1941 will be made pursuant to the law applicable to 1941 in the recomputation under Rule 50. The issue with respect to an alleged further adjustment in computing the excess profits credit for 1940 for carryover purposes, and involving an alleged correction for net capital reduction, will be discussed in connection with respondent's claimed adjustment for net capital reduction or addition for the taxable years 1941 to 1945, inclusive.Excess Profits Credit Adjustment for Net Capital Addition or ReductionUnder the section 722 issue herein we have determined a CABPNI of $ 4,300,000 and pursuant to section 722(a) the petitioner's excess profits "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." (Emphasis supplied.)*651 Insofar as applicable herein, section 713 of the*218 1939 Code 5 is essentially the same for all of the years involved herein. Pursuant to the provisions of section 713(a)(1) (A), (B), and (C), the petitioner's excess profits credit based on income is computed as 95 percent of the average base period net income (the CABPNI herein), plus 8 percent of the net capital addition or minus 6 percent of the net capital reduction as defined in subsection (g). Briefly stated for our purposes, subsection (g)(1) defines net capital addition as the excess, divided by the number of days in the year, of the aggregate of daily capital addition over the aggregate of daily capital reduction for each day of the taxable year, and subsection (g)(2) defines net capital reduction as the converse thereof. Subsection (g)(4) provides that the daily capital reduction for any day of the taxable year shall be the aggregate of the amounts of distributions to shareholders, not out of earnings and profits, after the beginning of the taxpayer's first taxable year under the excess profits tax law and prior to such day.*219 The respondent affirmatively alleges error, which petitioner denies, in the statutory notice computation of the petitioner's allowable excess profits credit for each of the years 1940 to 1945, in that he failed to make the required plus or minus adjustment to the credit on account of petitioner's correct net capital addition or reduction. Respondent further alleges that such error results from his failure to determine the correct amount of "the daily capital reduction," as required by section 713(g)(4), on account of petitioner's distributions not out of earnings and profits in the form of "dividends."There is no dispute as to the facts herein that petitioner had no accumulated earnings on January 1, 1940, and had a deficit in its earnings and profits for tax purposes for each of the years 1940 to 1945, *652 inclusive; and, further, that petitioner made quarterly distributions to its stockholders in the form of "dividends" on its preferred and common stock in the amounts and on the dates during those years as set forth in revenue agents' reports included herein by reference.The revenue agent's report, Exhibit YYY herein, embraces schedules showing respondent's computations*220 of petitioner's net income and the various adjustments thereto, including deductions for income tax for 1940 and income and excess profits tax for 1941 to 1945, inclusive, in arriving at petitioner's earnings and profits for tax purposes available for distribution. As therein computed, the petitioner made substantial distributions not out of earnings and profits for tax purposes during each of the years 1940 to 1945, inclusive.In respondent's statutory notice the petitioner's distributions, not out of earnings and profits for each of the years 1940-42, were treated as not giving rise to a capital reduction until the following year while on the other hand such distributions for each of the years 1943-45 were treated as giving rise to a capital reduction in the year of distribution. Respondent asserts that his determinations for the years 1940-42 were clearly erroneous. Respondent further asserts that while his treatment of distributions not out of earnings for the years 1943-45 was correct, he erroneously understated the amount of capital reduction for each year because of the error as to the prior years 1940-42 and the cumulative effect of capital reductions for distributions *221 not out of earnings since the first excess profits tax taxable year. See Regs. 112, sec. 35.713-2(a).Petitioner asserts that for all years involved herein its earnings before taxes were in excess of dividends paid. Petitioner contends that in determining its excess profits credit with adjustments for capital changes as provided in section 713, based on the income method, the computation of the amount of dividend distributions not out of earnings for purposes of the capital reduction under subsection (g)(4) should be consistent with the provisions of section 718, relating to the computation of excess profits credit based on invested capital, which expressly prohibits the deduction of the current year's taxes in determining the current year's earnings and profits available for distribution.The petitioner's above contention has been heretofore considered and decided adversely to it. In ABC Brewing Corporation, 20 T.C. 515">20 T.C. 515, 528-530, affd. 224 F. 2d 483, we held that section 713 contains no provision similar to that found in section 718 and, further, in the computation of the excess profits credit under the income method that*222 respondent properly reduced the taxpayer's earnings for the taxable year by the amount of accrued taxes for that year in arriving at earnings and profits available for distribution for purposes of determining the taxable year's capital reduction under section 713(g)(4).*653 The respondent asserts an additional error in his method of computation of the capital reduction for each year involved on account of petitioner's distributions not out of earnings and profits, pursuant to section 713(g)(4). In the computations on which the statutory notice was based respondent determined that current earnings were first exhausted by the earliest distributions during the year before determining the time at which distributions not out of earnings were paid. Respondent now contends that current earnings remaining after the making of distributions in the form of "dividends" on preferred stock should be prorated to each quarter, with a resulting adjustment for daily capital reduction occurring at the time of each quarterly distribution in the form of "dividends" on common stock in the amount that each quarterly common stock distribution exceeded the proportion of total earnings or profits*223 attributable to that quarter. Respondent alleges that the method of proration he now contends for would serve to further increase the amount of the daily capital reduction for each of the years 1940 to 1945, inclusive. Section 115(a) of the 1939 Code defines the term "dividend," in part, as any distribution made by a corporation to its shareholders "out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made," and section 115(b) provides, in part, that "every distribution is made out of earnings or profits to the extent thereof." Under the facts of record and the cited statutory provisions the respondent has failed to establish any basis for prorating current earnings to each quarterly distribution for determining the capital reduction for each year. On this issue we hold against respondent.We conclude and hold in the instant case that in determining petitioner's allowable excess profits credit based on income under the provisions of section 713(a)(1) (A), (B), and (C), *224 the computation of the amount of capital reduction provided for in section 713(g)(4) embraces petitioner's distributions not out of earnings and profits made in each taxable year as hereinbefore decided, and also such distributions for the excess profits tax years prior thereto. Accordingly, we further conclude and hold that in arriving at the excess profits credits allowed in the statutory notice for the years involved, the respondent erroneously computed the amount of the capital reduction by failing to include therein the current year's distributions not out of earnings and profits for the year 1940 (for purposes of unused credit carryover) and the taxable years 1941 and 1942, and also the cumulative effect if any of such errors on the computations of the capital reduction for each of the subsequent years 1943, 1944, and 1945. Since the correct amount of petitioner's excess profits tax for *654 each of the years involved is at issue herein, the appropriate adjustments to the excess profits credit for each year will be made in the Rule 50 recomputation. Further, such recomputation will necessarily embrace the matter of whether respondent erroneously scheduled over-assessments*225 in excess profits taxes for the years 1941 and 1942 as affirmatively pleaded by respondent in connection with this issue.We come to the last standard issue herein with respect to the excess profits credit as adjusted for net capital addition or net capital reduction and involving the question of the computation of the corrected capital reduction under section 713(g)(4), as hereinabove decided, to the extent applicable to the years 1943, 1944, and 1945. This is an alternative issue affirmatively asserted by respondent in the event this Court allows petitioner section 722 relief and despite the bar of the statute of limitations to the assessment and collection of any deficiency in excess profits tax for those years.Respondent contends that the bar of the statute of limitations is an entirely separate issue having no bearing on the Court's jurisdiction to redetermine the petitioner's correct tax liability for the years before it even though assessment and collection of any deficiency would be barred. Respondent's position is that since the years 1943, 1944, and 1945 are before the Court for redetermination of petitioner's claims for relief and refund of excess profits taxes, the *226 Court's jurisdiction over those matters necessarily embraces jurisdiction to redetermine the correct amount of petitioner's allowable excess profits credit for each of those years to the extent necessary to determine the amount, if any, of the refund of excess profits taxes to which petitioner is entitled. We agree with that contention.Here the respondent contends that petitioner's excess profits credit must be recomputed to reflect the corrected capital reduction under section 713(g)(4) in redetermining petitioner's excess profits tax liability for the years 1943, 1944, and 1945 for the purpose of the Court's decision in this proceeding as to whether any net overpayments of excess profits taxes actually exist for those years.Respondent relies on the doctrine announced in Lewis v. Reynolds, 284 U.S. 281">284 U.S. 281. In that case the taxpayer filed a claim for refund of income tax grounded upon respondent's disallowance of claimed deductions. The respondent rejected the claim for refund on the basis that he had previously allowed an improper deduction and that a correct recomputation of the tax liability resulted in additional tax which was barred from assessment*227 by the statute of limitations. The taxpayer contended that respondent lacked authority to redetermine and reassess the tax after the statute had run. The trial court upheld the respondent and its judgment was affirmed by the circuit Court of Appeals which was affirmed by the Supreme Court. In its opinion *655 the Supreme Court quoted with approval the following language of the Court of Appeals:The above quoted provisions clearly limit refunds to overpayments. It follows that the ultimate question presented for decision, upon a claim for refund, is whether the taxpayer has overpaid his tax. This involves a redetermination of the entire tax liability. While no new assessment can be made, after the bar of the statute has fallen, the taxpayer, nevertheless, is not entitled to a refund unless he has overpaid his tax. The action to recover on a claim for refund is in the nature of an action for money had and received, and it is incumbent upon the claimant to show that the United States has money which belongs to him.The Supreme Court further stated that:While the statutes authorizing refunds do not specifically empower the Commissioner to reaudit a return whenever repayment*228 is claimed, authority therefor is necessarily implied. An overpayment must appear before refund is authorized. Although the statute of limitations may have barred the assessment and collection of any additional sum, it does not obliterate the right of the United States to retain payments already received when they do not exceed the amount which might have been properly assessed and demanded.Bonwit Teller & Co. v. United States, 283 U.S. 258">283 U.S. 258, says nothing in conflict with the view which we now approve.In our opinion the decision in the Lewis v. Reynolds case is controlling here, where petitioner seeks excess profits tax refunds, the amounts of which are dependent upon a recomputation of its excess profits tax liability and the allowable excess profits credit. If the recomputation herein is based in part on erroneous adjustments it would result in an erroneous credit not in accord with the statutory requirements of section 713(a)(1) (A), (B), and (C). Accordingly, we conclude that the Rule 50 recomputation herein must reflect the corrected capital reduction in order to arrive at petitioner's allowable excess profits credit and the amounts*229 of any actual overpayments for the years 1943, 1944, and 1945.Reviewed by the Special Division as to the 722 issues.Reviewed by the Court as to non-722 issues.Decision will be entered under Rule 50OPPEROpper, J., dissenting: This is apparently only one more grudging step on an endless road. Having at last accepted the jurisdictional command of the first Fendrich1 case and its numerous progeny, we now boggle at the corollary enunciated in the second Fendrich case that --*656 it is clear from the statutory provisions and legislative history that Congress established a procedure for the proper determination of the entire tax, and that such determination of the whole tax involves a single procedure which began with the timely filing of the application under § 722 and included the rejection thereof by the Commissioner and the petition to the Tax Court.* * * *We think all pertinent issues bearing upon the tax liability under Chapter 2 Subchapter E could be raised by the taxpayer. However, this is a two-way street. Had a deficiency been found, such deficiency could have been assessed and collected. The original application suspended the Statute of*230 Limitations and thereafter, the entire excess profits tax liability was open for determination. (Emphasis added.)H. Fendrich, Inc. v. Commissioner, 242 F. 2d 803, 807 (C.A. 7, 1957), reversing 25 T.C. 262">25 T.C. 262 (1955).In arriving at its conclusion, the court relied upon and cited with approval American Stand. Watch Co. v. Commissioner, 229 F. 2d 672 (C.A. 2, 1956).Adopting the reasoning of Fendrich, supra, May Broadcasting Co. v. Commissioner, 299 F. 2d 84 (C.A. 8, 1962), reversing 33 T.C. 1007">33 T.C. 1007 (1960), after a dissent in which seven members of the present Tax Court concurred, declares that (p. 89) --[a] valid basis exists for a Congressional desire to suspend the statute of limitations upon the filing of a § 722 application. The excess profits law presents*231 many complex problems. The record here shows that the taxpayer's application * * * was not acted upon until more than 9 years after its filing * * *Of course, as in any statute of limitations situation, the Commissioner could have protected himself. But of what avail to the parties or to this Court would a premature denial of section 722 relief be?Nor is Commissioner v. F. W. Poe Mfg. Co., 245 F. 2d 8 (C.A. 4, 1957), affirming on other grounds 25 T.C. 691">25 T.C. 691 (1956), any authority for the present result. Quite the contrary. Judge Parker makes it clear (pp. 9, 11) --that the reasoning of the Tax Court was erroneous and that the correct rule is that stated by the 7th Circuit [in Fendrich]. * * * Only the invoking of relief under section 722 could free the matters embraced in the standard issues from the bar of the statute of limitations. * * *.* * * *[This] case is just as though no relief under that section had been asked.Only the comparatively early case of Commissioner v. S. Frieder & Sons Co., 247 F. 2d 834 (C.A. 3, 1957), affirming a Memorandum Opinion of this Court, *232 superficially appears to hold to the contrary. But on examination it is apparent that the holding is in accord with F. W. Poe Mfg. Co., supra, for in Frieder (p. 838) "the taxpayer * * * has agreed to withdraw its [sec. 722] claim if the Tax Court is sustained on the statute of limitations issue." And Frieder must be compared with the most recent and interesting of all the authorities in this field. In Overland Corporation v. Commissioner, 316 F. 2d 777*657 (C.A. 6, 1963), reversing 34 T.C. 1001">34 T.C. 1001 (1960), both the Commissioner and the taxpayer were contending for standard-issue consideration despite the bar of the statute of limitations. The court held, after quoting at length from Fendrich and May Broadcasting Co.:From consideration of the applicable statutes and the foregoing authorities we conclude: * * * (4) that the decision of the Tax Court should be reversed and these cases remanded to that court for determination on the merits of all claims of Overland for relief and refund of taxes and the Commissioner's claims for deficiency assessments.Of course, invocation*233 of the doctrine of Lewis v. Reynolds, 284 U.S. 281 (1932), would mitigate somewhat the detriment to respondent of the effect of the statute of limitations if we were not also granting relief under section 722. But it is not clear to me whether this theory applies also to section 722 refunds; 2 nor whether we are saying here that taxpayers too will be barred when they are seeking to avoid the statute.I would follow the four circuits which have repudiated the present reasoning.As to section 722 itself, I respectfully dissent on the commitment issue. *234 It seems to me that under the interchange agreement petitioner was committed prior to the end of 1939 to take and pay for an indefinite but ascertainable amount of energy to be generated by the 25,000-kilowatt steam unit to the construction of which the Connecticut Power Company had in turn become committed on December 27, 1939. This was a change in capacity deemed to be a change in the character of petitioner's business on December 31, 1939. Studio Theatre Inc., 18 T.C. 548">18 T.C. 548 (1952). It may be that we should have to determine from the applicable evidence what the amount to be added would be, but this is a familiar task under section 722. See Blaisdell Pencil Co., 1469">16 T.C. 1469 (1951). Footnotes1. Except as otherwise noted the Code sections referred to herein are the Internal Revenue Code of 1939, as amended.↩1. Interchange receipts were from the Connecticut Valley Power Exchange in 1936, and from the Connecticut Power Co. in 1938 and 1939.↩2. Line losses of energy in the course of transmission and distribution.↩1. Represents the number of meters for power sales to other utility companies.↩2. Represents the number of street lamps in service on December 31 of each year located in the following number of cities: 73 for 1935; 74 for 1936; 75 for 1937; 76 for 1938; and 77 for 1939.↩3. Represents the number of railroads or street railways to which power was supplied. Petitioner sold electric power to the New York, New Haven & Hartford RR. throughout the base period and thereafter. Petitioner stopped selling electric power to the Connecticut Co. in 1927 and to the Connecticut Railway & Lighting Co. in 1938, when those companies ceased their streetcar operations.↩1. Includes ironers, heating appliances, lamp kits, radios, etc.↩1. Operating expenses for year 1938 include deduction for hurricane loss.↩1. Kilowatt-hours sold divided by number of meters.↩2. This date is as per stipulation par. 46, while stipulation par. 48 as to petitioner's long-term indebtedness at Dec. 31, 1936, does not include series C and D on that date.↩1. Amortization of bond discount and expenses on bonds outstanding for 1939, reduced by the amortization premium applicable to series H bonds.↩3. 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, except that, in cases described in the last sentence of section 722(b)(4) and in section 722(c), regard shall be had to the change in the character of the business under section 722(b)(4) or the nature of the taxpayer and the character of its business under section 722(c) to the extent necessary to establish the normal earnings to be used as the constructive average base period net income.(b) Taxpayers Using Average Earnings Method. -- The tax computed under this sub-chapter (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. For the purpose of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation * * *. Any change in the capacity for production or operation of the business consummated during any taxable year ending after December 31, 1939, as a result of a course of action to which the taxpayer was committed prior to January 1, 1940, * * * shall be deemed to be a change on December 31, 1939, in the character of the business, * * *↩4. SEC. 732. REVIEW OF ABNORMALITIES BY BOARD OF TAX APPEALS [NOW THE TAX COURT OF THE UNITED STATES].(a) Petition to the Board. -- If a claim for refund of tax under this subchapter for any taxable year is disallowed in whole or in part by the Commissioner, and the disallowance relates to the application of section 711(b)(1) (H), (I), (J), or (K), section 721, or section 722, relating to abnormalities, the Commissioner shall send notice of such disallowance to the taxpayer by registered mail. Within ninety days after such notice is mailed (not counting Sunday or a legal holiday in the District of Columbia as the ninetieth day) the taxpayer may file a petition with the Board of Tax Appeals for a redetermination of the tax under this subchapter. If such petition is so filed, such notice of disallowance shall be deemed to be a notice of deficiency for all purposes relating to the assessment and collection of taxes or the refund or credit of overpayments.(b) Deficiency Found by Board in Case of Claim. -- If the Board finds that there is no overpayment of tax in respect of any taxable year in respect of which the Commissioner had disallowed, in whole or in part, a claim for refund described in subsection (a) and the Board further finds that there is a deficiency for such year, the Board shall have jurisdiction to determine the amount of such deficiency and such amount shall, when the decision of the Board becomes final, be assessed and shall be paid upon notice and demand from the collector.↩5. SEC. 713. EXCESS PROFITS CREDIT -- BASED ON INCOME.(a) Amount of Excess Profits Credit. -- The excess profits credit for any taxable year, computed under this section, shall be -- (1) Domestic corporations. -- In the case of a domestic corporation -- (A) 95 per centum of the average base period net income, as defined in subsection (d),(B) Plus 8 per centum of the net capital addition as defined in subsection (g), or(C) Minus 6 per centum of the net capital reduction as defined in subsection (g).* * * *(g) Adjustments in Excess Profits Credit on Account of Capital Changes. -- For the purposes of this section -- (1) The net capital addition for the taxable year shall be the excess, divided by the number of days in the taxable year, of the aggregate of the daily capital addition for each day of the taxable year over the aggregate of the daily capital reduction for each day of the taxable year.(2) The net capital reduction for the taxable year shall be the excess, divided by the number of days in the taxable year, of the aggregate of the daily capital reduction for each day of the taxable year over the aggregate of the daily capital addition for each day of the taxable year.* * * *(4) The daily capital reduction for any day of the taxable year shall be the aggregate of the amounts of distributions to shareholders, not out of earnings and profits, after the beginning of the taxpayer's first taxable year under this subchapter and prior to such day.↩1. H. Fendrich, Inc. v. Commissioner, 192 F. 2d 916↩ (C.A. 7, 1951).2. "We do not reach the question whether the taxpayer could find refuge in the statute of limitations if the government were claiming equitable diminution of a refund otherwise payable to the taxpayer. Cf. Stone v. White, 1937, 301 U.S. 532">301 U.S. 532 * * *; Lewis v. Reynolds, 1932, 284 U.S. 281">284 U.S. 281 * * *." Commissioner v. S. Frieder & Sons Co., 247 F.2d 834">247 F. 2d 834, 838↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619555/ | DAVID M. CONNELLY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; ALABAMA PLASTIC SURGERY, P.A., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentConnelly v. CommissionerDocket Nos. 18322-91, 18323-911United States Tax CourtT.C. Memo 1994-436; 1994 Tax Ct. Memo LEXIS 440; 68 T.C.M. (CCH) 614; August 25, 1994, Filed *440 Decisions will be entered under Rule 155. David M. Connelly, pro se and as officer of petitioner Alabama Plastic Surgery, P.A. 2For respondent: Donald R. Gilliland. WELLSWELLSMEMORANDUM FINDINGS OF FACT AND OPINION WELLS, Judge: Respondent determined deficiencies in and additions to petitioners' Federal income tax as follows: Petitioner David M. ConnellyAdditions to TaxSec.YearDeficiencySec. 6651(a)(1)Sec. 6653(a)(1)Sec. 6653(a)(2)66611984$ 5,513$ 1,378.25$ 275.651$ 1,37819854,378218.901Petitioner Alabama Plastic Surgery, P.A.TaxableAdditions to TaxYearSec.Sec.Sec.EndedDeficiency66516653(a)(1)6653(a)(1)(A) 1984$ 20,371.43$ 3,055.71$ 1,018.57198546,086.094,608.612,304.30198645,429.78$ 2,271.49TaxableAdditions to TaxYearSec.Sec.Sec.Ended6653(a)(1)(B) 6653(a)(2)666119841$ 5,092.86 1985111,521,521986111,357.45*441 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. After a concession, 3 the issues for decision are: (1) Whether petitioner Alabama Plastic Surgery, P.A., may deduct certain amounts allegedly paid for medical malpractice insurance premiums; (2) whether petitioner Alabama Plastic Surgery, P.A., may deduct certain alleged rental expenses; (3) whether petitioner Alabama Plastic Surgery, P.A., may deduct certain "trust-related" expenses; (4) whether petitioner David M. Connelly received constructive dividends from Alabama Plastic Surgery, P.A.; (5) whether petitioners are liable for additions to tax for failure to file timely tax returns under section 6651; (6) whether petitioners are liable for additions to tax for negligence under section 6653; and (7) whether petitioners are liable for additions to tax for substantially understating income tax under section 6661. 3*442 FINDINGS OF FACT Some of the facts and certain documents have been stipulated for trial pursuant to Rule 91. The parties' stipulations are incorporated into this Memorandum Opinion by reference and are found accordingly. Petitioner David Connelly (petitioner) resided in Montgomery, Alabama, at the time he filed his petition. Petitioner Alabama Plastic Surgery, P.A. (APS) had its principal place of business in Montgomery, Alabama, at the time of the filing of its petition. APS is a cash method taxpayer and prior to December 31, 1987, used a fiscal year ending September 30. BackgroundPetitioner is a plastic surgeon. APS is an Alabama corporation which was formed for the purpose of conducting petitioner's plastic and reconstructive surgery practice. APS was originally incorporated in New York State on October 15, 1973, under the name "David M. Connelly, M.D., P.C.", but was reincorporated under its current name on September 14, 1979, in the State of Alabama. During 1975, APS moved its medical offices from Syracuse, New York, to Jackson Hospital and Clinic (the hospital) in Montgomery, Alabama. Petitioner has been the president, treasurer, sole shareholder, and sole*443 professional employee of APS since 1973. Petitioner's brother, Alan Connelly, has served as APS' secretary since 1973. During the years in issue, the Board of Governors of APS consisted of petitioner, Alan Connelly, and Dr. Frank Randall, a urologist on staff at the hospital. North Lake Leasing Corp. (NLL) is a corporation which was incorporated by petitioner on October 1, 1973, under the laws of the State of Ohio. NLL was formed for the purpose of handling leasing activities for petitioner's medical practice. Alan Connelly was elected president of NLL upon its incorporation and, as of trial, continued to serve NLL in such capacity. From the date of NLL's incorporation until April 1982, petitioner owned all of the stock of NLL. During April 1982, petitioner contributed all outstanding stock of NLL to the capital of APS. During September 1982, APS sold all of the NLL stock to Theodore Wagner, a builder who was a former business associate of petitioner and NLL. Petitioner first leased some office equipment for his office in Syracuse from NLL during 1974. After petitioners moved the medical practice from Syracuse to the hospital in Montgomery, petitioners expanded the practice*444 during 1977 by relocating to larger offices in the sixth-floor addition to the hospital. Petitioners engaged NLL to assume all responsibility for the new lease at the hospital. During December 1977, NLL signed a 5-year lease with the hospital. 4NLL also acquired equipment and furnishings for the medical practice. Since 1982, petitioner has not had a personal checking account. Instead, APS issued checks for petitioner's personal expenses from its own accounts. APS' books include an account called "Account 121, Advances to Employees", which recorded advances made by APS to petitioner for petitioner's personal expenses. During January 1984, NLL began providing bill-paying services for APS. NLL paid most of APS' expenses through NLL's issuance of a check drawn on an NLL account, made payable to the appropriate vendor. Initially, APS paid NLL a fee equal to 20 percent of the amount of the checks issued for APS. During April *445 1984, the fee was reduced to 7 percent. Petitioner's Reappointment to the Staff of the HospitalWhen petitioners moved the medical practice to Montgomery, Alabama, during 1975, petitioner also became a member of the staff of the hospital. Once petitioner became a member of the staff at the hospital, the hospital required that he undergo a reappointment process every 2 years as required by the Joint Commission on Accreditation of Health Care Organizations. Petitioner had to complete an application which provided the hospital with information regarding his malpractice insurance coverage and his involvement in any lawsuits. Prior to 1987, petitioner had repeatedly submitted the requisite applications to the hospital and had included invoices and/or bills purportedly from Barrier Insurance Co. (Barrier) which were stamped with the word "paid" to establish that he was insured. During 1987, in reviewing petitioner's application for reappointment, the medical executive committee at the hospital found that petitioner had not sufficiently established that he had the requisite insurance coverage. When the hospital's Board of Trustees (the hospital board) reviewed the findings of*446 the medical executive committee, the hospital board declined to reappoint petitioner. Petitioner was then given the opportunity for a hearing before a group of five physicians (the physicians committee) on the medical staff. After a formal hearing, the physicians committee found that petitioner had satisfied the insurance requirements and recommended to the hospital board that petitioner be reappointed. Despite the recommendation of the physicians committee, on December 30, 1987, the hospital board concluded that petitioner had not offered adequate proof of coverage. No other physician at the hospital had ever claimed to be insured by Barrier, and petitioner had not provided the hospital board with a certificate of insurance. The hospital board, however, decided to keep petitioner's appointment application "open", which meant that upon provision of specific information to the hospital, petitioner's application might still be approved after further investigation. The hospital board required that petitioner provide: (1) Barrier's address and telephone number along with any other contact information; (2) the name of Barrier's manager; (3) copies of Barrier's financial statements*447 establishing Barrier's capability of paying a $ 1 million judgment; and (4) a copy of petitioner's Barrier insurance policy. In addition to requesting information from petitioner, the hospital board initiated its own investigation in an attempt to verify petitioner's insurance coverage. The hospital board consulted with insurance officials of the State of Alabama, who could not locate Barrier. The hospital board unsuccessfully consulted Alabama Hospital Trust and Fund, an insurance company created by hospitals, and Mutual Assistance, an insurance company for many Alabama doctors. Finally, the hospital board hired a law firm, Sidley & Austin, to investigate a London, England, address on Chapelside Road which had been provided by Alan Connelly. Through a detective agency's investigation, the hospital board discovered that the street number which Alan Connelly provided did not exist on Chapelside Road in London. Ultimately, the hospital was unable to verify petitioner's coverage with Barrier. Medical Malpractice Insurance DeductionsOn its 1984, 1985, and 1986 Federal income tax returns, APS claimed deductions in the amounts of $ 67,067, $ 90,136, and $ 77,777.35, respectively, *448 for professional liability insurance. 5 The amounts claimed on APS' returns represent total amounts of checks issued by APS to NLL. Respondent disallowed the deductions and determined that APS did not establish that the amounts were ordinary and necessary business expenses or were expended for the purpose designated. *449 Rental ExpensesOffice SpaceFrom December 1, 1977, through November 30, 1982, the hospital leased 2,349 square feet of space to NLL at the monthly rate of $ 880.08 as evidenced by a written lease. Rider #1 to the lease from the hospital to NLL for such time period provided as follows: The leased premises described herein consist of the space described above with heating and air conditioning in accordance with architect's plans and specifications, reasonable plumbing facilities suitable for the space described above taking into account the purposes and size thereof, standard lighting fixtures and electrical outlets, painted metal stud dry-wall partitions placed in accordance with lessee's design and specification, standard acoustical ceilings, standard vinyl floor covering, and wooden doors with standard door hardware. The leased premises does not include cabinet work, non-standard finishing woodwork, wall panelling or wall covering (other than paint), extra or unusual electrical and plumbing outlets and fixtures and other non-standard office fixtures. At the instruction of lessee, lessor agrees to include such floor covering, wall covering, electrical and plumbing*450 fixtures and outlets, cabinet work, finishing woodwork, and other fixtures as the lessee shall specify, provided, however, that such fixtures shall be installed at lessee's cost. Such cost shall be determined by subtracting from the actual cost incurred in the installation of such fixtures the cost of the standard materials agreed by lessor to be furnished as a part of the leased premises. As soon as reasonably practicable after the completion of the leased premises and concurrent construction of the Jackson Hospital Medical Clinic addition, lessor shall submit to lessee a reasonably itemized statement of the additional cost incurred in completing the leased premises, and within 30 days thereafter, lessee agrees to pay to lessor such additional costs. Such additional costs shall bear interest at the rate of 8 percent per annum after 30 days from the date of the statement thereof submitted by lessor to lessee. All fixtures installed by lessor, including those additional fixtures installed at lessee's request as provided herein, shall be become [sic] fixtures of the leased premises and shall not be removed under any circumstances without lessor's written permission.Upon the*451 expiration of the initial lease, NLL renewed its lease with the hospital for another 5-year period. The second written lease provided that NLL pay monthly rent of $ 1,321.32 for 2,349 square feet of office space for the period beginning December 1, 1982, through November 30, 1987. For the 5-year period beginning May 1, 1983, through April 30, 1988, NLL sublet the 2,349 square feet of hospital office space to APS for a monthly rent of $ 3,800. The agreement was also evidenced by a written lease. On its tax returns for taxable years ended September 30, 1984, September 30, 1985, and September 30, 1986, APS claimed deductions for the monthly rental payments it made to NLL in the amounts of $ 41,800, $ 45,600, and $ 49,400, respectively. 6 Respondent disallowed the rental expenses claimed by APS to the extent that the rental expense paid by APS exceeded the rental expenses paid by NLL on the prime lease from the hospital because APS did not establish that the excess deductions were ordinary and necessary business expenses or were expended for the purpose designated. *452 Furniture and EquipmentDuring February 1974, NLL began leasing furniture and equipment to APS for use in its medical practice. On March 1, 1984, NLL and APS entered into a 5-year written lease agreement for the furniture and equipment. The lease began on March 1, 1984, and was automatically renewable for a similar term on the first day of each month in which new items were added to the lease. On its tax returns for taxable years ended September 30, 1984, September 30, 1985, and September 30, 1986, APS deducted as part of its rental expenses the amounts of $ 35,780.14, $ 42,333.06, and 51,529.04, respectively, for the furniture and equipment rental. NLL had capitalized the costs of the office furniture and equipment for its taxable years ended September 30 as follows: 1974$ 3,611.901975-0- 197616,042.951977-0- 197816,238.9919794,601.06198017,782.4919812,839.00198212,455.8119833,205.02198414,759.0719853,834.13198611,420.17Respondent determined that APS' allowable deduction for rental expenses for the office furniture and equipment was an amount that would permit NLL to recover three times its capitalized costs over a 7-year*453 period. Respondent allowed deductions for the furniture and equipment in the amounts of $ 24,482, $ 30,807, and $ 25,490 for APS' taxable years ended September 30, 1984, September 30, 1985, and September 30, 1986, respectively. Rolls RoyceDuring 1980, NLL purchased a 1974 Rolls Royce Silver Shadow for $ 36,500 for the purpose of leasing the vehicle to APS. On December 10, 1980, APS entered into a 60-month written lease with NLL under which APS was to pay $ 1,000 per month for the vehicle. The amount of the monthly lease payments was increased to $ 1,200, effective May 1, 1983. The Rolls Royce was not used for commuting between petitioner's residence and the hospital. The Rolls Royce was garaged at the hospital each night. From September 30, 1982, through November 20, 1986, petitioner drove the Rolls Royce 12,411 miles. On its tax returns for taxable years ended September 30, 1984, September 30, 1985, and September 30, 1986, APS deducted the Rolls Royce lease payments in the amounts of $ 13,200, $ 14,400, and $ 15,600, respectively. Respondent disallowed the deductions claimed by APS for the Rolls Royce rental payments because the payments were not determined to be ordinary*454 and necessary business expenses or expended for the purpose designated. Respondent also determined that APS' expenditures for the Rolls Royce personally benefited petitioner and resulted in constructive dividends to petitioner. Trust-Related ExpensesAPS set up a Profit-Sharing Pension Trust (the trust) as part of an employee benefit plan. On its tax return for taxable year ended September 30, 1984, APS deducted $ 11,904.43 as "trust-related" expenses. Respondent disallowed $ 9,469.71 of the trust-related expenses because APS did not establish that the amount in excess of $ 2,434.72 was for an ordinary and necessary business expense or was expended for the purpose designated. The disallowed deductions are composed of a real estate assessment, attorney's fees related to the real estate assessment, and travel expenses. 7*455 Real Estate Assessment and Related Attorney's FeesThe trust owned three residential lots in a development known as Foxchase. The trust was a member of the Foxchase Homeowners Association (the Association). The Association imposed an additional assessment on each of its members to finance the construction of roads in the Foxchase development. APS and other members of the Association unsuccessfully sued to block the assessment. APS ultimately paid, on behalf of the trust, the additional assessment fee as well as attorney's fees for the lawsuit. APS paid a total of $ 2,230 during January 1984 and claimed such amount as part of the trust-related expenses on its tax return for its taxable year ended September 30, 1984. The $ 2,230 consisted of $ 1,800 for the assessment, $ 56 for the interest on the assessment, $ 281 for the trust's attorney's fees, and $ 93 for the Association's attorney's fees. Travel ExpensesWashington, D.C.During 1984, petitioner traveled to Washington, D.C., accompanied by Charlotte Randall. APS paid the round-trip airfare for the trip for both petitioner and Ms. Randall, which totaled $ 860. Petitioner was not the trustee of the trust*456 at the time he took the trip to Washington, D.C. APS claimed a deduction for the amount of the airfare for the trip to Washington, D.C., as part of its trust-related expenses on its tax return for taxable year ended September 30, 1984. Respondent disallowed the deductions for the travel expenses for the trip to Washington, D.C., because APS did not establish that the expenses were ordinary and necessary expenses or expended for the designated purpose. Respondent also determined that APS' payment of the travel expenses of petitioner and Ms. Randall's trip to Washington, D.C., resulted in a constructive dividend to petitioner. BermudaDuring 1984, petitioner traveled to Bermuda accompanied by Ms. Randall. APS paid the expenses for this trip, which totaled $ 2,295.75, consisting of $ 756 for round-trip Montgomery-Bermuda airfare, and $ 1,549.09 for lodging, tips, taxis, motorbike rentals, and parking. 8 Petitioner was not the trustee of the trust at the time he took the trip to Bermuda. *457 APS claimed a deduction for the travel expense for the trip to Bermuda as part of the trust-related expenses on its tax return for taxable year ended September 30, 1984. Respondent disallowed the deductions for the travel expenses for the trip to Bermuda because APS did not establish that the expenses were ordinary and necessary expenses or expended for the designated purpose. Respondent also determined that APS' payment of the travel expenses for petitioner and Ms. Randall's trip to Bermuda resulted in a constructive dividend to petitioner. London, EnglandDuring 1984, petitioner traveled to London, England, accompanied by Ms. Randall and Mabel Krass. While in London, petitioner attended an investment seminar sponsored by an organization known as INEX. Petitioner also took a side trip to the Isle of Man. The total cost of the trip to London for petitioner, Ms. Randall, and Ms. Krass, including airfare, lodging, a rental car, the conference fees, petitioner's trip to the Isle of Man, and miscellaneous charges at one of the hotels was $ 3,659.09. Petitioner was not the trustee of the trust at the time he took the trip to London. APS claimed a deduction for the total amount*458 of the trip to London for petitioner and his companions as part of its trust-related expenses on its tax return for taxable year ended September 30, 1984. Respondent disallowed the deductions for the travel expenses for the trip to London because APS did not establish that the expenses were ordinary and necessary expenses or expended for the designated purpose. Respondent also determined that APS' payment of the travel expenses of petitioner and his companions' trip to London resulted in a constructive dividend to petitioner. Constructive DividendsPrior to and throughout the years in issue, numerous loans 9 were entered into among petitioner, APS, NLL, and Dixie Builders (Dixie). 10 Some of the transactions were recorded through the use of promissory notes. The notes were payable on demand. Generally, the notes provided for the accrual of periodic, monthly interest. Several of the notes had no maturity date. *459 APS often advanced petitioner large sums of money to be used to pay petitioner's personal expenses. The amount due to be repaid by petitioner was recorded in APS' Account 121. Account 121 was periodically reduced on account of purported repayments by petitioner. Respondent determined that some of the transactions resulted in dividend income to petitioner because the advances were made for petitioner's personal benefit and, in essence, had permitted petitioner to use corporate property without compensation to APS. We limit our discussion of the facts with respect to the various loans entered into by petitioner to those transactions which are relevant to respondent's determinations of constructive dividends. Taxable Year 1984Respondent determined that specific reductions in the Account 121 balance in the amounts of $ 21,000, $ 15,000, and $ 10,000 which reduced petitioner's outstanding obligation to APS constituted constructive dividends for taxable year 1984. On March 12, 1984, petitioner borrowed $ 50,000 from Harter Bank and Trust (Harter Bank). On March 16, 1984, petitioner lent the $ 50,000 to NLL, and NLL gave petitioner note No. 0110. On March 17, 1984, NLL made*460 a $ 21,000 payment to petitioner on note No. 0110, thus reducing the amount owed on the note No. 0110. On March 21, 1984, petitioner made a $ 21,000 cash payment to APS which reduced the amount outstanding in Account 121. On September 28, 1984, petitioner borrowed $ 20,000 from NLL and gave NLL note No. C003, which had no maturity date. On the same date, petitioner made a $ 20,000 payment to APS. Of the $ 20,000, $ 15,000 was used to reduce petitioner's outstanding balance in Account 121, and the remaining $ 5,000 was treated as a loan from petitioner to APS rather than further decreasing Account 121. Petitioner had not made any payments on the $ 20,000 note as of December 31, 1985. On November 1, 1982, APS lent Dixie $ 1,000 as evidenced by note No. 2042. On September 30, 1983, petitioner lent Dixie $ 9,000 as evidenced by note No. 2051. Sometime prior to September 24, 1984, APS assigned note No. 2042 to petitioner. Petitioner then assigned the two notes to APS, and Account 121 was reduced by $ 10,000, the total of the amounts on the face of the notes. Taxable Year 1985Respondent determined that the reduction of the Account 121 balance in the amounts of $ 8,000, *461 $ 400, and $ 25,625 constituted constructive dividends for taxable year 1985. On September 1, 1985, Account 121 was reduced by $ 8,000. Petitioner did not make any payments to APS on account of the $ 8,000 reduction. Instead, petitioner issued note No. C014 to APS in the amount of $ 8,000 to document the outstanding obligation that existed between petitioner and APS. On the same date, APS assigned note No. C014 to NLL, and the balance due from petitioner to NLL was increased by $ 10,000 in two additional transactions. On September 30, 1985, note No. C014 was deemed paid by offset against note No. 0109 11 and note No. 0110. 12*462 On Septembher 1, 1985, APS made a payment of $ 400 on petitioner's behalf. Account 121 was reduced by $ 400, and petitioner's obligation was evidenced by increasing the amount owed on note No. C015 from petitioner to APS. On the same date, APS assigned the note to NLL. On September 30, 1985, Account 121 was reduced by $ 25,625. Petitioner did not make any payments to APS on account of the $ 25,625 deduction. Instead, petitioner issued note No. C019 to APS in the amount of $ 25,265 to document the outstanding obligation that still existed between petitioner and APS. On the same date, APS transferred the note No. C019 to NLL to reduce the balance owed by APS to NLL. As of December 31, 1985, petitioner owed NLL $ 25,625. APS' and Petitioner's Income Tax ReturnsAPS reported negative or zero taxable income figures with no claimed net operating loss (NOL) deductions on each of its income tax returns for its taxable years ended September 30, 1981, September 30, 1982, September 30, 1984, September 30, 1985, and September 30, 1986. On APS' return for its taxable year ended September 30, 1983, APS reported taxable income in the amount of $ 9,474.21. On its return for its *463 taxable year ended September 30, 1985, the amount of total deductions, $ 296,055.62, exactly matched the amount of total income. Petitioner reported no wage income on his personal income tax returns for taxable years 1981, 1983, 1984, and 1985. On his 1982 personal income tax return, he reported wages of $ 170,000, which were offset by a reported Schedule E loss of $ 342,456.75. On his 1986 personal income tax return, he reported wages in the amount of $ 140,000, which was substantially offset by a reported Schedule E loss and an NOL carryover. Each of petitioner's personal income tax returns for taxable years 1981 through 1985, inclusive, reports negative total income figures and negative adjusted gross income figures. Petitioner's personal income tax return for 1986 reports zero taxable income. Alan Connelly prepared the tax returns for petitioner and APS for each of the taxable years at issue. APS' tax return for its taxable year ended September 30, 1984, was due on December 15, 1984. APS filed its return for taxable year ended September 30, 1984, on February 25, 1985. APS' tax return for its taxable year ended September 30, 1985, was due on December 15, 1985. APS filed*464 its return for taxable year ended September 30, 1985, sometime between January 28, 1986, and January 31, 1986. Petitioner's 1984 tax return was due August 15, 1985, and petitioner filed his return on July 24, 1986. OPINION Medical Malpractice Insurance ExpensesPetitioners contend that APS is entitled to deduct payments for medical malpractice insurance. Respondent contends that APS is not entitled to deduct the payments because the payments were made to NLL. Respondent further contends that APS has failed to establish that NLL subsequently transferred the payments to Barrier. Under section 162, a taxpayer is allowed to deduct all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Section 1.162-1, Income Tax Regs., specifically includes insurance premiums as deductible business expenses. Insurance premiums, however, are not deductible unless an insurance arrangement actually exists. Anesthesia Serv. Medical Group, Inc. v. Commissioner, 85 T.C. 1031">85 T.C. 1031, 1038 (1985), affd. 825 F.2d 241">825 F.2d 241 (9th Cir. 1987). The taxpayer has the burden of proof. Rule 142(a); *465 Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). We agree with respondent that petitioners have not established that an insurance arrangement existed between APS and Barrier. Petitioner testified that he has never had any direct contact with any representatives at Barrier. Alan Connelly testified that NLL does not possess any documents, including correspondence, canceled checks, or contracts which verify payments, transactions, or any other communications between NLL and Barrier. Gregg Everett, counsel for the hospital, testified that petitioner had not been able to prove that he was insured with Barrier. Mr. Everett further testified that the hospital's subsequent efforts to locate an insurance company by the name of Barrier were unsuccessful. Based on the record in the instant case, we are not convinced that the alleged insurance relationship existed between APS and a company by the name of Barrier. The only evidence offered to establish the alleged malpractice insurance payments to Barrier is petitioner's self-serving statements. Petitioner testified that he knew he was insured by Barrier because Barrier defended him in a malpractice suit which, due*466 to Barrier's efforts, was ultimately dismissed. Petitioners, however, offered no documentary evidence supporting such claim. We need not accept at face value such uncorroborated testimony if it is questionable, improbable, or unreasonable. Quock Ting v. United States, 140 U.S. 417">140 U.S. 417, 420-421 (1891); Fleischer v. Commissioner, 403 F.2d 403">403 F.2d 403, 406 (2d Cir. 1968), affg. T.C. Memo. 1967-85; Boyett v. Commissioner, 204 F.2d 205">204 F.2d 205, 208 (5th Cir. 1953), affg. a Memorandum Opinion of this Court; Tokarski v. Commissioner, 87 T.C. 74">87 T.C. 74, 77 (1986). After reviewing the record in the instant case, we find petitioner's testimony to be highly questionable. Moreover, petitioners could have called witnesses or introduced documents from the alleged malpractice suit to establish that APS had an insurance policy with Barrier. "The rule is well established that the failure of a party to introduce evidence within his possession and which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable." Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158">6 T.C. 1158, 1165 (1946),*467 affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). Based on the record in the instant case, we hold that petitioners have failed to prove that APS was insured by Barrier. Anesthesia Serv. Medical Group, Inc. v. Commissioner, supra. Consequently, we sustain respondent's disallowance of the deductions for professional liability insurance. Rental ExpensesOffice SpaceRespondent determined that APS is entitled to deduct rental payments in the amount of only $ 1,321.32 per month, the same amount NLL paid to the hospital on the prime lease during the taxable years in issue. Petitioners, however, contend that APS is entitled to deduct its rental payments to NLL in the amount of $ 3,800 per month, the monthly rental rate as specified in its lease with NLL during the taxable years in issue. Petitioners contend that APS may deduct the higher rate because NLL improved the office space before subleasing to APS. Respondent does not dispute that the office space was improved before it was leased to APS. Instead, respondent contends that APS has not shown that NLL made the improvements. Section 162(a)(3) allows deductions for *468 ordinary and necessary "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." The taxpayer has the burden of proof. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). Petitioners have not offered any evidence other than petitioner's self-serving testimony to substantiate that NLL made the improvements to the office space. The lease between the hospital and NLL specifically provided in Rider #1 that the hospital would provide all of the basic improvements to the premises such as heating, air conditioning, plumbing, lighting, electrical outlets, wall partitions, vinyl floors, and wooden doors. Rider #1 further provided that the leased premises did not include additional improvements such as cabinetry, woodwork, wall paneling or wallpaper, extra or unusual electrical or plumbing outlets, and other nonstandard office fixtures. Rider #1 states, however, that the hospital will install such additional improvements including floor covering (i.e., carpeting), wall covering*469 (i.e., wall paper), electrical and plumbing fixtures and outlets, cabinetry, woodwork or other fixtures as specified by NLL at NLL's cost. Consequently, according to the lease, all of the basic improvements were provided by the hospital. The sublease between NLL and APS 13 does not indicate that any additional improvements were made. Petitioner testified that NLL contracted for and paid for the construction of the office space. Petitioner further testified that NLL purchased and arranged for the installation of solid oak doors, cork wallpaper, carpeting, plate glass, plumbing, an operating room, a folding privacy screen, all of the cabinetry, and all of the lighting fixtures. Petitioners, however, failed to provide any records such as bills or work orders to verify that NLL made such improvements. We need not accept at face value such uncorroborated testimony if *470 it is questionable, improbable, or unreasonable. Quock Ting v. United States, 140 U.S. at 420-421; Fleischer v. Commissioner, 403">403 F.2d at 406; Boyett v. Commissioner, 204 F.2d at 208; Tokarski v. Commissioner, 87 T.C. at 77. Based on the record in the instant case, we find such testimony to be highly questionable. Moreover, petitioners could have called witnesses or introduced documents to establish the extent of the improvements paid for by NLL. Petitioners' failure to introduce evidence within their possession weighs heavily against them. Wichita Terminal Elevator Co. v. Commissioner, supra at 1165. Accordingly, based on the record in the instant case, we hold that petitioners have failed to prove that APS is entitled to rental deductions for office space in excess of those allowed by respondent. Consequently, we sustain respondent's disallowance of the rental deductions for office space in excess of the amount NLL paid the hospital on the prime lease. Office Furniture and EquipmentRespondent determined that APS*471 may deduct rental expenses for office furniture and equipment to the extent of only $ 24,482, $ 30,807, and $ 25,490 for the respective taxable years in issue. In the notices of deficiency, respondent determined that the proper amounts of rental deductions to APS were those which would permit NLL to recover three times its capitalized costs over a 7- year period. Petitioners contend that APS is entitled to deduct expenses for the rental of furniture and equipment for its medical practice in the amounts of $ 35,780, $ 42,333.06, and $ 51,529.04. Section 162(a) allows taxpayers to deduct all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Petitioners have the burden of proof. Rule 142(a). Petitioners, however, have failed to offer any evidence as to why APS is entitled to the deductions in the amounts claimed on its tax returns. Accordingly, petitioners have failed to satisfy their burden of proof. Consequently, we sustain respondent's disallowance of the rental expense deductions for office furniture and equipment beyond the amounts allowed in the notice of deficiency. Rolls RoycePetitioners contend that *472 APS is entitled to deduct $ 13,200, $ 14,400, and $ 15,600 during the respective taxable years in issue for the expense of leasing the 1974 Rolls Royce Silver Shadow. Respondent contends that the lease payments are not deductible by APS because the leasing of the Rolls Royce was not an ordinary and necessary business expense. In general, section 162 allows a deduction for ordinary and necessary business expenses. The term "ordinary" means that the expense must have a reasonably proximate relationship to the operation of the taxpayer's trade or business. Deputy v. duPont, 308 U.S. 488">308 U.S. 488, 495-496 (1940); Challenge Manufacturing Co. v. Commissioner, 37 T.C. 650">37 T.C. 650, 660 (1962). The term "necessary" in the context of section 162 means that the expense must be "appropriate" or "helpful" to the taxpayer's trade or business. Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467, 471 (1943); Carbine v. Commissioner, 83 T.C. 356">83 T.C. 356, 363 (1984), affd. 777 F.2d 662">777 F.2d 662 (11th Cir. 1985). The taxpayer has the burden of proving that the expenses are ordinary and necessary*473 business expenses. Rule 142(a). Petitioners primarily contend that APS is entitled to the deductions for the lease payments as business expenses because the Rolls Royce was used for advertising and promotion purposes. Petitioners argue that "the vehicle itself bespoke of quality in a way that this marque is known world wide." Petitioners also contend that the lease payments are deductible because the Rolls Royce was used for business transportation to and from medical conventions and was never used for personal transportation purposes. On the other hand, respondent contends that the leasing of the Rolls Royce was for petitioner's personal benefit. With respect to the alleged advertising purpose of the Rolls Royce, respondent contends that the potential for the Rolls Royce to attract customers while parked in the physicians' parking area at the hospital or in a hotel parking deck at a medical convention is, at best, remote. Respondent acknowledges that the "Rolls Royce might conceivably draw attention to Dr. Connelly and evince his personal taste for luxury automobiles", but contends that such a preference "has nothing to do with how well he can perform plastic surgery." With*474 respect to the alleged business transportation use of the Rolls Royce, respondent contends that APS has not established such business use. We specifically addressed the deduction of the leasing expenses of an automobile in Tussaud's Wax Museum v. Commissioner, T.C. Memo 1966-211">T.C. Memo. 1966-211. In Tussaud's, the taxpayer claimed deductions for lease payments on a 1962 Lincoln Continental. The taxpayer argued that it would be good business practice to have an expensive car parked outside its business to impress people and give the appearance of financial stability. We denied the deductions because the taxpayer had not established that a proximate relationship existed between the claimed expenses and the business. Our opinion in Tussaud's relied on Henry v. Commissioner, 36 T.C. 879">36 T.C. 879 (1961). In Henry, the taxpayer, a tax attorney and accountant, purchased a yacht on which he placed a flag bearing the number "1040". The purpose of the flag was to invite inquiries and promote taxpayer's business in yachting circles where there were potential clients. In Henry, we stated: Not only is it incumbent upon petitioner*475 to show that the claimed business expenses do not in fact represent expenditures for primarily social or personal purposes but it must appear that there is a proximate -- rather than merely a remote or incidental -- relationship between the claimed expenses and petitioner's practice as a lawyer and an accountant. [Id. at 884; citations omitted.]We denied the deductions claimed by the taxpayers in Henry because we found that any relationship between the yacht and the promotion of the taxpayer's businesses was merely incidental. The taxpayer in Henry did not offer a single example of a client who came to the taxpayer for professional services based on a boating contact. In the instant case, we find that petitioners have not established a proximate relationship between the Rolls Royce expenses and the promotion of APS' medical practice. We believe that the proposition that the leasing of the Rolls Royce enhances petitioner's skill, usefulness, or reputation as a physician is at best, dubious. In addition, petitioners have failed to offer any evidence of any patients who were attracted to APS' medical practice by virtue of the leasing*476 of the Rolls Royce. 14Petitioners also argue that APS may deduct*477 the Rolls Royce expenses because the vehicle was used to transport petitioner to and from medical conventions. 15 Respondent contends that petitioners have not established that the Rolls Royce was used for business purposes. We agree with respondent that petitioners have failed to substantiate that the Rolls Royce was used for travel to and from medical conventions. Section 274(d) provides that no deduction shall be allowed under section 162 for any travel expense unless the taxpayer substantiates by adequate records or sufficient evidence corroborating the taxpayer's own statement (1) the amount of such expense or other item, (2) the time and place of the travel, and (3) the business purpose of the expense. 16*478 Petitioners rely on petitioner's testimony that the Rolls Royce was used for various business trips. The explicit language of section 274(d), however, requires that petitioners provide corroborating evidence. Petitioners have failed to offer any of the proof required by section 274(d) to substantiate the travel expenses. Accordingly, we hold that petitioners have failed to meet their burden of proof and therefore sustain respondent's disallowance of the deductions for the lease payments on the Rolls Royce. Trust-Related ExpensesReal Estate Assessment ExpensesOn its tax return for taxable year ended September 30, 1984, APS deducted assessment expenses and attorney's fees related to its trust. Respondent contends that APS is not entitled to the deductions because the expenses are properly attributable to the trust. At trial, petitioners acknowledged that the expenses were those of the trust. Accordingly, as the expenses were properly attributable to the trust, we sustain respondent's denial of the deductions for the assessment expenses and the related attorney's fees. See S.A. Manohara, M.D., Inc. v. Commissioner, T.C. Memo. 1994-333.*479 Travel ExpensesPetitioners contend that APS is entitled to deduct trust-related expenses for travel to Washington, D.C., Bermuda, and London, England, pursuant to section 162 because the expenses were related to its trade or business. Respondent contends that APS is not entitled to the deductions because petitioners have not established that the expenses were for ordinary and necessary business purposes. Although APS' tax returns claim that the travel expenses were trust related, it is unclear whether the expenses were incurred on behalf of the trust or on behalf of APS. Petitioner's testimony is confusing on this point since petitioner initially justified the trust-related expenditures by suggesting, in his testimony, that the trips were made to learn about investments for the trust. Subsequently, however, petitioner acknowledged that he was not the trustee at the times when the trips were taken. Petitioner also testified that he took the trips to learn about investment opportunities for APS. In any event, because petitioner testified that the trips were related to certain investments made by APS, we will proceed to analyze APS' entitlement to the deductions rather that*480 summarily denying the deductions as expenses of the trust as we did with respect to the real estate assessment expenses. Section 162(a)(2) allows deductions for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including trade or business travel expenses while away from home. Section 212 allows deductions for all ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income or for the management, conservation, or maintenance of property held for the production of income. 17To be deductible under section 162(a)(2) or section 212, travel expenses must be: (1) Ordinary or "normal, usual or customary," Deputy v. duPont, 308 U.S. 488">308 U.S. 488, 495 (1940); (2) necessary*481 or "appropriate and helpful," Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 113 (1933); and (3) proximately related to the trade or business of the taxpayer, Kinney v. Commissioner, 66 T.C. 122 (1976); Hosbein v. Commissioner, T.C. Memo 1985-373">T.C. Memo. 1985-373. Additionally, traveling expenses to and from a destination will not be deductible if the primary purpose of the trip is personal. Kinney v. Commissioner, supra at 127; sec. 1.162-2(b)(1), Income Tax Regs.Section 274(d) provides that no deduction shall be allowed under section 162 or 212 for any travel expense unless the taxpayer substantiates by adequate records or sufficient evidence corroborating the taxpayer's own statement (1) the amount of such expense or other item, (2) the time and place of the travel, (3) the business purpose of the expense. Petitioner testified that the three trips in issue were financial meetings. Petitioners do not dispute that the meetings were nonmedical in nature. Petitioners, however, contend that even a nonmedical meeting can be in pursuit of a trade or business. Petitioners also contend*482 that APS may deduct the expenses of petitioner's companion or companions on the various trips. Because of the factual distinctions among the three trips, we address each trip separately. Washington, D.C.APS paid for round-trip airfare for petitioner and a companion, Ms. Randall, to visit Washington, D.C. Petitioners maintain that petitioner and Ms. Randall attended a seminar organized by the American Society of Aesthetic Surgery about the marketing of plastic surgery services. Petitioner testified that he learned about equipment which would enable a plastic surgeon to create an electronic image of a patient and then allow the surgeon to alter the image to demonstrate to the patient the potential enhancements that may be realized through plastic surgery. Respondent contends that petitioner has not substantiated the business purpose. We agree with respondent. Although a seminar on the marketing of plastic surgery services might qualify as an ordinary and necessary expense which is proximately related to petitioner's plastic surgery practice, petitioner's uncorroborated testimony is insufficient in the instant case to satisfy petitioners' burden of proof. In addition, petitioners*483 have not met the strict substantiation requirements of section 274(d). Petitioners have not offered any evidence other than petitioner's testimony with respect to the trip to Washington, D.C. There is no documentation in the record to corroborate the business purpose of the trip. 18 We note that petitioners could have introduced documents or called witnesses to corroborate the business purpose of the trip. Petitioners' failure to introduce evidence in their possession weighs heavily against them. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. at 1165. Additionally, even if petitioners had established through corroborating evidence that petitioner had a valid business purpose in making the trip to Washington, D.C., we would deny the*484 deduction for Ms. Randall's airfare based on the record in the instant case because petitioners failed to introduce any independent evidence corroborating Ms. Randall's purpose in accompanying petitioner. Sec. 274(d). BermudaAPS paid the expenses of petitioner and Ms. Randall's travel to Bermuda. Petitioners contend that petitioner and Ms. Randall attended an investment seminar which related to his trade or business. Although petitioners concede that the meeting "was not plastic surgery," they contend that the "gain * * * paid a lot of expenses" for APS. Respondent contends that petitioner's inconsistent testimony regarding the business purpose, i.e., his assertion that the expenses were incurred for the trust and then his assertion that the expenditures were for APS, renders the business purpose claim too tenuous to be allowed. We agree with respondent that the business purpose claim of the expenses is quite tenuous. Consequently, we are not convinced that the convention enhanced petitioner's skills as a plastic surgeon nor contributed to the business of APS. Accordingly, we hold that the travel expenses are not deductible under section 162. As to section 212, 19*487 *485 petitioner testified that, as a result of attending the conference in Bermuda, he has been able to improve the financial performance of APS both by increasing the profitability of investments and reducing the risk of loss from making uninformed investments. Petitioners, however, failed to establish that the knowledge petitioner gained at the seminar affected any specific investments. Although petitioner testified that the Bermuda seminar educated him about timing strategies for entering and exiting the market and that he utilized such strategies in investing in a Fidelity mutual fund 20 several months after the Bermuda trip, APS' tax return indicates that APS invested in the Fidelity Overseas mutual fund almost 2 years after the stipulated time of the trip. A taxpayer ordinarily is not permitted to deduct travel expenses under section 212 for trips which merely give him "a feel for the market" and are not tied to specific transactions. Kinney v. Commissioner, 66 T.C. at 127 (citing Walters v. Commissioner, T.C. Memo 1969-5">T.C. Memo. 1969-5). Even if petitioners were able to link the trip to specific investments, they have not satisfied*486 the substantiation requirements of section 274(d). Petitioners presented no documentation whatsoever as to the business purpose of the trip to Bermuda. 21Moreover, assuming that petitioners could establish that the travel expenses were ordinary and necessary business or investment expenses, we would still hold that Ms. Randall's travel expenses were nondeductible as personal expenses. Petitioner testified that he invited Ms. Randall to accompany him to encourage her to stay on as a patient, to refer other patients, and to supply APS with investment funds. Petitioners, however, offered no evidence corroborating the purpose of having Ms. Randall accompanying petitioner. Consequently, petitioners have not satisfied all of the requirements of section 274(d). We therefore sustain respondent's disallowance of the travel expenses for the trip to Bermuda. London*488 APS paid for petitioner, Ms. Randall, and Ms. Krass to travel to London, England. Petitioners contend that petitioner and his two companions attended the seminar sponsored by INEX to learn about foreign investment opportunities. Respondent contends that petitioner's inconsistent testimony regarding the business purpose, i.e., his assertion that the expenses were incurred for the trust and then his assertion that the expenditures were for APS, renders the business purpose too tenuous to be allowed. As to petitioner's contention that the expenses are deductible under section 162, we agree with respondent. We fail to see any connection between the expense and petitioner's profession of plastic surgery. Consequently, we are not convinced that the seminar enhanced APS' business or petitioner's skills as a plastic surgeon. Accordingly, we hold that the travel expenses are nondeductible under section 162. As to petitioners' contention that the expenses are deductible under section 212, 22 petitioner testified that as a result of attending the conference in London, he learned about investing in an American mutual fund which purchased either American depository receipts of foreign*489 companies or the stock of foreign companies. Petitioners, however, failed to establish a link between the conference and any investments. Although petitioner testified that the London seminar taught him about international mutual funds and that he invested in a Fidelity mutual fund several months after the London trip, APS' tax return indicates that APS invested in the Fidelity Overseas mutual fund almost 2 years after the stipulated time of the trip. Consequently, as the trip is not tied to any specific transaction, Kinney v. Commissioner, supra at 127 (citing Walters v. Commissioner, T.C. Memo. 1969-5), we hold that APS is not entitled to any deduction for such expenses.*490 We further note that the provisions of section 274(h), which apply to trips taken outside North America, apply to the trip to London. Section 274(h), in pertinent part, requires that the taxpayer establish (1) for taxable years beginning prior to January 1, 1987, that the meeting attended was directly related to an activity engaged in for profit under section 212, and (2) that it was as reasonable for the meeting to be held outside the North American area as within the North American area. Petitioners have neither established that the meeting was directly related to activity under section 212 nor offered any evidence which establishes that it was as reasonable for the meeting to be held outside North America as within North America. Additionally, assuming that petitioners could establish that the travel expenses were ordinary and necessary business or investment expenses, we would still hold that Ms. Randall and Ms. Krass' travel expenses were nondeductible. Petitioner testified that he invited Ms. Randall and Ms. Krass to attend to encourage them to stay on as patients, to refer other patients, and to supply APS with investment funds. As petitioners have failed to offer any*491 corroborating evidence as to the purpose of having Ms. Randall and Ms. Krass accompany petitioner, petitioners have not satisfied all of the requirements of section 274(d). Consequently, we sustain respondent's disallowance of the travel expenses for the trip to London. Constructive DividendsPursuant to sections 301(c) and 316(a), a corporation's distributions of property to a shareholder with respect to its stock are taxed as dividends to the shareholder to the extent of the corporation's earnings and profits. Sec. 301(c)(3). Corporate payments to a shareholder which confer personal benefits on the shareholder may constitute constructive dividends to the shareholder. "The fact that no dividends are formally declared does not foreclose the finding of a dividend-in-fact." Noble v. Commissioner, 368 F.2d 439">368 F.2d 439, 442 (9th Cir. 1966), affg. T.C. Memo 1965-84">T.C. Memo. 1965-84. Respondent contends that petitioner received constructive dividends from APS in the form of (1) reductions in the amounts petitioner owed APS recorded in its Account 121, (2) the lease payments for the Rolls Royce, and (3) the payments of travel expenses for petitioner*492 and his companion or companions to visit Washington, D.C., Bermuda, and London. We address each contention separately. Reductions in Account 121APS made many cash advances to petitioner and recorded them in its Account 121. Petitioners contend that petitioner repaid some of the amount due through cash payments and the assignment of promissory notes on which petitioner was the obligee. Respondent contends that the transactions were not legitimate and that petitioner indulged in an "elaborate scheme" in which petitioner purportedly borrowed money from APS, but was relieved of his indebtedness behind a cloud of purported loan transactions among petitioner, NLL, APS, and Dixie. The controlling factor in deciding whether the transactions between APS and petitioner were loans or constructive dividends is whether at the time of the withdrawals the parties intended that the amounts would be repaid. Berthold v. Commissioner, 404 F.2d 119">404 F.2d 119 (6th Cir. 1968), affg. T.C. Memo. 1967-102; Haag v. Commissioner, 88 T.C. 604">88 T.C. 604 (1987), affd. without published opinion 855 F.2d 855">855 F.2d 855 (8th Cir. 1988).*493 We must examine all of the facts and circumstances surrounding the transactions. J.S. Biritz Constr. Co. v. Commissioner, 387 F.2d 451">387 F.2d 451, 453 (8th Cir. 1967), reversing T.C. Memo. 1966-227; Haag v. Commissioner, supra.In analyzing the transactions, respondent's determinations that the cash "advances" are dividends are presumptively correct, and petitioners have the burden of proving that respondent's determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933); Wilson v. Commissioner, 10 T.C. 251">10 T.C. 251, 255-256 (1948), affd. sub nom. Wilson Bros. & Co. v. Commissioner, 170 F.2d 423">170 F.2d 423 (9th Cir. 1948). Taxable Year 1984Respondent determined that the reduction of the Account 121 balance in the amounts of $ 21,000, $ 15,000, and $ 10,000 constituted constructive dividends for taxable year 1984. On March 12, 1984, petitioner borrowed $ 50,000 from Harter Bank. On March 16, 1984, petitioner lent the $ 50,000 to NLL, and NLL gave petitioner note No. 0110. On March 17, 1984, NLL *494 made a $ 21,000 payment to petitioner on note No. 0110, thus reducing the total amount owed under note No. 0110. On March 21, 1984, petitioner made a $ 21,000 cash payment to APS which reduced the amount outstanding in Account 121. Respondent contends that petitioner engaged in a plan under which NLL ostensibly made a partial payment on one of the loans from petitioner, but was actually funneling funds from itself to APS to relieve petitioner of his obligation under Account 121. On September 28, 1984, petitioner borrowed funds from NLL and gave NLL note No. C003, which had no maturity date. On the same date, petitioner made a $ 20,000 payment to APS. Of the $ 20,000, $ 15,000 was used to reduce petitioner's outstanding balance in Account 121, and the remaining $ 5,000 was treated as a loan from petitioner to APS rather than further decreasing Account 121. Petitioner had not made any payments on the $ 20,000 note as of December 31, 1985. Respondent contends that NLL in effect transferred $ 15,000 to APS to reduce petitioner's balance in Account 121. On November 1, 1982, APS lent Dixie $ 1,000 as evidenced by note No. 2042. On September 30, 1983, petitioner lent Dixie $ 9,000*495 as evidenced by note No. 2051. Sometime before September 24, 1984, APS assigned note No. 2042 to petitioner. Petitioner then assigned the two notes to APS, and Account 121 was reduced by $ 10,000, the total of the amounts on the face of the notes. Respondent contends that because the notes were several years old, their fair market value was less than face value. Respondent further contends that because the note No. 2042 was merely transferred by APS to petitioner and then back to APS, petitioner received a $ 1,000 constructive dividend since he was relieved of the indebtedness. Respondent contends that note No. 2051 is suspect because petitioner and Alan Connelly owned 48 percent of Dixie and never intended to make a payment on the note. Respondent thus argues that the $ 9,000 reduction is a constructive dividend to petitioner. Taxable Year 1985Respondent determined that the reduction of the Account 121 balance in the amounts of $ 8,000, $ 400, and $ 25,625 constituted constructive dividends for taxable year 1985. On September 1, 1985, Account 121 was reduced by $ 8,000. Petitioner did not make any payments to APS on account of the $ 8,000 reduction. Instead, petitioner*496 issued note No. C014 to APS in the amount of $ 8,000 to document the outstanding obligation that still existed between petitioner and APS. On the same date, APS assigned note No. C014 to NLL, and the balance due from petitioner to NLL was increased by $ 10,000 in two additional transactions. On September 30, 1985, note No. C014 was deemed paid by offset against note No. 0109 and note No. 0110. Respondent contends that petitioner relieved himself of an $ 8,000 obligation under Account 121 by issuing a separate promissory note under which he had no economic burden. Respondent contends the intricate web of loans among the parties indicates the lack of substance to the underlying obligations. Respondent further contends that petitioner utilized NLL to eliminate his own personal obligations. On September 1, 1985, APS made a payment of $ 400 on petitioner's behalf. Account 121 was reduced by $ 400 and petitioner's obligation was evidenced by increasing the amount owed on note No. C015 from petitioner to APS. On the same date, APS assigned the note to NLL. Respondent contends that petitioner was relieved of his obligation to pay $ 400 to APS. On September 30, 1985, Account 121 *497 was reduced by $ 25,625. Petitioner did not make any payments to APS on account of the $ 25,625 deduction. Instead, petitioner issued note No. C019 to APS in the amount of $ 25,265 to document the outstanding obligation that still existed between petitioner and APS. On the same date, APS transferred note No. C019 to NLL to reduce the balance owed by APS to NLL. As of December 31, 1985, petitioner owed NLL $ 25,625. Respondent contends that there is no indication that the note was ever paid. Respondent further contends that the note lacks economic substance. In essence, respondent argues that the facts and circumstances indicate that APS was generating deductions by making payments to NLL and that NLL was, in turn, transferring money to APS when NLL was actually relieving petitioner of debt for his personal expenses. Respondent contends that the loans were merely a "smokescreen" to hide the fact that payments were being made by NLL to satisfy petitioner's personal obligations. As stated above, the characterization of a transfer from corporation to a shareholder depends on the facts and circumstances involved. Factors that the courts have considered in reaching a decision include*498 the following: The extent to which the shareholder controlled the corporation; whether the corporation had a history of paying dividends; the existence of earnings and profits; the magnitude of the advances; how the parties recorded the advances on their books and records; whether the parties executed notes; whether security was provided for the advances; whether there was a fixed schedule of repayment; whether interest was paid or accrued; whether the shareholder made any repayments; whether the shareholder was in a position to repay the advances; and whether the advances to the shareholder were made in proportion to his stockholdings. Thielking v. Commissioner, T.C. Memo. 1987-227 (citing Alterman Foods, Inc. v. United States, 505 F.2d 873">505 F.2d 873, 877 n.7 (5th Cir. 1974); J.S. Biritz Constr. Co. v. Commissioner, 387 F.2d 451">387 F.2d 451, 453 (8th Cir. 1967), revg. T.C. Memo. 1966-227). None of these factors, standing alone, is determinative. Alterman Foods, Inc. v. United States, supra at 876-877 n.6. The objective factors are useful in determining*499 whether there is a true intention to repay. Id. at 877. In the instant case, petitioners have failed to present any evidence or make any arguments as to petitioner's intent to repay the advances made by APS. Based upon our exhaustive review of the record in the instant case, we conclude that petitioners have failed to prove that respondent's determinations with respect to the reductions in Account 121 are erroneous. Petitioner was the sole shareholder of APS. Consequently, petitioner completely controlled the extent to which APS made the advances to petitioner. APS did not have a history of declaring dividends, and APS apparently had substantial earnings and profits with which to do so. APS made numerous advances. Petitioner did not provide any security for the advances, and there was no fixed schedule of repayment. No interest payments were made, although they were provided for in the notes. APS' disinterest in interest is remarkable. Additionally, the repayments were made in "roundabout" patterns which strongly suggest that petitioner never intended to repay the advances, but merely wanted to make it appear that he had repaid the advances. *500 Finally, it appears that petitioner had the money to repay the advances, but merely developed a way to have his personal expenses paid by the corporation without any cost to him. Based on the foregoing, we hold that petitioners have failed to prove that the reductions in Account 121 were not constructive dividends to petitioner. Rolls Royce and Travel ExpensesCorporate payments for property used by a shareholder for purposes which are not proximately related to the corporate business result in the inclusion of the fair rental value of such property in the shareholder's income as constructive dividends to the extent of the corporation's earnings and profits. Falsetti v. Commissioner, 85 T.C. 332">85 T.C. 332, 356 (1985). For a corporate benefit to be treated as a constructive dividend, the item must primarily benefit the taxpayer's personal interests as opposed to the business interests of the corporation. Ireland v. United States, 621 F.2d 731 (5th Cir. 1980); Palo Alto Town & Country Village, Inc. v. Commissioner, 565 F.2d 1388 (9th Cir. 1977), remanding T.C. Memo 1973-223">T.C. Memo. 1973-223;*501 Commissioner v. Riss, 374 F.2d 161 (8th Cir. 1967). Rolls RoyceWe have held above that the lease payments of the Rolls Royce do not constitute ordinary and necessary business expenses. Consequently, our remaining inquiry as to the Rolls Royce expenses is limited to whether petitioner obtained a personal benefit from APS' leasing of the Rolls Royce. Petitioners have not offered any documentation establishing the use of the vehicle for business purposes. The only evidence petitioners offered is petitioner's self-serving testimony that he used the car to drive to medical conventions. We need not accept petitioner's self-serving statements if they are questionable, improbable, or unreasonable. Quock Ting v. United States, 140 U.S. at 420-421; Fleischer v. Commissioner, 403 F.2d at 406; Boyett v. Commissioner, 204 F.2d at 208; Tokarski v. Commissioner, 87 T.C. at 77. Under the circumstances of the instant case, we find such testimony to be questionable. Consequently, petitioners have failed to prove that petitioner did *502 not derive personal benefit from the leasing of the Rolls Royce. Accordingly, we hold that petitioner received constructive dividends equal in amount to the lease payments made by APS to NLL. Travel ExpensesWe have held above that the travel expenses of petitioner and his companions to Washington, D.C., Bermuda, and London do not constitute ordinary and necessary business expenses. Consequently, our remaining inquiry as to the travel expenses is limited to whether petitioner obtained a personal benefit from APS' payment of the travel expenses. Petitioners concede that the trips were not for medical education. Petitioners also acknowledge that petitioner did some sightseeing during his trip to London. Respondent contends that all of the trips were to locations that have personal appeal and that petitioner did not adequately substantiate his itinerary to establish that he did not engage in any personal activities on the trips. Accordingly, respondent contends that the amounts paid for Ms. Randall and Ms. Krass' travel expenses are also constructive dividends. We agree with respondent. Petitioners have not presented any credible evidence establishing that the trips were*503 nonpersonal in nature. Accordingly, we sustain respondent's determinations that the travel expenses are constructive dividends to petitioner. Section 6651(a)(1) Additions to TaxIn the case of a taxpayer who fails to timely file a tax return, section 6651(a)(1) provides for an addition to tax, unless the taxpayer can demonstrate that the failure to file was due to reasonable cause and not due to willful neglect. Sec. 6651(a)(1). Although reasonable cause is not defined in the Internal Revenue Code, the regulations state: "If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to a reasonable cause." Sec. 301.6651-1(c)(1), Proced. & Admin. Regs. Willful neglect has been defined as a "conscious, intentional failure or reckless indifference". United States v. Boyle, 469 U.S. 241">469 U.S. 241, 245 (1985). The questions of whether petitioners have acted with "reasonable cause" and not with "willful neglect" are questions of fact, and petitioners have the burden of proof. Rule 142(a); Lee v. Commissioner, 227 F.2d 181">227 F.2d 181, 184 (5th Cir. 1955),*504 affg. a Memorandum Opinion of this Court. It is undisputed that APS' corporate income tax returns for taxable years ended September 30, 1984, and September 30, 1985, were not timely filed. Consequently, we must decide whether APS' untimely filing was due to reasonable cause and not due to willful neglect. Petitioners failed to introduce any evidence or make any arguments as to the additions to tax under section 6651(a)(1) as to APS. Consequently, petitioners have failed to meet their burden of proof as to APS' failure to file addition. Accordingly, we sustain respondent's determination with respect to the additions to tax under section 6651(a)(1) as to APS for its taxable years ended September 30, 1984, and September 30, 1985. As to petitioner, it is undisputed that his 1984 tax return was not timely filed. Consequently, we must decide whether petitioner's untimely filing was due to reasonable cause and not due to willful neglect. Petitioners contend that petitioner had reasonable cause for the late filing of his return because he was preoccupied with the audit of his taxable years 1980 through 1983 as well as involved with obtaining a refund for taxable year 1977. It is *505 well established that an assertion of being "too busy" will not relieve a taxpayer from the duty to file a timely return. Dustin v. Commissioner, 53 T.C. 491">53 T.C. 491, 507 (1969), affd. 467 F.2d 47">467 F.2d 47, 50 (9th Cir. 1972); Olsen v. Commissioner, T.C. Memo. 1993-432; Smith v. Commissioner, T.C. Memo. 1993-203; Weiland v. Commissioner, T.C. Memo. 1982-601. Consequently, we sustain respondent's determination as to the failure to timely file addition as to petitioner for taxable year 1984. Section 6653 Additions to Tax for NegligenceSection 6653(a) provides that if any part of any underpayment of tax is due to negligence or the intentional disregard of rules and regulations, there shall be added to the tax an amount equal to 5 percent of the underpayment. 23*506 Section 6653(a) also imposes an addition to tax in the amount of 50 percent of the interest due on the portion of the underpayment attributable to negligence. 24Respondent's determination that petitioners were negligent is presumed correct, and petitioners bear the burden of proving that they were not negligent. Rule 142(a); Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791-792 (1972). Negligence is defined as the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 937 (1985). A taxpayer's failure to file a timely tax return is a prima facie case of negligence. Emmons v. Commissioner, 92 T.C. 342">92 T.C. 342, 349 (1989), affd. 898 F.2d 50">898 F.2d 50 (5th Cir. 1990). For *507 APS' taxable years ended September 30, 1984, and September 30, 1985, and petitioner's taxable year 1984, petitioners failed to introduce evidence tending to meet or rebut respondent's prima facie case of negligence. Consequently, we sustain respondent's determinations for such years based on the failure to timely file tax returns. For APS' taxable year ended September 30, 1986, and petitioner's taxable year 1985, petitioners have failed to offer any evidence to support a finding that petitioners are not negligent. Petitioners merely maintain that petitioner is incapable of behaving in a negligent manner. Based on petitioners' failure to meet their burden of proof, we sustain respondent's determinations as to the negligence additions. Section 6661 Additions to Tax For Substantial Understatement of Income TaxSection 6661(a) imposes an addition to tax on a substantial understatement of income tax. An understatement is substantial where it exceeds the greater of 10 percent of the tax required to be shown on the return or $ 5,000. Sec. 6661(b)(1)(A). APS had substantial understatements for all of the years in issue. Petitioner had a substantial understatement for taxable*508 year 1984. The section 6661 addition to tax is not applicable, however, if there was substantial authority for the taxpayer's treatment of the items in issue or if relevant facts relating to the tax treatment were disclosed on the return. Sec. 6661(b)(2)(B)(i) and (ii). Petitioners have not made any arguments regarding the substantial understatement additions to tax. Accordingly, we hold that petitioners are liable for the additions to tax under section 6661 as determined by respondent. All other arguments of petitioners have been considered and found to be without merit. To reflect the foregoing, Decisions will be entered under Rule 155. Footnotes1. These cases were consolidated by order of the Court. For convenience, unless otherwise indicated, these cases will be collectively referred to as "the instant case".↩2. Petitioner was formerly represented by Alan Connelly, who withdrew his entry of appearance prior to the trial of the instant case.↩1. 50 percent of the interest due on the deficiency.↩3. Respondent has conceded that petitioner David M. Connelly properly claimed partnership losses on his 1984 and 1985 Federal income tax returns.↩4. Prior to December 1977, neither NLL nor APS had a written lease with the hospital.↩5. APS habitually issued the checks at the end of the alleged policy periods. The following is an itemized list of the checks and the policy periods for which petitioners allege the checks were issued: Ending Date ofDateCheck No. AmountPolicy Period 09/27/841013$ 7,9739/30/8309/28/84101630,0009/30/8409/30/84102024,0879/30/8409/30/8410215,0079/30/85Total--09/30/84 67,06709/01/851127-1130$ 20,0289/30/8509/16/851133-113620,0289/30/8509/17/851137,113810,0149/30/8509/18/8511395,0169/30/8509/29/851147,114814,0209/30/8609/29/851150-115221,0309/30/86Total--09/30/85 90,13609/12/861210$ 7,0109/30/8609/16/861212-121642,0609/30/8609/16/861220119/30/8609/30/8612279,565.459/30/8709/30/861233-123419,130.909/30/87Total--09/30/86 77,777.35APS' check number 1021, dated Sept. 30, 1984, to NLL for $ 5,007 was deposited by NLL on July 3, 1985. APS' check number 1020, dated Sept. 30, 1984, to NLL for $ 24,087 was deposited by NLL on Sept. 5, 1985.↩6. The amount of the deductions taken by APS varied from year to year because APS deducted 11 months of rent totaling $ 41,800 for its taxable year ended Sept. 30, 1984, 12 months of rent totaling $ 45,600 for its taxable year ended Sept. 30, 1985, and 13 months of rent totaling $ 49,400 for its taxable year ended Sept. 30, 1986.↩7. Specifically, respondent disallowed $ 2,230 in real estate assessment and attorney's fees, $ 860 for the trip to Washington, D.C., $ 2,295 for the trip to Bermuda, and $ 3,659.09 for the trip to London, England. We note that these figures total $ 9,044.09, which is $ 425.62 less than $ 9,469.71, the total amount denied in the notice of deficiency. The parties have failed to account for the discrepancy.↩8. The parties stipulated that the $ 1,549.09 consisted of $ 1,349.09 for lodging, $ 4 for tips, $ 57 for taxis, $ 44 for motor bike rentals and $ 18 for parking. We note that these amounts total $ 1,472.09, which is $ 77 less than $ 1,549.09. The parties have failed to account for the discrepancy.↩9. We refer to the various transactions as "loans" for convenience, not as a characterization of the transaction in any way.↩10. There is little information in the record regarding Dixie Builders other than the parties' stipulation that Dixie Builders was, at one time, owned by petitioner, Alan Connelly, and Theodore Wagner. Petitioner owned 45 percent, Alan Connelly owned 3 percent, and Theodore Wagner owned 52 percent.↩11. Note No. 0109 was given by NLL to petitioner on Dec. 1, 1983, reflecting that NLL owed petitioner $ 21,754.69. From December 1983 through September 1985, NLL and petitioner engaged in many transactions which affected the amount due on note No. 0109. On Sept. 30, 1985, the date on which the debt was extinguished by offset with note No. C014, NLL owed petitioner $ 10,990.10 on note No. 0109.↩12. Note No. 0110, as stated above, was originally given by NLL to petitioner in the amount of $ 50,000 on Mar. 16, 1984, when petitioner lent NLL the $ 50,000 he borrowed from Harter Bank. From March 1984 through September 1985, NLL and petitioner engaged in many transactions, which affected the amount due on note No. 0110. On Sept. 30, 1985, the date on which the debt was extinguished by offset with note No. C014, NLL owed petitioner $ 26,890 on note No. 0110.↩13. We note NLL's sublease with APS is an identical form lease to the lease between the hospital and NLL with the exception of any riders attached.↩14. We note that in response to respondent's contention that the Rolls Royce would not attract customers in the physicians' parking lot at the hospital or in a hotel parking lot at a medical convention, petitioner argues that the Rolls Royce was viewed by millions of people when the car appeared in a television miniseries. On brief, petitioner states that the real advertising impact for it [the Rolls Royce], however, was when it was used as a central part of the story "Roses for the Rich", a CBS miniseries starring Bruce Dern and Lisa Hartman. The film was made in Warrior, Alabama. The large screen credit for the car to Alabama Plastic Surgery, P.A. was seen for most of the week by eight and one-half million people.↩Petitioners did not mention this appearance of the Rolls Royce prior to the answering brief. In any event, petitioners have not established when the show was aired or that petitioners gained any patients from the viewing.15. At trial, petitioner briefly mentioned that the Rolls Royce was also used for banking purposes. Petitioner, however, failed to further elaborate such a claim and did not offer any evidence to substantiate such a claim.↩16. For taxable years beginning after Dec. 31, 1985, sec. 274(d) does not apply to a "qualified nonpersonal use vehicle" which is defined in sec. 274(i) as any vehicle, which by reason of its nature, is not likely to be used more than a de minimis amount for personal purposes. Sec. 274(i), however, does not apply to any of APS' taxable years in issue since all of the years in issue began prior to its effective date. Even if sec. 274(i) were effective for the years in issue, we note that a Rolls Royce is a passenger automobile, and would therefore not meet the definition of "qualified nonpersonal use vehicle". See Davis v. Commissioner, T.C. Memo. 1993-599↩. Consequently, APS would still be subject to the strict substantiation requirements of sec. 274(d).17. We note that for taxable years beginning after Dec. 31, 1986, deductions are no longer permissible under sec. 212 for expenses allocable to a convention, seminar, or similar meeting pursuant to sec. 274(h)(7).↩18. The parties stipulated the cost of the airfare and the dates of the trip. We note, however, that although the parties stipulated that the trip to Washington, D.C., occurred in July, petitioner testified that the trip occurred in March 1984.↩19. Although petitioners argue that the travel expenses were authorized under sec. 162, petitioners emphatically maintain that the purpose of petitioner's attendance at the conventions was to learn about investment opportunities to "make money". Consequently, we analyze whether the travel expenses are deductible under sec. 212. As noted above, had the expenses been incurred in a taxable year beginning after Dec. 31, 1986, sec. 274(h)(7) would deny the deduction of the expenses because they were expended for a seminar for sec. 212 purposes. We note that the allocation rules contained in sec. 274(c) for travel outside the United States do not apply to the trip to Bermuda because the trip fits within the exception under sec. 274(c)(2)(A) for travel that does not exceed 1 week. Additionally, we note that the provisions of sec. 274(h) which apply to trips taken outside North America do not apply to petitioner and Ms. Randall's trip to Bermuda because North America is deemed to include Bermuda for conventions, seminars, and meetings which began after July 1, 1983, under sec. 274(h)(6)(B). Sec. 274(h), in pertinent part, requires that the taxpayer establish (1) for taxable years beginning prior to Jan. 1, 1987, that the meeting attended was directly related to an activity engaged in for profit under sec. 212, and (2) that it was reasonable for the meeting to be held outside the North American area.↩20. Specifically, petitioner testified that he made the Fidelity investment based on the knowledge gained at the Bermuda and London seminars combined.↩21. As with the trip to Washington, petitioner's testimony on the dates of the trip was different from the stipulation. Additionally, petitioner did not present any corroborating evidence of the date and times of the meetings in Bermuda.↩22. Although petitioner argues that the travel expenses to London were authorized under sec. 162, he emphatically maintains that the purpose of attendance at the conventions was to learn about investment opportunities to "make money". Consequently, we analyze whether the travel expenses are deductible under sec. 212. As noted above, had the expenses been incurred in a taxable year beginning after Dec. 31, 1986, sec. 274(h)(7) denies the deduction of the expenses because they were expended for a seminar for sec. 212 purposes. We note that the allocation rules of sec. 274(c) for travel outside the United States do not apply to the trip to London because the trip fits within the exception under sec. 274(c)(2)(A) for travel that does not exceed 1 week.↩23. For taxes due after Dec. 31, 1981, the specific section which sets forth the addition to tax for negligence is sec. 6653(a)(1). For tax returns due (without regard to extensions) after Dec. 31, 1986, the specific section which sets forth the addition to tax for negligence is sec. 6653(a)(1)(A).↩24. For taxes due after Dec. 31, 1981, the specific section which sets forth the addition to tax for interest due on the negligent portion of the underpayment is sec. 6653(a)(2). For tax returns due (without regard to extensions) after Dec. 31, 1986, the specific Code section which sets forth the addition to tax for interest due on the negligent portion of the underpayment is sec. 6653(a)(1)(B).↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619556/ | Keokuk and Hamilton Bridge, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentKeokuk & Hamilton Bridge, Inc. v. CommissionerDocket No. 10559United States Tax Court12 T.C. 249; 1949 U.S. Tax Ct. LEXIS 265; February 28, 1949, Promulgated *265 Decision will be entered under Rule 50. Petitioner, a private corporation, made a gift proposal to a city, which was accepted by the latter, wherein it agreed to execute a conveyance for the transfer of its toll bridge to the city; to deposit it with an escrow agent; and to vest title to the property in the city on the final payment on first lien revenue bonds. Until its bonded indebtedness was paid petitioner reserved the right to maintain and operate the bridge, and agreed to apply revenues in excess of maintenance and operating expenses to payment of interest and principal of debt. The parties agreed that if before final payment of debt another bridge was constructed within five miles of the old bridge, or the city failed to comply with all conditions attached to the gift, all of the city's rights under the gift proposal would cease and terminate and all right, title, and interest in the property would "revert to or revest in" the petitioner. An escrow agreement, to which the petitioner, its sole stockholder, the city, and the escrow agent were parties, contained substantially the same provisions, and authorized the escrow agent to hold deed and other instruments until the*266 performance of the conditions specified therein. Held:(1) Net income derived by the corporation from operation of the bridge and applied to payment of interest and principal on bonds is "income" within the meaning of that term as used in the Sixteenth Amendment and the Internal Revenue Code.(2) The income is not exempt from taxation under the provisions of section 116 (d), I. R. C.(3) Petitioner is not an exempt corporation under the provisions of subdivisions (6), (8), or (14) of section 101, I. R. C.(4) Petitioner is not entitled to amortization deductions for the cost of the bridge properties in the amount of its net income for each year. E. W. McManus, Esq., and J. O. Boyd, Esq., for the petitioner.Gene W. Reardon, Esq., for the respondent. Harlan, Judge. HARLAN *250 The respondent determined deficiencies in income and*267 excess profits taxes of petitioner and a 25 per cent delinquency penalty on excess profits taxes for failure to file timely excess profits tax returns, as follows:Excess profits taxIncome taxYeardeficiency25% delinquencyDeficiencypenalty1941$ 9,585.49$ 15,670.08$ 3,917.5219425,786.9138,990.579,747.6419435,037.9454,629.9613,657.49The sole issue is whether the petitioner is taxable on the net income which it realized from the operation of a toll bridge. Apparently the petitioner concedes that if it is taxable it is liable for the delinquency penalties asserted by the respondent, as no allegation of error is made in its petition with reference to the respondent's determination of the penalties for failure to file timely excess profits tax returns.FINDINGS OF FACT.Petitioner is a corporation, organized and incorporated April 28, 1941, under the laws of the State of Delaware. Its charter authorized it to acquire and operate bridges anywhere in the United States and also to engage in a wide range of activities, including "the business of exporting, importing, manufacturing, producing, buying and selling and otherwise dealing*268 in and with goods, wares and merchandise *251 of every class and description." The authorized issue of capital stock was 1,000 shares of common stock of a par value of $ 1 per share, with the right reserved in petitioner to increase or decrease its authorized capital stock. During the year 1941 petitioner was admitted to do business as a foreign corporation in the States of Iowa and Illinois.About 1870 Keokuk & Hamilton Bridge Co., an Iowa corporation, constructed and completed a toll bridge across the Mississippi River connecting the cities of Keokuk, Iowa, and Hamilton, Illinois. The bridge properties were operated continuously by the Keokuk & Hamilton Bridge Co. until on or about June 18, 1941, and thereafter by petitioner herein.The toll bridge is used by the Toledo, Peoria & Western Railroad Co. and the Wabash Railroad Co. as a means of crossing the Mississippi River between the cities of Hamilton, Illinois, and Keokuk, Iowa. The upper deck or highway part of the bridge connects with Federal highways on each side of the river and serves parts of Iowa, Nebraska, Kansas, and Missouri and parts of other states west and northwest in crossing the river in going to points*269 east, and in like manner serves a large section of Illinois, Indiana, Ohio, Kentucky, and other points east and south as a means of crossing the river in going to points west. Throughout its existence the bridge has been operated as a toll bridge and petitioner's income is derived from vehicular, railroad, and pedestrian traffic tolls.The city of Keokuk, Iowa, was organized as a municipal corporation under a special charter issued by the Legislature of Iowa and it constitutes a municipality duly organized under the laws of Iowa, having a population in excess of 15,000. In general, its people are engaged in manufacturing, construction work, and retail trades, with a substantial farming community adjacent. The city of Hamilton, Illinois, is duly organized as a municipal corporation under the laws of Illinois, having a population in excess of 2,000, engaged in manufacturing and retail trades and serving a large and prosperous farm community.The communities in and around Hamilton, Illinois, and Keokuk, Iowa, have no means of crossing the river except by the bridge above described, which has a length of approximately 3,200 feet, with an approach on the Illinois side of approximately*270 4,400 feet. The nearest bridge spanning the Mississippi River is at Fort Madison, Iowa, approximately 25 miles north, and the next nearest is at Quincy, Illinois, approximately 40 miles south. This bridge, since its construction, *252 has accommodated substantial transportation, both local and transcontinental.For a number of years prior to 1938 there had been agitation by the business people and the chamber of commerce of Keokuk for a free bridge into the city of Keokuk, Iowa. In 1938 the Keokuk city council appointed a bridge committee to investigate the situation. This committee made a written report recommending that the city offer $ 500,000 to the Keokuk & Hamilton Bridge Co. for its bridge and approaches, and in 1939 the city council authorized the mayor to make such offer. The then owner of the bridge refused this offer and made a counteroffer of approximately $ 1,350,000. At that price the city could not float a bond issue to buy the bridge. Thereupon, the city proceeded to have bills introduced in Congress authorizing it to build a new bridge. One such bill passed the House of Representatives.On February 7, 1941, the Keokuk & Hamilton Bridge Co. made a written*271 proposal of a gift of its encumbered bridge properties to the city of Keokuk. The gift proposal recited the existence of $ 88,000 of first mortgage bonds and $ 1,001,000 of second mortgage bonds, together with two coupons unpaid on each of these bond issues, and the company, as donor, proposed that the aforesaid bonds would be acquired by it and the lien thereof removed out of the proceeds of an issue of $ 775,000 of first lien revenue bonds to be placed upon the bridge property.The gift proposal provided that the management, until the final payment of the first lien revenue bonds, be designated by the donor; that the management be given the right to make certain specified improvements in the bridge out of the proceeds of said bond issue; that out of said proceeds all fees and expenses of engineers, bankers, and attorneys be paid; that a proper instrument of conveyance for the transfer of the property, including an assignment of all franchise and franchise rights, be deposited with a depositary, "to the end that the Donee will be vested with full and complete title to said property on the final payment of the First Lien Revenue bonds"; that the donor maintain its corporate organization*272 until the final payment of the bonds, for the purpose of protecting the holders thereof and of supplying an instrumentality for the maintenance of a management organization; that all income be deposited with the depositary; that the depositary pay from such funds the operating costs; that any excess be carried in a sinking fund from which interest on the bonds should be paid first, and the remainder used to retire the bonds; that the bonds be secured by a first mortgage or deed of trust; and that on the final payment on the bonds and all interest thereon, together *253 with the payment of all expenses and performance of all conditions, the depositary deliver the title papers to the donee and the management turn over the bridge property to the city.The gift proposal also contained the following provisions:If while any of the aforesaid First Lien Revenue Bonds are outstanding and unpaid there shall be constructed, or construction shall commence upon any other bridge across the Mississippi River within five miles above or below the existing bridge, which, in the opinion of the Consulting Engineers, will diminish income from or interfere with traffic on the existing bridge, the*273 same shall constitute a defeasance and reverter, and all rights of the City hereunder shall cease and terminate.A failure on the part of the Donee to comply with any or all of the conditions herein attached to this gift shall operate as a forfeiture of all the rights of the Donee hereunder and said property shall revert to the Donor, and all the right, title and interest in and to said property and to said franchise or franchises shall revert to and revest in the Donor as fully and completely as if this instrument had not been executed, and no right or rights in and to said property or the proceeds of any of the tolls collected in the operation thereof shall exist in favor of the Donee. The depositary shall thereupon surrender and return to the Donor, its successors or assigns all instruments of transfer or funds so deposited with said depositary under and by virtue of the provisions hereof.On February 7, 1941, the city council passed a resolution "That the city of Keokuk does hereby accept said proposed gift, subject to all the terms and conditions therein expressed * * *."On April 28, 1941, the day that the certificate of incorporation was issued to petitioner, the city of Keokuk, *274 with the approval of the Keokuk Bridge Committee and the Bridge Committee of the Keokuk Chamber of Commerce, executed the following instrument:The undersigned, City of Keokuk, Iowa, will accept a deposit in escrow of a conveyance from your company [petitioner] of the property described in the gift proposal dated February 7, 1941, between the undersigned and Keokuk and Hamilton Bridge Company, an Iowa corporation as a compliance with the provisions of said gift proposal. Your company, however, to be subject to and to assume and agree to perform all the terms and conditions of said gift proposal.The Keokuk & Hamilton Bridge Co. executed a deed, as of May 1, 1941, conveying all real estate and bridge property to petitioner, which instrument was recorded on July 18, 1941.As of May 1, 1941, petitioner executed an indenture of mortgage pledging all of the real estate, bridge structures, machinery, and all other property then owned or thereafter to be acquired, including the revenues from the bridge, for the equal and proportionate benefit and security of all present and future holders of bonds issued under and secured by the indenture and the coupons thereto attached, in favor *254 *275 of the Guaranty Trust Co. of New York and Arthur E. Burke, as trustees, securing an issue of $ 775,000 par value of bonds.In article three of the indenture of mortgage it is provided that:All of the revenue derived from the properties in this indenture mentioned and described, including the said bridge and the operation thereof, shall be collected by the company and the company covenants that it will deposit all such revenues from day to day promptly upon receipt thereof with the State Central Savings Bank of Keokuk, Iowa, * * * Such revenues shall be deposited in a special trust account known as the "Keokuk and Hamilton Bridge, Inc. Revenue Fund." * * *And article five of the indenture contains the following provision:The company covenants that so long as any bonds shall remain outstanding hereunder, it will not declare or pay any dividends on any of its capital stock of any class at any time outstanding or make any distribution to the holders of its capital stock of any class as such or apply any of its funds or assets to the retirement of any of its capital stock of any class at any time outstanding.The bonds contained the following provision: "The faith and credit of the*276 Company are pledged for the payment of this bond and all interest hereon according to the tenor and effect hereof * * *."Petitioner had a meeting of its board of directors on May 16, 1941, attended by all of its directors, at which the president of petitioner stated that:* * * the corporation [referring to petitioner] had been organized for the purpose of acquiring from Keokuk & Hamilton Bridge Company, an Iowa corporation, the existing bridge extending over the Mississippi River from a point in the city of Keokuk, Iowa, to a point in Hancock County, Illinois, together with its approaches and all real estate, rights in land, licenses, permits and franchises appurtenant thereto * * *.and that it was:* * * the intention of the stockholders * * * to transfer and convey the said property to the City of Keokuk, Iowa, as and when $ 775,000.00 of bonds had been retired; provided that in the meantime no other bridge across the Mississippi River within five miles above or below the said existing bridge shall be constructed or the construction thereof commenced.On June 18, 1941, the petitioner corporation executed a deed providing for the conveyance of its bridge properties to the city*277 of Keokuk, subject to (a) the indenture of mortgage and deed of trust from petitioner to Guaranty Trust Co. of New York and Arthur E. Burke, as trustees, to secure the $ 775,000 first mortgage sinking fund 4 per cent bonds of petitioner corporation, and (b) agreement on the part of the city of Keokuk that the bridge should be maintained in perpetuity as a free bridge for vehicular and pedestrian traffic.On June 18, 1941, an escrow agreement was entered into by Keokuk *255 and Hamilton Bridge, Inc., party of the first part, James M. Fulton, sole stockholder of petitioner, party of the second part, the city of Keokuk, a municipal corporation, party of the third part, and the State Central Savings Bank of Keokuk, as escrow agent and party of the fourth part. Petitioner deposited with the escrow agent the deed conveying the bridge properties to the city, along with an executed copy of the gift proposal of February 7, 1941, and a copy of the indenture dated as of May 1, 1941, executed by petitioner in favor of the Guaranty Trust Co. of New York and Arthur E. Burke, as trustees, to secure the $ 775,000 of bonds. James M. Fulton deposited a certificate of all the issued and outstanding*278 stock of petitioner, endorsed in blank. The city of Keokuk deposited its executed resolution of acceptance dated February 7, 1941, and its consent to the performance of the gift proposal on the part of petitioner, which was executed April 28, 1941.The escrow agreement provided that the deed to the bridge property and stock of petitioner held by the escrow agent was to be delivered by it to the petitioner when it received advice from the Guaranty Trust Co. of New York that all of the bonds secured by the mortgage indenture had been paid in full or that funds sufficient to redeem them had been deposited with the trustee. If, however, prior to the receipt of such advice, the consulting engineers advised the escrow agent that construction had commenced upon another bridge across the Mississippi River within five miles above or below the existing bridge which would diminish the income from the existing bridge, the escrow agent was authorized and instructed to deliver the deed to the petitioner and the stock certificate to James M. Fulton. During the time the stock was held by the escrow agent, James M. Fulton reserved to himself and his assigns the right to vote the stock. The petitioner*279 agreed that when the city became entitled to the delivery of the deed, it would pay to the city any funds then in its hands whether derived from revenues from the operation of the bridge or from insurance, less any funds necessary to pay any and all taxes, and less all expenses of dissolution.In accordance with the indenture of mortgage and deed of trust securing the petitioner's outstanding bond issue, all of petitioner's receipts are deposited daily with the depositary bank and placed in either a revolving fund or a revenue fund. The current operating expenses of petitioner are paid out of the revolving fund, and originally the balance left in this fund was limited to $ 5,000. The receipts of petitioner deposited with the depositary bank in excess of the sums necessary for the operation of the revolving fund, costs of extraordinary *256 replacements and repairs of the bridge properties, cost of insurance on the bridge properties, etc., are periodically paid to the trustees under the indenture of mortgage and deed of trust and used by the trustees for the payment of interest and retirement of petitioner's outstanding bonds. At no time since the organization of petitioner*280 has there been any declaration of dividends of any kind and no dividends have been paid. The petitioner has its bridge properties insured for $ 900,000 and it, together with the trustees under the indenture of mortgage, are jointly named beneficiaries under the policy. Petitioner's current expenses consist principally of salaries and wages paid to its officers and employees, state and county property taxes, and repairs. The petitioner had an average of about eleven employees, who were under the control of and paid by it.The excess of receipts or tolls received by petitioner over its expenses and other charges was entered on petitioner's books as "Equity accruing to the city of Keokuk" in the amounts of $ 22,262.10 for the period June 18, to December 31, 1941, $ 69,815.51 for 1942, and $ 84,473.84 for 1943. The amounts of petitioner's outstanding bonds retired were, none in 1941, $ 59,000 in 1942, and $ 61,000 in 1943, leaving an outstanding bonded indebtedness of $ 655,000 ($ 775,000 minus $ 120,000) at the end of the year 1943. The petitioner continued after 1943 to retire part of this indebtedness each year and at the end of the year 1947 it was reduced to $ 173,000. At the*281 time of the hearing on February 9, 1948, there was in excess of $ 75,000 of funds on hand with which to retire bonds at the next period. This would leave approximately $ 100,000 of bonds outstanding.Petitioner has no activity other than the operation of the bridge property and has no other source of receipts.All of the cash proceeds arising from the sale of the bonds were used by petitioner in paying the former owner for the bridge property, franchises, etc., $ 675,000, the cost of the proceedings and expenses in securing the money evidenced by the issue of bonds, $ 38,750, plus miscellaneous expenses incident thereto of $ 1,582.06, plus an improvement fund for the improvements and betterments required by the gift proposal of $ 59,667.94, which improvements and betterments ultimately cost $ 54,286.47, leaving an unexpended balance of $ 5,381.47, which was transferred to the revenue fund on September 25, 1945, and applied toward the retirement of the bonds.The gift proposal was made under the municipal gift statute of Iowa (section 10,188 of the Code of 1939, now section 365.6 of the Code of Iowa for 1946), which authorizes a city to accept a gift in the public interest and to *282 administer the same in pursuance of the terms of the *257 gift. It also provides that no title shall pass unless and until accepted by the city and when so accepted, the conditions attached to the gift become binding upon the city.James M. Fulton, secretary of petitioner corporation, was the nominal or record holder of petitioner's 1,000 shares of outstanding capital stock, but Royal D. Edsell, New York, New York, who was president and manager of petitioner from the time of its incorporation until his death in 1945, was the actual owner. Upon the death of Royal D. Edsell in 1945 the 1,000 shares of stock of petitioner went to his surviving wife, Marian M. Edsell, New York, New York. Subsequent to the Commissioner's field examination of petitioner's income and excess profits tax liability for the years here involved, the city of Keokuk purchased the 1,000 shares from Marian M. Edsell for $ 15,000, title being taken in the name of W. A. Logan, trustee, for the use and benefit of the city of Keokuk. A new stock certificate was substituted for the old stock certificate in escrow at the depositary bank.Petitioner filed timely income tax returns for the years 1941, 1942, and 1943*283 with the collector of internal revenue for the district of Iowa. In its returns it claimed income tax deductions under the designation, "Non-taxable Income Accruing to Municipality under Contract" in the amounts of $ 41,262.10 for 1941, $ 69,815.51 for 1942, and $ 86,473.84 for 1943. The net income reported in each return was none. On December 21, 1944, petitioner filed delinquent excess profits tax returns for the years 1941, 1942, and 1943.The Commissioner determined that the sums of $ 41,262.10 for 1941, $ 69,815.51 for 1942, and $ 86,473.84 for 1943 which were designated in petitioner's returns as "Non-taxable Income Accruing to Municipality under Contract" constituted taxable income to petitioner for each respective year.OPINION.The respondent contends that the petitioner is a corporation engaged in a business activity, that it is an entity separate and apart from its bondholders and/or the city of Keokuk, and, consequently, is subject to Federal taxation like any other taxable corporation upon the income derived from the operation of its bridge properties. The petitioner contends that it is not subject to tax upon this income, and its arguments in support of this contention*284 will be considered in the order in which they are advanced on brief.Petitioner urges that the conditions imposed by the gift proposal and the limitations upon the use of the revenues contained in the indenture of mortgage preclude it from having any gains, profits, or *258 income. Citing Eisner v. Macomber, 252 U.S. 189">252 U.S. 189; Helvering v. Edison Brothers Stores, 133 Fed. (2d) 575; Hirsch v. Commissioner, 115 Fed. (2d) 656; Crews v. Commissioner, 89 Fed. (2d) 412; Dallas Transfer & Terminal Co. v. Commissioner, 70 Fed. (2d) 95, and others, petitioner urges that, in order to have "income" as that term is used in the Sixteenth Amendment to the Constitution and in the Internal Revenue Code, it must realize a gain or profit which it can apply to its "separate use, benefit and disposal." The cited cases so held. We do not agree, however, that, because petitioner was bound by the terms of the gift proposal and the indenture of mortgage to apply the revenues from the toll bridge first to the payment of maintenance*285 and operating expenses and secondly to interest and principal on its bonds, it did not receive a gain or profit for its separate use and benefit. It is not unusual for a corporation to agree, as did the petitioner, to apply its profits to the payment of a mortgage indebtedness. Action taken pursuant to such an agreement results in a reduction of its liabilities and is an application of profits to its separate use and benefit. And the fact that it had entered into an escrow agreement providing that title to the mortgaged property shall pass to a city when the indebtedness is paid, and that each payment accelerated the time when the city will acquire title, does not detract from the nature of the revenues derived from that property during the period it is owned and operated by petitioner. Any person may decide to give his property to another after it is paid for, and may even enter into a binding agreement to do so, but in the interim any revenue derived from that property is his income, and, unless it falls within the exemption provisions of the statute, is taxable to him. The petitioner received "income" from the operation of the bridge property within the meaning of that term*286 as used in the Sixteenth Amendment and in the Internal Revenue Code, even though it was bound by the provisions of the gift proposal and the mortgage indenture to apply that part which remained after payment of expenses to the reduction of its bonded indebtedness. Cf. Amalgamated Housing Corporation, 37 B. T. A. 817; affd., 108 Fed. (2d) 1010.Furthermore, all that has been said concerning the benefit to the petitioner from the reduction of its debt through the application of the toll payments received to said debt becomes even more evident when it is considered that petitioner herein might, in the event some governmental or private organization would build a bridge within five miles of petitioner's bridge, retain the bridge as its own property and never deliver it to the city of Keokuk, in which event all the money received *259 by petitioner during the taxable years would inure to its own enrichment.Petitioner also urges that the revenues which it collected and applied to the payment of its indebtedness are not income because they replaced the capital procured for the acquisition of the bridge property. That the revenues*287 in excess of expenses were used to replace the capital which petitioner borrowed from the insurance companies is not disputed. But these revenues were not paid to petitioner for the purpose of reimbursing it for a capital expenditure. They represented toll charges received from its patrons for the use of the bridge. In this respect the facts in the instant proceeding differ from Decatur Water Supply Co. v. Commissioner, 88 Fed. (2d) 341; Edwards v. Cuba Railroad Co., 268 U.S. 628">268 U.S. 628, and related cases, cited by the petitioner. In the Decatur case, upon which petitioner places strong reliance, the city of Decatur, Illinois, desired to enlarge and extend its water supply system. Due to constitutional debt limit restrictions, it became necessary for the city to organize the Decatur Water Supply Co. for the purpose of having it acquire the land needed for the reservoir basin in connection with a new dam to be constructed by the city. Public spirited citizens subscribed to the new company's capital stock. The charter issued by the city provided for the dissolution of the company and conveyance of its reservoir*288 land to the city upon the retirement of the capital stock. The city operated the water system. The water collections were made by the city and were used to pay the city's expenses of operating its water system, and 90 per cent of the excess was distributed to the company for the payment of dividends and retirement of its capital stock. The company paid a tax upon the sums paid as dividends to its stockholders, but contended that the payments in retirement of its capital stock did not constitute taxable income to it. The Circuit Court of Appeals for the Seventh Circuit agreed with the petitioner's contention on the ground that the payments came to it from the city burdened with the unalterable obligation to return them to the preferred stockholders in retirement of capital, and it held that they were not taxable income. In the course of its opinion the Circuit Court discussed the Cuba Railroad case and stated that the analogy between the facts of that case and those involved in the Decatur case was pronounced. In the Cuba Railroad case the Supreme Court held that subsidy payments made by the Republic of Cuba to a railroad company were reimbursements for capital expenditures*289 and were not income within the meaning of the Sixteenth Amendment. In reaching this conclusion the Court stated that the contributions were not profits or gains from the use or operation of *260 the railroad and were not made for services rendered or to be rendered, and the logical inference is that, if they had been, the court would have held that they represented income when received and not a replacement of capital. The revenues realized by the petitioner from the operation of the bridge are not exempt from tax as amounts received to replace capital or reimburse it for capital expenditures.Section 116 (d) of the Internal Revenue Code provides for the exemption from Federal taxation of income derived from any public utility or the exercise of any essential governmental function and accruing to any political subdivision of a state. Petitioner urges that its income is exempt from tax under this provision of the statute. It argues that a reading of the gift proposal and accompanying documents indicates a delivery of title and intention to vest a present interest in the bridge property in the city of Keokuk, subject, however, to a defeasance or reverter if certain conditions*290 were not performed; that the city thus became the owner of the property; that petitioner is a mere instrumentality created by the city to manage the property and collect and handle the revenues so that the city may acquire the bridge and make it free of tolls; that in maintaining and operating the bridge it acted as an instrumentality of the city engaged in the exercise of an essential governmental function; and that the income accrued to the city.We are unable to agree with the petitioner. During the taxable years the deed to the bridge property was held by the escrow agent in accordance with the escrow agreement. The "distinctive feature of an escrow is the delivery of a deed to a third person to await the performance of some condition whereupon the deed is to be delivered to the grantee and the title is to pass, the depositary being the agent of both parties, and the instrument not being effective as a conveyance until the condition is performed." 8 R. C. L. 994. To the same effect, see Jackson v. Rowley, 88 Iowa 184">88 Iowa 184; 55 N. W. 339, 340. The escrow agreement provides that the escrow agent is to hold the deed until*291 advised, among other things, that "all of the bonds secured by said indenture have been paid in full, or that funds have been deposited with the trustee sufficient to redeem and retire all of the outstanding bonds," and, upon receipt of such advice, the escrow agent is authorized and instructed to deliver the deed to the city. The agreement also provides that in the event the escrow agent is advised by the consulting engineers that construction of another bridge has been commenced within five miles of the existing bridge, it is authorized and instructed to deliver the deed and other instruments then in its hands to the petitioner. The gift proposal provides that on "the final payment of *261 said First Lien Revenue Bonds and all interest thereon, * * * and on the due performance of all the conditions herein specified, * * * then the depositary shall deliver the title papers to the Donee, and the management shall turn over said property to said City." We think it is clear from these provisions that delivery of the deed to the city was to await the performance of the enumerated conditions, and that the apparent intention was that the city was not to acquire title to or ownership*292 of the bridge property pending such performance.In support of its contention that the city was the owner of the bridge property during the taxable years, the petitioner points to the provision of the gift proposal that a failure on the part of the city "to comply with any or all of the conditions attached to this gift shall operate as a forfeiture of all the rights of the Donee hereunder and said property shall revert to the Donor, and all the right, title and interest in and to said property and to said franchise or franchises shall revert to and revest in the Donor as fully and completely as if this instrument had not been executed * * *." Petitioner urges that the use of the words "revert" and "revest" indicates that title to the property was vested in the city during the taxable years, subject to reverter. We do not agree. An examination of the gift proposal shows that the only conditions imposed therein upon the city were that after the payment of the bonds and delivery of the conveyance the bridge should be forever free to vehicular and pedestrian traffic and should be maintained by the city in a state suitable for such traffic. Inasmuch as failure on the part of the city*293 to perform these conditions could occur only after the bonds were paid and ownership of the bridge acquired by it, the use of the words "revert" and "revest" in connection with the return of the property to petitioner in the event the city failed to comply with these conditions was proper. They have no bearing, however, upon the ownership of the bridge property during the taxable years, when the bonds were still the outstanding indebtedness of petitioner and the deed had not been delivered to the city by the escrow agent.Our conclusion from the foregoing is that during the taxable years the ownership of the bridge property remained in the petitioner. It collected the revenues from the operation of the bridge, and these revenues, after paying maintenance and operating expenses, were applied to the payment of principal and interest on its indebtedness to the bondholders. While it was a public utility (cf. Clarksburg-Columbus Short Route Bridge Co. v. Woodring, 89 Fed. (2d) 788), none of its *262 income accrued to the city. The real beneficiaries of its operations during the taxable years were the bondholders. It was not an agency or instrumentality*294 of the city engaged in an essential governmental function. It was a private corporation, organized under the laws of Delaware. It paid property taxes levied on its property by the local taxing authorities. It was managed and controlled by its own officers and directors, and none of its stock was owned by the city. It is not entitled to exemption from taxation on its income under the provisions of section 116 (d) of the code. Citizens Water Co., 32 B. T. A. 750; affd., 87 Fed. (2d) 874; City of Burlington v. United States, 148 Fed. (2d) 887; Bear Gulch Water Co., 40 B. T. A. 1281; affd., 116 Fed. (2d) 975; certiorari denied, 314 U.S. 652">314 U.S. 652. Cf. Appeal of City of Dubuque Bridge Commission, 232 Iowa 112">232 Iowa 112; 5 N. W. (2d) 334.The petitioner also contends that it is a tax exempt corporation under section 101 (6), (8), or (14) of the code. Under subdivision (6) petitioner claims exemption as a corporation "organized and operated exclusively for * * * charitable*295 * * * purposes * * * no part of the net earnings of which inures to the benefit of any private shareholder or individual * * *." Under subdivision (8) it claims exemption as an organization "not organized for profit but operated exclusively for the promotion of social welfare * * * and the net earnings of which are devoted exclusively to charitable * * * purposes." Under subdivision (14) it claims exemption as a corporation "organized for the exclusive purpose of holding title to property, collecting income therefrom, and turning over the entire amount thereof less expenses to an organization which itself is exempt from the tax imposed by this chapter."This and other courts have frequently stated that statutes creating an exemption must be strictly construed and that where a taxpayer is claiming an exemption it must meet squarely the tests laid down in the provision of the statute granting exemption. Petitioner does not meet the requirements of either subdivision (6), (8) or (14) of section 101. It was organized as a private business corporation and operated during the taxable years upon a profit basis. Its income after payment of expenses was used to pay interest on its outstanding*296 bonds and for the retirement of bonds. No part of it was turned over to a charitable organization or was devoted to charitable purposes, and no part of it was turned over to an organization, such as the city of Keokuk, which itself is exempt from tax. Petitioner is not a tax exempt corporation under the statutory provisions upon which it relies.*263 As a final and alternative contention, the petitioner urges that it is entitled to amortization deductions for the cost of its bridge properties in the amount of its net income for each year. The assets acquired by petitioner consisted of real estate, personal property, and intangibles, i. e., franchises and licenses. The petitioner is not here claiming any depreciation deductions based on exhaustion, wear, and tear of its tangible properties, and clearly there is no justification for any amortization allowances based on exhaustion of such assets by passage of time. If the intangible properties of petitioner are exhausted "* * * by the passage of time or otherwise the petitioner is entitled to spread the amount paid * * * [therefor] over the determinable period of its life and to deduct an aliquot part thereof in each year." *297 Dallas Athletic Association, 8 B. T. A. 1036, 1039-1040; Rainbow Gasoline Corporation, 31 B. T. A. 1050, 1056. There is no evidence, however, that the probable useful life of petitioner's intangible properties is limited to a fixed period of time. It follows, therefore, that petitioner is not entitled to amortization deductions for the costs of either its tangible or intangible properties.Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/204047/ | 585 F.3d 479 (2009)
Pius AWUAH, Nilton Dos Santos, Geraldo Correia, Benecira Cavalcante, Denisse Pineda, Jai Prem, Aldivar Brandao, Phillip Beitz, Richard Barrientos, Marian Lewis, Stanley Stewart, and all others similarly situated, Plaintiffs, Appellees,
v.
COVERALL NORTH AMERICA, INC., Defendant, Appellant.
No. 09-1284.
United States Court of Appeals, First Circuit.
Heard October 5, 2009.
Decided October 27, 2009.
Michael D. Vhay with whom Paul S. Ham, Norman M. Leon, John F. Dienelt and DLA Piper LLP were on brief for appellant.
*480 Hillary Schwab with whom Harold L. Lichten, Shannon Liss-Riordan and Lichten & Liss-Riordan, P.C. were on brief for appellees.
Before BOUDIN, STAHL and LIPEZ, Circuit Judges.
BOUDIN, Circuit Judge.
This is an attempted interlocutory appeal by Coverall North America, Inc., seeking review in this court of a discovery-related order by the district court in litigation now pending before it. The case in the district court is a class action by Coverall's "franchisees" alleging that Coverall made misrepresentations, failed to keep its contractual promises, and wrongly classified them as independent contractors; the nature of Coverall's operations and other pertinent background is described in Awuah v. Coverall North America, Inc., 554 F.3d 7 (1st Cir.2009).
During discovery, Coverall's former chief financial officer, Steven R. Cumbow, was deposed and the deposition initially sealed because of Coverall's claims that it revealed privileged and confidential information about Coverall's business practices including various accounting matters. Thereafter, in October 2008, the plaintiffs moved to unseal the deposition so that they could make fuller use of it. The district court held a hearing, reviewed disputed passages and unsealed portions that it found not to be privileged.
Coverall then sought a protective order as to certain passages of Cumbow's deposition that it claimed revealed trade secrets or competitively sensitive information, and after further proceedings the district judge ruled against the trade secrets claim but agreed that certain deposition passages although not all those requested by Coverallshould remain sealed because they are competitively sensitive. Although Coverall sought protection for passages on 28 pages of Cumbow's deposition, protection was granted for all passages on 15 pages and, on another page, for one passage but not a second. Coverall has now appealed from the denial of protection as to the remaining passages (and their disclosure has been stayed pending this appeal).
The general rule is that interlocutory orders are not immediately reviewable but must await a final judgment; however, among a number of exceptions is that created by the collateral order doctrine, Cohen v. Beneficial Indus. Loan Corp., 337 U.S. 541, 545-47, 69 S.Ct. 1221, 93 L.Ed. 1528 (1949), which allows interlocutory appeal of orders that decide issues that meet all four of these criteria: they (1) are distinct from the merits, (2) are definitive as to the issues sought to be reviewed, (3) affect interests that could not be vindicated by appeal after a final judgment, and (4) present an important issue meriting immediate review. Gill v. Gulfstream Park Racing Ass'n, Inc., 399 F.3d 391, 398 (1st Cir.2005).[1]
Many discovery orders are effectively reviewable on final judgment, but disclosure of allegedly privileged or sensitive information may threaten immediate harm that cannot later be undone on review of the final judgment. The unsealing order in this case meets that test and also definitively resolves the question whether *481 the disputed passages are to be made public. Plaintiffs dispute that the confidentiality issue is "distinct from the merits" of the casea criterion whose application may in some instances not be straightforward;[2] but we bypass that question because we conclude that the final requirementimportancecannot be satisfied.
It might be asked why such requirements exist at all if an order may cause irreparable harm that cannot be undone by later review, but the final judgment rule implicitly accepts that some harms may result from deferring appeals; for example, a court may unreviewably refuse to dismiss a case on summary judgment prior to trial, thereby imposing heavy costs on the defense. Digital Equip. Corp. v. Desktop Direct, Inc., 511 U.S. 863, 872, 114 S.Ct. 1992, 128 L.Ed.2d 842 (1994). But piecemeal appeals impose costs of their own by multiplying proceedings and delaying resolution. Will, 546 U.S. at 350, 126 S.Ct. 952; Spiegel v. Trs. of Tufts Coll., 843 F.2d 38, 46 (1st Cir.1988). The final judgment rule, tempered by exceptions, is a compromise.
Further, in the course of a single case, discovery-related orders are often numerous and often close calls. Yet they are rarely overturned on appeal, because review is normally for abuse of discretion, Mack v. Great Atl. & Pac. Tea Co., 871 F.2d 179, 186 (1st Cir. 1989); typically such orders involve balancing conflicting interests and depend on the trial judge's hard-won familiarity with the course of proceedings. The benefits of routinely allowing such appeals are judged not to outweigh the unquestionable costs. Reise v. Bd. of Regents of Univ. of Wis. Sys., 957 F.2d 293, 295 (7th Cir.1992); Donlon Indus., Inc. v. Forte, 402 F.2d 935, 937 (2d Cir. 1968) (Friendly, C.J.).
The "importance" requirement in the collateral order doctrine thus serves as a mediating device, just as it does with mandamus, another vehicle for review of interlocutory orders with somewhat different criteria. See United States v. Horn, 29 F.3d 754, 769-70 (1st Cir.1994). Although Coverall says that trade secrets should be treated differently than other subjects sought to be reviewed on an interlocutory basis, claims that revealing information will cause irreparable harm can be made as to many types of material, and the circuits have regularly denied interlocutory appeals in which litigants sought to challenge discovery orders governing what information needs to be disclosed and to whom.
This is the settled rule in this circuit, In re Insurers Syndicate for the Joint Underwriting of Medico-Hosp. Prof'l Liab. Ins., 864 F.2d 208, 210 (1st Cir.1988), and most others; a collection of such decisions appears in an addendum to this decision. As a leading treatise explains:
[C]ourts routinely dismiss appeals from orders granting discovery, denying discovery, granting protective orders, granting a protective order narrower than requested, denying protective orders, refusing to modify protective orders, or dealing with the procedures for conducting discovery.
15B Wright, Miller & Cooper, supra, § 3914.23, at 124-30. While one circuit has created an automatic exception when a party is ordered to disclose trade secrets, In re Carco Elecs., 536 F.3d 211, 213 & n. 3 (3d Cir.2008), it recognized that "[o]ther *482 courts of appeals have rejected our approach."
The situation is different where a discovery order is directed to a non-party who is not otherwise part of the litigation, e.g., Gill, 399 F.3d at 393-94, 399 (allowing appeal by a non-party ordered to disclose claimed privileged information), and thus cannot ordinarily appeal from a final judgment. Nat'l Ass'n of Chain Drug Stores v. New England Carpenters Health Benefits Fund, 582 F.3d 30, 41 (1st Cir.2009). Similarly, when an individual is held in contempt for refusing to produce information, the contempt order may be immediately appealable. Corporacion Insular de Seguros v. Garcia, 876 F.2d 254, 256-57 (1st Cir.1989). But Coverall is a party and lacks contempt as a means of testing the order (because the deposition material is already in court files but temporarily sealed).
Turning then to the importance criterion, cases deemed to qualify usually present a disputable legal issue whose importance turns on the likelihood that it will arise in other cases. E.g., Cohen, 337 U.S. at 547, 69 S.Ct. 1221; U.S. Fidelity, 578 F.3d at 56; United States v. Filippi, 211 F.3d 649, 651 (1st Cir.2000). In such cases there are special benefits to "the system" from getting the issue resolved and, in addition, the de novo standard of review for legal issues makes a different outcome on appeal a far more realistic possibility than with fact-specific discovery rulings tested for abuse of discretion. In re Cont'l Inv. Corp., 637 F.2d 1, 7 (1st Cir.1980).
There is no "legal" issue presented by the merits of the discovery order in this case. The district court's decisions on virtually all of the disputed passages involved routine judgments about the likelihood that competitive harm will be done by disclosures about particular aspects of Coverall's business operations. It would be hard to think of more fact-bound controversies or ones more likely to turn on largely speculative judgments about a business with which the district court is now familiar as a result of managing the case and its extensive review of the disclosure issues. Coverall does not even attempt to frame an abstract legal issue for our review.
Some collateral order cases suggest that only distinctly legal issues can qualify; others, by referring only to importance, might suggest that in rare cases the significance of the interest at stake or even the magnitude of an error might qualify.[3] We have no reason to pursue those possibilities because nothing of the kind has been established here. What is before us is a routine set of arguments, none too strong in themselves, that the judge underestimated the potential for competitive damage as a result of the release of the limited number of passages he declined to protect. See, e.g., Poliquin v. Garden Way, Inc., 989 F.2d 527, 532 (1st Cir.1993).
Of course, Coverall has fought energetically and over a considerable period against the disclosures and one might infer that this resistance is a proxy demonstrating the extreme competitive sensitivity of the information. The inference, not in any *483 case proof that the district court was mistaken, is hardly air-tight: Coverall has been chargedit has not been found liable in this casewith activities that could be viewed as highly unattractive. See Awuah, 554 F.3d at 8-9. It is not necessarily the disclosure to competitors that makes the district court's order a matter of concern. Others, including enforcement agencies and potential plaintiffs, may find the disclosures of interest in ways that would not serve Coverall's interests.
Conversely, one may ask why plaintiffs are pressing for unsealing since the protective order allows plaintiffs' counsel access to the information; merely embarrassing a defendant into settlement might not be an appealing ground for forced disclosure. But, asked at oral argument how the sealing of available information disadvantaged plaintiffs, plaintiffs' counsel offered reasons why counsel were handicapped by the protective orderfor example, in working with experts or other potential witnesses and during arbitration to which some plaintiffs may be subjectand the reasons were not implausible.
The appeal is dismissed for want of a final judgment. Costs are awarded in favor of appellees.
It is so ordered.
ADDENDUM
Many cases in other circuits disallow immediate appeals of discovery orders that govern what information needs to be disclosed and to whom. E.g., Chase Manhattan Bank, N.A. v. Turner & Newall, PLC, 964 F.2d 159, 162-63 (2d Cir.1992) (dismissing an appeal of an order to produce privileged documents); MDK, Inc. v. Mike's Train House, Inc., 27 F.3d 116, 120 (4th Cir.) ("The dangers of a trade secrets exception to the nonappealability of discovery orders should be apparent."), cert. denied, 513 U.S. 1000, 115 S.Ct. 510, 130 L.Ed.2d 417 (1994); Texaco Inc. v. La. Land & Exploration Co., 995 F.2d 43, 43-44 & n. 4 (5th Cir.1993) (dismissing an appeal of an order to produce privileged documents and collecting cases holding that discovery orders are not appealable); Coleman v. Am. Red Cross, 979 F.2d 1135, 1138 (6th Cir.1992) (en banc) ("We have held repeatedly that orders denying or granting discovery are not appealable under the collateral order doctrine."); Dellwood Farms, Inc. v. Cargill, Inc., 128 F.3d 1122, 1125 (7th Cir.1997) (Posner, C.J.) ("It is true that a discovery order is not deemed collateral even if it is an order denying a claim of privilege."); Iowa Beef Processors, Inc. v. Bagley, 601 F.2d 949, 953 (8th Cir.1979) ("Most courts, including this one, have held that orders compelling the production of documents or testimony are not appealable as collateral orders or otherwise. We review an order partially lifting a protective order as the functional equivalent of an order compelling production of documents or testimony ...." (citations omitted)); In re Nat'l Mortgage Equity Corp. Mortgage Pool Certificates Litig., 821 F.2d 1422, 1424 (9th Cir.1987) ("Review is not available to determine whether previously disclosed material should be the subject of a protective order.... These matters are for the district court...."); Boughton v. Cotter Corp., 10 F.3d 746, 749-50 (10th Cir.1993) (denying an appeal of an order requiring production of allegedly privileged information and attorney work product); Rouse Constr. Int'l, Inc. v. Rouse Constr. Corp., 680 F.2d 743, 745-46 (11th Cir.1982) (finding an order compelling production of financial statements not appealable).
NOTES
[1] Some of our cases condense the four factors into three, Lee-Barnes v. Puerto Ven Quarry Corp., 513 F.3d 20, 25 (1st Cir.2008) (quoting Will v. Hallock, 546 U.S. 345, 349, 126 S.Ct. 952, 163 L.Ed.2d 836 (2006)), but the substance is the same: a definitive decision, distinct from the merits, on an important issue, which would effectively be unreviewable at the end of the case. See also U.S. Fidelity & Guar. Co. v. Arch Ins. Co., 578 F.3d 45, 54-55 & n. 15 (1st Cir.2009).
[2] See, e.g., Van Cauwenberghe v. Biard, 486 U.S. 517, 527-29, 108 S.Ct. 1945, 100 L.Ed.2d 517 (1988); United States v. MacDonald, 435 U.S. 850, 859-60, 98 S.Ct. 1547, 56 L.Ed.2d 18 (1978); 15A Wright, Miller & Cooper, Federal Practice and Procedure § 3911.2, at 378-95 (2d ed. 1991) (discussing cases relevant to this factor).
[3] E.g., Digital Equip., 511 U.S. at 879, 114 S.Ct. 1992 (stating that what "qualifies as `important'" is "being weightier than the societal interests advanced by the ordinary operation of final judgment principles"); Lee-Barnes, 513 F.3d at 26 (same); 15A Wright, Miller & Cooper, supra, § 3911.5, at 430-32; see also Mitchell v. Forsyth, 472 U.S. 511, 524-30, 105 S.Ct. 2806, 86 L.Ed.2d 411 (1985) (holding rejection of qualified immunity immediately appealable); Abney v. United States, 431 U.S. 651, 662, 97 S.Ct. 2034, 52 L.Ed.2d 651 (1977) (holding rejection of a double jeopardy claim immediately appealable). | 01-04-2023 | 02-07-2011 |
https://www.courtlistener.com/api/rest/v3/opinions/4619559/ | SCHWABACHER HARDWARE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Schwabacher Hardware Co. v. CommissionerDocket No. 102339.United States Board of Tax Appeals45 B.T.A. 699; 1941 BTA LEXIS 1082; November 13, 1941, Promulgated *1082 1. Petitioner borrowed funds from a bank under conditions imposed by a letter from the bank to petitioner. The letter stated that a line of credit would be granted to petitioner on condition that petitioner would not declare further dividends until its financial condition warranted it. No other writing was involved in the contract. The letter was not signed by or for petitioner. Held, that, since petitioner did not execute a written contract prior to May 1, 1936, restricting its payment of dividends, it is not entitled to a credit under section 26(c)(1) of the Revenue Act of 1936. 2. Funds were embezzled from petitioner by one of its employees in the taxable year. In a later year petitioner was reimbursed for a portion of the embezzlements. Held, that petitioner may not deduct losses in the taxable year for which it was subsequently reimbursed. E. B. Elliott Co.,45 B.T.A. 82">45 B.T.A. 82. Charles Horowitz, Esq., for the petitioner. B. H. Neblett, Esq., for the respondent. HILL *699 Respondent determined a deficiency in petitioner's income tax for the year 1937 in the sum of $13,504.83. By amended answer respondent has*1083 asked for an increased deficiency in petitioner's 1937 income tax in the sum of $14,848.75. The first issue is whether or not petitioner is entitled to a credit under section 26(c)(1) of the Revenue Act of 1936. The second issue is whether or not petitioner is entitled to a loss for amounts embezzled from it in the taxable year for which amounts petitioner was in a later year reimbursed. Most of the facts were stipulated. Additional facts were adduced from evidence presented at the hearing. *700 FINDINGS OF FACT. Petitioner is a corporation organized and existing under the laws of the State of Washington and is engaged in the wholesale hardware business. Petitioner's income and excess profits tax return for the taxable year was filed on March 12, 1938, with the collector for the district of Washington at Tacoma, Washington. Petitioner paid income and excess profits tax for the year 1937 in four installments in the total sum of $12,702.03. Petitioner has for many years borrowed money from the Bank of California, N.A., hereinafter referred to as the bank, in order to carry on its business. On or about February 6, 1936, petitioner, through Nathan Eckstein, chairman*1084 of its board of directors, with the knowledge and consent of the president of petitioner, Morton L. Schwabacher, orally applied to the bank at Seattle, Washington, for a line of credit to the extent of $200,000. On February 8, 1936, G. L. Wakeman, the manager of the Seattle branch of the bank, telephoned Eckstein and informed him that the bank would conditionally approve a $200,000 line of credit to petitioner and that Wakeman, on behalf of the bank, would write petitioner a letter approving the line of credit on conditions to be stated in such letter. The bank, through Wakeman, then wrote the following letter, dated February 8, 1936: Confirming our telephone conversation of this morning, we are pleased to place at the disposal of the Schwabacher Hardware Company, an open line of credit for this year, in the amount of $200,000. We also consent to the payment of a dividend in the amount of $40,000.00 at this time, with the understanding that no further dividends will be declared until the condition of the business amply warrants it, and that no further personal overdrafts will be permitted. In granting this line of credit, we expect you to take advantage of all possible discounts, *1085 and be prepared to liquidate the bank indebtedness at your low period. We shall appreciate your keeping in touch with us from time to time, and furnishing us with a mid-season statement of condition. The above quoted letter of February 8, 1936, was received by petitioner on February 9, 1936. On that date petitioner was indebted to the bank on a note dated February 3, 1936, in the sum of $30,000. Following receipt of the letter of February 8, 1936, from the bank petitioner proceeded to borrow additional money. On December 26, 1936, petitioner was indebted to the bank in the sum of $100,000. The amounts borrowed from the bank, the payments by petitioner to the bank, and the balances owed the bank by petitioner in the year 1936 were as follows: Additional borrowingsPaymentsBalanceBalance, Dec. 26, 1935$35,000Feb. 1936$130,000165,000Apr. 193620,000185,000May 13, 193620,000165,000Sept. 22, 193620,000145,000Oct. 31, 193615,000130,000Nov. 19, 193615,000115,000Nov. 21, 193615,000100,000Dec. 1936100,000*701 The balance at December 26, 1936, was comprised as follows: Date of promissory noteDue datesAmountsOct. 22, 1936Jan. 20, 1937$15,000Oct. 30, 1936Jan. 28, 193715,000Nov. 9, 1936Feb. 7, 193735,000Nov. 21, 1936Feb. 19, 193735,000Total100,000*1086 The amounts borrowed were evidenced by promissory notes payable 90 days after date, executed by petitioner, payable to the bank, and delivered to the bank on the respective dates of the notes. During the year 1937 petitioner, pursuant to the terms and conditions of the letter of February 8, 1936, borrowed additional sums from the bank in the total amount of $140,000, as follows: February, $35,000; March, $50,000; April, $30,000; and June, $25,000. During the year 1937 petitioner repaid the bank a total of $155,000, as follows: January, $15,000; July, $25,000; August, $25,000; September, $25,000; October, $30,000; November, $10,000; and December, $25,000. Petitioner failed to take discounts on merchandise purchases for the year 1937 in a total amount of $654,365.56. Petitioner's lowest indebtedness to the bank in the year 1936, after February 8, 1936, was $100,000. Petitioner's lowest amount of indebtedness to the bank in the year 1937 was $85,000. From and after February 8, 1936, to and including the year 1937, oral conferences relative to the financial condition of petitioner were held from time to time between the bank and petitioner through Wakeman on behalf of the*1087 bank and Eckstein on behalf of petitioner. On or about June 26, 1936, petitioner furnished the bank an interim balance sheet dated June 27, 1936. Under date of December 17, 1937, the bank, through its manager, Wakeman, addressed to petitioner the following letter, which was mailed to and received by petitioner on December 18, 1937: Under date of February 8, 1936 we addressed a letter to you, copy herewith. Inasmuch as you will soon be closing the books of the Schwabacher Hardware Company, Inc. for the year 1937, we wish to say that we are still of the opinion that no dividends should be paid at this time. *702 No dividend was declared by petitioner for the year 1937. Between January 1 and April 30, 1937, an employee of petitioner embezzled funds from petitioner in the sum of $2,068.74. That employee embezzled further sums from petitioner between May 1 and December 31, 1937, in the amount of $4,767.02. Prior to January 1, 1937, that employee embezzled funds of petitioner in the sum of $17,879.12. The sums of $2,068.74 and $4,767.02 which had been embezzled by the employee of petitioner in 1937 were charged on petitioner's books of account to freight expense*1088 and claimed as a deduction on petitioner's income and excess profits tax return for the year 1937 as a part of cost of goods sold in the amount of $1,442,209.10. In determining a deficiency in petitioner's income tax respondent made no adjustment in respect of the amount of cost of goods sold. Petitioner has received and has been allowed by respondent a deduction for the year 1937 in an amount equal to the amounts embezzled by petitioner's employee during that year. In determining a deficiency respondent allowed petitioner a deduction of $1,068.74 for the amounts embezzled by the employee during the year 1937, without taking into account the items of $2,068.74 and $4,767.02. In his notice of deficiency respondent did not take into account the amounts of $2,068.74 and $4,767.02, nor attempt to increase the adjusted net income by those amounts, or any part thereof. At all times prior to January 1937 and up to and including April 30, 1937, petitioner was protected by a valid and existing bond issued by a solvent surety against loss sustained on account of the embezzlements during that period in the principal sum of $1,000. During the period from May 1 to December 31, 1937, petitioner*1089 was also protected by a valid and existing bond issued by a solvent surety against the losses sustained in that period on account of the embezzlements. The embezzlements, including the nature and amount of the embezzlements, for the year 1937, as well as the embezzlements prior to 1937, were first discovered by petitioner on or about November 27, 1939, and a claim therefor was asserted against the surety by petitioner on December 22, 1939. On or about February 28, 1940, petitioner received from the surety the sum of $13,723.61 under the terms and conditions of the following agreement: We, Schwabacher Hardware Company, a corporation, with principal office and place of business at Seattle, Washington, hereby acknowledge receipt of $13,723.61 from Fidelity and Deposit Company of Maryland as a loan repayable, without interest, solely from and to the extent of any recovery we may hereafter make from Union Pacific Railroad Company or any other person, copartnership or corporation on account of losses sustained by us by reason of the Union Pacific Railroad Company accepting checks drawn by us and payable *703 to it, cashing the same and failing to apply the proceeds as directed*1090 thereon, including all checks shown in proof of loss heretofore submitted to the Fidelity and Deposit Company of Maryland under the date of December 22, 1939. We hereby agree to enter and prosecute a civil action or actions against said Union Pacific Railroad Company or other persons on the aforementioned claim, with all due diligence, at the sole liability and expense and under the direction and control of the said Fidelity and Deposit Company of Maryland. As security for the loan aforesaid, we hereby pledge any judgment we may hereafter recover on the foregoing claim against said Union Pacific Railroad Company or others and all moneys which shall hereafter be paid thereon by said Union Pacific Railroad Company or other person or persons, firm or corporation, any such recovery to be distributed as follows: First, reimbursement of all expenses and costs of litigation incurred by Fidelity and Deposit Company of Maryland, including its attorneys' fees, and of Schwabacher Hardware Company for any liability, costs and expenses incurred by it at the request of or with the consent of said Fidelity and Deposit Company of Maryland, or that imposed by law upon Schwabacher Hardware Company. *1091 Second, reimbursement to Schwabacher Hardware Company of all losses proved against Union Pacific Railroad Company or other defendant for which recovery is obtained over and above the amount of the aforesaid loan. Third, out of the balance of the proceeds of the recoveries aforementioned, the aforementioned loan will be repaid. * * * This agreement was modified in June 1940 by a "Supplemental Agreement" which provided that there were certain claims which petitioner had against the Union Pacific Railroad Co. which petitioner did not desire to assert against such company and which were not to be considered as liabilities of the surety on its bond or bonds. The supplemental agreement also provided that petitioner receive reimbursement out of amounts which might be recovered in the suit against the Union Pacific Railroad Co. in excess of the "loan" received from the surety to the extent of $997.92. Of the sum of $13,723.61 received by petitioner in 1940 from the surety, the sum of $4,767.02 is in respect of funds embezzled from petitioner during the period from May 1 to December 31, 1937. Petitioner is entitled to additional deductions from its adjusted net income for*1092 the year 1937 for state excise taxes in the sum of $865.56 and social security taxes in the sum of $364.06 which accrued in 1937 but were not taken as deductions on the return because not ascertained at the time that return was made. By amended answer, respondent seeks to eliminate the sum of $4,767.02 from cost of goods sold and to restore that amount to gross income of petitioner for the taxable year. He also requests the elimination of a deduction for $1,068.74 for loss due to embezzlement in the year 1937 which he allowed petitioner in his notice of deficiency and prays that we restore that amount to gross income. *704 In addition respondent added the sum of $103.71 representing the amount of the $1,000 received from the surety which was allocable to the embezzlements occurring between January 1 and April 30, 1937. OPINION. HILL: At the hearing counsel for petitioner objected to the stipulated facts regarding the receipt of funds by petitioner from the surety in 1940 on the ground of materiality. We hereby overrule the objection. The materiality of these facts will be apparent from our discussion of the second issue. The first question presented is whether*1093 or not petitioner is entitled to a credit under section 26(c)(1) of the revenue Act of 1936. 1 Petitioner contends that it was restricted in the payment of dividends in the taxable year by a written contract executed by petitioner prior to May 1, 1936. Respondent argues that the credit must be denied on the ground that the contract which restricted payment of dividends by petitioner was not a written contract executed by petitioner. *1094 The contract upon which petitioner relies in its claim for the credit is contained in a letter written by the bank to petitioner in which the bank, through its manager, announced that it was placing an open line of credit at petitioner's disposal and consented to an immediate payment of a $40,000 dividend, "with the understanding that no further dividends will be declared until the condition of the business amply warrants it * * *." This was the only writing involved in the contract. No one signed the contract on behalf of petitioner. In our opinion this was not a written contract executed by petitioner. In , the Supreme Court stated: The natural impression conveyed by the words "written contract executed by the corporation" is that an explicit understanding has been reached, reduced to writing, signed and delivered. We consider that "executed", as used in the language just quoted, means signed by or for the taxpayer. *705 A taxpayer claiming a credit under section 26(c)(1) of the Revenue Act of 1936 must show strict compliance with the terms of the statute. *1095 . In the Union Telephone case we held that a contract was not executed by the taxpayer within the meaning of section 26(c)(1) where the taxpayer's parent corporation executed the contract for which the credit was claimed, even though it was shown that it was customary for the parent corporation to enter into contracts for its subsidiaries, which acquiesced in such action of the parent. In , we held that a contract entered into by the predecessor of the taxpayer, which had orally assumed the predecessor's liability under the contract, was not a contract executed by the taxpayer. In that case we stated: The evidence indicates that petitioner did assume its predecessor's liabilities under that contract. But it did not do this by similar contract to which it affixed its corporate signature. In , we held that a contract which was executed by promoters of the taxpayers prior to its incorporation and was ratified or adopted by actions of the taxpayer was not a contract executed by the taxpayer within the meaning of section*1096 26(c)(1). Upon authority of the Union Telephone Co., Boeckeler Lumber Co., and Kolor-Thru Corporation cases, we hold that petitioner is not entitled to a credit under section 26(c)(1) of the Revenue Act of 1936. The second issue is whether or not petitioner is entitled to a deduction for amounts embezzled from it during the taxable year for which petitioner received reimbursement from a surety in 1940. Petitioner contends that the amounts embezzled in the taxable year are deductible, since the surety did not reimburse petitioner for its losses until after that year. Respondent contends that deductions for losses by embezzlement in the taxable year should be reduced to the extent that such losses were compensated for by insurance, notwithstanding that such compensation occurred in a taxable year subsequent to that of the embezzlement. Petitioner relies upon the case of , in which the Circuit Court of Appeals for the Ninth Circuit held that a loss for jewelry Stolen in the taxable year was deductible in toto in the taxable year, even though a claim against an insurance company for reimbursement of the loss was*1097 compromised, and the amount agreed upon paid, in the following year. That case was apparently presented and decided on the narrow question of whether the claim against the insurance company for loss by theft was accruable in the taxable year in which the loss occurred. *706 The court held, on the facts there, that the claim was not so accruable and that hence the loss was not "compensated for by insurance or otherwise" in the taxable year. That question is not involved in the consideration of our decision here. In the instant case we hold for respondent upon the principle that deductions of a taxable year before us may be adjusted to reflect a later refund or reimbursement, even though such refund or reimbursement may occur after the taxable year involved. , and cases therein cited. Respondent denied deductions for the amounts embezzled during the period from May 1 to December 31, 1937, on the ground that full recovery for those losses was had by petitioner from the surety in 1940. As to the amounts embezzled in the period January 1 through April 30, 1937, respondent determined that the sum of $103.71 of the $1,000 surety*1098 bond related to such losses and limited the deduction for such losses to the sum of $1,965.03. The sum of $103.71 was arrived at by determining the relation which the sum of $2,068.74, the amount embezzled from January 1 through April 30, 1937, bears to $19,947.86, the total amount embezzled prior to January 1, 1937, and through April 30, 1937, and multiplying that result by $1,000. This is the proper method of determining the proportion of the $1,000 reimbursement which relates to the embezzlements from January 1 through April 30, 1937. Petitioner has conceded that the additional deduction of $1,068.74 which respondent allowed in his notice of deficiency should be eliminated and that amount restored to gross income. On the authority of , we hold that these adjustments should be made. Although the amounts received by petitioner from the surety in 1940 were in the form of a "loan", the amounts received were repayable only out of the proceeds of a suit directed against the Union Pacific Railroad Co. There was no requirement that petitioner repay the amounts received other than from such proceeds. Accordingly, the amounts received from the*1099 surety must be deemed to be true reimbursement for the losses. Since we have sustained respondent on both issues, we hold, in accordance with the stipulation of the parties, that there is a deficiency in petitioner's income tax of $14,848.75. Decision will be entered under Rule 50.Footnotes1. SEC. 26. CREDITS OF CORPORATIONS. In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax - * * * (c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. - (1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619561/ | LAVENSTEIN CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Lavenstein Corp. v. CommissionerDocket No. 7221.United States Board of Tax Appeals6 B.T.A. 1134; 1927 BTA LEXIS 3335; April 29, 1927, Promulgated *3335 Affiliation denied. Richard H. Mann, Esq., for the petitioner. J. Harry Byrne, Esq., for the respondent. LANSDON *1134 The Commissioner has asserted deficiencies in income and profits taxes for the years 1919 and 1920, in the respective amounts of $2,311.69 and $339.49. The only question at issue is whether the petitioner was affiliated with the Lavenstein Bros. Co., Inc., during the taxable years, and entitled to have its tax liability computed on the basis of a consolidated return for each of such years. FINDINGS OF FACT. The petitioner is a Virginia corporation, with its principal office at Petersburg. It was incorporated in March, 1917, with authorized capital of $25,000, divided into 2,500 shares of the par value of $10, each, all of which was issued in equal proportions to M. E. Lavenstein, H. H. Lavenstein, and A. L. Lavenstein. At the date of its incorporation it took over the cash and miscellaneous assets of the Lavenstein Bros. Co., Inc., and thereafter conducted the general merchandise business theretofore operated first by Lavenstein Brothers, a partnership, and later by Lavenstein Bros. Co., Inc. Lavenstein Bros. Co. *3336 , Inc., is a Virginia corporation, with its principal office at Petersburg. It was organized on April 13, 1915, with authorized capital of $50,000, divided into 500 shares of the par value of $100, each, all of which was issued in equal proportions to M. E. Lavenstein, H. H. Lavenstein, and A. L. Lavenstein, in exchange for all the assets and subject to all the liabilities of the business theretofore conducted by the three Lavensteins as equal partners, and hereinafter referred to as the partnership. On November 26, 1913, the stock and fixtures of the partnership were destroyed by fire. The insurance companies in which the partnership held fire insurance policies denied liability for the fire losses. *1135 The partnership thereupon brought suit for the recovery of the amounts of coverage represented by their fire insurance policies, and, after several years of litigation, secured judgment for the full amount of the claims, and such judgment was paid in cash prior to June 1, 1920. The refusal of the insurance companies to pay the losses sustained from the destruction of the stock and fixtures made it impossible for the partnership to pay bank loans and accounts for merchandise*3337 purchased from certain wholesale merchants. With such obligations in its financial statement offset only by a disputed claim against fire insurance companies, the partnership had great difficulty in financing its business and in securing credit from wholesale houses. On April 13, 1915, Lavenstein Bros. Co., Inc., was organized as set forth above, and at once entered into the following agreement with the three Lavensteins and the representatives of the creditors of the partnership: AGREEMENT made this 24th day of April, 1915, by and among M. E. Lavenstein, Harry H. Lavenstein, and Abraham L. Lavenstein, of the City of Petersburg, in the State of Virginia, parties of the first part, the National Bank of Petersburg, Virginia, The Southern Dry Goods and Notion Co., Incorporated, and A. Wright Co. all of the City of Petersburg, in the State of Virginia; the Richmond Dry Goods Co., Incorporated, and Kaufman & Co., of the City of Richmond, in the State of Virginia, The Baltimore Bargain House, and Schloss Bros. & Co. of the City of Baltimore, in the State of Maryland, parties of the second part, and Lavenstein Brothers Company, Inc., of the City of Petersburg, in the State of Virginia, *3338 party of the third part: WHEREAS the parties of the first part are all of the stockholders of Lavenstein Brothers Co. Incorporated, engaged in the business of buying and selling general merchandise, with its place of business in the City of Petersburg, in the State of Virginia, with a paid up capital stock of $50,000.00, and, WHEREAS the parties of the second part are the largest creditors of the said parties of the first part, heretofore trading as partners under the firm name of Lavenstein Brothers, and which said indebtedness and other indebtedness of said Lavenstein Brothers has been assumed by the party of the third part; and, WHEREAS the parties of the first part, and the party of the third part desire further time for the payment of the indebtedness due and owing to the said parties of the second part, and to assure and secure the payment of said debts by a transfer and assignment of all of the capital stock of the said Lavenstein Bros. Co. Incorporated, excepting two shares thereof, and the control, management and direction of said business under the terms and conditions hereinafter set forth; NOW THEREFORE, in consideration of the premises and the sum of $1.00 lawful*3339 money of the United States, each to the other in hand paid, the receipt of which is hereby acknowledged, and in consideration of the undertakings by the parties of the second part as herein provided, it is agreed as follows: FIRST The said parties of the first part shall transfer, assign and deliver to E. E. Hinckle, B. F. Caston, and Samuel Burwell 498 shares of the paid up capital *1136 stock of Lavenstein Brothers Co. Incorporated for the joint use and benefit of the parties of the second part, in the following amounts, namely: SharesE. E. Hinckle168B. F. Caston165Samuel Burwell165the remaining two shares of the paid up capital stock to be retained by M. E. Lavenstein and Abraham L. Lavenstein, one share each, for the purpose of conducting the business, and to be held under the terms and conditions of this agreement. SECOND That for the indebtedness due and owing to the parties of the second part, said Lavenstein Brothers Co. Incorporated, has executed and delivered to the several parties of the second part, their several promissory notes bearing even date herewith, and payable three months after date in the following amounts, respectively: *3340 To the National Bank of Petersburg, one note for$31,250.00To Virgina National Bank of Petersburg, one note for20,000.00To Richmond Dry Goods Co. of Richmond, one note for13,001.85To Kaufman & Co. of Richmond, one note for3,694.02To Baltimore Bargain House of Baltimore, one note for16,543.12To Schloss Bros. & Co. of Baltimore, one note for11,489.04To Southern Dry Goods and Notion Co. of Petersburg, one note for5,512.45To A. Wright & Co. of Petersburg, one note for2,043.04each and all of said notes being personally endorsed by said parties of the first part, and such other endorsements as are now had by any of the said parties of the second part. And it is expressly understood and agreed that such notes shall be renewed or extended until January 1st, 1916, or until the prior termination of this agreement: THIRD The absolute control and management of all of the stock of merchandise, and all furniture and fixtures, notes and accounts receivable, and other personal property of every character and description and all of the real estate heretofore transferred, and now owned by Lavenstein Brothers Co. Incorporated, shall be turned over*3341 and delivered to the said E. E. Hinckle, B. F. Caston and Samuel Burwell, who shall be elected Directors of the said Lavenstein Brothers Co. Incorporated, together with the said M. E. Lavenstein and Abraham L. Lavenstein. FOURTH The parties of the first part further agree that the parties of the second part, by and through said E. E. Hinckle, B. F. Caston, and Samuel Burwell, or such others as may be nominated to take their places, shall have the absolute and exclusive right to determine the manner in which the said business shall be conducted, and the policies which shall be adopted for the conduct of said business, free from any interference by the parties of the first part, until all of the expenses that may be incurred by the parties of *1137 the second part, or by said E. E. Hinckle, B. F. Caston and Samuel Burwell, and all of the obligations contracted in such business and all indebtedness due and owing to the parties of the second part has been fully paid off, satisfied and discharged; and that the business shall be conducted as long as they may deem proper and right and until January 1st, 1916, if the same can be done, in their judgment, without suffering any loss, *3342 and that they will manage and conduct said business according to their best business judgment. The Parties further agree that during the term the said business is in operation as herein provided, under the control and direction of the parties of the second part, sales shall be made only in the course of regular retail trade for cash, and no sales shall be made on credit except with the approval and consent in writing of the Secretary of the Corporation, and such sales shall be made so as to realize a fair profit, over and above the cost price of the merchandise except when otherwise determined by the Board of Directors, and at any time after January 1st, 1916, or after such time as this contract may be terminated prior to January 1st, 1916, said E. E. Hinckle, B. F. Caston and Samuel Burwell or their successors for and on behalf of the parties of the second part shall have and reserve the privilege of selling the stock of merchandise, furniture and fixtures, real estate and all the assets of every terms as they may deem proper and believe will bring the most net cash for same, and out of the proceeds therefrom they shall first pay all expenses and prior debts and debts contracted*3343 by the corporation after date of this agreement, and the balances then due to the parties of the second part, with accrued interest, and the remainder if any, to be paid to the parties of the first part, their legal representatives or assigns. FIFTH The employment of the parties of the first part as President, Vice-President, Secretary, and of Miss Maggie Hutchinson as Assistant Secretary during the term of this agreement, is based upon the express condition that they and each of them devote their entire time and attention to the business of the corporation under the direction and supervision of the Board of Directors. And if they, or either of them, fail to discharge their duties in good faith as required by their employment they, or either, or all of them, may be discharged by the Board of Directors at any special meeting for such purpose, or by direction of said E. E. Hinckle, B. F. Caston and Samuel Burwell, or their successors, it being further stipulated and agreed that all purchases of merchandise in conducting said business shall be approved and confirmed by E. E. Hinckle, B. F. Caston, and Samuel Burwell, or either of them. The salaries of the President, Vice-President, *3344 Secretary and Assistant Secretary and all of the employees of the corporation shall be fixed and approved by the Board of Directors. Said E. E. Hinckle, B. F. Caston and Samuel Burwell shall receive no compensation for their services but shall be reimbursed for any and all expenses that may be incurred by them. SIXTH The Treasurer shall have the supervision of the finances of the business, and shall make all of the deposits of the said corporation in the National Bank of Petersburg, and Virginia National Bank is such proportion as he may deem proper; all checks drawn against such bank accounts shall be signed by the President, and countersigned by the said Treasurer, or in his absence, by Samuel Burwell. *1138 The Assistant Secretary shall also make weekly detailed reports of the business, showing the daily sales for cash and on credit, expenses, disbursements for purchases of merchandise, and payments otherwise, and all details pertaining to the business, said reports to be made in triplicate, one thereof being kept in the files in the office of the Corporation, one to be forwarded to B. F. Caston, 500 W. Baltimore St., Baltimore, Md., and the third to be retained*3345 by the Treasurer in his office in Richmond, Virginia; and with such reports the Assistant Secretary shall send the Treasurer such checks as may be required to pay for merchandise purchases, general expenses, and other essentials, the pay roll of the employees and checks for the residue of receipts shall be made payable to the several parties of the second part in proportion to their respective claims. SEVENTH It is further agreed that on then days' notice at any time before January 1st, 1916, or before the prior termination of this agreement, the parties of the first part may pay to the parties of the second part the amounts due and owing to them respectively, and upon such payments the parties of the second part agree to have transferred, reassigned and delivered to the parties of the first part all of the assets remaining on hand unsold and uncollected of said corporation, together with the capital stock thereof held by them or for their benefit, and any other or further securities held by any of them for the payment of their respective claims. In the event of the liquidation of the business of Lavenstein Brothers Co. Incorporated, by sale or otherwise, on or before January*3346 1st, 1916, or at any time thereafter, any of the parties of the second part holding securities or collateral shall dispose of such securities or collateral for cash either at public or private sale for the best price they can obtain for the same, at such time and place as may suit their convenience, and said parties shall participate in the proceeds of the sale of the assets of the corporation to the extent of the remainder that may be due and owing them. Ten days' notice of such sale shall be given in writing to the corporation by registered mail. If, on January 1st, 1916, the fire insurance policies of Lavenstein Brothers, for which suits are pending and which were transferred to Lavenstein Brothers Co. Incorporated, subject to the rights, uses and purposes for which said policies are held by B. F. Caston and the Virginia National Bank, have not been settled or collected, or their validity fully determined, this agreement may be continued on the same terms and conditions for such further time as may be mutually agreed upon by all of the parties of the second part with the parties of the first part. Nothing herein stated or contained shall limit or restrict the right of such*3347 of the parties of the second part as now hold securities or collateral for all or any part of the indebtedness owing to them by the parties of the first part to retain such collateral or securities for such indebtedness, their right thereto being hereby expressly confirmed and recognized, and the proceeds of any such collateral or securities that may be received prior to January 1st, 1916, or the earlier termination of this agreement shall be applied by the holder of such collateral or securities as payment on account of their respective notes. The said E. E. Hinckle, B. F. Caston, and Samuel Burwell join in the execution of this agreement to signify their consent and willingness to perform the duties required of them in good faith, but should they or any of them for any reason be unable to perform such duties then, in such an event, a successor or successors shall be named with the consent in writing of a majority, of the *1139 parties of the second part, and such successor or successors shall have the same rights, powers and obligations herein given to said E. E. Hinckle, B. F. Caston and Samuel Burwell. EIGHTH The terms and conditions of this agreement are approved, *3348 ratified and confirmed by resolution of the Board of Directors of Lavenstein Brothers Co. Incorporated, and the President and Secretary thereof authorized to execute same on behalf of the Corporation, and the conditions of this agreement shall extend to and be binding upon all the parties hereto, and their administrators, successors, and assigns. Nothing herein contained shall, in any wise, affect the agreement heretofore made in connection with the loan of $10,000.00 to the said Lavenstein Brothers by or through Schloss Brothers & Co. In March, 1917, it became necessary to make some further arrangements to protect the interests of the creditors and enable the Lavenstein Corporation to carry on its business. Accordingly the petitioner was organized as hereinbefore set forth and took over from the Lavenstein Bros. Co., Inc., certain properties designated as live assets. Thereafter, the Lavenstein Bros. Co., Inc., retained only the real estate and the claims against the insurance companies as its assets, and the claims of the creditors as enumerated in the agreement above set forth as its liabilities. On March 19, 1917, Lavenstein Bros. Co., Inc., leased the building to which*3349 it retained title to the petitioner for a rental of $5,400 per annum. Thereafter, it held no stockholders' or directors' meetings and transacted no further business until it prevailed in its suit against the insurance companies prior to June 1, 1920. From the date of its incorporation the petitioner paid all the expenses of operating Lavenstein Bros. Co., Inc., kept the accounts of such corporation in its own books of account and paid the taxes on its real estate. On June 1, 1920, in conformity with judgment rendered by the Supreme Court of Virginia, Lavenstein Bros. Co., Inc., received in cash the full amount of the disputed insurance claims, and immediately paid in full all the obligations due banks and other creditors as set forth above. Thereupon the nominees of the creditors' committee assigned the stock standing in their name to the Lavenstein brothers in equal proportions, and in all other respects carried out the terms of the agreement entered into on April 24, 1915. The petitioner and the Lavenstein Bros. Co., Inc., made a consolidated income and profits-tax return for each of the years 1919 and 1920. Upon audit of such returns the respondent disallowed affiliation*3350 for the year 1919, and the period from January 1 to June 1, 1920, and determined the deficiencies here in question. *1140 OPINION. LANSDON: The only question here is whether the petitioner and Lavenstein Bros. Co., Inc., were affiliated during the taxable years. This issue must be determined by ascertaining the ownership of the shares of the capital stock of Lavenstein Bros. Co., Inc., which were held by the nominees of the creditors during the period in controversy. This stock was issued in equal proportions to the Lavenstein brothers, and, in conformity with the agreement which we have incorporated in our findings of fact, was assigned to nominees of the creditors' committee, was reissued to such nominees, and stood in their names during the time here involved. The petitioner contends that the actual ownership of the stock of Lavenstein Bros. Co., Inc., was, at all times, in the three Lavenstein brothers; that it was held by the nominees of the creditors' committee only as security for the debts listed in the agreement; and that by the terms of the agreement it could, at any time, have the stock transferred to it on the payment of the debts in question. Upon the*3351 facts we are unable to agree with these contentions. During the period in controversy, the stock was outstanding in the names of the nominees of the creditors' committee. Such nominees had complete control both of the stock and of operation of the business. The alleged actual owners of such stock had no record title to it and could acquire such title only by paying the debts in question in full, which they were unable to do at any time prior to the collection of the insurance policies. In these conditions we are of the opinion that, even if the Lavensteins had an equitable title to the stock in question, they were unable to exercise any of the powers of ownership or control. Judgment will be entered for the respondent.GREEN, PHILLIPS and TRUSSELL dissent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4537409/ | Filed 5/28/20
CERTIFIED FOR PUBLICATION
THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
SECOND APPELLATE DISTRICT
DIVISION EIGHT
MATTHEW BOERMEESTER, B290675
Plaintiff and Appellant, (Los Angeles County
Super. Ct. No. BS170473)
v.
AINSLEY CARRY et al.,
Defendants and Respondents.
APPEAL from a judgment of the Superior Court of Los
Angeles County. Amy D. Hogue, Judge. Reversed and remanded
with directions.
Hathaway Parker, Mark M. Hathaway and Jenna E. Parker
for Plaintiff and Appellant.
Young & Zinn, Julie Arias and Karen J. Pazzani for
Defendants and Respondents.
_____________________________
Matthew Boermeester was expelled from the University of
Southern California (USC) for committing intimate partner violence
against Jane Roe.1 The superior court denied his petition for writ of
administrative mandate to set aside the expulsion. He appeals,
contending, among other things, that the process leading to his
expulsion violated his right to a fair hearing. We conclude USC’s
disciplinary procedures at the time were unfair because they denied
Boermeester a meaningful opportunity to cross-examine critical
witnesses at an in-person hearing. We thus reverse and remand
with directions to the superior court to grant the petition for writ of
administrative mandate.
FACTUAL AND PROCEDURAL BACKGROUND2
Boermeester was a member of the USC football team, who
kicked the game-winning field goal for USC at the 2017 Rose Bowl.
Roe was also a student-athlete who played tennis for USC.
Boermeester and Roe dated from March 2016 to approximately
October 2016. On January 21, 2017, two USC students observed
Boermeester put his hand on Roe’s neck and push her against a
wall. They reported this incident to the USC men’s tennis coach,
which resulted in the initiation of an investigation. Boermeester did
not deny he put his hand on Roe’s neck and that she had her back
1 Although Jane Roe has identified herself to the public in the
events at issue, we will continue to use a pseudonym or initials to
refer to Roe and other witnesses in this opinion. (Cal. Rules of
Court, rule 8.90.)
2 Our recitation of facts is derived solely from the evidence in
the administrative record, and not the declarations submitted by
Boermeester that were not made part of the record.
2
against a wall while he did so. He contends, however, he did not
intend to harm her and they were merely “horsing around.”
Initial Interview with Jane Roe
Roe agreed to meet with USC’s Title IX office3 on January 23,
two days after the incident. Roe’s advisor was present.
Roe reported she spent the day with Boermeester on Friday,
January 20, 2017. He called to ask her to pick him up from a party
at approximately 12:30 or 1:00 a.m. on January 21, 2017. She did,
and they returned to her home after getting food. Boermeester was
the drunkest she had ever seen. He yelled in the alley behind her
house, trying to be funny.
Roe had her dog, Ziggy, with her. Boermeester wanted her to
drop Ziggy’s leash to allow him to run in the alley. He grabbed the
back of Roe’s hair hard and said “drop the fucking leash.” Roe
refused. Boermeester responded by increasing his hold on Roe’s
hair, causing her to drop the leash because it “hurt.”
Boermeester then grabbed Roe “tight” by the neck, causing her
to cough. He laughed and let go. He grabbed her by the neck twice
more and pushed her hard against a concrete wall that ran along the
alley behind her duplex. Roe’s head hurt after she hit the wall.
Three USC students, DH, TS, and MB2, exited their
apartments. Roe believed they were woken up by the loud yelling.
When they asked after Roe, Boermeester told them that he and Roe
3 The University’s Policy and Procedures on Student Sexual,
Interpersonal, and Protected Class Misconduct (sexual misconduct
policy) prohibits conduct such as intimate partner violence. It is
intended to comply with statutes prohibiting discrimination in
education, including Title IX of the Education Amendments of 1972
(20 U.S.C. § 1681 et seq.) (Title IX). As a result, the office which
implements the sexual misconduct policy is known as the Title IX
office.
3
were just “playing around.” DH and TS, who lived on the other side
of Roe in the duplex, took her into their apartment. Boermeester
was asleep when she got back to her room.
The next day, Roe told Boermeester that he scared DH and TS
because “it looked really bad when you pushed me and it looked
really bad with your hand around my neck.” He replied, “it was a
joke, we were messing around, tell them to calm down” and added,
“tell them you’re into that,” implying that it was foreplay. When
Roe asked him, “what if you hurt me bad? Would you feel bad?
If you were playing around and it hurt?” Boermeester told her,
“no” because it would have been “brought on by” her.
The Title IX coordinator explained Roe had the option to
request an avoidance of contact order (AOC) prohibiting
Boermeester from contacting her. Roe indicated she wanted the
AOC as well as temporary emergency housing because Boermeester
had a key to her house. The investigator noted Roe was crying
throughout the meeting.
Roe acknowledged she was in a “bad situation” but was
conflicted about what to do because she still cared for Boermeester.
Roe indicated she did not want to participate in an investigation and
did not want Boermeester to be charged with anything other than
the January 21, 2017 incident. She was informed the Title IX office
was obligated to investigate and could proceed without her consent.
Boermeester was charged with the January 21, 2017 incident of
intimate partner violence4 for which there were eyewitnesses.
4 USC’s sexual misconduct policy defines intimate partner
violence as violence committed against a person with whom the
accused student has a previous or current dating, romantic,
intimate, or sexual relationship. “Violence means causing physical
harm to the person or to their possessions. Intimate partner
4
Boermeester is Notified of the Investigation
On January 26, 2017, USC notified Boermeester of an
investigation into the events of January 21 and that he may have
violated USC’s sexual misconduct policy by committing intimate
partner violence. He was placed on interim suspension and received
an AOC letter.
That day, Roe exchanged a series of text messages with the
investigator stating, I am “pretty freaked out about today. I know
I’ve said this a lot but I really can’t emphasis [sic] enough that you
guys please please make it clear that I did not bring this forward
that I want nothing to do with it and I’m not pressing any charges.”
She further stated, “He can’t know I made a statement. Can you not
tell him I made a statement[?] Like he can’t know I met with you
guys.” The investigator assured her Boermeester would be advised
the investigation was initiated by the Title IX office and he would
not be made aware of her statement until the time of the evidence
review.
Jane Roe Recants
Roe and her advisor met with the investigator on January 30,
2017. Roe indicated she had reservations about the investigation
because she felt as though her voice was not heard and that it was
more about “burning him” than her wellbeing. Roe explained she
thought she was in a supportive environment when she initially met
with the Title IX office and so she freely shared her story. Although
she understood the Title IX office was “trying to do the right thing,”
violence may also include non-physical conduct that would cause a
reasonable person to be fearful for their safety; examples include
economic abuse and behavior that intimidates, frightens, or isolates.
It may also include sexual assault, sexual misconduct, or stalking.
Intimate partner violence can be a single act or a pattern of
conduct.”
5
it has made things for her more “difficult.” Roe felt bullied by the
process and no longer “fully believe[d]” many of the statements she
initially made to the Title IX office.
Roe also requested the AOC be lifted because she had changed
her mind. She requested the AOC during her first meeting because
she did not “trust” that it would be clearly conveyed to Boermeester
that the investigation was initiated by the Title IX office, not her.
She did not want Boermeester to be “mad” at her. She remarked
“at the end of the day, he is like my best friend so it is like you are
taking that away too.” She explained, “you think this is to protect
me. Feels like I lost control on everything and I feel like you are
controlling who I can talk to.” Roe stated that she did not feel she
was in danger. She was upset they could not speak. She believed
that the investigation was too harsh and that instead, Boermeester
should be mandated to go to counseling and be placed on probation.
The next day, Roe texted the investigator, “Will I know
tomorrow if I can get rid of my statement because I really don’t want
it used and I don’t even think it is fair because I still disagree with
somethings I said so to use it wouldn’t be accurate and I just have
been stressing about if it’s being used or not so will [the coordinator]
have an answer for me tomorrow?”
Meanwhile, media attention surrounding the suspension had
begun. Roe’s roommate reported Roe was worried about the impact
the publicity would have on Boermeester’s future career and NFL
prospects. On February 8, Roe tweeted in response to media reports
about Boermeester: “I am the one involved in the investigation with
Matt Boermeester. The report is false. @Deadspin @latimes
@ReignofTroy.”
6
Boermeester’s Statement
On January 30, 2017, Boermeester was interviewed by the
investigator with a USC administrative assistant present.
Boermeester’s mother attended as his advisor. Boermeester
generally confirmed the events of January 21 as Roe had described
them; however, he denied intending to hurt her.
He reported he and Roe ate at the Cheesecake Factory at
approximately 4:00 p.m. Later that night, he text messaged Roe to
pick him up from a party because he was unable to drive. He had
three glasses of wine at the restaurant and four to five beers at the
party. When they arrived at Roe’s home after picking up food, they
began playfully throwing french fries at one another.
Boermeester wanted to watch Roe’s dog run around so he
asked her to let the dog go. They were standing by a wall when he
instructed her to release the dog. He acknowledged he put his hand
around her neck while she stood against the wall, but denied they
were arguing or that he was angry. He also denied choking her or
slamming her head against the wall. He believed Roe felt safe with
him. He asserted he did not have a tight grip on her.
Boermeester reported he and Roe spent the next three nights
together and were sexually intimate. They saw each other every day
until she left for a tennis match on January 26, 2017. Boermeester
recalled he and Roe laughed about TS and DH assuming it was “real
violence.”
Boermeester believed the eyewitnesses misinterpreted what
they saw. Although he understood how it looked to them, he
thought it was ridiculous they wanted her to spend the night over at
their home rather than sleep with him.
7
He explained he and Roe sometimes put their hands on each
other’s necks during sex. When asked what impact this has had on
him, he stated, “I know to never do anything that resembles
domestic violence in public again. To be aware of my surroundings.”
The investigator asked, “just in public?” He responded, “Well no,
just to never give the impression of domestic violence.” Boermeester
stated, “I feel like a monster even though I didn’t do anything. I
can’t go to class, rehab, etc. I’m kinda sleeping, it’s on my mind all of
the time.”5
On February 14, 2017, the Title IX office notified Boermeester
he would also be investigated for violating the AOC. He provided a
written response by email denying contact with Roe in any format.
He asserted he had moved home to San Diego and had remained
there aside from meeting with his lawyer.
Additional Witness Statements
USC’s Title IX investigator interviewed over a dozen people,
including Roe, Boermeester, the eyewitnesses, Roe’s roommates and
friends, and Boermeester’s ex-girlfriend. The investigator made it a
general practice to re-read the statement to the person after the
interview to confirm accuracy.
MB2 is Roe’s neighbor. He initially reported he did not see
any physical contact between Roe and Boermeester. He explained
he heard an argument between a man and a woman about a dog.
When he walked outside to take out his trash and see what was
happening, “it kinda settled a little bit.” Roe approached him a few
days later to ensure he did not get the wrong impression.
5 Boermeester had knee surgery in early January 2017 and was
scheduled to receive rehabilitation and physical therapy from USC
staff. The Title IX office noted his treatment at USC facilities was
not prohibited by the interim suspension.
8
One month later, MB2 called the investigator to admit he had
not been truthful in his initial statement because he was trying to
“protect” Roe’s wishes to “keep it on the down low” and “downplay”
the incident. He explained Boermeester’s attorney attempted to
speak with him at his home in March 2017. He told the attorney
what he initially told the Title IX investigator. However, he decided,
“the lawyer coming to speak to me, finding my apartment, I don’t
want to keep this any longer, perpetuating this lie.”
During a second interview, MB2 reported he heard laughing
and screaming sounds coming from the alley by his home, which
initially seemed playful. The noise then changed to what sounded
like a male trying to “assert his dominance” over a female. MB2
looked into the alley and saw Boermeester standing in front of Roe
with both hands around her neck. He then pushed her into the alley
wall and she began to make “gagging” noises. MB2 added, “once he
put his arms around her the first time she wasn’t saying anything.”
MB2 believed, “this guy is violent. He domestically was abusing
her.” He stated, “truth is I really wanted to beat the shit out of this
guy.” Because of what he saw, MB2 grabbed a trash bag and went
outside. He asked them how things were going, which “broke it up.”
Afterwards, Boermeester and Roe walked back to her apartment.
DH is a member of the USC men’s tennis team and Roe’s
neighbor. He was reluctant to participate in the investigation but
described what he saw on the night of January 21, 2017.
He reported he heard screaming. He heard a male voice yelling
loudly and a female voice talking but could not make out what they
were saying. He looked outside and saw Roe and Boermeester
standing by the wall. He noticed Roe’s dog running in the alley,
which made him realize something was wrong because Roe did not
allow her dog to run freely. He saw Roe pinned against the wall by
9
Boermeester, who had his hand around her chest/neck. DH did not
see or hear Roe hit the wall.
TS is also a member of the USC men’s tennis team and is DH’s
roommate. He reported DH woke him up, urgently stating, “we
gotta go downstairs, [Boermeester] is hitting [Roe].” When they got
downstairs, DH asked to speak to Roe. Boermeester walked back to
Roe’s house. DH tried to convince her to spend the night at their
apartment. DH observed Roe was “playing casual at first” and tried
to “downplay it.” When DH confronted her about Boermeester’s arm
around her throat, she rationalized it by saying, “he’s just drunk.”
About 15 to 20 minutes later, Roe returned home, crying. She then
texted that Boermeester was asleep and stated, “I am safe. Thanks
for looking out for me.” TS and DH reported the incident the next
day to the men’s tennis coach.
Roe’s roommates and friends uniformly reported that Roe and
Boermeester’s relationship was volatile, but they did not personally
witness any physical violence between them. Most of them did not
believe Roe was in any physical danger. Instead, they often heard
Roe and Boermeester demean one another by calling each other
names. As the investigation progressed, Roe indicated to her friends
she did not want them to participate in the investigation.
Roe stated in a text message to TS, “Look what I want to say
is I’m helping Matt. I know you won’t agree with it but he’s already
gotten a shit ton of punishment for something I didn’t want to
happen in the first place. I wanted non[e] of this to take place at all.
He’s already suspended for probably two months and will be kicked
off the team and has a restraining order from me. I literally wanted
non[e] of it so what I’m asking as a friend is don’t say much. Please
don’t fuck him over more. I’m not in danger at all I trust him I trust
10
that he won’t ever hurt me again. I just hate that any of this is
going on. So I’m begging you.”
Roe confided in a few friends that Boermeester had given her
bruises. A text message from Roe to GO also indicated Roe may
have been in contact with Boermeester while the AOC was in place.
Boermeester’s ex-girlfriend, AB, dated him for almost three
years. She reported she and Boermeester would wrestle and joke
around. It sometimes started as tickling but would end in him
placing her in a “chokehold.” She would tell him to stop and he did.
She estimated he had his hands around her neck five to ten times.
When Boermeester placed his hands around her neck, “it crossed the
line from being joking and then it would be too much.” On two
occasions, he shoved her during an argument.
AB’s mother thought their rough housing was “always [going]
too far.” She “freaked out” when she saw Boermeester with his
hands around AB’s neck and screamed, “get your arms off [my]
daughter right now!” Boermeester apologized, but AB did not think
he realized he was “definitely too rough.” Nevertheless, AB did not
believe her parents were concerned about her safety when she was
dating Boermeester.
Surveillance Video
The investigator retrieved surveillance video of the incident
from a camera located in the alley approximately two buildings
away from Roe’s duplex. The recording does not contain audio and
is grainy. It is undisputed the video depicts Boermeester and Roe
interacting in the alley after midnight on January 21, 2017. The
video supports the trial court’s description of the events as follows:
“At 12:16:16 a.m., the video shows Petitioner shoving Roe from
the area adjacent to the house into the alleyway. At 12:16:50,
Petitioner appears to be holding Roe’s neck or upper body area.
11
At 12:17:12, Petitioner grabs Roe by the neck and pushes her toward
the wall of the alley. At 12:17:13 and 112:17:14, Roe’s head and
body arch backwards. Between 12:17:16 and 12:17:26, Petitioner
and Roe are against the wall and barely visible from the camera.
At 12:17:26, Petitioner backs away from the wall and re-enters the
camera’s view. At 12:17:28, Roe re-enters the camera’s view. Roe
and Petitioner proceed to push each other. At 12:17:38, Petitioner
moves toward Roe and appears to be pushing her against the wall.
At 12:17:40, a dog can be seen running across the alley. At 12:17:57,
a third party enters the camera’s view and walks in the direction of
Petitioner and Roe. At that moment, Petitioner and Roe walk away
from the wall and back towards the house. At 12:18:19, the third
party walks over to the dumpster, places a trash bag inside, and
walks back toward the house.”
USC’s Findings and Disciplinary Action
Based on the evidence obtained, the investigator found
Boermeester violated USC’s misconduct policy by engaging in
intimate partner violence and violating the AOC. The investigator
submitted her findings to the Misconduct Sanctioning Panel, which
is comprised of two staff or faculty members and an undergraduate
student. The panel decided upon a sanction of expulsion.
Boermeester appealed the findings of fact and determination
of violation to the Vice President for Student Affairs. An appellate
panel found the evidence supported the findings, but recommended
a two-year suspension because Boermeester’s conduct could have
been “reckless” rather than intentional. The Vice President for
Student Affairs rejected the appellate panel’s recommendation and
affirmed the decision to expel Boermeester, reasoning the sanction
was appropriate under the sexual misconduct policy regardless of
whether Boermeester intended to harm Roe or not.
12
Proceedings in the Superior Court
Boermeester filed a petition for writ of mandate in the
Superior Court under Code of Civil Procedure section 1094.5.
The court denied the petition for writ of mandate. Boermeester
appealed.
DISCUSSION
Boermeester contends he was denied notice of the allegations
against him and that interim measures were improperly imposed.
We find these contentions meritless.6 Boermeester also contends he
was entitled to a live evidentiary hearing where he can cross-
examine witnesses. We find Boermeester’s fair hearing argument
supported by caselaw and thus reverse and remand.
Because we conclude Boermeester was deprived of a fair
hearing for lack of a meaningful opportunity to cross-examine
critical witnesses at an in-person hearing, we decline to address
whether USC’s policy was also unfair because the Title IX
investigator held the dual roles of investigator and adjudicator.
We also need not address Boermeester’s other claims of error,
including whether substantial evidence supported USC’s findings.
6 To the extent Boermeester argues USC’s Title IX office was
biased against him, an argument that appears throughout his
appellate briefs, he has presented no legal or factual basis to support
this argument other than to say its decisions were not in his favor.
Boermeester has failed to meet his burden to demonstrate
prejudicial error in this regard. (In re Marriage of McLaughlin
(2000) 82 Cal. App. 4th 327, 337.) Boermeester also complains Roe
was not provided proper notice she was a suspected victim and
intended reporting party in the proceedings. Boermeester lacks
standing to assert Roe’s rights in this matter. (Angelucci v. Century
Supper Club (2007) 41 Cal. 4th 160, 175; see Code Civ. Proc., § 367.)
13
I. Standards of Review
In an appeal from a judgment on a petition for writ of
mandate, the scope of our review is the same as that of the Superior
Court, that is, we review the agency’s decision rather than the
Superior Court’s decision. (Doe v. University of Southern California
(2016) 246 Cal. App. 4th 221, 239 (USC I).) We determine “whether
the respondent has proceeded without, or in excess of, jurisdiction;
whether there was a fair trial; and whether there was any
prejudicial abuse of discretion.” (Code Civ. Proc., § 1094.5, subd.
(b).) “Abuse of discretion is established if the respondent has not
proceeded in the manner required by law, the order or decision is
not supported by the findings, or the findings are not supported by
the evidence.” (Ibid.)
“The statute’s requirement of a ‘ “fair trial” ’ means that there
must have been ‘a fair administrative hearing.’ ” (Gonzalez v. Santa
Clara County Department of Social Services (2014) 223 Cal. App. 4th
72, 96.) “A challenge to the procedural fairness of the
administrative hearing is reviewed de novo on appeal because the
ultimate determination of procedural fairness amounts to a question
of law.” (Nasha v. City of Los Angeles (2004) 125 Cal. App. 4th 470,
482.) However, we review for substantial evidence USC’s
substantive decisions and factual findings. (USC I, supra, 246
Cal.App.4th at p. 239; Code Civ. Proc., § 1094.5, subd. (c).)
II. Boermeester Received Sufficient Notice
Boermeester complains he was not provided full notice that
the Title IX investigation would “extend to his entire relationship
history with [Roe], nor his relationship history with a previous
girlfriend who did not attend USC.” Thus, he claims he was
unaware the investigator was “collecting evidence to support her
opinion about an alleged ‘pattern’ of intimate partner violence, nor
14
that he needed to produce evidence to combat [the investigator’s]
preconceived notions about domestic violence.” We disagree.
“Generally, a fair procedure requires ‘notice reasonably
calculated to apprise interested parties of the pendency of the
action . . . and an opportunity to present their objections.’
[Citations.] With respect to student discipline, ‘[t]he student’s
interest is to avoid unfair or mistaken exclusion from the
educational process, with all of its unfortunate
consequences . . . Disciplinarians, although proceeding in utmost
good faith, frequently act on the reports and advice of others; and
the controlling facts and the nature of the conduct under challenge
are often disputed. The risk of error is not at all trivial, and it
should be guarded against if that may be done without prohibitive
cost or interference with the educational process.’ [Citation.] [¶]
‘At the very minimum, therefore, students facing
suspension . . . must be given some kind of notice and afforded some
kind of hearing.’ [Citation.] The hearing need not be formal, but ‘in
being given an opportunity to explain his version of the facts at this
discussion, the student [must] first be told what he is accused of
doing and what the basis of the accusation is.’ [Citation.]” (USC I,
supra, 246 Cal.App.4th at p. 240, quoting Goss v. Lopez (1975) 419
U.S. 565, 579–580 (Goss).)
Here, USC’s misconduct policy provides that an accused
student be given “[w]ritten notice of the alleged policy violation
including the specific acts, the date/period of time, and [the] location
[where the act allegedly occurred].” Boermeester acknowledges USC
complied with this policy. Indeed, USC informed him on January
26, 2017, that it was investigating a report he committed intimate
partner violence, “specifically, grabbing Jane Roe by the neck, and
pushing her head into a cinder block wall multiple times on/or about
15
January 21, 2017.” He was later notified of a second policy violation,
“specifically, contacting and communicating with [Roe] via text,
phone call, social media, and in-person since the issuance of the
Avoidance of Contact Order issued by Dr. Lynette Merriman and
served on you January 26, 2017.”
Boermeester reviewed the evidence compiled by the
investigator and responded to both allegations by written statement.
In his response, he complained about the interview with his ex-
girlfriend and contended her statement was “completely irrelevant
to the evidence relating to what happened on January 21, 2017.”
Boermeester also viewed text messages from Roe to GO in which she
indicated she had been in contact with him after issuance of the
AOC. After reviewing the evidence related to the AOC violation,
Boermeester responded by denying he had contact with Roe.
Boermeester’s written statements belie his contention that he
did not get notice of the extent of the investigation into his actions.
Boermeester was not only provided notice of the factual basis of the
allegations against him, he was also provided with a meaningful
opportunity to respond to them. We find that is sufficient notice of
the violations with which he was charged. (USC I, supra, 246
Cal.App.4th at pp. 240–241.)
III. The Interim Suspension Was Not Unfair
Boermeester next argues his interim suspension was “patently
unfair” because it was imposed without a hearing and he was not
provided with the evidence supporting it. In his reply brief,
Boermeester asserts the evidence was insufficient to support the
interim suspension. We are not persuaded.
Goss, supra, 419 U.S. 565, cited by Boermeester, supports our
conclusion. Goss recognized the need for interim measures, allowing
for the immediate removal of a student without notice or hearing if
16
the student “poses a continuing danger to persons or property or an
ongoing threat of disrupting the academic process . . .” (Id. at p.
582.) It held an accused student must be given “some kind of notice
and afforded some kind of hearing” when faced with disciplinary
proceedings. Goss did not hold a student was entitled to two
different notices and two different hearings if interim measures
were also imposed. (Id. at pp. 579–580.)
USC’s policy comports with Goss. It states that interim
protective measures, including interim suspension, may be imposed
when there is information the accused student poses a substantial
threat to the safety or well-being of anyone in the university
community. In deciding whether to impose interim protective
measures, the policy sets forth specific factors for consideration,
including whether the reported behavior involved the use of a
weapon or force, the risk of additional violence or significant
disruption of university life or function, whether there have been
other reports of prohibited conduct by the respondent, and the
university’s obligation to provide a safe and non-discriminatory
environment. It further states, “[a] student or organization subject
to interim protective measures is [to be] given prompt written notice
of the charges and the interim measure. An opportunity for review
of the measure is provided within 15 days of the notice by the Vice
President for Student Affairs or designee.”
Consistent with its policy, USC provided Boermeester with
notice of the charges against him and a review of the interim
suspension. Boermeester was notified of the charges against him,
the interim suspension, and the AOC, by letter dated January 26.
The letter advised him to schedule a meeting with the Title IX
investigator, at which time he would be able to “review the basis for
the investigation,” review his procedural rights, ask questions,
17
provide a statement, and submit relevant information or the identity
of potential witnesses. Thereafter, on January 30, Boermeester met
with the investigator. The record shows USC reviewed the basis for
the investigation with him at the meeting. On the same day,
Boermeester requested the interim suspension be discontinued or
modified because two witnesses “misinterpreted” the incident and
because it placed an undue burden on him. The request was denied
by USC’s Vice President of Student Affairs on January 31. In sum,
Boermeester was informed of the evidentiary basis for the interim
suspension and was provided with a hearing. His contentions to the
contrary are thus meritless.
It appears Boermeester is actually asserting USC should have
provided him with a preliminary hearing prior to the full
evidentiary hearing. However, Boermeester presents no authority
for this proposition. Nor does he present any authority for the
proposition USC was required to share its ongoing investigation
with him.
In his reply brief, Boermeester asserts there was insufficient
evidence he posed a threat to Roe or any other student to support
the interim suspension. As an initial matter, we may disregard
arguments raised for the first time in a reply brief. (WorldMark,
The Cloud v. Wyndham Resort Development Corp. (2010) 187
Cal. App. 4th 1017, 1030, fn. 7.) In any case, sufficient evidence
supported the interim suspension. Roe stated Boermeester pulled
her hair, pushed her against a wall, and put his hand on her neck.
DH’s statements supported Roe’s version of the events. Further,
Boermeester admitted he had his hand on her neck and she was
against a wall. While there was also evidence Boermeester did not
pose a threat to Roe, we decline to reweigh the evidence.
18
IV. Fair Procedure Requires Boermeester Be Given the
Opportunity to Cross-Examine Critical Witnesses at An
In-Person Hearing
We find meritorious Boermeester’s contention that he should
have had the right to cross-examine the witnesses against him at an
in-person hearing. In reaching this conclusion, we reject a number
of forfeiture-related arguments advanced by USC and the dissent.
We also find the errors identified are not harmless. We thus reverse
and remand.
A. Relevant Legal Authorities
California has long recognized a common law right to
“fair procedure” when certain private organizations have rendered a
decision harmful to an individual. (Doe v. Allee (2019) 30
Cal. App. 5th 1036, 1061 (Allee); Doe v. University of Southern
California (2018) 29 Cal. App. 5th 1212, 1232, n. 25; Doe v. Regents of
University of California (2018) 28 Cal. App. 5th 44, 56 (UC Santa
Barbara); Pomona College v. Superior Court (1996) 45 Cal. App. 4th
1716, 1729–1730.) Courts have applied the right to fair procedure to
disciplinary proceedings involving sexual misconduct by students at
private universities.7 These opinions uniformly hold the disciplinary
7 Unlike private universities, the requirements for disciplinary
hearings at public universities are grounded in constitutional due
process principles. (Allee, supra, 30 Cal.App.5th at p. 1061.) Some
courts have observed that the common law requirements for a fair
disciplinary hearing at a private university “mirror” the due process
protections that must be afforded a student at a public university.
(Ibid.) Other courts merely find due process jurisprudence
“instructive” in cases involving private universities. (Claremont
McKenna, supra, 25 Cal.App.5th at p. 1067, fn. 8.) In either case,
we may rely on cases involving public university disciplinary
proceedings.
19
proceedings need not include all of the safeguards and formalities of
a criminal trial and the formal rules of evidence do not apply.
(Allee, supra, 30 Cal.App.5th at p. 1062; UC Santa Barbara, supra,
28 Cal.App.5th at p. 56.) Instead, fair hearing requirements are
“ ‘flexible,’ ” and do not mandate any “ ‘rigid procedure.’ ” (Allee,
supra, 30 Cal.App.5th at p. 1062.)
Courts also agree fundamental fairness requires the accused
be given “ ‘ “a full opportunity to present his defenses.” ’ ” (Allee,
supra, 30 Cal.App.5th at p. 1062, quoting Doe v. Regents of
University of California (2016) 5 Cal. App. 5th 1104 (UC San Diego).)
A university must balance its desire to protect victims of sexual
misconduct with an accused’s need to adequately defend himself or
herself. Added to these competing interests is the university’s desire
to avoid diverting its resources and attention from its main calling,
which is education. (Doe v. Claremont McKenna College (2018) 25
Cal. App. 5th 1055, 1066 (Claremont McKenna).) “ “Although a
university must treat students fairly, it is not required to convert its
classrooms into courtrooms.’ ” (UC San Diego, supra, 5 Cal.App.5th
at p. 1078.)
In examining what kind of hearing comports with fair
procedure, California courts have concluded a university must
provide the following to the parties involved in a sexual misconduct
disciplinary proceeding: notice of the charges and the university’s
policies and procedures (USC I, supra, 246 Cal.App.4th at p. 241);
compliance with those policies and procedures (UC San Diego,
supra, 5 Cal.App.5th at p. 1078); access to the evidence (UC Santa
Barbara, supra, 28 Cal.App.5th at pp. 57–59); an in-person hearing
that includes testimony from critical witnesses and written reports
of witness interviews (Doe v. Westmont College (2019) 34
Cal. App. 5th 622, 637 (Westmont College); and direct or indirect
20
cross-examination of critical witnesses in cases where credibility of
the witnesses is central to a determination of misconduct (Doe v.
Occidental College (2019) 40 Cal. App. 5th 208, 224 (Occidental
College); Allee, supra, 30 Cal.App.5th at p. 1039).
B. USC’s Sexual Misconduct Policy in 2017
USC’s student handbook includes its policies and procedures
governing investigations into student sexual misconduct.8 Stalking
and intimate partner violence were identified as some of the
prohibited conduct. USC’s policy dictated an investigation was to be
a “neutral, fact-finding process. Reports [were] presumed to be
made in good faith. Further, Respondents [were] presumed not
responsible.” The presumption of non-responsibility was overcome
when a preponderance of evidence established the respondent
committed the prohibited conduct.
The handbook required the Title IX office to contact the
reporting party and the respondent at the initiation of an
investigation to explain their rights and to schedule a meeting.9
An investigator was assigned to the matter and interviewed
witnesses and assembled other evidence.
The rules of evidence and discovery generally did not apply.
Sexual history was relevant “[w]hen there [was] evidence of
substantially similar conduct by a Respondent, regardless of a
finding of responsibility.” The sexual history evidence could be used
8 USC’s sexual misconduct policy has been amended since 2017.
However, we review the policy as it existed at the time of the
disciplinary proceedings against Boermeester.
9 Regardless of who reported the student misconduct, USC
designated the individual who experienced the prohibited conduct as
the “reporting party.” The “respondent” was the individual accused
of committing the misconduct.
21
“in determining the Respondent’s knowledge, intent, motive,
absence of mistake, or modus operandi[.]”
After the investigation, the parties could review the evidence
in a process known as “Evidence Review.” Once the parties
completed Evidence Review, the Title IX coordinator and assigned
investigator conducted separate hearings, known as “Evidence
Hearings,” where each party could present a statement or evidence
at the Title IX offices. Each party was permitted to submit
questions to be asked by the Title IX coordinator at the other party’s
Evidence Hearing. The Title IX coordinator had discretion to
exclude inflammatory, argumentative, or irrelevant questions. Any
“new information” shared by a party during the Evidence Hearing
was relayed to the other party for a response.
After the Evidence Hearing, the Title IX office prepared a
Summary Administrative Review (SAR), which presented and
analyzed the information collected. The investigator made findings
of fact in consultation with the Title IX coordinator and using a
preponderance of the evidence standard, determined whether a
violation occurred.
A “Misconduct Sanctioning Panel,” comprised of three
members of the USC community, determined the appropriate
discipline after review of the SAR. The parties could appeal the
disciplinary action to USC’s Vice President for Student Affairs.
An appellate panel, comprised of three anonymous individuals from
the USC community, reviewed the appeal and made a
recommendation to the Vice President for Student Affairs, who could
accept or reject the recommendation.
C. Forfeiture
We address the threshold issue of whether Boermeester has
preserved his right to assert on appeal that he was improperly
22
denied cross-examination of witnesses at a live evidentiary hearing.
We find he has.
USC contends Boermeester forfeited the issue when he failed
to request cross-examination of third-party witnesses and waived it
when he refused to submit written questions for Roe. We decline to
fault Boermeester for failing to request cross-examination of other
witnesses because such an objection was not supported by the law at
the time and would have been futile in any case. (People v. Brooks
(2017) 3 Cal. 5th 1, 92 [“ ‘Reviewing courts have traditionally excused
parties for failing to raise an issue at trial where an objection would
have been futile or wholly unsupported by substantive law then in
existence.’ ”]; see also Corenbaum v. Lampkin (2013) 215
Cal. App. 4th 1308, 1334 [“An appellant may challenge the admission
of evidence for the first time on appeal despite his or her failure to
object in the trial court if the challenge is based on a change in the
law that the appellant could not reasonably have been expected to
foresee.”].)
At the time of these disciplinary proceedings in 2017, neither
the law nor USC’s sexual misconduct policy contemplated cross-
examination of third-party witnesses at an in-person hearing. Allee,
which extends cross-examination rights to third-party witnesses,
was not published until January 4, 2019. In 2016, the existing law
on this point was set forth in USC I, which cited with approval a
case that held, “ ‘[a]lthough we recognize the value of cross-
examination as a means of uncovering the truth [citation], we reject
the notion that as a matter of law every administrative
appeal . . . must afford the [accused] an opportunity to confront and
cross-examine witnesses.’ ” (USC I, supra, 246 Cal.App.4th at
23
p. 245.) Under these circumstances, Boermeester could not
reasonably have been expected to foresee Allee’s holding.10
Moreover, any objection would have been futile because the
Title IX office had made it clear they were not going to deviate from
USC’s sexual misconduct policy and procedures. This is
demonstrated by USC’s denial of Boermeester’s request that Roe’s
answers to his questions at the Evidentiary Hearing be transmitted
to him “unfiltered,” meaning verbatim, and prior to the SAR. The
Title IX coordinator replied, “The process does not afford that.
Please review our policy.” It is reasonable to conclude a request to
question other witnesses would likewise have been denied and an
objection is futile under such circumstances. (See People v. Hopkins
(1992) 10 Cal. App. 4th 1699, 1702 [after mistrial objection overruled
on a legal ground, defense counsel could reasonably have believed
further objections would be fruitless]; In re Antonio C. (2000) 83
Cal. App. 4th 1029, 1033 [“[W]here an objection would have been
futile, the claim is not waived.”].)
Because we conclude Boermeester did not forfeit his right to
cross-examine third-party witnesses, we likewise conclude there was
no waiver of his right to an in-person hearing.
10 The dissent asserts Boermeester could have foreseen Allee
because his attorney also represented the accused student in Allee.
In 2019, Boermeester’s attorney persuaded the Allee court to rely on
Doe v. University of Cincinnati (S.D. OH 2016) 223 F. Supp. 3d 704,
711, which held that cross-examination was essential in student
disciplinary proceedings. As discussed above, however, California
authority was to the contrary when Boermeester’s proceedings
occurred. (USC I, supra, 246 Cal.App.4th at p. 245.) Boermeester’s
attorney in 2017 could not have foreseen that California law would
change in 2019 as a result of an Ohio case. We decline to charge
attorneys with such foresight.
24
We also decline to find forfeiture based on Boermeester’s
refusal to submit questions for Roe. The record shows Boermeester
did object to the process by which Roe would be questioned.
Specifically, he asked for Roe’s answers to be relayed to him
“unfiltered” or word-for-word so he could use them in his formal
statement to USC. He explained, “The failure to record or
transcribe any of the interviews and the admission by at least one
witness that he lied during his initial interview [referring to MB2]
have shaken our confidence in the accuracy of this investigation.”
Boermeester declined to submit questions for Roe only after his
request was rejected.
Given these circumstances, Boermeester did not waive the
right to raise the issue of Roe’s cross-examination on appeal.
(See Warner Constr. Corp. v. City of Los Angeles (1970) 2 Cal. 3d 285,
299–300, fn. 17 [no waiver where objection was overruled and
objecting party attempted to minimize impact of admission of
evidence].) To the extent USC contends Boermeester’s objection was
insufficiently specific, that is, he failed to object on the ground he
could not question Roe at an in-person hearing, we conclude that
objection was not supported by the law at the time and would have
been futile for the same reasons specified above.
We do not find persuasive the dissent’s invited error analysis.
An error is invited when a party purposefully induces the
commission of error. (Norgart v. Upjohn Co. (1999) 21 Cal. 4th 383,
403.) The doctrine of invited error bars review on appeal based on
the principle of estoppel. (Ibid.) The doctrine is intended to prevent
a party from misleading a trial court to make a ruling, and then
profit from it in the appellate court. (Ibid.)
The dissent accuses Boermeester of making a tactical decision
when he refused to submit questions for Roe. The record shows
25
Boermeester only declined to question Roe further after his request
to receive verbatim answers before the SAR was denied. The record
does not demonstrate it was a tactical decision designed to induce
USC to make an erroneous decision that Boermeester could then
challenge on appeal. Instead, the record demonstrates a
disagreement about the process by which Roe would be questioned.
It is clear Boermeester merely abided by USC’s established
rules and procedures. USC’s policy did not allow for Roe to be
questioned at an in-person hearing that Boermeester could attend.
Neither did it contemplate questioning third party witnesses at an
in-person hearing. The doctrine of invited error does not apply when
a party, while making the appropriate objections, acquiesces to an
established procedure such as this one. (See K. G. v. County of
Riverside (2003) 106 Cal. App. 4th 1374, 1379 [“ ‘ “ ‘An attorney who
submits to the authority of an erroneous, adverse ruling after
making appropriate objections or motions, does not waive the error
in the ruling by proceeding in accordance therewith and endeavoring
to make the best of a bad situation for which he was not
responsible.’ ” [Citations.]’ ”].) Here, Boermeester objected to the
format of his questions to Roe and we find that any request to
question third party witnesses would have been futile. Boermeester
did not invite the error by acquiescing to USC’s sexual misconduct
procedure.
Finally, we reject the contention Boermeester forfeited this
issue when he failed to raise it in his administrative appeal.
Boermeester was prohibited from arguing the proceedings were
unfair in his administrative appeal. An appeal on this basis would
have been futile. (In re Antonio C., supra, 83 Cal.App.4th at
p. 1033.)
26
D. Merits
We now reach the merits of Boermeester’s challenge to the
fairness of the disciplinary proceedings against him. Relying on
Allee, supra, 30 Cal.App.5th at page 1039, he primarily takes issue
with the investigator’s “overlapping and conflicting” roles in the
proceedings and the denial of his right to cross-examine witnesses.
(Id. at p. 1069.)
Allee involved a student’s expulsion from USC for
nonconsensual sex with another student. Division 4 of this court
concluded USC’s disciplinary procedure failed to provide the accused
student with a fair hearing. (Allee, supra, 30 Cal.App.5th at 1039.)
The Allee court held that “when a student . . . faces severe
disciplinary sanctions, and the credibility of witnesses (whether the
accusing student, other witnesses, or both) is central to the
adjudication of the allegation, fundamental fairness requires, at a
minimum, that the university provide a mechanism by which the
accused may cross-examine those witnesses, directly or indirectly, at
a hearing at which the witnesses appear in person or by other
means (e.g., videoconferencing) before a neutral adjudicator with the
power independently to find facts and make credibility
assessments.” (Id. at p. 1069.)
At the time of the disciplinary proceedings in Allee, USC’s
sexual misconduct policy did not require an in-person hearing and
the Title IX investigator served multiple roles in the proceedings.
(Allee, supra, 30 Cal.App.5th at p. 1069.) The Allee court found fault
with the investigator’s “unfettered” discretion to conduct the
investigation, determine credibility, make findings of fact, and
impose discipline. (Id. at p. 1070.)
The court reasoned, “The notion that a single individual,
acting in these overlapping and conflicting capacities, is capable of
27
effectively implementing an accused student’s right of cross–
examination by posing prepared questions to witnesses in the course
of the investigation ignores the fundamental nature of cross-
examination: adversarial questioning at an in person hearing at
which a neutral fact finder can observe and assess the witness’
credibility.” (Allee, supra, 30 Cal.App.5th at p. 1068.) The court
concluded, “a right of ‘cross-examination’ implemented by a single
individual acting as investigator, prosecutor, factfinder and
sentencer, is incompatible with adversarial questioning designed to
uncover the truth. It is simply an extension of the investigation and
prosecution itself.” (Ibid.)
Since Allee, Divisions 6 and 7 of this court have reached
similar conclusions regarding the need for some form of cross-
examination at a live hearing. In Westmont College, supra, 34
Cal. App. 5th 622, a student was suspended after a three-member
panel determined the evidence supported an accusation he sexually
assaulted another student. The trial court granted the accused
student’s petition for a writ of administrative mandamus on the
ground the college did not give him a fair hearing. (Id. at p. 625.)
Division 6 affirmed, finding the college’s investigation and
adjudication of the complainant’s accusation “was fatally flawed.”
(Westmont College, supra, 34 Cal.App.5th at p. 625.) The Court of
Appeal found fault with the panel’s failure to hear testimony from
critical witnesses, even though it relied on their prior statements to
corroborate the complainant’s account and to impeach the accused’s
credibility. It also found the panel improperly withheld material
evidence from the accused that its own policies required it to turn
over and did not give the accused the opportunity to propose
questions to be asked of the complainant and other witnesses. (Id.
at pp. 625–626, 636–639.) Because the record indicated two panel
28
members relied on the credibility determination of the investigator,
who was the third panel member, the court also held each member
of the panel must hear from the critical witnesses—in person, by
videoconference, or some other method—before assessing credibility.
(Id. at p. 637.)
In Occidental College, supra, 40 Cal. App. 5th 208, Division 7
applied the holding in Westmont and found a student expelled for
sexual assault had received a fair hearing. In Occidental College, an
external adjudicator heard testimony from the parties, the
investigator, and five witnesses during a live hearing. The
adjudicator recommended disciplinary action after considering the
testimony, summaries of witness interviews, and the investigative
report. (Occidental College, supra, at p. 219.) The court found
“Occidental’s policy complied with all the procedural requirements
identified by California cases dealing with sexual misconduct
disciplinary proceedings: both sides had notice of the charges and
hearing and had access to the evidence, the hearing included live
testimony and written reports of witness interviews, the critical
witnesses appeared in person at the hearing so that the adjudicator
could evaluate their credibility, and the respondent had an
opportunity to propose questions for the adjudicator to ask the
complainant.” (Id. at p. 224; accord Claremont McKenna, supra, 25
Cal.App.5th at p. 1070 [“where the accused student faces a severe
penalty and the school’s determination turns on the complaining
witness’s credibility . . . the complaining witness must be before the
finder of fact either physically or through videoconference or like
technology to enable the finder of fact to assess the complaining
witness’s credibility in responding to its own questions or those
proposed by the accused student”].)
29
We agree with the above authorities: In a case such as this
one, where a student faces a severe sanction in a disciplinary
proceeding and the university’s decision depends on witness
credibility, the accused student must be afforded an in-person
hearing in which he may cross-examine critical witnesses to ensure
the adjudicator has the ability to observe the witnesses’ demeanor
and properly decide credibility. (Occidental College, supra, 40
Cal.App.5th at p. 224; Claremont McKenna, supra, 25 Cal.App.5th
at p. 1070; Allee, supra, 30 Cal.App.5th at p. 1066.) In reaching this
conclusion, we agree with the prevailing case authority that cross-
examination of witnesses may be conducted directly by the accused
student or his representative, or indirectly by the adjudicator or by
someone else. (Ibid.) We further agree the cross-examiner has
discretion to omit questions that are irrelevant, inflammatory, or
argumentative. (UC San Diego, supra, 5 Cal.App.5th at pp. 1086–
1087.)
Although we refer to an “in-person hearing,” we do not mean
to say that the witnesses must be physically present to allow the
accused student to confront them. Instead, the witnesses may
appear in person, by videoconference, or by another method that
would facilitate the assessment of credibility. (Claremont McKenna,
supra, 25 Cal.App.5th at p. 1070; Doe v. Univ. of Cincinnati (6th Cir.
2017) 872 F.3d 393, 406 (Univ. of Cincinnati) [university’s
procedures need only provide “a means for the [review] panel to
evaluate an alleged victim’s credibility, not for the accused to
physically confront his accuser.”].)
Boermeester did not receive this type of hearing under USC’s
2017 sexual misconduct policy. USC’s policy to hold separate
Evidentiary Hearings and limit cross-examination does not meet the
30
fair procedure requirements identified in Allee, Westmont College,
Occidental College, and Claremont McKenna.
Under the separate Evidentiary Hearing procedure, the
reporting party could respond to the evidence collected and answer
any questions submitted by the respondent without the respondent’s
presence. This procedure effectively denied Boermeester a hearing.
An accused student is not given a meaningful opportunity to
respond to the evidence against him if he is not allowed to attend
the very hearing at which the evidence is presented. (Goldberg v.
Regents of University of Cal. (1967) 248 Cal. App. 2d 867, 882 [due
process requires students be “given ample opportunity to hear and
observe the witnesses against them”].)
Even if the Evidence Hearings were not separate and
Boermeester was allowed to attend, the limited cross-examination
afforded by USC prevented him from fully presenting his defense, as
required by fair procedure. (UC San Diego, supra, 5 Cal.App.5th at
p. 1104.) Under the sexual misconduct policy, Boermeester could
only submit questions for Roe to be asked by the Title IX coordinator
at the Evidence Hearing. Boermeester had no opportunity to
question any other witness or ask follow-up questions of Roe.
These limitations prevented Boermeester from fully presenting his
defense, which was that the eyewitnesses misunderstood what
happened between him and Roe on January 21, 2017. Allowing
Boermeester to submit questions for critical witnesses, such as AB,
MB2, DH, and TS, at a live hearing would further truth finding by
allowing him to test their recollection, their ability to observe the
incident, and any biases they may have. It is well established
“ ‘cross-examination has always been considered a most effective
way to ascertain truth.’ ” (Univ. of Cincinnati, supra, 872 F.3d at
pp. 401–402.)
31
In short, an in-person hearing coupled with indirect or direct
cross-examination would enable the adjudicator to better assess
witness credibility in a case where credibility is central to a
determination of sexual misconduct. (Univ. of Cincinnati, supra,
872 F.3d at pp. 401–402; Elkins v. Superior Court (2007) 41 Cal. 4th
1337, 1358 [“Oral testimony of witnesses given in the presence of the
trier of fact is valued for its probative worth on the issue of
credibility, because such testimony affords the trier of fact an
opportunity to observe the demeanor of witnesses.”]; Doe v. Baum
(6th Cir. 2018) 903 F.3d 575, 586.)
USC contends the holdings in Allee and the other university
sexual misconduct cases should not be extended to an intimate
partner violence case on the ground those cases only apply to sexual
assault or similar sexual misconduct. According to USC, cross-
examination is required in sexual misconduct cases because the
misconduct takes “place behind closed doors, with no witnesses
other than the parties, and the key issue in dispute [is] consent.”
USC claims the situation is different here because the misconduct
“took place in public, was witnessed by at least two individuals, and
was captured on video.”
The dissent similarly distinguishes a university sexual
misconduct case from an intimate partner violence case. In a sexual
misconduct case, according to the dissent, the accused seeks cross-
examination to “shake” the accuser’s story that their sexual
encounter was not consensual. The dissent asserts the sexual
misconduct case is different because it does not involve a domestic
relationship and the victim does not recant.
We disagree. Sexual misconduct cases may also arise from
domestic relationships and victims also recant in such cases.
Further, from a procedural standpoint, we see little difference
32
between a sexual misconduct case such as that described by USC
and the dissent and an intimate partner violence case such as this
one. Both cases require the university to make credibility
determinations based on conflicting statements. It is irrelevant to
us whether the conflict exists because the man and the woman have
competing narratives or the man and woman’s narrative competes
with that of third party witnesses.
USC was presented with two versions of the January 21
incident. On the one hand, Roe and Boermeester claimed it was
playful and not violent. On the other hand, the third party
witnesses and Roe, in her initial statement, claimed it was violent
and not playful. Given this conflict, “the credibility of witnesses
(whether the accusing student, other witnesses, or both) is central to
the adjudication of the allegation” in this case, just as it was in Allee
and the other university sexual misconduct cases. (Allee, supra, 30
Cal.App.5th at p. 1069; see also Claremont McKenna, supra, 25
Cal.App.5th at p. 1070.)
We acknowledge the dissent’s point that Roe had recanted and
it may or may not have benefitted Boermeester to question her
further. However, as USC indicates, it was not Roe, but the
eyewitnesses, who were pivotal to USC’s decision. According to
USC, they provided the necessary support for Roe’s initial account.
Thus, even absent cross-examination of Roe, Boermeester should
have been able to cross-examine the third-party witnesses to test
their recollection, their ability to observe the incident, and any
biases they may have had against him.
USC claims credibility of witnesses was not central to the
adjudication in this case due to the extensive corroborating evidence,
including the video tape. USC overstates the evidence. The
surveillance video is not conclusive. The picture is grainy and there
33
is no audio. The video camera is positioned approximately two
buildings away from Roe and Boermeester. They are small figures
in the frame of the video. Additionally, there is a light on the left
side of the frame, which renders the interaction between
Boermeester and Roe when they are near the wall barely visible. At
best, the video corroborates Roe’s initial statement, MB2’s second
statement, and DH’s statement of what occurred on January 21,
2017. However, both Roe and MB2 recanted their initial statements
to the investigator. Contrary to USC’s assertion, adjudication of this
matter rests on a determination of the credibility of inconsistent
witnesses, just as in Allee, Occidental College, and Westmont
College. Accordingly, these authorities apply to this intimate
partner violence case.
We likewise find unpersuasive USC’s argument that sexual
assault and other sexual misconduct violations are different from
violations involving intimate partner violence and thus should be
treated differently. USC’s own student handbook describes only
four “categories” of student misconduct: (1) non-academic violations;
(2) academic integrity violations; (3) admissions violations; and (4)
sexual, interpersonal, and protected class misconduct cases. Under
the “University’s Policy and Procedures on Student Sexual,
Interpersonal, and Protected Class Misconduct,” the same
investigative and adjudicative procedure applies to each violation,
including “sexual assault and non-consensual sexual contact,”
harassment, stalking, and intimate partner violence. In short, USC
does not treat sexual misconduct and intimate partner violence
cases differently. Neither does fair procedure.
E. Harmless Error
Lastly, USC asserts any error was harmless, arguing,
“[n]o amount of additional process would change what can be plainly
34
observed on the security footage and confirmed in Boermeester’s
own statements.” We are not convinced. As we have discussed,
USC overstates what the surveillance video shows. At best, it
corroborates Roe’s initial statement. Moreover, although
Boermeester admits he put hands on Roe’s neck while she was
positioned against the wall, he asserts it was playful. This is hardly
a confession to intimate partner violence.
At bottom, this case rests on witness credibility. Even if Roe
had not recanted, USC was still faced with conflicting accounts of
the incident: Boermeester disputed the characterization of the
incident as violent, contending they were merely “horsing around.”
MB2, an eyewitness to the incident, admitted he lied in his initial
statement. Given these conflicting statements, we cannot say the
record contains such overwhelming evidence as to render harmless
the errors identified in this case.
DISPOSITION
The judgment is reversed and the matter remanded to the
superior court with directions to grant Boermeester’s petition for
writ of administrative mandate. Should USC choose to proceed with
a new disciplinary hearing, it should afford Boermeester the
opportunity to directly or indirectly cross-examine witnesses at an
in-person hearing. Each party to bear his or its own costs on appeal.
CERTIFIED FOR PUBLICATION
BIGELOW, P. J.
I Concur:
STRATTON, J.
35
Boermeester v. Carry et al.
B290675
WILEY, J., Dissenting.
Unaccountably, in California’s first appellate student
discipline case about domestic violence, the aggressor emerges as
the victim. But the university was right to discipline this man.
Substantial evidence shows he committed domestic violence. All
procedures were fair. Overturning this discipline is
unwarranted.
I
Substantial evidence reveals a textbook case of domestic
violence. I append the victim witness interview and invite
readers to examine it. (See appendix, post, pp. 24–37.)
A
I summarize the victim’s interview.
After midnight, a drunken man called the woman he lived
with. It was in the early hours of Saturday, January 21, 2017.
He wanted her to come get him at a party and drive him home.
She obeyed.
He was the drunkest she had seen him. She brought her
dog Ziggy along in a cage in the car. The man was mean to Ziggy,
and the dog was shaking. The man yelled at the dog, which
cowered in the cage.
They got home and went to the alley. He wanted her to
drop Ziggy’s leash but she did not want to. The man wanted to
see Ziggy running off the leash. The woman did not want Ziggy
off the leash.
1
The man grabbed the back of the woman’s hair hard and
said “drop the fucking leash.” She said no. The man grabbed the
woman harder. It hurt, so she dropped the leash.
The man grabbed the woman by the front of her neck. He
had done this before. He did it to “freeze her” when he wanted to
stop her. When he did this, it sometimes scared her.
When he grabbed her by the throat this time, it was harder.
His grip was tight. She could breathe but it hurt and she
coughed.
He let go and laughed.
The man chose this moment to comment about Westworld.
This sci-fi show is about a theme park where robots look like
humans. Humans pay to enter and do as they please to the
robots. The humans can be violent and abusive without
consequences because the robots’ programming forbids harm to
humans.
The man told the woman about Westworld: “you can hurt
the robots because they aren’t well.”
The man took her by the neck and pushed her hard against
the concrete wall. Her head hit the wall. He let go and then did
it again.
A neighbor came into the alley. The man told the neighbor
they were just playing around.
B
The man and the woman were students at the University of
Southern California. The man is Matthew Boermeester. The
woman is Jane Roe.
USC has student conduct rules. One USC rule prohibits
intimate partner violence. The rule says intimate partner
2
violence is also known as domestic violence and includes causing
physical harm to another person.
USC’s rule against violence does not contain a playing
around defense.
Witnesses reported Boermeester’s treatment of Roe to USC,
which promptly launched an investigation. On Monday, January
23, 2017, accompanied by her adviser Nohelani Lawrence, Roe
met with a USC investigator and spoke at length. Roe cried
throughout this interview.
C
California law is familiar with domestic violence. USC is
too. USC is an established institution of higher education that
has promulgated rules about domestic violence and has hired
professionals to investigate these cases. These trained
professionals work daily in this specialized world. Their
firsthand experience supplements their training. It is reasonable
and procedurally customary to ascribe expertise about domestic
violence to USC and to its campus specialists.
Boermeester says we should assume USC is ignorant. But
he gives neither reason nor legal authority for his self-serving
and illogical suggestion.
D
Domestic violence is violence between people living
together in an intimate relationship. (People v. Brown (2004) 33
Cal. 4th 892, 895, fn. 1 (Brown).) USC refers to this type of
violence more generally as intimate partner violence.
Domestic violence is a serious social and legal problem in
the United States, occurring in every economic, racial, and ethnic
group. Compared to other crimes, domestic violence is vastly
underreported. Until recent decades, it was largely hidden from
3
public examination. A fundamental difference between domestic
violence and other violence (like street violence) is domestic
violence happens within ongoing relationships expected to be
protective, supportive, and nurturing. The ties between victim
and abuser often are strong emotional bonds, and victims
frequently feel a sense of loyalty to their abusers. (Brown, supra,
33 Cal.4th at pp. 898–899.) Often abusers use psychological,
emotional, or verbal abuse to control their victims. (Id. at p. 907.)
Victims who report abuse to authorities may later protect
the abuser by recanting their own reports. This presents an
exceptional challenge for authorities. (Brown, supra, 33 Cal.4th
at p. 899.)
In the Brown case, an expert explained domestic violence
victims, after describing the violence to police, often later
repudiate their descriptions. There is typically “anywhere
between 24 and 48 hours where victims will be truthful about
what occurred because they're still angry, they're still scared.”
But after they have had time to think about it, they commonly
change their minds. About 80 to 85 percent of victims recant at
some point in the process. Some victims will say they lied to
authorities; almost all will attempt to minimize their experience.
(Brown, supra, 33 Cal.4th at p. 897; see also id. at p. 903 [quoting
another expert who testified that, about 80 percent of the time, a
woman who has been assaulted by a boyfriend, husband, or lover
will recant, change, or minimize her story].)
Recanting is common because it is logical. The victim may
still care for the abuser and may be hoping he will not do it again.
(Brown, supra, 33 Cal.4th at p. 897.) The abuser or the abuser’s
family may be pressuring or threatening the victim. (Ibid.)
4
Professionals familiar with domestic violence understand
victims logically may recant to protect themselves because
recanting can appease the abuser.
The Brown opinion held expert testimony about recanting
was admissible for the purpose of disabusing jurors of common
misconceptions about how victims behave. (Brown, supra, 33
Cal.4th at pp. 905–908.) Part of the court’s logic was, “when the
victim’s trial testimony supports the defendant or minimizes the
violence of his actions, the jurors may assume that if there really
had been abusive behavior, the victim would not be testifying in
the defendant’s favor.” (Id. at p. 906.) In many or even most
cases, however, that assumption would be incorrect.
USC presumably knows all this. There is no basis for
presuming it is ignorant.
E
Substantial evidence permitted the USC investigator to
understand Roe’s account as a classic case of domestic violence.
Roe’s lengthy interview record, which appears at the end of this
dissent, is substantial evidence.
Roe’s account revealed Boermeester stayed at her
apartment for a semester. Boermeester controlled her. He told
her when she could speak and when she was too close to him. He
used physical abuse when she did not obey. He poked and hit
her, causing bruising. He told her to shut up. He kicked her
when she got too close. He took her by the neck to “freeze her”
when he wanted to stop her.
Boermeester made Roe feel worthless. He told her she was
stupid and a lousy tennis player. (Roe was a nationally ranked
member of the USC tennis team.) He was rude to her parents
5
and her friends, thus undermining her emotional support system
and imposing a me-or-them choice.
Boermeester punished Roe if she misbehaved and made her
feel as though problems were her fault, not his. He refused to
return her apartment key, despite paying no rent and having no
right to be there. He never apologized or took responsibility.
When she asked if he would feel bad or sorry if he hurt her, he
said no, because she brought it on herself.
In this domestic relationship, Boermeester grabbed Roe by
the neck on January 21, 2017. He pushed her hard against a
concrete wall, she hit her head, he let go, and then he did it
again. He did not stop until a neighbor appeared, and then
Boermeester said they were just playing around.
On January 23, 2017, Roe asked USC for an Avoidance Of
Contact order against Boermeester. She requested emergency
housing. The implication is unmistakable: she was scared of
Boermeester and wanted to get away from him.
F
The domestic violence victim recanted. On Tuesday,
January 24, 2017, Roe began recanting, and she continued in the
following days. On February 7, 2017, Roe tweeted to the media
that the charges against Boermeester were false. Roe became
increasingly extensive in her recantation, through to the end of
USC’s investigation.
II
USC’s investigation was thorough and fair.
The investigator interviewed 18 witnesses and wrote a 78-
page single-spaced report. The report included lengthy
statements from Boermeester and from Roe that vigorously
asserted his innocence.
6
The amount of process was considerable. Accompanied by
his mother, who is an attorney, Boermeester gave his side of the
story during the investigation. Boermeester retained a law firm.
On March 10 and 22, 2017—twice—he had the opportunity to
review all information and documents the investigator gathered.
Boermeester and his retained attorney reviewed this evidentiary
record. Boermeester then had the opportunity to submit
questions for Roe, but (through his attorney) he declined to do so.
After reviewing the evidence, Boermeester had the opportunity to
respond to the evidence, to answer questions posed by Roe, and to
submit new information. Neither Boermeester nor Roe
submitted questions for each other or for anyone else. Both opted
to skip their hearings and to submit written statements in lieu of
meeting.
USC’s process involved four layers of review.
First was the investigation. Upon concluding the extensive
investigation, the investigator determined Boermeester was
responsible for intimate partner violence.
The second layer was a separate panel. The sanctions
panel reviewed the record and decided to expel Boermeester.
The third layer was the Misconduct Appellate Panel.
Boermeester appealed to this separate panel. Pages 494 and 495
of the Administrative Record spell out the duties of this
Misconduct Appellate Panel. These rules empowered the
Misconduct Appellate Panel to decide whether substantial
evidence supported the investigator’s fact finding. The
Misconduct Appellate Panel also was to determine whether this
fact finding supported the investigator’s conclusions about policy
violations.
7
This Misconduct Appellate Panel exercised independent
judgment. It recommended a two-year suspension rather than
expulsion for Boermeester.
The fourth layer was USC’s Vice President for Student
Affairs, who was USC’s final decisionmaker on student discipline.
This USC Vice President overruled the Misconduct Appellate
Panel’s recommendation and determined the appropriate
sanction was expulsion.
Boermeester applied for a fifth layer of review by filing in
the Superior Court. On March 21, 2018, the trial judge rendered
a comprehensive and thoughtful 22-page opinion rejecting
Boermeester’s claims.
The trial court found substantial evidence supported USC’s
decision to discipline Boermeester.
The trial court emphasized the contemporaneous nature of
Roe’s initial statement on January 23, 2017, noting the law
ascribes more reliability to statements made right after a
stressful event than to statements made only after witnesses
have had time to ponder the consequences of their words.
The judge quoted from the Brown case, reciting the
established tendency of domestic violence victims to recant as
part of the behavior patterns common in abusive relations. The
judge wrote the “tendency is so well established that it is
admissible, in the form of expert testimony, in prosecutions of
domestic violence cases.”
The judge canvassed California law and rejected
Boermeester’s claim that USC had denied him due process. The
court found USC accorded Boermeester ample process.
In sum, Boermeester got full notice of the charges and the
evidence against him. He had multiple opportunities to respond.
8
The process took more than a year and generated a record
exceeding 2,000 pages.
The process’s conclusion was Boermeester took Roe by the
throat and shoved her against a concrete wall, which was
intimate partner violence. USC deliberated about the penalty
and decided to expel Boermeester.
USC’s process was careful and fair. Its conclusion was
straightforward: Boermeester should be disciplined for his
domestic violence.
III
Boermeester’s least specious argument about his
supposedly unfair treatment concerns live witness cross-
examination. (I agree Boermeester’s notice was ample and his
suspension was proper.) But Boermeester refused to submit
cross-examination questions for Roe. No wonder. His tactical
reason was that questioning Roe was the last thing Boermeester
wanted, now that she had recanted completely and had come over
to his side in a public way, on Twitter and all the rest.
Questioning Roe—chancing any opportunity for her to modify or
to contradict her recantation—offered Boermeester only peril.
From Boermeester’s perspective, Roe’s recantation was perfect as
it stood. Additional questioning could only spoil a good thing. So
naturally Boermeester’s lawyer refused to submit questions for
Roe.
That means the cross-examination issue on appeal is
entirely manufactured. It is not unfair to deny someone
something they did not want.
Lest there be doubt, study the exact words in the record.
USC asked Boermeester’s attorney to submit questions for Roe
and, through counsel, Boermeester refused. In response to USC’s
9
invitation to propose questions for Roe, Boermeester’s lawyer told
USC “I am not interested in having [Roe] come in and being put
on the spot yet again.” The italics are mine.
Boermeester and his lawyer were free to ask for anything
they wanted because the USC investigator created a continuously
productive and collegial working relationship during the
investigation. When Boermeester’s lawyer peppered USC with e-
mail questions, USC responded promptly and professionally.
For example, Boermeester’s lawyer e-mailed USC that he
could not access a document from his desktop computer. USC
wrote back within five minutes: “I just checked and you were
granted access. I went ahead and re-invited you. Let me know if
it works.”
Sometimes USC did not grant Boermeester and his lawyer
everything they wanted. But other times USC did accommodate
Boermeester and his lawyer. USC’s written rules did not
mandate or require these accommodations. USC gave them
anyway, because it was behaving fairly and reasonably.
For instance, USC offered Boermeester and his lawyer a
second time to examine the evidentiary record—an invitation
Boermeester and his lawyer accepted. No USC rule required
this.
In another situation, Boermeester’s lawyer asked USC to
give Boermeester access to a telephone while examining evidence
because the lawyer had “run into a serious snag here.” USC
granted his request: “No problem.”
It was 4:59 p.m. when Boermeester’s lawyer e-mailed this
request for a favor. It was 8:09 p.m. that same day when USC
granted the favor Boermeester’s lawyer requested.
10
USC literally was working overtime to be responsive to
Boermeester and his lawyer.
Through all this free give and take, Boermeester’s lawyer
never requested live cross-examination. Rather, he expressly
disavowed it and instead asked that USC e-mail questions to Roe.
USC agreed to do that. USC’s response was: “You send me the
questions and we will ask them of [Jane Roe].”
Boermeester’s lawyer wrote “We would want to have
questions sent to [Jane Roe] to respond and answers sent to us
unfiltered.”
USC said it indeed would not filter. It would provide the
answers verbatim, and he would get them before any Summary
Administrative Review.
The sole difference between Boermeester’s lawyer and USC
during this e-mail exchange was whether Boermeester would or
would not get Roe’s answers that same afternoon—an immaterial
timing detail Boermeester never mentions in briefing to this
court.
Boermeester claims this one exchange about filtering shows
he adequately preserved for appeal all issues regarding cross-
examination. This is incorrect. USC told Boermeester it would
give him Roe’s unfiltered answers. True, there was an issue
about timing, but Boermeester has abandoned this timing issue.
He has never raised it in this appeal. His issue now is cross-
examination. But Boermeester wrote USC “I am not interested
in having [Roe] come in and being put on the spot yet again.”
Grasp the strangeness of this situation. To USC in 2017,
Boermeester’s lawyer said he did not want Roe to come in and be
put on the spot again. On appeal in 2020, Boermeester’s lawyer
11
now says it is reversible error because Roe did not come in and
was not put on the spot again.
To rule for Boermeester on this issue in this situation is
unusual. Accepting such an argument in this context is
unprecedented.
The same goes for witnesses besides Roe. Boermeester
never sought those cross-examinations, and for good reason.
These witnesses offered Boermeester nothing but danger.
Recall the context. The looming problem was Roe’s detailed
and damning original statement, the one appended to this
opinion. An objective reading of that statement reveals it as the
most powerful evidence in the case.
Boermeester admitted the basic physical facts. He told
USC “[m]y hand was on her neck, but it was normal.” When
asked whether Roe made contact with the alley wall,
Boermeester responded, “I mean, we were standing next to it. It
was a sexual thing.”
Given that Boermeester’s defense was his actions were
mere horseplay—horseplay that Roe understood and accepted—
there was no point in cross-examining witnesses besides Roe.
Cross-examining DH could not matter. DH saw Roe pinned
against the wall by Boermeester, who had his hand on her. DH
did not see or hear Roe hit the wall. DH’s account was consistent
with Boermeester’s version of events.
Cross-examining TS could not matter. TS did not report
seeing Boermeester put hands on Roe. TS arrived in the alley
after the event. He was not an eyewitness to the disputed event.
Cross-examining MB2 was like cross-examining Roe: a
good thing for Boermeester to avoid. MB2 initially minimized
having seen much in the alley. Then his guilty conscience made
12
MB2 contact USC on his own initiative. MB2 had initially
minimized because Roe asked him to protect Boermeester and to
downplay the event. But MB2 confessed his initial lie was
bothering him. What he had actually seen, he now revealed, was
that Boermeester “domestically was abusing [Roe].” He said the
“truth is I really wanted to beat the shit out of this guy
[Boermeester].”
Cross-examining a witness like that is playing with fire.
Boermeester sensibly passed on this opportunity to play Russian
roulette. Boermeester’s reasonable litigation strategy was to
disparage MB2’s second statement as a contradiction and to
avoid giving MB2 a soapbox on which to vent.
In sum, there is good reason why Boermeester never asked
to cross-examine witnesses other than Roe. These witnesses
either did not matter or were hazardous to question further.
Boermeester sensibly avoided further questions to these
witnesses.
There was no deprivation of a right to confrontation.
Rather, there was no request for it. This was a thoughtful
litigation strategy by competent counsel to avoid confrontation
and to leave the record as it stood. As it stood, the record was not
pretty, but defense counsel had to play the hand his client dealt
him. Adding questioning—adding confrontation—was not going
to help. It was likely to backfire. The choice was to argue the
case as it stood or to risk making the record worse. Counsel
chose to steer clear of the risk. That was reasonable. But that
also should have shut off any appeal on the topic.
Boermeester claims futility. He says it would have been
futile to ask for what he now says was indispensable. That is
incorrect. His attorney was vigilant and aggressive. When he
13
wanted something, he asked for it. Sometimes USC
accommodated him; sometimes not. Every institution is free to
depart from written procedures when both sides agree that is the
fair and reasonable thing to do. Nothing barred Boermeester
from asking for further questions for any witness.
Boermeester did not ask for questions, not because it was
futile to do so, but because he did not want further questions. As
we have seen, the record contradicts his claim it was futile for
him to request questioning.
Boermeester cites In re Antonio C. (2000) 83 Cal. App. 4th
1029, 1033, but there the prosecution conceded futility. That also
is true of People v. Hopkins (1992) 10 Cal. App. 4th 1699, 1702,
where there is no sign the parties contested the issue of futility
and consequently no analysis of the issue. These cases are
irrelevant.
To show it is futile to object, counsel generally must show it
is costly to assert your rights. (E.g., People v. Hill (1998) 17
Cal. 4th 800, 820.) There was nothing like that in the civil and
productive working relationship between Boermeester and USC.
To reverse USC for failing to grant Boermeester something he
never requested is unwarranted. It would be unprecedented, and
an unwise retreat from the usual rule.
The usual rule is you must ask for something you later
claim on appeal was vital, so the school can know what you want
and can resolve your issue short of litigation. (Doe v. Occidental
College (2019) 37 Cal. App. 5th 1003, 1018 (Occidental I) [issue
must be raised in the first instance at the hearing or appellant
forfeits it]; Doe v. Occidental College (2019) 40 Cal. App. 5th 208,
225 (Occidental II) [“By failing to make the argument until his
14
appeal to this court, [the complaining student] forfeited it.”]
[collecting forfeiture authorities].)
The rationale for this rule is fairness and efficiency. A
school is entitled to learn the contentions of interested parties
before litigation is instituted so it can gain the opportunity to act
and to render litigation unnecessary. (See Sierra Club v. City of
Orange (2008) 163 Cal. App. 4th 523, 535.)
Boermeester asks to be excused from this rule of fairness
and efficiency, so on appeal he can get what he never requested
during the school’s proceedings.
I would stick with the usual rule: if you want something,
ask for it. Stockpiling secret grievances should not be acceptable.
Boermeester also makes a different argument than futility.
This argument is unforseeability. Boermeester now claims he
could not reasonably have been expected to foresee the holding in
Doe v. Allee (2019) 30 Cal. App. 5th 1036 (Allee) requiring cross-
examination. Boermeester makes this unforseeability argument
as another excuse for attacking USC about the cross-
examinations he never asked USC to give him.
Boermeester’s unforseeability argument is insupportable.
In 2016, before the events in Boermeester’s case, a court already
had held “cross-examination was essential to due process” in a
student discipline case. (Doe v. University of Cincinnati
(S.D.Ohio 2016) 223 F. Supp. 3d 704, 711.) This ruling was
affirmed on appeal. Represented by the same lawyer now
representing Boermeester, student Doe in the Allee case relied
heavily on this University of Cincinnati precedent. The Allee
court followed this lawyer’s lead, repeatedly citing and discussing
both the trial and appellate rulings in the University of
15
Cincinnati case. (Allee, supra, 30 Cal.App.5th at pp. 1059, 1061,
1062, 1064, 1066, 1068.)
In short, Boermeester’s lawyer in 2017 indeed could have
foreseen something written into law in 2016.
So the strangeness remains. Boermeester’s lawyer was
comfortable asking USC for favors because USC was responsive
and professional. Boermeester’s lawyer had legal authority for
demanding cross-examination. Yet this lawyer never requested
cross-examination. It was the opposite: Boermeester’s lawyer
wrote he did not want it. But now Boermeester’s lawyer says
USC treated him unfairly for not giving him what he did not
want. That is strange.
IV
Boermeester seeks to import precedents into this domestic
violence setting from outside it, but his suggestion is unsound.
These precedents involve cross-examination when a woman and a
man tell conflicting stories: he said nothing bad happened; she
said oh yes it did. In those cases, disciplinarians had to decide
which speaker to believe. The accused man wanted cross-
examination to shake the woman’s story. Here, by contrast, the
two versions came from one witness: Roe’s witness statement
close to the event versus Roe’s later recantations. Boermeester
did not want to cross-examine Roe because that tactic could only
harm him.
Boermeester cites precedents, but they never deal with a
victim of domestic violence who recants. His citations do not
apply here, because the worth of cross-examination to an accused
changes fundamentally when the victim recants. An accused
wants to confront accusers steadfast in their accusations to shake
the force of their accusations. But when a domestic violence
16
victim has publicly recanted, the accused already has all he
wants. Further questioning offers him only hazard.
Boermeester’s precedents follow a common fact pattern
inapplicable to this case. The common fact pattern involves two
people who do not live together: they are not cohabitants. They
are not in a domestic relationship. And there is no domestic
violence. Rather, there is some short-lived and unhappy sexual
encounter, with the woman and the man maintaining different
versions afterwards about what happened. There is never
recantation. Thus there is never the situation where the accused
wants to sustain, not to shake, the recantation.
There are 11 such cases.
1. Occidental II, supra, 40 Cal.App.5th at pages 211–220
[woman and man lived separately and disagreed
about whether she was too incapacitated to consent to
sexual relations after a fraternity party; no mention of
domestic violence or a recanting witness];
2. Occidental I, supra, 37 Cal.App.5th at pages 1006–
1013 [woman and man lived separately; sexual
penetration after a party; man said woman consented;
woman said she did not consent; no mention of
domestic violence or a recanting witness];
3. Doe v. Westmont College (2019) 34 Cal. App. 5th 622,
627–629 (Westmont) [woman and man lived
separately and disagreed about whether they had
intercourse during a college party; no mention of
domestic violence or a recanting witness];
4. Allee, supra, 30 Cal.App.5th at pages 1043–1053
[woman and man lived separately; one episode of
intercourse; man said woman consented; woman said
17
she did not consent; no mention of domestic violence
or a recanting witness];
5. Doe v. University of Southern California (2018) 29
Cal. App. 5th 1212, 1216–1229 (USC 2018) [woman and
man lived separately and disagreed about whether the
woman was too drunk to consent to a night of sexual
activity; no mention of domestic violence or a
recanting witness];
6. Doe v. Regents of University of California (2018) 28
Cal. App. 5th 44, 46–55 [woman and man lived
separately and disagreed about whether they had
sexual relations during a birthday party; no mention
of domestic violence or a recanting witness];
7. Doe v. Claremont McKenna College (2018) 25
Cal. App. 5th 1055, 1058–1064 [woman and man lived
separately and disagreed about whether the woman
consented to intercourse; no mention of domestic
violence or a recanting witness];
8. Doe v. Regents of University of California (2016) 5
Cal. App. 5th 1055, 1058–1072 [woman and man lived
separately and disagreed about whether they had
consensual sexual relations; no mention of domestic
violence or a recanting witness];
9. Doe v. University of Southern California (2016) 246
Cal. App. 4th 221, 224–238 [woman and man lived
separately and disagreed about whether the man
failed to protect the woman from sexual assault by
other men at a fraternity party; no mention of
domestic violence or a recanting witness];
18
10. Doe v. Baum (6th Cir. 2018) 903 F.3d 575, 578–580
(Baum) [woman and man lived separately and
disagreed about whether she was too incapacitated to
consent to sexual relations at a fraternity party; no
mention of domestic violence or a recanting witness];
11. Doe v. University of Cincinnati (6th Cir. 2017) 872
F.3d 393, 396–399 [woman and man lived separately
and disagreed about whether their one episode of
sexual relations was consensual; no mention of
domestic violence or a recanting witness].
In sum, Boermeester asks this court to do what no court
has done: overturn student discipline because the accused
student did not get a chance to question a recanter, which is
something the accused said he did not want and something that
could have done him no good.
The same is true for Boermeester’s new theory that the real
problem was his inability to cross-examine secondary witnesses
like MB2 and DH. If Boermeester has cited holdings to that
effect, I have missed them. I am not familiar with a holding that
discipline will be overturned when a school does not entertain
cross-examination that is never requested.
The cases to date all concern the right of confrontation
when it could possibly have done the man some good. No
precedent deals with a situation where the man wanted to avoid
confrontation because it offered him only peril.
V
It mystifies me how California Courts of Appeal have
concluded the federal due process clause applies when there is no
state action. Intermediate appellate courts have announced a
state common law rule that procedures in private schools should
19
mirror the federal constitution. That is a leap. State law
governing private schools can depart from constitutional rules
that govern state institutions. (E.g., Doe v. Trustees of Boston
College (1st Cir. 2019) 942 F.3d 527, 533–534.)
Someday the California Supreme Court may choose to trace
and to evaluate this rule’s rise in the lower California courts.
If this happens, it may be notable that the present is a time
of ferment in the field of student misconduct discipline.
A
The law is in ferment.
Boermeester contends it is unconstitutional for schools to
use a disciplinary process departing from a fully adversarial
model. USC designed a less adversarial model we can call an
investigatory, as opposed to an adversarial, approach.
It may be some esteemed institutions of higher education
prefer an investigatory approach to an adversarial one. (See
Tamara Rice Lave, A Critical Look at How Top Colleges and
Universities Are Adjudicating Sexual Assault (2017) 71 U.Miami
L.Rev. 377, 393–394.)
Perhaps there are good reasons why.
Some courts condemn the investigatory approach. (See
Baum, supra, 903 F.3d at pp. 581–585; Allee, supra, 30
Cal.App.5th at pp. 1067–1069 [citing Baum].)
But this position is controversial. (See Haidak v.
University of Massachusetts-Amherst (1st Cir. 2019) 933 F.3d 56,
68–71 [criticizing Baum; U.S. law considers the inquisitorial or
investigatory model “fair enough for critical administrative
decisions like whether to award or terminate disability benefits.
See Sims v. Apfel [(2000)] 530 U.S. 103, 110–[1]11 . . . (explaining
that Social Security proceedings are inquisitorial rather than
20
adversarial).”]; Westmont, supra, 34 Cal.App.5th at p. 637
[combining investigative and adjudicative functions does not,
without more, deprive a student accused of sexual misconduct of
a fair hearing]; USC 2018, supra, 29 Cal.App.5th at p. 1235, fn.
29 [although investigator held dual roles as the investigator and
adjudicator, the combination of investigative and adjudicative
functions does not, without more, constitute a due process
violation].)
In sum, there is a nationwide legal debate about the right
way to investigate claims of student misconduct. There is little
consensus.
B
The facts are in ferment. At this moment there is
considerable procedural experimentation. On hundreds or
thousands of campuses across the land, informed and thoughtful
people are discussing the right way to handle these cases. This
discussion is in good faith and is wide open. There is ongoing
innovation and little consensus.
The American Law Institute (ALI) launched a project in
2015 to evaluate this debate and to advise school decisionmakers.
By design, the ALI’s process is deliberate and thoughtful. The
project remains in process.
C
At this moment of discussion, a grave concern is the effect
of mandatory cross-examination on the willingness of victims to
report abuse.
We are learning a lot recently about why abuse victims
may be reluctant to report abuse and to trigger a process leading
to more abuse.
21
Being cross-examined is an unattractive prospect. Skilled
cross-examiners take pride in being fearsome. We often say a
good cross-examination “destroyed” a witness, that the cross-
examination was “scathing.” These words are accurate. They are
telling.
The prospect of being destroyed by a scathing cross-
examination can deter reporting. Fine words in opinions
somewhere about all the possible procedural adjustments may
mean little to a lonely and traumatized woman anguishing over
her options.
Striking the right balance is a challenge. It would be
beneficial to tap the ongoing national debate and
experimentation before promulgating some mandatory
constitutional code of campus procedures. Judge Henry Friendly
praised the wisdom of Justice Harlan and quoted his words: “I
seriously doubt the wisdom of these ‘guideline’ decisions. They
suffer the danger of pitfalls that usually go with judging in a
vacuum. However carefully written, they are apt in their
application to carry unintended consequences which once
accomplished are not always easy to repair.” (Henry Friendly,
Some Kind of Hearing (1975) 123 U.Penn. L.Rev. 1267, 1302,
quoting Sanders v. United States (1963) 373 U.S. 1, 32 (dis. opn.
of Harlan, J.).)
D
Striking the right balance ought to concern courts, but not
in this case. This case was never about a denial of cross-
examination—not until now, at any rate. At the university level,
Boermeester disavowed interest in “putting Roe on the spot
again” because his litigation strategy was to sustain her
recantation and to avoid roiling it. Nor did Boermeester lift a
22
finger to try to cross-examine other witnesses during USC’s
process.
Boermeester’s counsel has manufactured this cross-
examination issue. He has done so because he hopes someone
will accept his construct, not because cross-examination was
anything he sought at the time. His construct makes
Boermeester the victim. USC is the perpetrator.
This is awry. I would not intrude on USC’s
decisionmaking, which was procedurally proper and is supported
by substantial evidence.
WILEY, J.
23
APPENDIX
Jane Roe Intake Interview
Source: Administrative Record pp. 183–189
Word count: 3404
Notes: “T9” presumably means Title IX
MB presumably means Matthew Boermeester
Jane Roe Intake – (JR)
Date: January 23, 2017
Location: CUB
Advisor: Lani Lawrence
Interviewers: Lauren Elan Helsper (LEH) and Gretchen Means
(GM)
JR has been dating Matt since March 2016. Their relationship
was on and off for a while but that is when they started seriously
seeing each other.
Why are you here today?
- JR knows this is a “bad situation” but she hasn’t told
anyone. “This is the worst one, the one people know”
(regarding the incident over the weekend which prompted
her coming to the office)
- “I still care about him”
At the beginning of the relationship JR had bruises on her arm
from Matt and her dad found out and wanted her to get a
24
restraining order against him. JR told her father that the bruise
was “circumstantial” and his concern died down. Her parents
don’t like him.
She doesn’t know what to do or if she wants to do anything. She
knows he can’t be in her life
Matt lived with her all fall semester. He got “screwed out” of his
rent situation in August and it fell through. He presented it to
JR as, “I am here all the time, I am going to live with ‘CT’ and
pay a little there” but stay with JR really. He told her about
living with CT and paying money there so they weren’t moving in
together. He wasn’t paying rent to JR or to CT. Matt moved his
stuff into her apartment and he was living with her. He never
presented it to her though as he was going to move in. He never
left. They broke up and he would stay or they would fight and he
wouldn’t leave.
Now he has his own apartment since Christmas break but he has
still been at her apartment.
Matt tells JR that he hates her and is mad at her and when she
asks “Why are you here?” He said, “I can do whatever the fuck I
want” and tells her to “Shut up.”
“There is no arguing with him. He doesn’t think he is doing
anything wrong.” Matt thinks JR deserves it. They broke up
because JR went to dinner with her ex and lied about it to Matt
and so he sees it as her fault. The other day, JR asked Matt,
“What if you hurt me bad. Would you feel bad? If you were
25
playing around and it hurt?” Matt told her “no,” because it would
have been brought on by her. He gets mad at her if she doesn’t
back away or stop talking when he tells her too [sic].
JR acknowledges that she knows that this is not her fault.
Matt was not nice to her roommates so they didn’t like him. One
of her roommates tried to get her evicted because he was there.
This was in end of October. The roommate went to the landlord
instead of talking to JR. The roommate didn’t realize that Matt
doesn’t listen to JR when she tells him to leave and instead tells
her that she can leave but it is her house.
She is 5”4-5”’5 [sic] and she weighs 130. He is stronger than she
is but she doesn’t factor that into things.
On Friday they spent the day together. They are not together
and haven’t been together for a while but he still is at her house
often. They had a “good day.” MB went to party and was
drinking a lot. He called her at 12:30–1am to pick him up so she
did. (He often goes out, parties, and calls her to pick him up).
They went to get food and came back to her place. He was the
drunkest she has ever seen him. He was yelling at people and
tried to be funny. There is an alley behind the house and he was
yelling in the alley.
They got out of the car and he wanted her to drop Ziggy’s leash
but she didn’t want to. (He is mean to Ziggy and she was shaking
in the floor. He yells at her and she cowers in the cage). He
grabbed the back of JR’s hair hard and said “drop the fucking
26
leash” and she said no. Matt grabbed JR harder and then she
dropped the leash because it “hurt.” DH heard them yelling.
Matt grabbed JR by the neck (which he has done before but this
time it was harder). She was coughing and he let go and
laughed. He made a comment about the show “west world” and
how you can hurt the robots because they aren’t well. JR didn’t
really understand it). He grabbed her by the neck, pushed her
hard against the [concrete] wall, she hit her head, he let go and
then did it again. DH and TS saw and another neighbor came
out. He said that they were just “playing around.”
DH and TS took her into their apartment and Matt was asleep
when she got back to her room.
(Regarding holding her by the neck) - Matt grabbed her from the
front. He was holding “tight.” She could still breathe but it hurt
and she coughed. He has done this before. But he says that he is
“messing around.” He does it when he is rough housing (not
sexually) or to “freeze me” when he wants to stop her. The times
they were “messing around” she was sometimes scared.
He hits her or does something to egg her on and tries to get her to
play and then he grabs her by the neck to stop her.
This Friday was the “worst.” Her head hurt for a little after she
hit the wall.
She often has bruises on her legs or arms because “he is always
doing something.”
27
If JR didn’t stay with Matt after the incident, “he wouldn’t
understand.” For example, the next day he slept all day in her
bed. She went to speak to DH and Matt said don’t go over there,
“tell him to deal with his shit” and Matt was “freaking out” and
said, “what the fuck? Why are you taking that long?” (when it
was only 30 minutes)[.] Matt just yells at her. She didn’t want to
make it worse and so she just does what he says to avoid yelling
and conflict.
Bruises on arms – When JR doesn’t do what Matt wants she gets
bruised. That is a more recent thing (when they were together,
he would grab her arm too tight). Recently Matt is “more angry,”
“I am too close to him or I don’t get away fast enough or if I don’t
stop talking” then he hits her with a pointed finger so she gets
bruises. He does that to her arm, leg, lower back, stomach.
Sometimes he laughs. She feels like she doesn’t respond as
“severely” as she should. She says ouch but doesn’t laugh, but
she “downplays it” and is not firm. She does this to keep it light
and because she is uncomfortable. She tried yesterday to be more
serious and he said, “stop, I don’t care.” He didn’t take her
seriously.
Matt has pulled her hair more than once. He gives her a dead
arm/leg (punches in a certain spot so the body goes numb and it
hurts but it goes limp). It is a hard hit. He does this when she
doesn’t do what he wants her to do.
He thinks it is fun to “fight” and wants her to engage and eggs
her on or when she doesn’t do what he wants. Even when she
does engage. (He slaps her 15 times to egg her on and then
28
finally she does it back and says stop and he says stop and then
he will do it again and say, he had to get her back). “It is to get
her going.” JR thinks he thinks it is having fun.
He did it yesterday when they were just watching TV and he
started (she doesn’t know what starts it) and he starts messing
with her, hitting her and she says stop and he will keep going.
“It feels too painful for it to just be playful but the attitude
behind it is just being playful.” She is not sure if this is what he
is used to from his brothers or is not realizing enough is enough.
When Matt first started hurting her, it was not often and it has
gotten worse. “I was kind of taken aback.” The first time she
was scared of him was when they got into a fight at the beginning
of the relationship. He was yelling, and “shook me really hard”
and threatened to hit her. This was the first time she was
scared. This was a while ago. She thought about it like just a
fight. “He said that he is only like this because she made him do
this, or he can’t trust her or they weren’t actually together and
that “he will get better.”
“It then started playful and it hurt but his attitude was confusing
and it just got worse and worse and then I was like in it.”
Before Matt, JR was with someone else that was a really good
guy. They were together for about 2 years. Matt came into her
life. He is very manipulative and she believed that she wanted to
be with Matt instead. “[T]he highs are very high and the lows
are very lows [sic].” At that point her relationship with the other
29
guy was “very solid.” “Matt was flashy” and took her on crazy
dates that the other guy couldn’t give her. She drifted to Matt.
He said that at first, he couldn’t be nice to her because she was
with the other guy and that made sense to her at the time.
They had problems in the relationship. He was mean and always
putting her down. He told her how stupid she is. Recently for a
24 hour period she decided to write down every mean thing he
said to her on her phone. She read a long list of things. After
hearing how dumb she is, how bad she is at tennis, and always
being put down, she started to believe it.
JR did not cheat on Matt but “when things got bad” (her ex was
always sweet) [s]he sometimes would go to dinner with the other
guy because “it was really bad” (with Matt). She slept over her
exes [sic] house but didn’t do anything. She knew it would
sabotage the relationship with Matt. The next day, she told Matt
and he shook her, Matt was so “mad” and somehow convinced JR
that she needed to fix it. He made her feel bad and that she was
imagining these problems. “So he would give me one more
chance.” “[B]ut already then I was on his leash.” The whole time
she had to prove herself.
In the end of October, her ex said that he had to go back to Brazil
and that he wanted to go to dinner with her first. She went
without telling Matt but he found out. Matt broke up with her.
He told her that she deserved it. He told her that she could still
prove her worth and “get me back.” He would go out nightly and
come back to JR’s place and yell at her nightly and she would cry
and it was “very intense.”
30
When they broke up (and in her prove herself phase) she hooked
up with someone and he was nice to her. Matt found out and
thought that, “I did so much wrong that I deserve this.”
He still lived in her room and slept in the same bed as JR even
though they were broken up. That is when her roommate tried to
evict her.
They didn’t talk for a week over New Years and then he was at
his apartment for a week. He had surgery on his knee, he got
sick and came back to JR’s because he said, “closer to walk
there.” Matt told her that he came to stay with her because “You
do what I say, I hate you but it is easier.” “I need to take care of
him he says.”
His ego is “through the roof” since the Rose Bowl.
She spent a lot of time over the summer with his family. His dad
is super sweet and submissive, his mom runs the family. Mom is
a lawyer, she is very nice but in charge of the family.
JR gave a timeline of events:
December 2015–April 2016 Matt was in her life (seeing each
other but not dating)
April 2016–end of October 2016 – they were dating
June 2016 (early) – shaking incident
1st August – he officially moved into her house
End of October 2016 – they broke up but he was still at her
house. He was going on dates with girls and talking to girls
while living with her
31
Matt moved out the first week of spring 2017
From April to June – there were no physical incidents
The shaking incident was in June because she went to dinner
with her ex
June to when Matt moved-in to her place in August – the
physical contact was not very often maybe once a week if not less.
“It was playful but it wasn’t that bad. It has gotten stronger. It
didn’t hurt like now.”
Her parents noticed the bruising before the June incident – Matt
kicked her when she was in bed because she was coming closer to
him and her kicked her arm to get her away. Her parents found
out because she was crying and told her ex that she was scared of
Matt and he called her parents and told them
Shaking incident – “he was mad because I didn’t want to show
him my phone so he took it, threw it out the door” and then shook
her.
The physical contact “became more often and more hurtful” – “I
think it is longer than I really want to remember. In my mind I
think it was really recently. But then I had the bruise on [my]
arm in May.” It has been more often since they broke up if not
before then and probably something every day but the degree
varies if they spend solid hours together in privacy.
- He did these things privately. She doesn’t think anyone
knew.
- Her roommates knew but her voice didn’t get the urgency
to make them think it was bad. They knew he was verbally
abusive.
32
The next day (after the weekend incident) she tried to talk to
Matt and she said that he scared DH and TS and they heard him
yelling and “it looked really bad when you pushed me and it
looked really bad with your hand around my neck.” Matt said “it
was a joke, we were messing around, tell them to calm down.” He
said, “tell them you’re into that” and he implied that it was
foreplay.
Matt is the star child and is very spoiled but if his parents knew
they would be very mad. Matt does not talk to her nicely
Mom – [name redacted] (lawyer)
He never forced her during sex or hurt her during sex.
On Saturday he was yelling which got DH and TS’s attention, He
was just being a loud drunk person. DH at first thought it was a
loud drunk person and then he heard JR’s voice. At first she was
laughing, probably they heard her say no to drop the leash. He
woke them up and then they heard her.
He wanted to “toughen me up.” He wanted me to call him names
back or hit him back. He thought [she] was too submissive
because she didn’t want to.
Looking back how do you think your roommates might describe
you as they thought something was going on?
- Her best friend wanted her out of the relationship for a
long time. She was strong and told JR she was “weak.”
33
- DH would say she has been very “preoccupied” she can’t do
what she wants. She is very controlled.
- People didn’t understand the severity but knew that he was
treating her badly. They thought she was being weak or
stupid. She was she knew because it is hard.
- “He is very good at making me feel like I need him.”
He has torn her down so she has become dependent
on him.
- Throughout the time, her ex was supportive and telling her
she was the best and trying to lift her up but it wouldn’t
register because Matt was saying negative things to her
- She still had feelings for Matt and she didn’t know why.
She has been “holding onto the highs even though it has
been low for a really long time.”
A week before they broke up she went to him to break up because
he was mean and disrespecting her parents and but [sic] he told
her “no, we aren’t breaking up.” He said “every time we get into
a fight, you are going to run? No, we are going to work this out.”
He always said that he was the best thing that she was going to
get. She started to believe it and she couldn’t go anywhere.
Now she is starting to realize how bad it was. She became numb
that he treats her bad and isn’t worked up like she was in the
past. ([T]his is after the break). She made him soup because he
told her he was sick and she offered toast. He was so mean about
the toast that she cried. But in the past week, she is stronger.
34
Last night, he said that he is done and that he won’t come over
anymore. But in the past, she would say, “no, don’t go” but she
“still can’t say get the fuck out.” She is less madly in love with
him than she was before.
Her best friend is dating RP and he is a great guy. RP told her
Matt is ‘bad news.’ RP asked MB for JR’s key back over break
and Matt said no.
GM explained her options regarding moving forward:
1. Avoidance of Contact – and we will try to get the key back
from him
2. GM explained that we have to investigate what happened on
Friday even without her because of the witnesses and the
neighbor
a. This afternoon there is a panel regarding an interim
suspension
i. Clay already knows
She is scared because she didn’t want “to burn him.” She knows
that she didn’t bring it to us. GM explained that people are very
scared for her. GM said that it will be clear it was made by T9
and not her.
She graduates in December 2017 and he has one more year at
USC.
DH told JR that he is not going to participate.
35
GM offered emergency housing. She wants it to feel safe. She
wants it tonight and tomorrow night and then Sunday and
Monday when she returns from her team tennis trip.
GM explained:
1. The panel will meet re: to discuss whether interim action is
necessary to protect JR and restrict him
2. AOC will be served from T9 and Matt will not be allowed to
contact apartment – mates (JR stated that she wants the AOC)
3. He will be served with the charge letter for IPV
4. He will be served with everything at once – on Thursday
after she goes to Auburn
JR’s dad is a professor and if he calls we can explain the process
and [what] we are doing.
Matt has the password for her computer and she is going to
change it.
She has a hard time relating to the severity for herself and for his
consequences
Witness – Best friend is an alum (GO);
She is going to get us the name of the neighbor – MB2
{REDACTED}
Lani’s number – GM has
JR is not participating in the investigation. JR and LL completed
the FERPA form and the confidentiality agreement
36
GM explained academic accommodations
Investigator Notes: JR was crying throughout the meeting. She
offered information regarding her entire history with MB. After
GM told her that T9 was forced to go through an investigation on
the Friday incident as there are witnesses, JR said that she
understand[s]. JR does not want to participate in the
investigation and did not want T9 to charge on the conduct that
she divulged other than the Friday incident.
37 | 01-04-2023 | 05-28-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619562/ | ESTATE OF MELVIN M. MONTGOMERY, DECEASED, LEAH B. MONTGOMERY, PERSONAL REPRESENTATIVE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Montgomery v. CommissionerDocket No. 29658-87United States Tax CourtT.C. Memo 1988-457; 1988 Tax Ct. Memo LEXIS 501; 56 T.C.M. (CCH) 285; T.C.M. (RIA) 88457; September 22, 1988Roland A. Suess, for the petitioner. W. Scott Green, for the respondent. RAUMMEMORANDUM OPINION RAUM, Judge: The Commission determined a deficiency in estate tax in the amount of $ 68,781.19 in respect of the estate of Melvin*504 M. Montgomery, who died on September 29, 1983, a resident of North Dakota. The case was submitted on the basis of a stipulation of facts. After concessions, the remaining dispute relates to the computation of the marital deduction, which in turn depends upon the correct interpretation of Article III of the decedent's will. Article III sets forth a formula by which the amount of property to be given outright to the widow by that article is to be determined. In particular, the issue is whether, pursuant to that formula, the amount this given outright to the widow must be reduced, inter alia, by the amount of property in Article IV which satisfies the conditions for "qualified terminable interest property" of section 2056(b)(7) of the Code. A clearer picture of the problem will emerge shortly. Decedent's will was executed on August 13, 1982. Unless decedent's wife predeceased him she was the only beneficiary of the entire will apart from certain remainder interests in a trust established pursuant to Article IV, hereinafter more fully described. Article II of the will made a specific bequest to the decedent's wife of "all of the household goods, books, apparel, jewelry and*505 all other articles of household or personal use or adornment, any automobiles * * * and * * * all of the oil and gas producing royalties, minerals and other oil and gas properties of every kind and nature * * *". Thereupon, Article III provided for the devise and bequest of property outright to the wife in accordance with a formula as follows: ARTICLE III.In the event that my beloved wife, LEAH B. MONTGOMERY, survives me, I give, devise and bequeath outright to her, assets of my estate, whether in cash or in kind for a value as of the date selected by my Personal Representative, for valuation of those assets for Federal Estate Tax purposes, equal to fifty percent (50%) of the value of my adjusted gross estate (which term for this purpose shall mean gross estate reduced by the sum of the amounts allowable as a deduction under Section 2053 or 2054, I.R.C. as amended), as finally determined for Federal Estate Tax purposes, less the aggregate value of any property qualifying for the marital deduction which is allowed for Federal Estate Tax purposes by reason of interests in property, irrespective of whether probate or nonprobate, passing*506 or which passed to my wife, otherwise than by the terms of this Article of my Will. However, in no event shall there be included in the said assets or proceeds of any assets with respect to which the marital deduction would not be allowed for Federal Estate Tax purposes. * * * [Emphasis supplied.] Decedent then devised and bequeathed, in Article IV of the will, the "rest, residue and remainder of [his] estate properties" to his Trustee, The First National Bank & Trust Co. of Williston "in trust as a trust fund hereinafter referred to as the 'Melvin M. Montgomery Trust'" (the trust). The trust's "net income" and "such amounts from principal of this trust fund as my Trustee deems advisable or necessary" were to be paid to decedent's wife "in quarterly or more frequent installments during her lifetime * * * for the proper care, support, maintenance and comfort". At the wife's death, 25 percent of the "remaining balance" of the trust estate, including any undistributed income, was to be distributed to decedent's stepson and the remaining 75 percent was to continue in trust with the income to be distributed for the use and benefit of the decedent's two aunts and the children*507 of his stepson. After the death of the two aunts, the remaining trust estate and accumulated income were to be distributed to the children of the decedent's stepson, when they reached the age of 25 years. In addition, the will provides as follows with respect to the trust: (6) No title in the Trust or Trusts created in and by this Article [IV] of my Will, or in the income therefrom, shall vest in any beneficiary, and neither the principal nor the income of any such Trust Estate shall be liable for the debts of any beneficiary, and no beneficiary shall have any power to sell, transfer, encumber or in any other manner to anticipate or dispose of his or her interest in any such Trust Estate created by the terms of this Article, or the income produced thereby, prior to the actual distribution thereof by my Trustee to said beneficiary. The will was admitted to probate in the County Court of Williams County, North Dakota, with decedent's wife Leah B. Montgomery as Personal Representative. Except for $ 625,146 assets transferred to the trust, the estate has not been distributed and no such distribution has been ordered by the probate court. Petitioner filed a Federal estate*508 tax return dated June 27, 1984, and an amended return dated August 20, 1985. The amended return requested a refund as a result of the deletion from the estate of the value of a retirement annuity. That amendment is not in controversy here. On the original estate tax return, dated June 27, 1984, an election was made that $ 300,000 of the assets which passed to the trust be treated as qualified terminable interest property (QTIP) under section 2056(b)(7). The property of this election is not at issue. In addition, no question has been raised as to the property's qualification as QTIP on any other basis. 1 Consequently, the effect of the election under section 2056(b)(7) was to transform the $ 300,000 interest in the trust from terminable interest property not qualifying for the marital deduction into QTIP which is allowed as part of the marital deduction. Section 2056(b)(1) and (7). On both the original and amended estate tax returns, petitioner took a marital deduction consisting of two separate parts, the second of which*509 was the $ 300,000 QTIP. But in computing the amount of the Article III component of the first part 2 (50 percent of the value of the "adjusted gross estate * * * less the aggregate value of any property qualifying for the marital deduction * * * passing or which passed to my wife, otherwise than by the terms of this Article"), the estate failed to reduce the adjusted gross estate by the $ 300,000 QTIP. In his notice of deficiency, the Commissioner disallowed $ 300,000 of the claimed marital deduction. The Government's position here is that decedent's bequest in Article III of his will must be reduced by the $ 300,000 QTIP. It argues that the QTIP is encompassed within that "property qualifying for the marital deduction * * * passing or which passed to my wife" which Article III states is to reduce decedent's bequest to her of "fifty percent (50%) of the value of my adjusted*510 gross estate". The $ 300,000 reduction in the Article III bequest would thus reduce the marital deduction by that amount. The Internal Revenue Code provisions governing this case are all contained within section 2056 of the Code. Section 2056(a) provides that "the value of the taxable estate shall * * * be determined by deducting from the value of the gross estate an amount equal to the value of any interest in property which passes or has passed from the decedent to his surviving spouse, but only to the extent that such interest is included in determining the value of the gross estate". Section 2056(b), which is concerned with limitations on the marital deduction in the case of life estates or other terminable interests, then sets forth the general rule in paragraph (1) thereof that no marital deduction under section 2056(a) is allowed for a terminable interest. That type of interest is described therein as an interest passing to the surviving spouse if "on the lapse of time, on the occurrence of an event or contingency, or on the failure of an event or contingency to occur, [the interest] *511 * * * will terminate or fail". An exception to the nondeductibility of terminable interests was created by a new paragraph (7) that was added to section 2056(b) in 1981 in the case of "qualified terminable interest property" (QTIP), 3 a new concept that was then introduced into our estate tax law. Section 2056(b)(7)(A)(i) provides that, for the purpose of the marital deduction, such qualified terminable interest property "shall be treated as passing to the surviving spouse". QTIP is defined in section 2056(b)(7)(B)(i) as property: (I) which passes from the decedent, (II) in which the surviving spouse has a qualifying income interest for life, and (III) to which an election under this paragraph applies. The surviving spouse has a qualifying interest for life in the QTIP if (section 2056(b)(7)(B)(ii)): (I) the surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals, * * * and (II) no person has a power to appoint any*512 part of the property to any person other than the surviving spouse.Further, section 2056(b)(7)(v) provides that "An election under this paragraph with respect to any property shall be made by the executor on the return * * *. Such an election, once made, shall be irrevocable". The question before us is whether the QTIP elected by the estate here is described in Article III of decedent's will in the language providing for the reduction of the wife's 50 percent bequest by "the aggregate value of any property qualifying for the marital deduction * * * by reason of interest in property * * * passing or which passed to my wife, otherwise than by the terms of this Article of my Will". We conclude that the language does encompass the QTIP and, consequently, that it reduces the bequest in Article III, with the consequence that the widow was given outright in Article III only that amount of property that would bring the material deduction up to 50 percent of the decedent's adjusted gross estate, as was plainly intended in that article. The $ 300,000 QTIP eliminated that amount of property from the Article III computation, which was automatically added to the residuary trust established*513 by Article IV in which the widow was given a life interest. The QTIP itself is, of course, deductible as part of the marital deduction as authorized by section 2056(b)(7). The problem before us can perhaps be better understood by noting another, and even more significant change in respect of the marital deduction that was made in our estate tax law in 1981 by ERTA. Prior to the enactment of ERTA, the amount of the marital deduction was specifically limited by the then section 2056(c)(1) so as not to exceed $ 250,000 or 50 percent of the value of the "adjusted gross estate". That ceiling was entirely removed by ERTA, and thereafter all property included in the gross estate that passes or has passed to the surviving spouse is eligible, without limitation, for the marital deduction. Moreover, the ineligibility of terminable interests in property for the marital deduction was relaxed to the extent of "qualified terminable interest property" as provided in the new section 2056(b)(7) described above. What gives rise to situations like that encountered here is that prior to the 1981 Act there was widespread use of wills containing "formula" bequests and devises to the surviving spouse,*514 so drafted as to make certain that the spouse would receive outright under the will only that amount of property that would bring the total allowable marital deduction up to 50 percent of the "adjusted gross estate". Article III of the will before us obviously embodies such careful draftsmanship, and in all probability follows or adapts one of the standard forms thus used before ERTA. The irony for petitioner here is that the will was executed in 1982, after the 1981 enactment of ERTA, and there was no necessity for any such drafting maneuvering to come within a then nonexisting 50-percent limit. It would seem that the draftsman of the will at issue was probably unaware of the changes wrought by the 1981 Act, 4 and needlessly saw to it that the surviving spouse was to be given only that amount of property outright that would be required to come up to but not exceed the perceived 50 percent limit. And Article III was written in iron-clad terms plainly calculated to achieve that result. If it is read as written, it seems squarely to cover the present case so as to require that the QTIP be taken into account in deciding how much was given to the widow outright by Article III. Counsel*515 has now attempted to make the best out of a bad situation, and we proceed to consider the various arguments that are obviously intended to extricate the estate from the predicament in which it now finds itself. We quite agree with petitioner's opening contention that a testator's intent as expressed in his will controls the legal effect of his disposition. Indeed, the Supreme Court of North Dakota has plainly*516 indicated that in construing the terms of a will its purpose is to ascertain the intent of the testator. Erickson v. Ward,351 N.W.2d 445">351 N.W.2d 445, 446 (N.D. 1984); Quandee v. Skene,321 N.W.2d 91">321 N.W.2d 91, 95 (N.D. 1982); Hitz v. Estate of Hitz,319 N.W.2d 137">319 N.W.2d 137 (N.D. 1982); In re Tonneson's Estate,136 N.W.2d 823">136 N.W.2d 823 (N.D. 1965); In re Glavkee's Estate,34 N.W.2d 300">34 N.W.2d 300 (N.D. 1948). If the language of the will is clear and unambiguous, then the testator's intent must be determined from the language of the will itself. Erickson v. Ward, supra;Quandee v. Skene, supra;Graves v. First National Bank in Grand Forks,138 N.W.2d 584">138 N.W.2d 584, 592 (N.D. 1965). Here, petitioner seems to find ambiguity in two of the phrases used in the portion of Article III of decedent's will which reduces the 50-percent bequest to the wife. First, petitioner argues that "The interest of the surviving spouse was a terminable interest, and therefore did not qualify for the marital deduction". Pet. br. p. 6, par. a. In addition, it argues that the QTIP did not actually pass to the wife. Pet. br. *517 p. 3, par. 5, p. 4, p. 6, par. b. Petitioner's first contention can be readily dismissed. The language put at issue by that contention provides that the Article III bequest is to be reduced by "property qualifying for the marital deduction". Although it appears that the interest given to decedent's wife in the residuary trust would otherwise be a nondeductible terminable interest, the estate's QTIP election made on the estate tax return served to qualify the underlying property for the marital deduction. Neither the effectiveness of the election nor any other basis for disqualification of the property has been raised and, in the absence of any such challenge to the QTIP, there can be no question that the QTIP is "property qualifying for the marital deduction" under Article III of decedent's will. The only language with respect to which there can be said to be any arguable question is the language which describes the property as "passing" or having "passed" to decedent's wife. Petitioner claims that the QTIP did not "pass" while the Government contends that it did. Petitioner's argument seems to be based on a definition of the words "passing or which passed" which equates*518 the word "pass" with actual physical transfer. We find the meaning of the word "pass" to be clear, under both North Dakota law and Federal estate tax law, and we conclude that petitioner's contention must be rejected. Initially, it should be noted that it is not the underlying trust property itself that decedent's will describes as "passing or which passed" to his wife, but "interests in property" which, if so passing, reduce the Article III bequest. Decedent's wife received a life interest in the trust property. There is no question that she did not receive the trust property outright, but that such property was instead transferred to decedent's trustee in trust for the wife and, later, for other beneficiaries. Petitioner's reading of the word "pass" as equivalent to the word transfer is particularly ill suited when applied to a life interest in property, as distinguished from the property itself. Decedent's wife's life estate could not be the object of a transfer under petitioner's definition of the word "pass". Moreover, in North Dakotain the same context as we have before us, i. *519 e., the interpretation of the terms of a will, the word "pass" has been used as the equivalent of "give, devise, and bequeath". Holien v. Trydahl,134 N.W.2d 851">134 N.W.2d 851, 855-856 (N.D. 1965). This interpretation is consistent with that used by this Court for estate tax purposes. The understood meaning of the word "passing" in the estate tax context is particularly relevant here where the will, obviously drafted by an attorney, uses the phrase "passing or which passed" in a context in which it is clear that the estate tax consequences of the provision of the will were a predominant concern. In such a will, the term is to be given its "accustomed technical meaning according to common legal usage thereof". Old Kent Bank and Trust Co. v. United States,362 F.2d 444">362 F.2d 444, 451 (6th Cir. 1966). Cf. Estate of Harmon v. Commissioner,84 T.C. 329">84 T.C. 329, 336 (1985). Section 2056(c) of the Code states that "an interest in property shall be considered as passing from the decedent to any person if and only if": (1) such interest is bequeathed or devised to such*520 person by the decedent; (2) such interest is inherited by such person from the decedent; (3) such interest is the dower or courtesy interest (or statutory interest in lieu thereof) of such person as surviving spouse of the decedent; (4) such interest has been transferred to such person by the decedent at any time; (5) such interest was, at the time of the decedent's death, held by such person and the decedent (or by them and any other person) in joint ownership with right of survivorship; (6) the decedent has a power (either alone or in conjunction with any person) to appoint such interest and if he appoints or has appointed such interest to such person, or if such person takes such interest in default on the release or nonexercise of such power; or (7) such interest consists of proceeds of insurance on the life of the decedent receivable by such person.Of the seven means of "passing" property listed under subsection (c), only one, in paragraph (4), reflects the definition to which petitioner claims the word, as used in decedent's will, must be limited. Section 2056 does*521 not so limit the word passing, but, instead, provides that property also passes if it is "bequeathed or devised" or "inherited". As hereinbefore noted, these latter meanings are more in keeping with the "passing" of the wife's life estate than is the meaning which petitioner presses on us. Moreover, in this Court, we have given the word "passing" the same broad meaning as is set forth in section 2056(c). In Parker v. Commissioner,62 T.C. 192">62 T.C. 192 (1974), we held that property passed to the decedent's spouse under his will despite the fact that the spouse did not receive the property, but allowed it to be disributed to a residuary trust. In that case the Court explicitly stated that "We do not think the words 'passes or has passed,' * * * can be equated with 'distributed'". Parker,62 T.C. at 197. 5*522 Another indication of the meaning of "pass" is provided by Estate of Hoelzel v. Commissioner,28 T.C. 384">28 T.C. 384 (1957). Although the word "pass" was not explicitly defined or discussed therein, the holding, in circumstances essentially like those before us, supports the Government's contention here that the QTIP passed. In Estate of Hoelzel, the decedent's will provided that (at 386): The property devised and bequeathed by this Article shall be reduced by the portions of such gross estate which pass to my wife, but do not constitute a part of my estate at the date of my death, and by the portions which pass to my wife by virtue of the bequests of Article One hereof. * * * [Emphasis supplied.]The Court held that the bequest was properly reduced by life interests that the decedent's spouse received on his death in payment of annuity and insurance contracts. It was determined that the life interests were, under the foregoing provisions of the decedent's will, "portions of [his] gross estate which pass to my wife" and that they, consequently, reduced the bequest to the wife. [Emphasis supplied.] Given the usual technical meaning accorded the*523 term "pass" in a will, as distinguished from transfer or distribute, there can be no doubt that the life interest in the QTIP passed to decedent's wife. It devolved to her under the terms of decedent's will, regardless of whether it was distributed. Moreover, there is no basis for concluding that the QTIP, by virtue of its character as such or more generally as a type of terminable interest property, does not pass in the same manner as other property. Even before QTIP was given special treatment and excepted from the disallowance for terminable interest property, it was recognized that terminable interests "pass". The legislative history of the Revenue Act of 1948, which first disallowed the deduction of terminable interests, is replete with references to them as interests which pass. See S. Rept. No. 1013, 80th Cong., 2d Sess. 28 (1948), 1 C.B. 285">1948-1 C.B. 285, 305; S. Rept. No. 1013, Part 2, 80th Cong., 2d Sess. 7-15 (1948), 1 C.B. 331">1948-1 C.B. 331, 341-344. Their disallowance in 1948 from the marital deduction was in no way based upon their not passing to the surviving*524 spouse. To the contrary, the deduction was disallowed as to these interests, despite their passing to the spouse, in order to promote another policy. That policy was to "equate the decedent in the common-law State with the decedent in the community-property State". S. Rept. No. 1013, 80th Cong., 2d Sess. 28 (1948). See United States v. Stapf,375 U.S. 118">375 U.S. 118, 128 (1963); Estate of Schildkraut v. Commissioner,368 F.2d 40">368 F.2d 40, 42 (2nd Cir. 1966). Such equality was best served if terminable interests were not allowed as part of the marital deduction and that deduction was "restricted to the transfer of property interests that will be includible in the surviving spouse's gross estate". United States v. Stapf,375 U.S. at 128. See Dougherty v. United States,292 F.2d 331">292 F.2d 331, 337 (6th Cir. 1961). The broad category of terminable interests was thus recognized as passing, but disallowed as a deduction nonetheless in order that the property not escape estate taxation completely. Dougherty,292 F.2d at 337; Doughty v. United States,296 F. Supp. 1078">296 F.Supp. 1078, 1081 (D. Mont. 1969). The fact that QTIP*525 was set aside from other terminable interests for more favorable treatment by section 403(d) of the Economic Recovery Tax Act of 1981, Pub. L. 97-34, 95 Stat. 302, cannot be said to have changed the nature of QTIP from property which is regarded as passing to the decedent's spouse. In 1981, QTIP was recognized as passing, although not "passing outright". H. Rept. No. 97-201, 160 (1981), 2 C.B. 378">1981-2 C.B. 378. Petitioner argues that the interpretation of Article III of decedent's will requiring the reduction of the bequest therein by the QTIP would seriously compromise the decedent's testamentary intent to leave his wife half of his "adjusted gross estate". 6 Pet. br. p. 5; Pet. rep. br. p. 4-5. On the record before us, all we can do is attempt to glean the decedent's intent from the words of the will he left behind. Based on those words, we conclude that the Article III bequest must be reduced by the QTIP. Petitioner additionally argues that such interpretation of the will's language will result in "a possible double tax on the $ 300,000.00". Pet. br. p. 8. This argument is midguided. *526 To be sure, the QTIP is likely to be included in the wife's estate at her death under section 2044. However, this is the correct result since that same property will have generated a marital deduction for the decedent's estate. Petitioner's argument fails to take into account that, when the QTIP is treated as part of the 50-percent bequest to the spouse, it also counts as part of the property passing to the spouse which makes up the marital deduction. As we interpret the will, the QTIP is a factor that must be taken into account in the computation of the 50-percent limitation established by Article III. Consequently, less of the decedent's other property passes to the wife outright. The QTIP passes to her and generates a marital deduction, while less of the decedent's other property passes to her under Article III and, consequently, the marital deduction stems from less of that other property. The QTIP does results in a marital deduction to decedent's estate and the later application of section 2044 to the wife's estate does not constitute double taxation of the QTIP. Decedent's bequest under Article III is reduced by the QTIP elected. Decision will be entered under Rule*527 15.Footnotes1. Thus, there is no issue before us in respect of the problem involved in Estate of Howard v. Commissioner,↩ 91 T.C. (Aug. 23, 1988). 2. On the original return the amount claimed for the first part was $ 708,952, but this was reduced to $ 636,449 in the amended return, the difference being attributable presumably to the elimination of the annuity component of the gross estate -- a matter not in dispute here. See supra,↩ p. 4. 3. Section 403(d)(1) of the Economic Recovery Tax Act of 1981 (ERTA), Pub. L. 97-34, 95 Stat. 302. ↩4. A strong indication that the will was carefully drafted to take into account the pre-ERTA provisions of the Code is the use of the term "adjusted gross estate" in Article III. That term had previously appeared in section 2056(c) of the Code, but was no longer of any relevance in respect of the marital deduction and had completely disappeared in section 2056↩ as revised by the 1981 Act. Indeed, the term "adjusted gross estate" is one that generally has no relevance in the entire estate tax law except for the provisions dealing with the extensions of time for payment of tax where the estate consists largely of an interest in a closely held business. Secs. 6166 and 2035(d)(4). 5. North Dakota has also distinguished property which "passes" from that which is distributed but has done so in the context of intestate succession, not succession by will. Hoffman v. Hoffman's Heirs,73 N.D. 637, 17 N.W.2d 903">17 N.W.2d 903, 905↩ (1945). 6. See n. 4, supra,↩ as to significance of term "adjusted gross estate". | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619564/ | Paul F. and Agnes J. Stutz v. Commissioner.Stutz v. CommissionerDocket No. 3469-62.United States Tax CourtT.C. Memo 1965-166; 1965 Tax Ct. Memo LEXIS 162; 24 T.C.M. (CCH) 888; T.C.M. (RIA) 65166; June 24, 1965*162 In 1959 the petitioners abandoned the use of property as their residence and thereafter, until March 23, 1960, held such property with the intention of renting it. Despite continuous efforts, the property was never rented. On March 23, 1960, they ceased attempts to rent such property and thereafter held it for sale only. It was sold on July 1, 1960. Held, that the property had not been appropriated or converted to income-producing purposes and hence there was no transaction entered into for profit as required by section 165(c)(2) of the Internal Revenue Code of 1954 for the deduction of any loss sustained upon the sale of the property. Held, however, that from January 1 to March 23, 1960, the property was held by the petitioners for the production of income, namely rent, within the intendment of sections 212 and 167(a)(2) of the Code and that under section 62(5) the petitioners are entitled to deduct from gross income, in computing adjusted gross income, various amounts expended in attempting to rent the property and for maintenance thereof during such period, and a reasonable allowance for depreciation on the property during such period. The amounts deductible*163 determined. Paul F. Stutz, pro se, 2261 Westbrook Dr., Toledo, Ohio. Charles H. Powers, for the respondent. ATKINSMemorandum Findings of Fact and Opinion ATKINS, Judge: The respondent determined a deficiency in income tax for the taxable year 1960 in the amount of $661.57. The petitioners claim an overpayment of income tax in the amount of $520.72. The principal issue presented is whether the petitioners are entitled to a loss deduction, under section 165 of the Internal Revenue Code of 1954, upon the sale of property which had previously been used by them as their residence. Also involved is the question*166 whether the petitioners are entitled to deductions for depreciation and costs of repairing and maintaining the property. Findings of Fact Some of the facts have been stipulated and are incorporated herein by this reference. The petitioners are husband and wife, residents of Toledo, Ohio. They filed a joint income tax return for the taxable year 1960 with the district director of internal revenue, Cleveland, Ohio, reporting items of income and expense on the cash method of accounting. In April 1953 the petitioners purchased a house and lot located at 4217 Willis Boulevard, Toledo, Ohio (hereinafter sometimes referred to as "the property") which was used by them as a personal residence. The cost of the property was $11,500, and their mortgage payments were $70 monthly. From the time the petitioners purchased the property until 1958, when a storm sewer was installed and the blacktop road fronting the property was paved with concrete, water stood in the front yard and in the street during wet seasons. At the same time curbing was installed on both sides of the road which, after the improvements were made, was divided by a grass median strip. At the time of purchase the paint*167 around the kitchen door was blistered and peeling. This was repaired, but the blistering recurred periodically until air vents were installed between the framework and the insulation. The house was painted several times between 1953 and 1959 as part of its general maintenance. In 1956 the petitioners further improved the property by installing a new septic tank at a cost of $280. In 1953 the back yard was completely overgrown, but was cleared and subsequently maintained by the petitioners. In 1957 or 1958 a gas line was installed along Willis Boulevard. In 1955 or 1956 a parochial grade school and church were constructed within about two and one-half blocks of the petitioners' property. In 1958 property within 3 or 4 blocks of petitioners' property was purchased for the purpose of constructing a Catholic coeducational high school. In May 1959, Paul Stutz moved to Akron, Ohio, to accept a position there. Agnes Stutz remained in the Toledo residence until the end of August 1959, when she left to join her husband in Akron, where they took up residence in September 1959. Thereafter the property remained vacant so long as it was owned by them. In the summer of 1959, the petitioners*168 listed the Toledo residence for sale under an exclusive 90-day contract with a large realty company in Toledo. Such company showed the property to several prospective purchasers, one of whom offered to purchase it for $11,000. This offer was later reduced to $10,500, and was accepted by the petitioners. However, the sale was not consummated because the prospective purchaser decided to invest his money in a business which he was starting. No other offers were received and the listing expired in late August or early September of 1959. The petitioners discussed the question of what to do with the property and decided that, since they would not be in the city, they would not renew the listing and not continue trying to sell the property but instead would attempt to rent it. Beginning in September 1959, the property was, from time to time, advertised in a local newspaper for rent at $100 per month, later at $90 per month and finally, in 1960, at $80 per month. The advertisements were set forth under the listing "Houses for Rent - Unfurnished," and did not offer the property for sale. The petitioners in 1959 expended at least the amount of $6.18 for advertising the house for rent. Most*169 of the negotiations looking toward rental of the property were handled for the petitioners by Paul Stutz's mother, Gladys E. Stutz, and his brother, Robert Stutz, who lived with his mother in her home which was located about a mile from the petitioners' property. The advertisements listed the telephone number of Gladys E. Stutz. Robert and his mother received several inquiries concerning the renting of the property, and the premises were shown to several prospective tenants. On one occasion, Robert informed Paul of a prospect and Paul prepared a lease agreement, but the prospect subsequently decided to purchase a house instead. On another occasion, in March 1960, a couple telephoned and then came by to see the property. They agreed to rent the premises and left a $20 deposit with Gladys Stutz, who gave them the key. Subsequently, they stated that they no longer desired to rent the property, and Gladys Stutz refunded the $20 deposit. On March 23, 1960, the petitioners addressed a letter to a Toledo real estate salesman, accepting his offer of March 19, 1960, to attempt to obtain a purchaser for the property. The petitioners at that time decided to try to sell the property because*170 their resources were limited and they could not afford to hold the property for rent any longer. The salesman found a purchaser, Eva Lockard, and on June 11, 1960, she and the petitioners executed a contract for the purchase and sale of the property. On July 1, 1960, Eva Lockard and the petitioners executed a "Land Contract," which provided for the sale of the property for a consideration of $9,000, consisting of $1,000 in cash and the balance in monthly installments of $100 with interest at 6 1/2%. The petitioners paid a commission of $540 to Travis in connection with this sale. Eva Lockard paid the petitioners $100 on August 6, 1960. On September 3, 1960, she paid them $216.11, representing a $100 monthly payment plus $116.11 for real estate taxes. The contract provided that the balance due would immediately be paid in full in the event that Eva Lockard should be successful in disposing of a certain parcel of property. In fact, this was done and the balance due the petitioners was paid in 1960. In their return for 1960, the petitioners claimed as an ordinary loss deduction an amount of $2,907.50 resulting from the sale of their property, computed as follows: Basis of property$11,500.00Broker's commission540.00Real estate taxes116.11Miscellaneous expense1.39Total$12,157.50Less: Sales price$9,000.00Accumulated depreciation250.009,250.00Loss on sale$ 2,907.50*171 During the period January 1 to March 23, 1960, the petitioners in connection with attempts to rent the property expended a total of $106.56 for telephone calls, advertising, and travel. During the period January 1, 1960 through July 1, 1960, they also incurred various expenses in connection with maintaining the property. They expended $17.36 for electricity and $76.70 for heating oil, of which amounts one-half was attributable to the period before March 23. They also expended $26.30 for furnace service prior to March 23. An amount of $5 for yard upkeep was expended after March 23. In their return for 1960, the petitioners reported rental received in the amount of $200 (consisting of the two $100 payments received from Eva Lockard), depreciation on the property of $125, and repairs and other expenses totaling $221.49, resulting in a claimed net loss from rents in the amount of $146.49. They also claimed the standard deduction in the amount of $953.15, representing 10% of the reported adjusted gross income. In the notice of deficiency, the respondent disallowed as a deduction the claimed loss of $2,907.50 on the sale of the property, with the following explanation: It has*172 been determined that you have not established that you converted the residence to rental property or, if such a conversion was made, the value thereof on the date of the alleged conversion. Accordingly, the loss claimed is not allowable as a deduction under Section 165 of the Internal Revenue Code of 1954 and is specifically prohibited by the provisions of Section 262 of the Internal Revenue Code of 1954. In such notice, the respondent also disallowed as a deduction the claimed net loss from rents of $146.49, with the following explanation: It has been determined the gross rent reported was an integral part of the sales price of your personal residence. The expenses claimed are therefore a part of the cost of selling the residence and as personal expenses are not deductible due to the prohibition of deducting personal expenses by the provisions of Section 262 of the Internal Revenue Code of 1954. From January 1 to March 23, 1960, the property was held by the petitioners for the production of rents. Thereafter, until July 1, 1960, they held the property for sale, and not for the production of rents. Opinion*173 We will first consider whether the petitioners are entitled to the claimed loss deduction of $2,907.50 upon the sale of the property at 4217 Willis Boulevard, Toledo, Ohio. It is the contention of the petitioners that they did sustain a loss upon the disposition of such property and that it is deductible under section 165(c)(2) of the Internal Revenue Code of 1954, 1 as a loss incurred in a transaction entered into for profit, though not connected with a trade or business. The property in question had been purchased in 1953 by the petitioners as their personal residence and it was actually used as a residence until the end of August 1959, when Agnes Stutz joined her husband*174 in Akron, Ohio. The property was listed with a realty company for sale in the summer of 1959 under an exclusive 90-day contract which expired in late August or early September 1959. The property was not sold during that time and the listing was not renewed. Rather, the petitioners decided to rent the property, instead of selling it, and unsuccessful attempts were made to rent the property over the period from September 1959 until March 23, 1960, when the petitioners abandoned attempts to rent the property and authorized a real estate salesman to attempt to sell the property. The property was sold on July 1, 1960. The petitioners contend that when, in September 1959, they made efforts to rent the property such property was converted to property held for income-producing purposes and that therefore any loss upon its subsequent sale constituted a loss in a transaction entered into for profit. The respondent, on the other hand, maintains that the petitioners did not rent or otherwise appropriate the property to income-producing purposes and that therefore any loss sustained upon the sale would not constitute a loss sustained in a transaction entered into for profit, but would constitute*175 a personal loss, the deduction of which is not permitted by section 165(c)(2) of the Code and the regulations thereunder. 2In Heiner v. Tindle, 276 U.S. 582">276 U.S. 582, the Supreme Court held that a loss sustained upon the sale of property which had originally been the residence of the taxpayer, but which had been abandoned as such and had been rented for a number of years, constituted a loss in a transaction entered into for profit within the meaning of section*176 214(a)(5) of the Revenue Act of 1918, which corresponds to section 165(c)(2) of the Internal Revenue Code of 1954. The Court stated that section 214 was intended to permit deductions of capital losses wherever the capital investment was used to produce taxable income, and that the appropriation of the property to rental purposes was the transaction entered into for profit which resulted in the loss. Thereafter, in Morgan v. Commissioner, (C.A. 5) 76 F. 2d 390, certiorari denied 296 U.S. 601">296 U.S. 601, and Rumsey v. Commissioner, (C.A. 2) 82 F. 2d 158, certiorari denied 296 U.S. 601">296 U.S. 601, affirming Memorandum Opinions of this Court, it was held that where the taxpayers had ceased to use the property as their residence and had placed it in the hands of real estate agents for rent or sale, but the property had not been rented, there had not been a transaction and therefore no "transaction entered into for profit". The courts stressed the fact that since the property had not been rented the taxpayer was free to reoccupy the premises as a residence or to sell the same, and thus distinguished Heiner v. Tindle, supra.*177 We reached the same conclusion in Allen L. Grammer, 12 T.C. 34">12 T.C. 34, where the taxpayer had merely listed the property for rent with a real estate broker, but the property had not been rented prior to the time of sale. In view of the foregoing, we must conclude that any loss sustained by the petitioners in the instant case upon the sale of their property would not constitute a loss in a transaction entered into for profit within the meaning of section 165(c)(2) of the Code. In view of this conclusion, it becomes unnecessary to consider the respondent's additional contention that the petitioners have not established the fair market value of the property at the time of its claimed conversion to income-producing purposes. The respondent also held that the petitioners are not entitled to deductions of various amounts paid by them in 1960 in attempting to rent the property and for maintenance of the property, or to a deduction for depreciation of the property. Section 212 of the Internal Revenue Code of 1954 provides that in the case of an individual there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during*178 the taxable year for the production or collection of income or for the management, conservation, or maintenance of property held for the production of income. Section 167(a)(2) of the Code provides that there shall be allowed as a deduction a reasonable allowance for the exhaustion, wear and tear of property held for the production of income. Section 63(b) of the Code provides that where an individual elects under section 144 to use the standard deduction (as was done by the petitioners herein) there shall be allowed as deductions from adjusted gross income in computing taxable income only the standard deduction and the deductions for personal exemptions. However, under section 62(5) of the Code an individual, in computing adjusted gross income, is permitted to deduct from gross income the amounts allowed as deductions by sections 212 and 167 "which are attributable to property held for the production of rents * * *". As we have heretofore pointed out in Mary Laughlin Robinson, 2 T.C. 305">2 T.C. 305, and William C. Horrmann, 17 T.C. 903">17 T.C. 903, the question of whether residence property has been converted to property held for the production of income for purposes of the application*179 of sections 23(a)(2) and 23(1)(2) of the 1939 Code (corresponding to sections 212 and 167(a)(2) of the 1954 Code) is an entirely different question from that of whether there has been such an appropriation or conversion of a residence to income-producing purposes as to constitute a transaction entered into for profit for purposes of the application of section 23(e)(2) of the 1939 Code (corresponding to section 165(c)(2) of the 1954 Code). 3 As pointed out hereinabove, the mere listing of the property for rental is not sufficient to constitute a transaction entered into for profit for purposes of section 165(c)(2). However, as we stated in William C. Horrmann, supra, in determining whether property is held for the production of income, within the meaning of the statute, the use made of the property and the owner's intent in respect to the future use or disposition of the property are generally controlling. In that case we held that where the taxpayer had abandoned the use of property as his residence and had made efforts to rent it, the property was held for the production of income, even though no income was in fact received from the property. See also Mary Laughlin Robinson, supra.*180 *181 It is the position of the respondent that the efforts made by the petitioners to rent the property, which had been their residence, were mere token efforts and were not sufficient to establish that during 1960 the property had been converted to property held for the production of income from rents. We are satisfied, however, from the evidence, including the testimony of the petitioner Agnes Stutz, that about September 1, 1959, the petitioners abandoned the use of the property as their residence and thereafter held it with the intention of renting it. Continuous efforts were made to rent the property from that time until March 23, 1960, when such efforts were abandoned and the decision was made to sell it. Under the circumstances, it is our conclusion that from January 1 to March 23, 1960, the property was held by the petitioners for the production of income, within the meaning of section 167 and section 212 and the regulations under section 212, 4 namely rents, thus rendering the provisions of section 62(5) of the Code applicable. *182 It follows that the amount of $106.56 expended by the petitioners for telephone calls, advertisement, and travel in attempting to rent the property is deductible under section 62(5) of the Code. Also, any amounts expended for maintenance of the property during the time that it was held for the production of rents, namely, during the period January 1 to March 23, 1960, are deductible under section 62(5), but amounts expended after March 23, 1960, when the property was held for sale, are not deductible. The respondent on brief does not question the amount of expenditures made and concedes that a reasonable allowance for depreciation of the property would be $250 per year, but he contends that the petitioners have failed to show the portion of the expenditures and depreciation properly attributable to the period January 1 to March 23, 1960. We think, however, that the record affords a reasonable basis for an allocation of the amounts to the period in 1960 before and after March 23. In the exercise of our best judgment, we have concluded and have found as a fact that one-half of the amounts of $76.70 and $17.36 paid for heating oil and electricity, respectively, are attributable*183 to the period prior to March 23. We have also found that the full amount of $26.30 expended for furnace service is attributable to such period. These amounts will be allowed as deductions in the recomputation under Rule 50. However, we have concluded that the amount of $5 expended for yard upkeep is not attributable to such period, and is therefore not deductible. Upon the recomputation under Rule 50, there will be allowed as a deduction depreciation on the property for the period January 1 to March 23, 1960, based upon an annual allowance of $250. Decision will be entered under Rule 50. Footnotes1. Section 165 of the Code provides in part as follows: (a) General Rule. - There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. * * *(c) Limitation on Losses of Individuals. - In the case of an individual, the deduction under subsection (a) shall be limited to - * * *(2) losses incurred in any transaction entered into for profit, though not connected with a trade or business * * *.↩2. Section 1.165-9 of the Income Tax Regulations provides in part as follows: (a) Losses not allowed. A loss sustained on the sale of residential property purchased or constructed by the taxpayer for use as his personal residence and so used by him up to the time of the sale is not deductible under section 165(a). (b) Property converted from personal use. (1) If property purchased or constructed by the taxpayer for use as his personal 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 sustained on the sale of the property shall be allowed as a deduction under section 165(a)↩.3. Thus, in Mary Laughlin Robinson, supra, we stated: Earlier cases, such as Morgan v. Commissioner, 76 Fed. (2d) 390, involving a question whether sale of an abandoned home, sold two years later without having been rented, was a sale in a "transaction entered into for profit," under section 23(e) of the Revenue Act; and Phipps v. Helvering, 124 Fed. (2d) 292, involving the question whether loss on demolition of a former home was loss in a profit transaction, do not control under the amendment of 1942 [adding section 23(a)(2) of the 1939 Code, which is the predecessor of section 212 of the 1954 Code], for had Congress, in enacting section 121 intended nothing more than to cover transactions "entered into for profit" they would, no doubt, have used that expression, already used in section 23(e) and continued therein. That language, however, was not used, either in section 121(a) as to expenses, or in section 121(c) broadening the field of allowable depreciation. In both the expression used is "held for the production of income." Obviously, Congress thereby meant something different than "transaction entered into for profit" left in section 23(e). And in William C. Horrmann, supra, we stated in part: The language of the Code sections applicable in issues one and two was property held for the production of income, and the language of section 23(e)(2) of the Code is different. In order for a loss to be deductible under that section it must be incurred in any transaction entered into for profit. In a situation where the use of the property as a personal residence has been abandoned, and where the owner has offered the property for sale or for rent and finally sells the property at a loss, that distinction in language may result in allowing a deduction in one case and not allowing a deduction of another type. * * *.↩4. Section 1.212-1 of the Income Tax Regulations provides in part as follows: (b) The term "income" for the purpose of section 212 includes not merely income of the taxable year but also income which the taxpayer has realized in a prior taxable year or may realize in subsequent taxable years * * *. * * * ordinary and necessary expenses paid or incurred in the management, conservation, or maintenance of a building devoted to rental purposes are deductible notwithstanding that there is actually no income therefrom in the taxable year, and regardless of the manner in which or the purpose for which the property in question was acquired. Expenses paid or incurred in managing, conserving, or maintaining property held for investment may be deductible under section 212 even though the property is not currently productive. * * *(h) Ordinary and necessary expenses paid or incurred in connection with the management, conservation, or maintenance of property held for use as a residence by the taxpayer are not deductible. However, ordinary and necessary expenses paid or incurred in connection with the management, conservation, or maintenance of property held by the taxpayer as rental property are deductible even though such property was formerly held by the taxpayer for use as a home. In this connection, it may be pointed out that paragraph (h) quoted above represents a liberalizing amendment, effected by T.D. 5331 (February 9, 1944) 1944 C.B. 98">1944 C.B. 98, of the regulations originally promulgated following the enactment by the Revenue Act of 1942 of section 23(a)(2) of the 1939 Code (predecessor of section 212 of the 1954 Code). Prior to amendment such paragraph read as follows (section 29.23(a)-15 of Regulations 111): Ordinary and necessary expenses in connection with the management, conservation, or maintenance of property used as a residence by the taxpayer or acquired by him for such use are not deductible, even though the taxpayer makes efforts to sell the property at a profit or to convert it to income-producing purposes, and even though the property is not occupied by the taxpayer as a residence, unless prior to the time that such expenses are incurred the property has been rented or otherwise appropriated to income-producing purposes by some affirmative act and has not been reconverted.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/3266643/ | The appellant brought suit in the Woodruff chancery court to quiet title to a strip of land fifty feet wide before granted by his predecessor in title to the White Black River Valley Railway Company (hereafter called White Black Company) on the *Page 801
ground that same had been abandoned and was no longer used for the purpose of a railroad. Appellant further prayed that the conveyances from the original grantee to subsequent companies be canceled and that the buildings, ties and rails upon said strip of land be decreed to be a part of the realty, and that his title to the same be confirmed and quieted as against all the appellees. The said White Black Company and its lessees were made defendants; also, the Farmers Loan Trust Company, now City Bank Farmers Trust Company of New York. These parties answered denying the allegations of the complaint and pleading to the jurisdiction of the court on the ground that the property involved was being administered by the federal district court in the state of Illinois in bankruptcy proceedings and that these proceedings were still pending.
The case was submitted upon the pleadings and agreed statement of facts. The trial court, without passing upon the merits of the controversy, held that it was without jurisdiction and dismissed the complaint "without prejudice, however, to another suit for the same cause after the final disposition of the Chicago, Rock Island Pacific Railway Company and the Choctaw, Oklahoma Gulf Railroad Company Reorganization Proceedings now pending in the district court of the United States for the Eastern Division of the Northern District of Illinois."
The sole question presented is the correctness of the trial court's dismissal of the complaint for want of jurisdiction. Therefore, those stipulations of fact relating to the merits need not be noticed. Those relating to the question of jurisdiction will be summarized as follows.
In the year 1900, the White Black Company, to secure $600,000 of its bonds, executed a deed of trust covering all of its properties including the subject of this controversy to the Farmers Loan Trust Company (now City Bank Farmers Trust Company of New York), which bonds are outstanding and not due. At the same time, the said White Black Company executed a lease of its properties for a term of eighty years to the *Page 802
Choctaw, Oklahoma Gulf Railroad Company (hereafter called Choctaw Company), which company, in 1904, assigned to the Chicago, Rock Island Pacific Railway Company (hereafter called Rock Island Company) its lease of the properties of the White Black Company, the Rock Island Company assuming the obligations of its lessor with respect to the operations of the White
Black Company. Thereupon, the Rock Island Company took over the White Black Company and operated it as a part of its system.
In 1933, the Rock Island and Choctaw Companies filed petitions in the district court of the United States for the Eastern Division of the Northern District of Illinois for a reorganization under the provisions of the "Railroad Reorganization Amendment" to the National Bankruptcy Act (11 USCA, 205 note). These petitions were approved by the court and Frank O. Lowden, James E. Gorman and Joseph B. Fleming were appointed trustees for the railroad companies, are in possession and control of their properties and now operating same under the orders of the court. The said trustees operated the White Black Company until February 10, 1935, at which time, under order of the Interstate Commerce Commission, operations ceased. The corporate existence of the White Black Company is still maintained, its franchise is in force, and the state of Arkansas has not through its constituted authorities, authorized the abandonment of the railroad or any part thereof.
There is now pending in the federal court, and undisposed of, the petition of the White Black Company challenging the powers of the trustees of the Rock Island and Choctaw Companies by the exercise of which they are attempting to violate the covenant in the lease from the White Black Company, and seeking to have said trustees carry out the lease according to its terms. The trustees have filed a reorganization plan with the Interstate Commerce Commission which provides for a disposition of all of the properties of the Rock Island and Choctaw Companies held by them, including leases of all other railway properties. *Page 803
In this proceeding, both the state of Arkansas and White Black Company have intervened in protest of the plan of the said trustees, which protest is still pending and undetermined by the court. On June 7, 1934, the federal district court, in which the aforesaid proceedings are pending, issued an injunction which is still in force and which prohibits all persons, firms and corporations from interfering by any legal process or otherwise, or disturbing any portion of the properties in possession of the trustees, or taking possession of any of said properties, or from bringing any suits or actions. It is further stipulated that no permission was applied for or obtained by the plaintiff herein from the district court above mentioned to file or prosecute the present suit, and, also, that since February 10, 1935, no trains have been operated over the tracks on the strip of land in question and the depot located thereon has been leased by the trustees to an individual to be used in no manner connected with the operation of the property as a railroad, and that no benefits have accrued to the plaintiff or any resident in the vicinity of the property from the aforesaid date.
We are of the opinion that the stipulated facts, as above summarized, are sufficient to show that the properties in controversy are held by the Rock Island Company under an eighty-year lease and have been incorporated into, and operated as a part of, the Rock Island Company since 1904; that there is now pending and undisposed of in the federal court a proceeding under which the trustees above named were appointed to take charge of the properties of the Rock Island Company and to effect a reorganization under the plan provided by the "Reorganization Amendment" to the National Bankruptcy Act. In that proceeding, the White Black Company is a party intervener seeking to require the Rock Island Company to carry out the lease in which the former company is lessor and the latter lessee, according to its terms.
The appellant concedes that by the provisions of the National Bankruptcy Act the court in which any *Page 804
proceedings are pending under said act acquires exclusive jurisdiction of the debtor and his property, wherever located. There can be no doubt that such is the law. 11 USCA, 205; Ex parte Baldwin, 291 U.S. 610,54 S. Ct. 551, 78 L. Ed. 1020; Isaacs v. Hobbs Tie Timber Co.,282 U.S. 734, 51 S. Ct. 270, 75 L. Ed. 645. The appellant, however, contends that this law has no application because (1) "the property involved in this action is not within the custody and control of the bankruptcy court for the reason that the court voluntarily abandoned that property as of no value to the bankrupt estate," and (2) that the trustees in bankruptcy have waived objection to the jurisdiction by voluntarily appearing in the court below and praying for affirmative relief.
The first contention overlooks the intervention of the White Black Company, namely, that the trustees be required, under the proposed reorganization plan to operate the property according to the terms of its lease to the Rock Island Company, or that all the property be restored to said White Black Company. In that intervention the state of Arkansas joined and these matters are still pending in the bankruptcy court.
On the second contention we think appellant is in error for the record shows that no affirmative relief was asked other than that the complaint be dismissed for want of equity. Moreover, the question of the interest of the trustee, City Bank Farmers Trust Company of New York, is involved as it holds a mortgage on the railroad track and depot buildings and its rights are being adjudicated in the bankruptcy proceedings.
We think the trial court correctly concluded that the instant suit is premature, which obviates the necessity of determining the validity of the appellant's contention insofar as it relates to the question of fixtures.
Affirmed. *Page 805 | 01-04-2023 | 07-05-2016 |
https://www.courtlistener.com/api/rest/v3/opinions/4619566/ | ROBERT BRUNTON STUDIOS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Robert Brunton Studios, Inc. v. CommissionerDocket No. 7447.United States Board of Tax Appeals15 B.T.A. 727; 1929 BTA LEXIS 2803; March 6, 1929, Promulgated *2803 1. INVESTED CAPITAL - LIMITATION - ASSETS ACQUIRED FOR STOCK. - Assets consisting of an option to purchase property and certain contracts for production of motion pictures, acquired by an individual without cost and transferred to a corporation in return for capital stock issued in 1918 and thereafter set up on the books of the corporation at a capital value equal to the par value of the stock issued, held, under section 331 of the Revenue Act of 1918, not to be subject to inclusion in invested capital even though an actual value be proved for such assets equal to the book value assigned. 2. DEPRECIATION. - On the facts, held, that the proved values of depreciable assets acquired for stock, even though such values could not be included in invested capital by reason of the limitation of section 331 of the Revenue Act of 1918, is the basis for computing depreciation, that section not being a limitation upon the allowances granted by section 234(a)(7) of that Act, and, the values of such assets determined. Ralph Smith, Esq., for the petitioner. Maxwell E. McDowell, Esq., for the respondent. TRUSSELL *728 This appeal is from the determination*2804 by respondent of deficiencies in income and profits taxes of $5,044.18 for 1918, $22,136.37 for 1919, and $7,486.94 for 1920. Errors are assigned upon respondent's exclusion from invested capital of certain amounts representing values claimed for an option, three motion picture production contracts, and the services and good will of an individual alleged to have been acquired for capital stock issued, and upon his disallowance of certain deductions taken in the taxable years in question as representing exhaustion of these assets. FINDINGS OF FACT. Prior to the year 1918 a corporation, known as the Paralta Studios, Inc., was engaged in motion picture production, having a studio with the necessary equipment at Los Angeles, Calif. This business was directed by one Robert Brunton, a motion picture director of long experience and considerable prominence in his profession. In the year mentioned this corporation became financially involved and was forced to suspend operations, its unpaid obligations for physical properties purchased and general expenses of operation being approximately $175,000. Following the suspension of operations by this corporation, Robert Brunton, through*2805 an arrangement with it, continued the business as a personal venture, operating under the name of the "Robert Brunton Company." In July of 1918, Brunton, through one Howard C. Hickman, procured from Paralta Studios, Inc., a lease with option to purchase its assets. These assets consisted of a lease of the land upon which the studio was located, embodying an option to purchase, and its studio facilities, properties, and equipment. The price provided to be paid by Hickman under the option was $125,000 and by the terms of this contract the purchase money might be paid directly to Paralta Studios, Inc., or to its creditors in satisfaction of the $175,000 of indebtedness referred to. Brunton also procured from the Paralta Studios, Inc., $50,000 to apply in reduction of this outstanding indebtedness and this was paid thereon, the creditors agreeing to withhold enforcement of their claims for *729 eight months. Following this Brunton exercised the option to purchase and paid on the purchase price of the property the sum of $41,062.70, and thereafter, on August 28, 1918, incorporated under the laws of the State of Arizona the "Robert Brunton Studios, Inc.," one of the petitioners*2806 herein, with an authorized capital stock of 250,000 shares of a par value of $250,000. On the same day seven shares of stock of this corporation were issued for cash at par, and Brunton made an offer in writing, entered on the minutes of the corporation, to convey or cause to be conveyed to the latter certain assets in return for the issue of 149,993 shares of its capital stock, these assets being described in the written offer as: 1st. That certain lease and option to purchase, dated the 10th day of August, 1918, made and entered into between Paralta Studios, Inc., a California corporation, party of the first part, and Howard C. Hickman, of Los Angeles, California, party of the second part, the same being an option to purchase the motion picture studio premises and property known as the Paralta Studio property, situated on Melrose Avenue, in the City of Los Angeles, County of Los Angeles, State of California, together with certain equipment and paraphernalia now situated upon said premises. 2nd. All of the equity and interest of said Howard C. Hickman in and to said studio premises, property and paraphernalia under said lease and option to purchase, arising by reason of payments*2807 made on account of the purchase price thereof or by reason of any other matter or thing whatsoever, the amount of such payments on account of said purchase price being the sum of $41,062.70. 3rd. A certain agreement dated the 12th day of July, 1918, made and entered into by and between Robert Brunton, doing business under the fictitious name of Robert Brunton Company, and Pathe Exchange, Inc., a New York Corporation for the manufacture and production by said Robert Brunton for said Pathe Exchange, Inc., of two certain motion picture photo-plays, together with all of the rights of said Robert Brunton therein and thereunder, said assignment to take effect as of the 1st day of August, 1918. 4th. A certain contract dated the 8th day of July, 1918, made and entered into by and between Robert Brunton, doing business under the fictitious name of Robert Brunton Company, and Haworth Pictures Corporation, an Arizona corporation, for the manufacture and production by said Robert Brunton for said Haworth Pictures Corporation of one motion picture, together with all of the rights of said Robert Brunton therein and thereunder, said assignment to take effect as of the 1st day of August, 1918. *2808 5th. A certain contract dated the 27th day of July, 1918, made and entered into by and between Robert Brunton, doing business under the fictitious name of Robert Brunton Company, and Helen Keller Film Corporation, a New York Corporation, for the manufacture and production by said Robert Brunton for said Helen Keller Film Corporation, of certain motion pictures, together with all of the rights of said Robert Brunton therein and thereunder, said assignment to take effect as of the 1st day of August, 1918. 6th. Generally the Good Will of Business of the business of said Robert Brunton heretofore conducted under the name and style of Robert Brunton Company in the manufacture and production of said motion pictures. The offer was accepted by the corporation, the assets transferred, and the stock issued as called for. Following this, it being necessary *730 to procure a working capital for the corporation, Brunton and two of his associates, Levee and Hickman, interested two men of large means, Hutton and Danzinger, and negotiated a contract to which the first named three individuals, the corporation, and the last named two individuals were parties. By this contract it*2809 was provided among other things that Hutton and Danzinger would subscribe to 50,000 of the 100,000 shares of treasury stock of the corporation at par; that Brunton and associates would convey to them, as a bonus, 50,000 of the 149,993 shares theretofore issued and also subscribe personally for 20,000 shares of the treasury stock at par, the latter to be paid for by surrender and cancellation of $21,000 in promissory notes of the corporation held by them and representing money advanced the corporation by them; that Brunton would individually purchase 7,500 shares of the treasury stock at 65 cents per share; that Brunton would not sell any of the stock held or to be purchased by him for a period of two years, would devote his entire time to managing and directing the corporation during that time with option given the corporation of two additional years' service; and that the aggregate of the compensation paid officers of the corporation for the succeeding five years should not exceed $60,000 per year. Capital stock was subscribed for, paid for, and issued in accordance with the foregoing agreement. Robert Brunton started as a scenic artist on the legitimate stage, and later he*2810 was one of the pioneers of art directing in the motion picture business. He had a very broad knowledge of the motion picture business and was experienced as a general supervisor and producer of pictures. Prior to August, 1918, much publicity had been given to his name with reference to his ability as an art director, and he was very highly regarded. He received at least one offer for his services of $1,000 per week in 1918. Robert Brunton is dead, his connection with petitioner having ceased in December, 1921. On February 24, 1920, a reorganization was effected whereby a new corporation by the same name, "Robert Brunton Studios, Inc.," was chartered under the laws of the State of Delaware and took over all assets and liabilities of the Arizona corporation and the latter thereupon suspended. In 1922 the name of petitioner was changed to "United Studios, Incorporated." M. C. Levee was an officer of both the Arizona and Delaware corporations during the periods in controversy and executed for both, returns for those years. The assets, business, and income here involved were from August 18, 1918, to February 24, 1920, the property of the Arizona corporation and during the balance*2811 of the calendar year 1920 were the property of the Delaware corporation. In setting up its books upon organization in 1918, the Robert Brunton Studios, Inc., balanced the stock issue of 149,993 shares by *731 allocating portions of same at par to the various assets acquired as follows: Equity paid for under option$41,062.70Good will50,000.00Original value of lease and option35,000.00Original value of contracts23,930.30Total149,993.00In determining the deficiencies here appealed from respondent allowed, for invested capital purposes only, the item of $41,062.70 as representing the stock issue of 149,993 shares. The Arizona corporation made a return for only the calendar years 1918 and 1919, and the Delaware corporation made a return for the full period from January 1 to December 31, 1920. In making such returns these two corporations included in their asset accounts, subject to depreciation, as an item of cost of the studio facilities and equipment, the $35,000 set up as the value of an option to purchase acquired for a similar amount of stock at par, and on this item deducted depreciation as follows: 1918$2,860.4919196,964.9919206,964.99*2812 Upon account of the items of $50,000 and $23,930.30, allocated to "good will" and "contracts," the Arizona corporation for the years 1918 and 1919, and the Delaware corporation for the year 1920, made deductions for exhaustion as follows: 191819191920Good will$16,666.66$16,666.67Contracts$9,870.9514,358.18All of these deductions were disallowed by respondent. The assets covered by the option to purchase acquired by Brunton from the Paralto Studios, Inc., had on August 18, 1918, a cash value of $35,000 in excess of the $125,000 required to be paid thereunder, or a total value of $160,000, and the payment of this sum of $125,000 by Brunton and the Robert Brunton Studios, Inc., cleared these assets of all prior liens and liabilities. OPINION. TRUSSELL: The deficiency notice dated July 27, 1925, and which is made a part of the petition filed, asserts deficiencies for the three calendar years 1918, 1919, and 1920, against the "Robert Brunton Studios, Inc., 5341 Melrose Ave., Los Angeles, Calif." *732 There are two issues presented for decision in this appeal - (a) what amounts, if any, may be included in petitioner's invested*2813 capital for the taxable years involved as representing assets stated to consist of an option to purchase certain tangible assets, together with an equity in such assets represented by payments made under the option, the good will of an individual business and three contracts, all of this property having been acquired for stock, and (b) whether or not a deduction from gross income is allowable on account of exhaustion of such assets. A decision on the first issue requires little discussion. Much testimony has been introduced with respect to the value of the assets in question but value in this instance is not the basis for computation of invested capital, as the acquisition of these assets was from an individual for stock issued in an amount in excess of 50 per cent of the total authorized capital stock of the corporation, and section 331 of the Revenue Act of 1918 applies, limiting the amount to be included in invested capital on account of the assets to their cost to the previous owner from whom acquired. The record shows no cost to Robert Brunton of the assets in question, other than payments totaling $41,062.70 made by him on the purchase price of the property covered by*2814 the option to purchase. No question is raised as to the action taken by respondent in respect to the equity in this property represented by the sum of these payments, its full cost having been allowed by him. This asset is the only one of the several acquired for the stock in question which shows a cost to the previous owner and respondent's determination of invested capital is approved. The second issue presents a different question, as the values of assets, allowable for purpose of computation of deductions from income on account of exhaustion, under section 234(a)(7) of the Revenue Act of 1918, are not subject to the limitations imposed by section 331 of that Act. ; . Let us consider the assets separately. A total of 149,993 shares of stock of a par value of $149,993 was issued for four assets, one of these being an equity in property of $41,062.70, representing cash payments already made on account of the purchase price. To this asset the corporation allotted a book value of $41,062.70. To the remaining three assets the corporation allotted the balance of the stock*2815 issue at par in the sum of $108,930.30, divided as follows: Good will$50,000.00Contracts23,930.30Option to purchase35,000.00108,930.30*733 If these values are provable as of the date of acquisition and the assets are depreciable in character, petitioner is entitled to deduction of a reasonable allowance for exhaustion. ;; . Petitioner's insistence is that the asset described as good will and which was acquired for 50,000 shares of stock issued was not the good will of the old business of Robert Brunton Co. but was a contract made by Robert Brunton to give his entire service to the corporation for a period of two years, with option given the latter for two years additional, and that the limitation of $60,000 per year placed on the aggregated salaries of all officers of the corporation by that agreement gave the corporation his services at a figure greatly below what he might expect to receive from other companies. It is insisted that although this item is designated as good will it really represents*2816 a contract for service to be rendered which had a great value above the salary to be paid and that the period of that service was in fact three years and this gave a basis upon which its value may be depreciated. We are satisfied from the record that Brunton was a man of great ability and experience in his profession, with a fine reputation, personal influence and good will. There is no doubt that his services were of great value to the corporation, probably in excess of the salary he drew. However, all other questions aside, the record shows clearly that this contract for services, which petitioner insists constituted the value of the item of good will and was the basis of its estimate of $50,000 ascribed to that value, was not acquired for the issue of stock in question. Brunton was in no way obligated to render service to the corporation as a consideration of the stock received. The contract for his services was executed on October 4, 1918, more than a month after the sale and transfer to the corporation of the assets in question for 149,993 shares of stock, and is shown to have been entered into as one of the considerations for the purchase of 50,000 shares of treasury stock*2817 at par by two wealthy investors, Hutton and Danzinger. Brunton was the holder of three-fifths of the corporate stock and it was essential to obtain cash capital and desirable to interest wealthy investors who would give financial strength to the corporation. Hutton and Danzinger were of this character, but, as a condition of their investment, they required of Brunton a contract to serve the corporation for a definite term and a share of his stockholdings as a bonus. Petitioner only claims a value for the item of good will as a result of the contract for service, and this we find was not acquired for the stock issued, but was an asset acquired later without cost to the corporation, and *734 any value which it might have is accordingly not the basis for a deduction for exhaustion. ; ; Aside from this question, however, the record shows that the asset actually acquired for this issue of 50,000 shares of stock was not Brunton's contract of service but the good will of the old business known as "Robert Brunton Company. *2818 " The contract detailing the transaction describes it in clear and unmistakable terms as: 6th. Generally the Good Will of Business of the business of said Robert Brunton heretofore conducted under the name and style of Robert Brunton Company in the manufacture and production of said motion pictures. The proof also gives a picture of the motion picture industry, and this business in particular, which shows that good will existed and had a very definite value. In fact we have no doubt that its value was equal to the par value of the 50,000 shares of stock issued therefor, but such conclusion does not make a loss in value of that asset due to the death of Robert Brunton the subject of a deduction under section 234(a)(7) of the Revenue Act of 1918 in arriving at net income. The three contracts for production of motion pictures which Brunton assigned the corporation as one of the considerations for the issue of 149,993 shares of stock and to which the latter allocated $23,930.30 par value of the stock issued, and which value it now seeks to prove and to be allowed to depreciate, are shown to our satisfaction to have had an intrinsic value. Moreover, the action of the officers*2819 of the corporation in the exercise of their best judgment in placing a value of $23,930.30 on these contracts when acquired, although not sufficient in itself, in this instance, to carry the burden of proof of such value, is evidence of actual value. . These contracts provided in the case of the Pathe Company for two pictures at $15,000 each, with a conditional bonus in each case of $3,000. The other contracts provided for rental of the studio to the producing companies for $500 per week and properties at a percentage of their cost and for reimbursement of the corporation at cost plus 10 per cent profit for any additional labor and material expended by it. The use of the properties of the corporation under these latter contracts was not exclusive, the corporation reserving the right to contract with other companies for their use concurrently and to use them itself during this time in the production of motion pictures. Under these latter contracts there was no possibility of loss to the corporation. They meant an absolutely certain income, the amount of which was dependent upon the time to produce the *735 pictures and*2820 the additional amount of scenery, sets, etc., which the corporation would be required to construct at the expense of the producer, and these conditions appear to us to be ones which could be calculated in advance with reasonable accuracy by the officers of the corporation. In other words, it appears to us that at the time when these officers placed a value of $23,930.30 on these contracts the facts were in their possession upon which men of the character and experience that the record shows them to be could have made a correct valuation. Certain of these officers testified at the hearing as to their valuation of the contracts and as to the reasonableness of that valuation in their opinion, both in the light of the facts then existing and now known after performance of the contracts. The net profit from these contracts is not shown, but it does appear in evidence that from the Pathe Company and Helen Keller Co. contracts, gross income of $24,095.52 and $57,000 was received during the balance of the calendar year 1918, and it is very apparent from the record that the operations of the corporation were profitable from its inception. We are of the opinion that petitioner has sustained*2821 sufficiently the burden of proof that the contracts in question had a reasonable value of $23,930.30. It appears that these contracts were performed in the calendar years 1918 and 1919, and the value assigned them is the basis for the deductions for exhaustion over those years, as made by petitioner. The remaining question pertains to the asset consisting of an option to purchase the properties of the Paralta Studios, Inc., acquired by the Arizona corporation from Brunton, and to which it ascribes a value of $35,000 on its books, balancing thereby a similar amount at par of the total stock issued to Brunton and associates. In respect to this item there is no proof as to a value for the property represented by the option to purchase held by the Paralta Studios, Inc., on the real property which it leased, which option was included in the assets covered by the option to purchase given Brunton by that company, but there is ample proof that the studio facilities and equipment had a value in excess of the $35,000 plus the option price of $125,000. This property is shown to have cost the Paralta Studios, Inc., a sum very largely in excess of $125,000 and the payment of that price*2822 under the option secured it clear of indebtedness. Its value was placed by witnesses in the neighborhood of $200,000. We conclude that the option to purchase had a reasonable cash value of $35,000 when acquired by Brunton from the Paralta Studios, Inc., under the proof showing that the property covered by it was worth that sum in excess of the option price of $125,000 or $160,000. *736 Robert Brunton, however, exercised the option and paid $41,062.70 on the purchase price and what the Robert Brunton Studios, Inc., acquired for the issuance of stock in the amounts of $35,000 and $41,062.70 to Brunton was the $160,000 property itself subject to an indebtedness thereon of $84,937.30 which the corporation thereafter paid off. This total of $160,000 represents the cost of these studio facilities and equipment in cash and stock to the corporation and this total is subject to depreciation for the taxable years in question. There appears to be no issue as to rate of depreciation upon the property. The deficiencies will be redetermined in accordance with the foregoing findings of fact and opinion. Reviewed by the Board. Judgment will be entered pursuant to Rule 50.*2823 STERNHAGEN concurs in the result. SIEFKINSIEFKIN, dissenting: The findings of fact in these proceedings show that Robert Brunton Studios, Inc., the Delaware corporation, did not exist until 1920 and that it acquired the assets and liabilities of the Arizona corporation of the same name, "and the latter thereupon suspended." It seems to me that we lack jurisdiction to pass upon the deficiencies asserted against the Arizona corporation, which must be for the years 1918 and 1919 (and possibly part of the year 1920). Neither the statute nor the rules of the Board permit a joint petition or a petition by other than the taxpayer. Whichever corporation filed the petition in this proceeding may require us to pass upon its tax liability, but we can not go further and pass upon the liability of someone other than the petitioner. The petition in Docket No. 7477 is verified by the president of United Studios, Inc., the same corporation as Robert Brunton Studios, Inc., the Delaware corporation, except for the change of name. The verification reads: M. C. LEVEE, being duly sworn, says that he is the President of the petitioner above named (name changed since 1920 from*2824 Robert Brunton Studios, Inc. to United Studios, Inc.); that as such officer and because of his connection and activities in the business and affairs of the Robert Brunton Studios, Inc., an Arizona company, and the Robert Brunton Studios, Inc., a Delaware company, he is thoroughly familiar with the situation brought about by the proposed action of the Commissioner of Internal Revenue resulting from audit of the corporation's books and records for the years 1918, 1919 and 1920; * * * I think it is obvious that the Delaware corporation is attempting to obtain a redetermination of the deficiency asserted against the *737 Arizona corporation. I believe the proceeding in Docket No. 7447 should be dismissed for lack of jurisdiction. MARQUETTE, TRAMMELL, ARUNDELL, VAN FOSSAN and MURDOCK agree with this dissent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619569/ | George M. Breidert and Lorraine L. Breidert, Petitioners v. Commissioner of Internal Revenue, RespondentBreidert v. CommissionerDocket No. 256-67United States Tax Court50 T.C. 844; 1968 U.S. Tax Ct. LEXIS 70; September 11, 1968, Filed *70 Decision will be entered for the petitioners. T, executor of his father's will, filed a formal waiver of his right to receive statutory commissions some 14 months after qualifying as executor. On the facts it is determined that he never intended to receive, nor did he in fact ever receive, any such commissions. Further, the estate did not have sufficient liquid assets to pay any such commissions. Held, petitioner may not be charged with having constructively received executor's commissions for income tax purposes, notwithstanding the fact that an estate tax return was filed claiming a deduction for "estimated" executor's fees, and notwithstanding a court order which erroneously contained a provision authorizing the payment of executor's fees. William Katz, for the petitioners.Martin R. Simon, for the respondent. Raum, Judge. RAUM*844 The Commissioner determined a deficiency in petitioners' income tax for the year 1963 in the amount of $ 5,466.37, all of which is in dispute in these proceedings. The sole issue is whether petitioner George M. Breidert constructively received executor's fees of $ 9,100.20 in 1963.FINDINGS OF FACTSome of the facts have been stipulated, and, as stipulated, are incorporated herein by this reference along with accompanying exhibits.George M. Breidert and Lorraine L. Breidert resided in Corona del Mar, Calif., during 1963, and filed a joint Federal income tax return for that year on the cash basis of accounting with the district director of internal revenue, Los Angeles, Calif. At the time of filing of the petition herein, George M. Breidert resided in Newport Beach, Calif.; Lorraine L. Breidert still resided in Corona del Mar, Calif.; George M. Beidert will hereinafter sometimes be referred to as petitioner.Petitioner's father, George C. Breidert, died testate on or about November*72 20, 1961, in Los Angeles, Calif. His will provided for the specific bequest of some minor items of personal property to his wife, Margaret P. Breidert, and directed that the rest, residue, and remainder of his estate be conveyed to Margaret P. Breidert and petitioner as trustees of a testamentary trust. The entire net income of this trust was payable to Margaret P. Breidert for her life, and upon her death the remainder was to be split into two equal shares; one-half to be distributed to petitioner, the other one-half to be held in trust for Evelyn Breidert Rude, the testator's daughter, for her life, and distributed upon her death to her lawful issue, subject to a trust in the case of issue under 25 years of age. Evelyn Breidert Rude had one child, Nancy Joan McLaughlin.Margaret P. Breidert was designated executrix under the will, and petitioner was named alternate executor "should she be unable or unwilling *845 to serve." She was in fact unable to serve because of illness, and never qualified or served as executrix. She died on July 1, 1962.Petitioner was duly appointed by the Superior Court of the State of California for the County of Los Angeles, and qualified as executor*73 of the estate of his father, George C. Breidert, on January 11, 1962. He performed services for the estate in this capacity throughout 1962 and until the final distribution of the assets of the estate in 1963. There was no provision in the testator's will for compensation to the executor.On or about January 30, 1963, a Federal estate tax return, Form 706, was filed by petitioner as executor of the Estate of George C. Breidert. The return, prepared by a firm of tax accountants and by petitioner's attorney, William Katz, disclosed a total gross estate of $ 268,125.35, less allowable deductions of $ 18,814.45 and the $ 60,000 exemption, leaving a taxable estate of $ 189,310.90. Among the items claimed as allowable deductions on the return was one for "estimated" executors' commissions of $ 9,000. When petitioner's attention was directed to the fact that the estate was claiming a deduction for executor's fees, he expressed his desire not to receive such fees. However, his attorney assured him that an amended return could be filed in the event that executor's fees were waived, and convinced him to wait until the filing of his final account as executor, when State law required that*74 he either demand or waive such fees. No such amended return was thereafter presented to petitioner by his attorney and none was filed. Petitioner never intended to receive any executor's fees.On or about March 22, 1963, petitioner, as executor, filed his "First and Final Account and Report, Petition for Distribution, and for Attorney's and Accountants' Fees" in the Superior Court of the State of California for the County of Los Angeles. Such account disclosed assets in the Estate of George C. Breidert remaining for distribution after the payment of all claims and expenses of administration except attorney's and accountant's fees (including the one-half community share of his wife, Margaret P. Breidert, who was deceased at the time of the filing of this account), of the following types and in the following amounts:Cash on hand and in banks$ 1,875.78Home at 4804 Vineta Ave., La Canada, Calif45,000.00Industrial property located at 13690 Vaughn St., San Fernando221,800.00Furniture and furnishings located in the home at 4804 Vineta Ave1,187.001960 Chevrolet automobile1,100.00Stock in Ilg Electric Ventilating Co.:235 shares -- common4,230.001 share -- preferred100.00Stock in the G. C. Breidert Co., San Fernando, 1,118.5 shares --common190,145.00465,437.78*75 *846 The G. C. Breidert Co. mentioned above was a closely held California corporation in which the decedent, George C. Breidert, had served as chief executive officer.Petitioner requested the Court to allow the accounting firm of Kahan, Seltzer, and Eckstein the sum of $ 5,000 for tax accounting services to the estate, and to allow William Katz, who served as petitioner's attorney in the administration of the estate, his statutory fees of $ 9,100.20 plus extraordinary fees of $ 5,000. Petitioner did not, however, request any fees for his services as executor, and in fact expressly stated in his petition to the Superior Court that: "the Executor herein hereby waives his extraordinary fees and all of his statutory commissions herein."The Estate of George C. Breidert possessed insufficient cash on hand to pay even the accountant's or attorney's fees at this time, and the devisees of the estate did not wish the other assets sold to satisfy these claims. Petitioner therefore informed the court:That the Cash on Hand in the amount of $ 1,875.78 will be expended for the payment on account of the fees of the accountants or attorney for the Executor; that the amount of such Cash *76 on Hand is insufficient to pay all of the fees payable by and to be allowed in this Estate. It is the desire of the devisees and legatees of said Estate to keep and retain all of the remaining assets of this Estate intact, and said legatees and devisees will provide the Executor with the necessary funds with which to pay in full the fees of the accountants and the attorney for the Executor herein, allowed in this Estate, and said legatees and devisees will adjust between themselves all matters pertaining to the advancement of said funds.On or about April 17, 1963, an "Order Settling Final Account and Decree of Distribution Under Will," prepared by petitioner's attorney, William Katz, was signed and entered by the Superior Court of the State of California for the County of Los Angeles. Besides decreeing the final distribution of the estate, the order allowed accountant's and attorney's fees in the amounts requested in the petition. Due to the negligence of petitioner's attorney in drawing up the order, provision was made in the order for the allowance of statutory executor's fees in the amount of $ 9,100.20 to petitioner. The order provided, in part:That the executor, George M. *77 Breidert, has waived his claim for extraordinary commissions and he is hereby allowed the sum of $ 9,100.20 as and for his statutory commissions as such executor; * * * that the amount of cash on hand in said estate is insufficient to pay the commissions of the executor or the fees of the certified public accountants or the fees of the attorney for the executor hereinabove allowed; that the devisees and legatees of said estate have expressed their desire to keep and retain all of the assets of said estate intact and to personally pay the commissions of the executor and the fees of the certified public accountants and the attorney for the executor outside of this estate, and pursuant to such request, the legatees and devisees of this estate are hereby ordered and directed to personally pay to George M. Breidert, as executor, the sum of $ 9,100.20 *847 as and for his statutory commissions as executor, the sum of $ 5,000.00 to Kahan, Seltzer and Eckstein hereinabove allowed as fees for services rendered by said certified public accountants, and the sum of $ 14,100.20 to William Katz, hereinabove allowed as and for ordinary and extraordinary services rendered by said William Katz*78 as attorney for the executor.Petitioner's attorney had intended that the order conform to the petition earlier filed with the Superior Court, which had provided that petitioner waived all executor's fees, statutory and extraordinary. The allowance of statutory commissions to petitioner was the result of inadvertence on his part or on the part of his secretary, or both, in that the order was prepared by copying or following another form in another case. However, no attempt was ever made to amend this order. Petitioner did not know of and did not approve the provision for executor's fees in the order, and intended to waive all executor's fees in connection with his father's estate.No formal books or records were maintained by petitioner as executor of the Estate of George C. Breidert, and no record or notation of any kind was ever made by the estate to indicate that petitioner was entitled to any amount as executor's fees, nor was any amount ever set aside for him or credited to his account for this purpose. Petitioner did not at any time request payment of executor's fees from the estate or from any of the devisees or legatees of the estate, and did not actually receive any*79 amount as executor's fees during the year 1963 or at any other time. An affidavit to this effect, dated May 24, 1966, was sworn to by petitioner and submitted to the Internal Revenue Service.Petitioner did not actually or constructively receive any executor's fees in 1963.OPINIONPetitioner was appointed executor under the will of George C. Breidert, his father, on January 11, 1962, and served in that capacity until the approval of his final account and the decree of final distribution by the Superior Court of California for the County of Los Angeles on or about April 17, 1963. No provision was made in the will for executor's fees or commissions, but under California law, petitioner was entitled to compensation for his services as executor according to a statutory schedule. Cal. Prob. Code sec. 901 (West Supp. 1967). Although the attorney for the Commissioner noted in his opening statement that the Government was putting petitioner to his proof that he never actually received executor's commissions during 1963, there no longer seems to be any dispute that petitioner did not in fact receive any amount as executor's fees in 1963 or any other year, and in any event we think*80 that this has been established by petitioner's evidence and have so indicated in our findings of fact. The primary contention of the Commissioner now is that petitioner "constructively" *848 received executor's fees in 1963 in the sum of $ 9,100.20, the amount to which he was entitled as statutory commissions, either because he failed effectively to waive his right to such commissions or because his waiver was made after his right to the commissions had matured to the point at which he could not avoid realization of the income by refusing to accept it. We hold that petitioner made an effective waiver of his statutory commissions and that he is not chargeable with the constructive receipt of income in respect of those commissions in 1963.Although petitioner had an "absolute" right to statutory commissions for his services as executor, such right did not "accrue" under State law until an order for payment was made by the Probate Court, see In re Johnston's Estate, 47 Cal. 2d 265">47 Cal. 2d 265, 272, 303 P. 2d 1, 6, and petitioner was entitled to make a binding waiver of his right to commissions at any time before the court ordered payment. See*81 In re Estate of Davis, 65 Cal. 309">65 Cal. 309, 310, 4 Pac. 22. Petitioner did so in his "First and Final Account and Report, Petition for Distribution, and for Attorney's and Accountants' Fees," filed with the Probate Court on or about March 22, 1963, in which he stated that "the Executor herein hereby waives his extraordinary fees and all of his statutory commissions." Consistent with this declaration, he made no request in the petition for an allowance of executor's fees, nor was any supplemental request ever made. Subsequently, petitioner's attorney inadvertently provided for the allowance and payment of statutory executor's fees to petitioner in the "Order Settling Final Account and Decree of Distribution" prepared by him for the court, and the court's failure to correct this error resulted in a decree ordering the legatees and devisees of the estate to pay statutory commissions of $ 9,100.20 to petitioner. But petitioner never attempted to enforce this provision in the court's order, and, according to his testimony, was not even aware of its existence until a short time before the trial herein. Moreover, in light of petitioner's earlier waiver*82 and the fact that the inclusion of the provision for executor's fees in the final order was the result of clerical error, we doubt whether any such attempt would have been successful. In these circumstances, it would be open to any devisee of the estate to obtain a nunc pro tunc order correcting the original decree by eliminating the provision for allowance and payment of executor's fees in conformance with petitioner's intent as expressed in his petition to the Probate Court. See In re Doane's Estate, 62 Cal. 2d 68">62 Cal. 2d 68, 396 P.2d 581">396 P. 2d 581, 41 Cal. Reptr. 165. Certainly, petitioner's affidavit to the Internal Revenue Service and his testimony and that of his attorney in these proceedings would make it impossible for petitioner to oppose this order, and we are satisfied that, despite the inadvertent allowance of executor's fees to petitioner in the final decree of the Probate Court, such fees were effectively waived by him so that he could not then and cannot now receive them.*849 Not only did petitioner waive his right to executor's fees, he did not even have sufficient cash on hand in the estate after paying the claims*83 of creditors and the expenses of administration to pay himself such fees had he desired them. In fact, the cash on hand was insufficient to cover the fees of the attorney and the accountants who rendered substantial services to the estate. There was never any point at which executor's fees in the amount of $ 9,100.20, or any other sum, were credited to petitioner's account, set apart for him, or otherwise made available to him either by the estate or by the legatees and devisees of the estate. See sec. 1.451-2, Income Tax Regs. Thus, there is no factual basis here for application of the doctrine of constructive receipt. See Mott v. Commissioner, 85 F. 2d 315, 317-318 (C.A. 6), affirming on this issue 30 B.T.A. 1040">30 B.T.A. 1040, 1044-1045; Estate of W. H. Kiser, 12 T.C. 178">12 T.C. 178, 180; S. A. Wood, 22 B.T.A. 535">22 B.T.A. 535, 537, Cf. Weil v. Commissioner, 173 F. 2d 805 (C.A. 2).Although the Government's principal contention is based upon "constructive receipt," a doctrine that we have found inapplicable on the facts of this case, it also suggests that*84 petitioner must be charged with the exectuor's fees because he "earned" them. It does not go so far as to argue that an executor may never waive his fees so as to prevent them from being included in his gross income, but it relies upon certain revenue rulings (Rev. Rul. 66-167, 1 C.B. 20">1966-1 C.B. 20; cf. Rev. Rul. 64-225, 2 C.B. 15">1964-2 C.B. 15; Rev. Rul. 56-472, 2 C.B. 21">1956-2 C.B. 21) to support its position that petitioner must in any event be accountable for the executor's fees. The precise theory of these rulings is not clear. Rev. Rul. 66-167, supra, appears to indicate that an executor may waive his right to compensation without incurring income tax liability, and the test is whether the waiver "will at least primarily constitute evidence of an intent to render a gratuitous service" (p. 21). Accordingly, if a waiver is made "within a reasonable time" after commencing to serve, it is regarded as "consistent with an intention to render gratuitous service" (headnote), but "if the timing, purpose, and effect of the waiver make it*85 serve any other important objective, it may then be proper to conclude that the fiduciary has thereby enjoyed a realization of income by means of controlling the disposition thereof" (p. 21). We need not consider whether this represents sound theory, because from our appraisal of the evidence we think petitioner never had any intention to receive compensation for his services, and that the factual foundation for applying the ruling against him is absent.To be sure, the record before us contains material that is confusing and contradictory in respect of petitioner's intentions. Much of the confusion is attributable to the bungling manner in which petitioner's counsel handled the matter. But we are satisfied from the evidence as *850 a whole, with particular reliance upon our impression of petitioner himself on the witness stand, notwithstanding contradictions in his testimony, that petitioner never in fact intended to receive any executor's fees, and that the subsequent written waiver merely formalized that intention.We hold that petitioner could render gratuitous services without subjecting himself to income tax liability therefor and that the factual basis does not exist*86 on this unusual record to charge him with having realized income on the theory of the revenue rulings, whatever that may be.Decision will be entered for the petitioners. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619570/ | Otto T. Mallery and Louise Mallery v. Commissioner. Otto T. Mallery v. Commissioner.Mallery v. CommissionerDocket Nos. 108606, 108605.United States Tax Court1943 Tax Ct. Memo LEXIS 362; 1 T.C.M. (CCH) 891; T.C.M. (RIA) 43169; April 13, 1943*362 Peter V. D. Voorhees, Esq., 20 Exchange Place, New York City, Samuel B. Stewart, Jr., Esq., and Howard H. Yocum, Esq., for the petitioners. Paul E. Waring, Esq., for the respondent. TYSON Memorandum Findings of Fact and Opinion Respondent determined deficiencies in income tax against petitioners in docket No. 108606 in the sum of $5,031.67 for the calendar year 1935 and against petitioner, Otto T. Mallery, in docket No. 108605, in the sum of $1,982.34 for the calendar year 1936. A loss on certain Bayshore Company preferred stock is claimed in each docket number; so if the loss is allowed for one of the two years its allowance for the other is automatically precluded. Petitioners claim an overpayment for the year 1935 in the amount of $8,452.87 in the event we decide both (a) that certain Bayshore Company preferred stock owned by Otto T. Mallery became worthless in that year and (b) that a certain indebtedness to Otto T. Mallery evidenced by a certificate of beneficial interest issued by the Costilla Trust became worthless and was so ascertained to be and charged off by Otto T. Mallery in that year. The first issue is whether or not petitioners are entitled to a $25,000 bad debt*363 deduction from gross income for the year 1935 in connection with a first lien certificate of beneficial interest in the Costilla Trust. The second issue concerns the year in which Bayshore Company preferred stock became worthless. The proceedings are consolidated. Findings of Fact Petitioners are husband and wife residing in Philadelphia, Pennsylvania. They filed a joint return for the calendar year 1935 with the collector of internal revenue for the First District of Pennsylvania. Petitioner, Otto T. Mallery (hereinafter referred to as Mallery), filed an individual return for the calendar year 1936 with the same collector. On November 14, 1908, the Costilla Estates Development Company (hereinafter referred to as the Development Company) was incorporated under the laws of Nevada for the purpose of acquiring approximately a half million acres of land in the San Luis valley, partly in Colorado and partly in New Mexico, and of developing the land as farming and grazing tracts with an irrigation system, railroad, and three towns. During the period from 1908 to 1920 Mallery made substantial investments in Series A and Series B bonds of the Development Company which are not here involved. *364 During part of this time he was a director of the Development Company. On July 21, 1921, pursuant to a plan proposed by a protective committee for bondholders of the Development Company for the purposes of raising new money and of avoiding foreclosure proceedings and expenses incident to receivership, the Costilla Trust (hereinafter referred to as the Trust) was created to become the beneficial owner of all the stock and all the Series A and B bonds of the Development Company. Security holders of the Development Company transferred their holdings therein to the trustees under the Trust and also contributed new money to the Trust. In exchange for the new money so contributed the trustees issued five percent first lien certificates to the contributors in an amount of twice the amount of the money contributed. In accordance with the plan Mallery contributed $25,000 of new money for which he received first lien certificate of beneficial interest of the Costilla Trust (hereinafter referred to as the Certificate), dated November 25, 1921, in the face amount of $50,000. The following statement appeared on the face of the Certificate: THIS CERTIFIES that * * * OTTO T. MALLERY * * * is *365 entitled, in respect of moneys advanced in aid of the consummation of the Plan proposed in Circular of said Hughes et al. Committee dated May 31st, 1921, to receive from the Trustees under said Declaration, as and when cash realization upon the trust assets shall have become such that the Trustees are able, and consider it expedient to distribute the same, the sum of * * * FIFTY THOUSAND * * * Dollars $50,000.00 * * *) with interest at the rate of five (5) per cent per anunm reckoned from the first day of July, 1921. In 1923, in order to avoid the high interest rate and pressing maturities of temporary loans, the trustees of the Trust arranged for a $100,000 bond issue on Colorado lands of the Development Company, secured by a mortgage dated May 1, 1923 having priority over all other liens on such lands. In 1924 Mallery purchased a bond in the face amount of $1,000 out of that issue. From 1921 to 1934, inclusive, the Development Company sustained operating losses in excess of $140,000 during each of such years and in 1935 a loss of $85,611.65. These losses were due principally to deductions of interest accrued on bonds of the Development Company which during all those years were *366 held by the Trust and none of which interest had been paid. The total of these operating losses was $2,675,449.37. In October 1932 the trustees issued a report to the holders of its certificates and obligations in which it was stated inter alia: that the $100,000 bond issue on the Colorado lands secured by the mortgage of May 1, 1923 and interest thereon in the amount of $11,000 was overdue; that there were outstanding tax sales certificates on certain real estate of the Costilla Estates Development Company in the amount of nearly $70,000; that there were also outstanding unpaid taxes on certain other of such lands in the amount of over $70,000 with interest and penalties thereon; that if the tax sales certificates were not paid the holders would have to assert the lien of the certificates against the real estate; and that the taxes must be paid or settled in order to preserve the trust property. The report stated further that the matured and unpaid bonds and the outstanding tax sales certificates and unpaid taxes constituted a menace to all the assets of the Trust; and that it was apparent that only the raising of additional funds to pay the matured bonds, tax certificates, *367 unpaid taxes, future taxes, and operating deficits could save anything out of the Trust properties. The report stated further that if $100,000 could be raised for use in paying unpaid taxes and tax sales certificates it was the expectation of the trustees that an arrangement could be made with the bond holders as to past due bonds. The report further stated that to raise the funds required the formation of a new corporation was contemplated and that in case of failure to secure sufficient stock subscriptions there would have to be a complete liquidation of all the Trust assets, probably through a receivership in which event "all interests in the Trust would be of doubtful or diminished or no value". The report urged all beneficiaries under the Trust to subscribe stock in the suggested new corporation. No new corporation was formed as contemplated by the report until the Costilla Land Company was organized, as hereinafter shown, on December 1, 1934. From 1932 to 1935 Mallery kept in touch with the situation regarding his investment in Costilla Estates Development Company and the Costilla Trust only through letters and reports of the trustees received by him. From the time of receiving*368 the October 1932 report Mallery failed to make any further investment in the Trust or the Development Company or in any proposed new company; but in the early part of 1935 considered the matter of investing in the proposed new company but gave up the idea when another holder of the Trust certificates declined to join him in engaging an expert on Western land values to investigate the value of their investments in the Trust. The trustees received no additional funds as a result of this October 1932 report, except that persons friendly to the Trust, including two of the trustees, formed a syndicate which put up $17,500. This sum was used to purchase tax sale certificates on Colorado lands and to pay taxes on approximately 30,000 acres of New Mexico grazing lands. Up to January 31, 1935, neither the trustees nor the Development Company had the funds with which to repay the syndicate the $17,500 and take over the tax liens acquired by it. Mallery received a report from the trustees, dated January 31, 1935, which stated, inter alia, that on December 1, 1934, a new company, the Costilla Land Company, had been organized under the laws of Nevada and that the trustees expected to cause*369 the Development Company to transfer all its assets to the new company. Beneficiaries under the Trust, including Mallery, were to be given the privilege of buying stock in the new company at par. Mallery received another report from the trustees, dated August 23, 1935, stating that the trustees had caused the Development Company to turn over all its properties to the Costilla Land Company and that stock was being issued to persons who provided the necessary capital to protect the property. This report also stated, in part, as follows: The Trust has no other property or assets and accordingly the Trust has now been completely terminated. All Trust Obligations and Certificates issued under the Declaration of Trust dated July 21, 1921, are without any value. Upon receipt of the August 23, 1935 report, Mallery wrote a pencil notation to his secretary, Miss Vail, on the upper right-hand corner of the report, saying: "Vail - claim loss in income tax". He also drew a circle around the part of the report which stated that these certificates were "without any value" and a line from the circle to the notation as an indication to his secretary that the loss on his certificate was to be claimed*370 on his income tax return. At the same time he made a mental charge-off of the certificate as worthless. Mallery did not keep a formal set of books or records of investments in 1935 and the practice which he followed of making the notation to his secretary instructing her to claim the loss on his income tax return was his normal method of charging off a loss. Petitioners filed joint income tax returns for the years 1932 and 1933 reporting net losses of $50,000 and $48,000, respectively, and showing no tax payable. In April 1936 petitioners filed a joint income tax return for the year 1935 with the word "tentative" typed on it. No deduction was taken in that return with respect to the certificate owned by Mallery because he did not have complete information as to the total amount which he thought might be deductible by reason of the total loss on his investment in the Costilla Trust and his A and B Bonds of the Development Company. Because of his uncertainty as to the total loss which might be claimed he took no deduction on his original return, but marked the return "tentative" with the intention of claiming the full amount of his loss when he had ascertained it. By letter dated*371 September 14, 1936, Mallery wrote to the collector of internal revenue, Philadelphia, informing him of the Costilla loss of $25,000 and explaining that when making his 1935 tentative return he had been unable to get complete information as to his total loss. In reply to this letter the collector requested Mallery to prepare and execute an amended return. Mallery complied with this request by filing such return. The original return marked "tentative" showed capital gains on securities held over ten years of $5,975.44. The amended return showed capital losses on securities held over ten years of $19,024.56. The difference of $25,000 represented the inclusion in the amended return of the Costilla loss to the extent of the investment in the first lien certificate. In filing the amended return Mallery erroneously limited the $25,000 Costilla loss to thirty percent thereof because he was under the mistaken impression that the loss had to be treated as a capital loss. In his determination of the deficiency respondent disallowed the $25,000 deduction on the ground that petitioners had not made a satisfactory showing that the certificate had become worthless during 1935 and that there had*372 not been a charge-off in that year. Mallery's certificate became worthless in 1935; should have been and was so ascertained by him; and was charged-off by him in that year. On August 24, 1938, petitioners in docket No. 108606 filed a claim for refund for the year 1935 in the amount of $8,531.50. The dates of certain of their payments on income tax for 1935 and the amounts thereof are as follows: $3,426.45 on September 18, 1936; $2,764.36 on October 6, 1936; and $2,340.69 on April 12, 1937. During the period from December 4, 1925 to January 16, 1927, Mallery purchased 50 shares of the preferred stock of the Bayshore Company at a total cost of $5,250, a certificate for same being issued October 8, 1928. He remained owner of this stock through 1936. Mallery's investment in the preferred stock was a long term speculative investment which depended for its success upon the growth and development of Jacksonville, Florida. The Bayshore Company was incorporated in 1925 under the laws of Florida for the purpose of acquiring a large body of land near Jacksonville, Florida; for the construction of a toll road through this property along the north shore of the St. Johns River to a terminus*373 near the mouth of the river and the Atlantic Ocean; and to offer the property for sale for residential, industrial, and beach development. From its organization to May 31, 1928 the Bayshore Company issued its preferred stock in the amount of $2,038,500, from the proceeds of which and from other sources it expended $556,300 for 17,000 acres of land and their development; $1,088,000 for the toll road and other construction; and $39,700 for equipment, furniture, fixtures, and deferred charges. In 1928 the Bayshore Company issued ten year 8 percent debenture gold bonds in the face amount of $700,000 to pay off its current and mortgage indebtedness and leave a working capital of $232,000 for an extension of the toll road and other improvements. As of May 31, 1928 the Bayshore Company had no liabilities except the $700,000 of outstanding 8 percent debenture gold bonds and its capital surplus at that time was estimated to be $232,280.86. During 1928 the real estate holdings of the Bayshore Company were appraised by the Jacksonville Realty Board, who assigned a sound present value to the lands of $2,547,651. This appraisal figure was carried on the balance sheet as of May 31, 1928 of the*374 Bayshore Company as the value of the land. The toll road was carried on the balance sheet at $1,531,391 as cost of its construction plus value of right-of-way. The total fixed assets of the company, as shown by the balance sheet, including an office building leasehold at $56,974.11 exceeded $4,000,000. In accordance with an option contained in its bond indenture, the Bayshore Company during the period from March 15, 1929 to March 15, 1932 paid $56,000 interest per annum arising on its bond indebtedness in scrip. On May 1, 1931, the Bayshore Company leased an office building in Jacksonville, Florida from the Southeastern Investment Company for a term of nine years and eight months for a total rental of $116,000, payable at the rate of $1,000 a month. On September 15, 1932, the Bayshore Company defaulted in the payment of interest on its outstanding $700,000 of ten year 8 percent debenture gold bonds and has paid no interest since that time. On December 1, 1932, it defaulted under the terms of its lease with the Southeastern Investment Company. In February 1933, pursuant to an action by the trustee on the bond indenture securing the payment of the $700,000 of bonds instituted in*375 the United States District Court for the Southern District of Florida, a receiver was appointed by the court to take over all of the company's property and he continued to operate the property through November 1936. In February 1933 the Southeastern Investment Company intervened in the receivership proceeding asserting damages for breach of the lease. On February 27, 1933, the receiver gave notice to the Southeastern Investment Company that he had elected to disaffirm and reject the lease. On March 30, 1935, a special master's report in the receivership proceedings awarded damages to the Southeastern Investment Company in the amount of $53,475. Of this amount $34,575, representing damages from April 1, 1935 through December 31, 1939, was to be reduced to its present cash value as of the date of the report. The report awarded to the Southeastern Investment Company the further amount of 10 percent of the total amount of its damages. This report was confirmed by the court on October 29, 1935. In February 1933 a committee was formed to protect the interest of the bondholders of the Bayshore Company. From 1932 to 1936, inclusive, the Bayshore Company had gross income of $10,914.39, *376 $5,048.79, $8,798.54, $8,785, and $5,542.29, respectively, as shown on its income tax returns. Its net losses also so shown for the same years were $235,725.18, $15,741.85, $107.08, $3,819.84, and $65,815.18, respectively. The Bayshore Company continued until 1936 to own substantially all of the assets which it had ever acquired. The consolidated balance sheet as of May 31, 1936 of the Bayshore Company and the Bayshore Water & Light Company, a small wholly owned subsidiary, and an analysis of the assets and liabilities of the two companies, both by the receiver, showed the Bayshore Company to have outstanding capital stock in the amount of $3,519,465.67, of which amount $2,019,466.67 represented preferred stock; total assets of $3,569,698.92; total liabilities, not including capital stock, of $941,730.60; and a deficit of approximately $891,000 including capital stock as a liability. From this balance sheet and analysis there was erroneously omitted as a liability the amount of $196,000 interest due on the bonds from September 15, 1932 to March 15, 1935, inclusive, which increased the deficit shown on the balance sheet and analysis by such amount. By August 24, 1936 all of the major*377 claims against the Bayshore Company, except its obligations to its security holders, had been disposed of or adjusted. On that date, the court gave judgment for the trustee in its action on the bond indenture in the sum of $1,120,000, plus interest, and ordered all of the property of the Bayshore Company to be sold. Such sale was made on October 5, 1936, at a public auction, and the bondholders' protective committee bid in such property for $300,000, subject to the approval of the court. On November 17, 1936, the court tentatively approved a plan of reorganization filed by the bondholders' committee dated November 10, 1936, as well as the sale for $300,000 subject to the right of any debenture holder or other creditor whose claim had been allowed by the final decree entered by the court or by any preferred stockholder of the Bayshore Company to file written objections thereto with the court on or before December 4, 1936, the objections, if any, to be considered at a hearing on December 7, 1936. The plan of reorganization, tentatively approved by the court on November 17, 1936, contained the following provisions relative to the preferred stock of the Bayshore Company: The debenture*378 holders have recovered judgment for the sum of $1,120,000 and interest, making the total obligation of the Company to them $1,287,377.70. The only bids at the sale, with the exception of the Committee's bid of $300,000, were scattered bids of small amounts for isolated portions of the property. In view of these facts the Committee feels that there is no possible equity in the preferred or common stock of the Company and this stock has therefore been disregarded in this Plan with one exception hereinafter noted. * * * * * * * *Each holder of the preferred stock of the old Company is to receive the right to subscribe to the Series A mortgage bonds [of a proposed new corporation] to the extent of 1% of the par value of his old holdings, or a total for all preferred stockholders of $20,288, with the right to over-subscribe and be allotted any portion of said Series A mortgage bonds not subscribed for by debenture holders or other preferred stockholders. In addition, each present preferred stockholder exercising such right will receive 25 shares of the $1 par value common stock of the new corporation for each $1,000 subscribed. [Brackets ours.] No objections were filed to either the*379 sale or the plan of reorganization and the hearing was continued from December 7 to December 14, 1936 in order for the bondholders' committee to make good their bid of $300,000 for the properties of the Bayshore Company. On December 14, 1936, the committee had failed to make good their bid and consequently to consummate the plan of reorganization, but, instead, filed on that date, an amendment to the original plan of reorganization. The amendment contained this provision concerning the preferred stock: Each holder of the old preferred stock of the old Company is to receive the right to subscribe to the new mortgage bonds of the new Company to the extent of 1% of the par value of his old holdings with the right to over-subscribe and be allotted any portion of said new mortgage bonds not subscribed for by the old debenture holders or other preferred stockholders. Each holder of the old preferred stock of the old Company so subscribing to the new mortgage bonds of the new Company is to receive new mortgage bonds of the new Company to the face amount of his subscription plus 25 shares of the new common stock of the new Company for each $1,000 subscribed. On December 14, 1936, the court*380 ordered that the matter be continued until January 11, 1937 at which time the bondholders' committee was to produce in open court in cash, or by certified check, the funds necessary to carry out their bid and the proposed amended plan of reorganization. Mallery in his 1936 income tax return reported $5,136.41 as a capital loss on his Bayshore Company preferred stock erroneously claiming such loss to the extent of thirty percent thereof, or $1,540.02. Respondent disallowed this loss in his notice of deficiency. The Bayshore Company's preferred stock, including that of petitioner, became worthless in 1936. Opinion TYSON, Judge: The first issue is whether or not petitioners are entitled to a deduction of $25,000 as a bad debt for the year 1935 by reason of the worthlessness of the Trust certificate held by Mallery. Petitioners contend that the certificate became worthless in 1935. Respondent contends that it became worthless or reasonably should have been ascertained to have become worthless prior to that year, and more specifically in 1932, and that the loss was not charged off in 1935 by petitioners as required by section 23 (k) of the Revenue Act of 1934. 1*381 In determining whether a taxpayer has ascertained a debt to be worthless the courts differ in the test to be applied. Some say the test is an objective one; that is, the proper year for deducting a bad debt is the year in which the taxpayer, as a reasonably prudent person, should have ascertained the debt to be worthless. Others apply the subjective test, namely, the proper year for such deduction is that in which the taxpayer himself actually ascertained the debt to be worthless. See . In the case at bar we think that in applying either test petitioners have met the requirements of the statute as to ascertainment. The strongest support for a contention made by respondent, that petitioner as a reasonably prudent person should have ascertained the certificate to be worthless prior to 1935, is found in the report of the trustees of the Costilla Trust, in October 1932, to the certificate holders. That report, in effect, stated that unless additional funds were raised to pay the matured first mortgage bonds, overdue taxes, tax sales certificates, and operating deficits, the Trust assets would have to be liquidated, *382 probably through a receivership, in which event all interests in the Trust would be of "doubtful or diminished or no value". Respondent points to petitioner's failure to invest any more funds in the enterprise after receiving this report as indicating that petitioner did ascertain, or should have ascertained, the certificate to have become worthless prior to 1935 and more specifically in 1932. While it is true that the report of October 1932 painted a pessimistic picture we do not believe that it indicates that the Trust certificates were then entirely worthless. In fact, the report was issued in an effort to save valuable properties which still remained as security for the certificates; and this being true it could not be said that the certificates then had no value. Nor do we think the fact that petitioner failed to invest new money in the enterprise an indication that he had ascertained the certificate to be presently worthless. He might reasonably have considered the enterprise to have such poor future prospects as not to warrant the risk of losing additional funds and yet believed his certificate then had value. Neither are the large operating losses suffered by the Development*383 Company of vital significance for the reason that such losses were due, to a large extent, to the accrual of interest on the bonds of the Development Company held by the Trust. Such losses did not result in an actual decrease in the assets securing the certificate, but merely increased the indebtedness to the certificate holders. In view of the fact that the Development Company continued its existence under its own management until 1935, we think that Mallery was justified in considering his certificate of some value until 1935 when he received notice from the trustees specifically stating that it had no value. It was in that year when all the assets securing the Trust certificates were turned over to a new company and, therefore, in that year when Mallery could point to a specific identifiable event establishing the worthlessness of his certificate. Accordingly, we have found as a fact, and so sold, that Mallery's certificate became worthless and was properly ascertained to be worthless in 1935. In addition to ascertainment of worthlessness petitioners must also show that Mallery made a charge-off of the debt represented by the certificate in 1935. The record shows that Mallery*384 kept no books, but that upon receipt of the notice from the trustees that the Trust certificates were worthless he penciled thereon a notation to his secretary to the effect she was to claim a loss on the certificate in his income tax return. At the same time he also made a mental charge-off of the worthless certificate. We think the notation and instruction to his secretary as well as the mental charge-off sufficiently complied with the applicable statute. See ; ; and . Neither does the fact that petitioners did not claim the deduction on the original "tentative" return preclude them from being entitled to the deduction. Cf. Petitioners indicated their intention of filing another return for the year 1935 by marking the original return "tentative". Respondent later permitted them to file an amended return on which the petitioners erroneously deducted as a capital loss only thirty percent of Mallery's loss on the certificate. Such*385 characterization does not prevent petitioners, under the circumstances of this case, receiving the benefit of a bad debt deduction if entitled to same. Mallery properly charged off the loss on his certificate as having occurred in 1935. We conclude that petitioners are entitled to a bad debt deduction from their gross income in 1935 in the amount of $25,000, the cost of the Trust certificate to Mallery. The second issue is whether the Bayshore Company preferred stock owned by Mallery became worthless in 1935 or 1936 or prior to those years. Petitioners contend that it became worthless in one of those years and respondent contends that petitioner has failed to sustain the burden of proof that the stock became worthless in either year. In what year Mallery's stock became worthless is a question of fact to be determined from identifiable events evidencing present worthlessness as opposed to imminence of worthlessness. ; . On the second issue it is our opinion that the record establishes*386 that the Bayshore Company stock became worthless in 1936 and we have so found as a fact. At the outset it should be borne in mind that the venture for which the Bayshore Company was organized and in which it engaged was speculative. It was a real estate development company whose success depended on the growth of Jacksonville, Florida. Thus there was always the potentiality, so long as the company owned its extensive real estate holdings including the toll road, that it might realize large profits from the operations and sale of such holdings. In 1928 the value of these holdings was written on the company's books to a sound value as determined by the Jacksonville Realty Board. These assets were practically the same in 1936 as they were in 1928. The value was written on the company's books after the termination of the Florida real estate boom; so that it is reasonable to assume that such value did not change materially thereafter. It is true that the company had operating deficits which prevented it from meeting its obligations as they matured and that this occasioned the receivership proceedings and the company's eventual downfall. Nevertheless, these deficits far from reduced the *387 book value of the company's assets to below its liabilities. Even as late as March 31, 1936 the balance sheet prepared by the receiver showed the company to have assets exceeding liabilities, exclusive of capital stock, of approximately $2,627,968.32. So even including the liability of $196,000 for interest on bonds, omitted from this balance sheet, the company had assets exceeding liabilities of approximately $2,431,968.32. The fact that the Bayshore Company went into receivership in 1933 does not establish that Mallery's stock was worthless in that year. The receivership was obviously caused by reason of the company's inability to meet its liabilities as they matured. The mere fact of the establishment of a receivership and its continuation does not establish worthlessness. ; ; ; and . Here, although the corporation went into receivership in 1933 it continued at least until in 1936 to operate its business and to retain*388 nearly all of its real estate holdings. Also, as stated above, the balance sheet after receivership showed the company to have assets of a value much in excess of its liabilities exclusive of capital stock. Under these circumstances we cannot say that receivership was the identifiable event which determined Mallery's stock to be worthless. Cf. ; ; and The identifiable events which we believe establish the worthlessness of the Bayshore Company preferred stock were: first, the sale of all of the company's property on October 5, 1936 for $300,000 at open bidding in a public auction upon a judgment rendered by the court on August 24, 1936 in favor of the bondholders in the sum of $1,120,000 plus interest, or a total of $1,287,377.70, which judgment, together with that in favor of the Southeastern Investment Company, it was necessary to satisfy through a judicial sale of all of Bayshore Company's assets before any realization could be had on that company's preferred or common stock; and second, the plan*389 of reorganization proposed by the bondholders' committee and tentatively approved by the court on November 17, 1936 wherein the facts concerning such judgment and sale were set forth, followed by a statement that "In view of these facts the Committee feels that there is no possible equity in the preferred or common stock of the Company". Upon the happening of these two events in 1936 any possibility of preferred stockholders in Bayshore Company realizing on their stock vanished. Westly V. E. Terhune, supra; It is true that the sale of all the property of Bayshore Company for $300,000 was not confirmed by the court in 1936, but it is shown that no interested party filed objections to such confirmation after being duly notified to do so if they had objections and the reason for the court's not so confirming the sale, as indicated in the court's orders, was not because of the inadequacy of the bid but was because the bondholders' committee purchasing the property failed to produce the necessary funds to comply with its bid. The judicial sale at open competitive public bidding, even though but tentatively confirmed in 1936 by*390 the court, conclusively indicates, in our opinion, that thereafter there remained no possibility of obtaining at a further judicial sale, which would have been necessary if the bid of $300,000 was not finally confirmed by the court, an amount in excess of the judgments against Bayshore Company so as to leave any value in its preferred stock. The fact that the bondholders' committee had been unable to obtain the necessary funds to comply with its bid by the end of 1936 is further evidence of the worthlessness of the preferred stock of Bayshore Company in that year for it indicates that the bid price for the property might have been too high. Accordingly, we have found as a fact, and so hold, that Mallery's preferred stock in the Bayshore Company became worthless in 1936 and that he is entitled to a deduction from gross income for that year of the full amount of such loss. As stated in the opening paragraph, this holding automatically precludes the allowance of the deduction for the same loss in 1935. Decision will be entered under Rule 50. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: (k) BAD DEBTS. - Debts ascertained to be worthless and charged off within the taxable year * * *↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619571/ | AMORY L. HASKELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Haskell v. CommissionerDocket No. 103967.United States Board of Tax Appeals46 B.T.A. 164; 1942 BTA LEXIS 892; January 27, 1942, Promulgated *892 A corporate distribution in liquidation was made to the petitioner in the taxable year. Held on the facts, that it was not made in complete liquidation of the corporation under section 115(c), Revenue Act of 1936, since not made in accordance with a plan specifying completion of liquidation within two years from the close of the year; held, further, that the corporate resolutions in later years did not effect, in the taxable year, a specification of the time limitation. Ambrose L. O'Shea, Esq., for the petitioner. Dean P. Kimball, Esq., for the respondent. DISNEY*164 OPINION. DISNEY: This proceeding involves income taxes for the calendar year 1937 in the amount of $33,479.82, the entire deficiency determined. The question for examination is whether income received by the petitioner was distributed as a part of a complete liquidation by a corporation under section 115(c) of the Revenue Act of 1936, 1*165 or whether gain is to be recognized under section 117(a) of the Revenue Act of 1936. 2*893 The case was submitted upon stipulations, and exhibits attached and referred to therein. Certain objections to some of the exhibits were overruled, and we find the facts to be as so stipulated. We set forth herein only those portions thereof deemed pertinent to discussion of the issue. The petitioner, who filed his income tax return for the calendar year 1937 in the first district of New Jersey, at Camden, New Jersey, was a stockholder in, and the president of, Triplex Safety Glass Co. of North America, hereinafter referred to as the company. He received from the company in 1937 as distributions in liquidation and reported as income the sum of $143,157.10. He computed his income tax on the theory that the distributions were in complete liquidation of the company, and therefore reported taxable long term gain, under section 117 of the Revenue Act of 1936, of 40 percent on certain preferred stock held more than five years at the date of the distribution and 30 percent on certain common and preferred stock held for more than ten years at the date of the distribution. There seems no dispute as to the periods of holding, the amounts received, or the actual gain realized. The*894 respondent determined that the distributions were received in partial liquidation and included 100 percent of the gain in petitioner's income, resulting in the deficiency above stated. The question, therefore, turns upon whether the company distributed to the petitioner in 1937, by way of complete liquidation as petitioner argues, or partial liquidation as respondent contends, conceding that there was distribution in liquidation. From December 31, 1928, until after the taxable year the company, organized to manufacture reinforced glass, was in litigation over alleged infringement of its patents. The result, after the case had been taken to the Supreme Court of the United States and sent back to the District Court, was a master's report on July 9, 1937, recommending that the company recover from Pittsburgh Plate Glass Co. (hereinafter called Pittsburgh) $1,560,378.59. On July 29, 1937, Pittsburgh paid the company $1,008,585.08 on the account, which amount was accepted under written stipulation that payment was *166 without prejudice to further claims. With due diligence, the company on October 28, 1637, brought before the District Court its motion to confirm the master's*895 report. On February 17, 1938, that court held that Pittsburgh was liable to the company for $1,520,378.59. Cross-appeals were perfected May 24, 1938, and the case was argued and submitted to the Third Circuit Court of Appeals on the record and briefs on December 12, 1938. On January 29, 1940, the matter was reargued to the Third Circuit Court of Appeals, pursuant to its directions. Delay in the decision of the matter was due to the reargument, and was beyond the control of the company. Decision was rendered by the Circuit Court on March 7, 1940. The company on its income tax returns for 1930 to 1932, inclusive, reported as accrued income amounts claimed to be due for the patent infringement involved in the litigation above described. Prior to a resolution of its stockholders on November 16, 1937, below described, the company's officers had considered the possibility of Federal income tax for that year because of the payment from Pittsburgh and had computed a possible maximum income tax of $199,156.20, and set up a reserve therefor at that time of about $200,000. In March 1938 an internal revenue agent reported to the company that its 1937 income and excess profits tax liability*896 was $197,465.46. The company had been advised by counsel at the time of the resolutions in 1937, and was advised later that there was, in counsel's opinion, no income or excess profits tax liability in 1937 upon the payment from Pittsburgh. The claim for excess profits tax was successfully resisted, and on July 16, 1938, the Commissioner allowed the claim of the company for exemption from the provisions of the capital stock tax law and has not since claimed that the company is subject thereto. Resistance to income tax being unsuccessful, it was paid June 13, 1939, claim for refund was filed, and on January 5, 1940, suit was filed for recovery in the amount of $136,727.62. That suit was still pending at the time of the hearing herein. From January 1, 1937, to the present time the company has engaged in no activities other than the prosecution of the above detailed litigation, and tax controversy with the United States Government over its income, capital stock, and excess profits taxes; and since November 16, 1937, the date of the above mentioned adoption of resolutions by the company's stockholders, has been in process of winding up its affairs. The claim for patent infringement*897 was at all such times practically the only asset of the company. On August 26, 1937, the president of the company stated the situation to a directors' meeting, reciting the payment received from Pittsburgh, the prosecution of the claim for the balance found due by the master, the fact that the company had certain obligations, *167 and possible tax liability (though counsel had advised otherwise) for which it was recommended that about $240,000 be reserved, leaving, out of the payment from Pittsburgh, $531,000. He suggested that a stockholders' meeting consider liquidation of the company, as of December 3, 1937. The board of directors accordingly resolved to retain $240,000 for possible tax claims, current expenses, and patent litigation, and that $531,000 be distributed in liquidation of the company as of December 3, 1937, that a special meeting of stockholders be called to approve such action, and that the officers be authorized to take steps necessary to collect the balance due from Pittsburgh. Notice was given of a special meeting of stockholders to be held November 16, 1937, for the purpose of considering authorizing the prosecution of the claim for the remainder*898 due from Pittsburgh, to authorize the officers to proceed with the orderly liquidation of the company and distribute funds currently available in liquidation, to appoint an agent for the complete liquidation of preferred stock and partial liquidation of common stock, and to distribute, on surrender of the certificates for cancellation $154.50 per share of preferred stock in complete liquidation thereof, and after setting aside a sum sufficient for complete liquidation of the preferred stock, to pay out $1.70 per share in partial liquidation of the common stock, all as of December 3, 1937. A letter from the president of the company accompanied the notice of the stockholders' meeting, explaining the situation as above outlined and the existence, after payment of obligations and reserves for liabilities, of funds sufficient to completely liquidate preferred stock and partially liquidate the common stock. On November 16, 1937, the stockholders passed resolutions authorizing the reservations for liabilities, the continuance of prosecution of the claim of the balance due from Pittsburgh, and the liquidation of the company, in full as to preferred stock and partial as to the common stock, *899 and to that end to appoint an agent to take steps to accomplish the complete liquidation of the preferred stock and partial liquidation of the common stock, and to pay as of December 3, 1937, $154.50 per share in full liquidation of the preferred stock on surrender of the certificates for cancellation and $1.70 per share in partial liquidation of the common stock. It was further resolved: And pursuant to paragraph 3, sub-division (d) of the Notice of the Meeting, dated October 14, 1937, that the officers be and they are hereby empowered at their sole and full discretion to make any other and further disbursements the Common Stockholders as may be warranted, should there by any further receipt on account of damages from Pittsburgh Plate Glass Company between this date and December 31, 1937. On November 22, 1937, the president and the secretary of the company wrote a letter to the stockholders, notifying them that on *168 November 16, 1937, at a special meeting, the stockholders had resolved to authorize the complete liquidation of the preferred stock and the partial liquidation of the common stock, and notifying the stockholders to surrender the certificates of preferred*900 stock for cancellation and the certificates of common stock for endorsement stamp. The petitioner, pursuant to such notice, surrendered his certificates of common stock for stamping, and about December 3, 1937, received thereon $102,523.60 and the subsequent return of the certificates; also surrendered his certificates of preferred stock and received in payment therefor $40,633.50. On March 25, 1938, a special meeting of the board of directors of the company was held at which there was considered a proposition from Pittsburgh that they would pay the additional claim for patent infringement in the amount of approximately $515,000 provided the company would not appeal on the question of interest, but otherwise a cross-appeal on the question of $515,000 would be taken. After discussion including consideration of possible income tax, though it was stated counsel advised there was such liability in the matter, it was resolved that counsel be instructed to proceed with an appeal, and that the views of some of the larger stockholders be obtained on the subject. On September 19, 1938, the internal revenue agent in charge wrote the petitioner proposing adjustments resulting in a deficiency*901 of tax in the amount of $33,479.82 in effect because of the view expressed that though it appeared to be the intention of the company to liquidate the entire capital stock of the company, the facts available did not indicate that the plan of liquidation specified a time in which the transfer of the property is to be completed and that it was held therefore that the distributions were not in complete liquidation of the corporation within the meaning of section 115(c) of the Revenue Act of 1936. At a directors' meeting on October 25, 1938, the president of the company stated the situation, in effect, that $199,160 had been reserved for tax liabilities, that on November 16, 1937, a plan for complete liquidation of the company had been adopted, that though an original assessment of $197,465.48 had been proposed, this upon reconsideration after protest had been reduced to about $1278000, that therefore about 30 cents per share on common stock could be distributed "as a partial distribution in accordance with the plan for complete liquidation of the company as heretofore adopted." The directors passed resolutions accordingly, referring to the previous plan for prompt and complete liquidation*902 of the company and authorizing distribution of 30 cents per share "as a further partial liquidation" and authorizing the officers to take all necessary steps "for such further partial *169 liquidation of the common capital stock" and authorizing the officers to appoint an agent to make such payment "in partial liquidation of the common capital stock", referring further to the distribution to be made "as a further partial liquidation" and further resolving as follows: RESOLVED FURTHER that pursuant to the plan for the complete liquidation and dissolution of this Company, as adopted at the Special Meeting of the Stockholders duly called and held on the 16th day of November, 1937, the officers of this company are hereby directed to complete the liquidation of the Company and to take such steps as may be requisite for the purpose of dissolving the Company not later than December 31, 1939. On November 21, 1938, the stockholders of the company were advised by letter from the president and the secretary that due to decision of the Income Tax Bureau of the Internal Revenue Department the full amount theretofore reserved for Federal taxes need not be maintained and that the directors*903 had released from the reserve an amount sufficient to pay 30 cents per share on the common stock "as a second payment in the series toward the complete liquidation of the Common Capital Stock of the Company." On January 31, 1939, the annual meeting of the stockholders of the company was held. The following resolution was passed: RESOLVED FURTHER that all the acts of the Board of Directors and the officers of the Company in distributing the sum of $54,679.50 as a further partial liquidation of the common stock of the company, pursuant to the plan heretofore adopted by the stockholders of this Company for the prompt and complete liquidation and dissolution of the company be and the same are hereby approved, ratified and confirmed. At the regular meeting of the board of directors on February 2, 1939, the chairman reported that in their regular meeting on January 31, 1939, the stockholders had, among other things, "approved a plan for the complete liquidation of the company by December 31, 1939." At the regular quarterly meeting of the directors on October 31, 1939, there was discussion of the fact that the stockholders had authorized dissolution not later than December 31, 1939. *904 The president of the company reported that such dissolution might be impossible by the end of the year since the expected decision of the Third Circuit Court of Appeals had not yet been handed down, although the company was to all intents and purposes already liquidated except for the claim against Pittsburgh. On January 9, 1940, the president and the secretary of the company notified the stockholders that no decision had as yet been rendered by the court and that "Accordingly, it is necessary to continue the corporate existence of our Company until such time as a final determination of that case is had from the Courts." At the annual stockholders' meeting on January 30, 1940, the president *170 reported inter alia that a decision had not yet been rendered by the court and it was therefore not possible to carry out the stockholders' directions for complete liquidation not later than December 31, 1939. Thereupon a resolution was adopted approving the actions of the board of directors in prosecuting the appeal and in instituting a suit against the collector of internal revenue, and repealing the stockholders' resolution at the last annual meeting that the date for complete*905 liquidation be fixed at not later than December 31, 1939, and that in lieu thereof the following resolution be adopted: RESOLVED FURTHER that the date for the complete liquidation and dissolution of the Company be and the same is hereby fixed at not later than December 31, 1940 and that the plan of liquidation adopted at the Special Meeting of the Stockholders held on November 16, 1937 be reaffirmed to the end that the same shall be completely accomplished before December 31, 1940. At a special meeting of the board of directors on March 15, 1940, the officers were instructed to proceed as rapidly as possible in the complete liquidation of the company "and when, as and if the Pittsburgh Plate Glass Company shall have complied with the mandate of the court and liquidated its indebtedness counsel and treasurer be prepared to submit to the Board of Directors a plan for this complete liquidation, distribute to stockholders all assets except what cash will be required to prosecute the claim for tax recovery and to consider the advisability of issuing to each stockholder script for his pro rata share in such recovery if received * * *." At a special meeting of the board of directors*906 on May 13, 1940, a resolution was adopted referring to passage of a resolution for complete liquidation on November 16, 1937, and providing, inter alia, that there is $371,820.60 available for final liquidation to the stockholders and that therefore, pursuant to and in continuation of the plan adopted November 16, 1937, and the resolutions adopted January 31, 1939, as amended, the following plan for the "final and complete liquidation of the Company be and the same is hereby adopted and recommended for adoption by the stockholders * * *." A special meeting of the stockholders was called for June 18, 1940, to pass upon the proposals, which were in effect that all common stock be canceled and $2.04 per share be paid thereon in full and complete liquidation and that liquidating certificates be issued to the stockholders for their interests, if any, in any further liquidation distribution, and "That this plan for final and complete liquidation of the Company be consummated and completed on or prior to December 31, 1940." On Juen 18, 1940, such proposals were, in effect, adopted by the stockholders. The petitioner's position is that he is entitled under section 117(a) of the Revenue*907 Act of 1936 to report less than 100 percent of the gain realized by him upon the corporate distributions received because *171 under section 115(c) of the Revenue Act of 1936 they were received as part of a "complete liquidation" defined by that section as one in complete cancellation of all stock in accordance with a bona fide plan under which the transfer is to be completed within a time specified in the plan not exceeding two years from the close of the taxable year during which is made the first of the series of distributions under the plan. He argues in brief that the company adopted a bona fide plan of liquidation of all of its stock, that the plan specified a date, within two years from the close of the taxable year within which the transfer of the property was to be completed, either in the original plan as shown by corporate resolutions passed in 1937, setting the date as December 31, 1937, or by amendment thereof by corporate resolution in 1938, specifying the period as ending December 31, 1939; further, he says that the statute does not require the distribution actually to be made within the two-year period, and that therefore the fact that it was not so made is*908 immaterial. The respondent on his part, although conceding that the plan was one of liquidation, argues that it was not one of "complete liquidation" within the statute because no time limit was set, and that the resolutions in the following year did not serve, and were not intended to serve to fix a time limit affecting the distribution made in the prior year, and that if there was amendment in 1938 to provide a time limit nunc pro tunc for the distribution made in 1937, then there was in 1940 repeal thereof and a change of the time limit to three years, and that a three-year plan does not come within section 115(c), Revenue Act of 1936. He further argues that the plan was not bona fide because the company was at all times concerned with the question of Federal income taxes, and that the revenue agent had pointed out to the taxpayer the lack of a time limit in the plan. We will first consider what appears to be the point most stressed by both parties, to wit, whether the plan of liquidation specified a time not exceeding two years from the close of the taxable year in which the first distribution is made, within which the liquidation is to be completed. The petitioner*909 says on this point that there was such time specified because of the following language in the stockholders' resolution of November 16, 1937: RESOLVED: * * * (d) And pursuant to paragraph 3, subdivision (d) of the notice of the meeting, dated October 14, 1937, that the officers be and they hereby are empowered at their sole and full discretino to make any other and further distributions to the common stockholders as may be warranted should there be any further receipt on account of damages between this date and December 31, 1937. December 31, 1937, was therefore, he argues, the termination of the time specified. The respondent calls such contention an afterthought *172 and points out that the petition contains no such allegation or view. We think that examination of the pleadings justifies the respondent's view. The petition does allege that the Commissioner erred in holding that no time limit was specified in the resolutions passed by the board of directors and stockholders, and that the Commissioner erred in failing to hold that the resolutions passed November 16, 1937, stated a plan of liquidation, and further erred in failing to hold that by resolutions adopted*910 October 25, 1938, the officers were directed to complete the liquidation not later than December 31, 1939; but neither allegations of error nor the statement of facts relied upon indicate any theory that the resolutions adopted November 16, 1937, contained any specification of time within which liquidation should be completed. On the contrary, the petition indicates a view that on November 16, 1937, a plan of liquidation was stated, and on October 25, 1938, a time limit was specified as two years from December 1937. We think that the petitioner did not at the time of filing this proceeding entertain a theory that the resolutions of November 16, 1937, specified a date within which liquidation was to be completed. Nor do we think that such resolutions did in fact specify such time. When analyzed, the resolution relied upon is found to state that the officers are empowered in their discretion to make distributions to the common stockholders as may be warranted "should there be any further receipt on account of damages between this date and December 31, 1937." It seems obvious to us from the context and the whole tenor of the paragraph that the date December 31, 1937, refers to the*911 time within which there might be "further receipt on account of damages" thereby empowering the officers to make further distributions, but that such distributions might be made at any time thereafter so far as any limitation being set is concerned. It would require distortion of the language to hold that the words "to make any other and further distributions" must be read as if followed immediately by "between this date and December 31, 1937", when the words actually immediately preceding the latter expression and not separated therefrom even by a comma are "should there be any further receipt on account of damages." If there had been any further receipt on account of damages on December 30, 1937, the officers on petitioner's theory would have been authorized to distribute it, yet likewise on their theory they would have been required to distribute it, if at all, on the same date. We think the only reasonable construction calls for reading and considering the language in the order it was actually used and that the officers were empowered to distribute "should there be any further receipt on account of damages between this date and December 31, 1937", but that the time within which*912 they might distribute was in nowise limited. This view *173 is consonant, we think, with the situation at that time. Litigation was pending in the United States Circuit Court of Appeals for the Third Circuit, involving at least $500,000, and complete liquidation was dependent upon the outcome of that litigation. The resolutions of November 16, 1937, arranged for the further diligent prosecution of that litigation and for the expense thereof, including payment of future legal fees. Though of course it is possible that there might have been some hope that by December 31, 1937, only 45 days after the date of the resolutions, such litigation might be terminated and the proceeds thereof ready for distribution, no evidence so indicates and we think that considering the preparations for litigation there can not reasonably be said to have been any such hope. Certainly in our view there was no intent, under all the circumstances, to set only a period of 45 days within which to complete the liquidation. The litigation, in fact, continued for more than two years, and though much of that time is not to be ascribed to any fault or delay on the part of the company, nevertheless we think*913 it obvious that on November 16, 1937, there was no expectation that the corporation could be liquidated by the end of the year. Indeed, upon brief the petitioner, discussing the resolution of October 25, 1938, says: "At that time the appeals in the patent suit had been perfected and were sure to be reached for argument within the following two months." Since apparently some such period as two months is considered by the petitioner reasonable within which to expect argument after perfection of the appeals, it appears to us that the end of litigation, payment and distribution could not have been expected within six weeks after November 16, 1937, before the litigation had reached the state of perfected appeal. Again, in the minutes of the board of directors on October 30, 1939, appears a statement that the previous authorization of the officers to dissolve by December 31, 1939, was discussed, and that the president reported that the dissolution would take place, if possible, but the decision of the court had not yet been handed down "and unless such decision were handed down by the end of the year it might be impossible for the officers actually to dissolve the corporation * * *. *914 " If as late as October 31, 1939, after the litigation had been pursued for almost two years after the date of the resolutions of November 16, 1937, it was still the opinion of the president that dissolution would not be possible unless the decision were handed down by the end of the year, it seems to us wholly unreasonable to think that much earlier in such litigation, on November 16, 1937, there was any expectation that the litigation would be ended, distribution made, and the corporation dissolved by the end of the year 1937. After the decision in the Circuit Court, on June 18, 1940, resolutions provided *174 for final and complete liquidation. Yet the remainder of the year, to December 31, 1940, was allowed therefor - several times as much time as between November 16, 1937, and the end of that year. Indeed, when the various resolutions and corporate acts throughout the year 1937 are reviewed, they contain indications that as to common stock, only a partial distribution was then contemplated; for reference is made in the president's statement on August 26, 1937, to "partial liquidation of the capital stock of the company", while in the resolutions of the directors on the*915 same date reference is made to liquidation of the preferred stock and, thereafter, with the remaining funds to the partial liquidation of the common stock; also to the complete and full liquidation of the preferred stock and the partial liquidation of the common stock. This reference to complete liquidation of preferred and partial liquidation of common stock is repeatedly used in such resolutions, in the notice of the stockholders' meeting to be held November 16, 1937, in the letter of the president accompanying such notice, in the resolutions of November 16, 1937, and in the letter from the president and secretary of November 22, 1937. These recitations throughout that year seem to us to cast doubt upon the idea of a plan of complete liquidation of both preferred and common stock at any time during 1937. We conclude and hold that the language of the resolution of November 16, 1937, does not express or specify a time limit for completion of liquidation within the intendment of section 115(c) of the Revenue Act of 1936. We next consider, therefore, whether, as petitioner contends, the resolutions of October 25, 1938, have the effect of incorporating in the plan of liquidation*916 the requisite specification of time limit. We think they do not have that effect with respect to the distribution in 1937 here involved. It seems to us plain that in order to get the benefit of section 115(c) petitioner must show that at the time of taxability of the distribution to him, there was extant a plan containing the requisite specification of time. The history of the legislation indicates well that the time element was by no means immaterial and that it was intentionally inserted for a purpose. In our opinion, even if we assume an amendment, on October 25, 1938, of the resolutions of November 16, 1937, it should not be given retroactive effect to cover a distribution prior to that time, but that the distribution when taxable to the recipient must have been under a plan containing the statutory requisite of a specification of a time limit for complete liquidation. Otherwise the distribution was not at that time a part of a complete liquidation. Respondent asserts, however, that there was in fact no such amendment. We agree with the petitioner that specific words of amendment are not necessary if the tenor of the resolution in fact constituted *175 the amendment*917 of the earlier resolution. The language relied upon reads as follows: RESOLVED FURTHER that pursuant to the plan for the complete liquidation and dissolution of this Company, as adopted at the Special Meeting of the Stockholders duly called and held on the 16th day of November, 1937, the officers of this company are hereby directed to complete the liquidation of the Company and to take such steps as may be requisite for the purpose of dissolving the Company not later than December 31, 1939. The gist of such resolution, in our opinion, is that the officers of the company are, pursuant to plan adopted November 16, 1937, directed to complete the liquidation not later than December 1, 1939. It does not seem to us that this is an amendment of the earlier plan, but that it is at most a reference to it, and a statement that what is now done is done pursuant to the earlier plan. In our opinion there is neither express nor implied amendment of the earlier plan, and when it is recalled that the lack of a time limit specified in the plan had been called to the attention of the company by a revenue agent prior to the passage of the resolutions of October 25, 1938, it appears that the statement*918 in the language above quoted is a rather selfserving reference to the action as being taken pursuant to the plan of November 16, 1937. We do not think that it serves to affect, modify or amend the plan as it existed throughout the year 1937. Moreover, we find that when it became apparent that because of the litigation the liquidation could not be completed within the time set in the resolution of October 25, 1938, the time was extended, by resolution on January 30, 1940, so as to expire December 31, 1940. This action was of course taken after the expiration of the original time set in the resolution of October 25, 1938, which time expired December 31, 1939. If the resolution of October 25, 1938, was an amendment of the resolution of November 16, 1937, it was repealed expressly by that of January 30, 1940; leaving us to consider the distribution made in 1937, as taken, under petitioner's theory, under a resolution providing for the completion of liquidation within a period of three years from the end of the year 1937. Such period was not, in 1937, allowed, although allowed by section 115(c) of the Revenue Act of 1938. No logic permits us at this time to view the distribution*919 made in 1937 as made under a resolution of October 25, 1938, when in turn that resolution must be on petitioner's theory considered itself repealed, and another substituted in lieu thereof, in 1940. So that if we consider the matter amended at all, it must be considered as amended by the resolution of January 30, 1940. That resolution and three-year period it provides can not be applied under section 115(c) of the Revenue Act of 1936, providing only for a two-year limitation. Under the law then effective, it is plain that *176 the distribution, in order to be free from the effect of section 117(a) of the Revenue Act of 1936, must be under the plan providing a two-year limitation upon completion of liquidation. It is therefore our opinion that the distributions to the petitioner in 1937 were not made under a plan of complete liquidation specifying completion within two years from the end of the taxable year, as required by section 115(c), Revenue Act of 1936. This conclusion makes it unnecessary to consider further questions suggested as to whether the plan of liquidation was bona fide and whether it was necessary for the plan actually to be consummated and the liquidation*920 completed within the two years specified in the plan, which admittedly was not done in this case. We therefore conclude and hold that the respondent did not err in applying to the distributions to the petitioner in 1937 the provisions of section 115(c) of the Revenue Act of 1936 and including in petitioner's income 100 percent of the admitted gain resultant from such distributions. Decision will be entered under Rule 50.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 distribute 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. For the purpose of the preceding sentence, "complete liquidation" includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation and under which the transfer of the property under the liquidation is to be completed within a time specified in the plan, not exceeding two years from the close of the taxable year during which is made the first of the series of distributions under the plan. In the case of amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits. ↩2. SEC. 117. CAPITAL GAINS AND LOSSES. (a) GENERAL RULE. - In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income: 100 per centum if the capital asset has been held for not more than 1 year; 80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years; 60 per centum if the capital asset has been held for more than 2 years but not for more than 5 years; 40 per centum if the capital asset has been held for more than 5 years but not fore more than 10 years; 30 per centum if the capital asset has been held for more than 10 years. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619573/ | MARY V. PYLE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Pyle v. CommissionerDocket No. 17866.United States Board of Tax Appeals16 B.T.A. 218; 1929 BTA LEXIS 2613; April 26, 1929, Promulgated *2613 An overdistribution by trustees under a trust debenture to the life tenant in 1920 does not justify the reduction of the taxable income properly distributable to said life tenant in 1921. William R. Conklin, Esq., Edward S. Bentley, Esq., and Robert W. Owens, Jr., Esq., for the petitioner. Harold Allen, Esq., for the respondent. MORRIS*218 This proceeding is for the redetermination of a deficiency in income tax of $842.86 for the calendar year 1921, and the sole question for determination is whether the respondent erred in disallowing a deduction of $10,637.56, representing an overpayment on account of income to the petitioner in 1920, not discovered by the trustees of the estate of William Scott Pyle until 1921, which said amount when discovered by the said trustees was withheld by them from the petitioner's income for 1921 in order to correct said error. FINDINGS OF FACT. The last will and testament of William Scott Pyle, deceased husband of the petitioner, provided, in so far as applicable here: THIRD: I give, devise and bequeath unto my Executors hereinafter named, all the rest, residue and remainder of my property real and*2614 personal of whatever nature and wherever situated, to have and to hold the same in TRUST during the life of my wife Mary Vanderhoef Pyle and also until my son William Scott Plye attains the age of twenty-five years or during his life if he should fail to attain the age of twenty-five years, for the following purposes, to collect the rents, profits and income arising therefrom and to pay the same to my said wife in quarter-yearly installments. * * * *219 The decedent nominated and appointed his wife and his brother, James Tolman Pyle, executors and trustees under his will. Samuel W. Fairchild, who succeeded James Tolman Pyle, trustee, and Mary V. Pyle, as trustees under the will of the decedent, and Adelaide McAlpin Pyle, individually, entered into an agreement under date of January 28, 1920, with Adolph Pricken for the sale to said Pricken of certain land and buildings located at 132-8 King Street, New York City, for $1,000,001, with the understanding: * * * That within the parcel above described there are certain strips of land which the Title Guarantee and Turst Company reports in exceptions I, J, K, and L of their report #748131, outstanding in the City of New York, *2615 and it is agreed that Sellers will, at their own expense, with all reasonable effort and speed, endeavor to acquire title to said strips. It Sellers are unable to acquire such title within six months they shall notify Purchaser in writing, which must, within ten days thereafter, elect whether it will take title to said parcels on the terms herein stated, but without title to said strips or refuse to take title, in which latter event, Sellers will return the deposit made hereunder with interest at 2% per annum from date of deposit to date of return, and shall also pay the reasonable costs of the examination of the title to the said premises, but not to exceed the rate charged by the Title Guarantee and Trust Company for such services where no policy of title insurance is issued, and contract then shall be cancelled and become null and void, and neither party shall be liable to the other for any damages, costs and expenses whatsoever except as above set forth. The deposit specified in the foregoing agreement was $25,000. The sellers were unable to secure title as required in the foregoing understanding within the period of time stipulated and the purchaser thereupon exercised his*2616 option and agreed to cancel the contract. The $25,000 was not returned to Pricken, however, in accordance with the terms of the contract, for the reason that said Pricken had been a tenant of one of the buildings on King Street and had not paid rent for several months, with the result that he owed the sellers approximately $21,000. The sellers deducted from the $25,000 the amount of Pricken's indebtedness and gave him a check for the balance amounting to $4,459.26. Under date of September 1, 1920, Adelaide McAlpin Pyle, individually, and Mary V. Pyle and Samuel W. Fairchild, as trustees aforesaid, entered into an agreement with one Theodore Southard, a dummy for Pricken, for the sale to the latter of the same properties provided for in the agreement with Pricken under date of January 28, 1920, for $1,100,000, payable $25,000 in cash upon signing the contract, with the understanding "that the said Twenty-five thousand Dollars ($25,000) is a part of the consideration for this contract and that the Sellers are under no obligation to return it in case the purchaser refuses or fails to take title hereunder through his fault;" and the balance as therein specifically mentioned. *220 *2617 Pricked paid the $25,000 required under the foregoing contract. It having been provided in the agreement of September 1, 1920. that the deed to the premises should be delivered upon the receipt of specified payments on December 1, 1920, and it having been understood and agreed that time was of the essence of the contract, the same parties entered into another agreement on November 30, 1920, extending the date for said delivery: * * * In consideration of the payment by the Purchaser of the additional sum of Twelve thousand ($12,000) Dollars on account of the purchase price of said property, receipt whereof is hereby acknowledged (Five thousand ($5,000.) Dollars of which said sum the Sellers shall be under no obligation to return in case the Purchaser refuses or fails to take title under said contract as hereby amended) said sum of Five thousand ($5,000.) Dollars and the Twenty-five thousand ($25,000.) Dollars paid on signing of said agreement of September 1st, 1920 being liquidated damages in case the Purchaser refuses or fails to take title hereunder through his fault, and in further consideration of the payment of the sum of Ten thousand ($10,000.) Dollars on January 15th, 1921*2618 in cash or by certified check, said sum of Ten thousand ($10,000.) Dollars to be credited against the purchase price of said contract, and the further agreement by the Purchaser that upon the sale of certain warehouses on Washington and West Streets which he is endeavoring to sell, that he will pay to the Sellers under this contract on the passing of the title to said Washington and West Streets properties the further sum of Fifteen thousand ($15,000.) Dollars or Twenty-five thousand ($25,000.) Dollars in cash or by certified check, said amount to be credited against the purchase price as agreed. * * * The contract of September 1, 1920, and the modifying agreement of November 30, hereinabove, were further modified by agreement under date of January 25, 1921, by which, in consideration of further promises on the part of the purchasers, the sellers agreed to adjourn the time for closing title to the properties until April 1, 1921. They further agreed that in the event the purchaser failed to take title on said date, through his fault, the sums of $25,000 and $5,000 mentioned in the two preceding contracts should be liquidated damages and be retained by the sellers. Pricken was*2619 finally unable to take title and the $30,000 deposit was forfeited. Samuel W. Fairchild, trustee, petitioned the court on or about February 1, 1921, to relieve him of his duties as trustee, and he was succeeded by George Leask. When the trust property was taken over by the said Leask and his cotrustee, Mary V. Pyle, it was divided into three groups, (1) that real and personal property which the estate owned outright, and (2) that property owned by James T. and William Scott Pyle, referred to as the joint account, consisting of real property valued at approximately $750,000, and (3) property owned by the heirs of James Pyle and the William Scott Pyle estate, successors to the *221 rights of William Scott Pyle. The estate's interest in the first group was 100 per cent, the second group 50 per cent, and in the third group 25 per cent. Upon the resignation of Fairchild as trustee an accounting was rendered to the Surrogate's Court for the period March 1, 1919, the date of the preceding accounting, to January 15, 1921, in which the transaction growing out of the contract of January 28, 1920, with Adolph Pricken hereinbefore referred to was recorded as "Rent, 132-8 King*2620 Street, to July 31, 1920, Adolph Pricken (see refund August 4, $4,459.26) $25,000." That accounting was duly approved by decree of the Surrogate's Court on March 9, 1921. The trustees filed a fiduciary return of income for the calendar year 1920 showing the total distributable income to the petitioner to be $28,220.44 which she duly reported in her individual tax return for that year. The trustees prepared and duly filed a fiduciary return of income for the calendar year 1921, in which it deducted $10,637.56 in computing the beneficiary's distributable income, to which return there was a note appended, in explanation of said deduction, as follows: Owing to the fact that in the year 1920 a contract was made for the sale of a large block of property, in which this estate had 1/2 undivided interest, and in accordance with the terms of the contract certain money was paid in and out of this money expenses in connection with this proposed sale and also alterations in the nature of betterments to the property were made, the adjustments made when this contract failed in its consummation showed there had been an overpayment on the books of income to the extent of $10,637.56 on which*2621 an income tax was paid by the life tenant, Mrs. William Scott Pyle in 1920. This item is therefore deducted from the income received during the year 1921. The total distributable income and credits to the petitioner according to that return amounted to $21,477.83, which sum agrees substantially with the amount reported by her in her individual income-tax return for the calendar year 1921. In preparing the accounting of the estate for the period January 15, 1921, the date of the preceding accounting, to January 1, 1924, it became necessary to refer to the last accounting made by the trustees, and in doing so it was discovered that because of a discrepancy arising out of the Pricken and Southard transactions hereinbefore discussed, the petitioner's distributable income for the calendar year 1920 had been overstated, and an adjustment was made in said accounting "to correct overdraft of payment on account of income during the year 1920 $10,913.63." That accounting was duly approved by decree of the Surrogate's Court on May 5, 1924. Upon audit of the books of the fiduciary for the taxable year 1921 the deduction of $10,637.56 was disapproved by the revenue agent *222 *2622 saying, "The deduction of $10,637.56, for an overpayment of cash to the beneficiary out of the income account of the estate in 1920, is not a proper deduction. The net income of the estate for 1920, was audited and adjusted to show the amounts of the various classes of income earned and distributable to the beneficiary in 1920. Therefore, the amount of actual cash paid to the beneficiary, whether more or less than her distributive share, does not affect her income tax liability in any year," which finding was approved by the respondent on the ground that that amount "represented an investment in the corpus of the estate by the trustee." OPINION. MORRIS: The facts briefly restated are that the petitioner's distributive income from the estate of William Scott Pyle was, through error, overstated for 1920 by $10,637.56, which error, when discovered by the trustees, was corrected by withholding that amount from the normally distributable income to the petitioner for the year 1921. The petitioner contends, in effect, that, because the Surrogate's Court of New York approved the accounting of the trustees for 1921, in which the sum in question was transferred to the corpus of the estate*2623 instead of being paid to the petitioner, it did not constitute income distributable to her within the meaning of section 219 of the Revenue Act of 1921, and, therefore, was not subject to income tax under that section. Section 219 of the Revenue Act of 1921, in so far as applicable to the question here at issue, provides: (a) That the tax imposed by sections 210 and 211 shall apply to the income of estates or of any kind of property held in trust, including - * * * (4) Income which is to be distributed to the beneficiaries periodically, whether or not at regular intervals * * *. * * * (d) In cases under paragraph (4) of subdivision (a), and in the case of any income of an estate during the period of administration or settlement permitted by subdivision (c) to be deducted from the net income upon which tax is to be paid by the fiduciary, the tax shall not be paid by the fiduciary, but there shall be included in computing the net income of each beneficiary that part of the income of the estate or trust for its taxable year which, pursuant to the instrument or order governing the distribution, is distributable to such beneficiary, whether distributed or not, * * *. Since*2624 the Act provides that there shall be included in computing the beneficiary's net income that part of the income of the trust, which, "pursuant to the instrument or order governing the distribution, is distributable to such beneficiary," and since the provision of the will under which the petitioner became beneficiary provided for the payment to her of all the profits and income arising from the *223 properties held in trust, in quarter-yearly installments, there can be no question but that the entire income and profits of the estate, undiminished in any manner whatsoever, should have been included in computing the petitioner's net income for 1921. Merely because the amount in question was not paid or distributed or, as the petitioner contends, was not "distributable" because of the overpayment in 1920 does not render it any the less income within the meaning of section 219, supra, and, therefore, taxable as such. The trustees simply erred in distributing to the petitioner a greater amount in 1920 than she was rightfully entitled to under the provisions of the trust indenture, which for our purpose must be regarded as creating an obligation on the part of the petitioner*2625 to reimburse the estate, out of future "distributable" income, the amount which had been erroneously credited or distributed to her. The error sought to be rectified occurred in 1920 and it is in that year, at least for income-tax purposes, that it must be corrected. We must, therefore, for the reasons stated, approve the findings of the respondent. Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619575/ | G. PAUL DORSEY, JR. AND KATHLEEN P. DORSEY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; GEORGE P. DORSEY AND MARIE L. DORSEY; LEE CLEMMER DORSEY AND GAYLE J. DORSEY; MARC DORSEY; AND PHILIP J. DORSEY AND MARY D. DORSEY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDorsey v. CommissionerDocket Nos. 15133-86, 1715-88United States Tax CourtT.C. Memo 1990-242; 1990 Tax Ct. Memo LEXIS 247; 59 T.C.M. (CCH) 592; T.C.M. (RIA) 90242; May 17, 1990, Filed Gary J. Elkins, Richard E. Kait, and Jerry F. Palmer, for the petitioners. Linda K. West, for the respondent. PARR, Judge. PARR*834 MEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies in and additions to petitioners' Federal income tax as follows: G. Paul Dorsey, Jr. and Kathleen DorseyDocket Nos. 15133-86 and 1715-88Additions to taxYearDeficiency1 Sec. 6659 Sec. 6653(a)(1)Sec. 6653(a)(2)1981$ 14,445.85$ 4,333.75--1982$ 4,340.20 -$ 217.01 **250 George P. Dorsey and Marie L. DorseyDocket No. 1715-88Addition to taxYearDeficiencySec. 66591981$ 34,778.46$ 10,433.54Lee Clemmer Dorsey and Gayle J. DorseyDocket No. 1715-88Addition to taxYearDeficiencySec. 66591981$ 7,459.00 $ 2,237.70 Marc DorseyDocket No. 1715-88Addition to taxYearDeficiencySec. 66591981$ 3,424.00 $ 1,027.20 Philip J. Dorsey and Mary D. DorseyDocket No. 1715-88Addition to taxYearDeficiencySec. 66591979$ 6,725.30 -1981$ 20,883.14$ 6,264.94 1982$ 3,978.20 $ 1,165.80 Respondent also determined increased interest pursuant to section 6621(c) 2 against the taxpayers for their respective taxable years*251 1981 and 1982. These cases were consolidated for trial, briefing, and opinion. The deficiencies are attributable to a charitable contribution deduction for a conservation easement petitioners gave to Historic Faubourg St. Mary Corporation (hereinafter referred to as "Historic Corporation"), a nonprofit charitable organization. The issues remaining for decision are whether (1) the fair market value of the donated facade easement is $ 245,000; (2) section 170(e) applies to reduce petitioners' contribution amount; (3) petitioners in both dockets are liable for additions to tax under section 6659 and increased interest under section 6621(c) for taxable year 1981; (4) petitioners in docket*252 No. 15133-86 are liable for the additions to tax under section 6653(a)(1), (2), and increased interest under section 6621(c) for taxable year 1982; (5) petitioners Philip and Mary Dorsey are liable for additions to tax under section 6659 and increased interest under section 6621(c) for taxable year 1982; and (6) petitioners Philip J. Dorsey and Mary D. Dorsey are liable for an increase in their 1979 tax due to a reduction in 1982 of the investment tax credit carryback. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts, together with the attached exhibits, are incorporated herein. All petitioners use the cash receipts and disbursements method of accounting. Petitioners G. Paul Dorsey, Jr., and Kathleen P. Dorsey resided in Metairie, Louisiana, at the time they filed the petitions in the above entitled cases. Petitioners George P. Dorsey and Marie L Dorsey; Lee Clemmer Dorsey and Gayle J. Dorsey; and Marc Dorsey, resided in New Orleans, Louisiana, at the time they filed the petition in docket No. 1715-88. *835 Petitioners Philip J. Dorsey and Mary P. Dorsey resided in Metairie, Louisiana, at the time they filed*253 the petition in docket No. 1715-88. During the late 1970's and early 1980's over eight million square feet of new office space in New Orleans, Louisiana, were constructed and readily occupied by major tenants, including oil companies. The demand for additional office space resulted in high rental rates which often exceeded the amount professionals and other office space seekers wished to pay. Accordingly, demand for smaller renovated office buildings increased and office renovation in downtown New Orleans escalated. During this time "Dorsey and Company," petitioners' primary business, occupied office space in one of New Orleans' major office buildings. After 15 years of occupancy petitioners were notified that office space would no longer be available to them on an ongoing basis. Accordingly, they began to look for alternative office space. Petitioners considered acquiring a building in the downtown area because rental rates for comparable office space in that area were relatively inexpensive. As a result, petitioners entered into a "conditional" purchase agreement with Mathilde Fitzpatrick Bowman ("Mrs. Bowman"), to acquire property situated on the corner of Gravier and Magazine*254 Streets in the Picayune Place Historic District of New Orleans, Louisiana (hereinafter referred to as the "Property"). The Property included a three-story improvement believed to have been constructed between 1830 and 1852 and last used as a retail outlet, printing shop, and warehouse. All historically designated buildings within the Picayune Place Historic District are regulated by the Historic District Landmarks Commission (the "Commission") of New Orleans to assure that historic values are maintained. Therefore, owners must seek and receive approval from the Commission before any visible exterior changes are made; i.e., alterations, new construction, and signs. Petitioners retained G. O. Occhipinti ("Mr. Occhipinti"), a structural engineer, to evaluate the costs of acquiring and renovating the Property. In addition, they retained Wayne Collier ("Mr. Collier"), an attorney and real estate developer familiar with facade donations, to discuss with the Commission and Historic Corporation the prospect of making a facade donation. After further consideration and Mr. Collier's recommendation, petitioners concluded that it would be feasible to acquire the Property, make the donation,*255 and renovate the building into first class office space. The events leading to the donation and renovation of the Property were as follows: (1) On November 11, 1981, Barry Fox and Associates, Architects, acting on behalf of petitioners, formally requested the Historic Corporation to consider a facade easement donation of the Property. (2) On November 17, 1981, the Architectural Review Committee of Historic Corporation considered and approved the proposed donation. (3) On November 18, 1981, petitioner Philip Dorsey was informed by Mr. Occhipinti that "in his opinion" it would cost $ 89,900 to restore the exterior of the Property. (4) On December 1, 1981, Ashton B. Avegno ("Mr. Avegno"), a licensed engineer, issued a "Certification of Structural Condition" on the Property, to The McEnery Company, Inc., a professional engineering corporation. The certificate summarized Mr. Avegno's observations and recommendations of the Property's condition and structural soundness. (5) On December 9, 1981, petitioners executed the Articles of Partnership, and formally formed the Gravier Street Partnership (the "Partnership"), a general partnership, under the laws of the State of Louisiana. *256 The Partnership was to "engage in acquisition, holding, owning, improvement, development, and management of immovable properties including construction of buildings, improvements, condominiums, offices and structures of any kind and the disposition and encumbering thereof by sale, lease, mortgage, or otherwise." The Articles of Partnership were filed on December 15, 1981. The partners and their respective partnership interests are as follows: G. Paul Dorsey, Jr.25%George P. Dorsey30%Philip J. Dorsey30%Lee C. Dorsey10%Marc C. Dorsey5%Philip J. Dorsey is the Managing General Partner. (6) On December 16, 1981, the Partnership, by "ACT OF CREDIT SALE," purchased the Property for the total sum of $ 350,000. 3 Under the terms of the contract the Partnership put $ 25,000 down and obligated itself to make monthly installments of $ 2,953.28 beginning January 1, 1982. In addition to other enumerated obligations, the Partnership obligated itself to commence construction and substantial renovation of the building within 210 days from the date of the sale, in order to convert it to modern *836 office spaces. The contract did not specify the amount*257 required to perform that obligation, nor did the Partnership place any money in escrow to cover its costs. The Partnership also entered into a "cost-plus" agreement with G. C. Occhipinti & Associates, Inc., as general contractor, to construct the renovations. However, the contract did not specify the "cost." (7) On December 22, 1981, the Partnership executed a "Covenant To Renovate" with Historic Corporation. The obligations created thereunder constituted covenants running with the Property and were binding on the Partnership and subsequent purchasers until the required facade restoration was complete. Moreover, the Partnership was obligated to perform the renovations to conform with the plans approved by Historic Corporation and in accordance with the conceptual approval granted by the Architectural Review Committee. To*258 insure full and faithful performance of the Partnership's obligation, Historic Corporation required the Partnership to deliver a letter of credit to it for an amount equal to the construction contract. As of December 22, 1981, the Property was zoned "Central Business District-4" (CBD-4) under the provisions of the Comprehensive Zoning Ordinance of the City of New Orleans (CZO). This classification allowed for a wide variety of retail and service commercial use including business offices. Under the zoning ordinance, the general height limitation in the district was 85 feet, subject to 20-foot set-back requirements. However, properties situated on Gravier and Magazine Streets were subject to 50- and 70-foot height limitations, respectively, on facades facing those streets. Since the Property is located on the corner of Gravier and Magazine Streets it is subject to both height limitations and dual, inconsistent, set-back requirements. Therefore, under a strict application of the zoning requirements, adding two additional floors to the existing structure would produce an extremely narrow and odd-shaped structure, creating undue hardship on its owners. The Board of Zoning Adjustments, *259 however, usually grants set-back restriction waivers in cases where that type of hardship arises. Furthermore, when owners of historic buildings seek the Commission's approval to make exterior changes, the Commission, upon approval of the proposals, usually recommends to the Board or City Council, as the case may be, that a waiver of the height and/or set-back restrictions be granted. Under these circumstances the Board or City Council routinely grants a waiver. 4(8) On December 30, 1981, the Partnership entered into the restrictive conservation easement at issue in this case, referred to as a "Grant of Perpetual Real Right," or "facade servitude," with the Historic Corporation. Under the conservation easement (hereinafter referred to as the "Easement" or "facade donation"), the Partnership and its successors agreed to "preserve and maintain the roof, *260 Gravier Street and Magazine Street exterior facade(s), the foundation, and structural support of the property, * * *." The Partnership, pursuant to its obligation under the covenant, executed a $ 90,000 irrevocable letter of credit with the Whitney National Bank of New Orleans, in favor of the Historic Corporation. Certificates of deposit were used to secure the letter. Among many other restrictions contained in the covenant, the Partnership transferred to Historic Corporation all air development rights and all privileges to sell or otherwise trade or bargain for transfer of development rights applicable to the Property. (9) In 1982 the Partnership obtained a short-term construction loan from Whitney National Bank, the proceeds of which were used to complete all renovations (interior as well as exterior) in accordance with both the sales contract and the Covenant to Renovate. Actual renovation of the Property began on April 21, 1982, and by August 27, 1982, restoration was 18 percent complete. (10) Sometime before November 3, 1982, petitioners called upon Hibernia National Bank to permanently finance the short-term construction loan from Whitney. In conjunction with the request, *261 the Bank required petitioners to have the Property appraised. Whereupon petitioners obtained the services of Max Derbes ("Mr. Derbes"), whose name appeared on the bank's list of qualified appraisers. In his report dated November 3, 1982, Mr. Derbes, assuming no easements existed on the Property, appraised the entire Property at $ 1,250,000. Thereafter, the Partnership obtained approximately $ 678,000 in principal financing from Hibernia National Bank. (11) By letter dated December 30, 1982, Mr. G. C. Occhipinti informed the Historic Corporation that the Partnership had either paid or fully deposited monies to cover all costs to complete the renovation of the Property. (12) By December 31, 1982, "Dorsey and Company" moved into the newly renovated building as tenants paying $ 17.50 per square *837 foot in rent annually. Between April 1, 1982, and February 1988, the Partnership spent not less than $ 600,015.07 to renovate the Property, of which not less than $ 511,689.35 was spent between April 1, 1982, and August 30, 1983, and not less than $ 88,325.72 was spent between August 31, 1983, and February 1988. On its U.S. Partnership Return of Income for taxable year 1981, *262 the Partnership listed the following assets and liabilities: AssetsCash$ 6,253 Buildings98,822 Land151,470 $ 256,545 LiabilitiesMortgages, Notes$ 334,755 Partners:Capital Accounts (78,210)$ 256,545 Based upon those figures, the Partnership apparently allocated a $ 118,913.16 5 basis to the donated easement. Furthermore, it claimed $ 245,000 as the fair market value of the charitable contribution to Historic Corporation. Five Schedules K-1 were attached to the Partnership's return for each partner listing each Partner's share of the facade donation as follows: G. Paul Dorsey, Jr$ 61,250 George P. Dorsey73,500Philip J. Dorsey73,500Marc Dorsey12,250Lee C. Dorsey24,500245,000Petitioners G. Paul Dorsey and Kathleen*263 M. Dorsey deducted $ 41,081 of their share of the charitable contribution on their joint 1981 Federal income tax return and deducted the $ 20,169 carryover on their joint 1982 return. Petitioners George P. Dorsey and Marie L. Dorsey, and Marc Dorsey deducted $ 73,500 and $ 12,250, respectively, on their 1981 Federal income tax return as their charitable contribution. Petitioners Lee Clemmer Dorsey and Gayle J. Dorsey deducted $ 23,633 of their share of the charitable contribution on their joint 1981 Federal income tax return. Petitioners Philip J. Dorsey and Mary D. Dorsey deducted $ 54,068 of their share of the charitable contribution on their joint 1981 Federal income tax return and deducted the $ 19,432 carryover on their joint 1982 return. Respondent determined the Property as a whole had a fair market value of $ 367,500. Moreover, he determined that 10 percent of such value, or $ 36,750, was properly allocable to the donated Easement. Accordingly, respondent issued statutory notices of deficiency to (1) petitioners G. Paul Dorsey, Jr., and Kathleen P. Dorsey, allowing $ 9,187.50 of their 1981 charitable deduction and disallowing the 1982 carryover; (2) petitioners George*264 P. Dorsey and Marie L. Dorsey, and Marc Dorsey, allowing $ 11,025 and $ 1,837.50, respectively, of the 1981 claimed deduction, disallowing the remainder; (3) petitioners Lee Clemmer Dorsey and Gayle J. Dorsey, allowing $ 3,675 of the claimed 1981 deduction and determining they were not entitled to a 1982 carryover; and (4) petitioners Philip J. and Mary D. Dorsey allowing, $ 11,025 of the claimed 1981 deduction, disallowing their 1982 carryover, and determining a $ 6,725.30 deficiency for 1979 relating to a reduction in the investment tax credit carryback from 1982. Respondent concedes that the fair market value of the entire Property and the Partnership's basis therein includes the $ 90,000 letter of credit. Accordingly, respondent now contends that $ 46,000 represents the fair market value of the facade donation. To establish the fair market value of the Easement, each party offered the report and testimony of an expert witness: Charles J. Tessier ("Mr. Tessier") for petitioners, and Irvington J. Eppling ("Mr. Eppling"), for respondent. Mr. Tessier's Valuation: Income Data ApproachMr. Tessier is a member of the Board of Directors of the Louisiana Realtors Association*265 and the National Association of Realtors, and has been a member and director of the Real Estate Board of New Orleans since 1973. Mr. Tessier also served as Treasurer, Secretary, Vice President, and in 1980, President of the Real Estate Board of New Orleans. He was Chairman of the Louisiana Real Estate Commission for three years and a member of that commission from 1972 to 1981. He is qualified to give an opinion as to the value of an interest in real estate. Mr. Tessier's appraisal, dated July 10, 1982, 6 was written in conjunction with W. John Tessier, 7*838 using the Income Data Approach to value. *266 In July 1982 relatively little information on appraising facade easements was available. Although the prevailing opinion was that easement grants affected the value of the property involved, the extent to which they did was not really known. Accordingly, Mr. Tessier contacted the Internal Revenue Service (IRS) to obtain information on valuing facade easements. In response, William K. Chance, an IRS engineer agent, sent Mr. Tessier revenue rulings and an article entitled "The Costs of Preservation: The Chicago Plan." 8Mr. Tessier, relying in part upon that information, valued the donated easement. In so doing, Mr. Tessier considered the effect existing zoning laws had on the highest and best use of the Property before and after the donation. In his opinion the highest and best use for the Property*267 before and after was a five- and three-story renovated office building, respectively. In order to determine the loss in value occurring as a result of the developmental restrictions, Mr. Tessier analyzed the Property before and after the imposition of the restrictions contained in the Easement. In so doing, he considered the following facts: (1) the facade covered the entire roof, the exterior surface, and its structural foundation; (2) the donation required the Partnership to perform all work Historic Corporation viewed as necessary to preserve and maintain the exterior's facade appearance and character; (3) the Partnership bore all costs for any exterior work required by Historic Corporation; (4) the Partnership was precluded from making any changes to the building's exterior without Historic Corporation's approval; (5) the donation was in perpetuity; and (6) the current use of the Property could not be changed in the future regardless of whether such use was its "highest and best use." After discussions with investors, realtors, and others, Mr. Tessier determined that the rent per square foot for renovated office space ranged between $ 14 to $ 17 per annum. He also*268 determined a capitalization rate of .1125. Mr. Tessier then determined the before and after value of the entire Property as follows: INCOME APPROACH(Considering "Highest And Best Use")(Five-Story Building)Projected Gross Revenue:16,995 Sq. Ft. at $ 15.00 $ 254,925 Less Estimated Expenses:$ 63,731 NET INCOME$ 191,194 Capitalized At .1125:($ 1,699,502/.1125) $ 1,699,502Minus Additional Cost Expense435,572BEFORE VALUE BY INCOME APPROACH$ 1,263,928INCOME APPROACH(Considering Three-Story Building)Projected Gross Revenue10,197 Sq. Ft. at $ 15.00 $ 152,995 Less Estimated Expenses:(Taxes, Insurance, etc.) $ 38,238 NET INCOME$ 114,717 Capitalized At .1125:($ 114,717/.1125) AFTER VALUE BY INCOME APPROACH$ 1,019,706He then subtracted the $ 1,019,706 9 "after" value from the $ 1,263,928 before value to arrive at $ 244,222, the fair market value of the facade donation. Mr. Tessier did not apply an estimated diminution percentage to the before value to arrive at the $ 244,222 fair market value of the donation. 10 Instead he mechanically*269 applied the "before-and-after" method. In an October 4, 1985, supplemental report, Mr. Tessier determined that the before highest and best use of the Property was a six-floor renovated first class office building, and thereafter, concluded that $ 366,583 was the fair market value of Easement. Mr. Eppling's Valuation: Market Data ApproachMr. Eppling is a member of American Institute of Real Estate Appraisers, Realtors National Marketing Institute (Commercial and Investment Certification), various real estate boards in New Orleans and Louisiana, and the Louisiana Realtors Association. He is qualified to give an opinion as to the value of an interest in real estate. *839 Mr. Eppling prepared a written report, dated November 10, 1987, appraising*270 the Property as of December 30, 1981. Before this appraisal, Mr. Eppling had never appraised a facade easement. Mr. Eppling used the Market Data Approach and the approach outlined in Hilborn v. Commissioner, 85 T.C. 677">85 T.C. 677, 688-690 (1985), to estimate the diminution of value to the Property caused by granting the facade easement. In Mr. Eppling's opinion the highest and best use of the Property was unchanged from its current use, a three-story office building, and he valued the building in its current unrenovated condition. Using seven "comparable sale" properties, Mr. Eppling concluded that the fair market value of the entire Property, as of December 31, 1981, was $ 350,000, or $ 34.32 per square foot. To this figure he added $ 20,000 in acquisition costs and $ 90,000 committed costs (letter of credit) to arrive at $ 460,000 as the "before" value. To arrive at an after value, Mr. Eppling considered the following restrictions: (1) Partnership (grantor) is required to maintain the roof, exterior facade, foundation, and structural support of the property; (2) owner must provide adequate insurance in favor of the grantor and Historic Corporation (grantee); (3) *271 Grantee has the right of ingress and egress for inspections; (4) Grantor conveyed all air development rights; and (5) the easement is perpetual. Mr. Eppling also reviewed the "Empirical Study of Sale of Property Encumbered with Facade Easements or Servitude" 11 and interviewed the vendors and vendees of the properties contained therein. After analyzing the above information and relying on the approach established in Hilborn v. Commissioner, supra, Mr. Eppling estimated that a 10-percent diminution resulted in the "before" value by granting the Easement. Mr. Eppling then multiplied the before value by the 10-percent diminution to arrive at $ 46,000, 12 representing the diminution in the entire market value of the Property and the fair market value of the Easement. *272 OPINION According to the "bundle of rights" theory, complete real property ownership, or title in fee, consists of a group of distinct rights, including development rights. "Each of these rights can be separated from the bundle and conveyed by the fee owner to other parties in perpetuity or for a limited time. When a right is separated from the bundle and transferred * * *, a partial, or fractional, property interest is created." American Institute of Real Estate Appraisers, Appraisal of Real Estate, 109 (9th ed. 1987). It is axiomatic that these rights are acquired along with the property. Thus, a portion of the cost of acquiring said property is attributable to the right to develop the property and all rights that make up the "bundle of rights." "An easement is an interest in real property that conveys use, but not ownership, of a portion of an owner's property." American Institute of Real Estate Appraisers, Appraisal of Real Estate, supra at 120. The value of an easement is estimated as some part of the amount of value it adds to the property it benefits, or the loss in value to the property it burdens. American Institute of Real Estate Appraisers, Appriaisal of*273 Real Estate, supra. Issues on valuing easements generally arise under eminent domain cases where property is "taken" and just compensation made. In those situations the owner's loss is measured by the extent to which governmental action has deprived him of an interest in property. See United States v. General Motors Corp., 323 U.S. 373">323 U.S. 373, 378 (1945). The value of that interest is determined by isolating it as a component of the overall fair market value of the affected property. Kimball Laundry Co. v. United States, 338 U.S. 1">338 U.S. 1 (1949). A facade servitude, for purposes of this case, is deemed to be the equivalent of a common law easement in perpetuity. See Hilborn v. Commissioner, 85 T.C. at 686. Thus, granting a facade easement is a relinquishment of part of the "bundle of rights" held by a property owner. See Nicoladis v. Commissioner, T.C. Memo. 1988-163. Valuation of Facade Easement DonationIn the instant case, the parties agree that the Easement is perpetual, Historic Corporation is a "qualified organization" for purposes of section 170(f)(3)(B)(iii), and the donation of the Easement, having*274 been made to preserve a historically significant structure, qualifies as a deductible "qualified conservation contribution" under sections 170(f)(3)(B)(iii) and 170(a)(1). See sec. 170(h)(4)(A)(iv). Unresolved is the charitable contribution amount. The amount allowable as a deduction with respect to a charitable contribution of property is usually determined by the fair market value of the property donated; i.e., "willing buyer, willing seller," on the date of the gift. Sec. 1.170A-1(c)(2), *840 Income Tax Regs. However, a conservation easement is normally granted by deed of gift; consequently, there is rarely an established market from which to derive fair market value. See Symington v. Commissioner, 87 T.C. 892">87 T.C. 892, 895 (1986). If no comparable sales of the particular type of conservation easement are available, the normal "willing buyer, willing seller" test is difficult to apply. Therefore, the fair market value of the easement for tax purposes will usually be determined indirectly by utilizing the "before-and-after" valuation method, thereby determining the negative effect the easement has on the value of the total property. 13 This method is not*275 to be applied mechanically, however, when other reliable indicators of market value are available. Sec. 1.170-14(h)(3)(i), Income Tax Regs.; S. Rept. No. 96-1007 (1980), 2 C.B. 599">1980-2 C.B. 599, 606. *276 The fair market value of the easement should be based on the highest and best use for the property on its valuation date, including potential development. See generally Stanley Works and Subsidiaries v. Commissioner, supra; Hilborn v. Commissioner, supra; Griffin v. Commissioner, T.C. Memo 1989-130">T.C. Memo. 1989-130; secs. 1.170A-14(h)(3)(i) and (ii), Income Tax Regs. "Highest and best use" 14 as defined by the American Institute of Real Estate Appraisers is: That reasonable and probable use that will support the highest present value, as defined, as of the effective date of the appraisal. Alternatively, that use, from among reasonable probable and legal alternative uses, found to be physically possible, appropriately supported, financially feasible, and which results in highest land value. The definition immediately above applies specifically to the highest and best use of land. It is to be recognized that in cases where a site has existing improvement on it, the highest and best use may very well be determined to be different for the existing use. * * * [B. Boyce, Real Estate Appraisal Terminology, 107 (1975).]*277 In determining the before and after "highest and best use," "The realistic, objective potential uses for the property control the valuation thereof." Symington v. Commissioner, 87 T.C. at 896; Stanley Works and Subsidiaries v. Commissioner, 87 T.C. at 400; Hilborn v. Commissioner, supra. See Olson v. United States, 292 U.S. 246">292 U.S. 246, 255-256 (1934); S. Rept. 96-1007 (1980), 2 C.B. 599">1980-2 C.B. 599, 606. Thus, in determining the reasonable and probable use that supports the highest present value we focus on the "highest and most profitable use for which the property is adaptable and needed or likely to be needed in the reasonably near future." Olson v. United States, 246">292 U.S. at 255. In determining the "before" value, consideration must be given to the effect of existing historic preservation laws and zoning laws that may already restrict the property's development regardless of the existence of the conservation easement. See Griffin v. Commissioner, supra; Losch v. Commissioner, T.C. Memo. 1988-230. This value is not, however, affected by whether*278 the owner actually intends to put, or has put, the property to its highest and best use before the date of donation. Symington v. Commissioner, 892">87 T.C. at 897; Stanley Works and Subsidiaries v. Commissioner, supra.The value of the property "after" the donation must also reflect its highest and best use. Accordingly, consideration of any new restrictions the easement places on the property must be taken into account. Losch v. Commissioner, supra.A. Highest and Best Use: "Before" and "After"Both experts agree the before-and-after method should be used to determine the fair market value of the Easement. Furthermore, they agree the highest and best use of the Property after the donation is a three-story renovated office building. They disagree, however, on its highest and best use before the Easement was granted. Petitioners' appraiser, Mr. Tessier, concluded that the most profitable "before" use was a five-story office building. Respondent's appraiser, Mr. Eppling, believed that an increase in the current number of floors was not economically or legally supportable in the near future. He*279 thereby concluded that the highest and best use *841 for the Property was its current use. We agree with petitioners. Petitioners' evidence illustrated that two or three additional floors could be added to the Property after the Commission's approval and after obtaining a waiver of the setback restrictions. They also introduced the testimony of Sandra Levy ("Ms. Levy"), 15 a Commission member, and Evelyn Pugh ("Ms. Pugh"), 16 a former director at the office of Safety and Permits. Their testimony, taken together, establishes to our satisfaction that (1) the Commission would have approved the additions and (2) the Board or City Council would have waived the set-back restrictions. Accordingly, we find it realistic and reasonably probable that two additional floors could have been added to the building, thereby putting the property to its most profitable use. *280 Furthermore, we find that the proposed addition was structurally possible. Although respondent's appraiser testified that he found any floor additions impractical due to the age of the building, Mr. Avegno, Jr., petitioners' witness and a structural engineer, testified that a two- or three-story addition was structurally possible. We find Mr. Avegno's testimony more persuasive on this issue. We also find that the addition was economically feasible. At the time of the donation the Picayune Place District was rapidly becoming a high-density commercial area bringing with it the demand for smaller office space. Based on the foregoing, we are persuaded that the highest and best use of the Property includes an 83-foot by 25-foot by 30-foot addition, 17 representing two additional floors and approximately 4,150 square feet in additional floor space. See Turner v. Commissioner, T.C. Memo. 1977-437; Small v. Commissioner, T.C. Memo. 1969-211; American Institute of Real Estate Appraisers, Appraisal of Real Estate, supra at 272. *281 B. Approach to ValuationWe must decide next whether granting the Easement had any effect on the fair market value of the Property, and if so, the value thereof. The parties use different approaches to arrive at the before-and-after "value" of the Property. Mr. Tessier uses both the Income Data and Cost Data Approaches and concludes that the Income Data Approach is more appropriate. In his opinion the Market Data Approach was inappropriate, since after the Property was renovated no true comparable properties could be found. Mr. Eppling, on the other hand, relies solely on the Market Data Approach. He rejected the Cost Approach saying, it was "based on the principle of substitution and it is unlikely that the demolition of the subject improvements would be allowed, thus reproduction or replacement costs have little relevance." He also rejected the Income Approach saying, it "cannot be used in that comparable rents for unrenovated shell properties were not available." We agree that the Cost Data Approach is inappropriate in these circumstances, since demolition and replacement of a historic building would be highly unlikely. On the other hand, because we are valuing*282 the loss associated with transfer of developmental rights on income producing property, we find the capitalization of income approach an appropriate method to consider. 18Hilborn v. Commissioner, supra; cf. Estate of Bennett v. Commissioner, T.C. Memo. 1989-681. See J. Eaton, Real Estate Valuation in Litigation, 258-260 (1982); American Institute of Real Estate Appraisers, Appraisal of Real Estate, supra at 120-121. Petitioners allege that a $ 245,000 loss in value resulted from their donation. 19 They further allege that respondent's appraiser*283 improperly applied the before-and-after method since he (1) limited the value analysis to its current use, i.e., an unimproved structure, and (2) failed to compute an "after value" before arriving at the value of the Easement. Respondent contends *842 the loss in value, attributable to the donation, is $ 46,000. 20We agree respondent failed to consider the highest and best use of the Property in determining the fair market value of the easement. We also agree respondent did not mechanically apply the before-and-after method. However, a strict mechanical application of the before-and-after method will not always aid in determining the fair market value of a facade easement, especially when the easement involves the relinquishment of two valuable property rights, as*284 it does here. A facade easement is different from an open space easement. In the former, the right to control the exterior of a building is involved while the latter involves no such right. Accordingly, we do not mechanically apply the before-and-after method. See S. Rept. No. 96-1007 (1980), 2 C.B. 599">1980-2 C.B. 599, 606. Valuation is not a precise science, and determining the fair market value of donated property on a given date is a question of fact to be resolved on the basis of the entire record. See McShain v. Commissioner, 71 T.C. 998">71 T.C. 998, 1004 (1979); Kaplan v. Commissioner, 43 T.C. 663">43 T.C. 663, 665 (1965). Expert opinion evidence is obviously admissible and relevant on the question of value and is intended to help the Court understand areas requiring specialized training, knowledge, or judgment. We are not, however, bound by the opinion of expert witnesses when, after weighing all the evidence in light of their demonstrated qualifications, their opinion is contrary to our own judgment. Barry v. United States, 501 F.2d 578">501 F.2d 578 (6th Cir. 1974); Kries' Estate v. Commissioner, 227 F.2d 753">227 F.2d 753, 755 (6th Cir. 1955), affg. *285 a Memorandum Opinion of this Court; Chiu v. Commissioner, 84 T.C. 722">84 T.C. 722, 734-735 (1985). Because we may find one expert more persuasive on one element of valuation and another more persuasive on another element, Parker v. Commissioner, 86 T.C. 547">86 T.C. 547, 562 (1986), we may embrace or reject expert testimony, whenever in our best judgment it is appropriate. Helvering v. National Grocery Co., 304 U.S. 282 (1938). Since the granting of a facade easement is a relinquishment of part of the "bundle of rights" held by a property owner, Nicoladis v. Commissioner, supra, an appraisal should include valuation of all rights attached to the property, including the right to develop the property. American Institute of Real Estate Appraisers, Appraisal of Real Estate, supra at 299. Furthermore, while the price paid for the property may have a bearing on its market value, it is not the investment, but the value of the interest in the property "taken" or donated that is being valued by indirect means. See J. Eaton, Real Estate Valuation In Litigation, supra at 7. In this case petitioners relinquished their rights to*286 (1) put the Property to its highest and best use, i.e., a five-story building, and (2) to some extent, control the exterior of the building. We are, therefore, placed in the position of indirectly valuing these lost rights. After examination of the experts' testimony, their written reports, and the entire record before us, we are persuaded that neither appraisal is flawless. Mr. Tessier (1) overestimated the "before" square footage; (2) failed to take into account vacancy potentials in calculating net income; (3) underestimated expenses; and (4) incorrectly calculated the "Cost Expense" he used to arrive at the "before" value. On the other hand, Mr. Eppling (1) failed to adjust his comparable properties for varying financing arrangements; (2) made a 15-percent downward adjustment to the property most like the subject property without explanation, and more importantly; (3) premised his analysis on the incorrect assumption that the highest and best use of the property was its current use. That is, he failed to consider the loss of development rights. Because of this latter error, Mr. Eppling's report does not aid us in determining the total fair market value of the Easement.*287 We agree with petitioners that the income approach is appropriate to value the fair market value of the Easement. However, due to the fact that here we are valuing two separate and distinct rights, we believe the method we employ below alleviates any potential problems arising from use of the income approach. 21The first step under our method is to determine the fair market value of the Property as of the date of donation; i.e., what a willing buyer and willing seller would agree to on that date. On December 16, 1981, the Partnership paid $ 369,205.16 to acquire the Property. On December 30, 1981, it was irretrievably out-of-pocket another $ 90,000. Both parties agree that the fair market value of the property includes*288 the $ 90,000. There is no evidence that the Property otherwise appreciated in value between December 15th and December 30th. In fact, both parties *843 agree that the Property did not appreciate in value during this time. Accordingly, we find $ 459,205.16 22 to be the fair market value of the Property as of the date of donation. Our next step is to determine the value attributable to the loss of control over the building's exterior. However, because there are no comparable sales we are constrained to apply a nonmechanical approach of the "before-and-after method." The only evidence presented on the "value" of that right was an amount equal to 10 percent of the Property's total fair market value. We accept it. However, since the right to control the exterior pertains only to the building and not the land, we allocate the total fair market value of the Property between the land and the building. 23 Next we apply the 10-percent*289 diminution to the value allocated to the building. The result is as follows: STEP # 1BEFORE FAIR MARKET VALUE$ 459,205.16 Less:(30,773.52) *EQUALS - FMV OF PROPERTY$ 428,431.64 Our final step is to value the loss of development rights. To do so, we first determine the "before" square footage and subtract from it the "after" square footage to arrive at the square footage attributable to the loss of development rights. From that base figure we compute a percentage, the numerator being the "square footage attributable to the lost development rights" and the denominator being the "before" square*290 footage. This gives us a percentage we then apply to the Property's remaining fair market value. The result is the value of the loss attributable to the development rights. With the foregoing in mind, we recompute the easement's fair market value as follows: STEP #2(1)BEFORE SQUARE FOOTAGE:14,287 *LESS: AFTER SQUARE FOOTAGE:10,197 EQUALS - SQUARE FOOTAGE ATTRIBUTABLE TOLOSS OF DEVELOPMENT RIGHTS:4,090 (2)4,090 EQUALS 28.63 PERCENT 14,287The $ 428,431.64 x 28.63 percent equals $ 122,648.92 the value attributable to the loss in development rights. We do not allocate the 28.63 percent between the land and building because the loss of development rights affects the total Property, not just the improvements. Based on the foregoing, we find $ 153,422 24*291 to be the total fair market value of the donated Easement. To state it another way, we find approximately a 33.41-percent 25 diminution in the Total fair market value of the Property as a result of the donation. SEE APPENDIX. Charitable Contribution AmountWe must also determine the charitable contribution amount for purposes of section 170(a). Section 170(e)(1)(A) reduces the charitable contribution amount by the amount of short-term capital gain the taxpayer would have recognized if the property donated had been sold at its fair market value on the date of donation. 26*292 Since the fair market value and the basis of the Property was the same on the date of donation we find section 170(e) inapplicable. 27 Accordingly, we find $ 153,422 the contribution amount for purposes of applying the limitations under section 170(b). *844 Philip J. and Mary D. Dorsey: ITC CarrybackPetitioners failed to present any evidence on this issue either at trial or in brief. Therefore, we assume that the issue will be resolved in the Rule 155 computation or that petitioners have abandoned it. Additions to TaxSection 6653Section 6653(a) provides for an addition to tax if any part of an underpayment is due to negligence or intentional disregard of rules and regulations. Negligence is defined as a lack of due care or failure to do what*293 a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 937 (1985). Petitioners bear the burden of proving they exercised due care and were reasonable in their reliance. Rule 142(a). Petitioners had no particular individual expertise in the area of facade valuation and therefore relied on Mr. Tessier's opinion. Mr. Tessier is a qualified appraiser, and there was some support for his report. Under the circumstances of this case, we do not believe petitioners were negligent. Accordingly, we find for petitioners on this issue. Sections 6659 and 6621(c)Pursuant to section 6659, valuation is overstated if the value of any property claimed on a return is 150 percent or more of the correct amount so determined. Sec. 6659(c). For this addition to apply, the underpayment for the taxable year attributable to the valuation overstatement must be at least $ 1,000. Sec. 6659(d). In the instant case petitioners valued the Easement at $ 245,000. We, however, found $ 153,305 to be the correct value. Therefore, the value of the easement claimed is not 150 percent or more of the correct value. Likewise there*294 is no valuation overstatement for purposes of section 6621(c)(3)(A)(i). Accordingly, we hold that petitioners are not liable for the increased interest under section 6621(c) or the addition to tax under section 6659(d). Decisions will be entered under Rule 155.Appendix To show how the result above is approximately the same as that under the income method we prepared the following. However, because Mr. Tessier's figures in his initial appraisal were not entirely accurate we make the following changes: (1) Total "before" square footage is 14,287. Total "after" square footage is 10,197. The "before" figure is calculated by taking the actual square footage, 10,197, subtracting from it the 60-square-foot loss in available rental space resulting from adding columns to support the two-floor addition, and adding 4,150, the total usable area of the two floor addition. (2) Fair rental value is $ 16.50 per square foot. (3) Vacancy allowance is 5 percent of the projected gross revenue. (4) Real estate taxes are $ 15,000 plus 29 percent of $ 15,000. (5) Insurance is $ 6,000 plus 29 percent of $ 6,000. (6) Management costs are 5 percent of effective income. (7) Utility*295 expenses are $ 1.25 per square foot. (8) Janitorial expenses are $ 0.55 per square foot. (9) Repairs and maintenance costs are $ 0.12 per square foot. (10) Reserves are $ 1,613. (11) Costs of adding the two floors are $ 71.50 per square foot, i.e., (4,150 X 71.50 = $ 296,725). CAPITALIZATION OF INCOME APPROACHHYPOTHETICAL BEFORE VALUEGross Potential Income(14,287 sq. feet X $ 16.50) $ 235,735.50 Less: 5 % Vacancy and Cr. Allowance 11,786.78 EFFECTIVE GROSS INCOME$ 223,948.72 LESS OPERATING EXPENSES:Real Estate Taxes $ 19,350.00Insurance 7,740.00Management Costs 11,197.44Utility Expenses 17,858.75Janitorial 7,857.85Repairs and Maint. 1,714.44Reserves 1,613.00Total Expenses$ 67,331.48) NET INCOME$ 156,617.24 NET INCOME divided by a .1125CAPITALIZATION RATE$ 1,392,153.20 LESS - COSTS OF ADDING TWO FLOORS($ 296,725.00) HYPOTHETICAL BEFORE VALUE$ 1,095,428.20 *HYPOTHETICAL AFTER VALUEGross Potential Income(10,197 sq. feet X $ 16.50) $ 168,250.50 Less: 5 % vacancy and Cr.(8,412.50) EFFECTIVE GROSS INCOME$ 159,838.00 LESS OPERATING EXPENSES:Real Estate Taxes $ 15,000.00Insurance 6,000.00Management Costs 7,992.00Utilities 12,746.25Janitorial 5,608.35Repairs and Maint. 1,223.64Reserves 1,250.00TOTAL OPERATING EXPENSES $ 49,820.24 NET RENTAL INCOME$ 110,017.76 NET RENTAL INCOME divided by a .1125CAPITALIZATION RATEEQUALS HYPOTHETICAL AFTER VALUE$ 977,935.64 * *296 *845 Subtracting the $ 1,095,428 "before" value from the $ 977,936 "after" value we arrive at an estimated value of $ 117,492. To this we add the $ 30,774 value to arrive at $ 148,266, representing the total loss attributable to the donation. Footnotes1. Unless otherwise indicated all section references are to the Internal Revenue Code, as amended and in effect for taxable years 1979, 1981, and 1982. All Rule references are to the Tax Court Rules of Practice and Procedure.↩*. 50 percent of the interest due on $ 4,340.20↩2. The statutory notice of deficiency for G. Paul Dorsey, Jr., and Kathleen Dorsey for taxable year 1982 states sec. 6621(b). However, the correct section is 6621(c). The interest on substantial underpayments under sec. 6621(c) is 120 percent of the interest accruing after December 31, 1984, due on the entire deficiencies.↩3. The initial purchase price was $ 350,000. Additionally, the Partnership paid $ 1,705.16 in closing costs and $ 17,500 in real estate commissions for a total cost of $ 369,205.16.↩4. City Council relies heavily on the professional opinion of the Commission when the Commission has reviewed and approved a proposed "construction" plan.↩5. Cost of land and building ($ 369,205.16) minus the Partnership's basis subsequent to the donation, as reported on its return ($ 98,822.00 plus $ 151,470.00 = $ 250,292.00) equals $ 118,913.16.↩6. On April 8, 1982 petitioners' expert appraiser, Mr. Tessier, placed a $ 245,000 value on the donated easement. On June 2, 1982, Mr. Tessier placed a $ 118,800 value on the Easement, as of the date the Property was purchased↩, representing 55 percent of the total value of the improvements. Mr. Tessier opined a $ 151,470 value for the land and a $ 216,030 value for the improvements as of the date petitioners purchased the Property for a $ 367,500 total value. However, he failed to include the $ 1,705.16 closing costs, which brings the total value of the Property to $ 369,205.16. 7. Charles Tessier and W. John Tessier, I.F.A., jointly prepared the report dated July 10, 1982. W. John Tessier has been in the profession of appraising all forms of real estate for 31 years and is also a qualified appraiser.↩8. The Appraisal Journal, July 1974. In this article, John Costonis, the author, concludes that the most appropriate method then available to value conservation easements was the income data approach.↩9. According to the evidence Mr. Tessier used $ 1,019,500 as the after value to arrive at $ 244,428 as the value of the facade easement. However, the correct figure is $ 1,019,706, which leaves $ 244,222.↩10. See Hilborn v. Commissioner, 85 T.C. 677↩ (1985).11. This study was prepared by Mr. Max Derbes for the Internal Revenue Service for a case not presently before this Court. The "comparable" properties therein are not comparable to the subject property; therefore, we do not consider it in reaching our decision on the property here in issue. ↩12. The $ 46,000 represents 10 percent of $ 370,000 ($37,000) plus 10 percent of $90,000, committed costs, ($ 9,000.↩13. The before-and-after method is the method recommended by the National Trust for Historic Preservation and the Land Trust Exchange in "Appraising Easements" -- Guidelines for Valuation of Historic Preservation and Land Conservation Easements, 19 (1984) and approved by the IRS. See Rev. Rul. 73-339, 2 C.B. 68">1973-2 C.B. 68, as clarified by Rev. Rul. 76-376, 2 C.B. 53">1976-2 C.B. 53. The method is also endorsed by Congress in connection with the adoption of the Tax Treatment Extension Act of 1980. See S. Rept. 96-1007 (1980), 2 C.B. 599">1980-2 C.B. 599, 606. See Hilborn v. Commissioner, 85 T.C. 677">85 T.C. 677 (1985); Stanley Works and Subsidiaries v. Commissioner, 87 T.C. 389">87 T.C. 389 (1986); Symington v. Commissioner, 87 T.C. 892">87 T.C. 892 (1986); Fannon v. Commissioner, T.C. Memo 1989-136">T.C. Memo. 1989-136; Thayer v. Commissioner, T.C. Memo. 1977-370↩.14. See Olson v. United States, 292 U.S. 246">292 U.S. 246, 255-256 (1934); Stanley Works and Subsidiaries v. Commissioner, 87 T.C. at 402; Symington v. Commissioner, 87 T.C. at 896-897; Continental Grain Co., Transferee v. Commissioner, T.C. Memo. 1988-577, reconsideration denied T.C. Memo. 1989-155↩.15. Ms. Levy is the director of the New Orleans and Central Business District Historic District Landmarks Commission and has been in that position for the past 12 years. As part of her duties she makes recommendations on behalf of the Commission to the Board of Zoning Adjustments. Some of the Commission's purposes are (1) to establish and improve property values; (2) to foster economic development; and (3) to encourage growth. ↩16. Ms. Pugh was an assistant city attorney for the city of New Orleans in 1981, and from November of 1982 until May of 1986 she served as director of the department in the Office of Safety and Permits.↩17. This represents 83 feet in length, 25 feet in width, and 30 feet in height. Accordingly, the total square footage is 14,347, i.e., 10,197 square feet plus 4,150 square feet.↩18. An appraiser using the income approach views the property in question as would an investor seeking an income-producing property, in this case a commercial office building. The estimate of value is based on a projection of gross income and operating expenses, i.e., net income, over a period of time, discounted to present worth by the capitalization process. Vesper v. Commissioner, T.C. Memo. 1989-358↩.19. The difference between their estimate of the Property's "before" and "after" values, i.e., $ 1,263,928 and $ 1,019,500, respectively. ↩20. The difference between the property's "before" and "after" $ 460,000 and $ 414,000 values.↩21. For example, respondent contends that if petitioners' "before" million dollars-plus value is used to determine the value of the easement then section 170(e) and section 1.170A-14(h)(3)(iii), Income Tax Regs.↩, will apply to reduce the contribution amount.22. Both parties also agree that $ 459,205.16 is the basis of the property.↩23. The total fair market value of the Property is $ 459,205.16. Petitioners allocated $ 151,470 to the land. Since there is no evidence to the contrary, we accept that allocation. Therefore, $ 459,205.16 minus $ 151,470 equals $ 307,735.16, the fair market value attributable to the improvements.↩*. $ 307,735.16 fair market value attributable to the Improvements x 10 percent.↩*. This figure takes into account the loss of 60 square feet in usable space as the result of having to add additional support columns in the building to support the additional two floors.↩24. $ 122,648.92 attributable to the loss of development rights and $ 30,773.52 attributable to the loss of control over the exterior of the building, rounded.↩25. See Higgins v. Commissioner, T.C. Memo. 1990-103↩, (loss of 43.8 percent in value of the property as a result of granting a conservation easement).26. In effect, the allowable charitable contribution deduction for ordinary income property is limited to the basis of the property donated. Lary v. United States, 787 F.2d 1538">787 F.2d 1538, 1540 (11th Cir. 1986); Glen v. Commissioner, 79 T.C. 208">79 T.C. 208, 212 (1982); Morrison v. Commissioner, 71 T.C. 683">71 T.C. 683, 688 (1979), affd. per curiam 611 F.2d 98">611 F.2d 98↩ (5th Cir. 1980).27. The fair market value of the partial interest donated and the basis attributable to that interest are the same. See secs. 1.170A-4(c)(1)(i) and (ii); sec. 1.170A-14(h)(3)(iii), Income Tax Regs.↩*. We round these figures to $ 1,095,428 and $ 977,936, respectively.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619576/ | Warner Mountains Lumber Company, Petitioner, v. Commissioner of Internal Revenue, RespondentWarner Mountains Lumber Co. v. CommissionerDocket No. 10154United States Tax Court9 T.C. 1171; 1947 U.S. Tax Ct. LEXIS 5; December 23, 1947, Promulgated *5 Decision will be entered under Rule 50. 1. Capitalization of Expenditures -- Properly Chargeable to Capital Account -- Sec. 113 (b) (1) (A). -- The propriety of capitalizing various expenditures determined. Held, inter alia, that expenses of unsuccessful efforts to sell are not properly chargeable to capital account.2. Capitalization of Expenditures -- Carrying Charges on Unproductive Property. -- Sec. 113 (b) (1) (A). -- The propriety of charging or of not charging certain items to capital as carrying charges on unproductive property determined.3. Capital Assets. -- Standing timber held to be a capital asset. L. Stanley Mauger, Esq., for the petitioner.William H. Best, Jr., Esq., for the respondent. Murdock, Judge. MURDOCK *1171 The Commissioner determined deficiencies in income tax as follows:1940$ 1,758.16194110,486.73194218,584.65194320,232.11*6 The principal issue for decision is whether the Commissioner erred in failing to allow the capitalization of certain items, including alleged carrying charges on a tract of timber, and deductions for depreciation or depletion on the amount thus capitalized. The only other issue is whether income from the sale of timber in 1943 was a capital gain rather than ordinary income.FINDINGS OF FACT.The petitioner is a Delaware corporation. The returns for the years in question were filed with the collector of internal revenue for the first district of Pennsylvania.The Commissioner, in determining the deficiencies, disallowed deductions of $ 27,112.93 for 1940, $ 37,828.61 for 1941, $ 40,013.87 for 1942, *1172 and $ 43,216.80 for 1943 claimed on the returns as "write-offs at 1.42" and "at 1.32."Nine individuals entered into an agreement on December 13, 1923, which provided that they should constitute a "syndicate" under the name of "The Lake County Oregon Pine Syndicate" for the purpose of taking over an option to purchase timber lands in Lake County, Oregon, given by the John Schroeder Lumber Co. and a contract for cutting the timber about to be made with George A. Stephenson. *7 Seven of the members of the group paid cash for their participations in the amount of $ 80,000, while the other two were given participations in a like amount for obtaining the option. Certificates of participation were issued for the interest of each participant. Two of the group were designated managers.The participants expected to dispose of the option and the cutting contract in a short time at a profit but, instead, had to buy the property, which consisted of about 25,000 acres, at a total cost of about $ 800,000, to be paid over a period ending on February 15, 1930. The payments were made. Interest was paid on the deferred payments. The Commissioner has allowed that interest to be capitalized, along with the purchase price of the property.The original cash contributions of the participants were only $ 80,000, and additional amounts had to be obtained to pay the purchase price and interest thereon, the taxes, and other expenditures. Those additional funds were obtained in varying amounts from several of the participants. A record was kept of most of those amounts in a "temporary loan account." Others were recorded as "preferred loans." There was no agreement in regard*8 to interest in connection with any of those amounts and no book entries were made currently showing any accrual of interest thereon. The syndicate paid $ 4,273.91 on April 24, 1930, for the benefit of Charles S. Hebard and accounted for the payment as interest due him on preferred loans. The record does not show that any other amount was ever paid as interest on any of the above amounts.The syndicate never filed any income tax returns.The petitioner was incorporated in December 1930 and all of the assets and liabilities of the syndicate were transferred to the petitioner on, or as of, December 31, 1930.The first and second preferred stock of the petitioner was issued to those participants who had advanced money, each receiving as many shares as 100 would go evenly into the sum of his advances and the equivalent of interest on that amount. The total used in the computation as interest on the "temporary loans" was $ 173,902.89 and on "preferred loans" was $ 14,693.07. None of those amounts was ever reported by the participants as income. The common stock was issued in proportion to the participation certificates held by each participant. *1173 One hundred shares of preferred*9 were issued in recognition of efforts of a participant which resulted in a standard gauge railroad being built to the property, and 50 shares of preferred were issued as compensation for legal services rendered principally in organizing the syndicate.The syndicate paid the following:Cost of cruises of timber$ 17,063.18Local taxes26,837.36Cost of fire protection and care4,622.13Telegraph, telephone, and stationery512.02Attorney's fees for examining title500.00Attorney's fees for organizing petitioner3,000.00Attorney's fees for collection of trespass damages151.43Attorney's fees, purpose not shown987.64Accounting fees, mostly for keeping its books850.00Expenses of unsuccessful efforts to sell the property20,001.69The only amounts received from the property by the syndicate were as follows:Grazing fees$ 14,501.84Interest474.64Damages for trespass2,281.43Total17,257.91The syndicate never cut or sold any timber from the property. The petitioner entered into a contract on January 4, 1940, with another lumber company whereby the latter was to cut and remove timber from the petitioner's property, paying therefor $ 50,000, plus*10 so much per thousand feet cut. The contract provided that all timber should remain the property of the petitioner until payment was received therefor. That and three similar contracts were in effect during the taxable years.OPINION.All of the events upon which the present controversy rests occurred during the period from the creation of the syndicate up to the end of 1930, when the petitioner corporation took over all of the assets and assumed the liabilities of the syndicate in exchange for its stock. The petitioner states in its brief that the syndicate was an association taxable as a corporation. Counsel for the respondent stated at the trial that the tax-free character of the transaction whereby the petitioner acquired the assets of the syndicate is not disputed and the petitioner is claiming the same basis which the property had in the hands of the syndicate. The opposite party has not taken exception to those statements and their correctness will be assumed. Section 113 (a) (6) of the Internal Revenue Code provides, as did the same section of the Revenue Act of 1928, that the basis of property *1174 acquired in a tax-free exchange shall be the same in the hands *11 of the transferee as it was in the hands of the transferor. Thus, one question to be determined in this case is, Should the syndicate or the corporation have capitalized any of the items here in controversy as a part of the cost or basis of the timber which the petitioner sold during the taxable years 1940 through 1943. The parties do not discuss the questions of how total cost or basis of the property as a whole is to be divided between land and timber, the rate to be used, or whether the deduction is to be for depreciation or depletion. The Court assumes that those questions are not in issue.The fee of $ 500 paid to an attorney for examining the title to the property was a part of the cost of that property. $ 17,063.18 paid for cruises of timber not connected with any sale was not a current expense, but, like the cost of a survey of newly acquired property, was properly chargeable to capital account as a part of the cost or basis of the timber. Frishkorn Real Estate Co., 15 B. T. A. 463. One hundred shares of preferred stock of the petitioner were issued to compensate one of the syndicate participants for his efforts in having a standard gauge*12 railroad built to the property. That, likewise, was not a current expense but, adding value to the property, was properly chargeable to capital account. Cf. Caflisch Lumber Co., 20 B. T. A. 1223. No point has been made as to the value of the stock and it will be assumed to have had a value, equal to its par value, of $ 10,000. Attorney's fees paid for services rendered in organizing the syndicate and in organizing the corporation are capital items, but are not a part of the cost or basis of property or timber owned either by the syndicate or by the corporation. Hotel De France Co., 1 B. T. A. 28. Such organization expenses relate to the entity itself rather than to any property which it owns. Fees paid in collecting damages for trespass are not capital expenditures, but are chargeable against the damages collected. The petitioner can not derive any benefit from other attorney's fees, since the record fails to disclose adequately the purposes for which they were paid.The largest amount which the petitioner claims should have been added to the cost of the property as a capital expenditure is $ 80,000. Allegedly, the*13 syndicate paid that for the option on the property, since syndicate participation certificates in the total amount of $ 80,000 were issued to the two men who brought the option to the syndicate. The other syndicate participants contributed $ 80,000 in cash for a like amount of participation certificates. A corporation acquiring an option under circumstances similar to those just described would take as its basis on the option the same basis which the option had in the hands of the transferor. Sec. 202 (c) (3) (B), Revenue Act of 1921, and secs. 113 (a) (6) and 112 (b) (5), I. R. C. The record does not show that the option had any cost to the two participants who contributed *1175 it to the syndicate and, consequently, the petitioner has failed to show that the syndicate or the petitioner acquired any basis for property as a result of the acquisition of the option in 1923.The next largest amount which the petitioner seeks to capitalize as a part of the cost of the property is the total of amounts paid for unsuccessful efforts to sell the property. The record gives practically no detail in regard to those expenditures. The $ 20,001.69 was described by the petitioner's only*14 witness as "amounts paid to this man Slattery who brought this thing to my uncle, while he gallivanted around the country at the syndicate's expense -- ostensibly trying to sell the property." There came a time when his efforts to sell the property had failed and the syndicate terminated that arrangement with Slattery. The amount paid for his unsuccessful efforts to sell the property might, under some circumstances, have been deducted as ordinary and necessary expenses or, perhaps, the total might have been deducted as a loss when the employment was terminated. Cf. H. B. Perine, 22 B. T. A. 201; Homer L. Strong, 14 B. T. A. 902; Pittsburgh & West Virginia Railway Co., 9 T.C. 268">9 T. C. 268. Expenses incident to an actual sale of property are sometimes offset against the proceeds of the sale in the computation of the gain. Spreckles v. Helvering, 315 U.S. 626">315 U.S. 626; Baltimore & Ohio Railroad Co., 29 B. T. A. 368; affd., 78 Fed. (2d) 460; Don A. Davis, 4 T. C. 329; affd., 151 Fed. (2d) 441.*15 But here the petitioner seeks to capitalize expenses of unsuccessful efforts to sell property. It cites no authority to support that contention. Those expenditures did not result in the acquisition, development, or improvement of property or create any benefit having a useful life beyond the taxable year in which they were made. Apparently, the only reason for capitalizing them in this case is that otherwise they will not be recouped by this taxpayer through any deduction. Hard luck of that kind is not a sufficient reason for doing something not authorized by the statute. They may not be recovered through deductions under section 23 (l) or (m).The petitioner contends that other expenditures were carrying charges. Those items consist of interest allegedly paid or accrued on the "loans" from participants, local taxes, cost of fire protection and care, expenses of telegraph, telephone, and stationery, and bookkeeping expenses. The syndicate never deducted those on any returns and, therefore, the right to charge them to capital account is claimed, with the result that they can now be included in the adjusted basis of the property in the hands of the petitioner for the purpose *16 of computing a deduction.Section 113 (b) (1) (A) of the code, as it applied to the years 1940 and 1941, provided that the basis of cost of property should be adjusted "For expenditures, receipts, losses, or other items, properly chargeable to capital account, including taxes and other carrying charges on *1176 unimproved and unproductive real property," except where deductions had been taken for such items in determining net income for prior years. That section, as it applied to the years 1942 and 1943, was substantially the same, except for the omission of the words "including taxes and other carrying charges on unimproved and unproductive real property." The respondent recognizes that the change was to make the law somewhat more liberal. The regulations under both provisions allowed taxes and carrying charges on unimproved and unproductive real estate to be capitalized. See Regulations 103, sec. 19.113 (b) (1)-1; Regulations 111, sec. 29.24-5 (b). Neither the statute nor the regulations define carrying charges. The Commissioner has made an argument in his brief that the items in question may be capitalized or not, depending upon the law and regulations applicable to the*17 year in which the expenditures were made or incurred. There was some confusion in the decisions and the regulations for a few years. See Ernest A. Jackson, 9 T. C. 307, in which the history of the treatment of carrying charges was reviewed. The petitioner argues that the provisions of the Internal Revenue Code mentioned above are controlling. The conclusion was reached in the Jackson case that the Congressional purpose was always the same, and later enactments, beginning with the 1932 Act, authorizing the capitalization of carrying charges on unproductive property, were merely for the purpose of clarification. Therefore, the question here need not be complicated by the vacillation which occurred prior to the 1932 Act.The Commissioner has allowed the capitalization of the interest paid to the sellers on the deferred installments of the purchase price of the property. He must have done that upon the theory that the property was unimproved and unproductive and the interest was a carrying charge. He does not make any argument in his brief that the property was not unimproved or unproductive for present purposes. Although the meaning of "carrying*18 charges" is not defined, nevertheless, it is clear that taxes are included. The Commissioner has not suggested any valid reason why the local taxes in the amount of $ 26,837.36 should not be capitalized. Another expenditure directly related to carrying the property was the $ 4,622.13 paid for fire protection and care. That item may also be capitalized as a carrying charge.It is not necessary to decide whether telegraph, telephone, and stationery expenses and bookkeeping expenses might ever be capitalized as carrying charges, because the record does not show any detail in regard to the expenditures classified under those headings or show the extent, if any, to which those expenditures are directly attributable to "carrying" the property and which part, if any, thereof represented current expenses of leasing the property for grazing, of collecting and *1177 recording other income, of carrying on efforts to sell the property, and of maintaining the organization. Expenditures made in unsuccessful efforts to sell the property, rather than to carry it, may not be classified as carrying charges.The largest amount which the petitioner contends should be capitalized as a carrying*19 charge is about $ 200,000, described as interest on the so-called temporary and preferred loans represented by money advanced by certain of the participants to enable the syndicate to pay the deferred installments of the purchase price of the property, the interest thereon, the taxes, and the other expenditures made by the syndicate. The respondent argues that the funds advanced by the participants were not true loans; there was no agreement in regard to the payment of interest on those advances and no interest could have been collected thereon; in any event, no interest was ever paid or accrued on those amounts and, consequently, the basis of the syndicate never could have included any theoretical interest on those amounts. He calls attention to the provision of the regulations that the interest which can be charged to capital account as a carrying charge shall not include "theoretical interest of a taxpayer using his own funds."One of the requirements of the statute as a prerequisite to capitalization of a carrying charge is that the interest be paid or accrued. A syndicate with only $ 80,000 of capital which is engaged in buying an unproductive piece of real estate at a cost*20 of $ 800,000 obviously has no means of paying interest currently on money advanced by participants in the syndicate without an impractical pyramiding of the borrowing process. Those participants must have realized that their only hope or expectation of ever recovering the advances and of realizing any additional returns on their investment would be through a profitable sale of the property, in whole or in part, and a division of the proceeds of that sale. It was recognized when the corporation was formed in 1930 that those participants who had advanced money should have a larger share in the new corporation by reason of the fact that they had never received any interest on the money advanced by them, and preferred stock was issued to cover theoretical interest on the advances. None of the participants ever reported in his income tax return that he had received any interest on his advances. Cf. Charles A. Collin, 1 B. T. A. 305. The question of interest apparently never arose until some time in 1930, not long before the organization of the petitioner.Since the syndicate never agreed to pay interest, never currently paid or accrued any interest, and*21 had no practical way of doing so, and, since the advances were turned into preferred stock, it might be reasonable to conclude that the advances were intended to be capital investments made by the participants, rather than loans. Cf. Swoby Corporation, 9 T. C. 887. Congress, in such a situation, did not mean *1178 to allow the pyramiding of interest charges that would result from borrowing money to pay the purchase price, borrowing money to pay the interest on amounts thus borrowed, borrowing money to pay the interest on those loans, etc., ad infinitum. The interest which the petitioner seeks to capitalize is not interest on the deferred purchase price, upon a purchase money mortgage, or the equivalent (the Commissioner has already allowed the interest paid on the deferred purchase price payments), but is something in addition to carrying charges of that kind and represents alleged interest on alleged debts contracted to pay the carrying charges themselves. Not only is there no authority in the statute or regulations for capitalizing theoretical interest of that kind, but its capitalization would be outside the purpose and spirit of those*22 statutes and regulations.The Commissioner has argued that none of the alleged interest was ever paid. The record shows clearly that none of it was ever paid or accrued currently, but $ 4,273.91 was paid on April 24, 1930, for the benefit of one of the participants and was accounted for as a payment of interest due him on loans. The remaining part of the approximate $ 15,000 which the petitioner contends was actually paid was not paid, but was merely a bookkeeping entry under date of December 31, 1930. A journal entry as of that date purports to account for $ 11,037.85 as interest paid on temporary loans. The explanation contained in the entry is as follows:7/28/30 Cr. Chas. S. Hebard4695.6711/28/30 Cr. Chas. S. Hebard6342.1811,037.85The above were monies Rec'd. by C S Hebard. From Mr Morgan Hebard -- on the same day -- Mr. C S Hebard was to loan these amts to the Syndicate, and on the same day or the next the Syndicate should have paid these amts back again to Mr C S Hebard on a/c of Interest due the latter on his Preferred Loans first made. The Items should have gone thru these records Through the Check & Cash Books but illness prevented and hence they*23 are thus entered here after Consultation with FVH Esq. Atty. GHS.The fact of the matter is that C. S. Hebard, having advanced money to the syndicate, received some money from his son which he regarded as a taking-over by the son of a part of his advances to the syndicate, although the money advanced by the son was advanced to the father and not to the syndicate. It also appears that the son deliberately refrained from advancing any funds to the syndicate. Shortly afterwards preferred stock of the petitioner, which otherwise would have gone to the father, was issued to the son, apparently in recognition of the loan which the son had made to the father. Obviously, there was no payment of interest by the syndicate in that transaction. The payment of $ 4,273.91 on April 24, 1930, requires no *1179 change in the conclusions reached partly upon the fact that the syndicate did not pay or accrue interest.The issuance of stock by the petitioner in recognition of the advances by the syndicate participants and also on the basis of a theoretical computation of interest on those advances, does not entitle the petitioner to capitalize such alleged interest payments as carrying charges*24 which the syndicate could not capitalize. The petitioner is not able to point to any authority, statutory or otherwise, to support its contention.The final contention of the petitioner is that money which it received in 1943 under contracts for cutting the timber represented proceeds from the sale of capital assets and whatever gain was involved should be regarded as a capital gain. That contention is sustained. Isaac S. Peebles, Jr., 5 T. C. 14; Estate of M. M. Stark, 45 B. T. A. 882.Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619578/ | Thurston Manufacturing Company, Petitioner, v. Secretary of War, RespondentThurston Mfg. Co. v. Secretary of WarDocket No. 106-RUnited States Tax Court11 T.C. 269; 1948 U.S. Tax Ct. LEXIS 93; September 14, 1948, Promulgated *93 An order will issue in accordance herewith. The amount of excessive profits of petitioner derived from its sales in 1942 which were subject to the Renegotiation Act, held, on the record, to be $ 125,000. Edward C. Park, Esq., James F. Armstrong, Esq., and Walter F. Gibbons, Esq., for the petitioner.Harland F. Leathers, Esq., and Robert H. Winn, Esq., for the respondent. Harron, Judge. HARRON *269 By notice dated August 19, 1944, the Under Secretary of War determined that *94 excessive profits of $ 125,000 were realized by petitioner during the fiscal year ended December 31, 1942, on contracts and subcontracts subject to renegotiation under section 403 of the Renegotiation Act (Sixth Supplemental National Defense Appropriation Act, 1942, as amended). The present proceeding was initiated by petitioner pursuant to section 403 (e) of the Renegotiation Act.The questions presented are: (1) Is the Renegotiation Act unconstitutional? (2) Were the profits received by petitioner from its renegotiable business during the fiscal year ended December 31, 1942, "excessive" within the meaning of the Renegotiation Act? A subsidiary question is whether, in the determination of excessive profits, if any, the amount of profits should be considered to be the net earnings after Federal income and excess profits taxes.This proceeding was submitted under stipulations of facts, oral testimony and exhibits.FINDINGS OF FACT.The facts which have been stipulated are found as stipulated. The stipulations are incorporated herein by this reference.Petitioner is a Rhode Island corporation, organized in 1912, with its principal place of business in Providence, Rhode Island. Since*95 1922 petitioner has been engaged exclusively in the manufacture and sale of metal-cutting tools, such as cutting saws, double end mills, taper shank end mills, milling cutters, and chucks. These tools, which are utilized in machine tools, are small expendable items, weighing approximately one-quarter pound each and selling for an average of $ 2.50 per item. They are made of various steel alloys, and generally require the observance of close tolerances in their manufacture. Petitioner produces both stock items, i. e., tools of standard dimensions, *270 and special items, which are tools manufactured in accordance with specifications submitted by the customers. During 1942 and the years prior thereto petitioner's sales were divided about equally between stock and special items.Petitioner's present plant was acquired and placed in operation in 1928 and it contains approximately 54,000 square feet of floor space. As of December 31, 1941, petitioner owned approximately 188 machines, of which about 50 per cent were milling machines, 25 per cent were turret and engine lathes, and 25 per cent were grinding machines. In addition, commencing in 1941 and continuing throughout 1942, *96 petitioner leased approximately 85 similar machines from the Federal Government at a total annual rental of $ 1,848.46. The latter machines required considerable reconditioning in order to be rendered usable, and this reconditioning was completed in the early part of 1942. The cost of reconditioning was included by petitioner in its production costs for the years 1941 and 1942.The years 1936 to 1939, inclusive, reflect a period of normal earnings and operations for petitioner.Petitioner's comparative balance sheet for the years 1936 to 1942, inclusive, is as follows:19361937ASSETSCurrent assets:Cash in bank$ 23,069.09 $ 28,268.28 Cash on hand151.51 338.10 Notes receivableAccouts receivable20,647.90 14,446.77 Merchandise inventory58,924.39 84,173.35 Prepaid assets and loans865.32 328.76 Good will12,500.00 12,500.00 Post war credit -- bondsTotal116,158.21 140,055.26 Fixed assets:Buildings and real estate69,021.25 66,962.50 Machinery and equipment17,331.99 22,911.24 Total86,353.24 89,873.74 Total assets202,511.45 229,929.00 LIABILITIES AND NET WORTHCurrent liabilities:Accounts payable11,096.01 5,796.79 Notes payable12,000.00 42,000.00 Loans and advances32,975.94 30,132.04 Reserve for Federal income tax -- current800.06 8,581.41 Reserves for Federal income tax -- prior years2,303.82 2,850.19 Accrued taxes -- miscAccrued interestTotal59,175.83 89,360.43 Net worth:Capital:Capital stock$ 64,500.00 $ 64,500.00 Paid in surplus10,500.00 10,500.00 Total75,000.00 75,000.00 Surplus:Earned surplus (at beginning)67,378.75 68,335.62 Net profit before Federal income tax1,756.93 38,914.36 Federal income taxes -- current(800.06)(8,581.41)Net profit after taxes956.87 30,332.95 Dividends paid(30,000.00)Miscellaneous items(3,100.00)Earned surplus (at end)68,335.62 65,568.57 Total liabilities and net worth202,511.45 229,929.00 *97 19381939ASSETSCurrent assets:Cash in bank$ 2,903.19 $ 20,986.69 Cash on hand345.40 401.79 Notes receivableAccounts receivable14,455.11 20,332.34 Merchandise inventory87,462.87 81,199.75 Prepaid assets and loans860.16 1,607.08 Good will12,500.00 12,500.00 Post war credit -- bondsTotal118,526.73 137,027.65 Fixed assets:Buildings and real estate64,903.7562,845.00 Machinery and equipment24,383.71 22,945.89 Total89,287.46 85,790.89 Total assets207,814.19 222,818.54 LIABILITIES AND NET WORTHCurrent liabilities:Accounts payable6,941.32 4,332.71 Notes payable42,000.00 54,000.00 Loans and advances18,509.81 20,176.50 Reserve for Federal income tax -- current1,591.37 Reserves for Federal income tax -- prior years2,132.83 Accrued taxes -- misc684.48 310.91 Accrued interest1,943.75 1,200.00 Total72,212.19 81,611.49 Net worth:Capital:Capital stock$ 64,500.00 $ 64,500.00 Paid in surplus10,500.00 10,500.00 Total75,000.00 75,000.00 Surplus:Earned surplus (at beginning)65,568.57 60,602.00 Net profit before Federal income tax(5,455.85)12,596.42 Federal income taxes -- current(1,591.37)Net profit after taxes(5,455.85)11,005.05 Dividends paid(5,400.00)Miscellaneous items489.28 Earned surplus (at end)60,602.00 66,207.05 Total liabilities and net worth207,814.19 222,818.54 *98 *271 19401941ASSETSCurrent assets:Cash in bank$ 26,165.57 $ 64.882.63 Cash on hand329.02 439.04 Notes receivableAccounts receivable37,659.02 54,379.01 Merchandise inventory98,975.85 156,899.51 Prepaid assets and loans2,112.30 6,570.68 Good willPost war credit-bondsTotal165,241.76 283,170.87 Fixed assets:Buildings and real estate60,786.25 58,727.50 Machinery and equipment30,664.13 33,823.35 Total91,450.38 92,550.85 Total assets256,692.14 375,721.72 LIABILITIES AND NET WORTHCurrent liabilities:Accounts payable5,412.57 6,236.60 Notes payable78,000.00 58,000.00 Loans and advances245.66 13,648.14 Reserves for Federal income tax -- current15,742.90 80,789.64 Reserves for Federal income tax -- prior years(97.13)(209.37)Accrued taxes -- miscellaneousAccrued interestTotal99,304.00 158,465.01 Net worth:Capital:Capital stock64,500.00 64,500.00 Paid in surplus10,500.00 10,500.00 Total75,000.00 75,000.00 Surplus:Earned surplus (at beginning)66,207.05 82,388.14 Net profit before Federal income tax47,123.99 143,358.21 Federal income taxes -- current(15,742.90)(80,789.64)Net profit after taxes31,381.09 62,568.57 Dividends paid(2,700.00)(2,700.00)Miscellaneous items(12,500.00)Earned surplus (at end)82,388.14 142,256.71 Total liabilities and net worth256,692.14 375,721.72 *99 1942ASSETSCurrent assets:Cash in bank$ 81,531.75 Cash on hand351.87 Notes receivableAccounts receivable97,253.85 Merchandise inventory267,691.68 Prepaid assets and loans9,537.39 Good willPost war credit-bonds16,763.14 Total473,129.68 Fixed assets:Buildings and real estate56,668.75 Machinery and equipment36,345.73 Total93,014.48 Total assets566,144.18 LIABILITIES AND NET WORTHCurrent liabilities:Accounts payable5,713.43 Notes payable13,000.00 Loans and advances2,422.64 Reserves for Federal income tax -- current225,670.78 Reserves for Federal income tax -- prior years(729.84)Accrued taxes -- miscellaneous6,155.98 Accrued interestTotal252,232.99 Net worth:Capital:Capital stock96,500.00 Paid in surplus10,500.00 Total107,000.00 Surplus:Earned surplus (at beginning)142,256.71 Net profit before Federal income tax283,262.10 Federal income taxes -- current(208,907.64)Net profit after taxes74,354.46 Dividends paid(14,400.00)Miscellaneous items4,700.00 Earned surplus (at end)206,911.18 Total liabilities and net worth566,144.18 *100 *272 The average of the fixed assets of the petitioner for the years 1936 through 1939 was $ 87,826.44. In 1942 fixed assets increased $ 5,188.04, to the total amount of $ 93,014.48.The average profit before taxes during the period 1936 through 1939 (excluding the year 1938, when loss was sustained), was $ 17,755.90 per annum. Petitioner's profits before taxes for the year 1942 amounted to $ 283,262.10, which represented a total increase of $ 265,506.20 above the average annual profit during the period 1936 through 1939.The following schedule shows the changes in ratios in the 1936-1939 period, and in 1942, of current assets to current liabilities, and of profits to net worth:1936-19391942Ratio of current assets to current liabilities171%188%Ratio of profits (before taxes) to net worth(at start of year), excluding lossyear of 1938 (average)12.7% 130%The following is a breakdown of petitioner's inventories during the above period:Summary of Inventories for Years 1936 to 19421936193719381939Raw stock$ 7,292,75$ 12,520.77$ 12,254.83$ 11,965.09Work in process16,856.3115,058.9712,465.3317,417.99Finished goods34,775.3356,593.6162,742.7151,816.6758,924.3984,173.3587,462.8781,199.75*101 Summary of Inventories for Years 1936 to 1942194019411942Raw stock$ 20,976.29$ 29,220.06$ 84,260.37Work in process47,633.3297,586.94136,505.38Finished goods30,366.2430,092.5146,925,9398,975.85156,899.51267,691.68Petitioner had orders on hand amounting to approximately $ 689,000 in the latter part of 1942, or almost three times its 1942 closing inventory of $ 267,691.68. There was no substantial number of orders canceled in that year.Petitioner's condensed comparative profit and loss statement for the years ended December 31, 1936 to 1942, inclusive, is as follows: *273 19361937Income:Net sales$ 224,430.39$ 290,259.00Other income230.12479.79Total income224,660.51290,738.79Costs:Material used:Inventory at beginning of year63,350.2058,924.39Material purchased52,211.7264,293.96Total115,561.92123,218.35Inventory at end of year58,924.3984,173.35Material used56,637.5339,045.00Labor:Productive -- direct50,538.4167,747.06Nonproductive -- indirect10,959.0116,238.04Prime cost118,134.95123,030.10Manufacturing expenses25,733.5735,012.12Administrative expenses9,118.7210,194.95Selling expenses31,824.2143,096.03Building expenses8,782.389,521.89Loss from bad debts193.75515.62Total costs -- before officers' compensation193,787.58221,370.71Net profit before taxes and officers' compensation30,872.9369,368.08Officers' compensation29,116.0030,453.72Net profit after officers' compensation and beforeFederal taxes1,756.9338,914.36*102 19381939Income:Net sales$ 168,589.19 $ 236,103.16Other income305.34 384.31Total income168,894.53 236,487.47Costs:Material used:Inventory at beginning of year84,173.35 87,462.87Material purchased31,274.78 37,314.63Total115,448.13 124,777.50Inventory at end of year87,462.87 81,199.75Material used27,985.26 43,577.75Labor:Productive -- direct37,936.02 45,976.88Nonproductive -- indirect8,794.63 15,489.61Prime cost74,715.91 105,044.24Manufacturing expenses25,848.08 27,319.60Administrative expenses11,018.74 12,137.79Selling expenses35,710.55 37,529.37Building expenses10,684.73 10,881.64Loss from bad debts434.54 142.41Total costs -- before officers' compensation158,412.55 193,055.05Net profit before taxes and officers' compensation10,481.98 43,432.42Officers' compensation15,937.83 30,836.00Net profit after officers' compensation and beforeFederal taxes(5,455.85)12,596.4219401941Income:Net sales$ 378,578.09$ 693,455.02Other income847.541,349.48Total income379,425.63694,804.50Costs:Material used:Inventory at beginning of year81,199.7598,975.85Material purchased87,942.28168,569.62Total169,142.03267,545.47Inventory at end of year98,975.85156,899.51Material used70,166.18110,645.96Labor:Productive -- direct71,408.67177,082.86Nonproductive -- indirect27,763.7019,858.97Prime cost169,338.55307,587.79Manufacturing expenses41,621.0878,006.77Administrative expenses17,131.9324,482.86Selling expenses43,510.7947,561.72Building expenses12,539.1615,835.47Loss from bad debts58.1381.68Total costs -- before officers' compensation284,199.64473,556.29Net profit before taxes and officers' compensation95,225.99221,248.21Officers' compensation48,102.0077,890.00Net profit after officers' compensation and beforeFederal taxes47,123.99143,358.21*103 1942Income:Net sales$ 975,507.21Other income2,086.19Total income977,593.40Costs:Material used:Inventory at beginning of year156,899.51Material purchased257,517.48Total414,416.99Inventory at end of year267,691.68Material used146,725.31Labor:Productive -- direct178,846.38Nonproductive -- indirect82,994.84Prime cost408,566.53Manufacturing expenses108,022.05Administrative expenses28,501.02Selling expenses47,263.72Building expenses23,774.28Loss from bad debts22.70Total costs -- before officers' compensation616,150.30Net profit before taxes and officers' compensation361,443.10Officers' compensation78,181.00Net profit after officers' compensation and beforeFederal taxes283,262.10*274 The following table sets forth the compensation paid to petitioner's officers for the period 1936 to 1942, inclusive, and the percentage of the stock of petitioner which was held by the respective officers of the petitioner.CompensationOfficers193619371938Joseph M. Redinger, Sr., presidentand treasurerNoneNoneNoneJoseph M. Redinger, Jr., vice presidentand general manager:Salary$ 5,200.00$ 5,300.00$ 5,200.00Bonus6,200.006,403.27386.92Total11,400.0011,703.275,586.92Charles F. Redinger, secretary:Salary3,640.004,385.004,420.00Bonus5,200.004,959.71194.33Total8,840.009,344.714,614.33Ira H. Redinger, mechanical engineerand assistant secretary:Salary1,820.002,455.002,600.00Bonus4,100.003,666.74120.58Total5,920.006,121.742,720.58Henry Gabrielson, assistant treasurer:Salary2,756.003,034.003,016.00Bonus200.00250.000Total2,956.003,284.003,016.00Total compensation29,116.0030,453.7215,937.83*104 CompensationOfficers193919401941Joseph M. Redinger, Sr., presidentand treasurerNoneNoneNoneJoseph M. Redinger, Jr., vice presidentand general manager:Salary$ 5,200.00$ 5,850.00$ 7,800.00Bonus6,000.0012,000.0020,000.00Total11,200.0017,850.0027,800.00Charles F. Redinger, secretary:Salary4,420.004,940.006,500.00Bonus5,000.0010,000.0018,000.00Total9,420.0014,940.0024,500.00Ira H. Redinger, mechanical engineerand assistant secretary:Salary2,950.003,640.005,200.00Bonus4,000.008,000.0016,000.00Total6,950.0011,640.0021,200.00Henry Gabrielson, assistant treasurer:Salary3,016.003,172.003,640.00Bonus250.00500.00750.00Total3,266.003,672.004,390.00Total compensation30,836.0048,102.0077,890.00CompensationPercentage ofstockholdingsOfficersas of 19421942Joseph M. Redinger, Sr., presidentand treasurerNone53.83%Josph M. Redinger, Jr., vice presidentand general manager:Salary$ 7,800.00Bonus20,000.00Total27,800.0015.39%Charles F. Redinger, secretary:Salary6,500.00Bonus18,000.00Total24,500.0015.39%Ira H. Redinger, mechanical engineerand assistant secretary:Salary5,200.00Bonus16,000.00Total21,200.0015.39%Henry Gabrielson, assistant treasurer:Salary3,840.00Bonus841.00Total4,681.00NoneTotal compensation78,181.00*105 *275 Joseph M., Jr., Charles F., and Ira H. Redinger are sons of Joseph M. Redinger, Sr. The latter, a highly skilled engineer, has held the controlling interest in petitioner since 1922; during the years 1936 to 1942, inclusive, he devoted approximately 20 per cent of his time to petitioner's operations. The sons, all technically trained, devoted their time exclusively to petitioner, working long hours in 1942. As shown in the table setting forth the compensation of officers, supra, the bonuses of $ 12,000, $ 10,000 and $ 8,000 received by the Redinger sons, respectively, in 1940, were increased to $ 20,000, $ 18,000 and $ 16,000 in 1941 and 1942.On January 1, 1942, petitioner owed notes payable in the aggregate amount of $ 58,000, which amount included a total of $ 32,000 worth of notes payable held by the Redinger sons. On the same date petitioner's capital stock outstanding, all held by the Redinger family, amounted to $ 64,500. During 1942 petitioner reduced its notes payable account to $ 13,000, largely by the issuance of additional capital stock to the Redinger sons in exchange for their notes payable, thus increasing the capital stock outstanding by $ 32,000. *106 Dividends in the amount of $ 14,400 were distributed by petitioner in 1942.Of petitioner's total net sales of $ 975,507.21 in 1942, the following represents a breakdown between nonrenegotiable and renegotiable net sales:Nonrenegotiable net sales:Jan. 1 to Apr. 28$ 225,000.00Apr. 29 to Dec. 31151,507.21Total nonrenegotiable net sales376,507.21Renegotiable net sales (Apr. 29 to Dec. 31):Sales directly to Government agencies$ 193,398.39Sales to civilian customers for war end use405,601.61Total renegotiable net sales599,000.00Total net sales in 1942975,507.21Petitioner's total profits before Federal taxes in 1942 amounted to $ 283,262.10. Petitioner's books do not show the portions of these profits allocable as between nonrenegotiable and renegotiable net sales. However, the parties have stipulated that such allocation of profits is made properly for the purposes of this proceeding by applying to the total profits the ratios that nonrenegotiable net sales and renegotiable net sales bear to total net sales, which ratios are, approximately, 39 per cent and 61 per cent, respectively.Petitioner's profits before*107 Federal taxes on its nonrenegotiable net sales amounted to $ 109,327.95, and its profits on its renegotiable net sales amounted to $ 173,934.15.Petitioner's average annual net sales rose from $ 250,264 during the profit-making years from 1936 through 1939 to $ 975,507 in 1942. Of *276 the latter amount, $ 599,000 represented renegotiable sales. The ratio of profits before taxes to net sales increased from about 7 per cent during the above prewar years to 29 per cent in 1942.The nature of petitioner's products and its manufacturing technique remained substantially the same in 1942 as during the period 1936 to 1939, inclusive. However, petitioner changed from a one-shift to a two-shift basis in 1941, and during 1942 its plant operated on two ten-hour shifts, six days a week. Also, some change-over in heat-treating equipment was necessitated by the Government's directive, issued in 1941 or 1942, that petitioner and all other companies in the industry use a less efficient molybdenum alloy in certain percentages of their products, in place of the high tungsten alloy. This requirement was suspended in 1944.Before and during the war petitioner manufactured its double-end mills*108 and chucks under royalty-free licenses from Joseph M. Redinger, Sr., the holder of patents thereon; the sales of these patented items comprised approximately 25 per cent of petitioner's total sales in 1942. Petitioner did not borrow any funds from the Government in 1942, nor did it purchase any machinery under certificates of necessity. Petitioner extended no financial assistance to other contractors or subcontractors during 1942.Late in 1941, or during 1942, petitioner developed a fixture for increasing its production of double-end mills, which effected some saving in tungsten. Petitioner also developed or redesigned a number of devices for saving labor in its production operations, such as a machine for automatically resharpening teeth in saws, and an "automatic indexing device" for semiautomatically cutting the side teeth in saws. Petitioner received unsolicited letters of commendation for its war work from the Commanding General of the Springfield Armory, and from the Commanding General of the Army Service Forces, in September 1945.Petitioner's plant had not operated at full capacity at any time before 1941. Except for a reduction in its charges for sharpening tools, petitioner's*109 prices remained substantially the same in 1942 as during the period 1936 to 1939, inclusive. The following schedule shows the approximate average number of tools sold, cost per tool, and profit per tool during the period 1936 through 1939 (excluding 1938 when a loss was incurred) and the entire year 1942, and on renegotiable sales in 1942:Average numberAverage costAverageof toolsper toolprofit persoldtool1936 through 1939 (excluding 1938)100,106$ 2.34$ 0.161942390,2031.77.73Renegotiable sales in 1942239,6001.77.73*277 The parties have stipulated that petitioner's representatives attended several hearings before respondent or his representatives with respect to its renegotiatble profits for the year 1942, and petitioner was afforded an opportunity to submit to respondent or his representatives such financial or other data as petitioner desired, before the issuance of respondent's determination herein.The parties in the instant case have stipulated that the testimony taken in , appearing at pages 615-764 of the transcript therein, *110 together with exhibits Q through GG in that case, shall be deemed in evidence herein to the extent that such evidence is material on all constitutional issues involved herein and on all questions of construction of the Renegotiation Act, reserving to counsel in the instant case the same objections made by counsel in the Stein Brothers case. The evidence referred to is incorporated herein by this reference.Petitioner's profits during the fiscal year ended December 31, 1942, from its sales subject to the Renegotiation Act were excessive, within the meaning of that act, in the amount of $ 125,000.OPINION.The first contention of the petitioner is that the Renegotiation Act of 1942 is unconstitutional. The Supreme Court has upheld the constitutionality of the act, in .The question to be decided is whether the profits received by petitioner from its renegotiable business in 1942 were excessive within the meaning of the Renegotiation Act. Petitioner's profits before Federal taxes, subject to renegotiation, amounted to $ 173,934.15. Respondent determined that these profits were excessive in the amount of *111 $ 125,000, which would leave petitioner profits of $ 48,934.15 on its renegotiable sales. Petitioner has the burden of proving that respondent's determination is erroneous. .Certain factors to be considered in determining whether profits are excessive are set forth in section 403 (a) (4) (A) of the Renegotiation Act, as amended by section 701 of the Revenue Act of 1943. Although these elements were not outlined in the Renegotiation Act before the above amendment, they "were already known by Congress to be in use in voluntary renegotiation when the act here in question was enacted," and "are the factors which any reasonable person would naturally use in determining the amount of excessive profits." . The factors are as follows:*278 (i) Efficiency of contractor, with particular regard to attainment of quantity and quality production, reduction of costs and economy in the use of materials, facilities, and manpower;(ii) reasonableness of costs and profits, with particular regard to volume of production, normal pre-war earnings, and comparison*112 of war and peacetime products;(iii) amount and source of public and private capital employed and net worth;(iv) extent of risk assumed, including the risk incident to reasonable pricing policies;(v) nature and extent of contribution to the war effort, including inventive and developmental contribution and cooperation with the Government and other contractors in supplying technical assistance;(vi) character of business, including complexity of manufacturing technique, character and extent of subcontracting, and rate of turn-over;(vii) 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 considered each of these elements as applied to petitioner's operations and financial status, and have accorded each factor the weight which we deemed proper.The petitioner contends that, in the determination of the question whether its profits for 1942 were excessive, and if so, in the determination of the amount of the excessive profits, consideration should be given, "either directly or indirectly," to the amount of its Federal income*113 and excess profits tax liability. Petitioner calls attention to the high rates of the income and excess profits taxes in 1942. While petitioner does not state its argument clearly to be that Federal taxes should be deducted, tentatively, from its profits on its renegotiable sales, so as to focus the first consideration upon the amount of profits after Federal taxes, petitioner does challenge the validity of the broad proposition that the question is whether profits, before allowance for taxes, are excessive. The argument has been presented to this Court before. See ; and .It was said in , that:We are to determine the excess profit in "profits derived from contracts with the Department and subcontracts," which under the statute means "the excess of the amount received or accrued under such contracts and subcontracts over the costs paid or incurred with respect thereto." (Italics supplied.)See section 403 (a), 4 (A) and (B) *114 of the Renegotiation Act. Our first inquiry must be about the amount of profits, regardless of the amount of Federal taxes thereon. Our analysis must start at that point. A determination which eliminates part of the profit as excessive also eliminates part of the burden of taxation, the tax being a variable which depends upon the profit allowed. Under section 403 (c) (3), in determining the amount of any excessive profits to be eliminated, there shall be allowed "credit for Federal income and excess *279 profits taxes." The factor of the income and excess profits taxes is one which follows upon the determination of what part of the profit is excessive, and the statute sets forth the chief factors which are to be considered in making that determination, as set forth above. All who are subject to the Renegotiation Act must be accorded equal consideration, and the act, properly construed, does not afford anyone avoidance of his share of the increased tax burden which was required to maintain the war effort. See .Whether or not the elimination of a certain amount of profit, as excessive*115 profit, will leave a concern too small a profit after taxes, or even will result in financial embarrassment, is a fact problem in a particular case. It would be unrealistic to fail to recognize that the revenue acts operate to reduce retained profits, entirely apart from the administration of the Renegotiation Act. Petitioner has called to our attention the following provision in section VI of the War Department Price Adjustment Board's "Principles, Policy and Procedure to be followed in Renegotiation," dated August 10, 1942, at page 12:* * * The effect of the excess profits tax on companies which are financially extended and have little or no tax base is frequently so severe, however, that strict adherence to the principle of considering only profits before taxes would leave practically nothing for the company, or even result in financial embarrassment, and under these circumstances the profit after taxes is a factor which may be taken into consideration in order not to impair its incentive to production.However, the record fails to support an application of the above in this proceeding. It does not appear that petitioner was "financially extended" in 1942, nor that it was*116 in the position of having "little or no tax base" for excess profits tax purposes. Furthermore, even assuming the refund as determined by respondent, there is no persuasive evidence that "practically nothing" would be left for petitioner as profits on its renegotiable sales after taxes, or that such refund would result in "financial embarrassment." Cf. We have noted in our analysis that petitioner's products, manufacturing technique, and prices remained substantially the same in 1942 as during the pre-war years 1936 to 1939, inclusive. Yet, a comparison of petitioner's approximate net sales and earnings during the profit-making years of the period 1936 through 1939 with those during 1942 reveals the following data: Petitioner's average annual net sales rose from $ 250,264 during the pre-war years to $ 975,507 in 1942, the latter amount including $ 599,000 of renegotiable business. Petitioner's average annual profits before taxes increased from $ 17,756 during the pre-war period to $ 283,262 in 1942. Of the 1942 figure, $ 173,934 represented profits on renegotiable sales alone. Thus, petitioner's total sales during*117 1942 were almost four times, and its renegotiable sales alone were about twice, the average sales during the pre-war years; *280 its total profits during 1942 were more than fifteen times, and its profits on renegotiable sales were almost ten times, its average annual profits during the pre-war years; and the ratio of profits to sales increased from about 7 per cent in the pre-war period to approximately 29 per cent in 1942. These increases, it may be observed, were accomplished not by appreciable additions to petitioner's fixed assets, but with the aid of machinery acquired at low rental from the Federal Government.As previously stated, respondent determined that $ 125,000 of petitioner's profits on its renegotiable business was excessive. This refund would leave petitioner with profits of $ 48,934 on renegotiable sales alone, which amount is almost as much as petitioner's total profits during the entire period 1936 through 1939 ($ 53,268).We are not persuaded from the evidence that the market for petitioner's products was saturated during the post-war years. Moreover, inasmuch as petitioner had orders on hand amounting to almost three times its inventory at the end*118 of 1942, we do not believe that petitioner was subjected to any extraordinary risk by reason of this inventory.It is concluded, and has been found as a fact, after a careful analysis of all the relevant evidence and the arguments of counsel, that the respondent correctly determined that the petitioner's profits from its renegotiable business during 1942 were excessive in the amount of $ 125,000.An order will issue in accordance herewith. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619579/ | Oregon Lumber Company, Petitioner, v. Commissioner of Internal Revenue, RespondentOregon Lumber Co. v. CommissionerDocket No. 31860United States Tax Court20 T.C. 192; 1953 U.S. Tax Ct. LEXIS 184; April 27, 1953, Promulgated *184 Decision will be entered under Rule 50. Exchanges of Like Kind -- Land for Standing Timber. -- Petitioner exchanged land for the right to cut and remove standing timber. Held, the exchange was not an exchange of property for property of a like kind within section 112 (b) (1), Internal Revenue Code. Clair M. Senior, Esq., for the petitioner.John H. Pigg, Esq., for the respondent. Johnson, Judge. JOHNSON *192 OPINION.Respondent has determined deficiencies in income and excess profits tax as follows:YearKind of taxDeficiency1942Excess profits$ 64,725.391943Income41,304.921944Excess profits18,362.11*185 The only issue before us is whether conveyances of certain lands by petitioner to the United States in 1940 in exchange for rights to cut and remove specified quantities of national forest timber constituted exchanges of property for property of like kind within the meaning of section 112 (b) (1), Internal Revenue Code.All other issues in the petition grow out of and will be controlled by the ultimate decision with respect to the "exchange" question.All of the facts are stipulated and are so found.Petitioner, a Utah corporation, was organized under the laws of that state during the year 1889. Its principal office and place of business is at Baker, Oregon. The returns for the years involved were filed with the collector of internal revenue for the district of Oregon.In 1940 petitioner was the fee simple owner of certain tracts of land within and adjacent to the national forests in Oregon. Part of this land contained standing timber and part of it had been cut over. Petitioner acquired some of this land prior to March 1, 1913, and the rest thereafter.In 1940 petitioner and the United States entered into three agreements, sometimes referred to as Exchange #56, Dee Exchange, *186 and Baker-Small Exchange, whereby the petitioner exchanged some of its land for national forest timber. These agreements were made under *193 an Act of Congress of March 20, 1922, 42 Stat. 465 (16 U. S. C. A. 485). 1*187 In a deed dated September 23, 1940, petitioner conveyed to the United States all the land it had agreed to convey under a Land Exchange Agreement dated April 3, 1940. This was the transaction referred to as Exchange #56. Under it petitioner conveyed to the United States title to approximately 44,661 acres of land in exchange for the right to cut and remove an equal value of national forest timber on an area of about 110,000 acres within the Whitman and Malheur National Forests in Oregon. The lands conveyed to the United States contained 515,408 M feet of standing timber. At the time of this exchange the fair market value of the cutting rights acquired by petitioner from the United States was $ 2.85 per M feet. The March 1, 1913, fair market value of the land and timber conveyed by the petitioner to the United States adjusted to the date of the exchange was $ 779,987.42. The cost to petitioner of this land and timber adjusted to the date of the exchange was less than either the value of the cutting rights received by it, or the March 1, 1913, value of the land and timber conveyed.The Land Exchange Agreement is extensive and detailed. It described the land to be conveyed and*188 lists the areas in which petitioner might cut the timber as designated by the forest officer. In part, the agreement is as follows:(a) The proponent agrees to convey to the United States under the said acts the lands described in "List A" attached hereto and made a part of this agreement.(b) The United States agrees to grant in exchange for the offered land and timber, and the proponent agrees to cut and remove an equal value of National Forest timber on an area of about 110,000 acres to be definitely designated on the ground by the Forest officer in charge prior to cutting on the area described in "List B" * * ** * * *(c) It is mutually agreed by the parties hereto that a total volume of 328,000 M feet of ponderosa pine timber will be granted in exchange for the land and timber of the proponent.The agreement also considered such items as the time allowed for cutting, the marking of timber, when it is to be cut, definition of merchantable *194 logs, scaling, logging plans and methods, slash disposal, fire prevention, occupancy, and improvement.In another deed dated February 19, 1940, petitioner conveyed to the United States all the land that it had agreed to convey under*189 a Land Exchange Agreement dated June 8, 1939. This was the transaction referred to as the Baker-Small Exchange. Petitioner conveyed to the United States title to approximately 18,354 acres of cut-over land valued at $ 36,681.98 in exchange for the right to cut and remove an equal value in national forest timber on an area of about 12,812 acres in the Whitman and Malheur National Forests in Oregon. The March 1, 1913, fair market value of the cut-over land adjusted to the date of the exchange was $ 45,885.43. The cost to petitioner of this land as adjusted to the date of the exchange was less than the value of the cutting rights received by it, but the value of the cutting rights was less than the March 1, 1913, value of the land conveyed. This agreement, like the one in Exchange #56, is likewise detailed and extensive in its consideration of the cutting requirements, the logging operations, and fire prevention methods. The agreement is in part as follows:(a) The proponent agrees to convey to the United States under the said acts the following described lands:* * * *(c) The United States agrees to grant in exchange for the above described offered land and timber, and the proponent*190 agrees to cut and remove, an equal value in National Forest timber on an area of about 12,812 acres to be definitely designated on the ground by the Forest Officer in charge prior to cutting in selected areas.In another deed dated February 19, 1940, petitioner conveyed to the United States all the land that it agreed to convey under the Land Exchange Agreement dated August 17, 1939. This was the transaction referred to as Dee Exchange. Petitioner conveyed to the United States title to approximately 920 acres of land of the agreed value of $ 69,502.54 in exchange for the right to cut and remove an equal value of national forest timber then standing on an area of about 1,700 acres within the Mt. Hood National Forest in Oregon. The lands conveyed contained 40,300 M feet of standing timber. The March 1, 1913, fair market value of the land and timber conveyed by the petitioner to the United States adjusted to the date of the exchange was $ 52,979.54. The cost to the petitioner of this land and timber adjusted to the date of the exchange was less than either the value of the cutting rights received by it or the March 1, 1913, value of the land and timber conveyed.The terms and the*191 form of the Land Exchange Agreement in the Dee Exchange are similar to the agreements in the other two transactions.*195 The primary issue is whether the transactions between petitioner and the United States resulted in an exchange of property for property of like kind under section 112 (b) (1), Internal Revenue Code. 2 Petitioner contends that the transactions constituted taxable exchanges and that there was a recognized gain resulting from the exchanges. Respondent's position is that there was no recognizable gain or loss resulting from the exchange. In general, the theory of the petitioner is that it exchanged land for a right to cut and remove national forest timber and that this was an exchange of unlike property. Respondent's premise under the above facts is that the conveyance of standing trees upon land creates an estate upon condition, and therefore the transactions constituted exchanges of property of like kind.*192 To resolve these differences we must first determine what the parties exchanged. In Exchange #56 "the United States agrees to grant in exchange for the above described offered land and timber, and the proponent agrees to cut and remove, an equal value in National Forest timber." Again, in the Dee Exchange, "the proponent agrees to cut and remove an equal value of National Forest timber," and like words are used in the Baker-Small Exchange. We can only conclude that in each of the agreements petitioner's land was exchanged for the right to cut and remove standing timber. Next, we must ascertain whether the right to cut and remove standing timber passed to the petitioner as realty or as personalty.The view most widely accepted is that growing trees constitute a part of the land and as such are real property. An agreement for their sale is a contract for the sale of an interest in land, and, for example, such an agreement is considered to be within the meaning of the statute of frauds. In some jurisdictions the courts have adopted what is known as the "immediate severance rule" which is to the effect that when standing timber is sold with the understanding that it is to be removed*193 immediately, or in a reasonably continuous manner, the sale is considered as being one for the sale of chattels. A few jurisdictions without qualification or limitation of any sort subscribed to the view that contracts for the sale of growing timber do not contemplate the conveyance of any interest in land. See 7 A. L. R. 2d 517; also, 34 Am. Jur. 495.On July 19, 1909, a decision was rendered by the United States District Court of Oregon involving the question whether the sale of standing timber was a conveyance of an interest in real property or a *196 transfer of personal property. We quote from the opinion of the court:Incidentally, the question has been presented whether the right to cut and remove standing timber is an interest in land which must be transferred by deed. In regard to the question, "it is now very generally recognized," say the authors of the American & English Encyclopedia of Law (volume 28, p. 541), "that a contract for the sale of trees, if the vendee is to have the right to the soil for a time for the purpose of further growth and profit, is a contract for an interest in land, but that where the trees are sold in the prospect*194 of separation from the soil immediately or within a reasonable time, without any stipulation for the beneficial use of the soil, but with license to enter and take them away, it is regarded as a sale of goods only, and not within the fourth section of the statute." [Goodnough Mercantile & Stock Co. v. Galloway, 171 F. 940">171 F. 940, 951.]In 1919 the Uniform Sales Act was enacted into the Oregon Code. Sec. 71-176, vol. 5, O. C. L. A., pp. 381, 382 (sec. 76, Uniform Sales Act), provided:"Goods" include all chattels personal other than things in action and money. The term includes emblements, industrial growing crops, and things attached to or forming a part of the land which are agreed to be severed before sale or under the contract of sale.In Reid v. Kier (1944), 175 Or. 192">175 Or. 192, 152 P.2d 417">152 P. 2d 417, the Supreme Court of Oregon was called upon to interpret this section of the code as it applied to the sale of standing timber. One of the parties argued that under this section of the code standing timber, which was sold under a written agreement, must be regarded as personal property. The court, in a well written*195 opinion, discussed the development of the Uniform Sales Act from its original source, the English Sale of Goods Act, to the present day Uniform Sales Act. The court concluded, on page 423, that "standing timber is deemed to be goods when and only when it is agreed to be severed before sale or under the contract of sale." In the Reid case there was no agreement that the standing timber was to be severed before sale or even at all. The court held that the Uniform Sales Act did not apply to the situation.We can only conclude from the Goodnough Mercantile & Stock Co. case and the Reid case that in Oregon, when there is an agreement to cut and remove standing timber from the land immediately or within a reasonable time, the agreement is for the sale of goods only.Focusing our attention on the agreements in the present case, we find in Exchange #56 "all timber marked for cutting shall be cut and removed on or before December 31, 1959"; in the Baker-Small Exchange "all timber marked for cutting shall be cut and removed on or before December 31, 1940"; in the Dee Exchange "all the timber granted on the described area under the exchange agreement shall be cut and removed from*196 the cutting area prior to December 31, 1943." Thus, in each one of the agreements, there was a definite time limit *197 for cutting and removing the designated timber. We have no evidence or reason to believe that the time limits set up by the parties were unreasonable. Therefore, applying the rule as established in Oregon to these agreements, we find and so hold that in the exchange of land for standing timber to be cut and removed within a definite time petitioner acquired goods only and not realty.An exchange of realty for personalty is not an exchange of property for property of like kind. Therefore, we are constrained to find for the petitioner.While it is our conclusion that there was an exchange of realty for personalty, we are of the opinion that under the authority of certain Oregon cases it would not be improper to conclude that petitioner's real property was exchanged for a license to cut and remove standing timber. See Elliott v. Bloyd, 40 Or. 326">40 Or. 326, 67 P. 202">67 P. 202; Coquille Mill & Tug Co. v. Robert Dollar Co., 132 Or. 453">132 Or. 453, 285 P. 244">285 P. 244. Under this theory an exchange of*197 real property for a license would not be an exchange of property of like kind. Therefore, the exchange would be taxable.In resolving this issue for the petitioner we are not unmindful of such cases as Sandy Holding Co. v. Ferro, 144 Or. 466">144 Or. 466, 25 P.2d 561">25 P. 2d 561, and the cases cited therein, which indicate that a sale of standing timber is a conveyance of an estate upon condition subsequent. However, the issues involved therein are not similar to the one before us. Arguendo, if, from the record, we were able to find and hold that the standing timber was realty in the hands of the petitioner, we must nevertheless reach the same conclusion as above for the reasons stated below.The situation presented here is not the first time we have been called upon to decide whether there is an exchange of like kind when one realty interest is exchanged for another. See Midfield Oil Co., 39 B. T. A. 1154; Kay Kimbell, 41 B. T. A. 940. In Midfield Oil Co., the taxpayer contended that an exchange of an oil and gas payment for an overriding oil and gas royalty was a nontaxable exchange under*198 section 112 (b) (1). In finding for the respondent, we determined that there were substantial differences in the properties exchanged. The first difference was the quantum of interest in the property itself. The oil payment was a limited interest, once paid the liability was removed. On the other hand, the royalty interest was in the nature of a fee for it continued as long as gas and oil would be produced from the property.By analogy to the present case petitioner exchanged a fee simple title for a limited right to cut and remove standing timber. It is our conclusion that the right to cut and remove standing timber is so intrinsically different from a fee in land that an exchange of one for the other is not an exchange of like property within section 112 (b) (1). *198 The right to cut and remove is transient and depends upon the affirmative action of the holder of that right. The fee is permanent and depends only upon the original grant. The right to cut and remove timber is more in the nature of utilization of land; the fee is ownership of the land itself. For these reasons we find and hold that the exchanges were not exchanges within section 112 (b) (1).Decision*199 will be entered under Rule 50. Footnotes1. § 485. Exchange of lands in national forests; cutting timber in national forests in exchange for lands thereinWhen the public interests will be benefited thereby, the Secretary of the Interior is authorized in his discretion to accept on behalf of the United States title to any lands within the exterior boundaries of the national forests which, in the opinion of the Secretary of Agriculture, are chiefly valuable for national-forest purposes, and in exchange therefor may patent not to exceed an equal value of such national-forest land, in the same State, surveyed and non-mineral in character, or the Secretary of Agriculture may authorize the grantor to cut and remove an equal value of timber within the national forests of the same State; the values in each case to be determined by the Secretary of Agriculture. * * *↩2. SEC. 112. RECOGNITION OF GAIN OR LOSS.(b) Exchanges Solely in Kind. -- (1) Property held for Productive use or investment. -- No gain or loss shall be recognized if property held for productive use in trade or business or for investment * * * is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619580/ | DUANE L. GALLENTINE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentGallentine v. CommissionerDocket No. 7926-90United States Tax CourtT.C. Memo 1992-14; 1992 Tax Ct. Memo LEXIS 19; 63 T.C.M. (CCH) 1747; T.C.M. (RIA) 92014; January 8, 1992, Filed *19 Decision will be entered under Rule 155. Duane L. Gallentine, pro se. Michael A. Urbanos, for respondent. COHEN, Judge. COHENMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined deficiencies of $ 9,706 and $ 7,097 in petitioner's Federal income taxes for 1982 and 1983, respectively, and additions to tax for fraud under section 6653(b)(1) and (2) and for underpayment of estimated tax under section 6654 for each year. In the answer, respondent alleged, in the alternative, that petitioner was liable for additions to tax under section 6651(a)(1) for failure to file returns and under section 6653(a)(1) and (2) for negligence. All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. After concessions, the issues for decision are whether petitioner is entitled to charitable contribution deductions beyond those allowed by respondent and whether petitioner is liable for the additions to tax for fraud. FINDINGS OF FACT Some of the facts have been stipulated, and the stipulated facts are incorporated herein by this reference. *20 Petitioner was a resident of Wisconsin at the time his petition was filed. During the years in issue, petitioner was a rate auditor for Yellow Freight Systems, Inc. He received wage income from his employer in the amounts of $ 27,866 for 1982 and $ 27,794 for 1983. During 1982, petitioner also received a taxable distribution of $ 4,070 from his employer's profit-sharing plan, interest income, and a State tax refund. Petitioner also received interest income in 1983. In 1982, petitioner ceased to use bank accounts and began conducting his affairs in cash. Petitioner's purpose in conducting his affairs in cash was to avoid seizure of his assets by the Internal Revenue Service. Petitioner posted a sign on his residence containing threatening language directed at Federal Government agents, including Internal Revenue Service agents, in an attempt to intimidate them. Petitioner was aware of his obligation to file timely Federal income tax returns. Petitioner filed timely Federal income tax returns on Forms 1040 for the years 1977 through 1981, inclusive. On those returns, petitioner reported wages received for his work as a rate auditor or a rate clerk. During 1981, petitioner*21 signed and submitted to his employer a Form W-4 withholding certificate, claiming four withholding allowances. During 1982 and 1983, petitioner was entitled to personal and dependent withholding allowances for himself and for his two children. (His wife filed a separate Federal income tax return for those years.) The itemized deductions to which petitioner was entitled were approximately $ 5,100 for 1982 and $ 5,400 for 1983. Petitioner was entitled to only three withholding allowances during 1982 and 1983. In 1982, petitioner knowingly signed and submitted to his employer a false Form W-4 withholding certificate, claiming entitlement to 13 withholding allowances. Federal income tax was withheld from petitioner's wages in the amounts of $ 2,380 in 1982 and $ 1,829 in 1983. On or about April 15, 1983, and on or about April 15, 1984, petitioner submitted to the Internal Revenue Service Forms 1040 for 1982 and 1983, respectively, on which he placed the word "object" on the lines on which he was to report (1) wages, salaries, tips, etc., (2) capital gain or loss, (3) other income, (4) total income, and (5) adjusted gross income. Petitioner reported the State tax refund that he *22 received in 1982 and small amounts of interest income for each year. Attached to the Forms 1040 were 15 pages of constitutional Fifth Amendment arguments and copies of various articles, correspondence, and pages from tax services. On July 11, 1983, the Internal Revenue Service assessed a $ 500 penalty under section 6702 against petitioner for filing a frivolous return for 1982. Petitioner paid 15 percent of the penalty and filed a claim for refund. That claim was denied, and, on September 27, 1983, petitioner commenced an action in the United States District Court for the District of Kansas. In a Memorandum and Order filed September 19, 1984, summary judgment was granted and costs were awarded against petitioner on the ground that his action was initiated in bad faith and for vexatious purposes because he knew, or should have known, that his position was patently frivolous and without any support in law or by court decision. In the Memorandum and Order, the court rejected petitioner's contention that the assessment of a civil penalty was barred because Garner v. United States, 424 U.S. 648">424 U.S. 648 (1976), allows a taxpayer to claim the Fifth Amendment privilege on*23 his income tax return. By this Memorandum, petitioner was advised: In United States v. Brown, 600 F.2d 248 (10th Cir. 1979), the Tenth Circuit held that Garner and United States v. Sullivan, 274 U.S. 259">274 U.S. 259 (1927), allow the Fifth Amendment self-incrimination privilege to be raised only as to information about the source of illegal income. The amount of income cannot be withheld by the taxpayer. See also United States v. Stillhammer, 706 F.2d 1072">706 F.2d 1072, 1076 (10th Cir. 1983); United States v. Irwin, 561 F.2d 198">561 F.2d 198, 201 (10th Cir. 1977). Plaintiff's tax return, from which no liability could be calculated, is, in effect, no return at all. United States v. Irwin, 561 F.26 at 201; United States v. Stillhammer, 706 F.2d at 1076. * * *In 1987, after trial by jury, petitioner was convicted of willful failure to file Federal income tax returns for 1982 and 1983, in violation of section 7203. In 1989, petitioner's conviction was affirmed by the Court of Appeals for the Tenth Circuit. In the Order and Judgment of the Court of Appeals for the Tenth Circuit filed March 6, 1989, the*24 court stated: On appeal, Mr. Gallentine claims that although he was indicted and convicted of failure to make a return, the offense he actually committed was failure to provide information required by the 1040 form, also prohibited by section 7203. The argument is without merit. This court has repeatedly held that "purported returns which do not contain information from which the I.R.S. can assess the taxpayer's tax liability are not returns within the meaning of the Internal Revenue Code or the tax regulations." United States v. Stillhammer, 706 F.2d 1072">706 F.2d 1072, 1075 (10th Cir. 1983); United States v. Lawson, 670 F.2d 923">670 F.2d 923, 927 (10th Cir. 1982); United States v. Rickman, 638 F.2d 182">638 F.2d 182, 184 (10th Cir. 1980); United States v. Brown, 600 F.2d 248">600 F.2d 248, 251 (10th Cir. 1979), cert. denied 444 U.S. 917">444 U.S. 917 (1979).Notwithstanding these adverse rulings of the United States District Court for the District of Kansas and the Court of Appeals for the Tenth Circuit, petitioner contended in documents filed in this case in 1990 that the determination of deficiencies and additions to tax in this case violated*25 petitioner's constitutional rights under the Fifth Amendment. OPINION At the time of trial of this case, petitioner had stipulated to certain facts, and respondent had conceded that petitioner was entitled to certain exemptions and deductions. The only evidence presented related to petitioner's contentions that (1) he was entitled to additional charitable contributions for which he did not have canceled checks and (2) his failure to file proper income tax returns for 1982 and 1983 and to pay the income tax due was due to a good faith misunderstanding about the Fifth Amendment and not due to an intent to defraud. Charitable ContributionsWith respect to the charitable contribution deductions, petitioner requests that we recognize a pattern of contributions reported on his returns for 1977 through 1981 and "redetermine deductible charitable contributions at a minimal ten percent figure of the adjusted gross income for 1982 and 1983 [which] is not unreasonable nor fatal being that there obviously is some basis for computation in light of all the testimony and evidence." Petitioner's testimony, however, is totally lacking in details sufficient for us to determine any additional*26 charitable deductions to which petitioner is entitled, and there is no justification for assuming that he is entitled to a deduction in the amount of 10 percent of adjusted gross income. The pattern on which petitioner relies is based on canceled checks for earlier years, and petitioner has no canceled checks for 1982 or 1983 beyond those reflected in concessions by respondent. Petitioner's testimony overall is unreliable, and we cannot make any additional allowance for charitable contributions. Addition to Tax for FraudRespondent has the burden of proving fraud for each year by clear and convincing evidence. Sec. 7454(a); Rule 142(b). The addition to tax for fraud is a civil sanction provided primarily as a safeguard for the protection of the revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from the taxpayer's fraud. Helvering v. Mitchell, 303 U.S. 391">303 U.S. 391, 401 (1938). Respondent's burden is met if it is shown that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. Stoltzfus v. United States, 398 F.2d 1002">398 F.2d 1002, 1004 (3d Cir. 1968);*27 Webb v. Commissioner, 394 F.2d 366">394 F.2d 366 (5th Cir. 1968), affg. T.C. Memo. 1966-81. Existence of fraud is a question of fact to be resolved upon consideration of the entire record. 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). Fraud will never be presumed. Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85, 92 (1970). Fraud may, however, be proved by circumstantial evidence because direct proof of the taxpayer's intent is rarely available. The taxpayer's entire course of conduct may establish the requisite fraudulent intent. Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111, 1123-1126 (1983); Stone v. Commissioner, 56 T.C. 213">56 T.C. 213, 223-224 (1971); Otsuki v. Commissioner, 53 T.C. 96">53 T.C. 96, 105-106 (1969). As petitioner was advised by the Court of Appeals for the Tenth Circuit, the Forms 1040 submitted by him were not valid returns. His failure to file tax returns, without more, is not proof of fraud, but it may be considered in conjunction with other facts that would establish fraudulent intent. Kotmair v. Commissioner, 86 T.C. 1253">86 T.C. 1253, 1261 (1986);*28 Rowlee v. Commissioner, supra.Nonetheless, petitioner contends that he did not intend to defraud in this case because he actually filed Forms 1040 containing his name, address, and social security number. Even if those forms constituted petitioner's notification to the Internal Revenue Service that he was refusing to provide information concerning his taxable income, they do not insulate him from the additions to tax for fraud. See Granado v. Commissioner, 792 F.2d 91 (7th Cir. 1986), affg. T.C. Memo. 1985-237. Petitioner's primary contention is that he sincerely believed that he was entitled to claim the Fifth Amendment privilege on his Federal income tax returns, based upon his reading of a law review article before his returns were due. As petitioner was advised in 1984 by the Memorandum and Order of the United States District Court for the District of Kansas, the cases on which petitioner relied involved illegal income. The law review article similarly deals with nontax criminal prosecutions. Petitioner's unreported income in this case was wage income from his employer. Petitioner reported his other legal income, *29 i.e., interest and a State tax refund. It is not credible that he had any legitimate fear of incrimination from reporting his wages. There is nothing in the record that suggests that petitioner had any reason to believe that he would be incriminated in any nontax matter by proper reporting of his income and deductions on his Federal income tax returns. Moreover, petitioner's filings in this case demonstrate that he had the ability and resources to conduct legal research. In a recent opinion affirming a criminal conviction for willful failure to file returns, the Court of Appeals for the Tenth Circuit described a comparable situation as follows: The record supports a finding that * * * [the defendant taxpayer] was aware of a high probability that his understanding of the tax laws was erroneous and consciously avoided obtaining actual knowledge of his obligations. * * * he never consulted with an attorney or an accountant to verify his understanding of the tax laws. Instead, he bolstered his beliefs by attending seminars on tax avoidance and speaking with others who asserted that they were not required to file. He admitted that he knew his interpretation differed from that*30 of the IRS and millions of American citizens. * * * The mere fact that * * * [the defendant] appeared to educate himself about the tax laws does not negate the possible inference that he selectively educated himself "in order to have a defense in the event of a subsequent prosecution." United States v. Alvardo, 838 F.2d 311">838 F.2d 311, 314 (9th Cir. [1988]), cert. denied, 487 U.S. 1222">487 U.S. 1222 (1988); see United States v. Glick, 710 F.2d [639] at 641-42 [(10th Cir. 1983)]. * * * [United States v. Fingado, 934 F.2d 1163">934 F.2d 1163, 1166-1167 (10th Cir. 1991).]Petitioner persisted in relying on his Fifth Amendment claims in this case in 1990 even though the Court of Appeals for the Tenth Circuit, in 1989, and the United States District Court, in 1984, had rejected his claims. We do not believe petitioner's claims of good faith reliance on his Fifth Amendment privilege. We conclude that petitioner was attempting what the Supreme Court has stated that he cannot do, which is to "draw a conjurer's circle around" the matter of his tax liability. United States v. Sullivan, 274 U.S. 259">274 U.S. 259, 264 (1927). The tax protest*31 nature of the materials printed on and attached to petitioner's filings establishes that his refusal to supply information was motivated by a desire to protest taxes rather than a fear of self-incrimination. See, e.g., Rechtzigel v. Commissioner, 703 F.2d 1063">703 F.2d 1063 (8th Cir. 1983), affg. 79 T.C. 132">79 T.C. 132 (1982); United States v. Neff, 615 F.2d 1235 (9th Cir. 1980). Petitioner also contends that he believed he was entitled to the withholding allowances claimed on his Form W-4 and that cases relying on false Forms W-4 as badges of fraud have no application to this case. See, e.g., Granado v. Commissioner, 792 F.2d 91 (7th Cir. 1986), affg. T.C. Memo. 1985-237. Forms W-4, however, may be false only because a taxpayer claims an excessive number of withholding allowances, such as the 13 claimed by petitioner. See, e.g., Zell v. Commissioner, 763 F.2d 1139">763 F.2d 1139 (10th Cir. 1985), affg. T.C. Memo 1984-152">T.C. Memo. 1984-152. The itemized deductions to which petitioner was entitled ($ 5,100 in 1982 and $ 5,400 in 1983) do not approach the amount necessary to justify his claim of 13 withholding*32 allowances (approximately $ 15,500). (The Court takes judicial notice that the Instructions to Forms W-4 for 1982 advised employees that the employer was required to send to the Internal Revenue Service copies of such forms claiming more than 14 withholding allowances.) We thus have found that petitioner's Form W-4 was knowingly false. There are other indicia of fraud in this case. Petitioner admitted that he ceased using bank accounts and began conducting his affairs in cash in order to avoid Internal Revenue Service seizure of his assets. Willful conduct indicating an intent to defeat and evade tax includes "concealment of assets or covering up sources of income, handling of one's affairs to avoid making the records usual in transactions of the kind, and any conduct, the likely effect of which would be to mislead or to conceal." Spies v. United States, 317 U.S. 492">317 U.S. 492, 499 (1943). In his post-trial brief, petitioner attempts to repudiate facts set forth in the stipulation signed by him and filed at the beginning of trial. He now argues that the Court lacks jurisdiction to adjudicate the additions to tax in this case. While he has jumped from one frivolous*33 position to another, he has refused to acknowledge errors, notwithstanding the adverse rulings of several courts against him. His claims of good faith are thus unpersuasive. On the entire record, there is clear and convincing evidence that petitioner's entire course of conduct was intended to evade or defeat the payment of Federal income taxes that he knew to be owing. The additions to tax for fraud will be sustained. To take account of the stipulation of settled issues, Decision will be entered under Rule 155. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619516/ | Ralph Freeman and Grace Freeman, Petitioners, v. Commissioner of Internal Revenue, RespondentFreeman v. CommissionerDocket No. 71275United States Tax Court33 T.C. 323; 1959 U.S. Tax Ct. LEXIS 34; November 25, 1959, Filed *34 Decision will be entered under Rule 50. Petitioner, owner of an electrical fixture supply company, instituted suit under the Federal antitrust laws against certain distributors of electrical equipment and contractors charging loss of profits and injury to his business and property during the years 1946 through 1950, inclusive. The complaint prayed for treble damages under the so-called Clayton Act. In 1953, before trial, there was a compromise settlement under which petitioner received a lump sum of $ 32,000, for which he executed a release in full satisfaction of all actual or statutory damages, costs, attorney fees, and matters referred to or alleged in the complaint. Neither the release nor any other evidence in the record establishes the extent, if any, the amount in question represented a recovery of lost capital. Held, that petitioner has failed to meet the burden of proof of error in respondent's determination that, after attorney's fees of $ 8,000, the entire recovery ($ 24,000), received in 1953 was taxable under section 22(a) of the 1939 Code. Richard B. Ryan, Esq., for the petitioners.D. W. Wolf, Esq., for the respondent. Fisher, Judge. FISHER*323 FINDINGS OF FACT.Petitioners, Ralph and Grace Freeman, are husband and wife, residing at 1619 Edgecumbe Road, St. Paul, Minnesota.*324 For the taxable year December 31, 1953, petitioners filed a joint Federal income tax return with the district director of internal revenue for the district of Minnesota. Ralph Freeman, hereinafter called petitioner, is an individual doing business as the Freeman Electric Supply Company, which was known as the Freeman Electric Company during the late 1940's and early 1950's. Business operations of Freeman Electric Company consisted primarily of the purchase and sale of electric fixtures. Customers of said business included electrical contractors, ultimate consumers, commercial stores (including chain and department stores), and*37 State jobs.Ralph established said business during the fall of 1945. During and subsequent to the year 1946, his business address was 2864 Chicago Avenue, Minneapolis, Minnesota.When petitioner started Freeman Electric Company during 1945, the business did not have any goodwill listed on its books. Assets of the business during 1946 consisted of a file cabinet, typewriter, desks, and a truck, having an aggregate value of approximately $ 3,000.Sometime during 1947, petitioner became aware of the fact that there was an agreement among suppliers, contractors, and others to prevent his buying and selling electrical fixtures. The parties to this agreement were the St. Paul Contractors Association (or St. Paul Electrical Contractors Association), Minneapolis Electrical Contractors Association, and other parties, all hereinafter referred to as defendants.The United States Government instituted a prosecution and civil antitrust action against these parties during the latter part of 1950, or during 1951. On March 27, 1953, the United States District Court for the District of Minnesota rendered its decision in said action, and held that defendants had violated the antitrust laws of*38 the United States. The court determined that defendants had combined and conspired to monopolize the trade and commerce in electrical equipment for installation in the Twin Cities area.Later in 1953, Ralph, doing business as Freeman Electric Company, instituted a civil action under the Sherman and Clayton Antitrust Acts to recover damages from the parties named as defendants in the above-noted proceedings. Said complaint states, in pertinent part, as follows:1. This Complaint is filed and these proceedings are instituted under the Act of Congress of July 2, 1890, commonly known as the "Sherman Act", 15 U.S. Code, Sec. 1, et seq., and the Act of Congress of October 15, 1941, commonly known as the "Clayton Act", 15 U.S. Code, Sec. 12, et seq., which statutes are hereinafter jointly referred to as the "antitrust laws", to recover damages for injury to the property and business of the plaintiff caused by acts of the defendants in violation of said antitrust laws and for other relief.* * * **325 20. As a direct and proximate result of the aforesaid acts, practices, agreements, combinations, conspiracies and boycott of the defendants, the plaintiff was prevented from selling*39 electrical lighting fixtures to many consumers for particular jobs which the plaintiff had a reasonable expectation of selling but for said acts; plaintiff and consumers to whom plaintiff had sold electrical lighting fixtures were unable to have electrical lighting fixtures sold by plaintiff installed; plaintiff was prevented from selling electrical lighting fixtures which plaintiff had purchased and held for sale; plaintiff was unable to purchase or secure certain electrical lighting fixtures desired by consumers and therefore was unable to sell to such consumers; plaintiff was denied the right to continue purchasing the electrical lighting fixtures of certain electrical manufacturers; (plaintiff's cost of doing business was substantially increased above what it would have been but for said acts; the normal expansion and growth of plaintiff's business and sales was greatly curtailed and limited; plaintiff suffered a substantial loss of business and profits which plaintiff had a reasonable expectation of receiving but for said acts; and plaintiff's said business and property were substantially damaged and diminished in value.21. The damage and injury to the property and business*40 of the plaintiff and the loss of profits to the plaintiff caused by the aforesaid agreements, combinations, conspiracies, acts and practices of the defendants, as aforesaid, amount in the aggregate to approximately one hundred and thirty-five thousand dollars ($ 135,000.00).* * * *25. The violations of the antitrust laws by the defendants referred to and specified above and the acts and practices forbidden by the antitrust laws committed by the defendants and referred to and specified above, have injured the plaintiff in his business and property as related and specified above in the amount of one hundred and thirty-five thousand dollars ($ 135,000.00). Three times said amount is four hundred and five thousand dollars ($ 405,000.00).Wherefore, plaintiff demands judgment against the defendants and each of them for four hundred and five thousand dollars ($ 405,000.00) plus reasonable attorneys' fees and costs herein. [Emphasis supplied.]The alleged restraint of trade forming the basis for this civil action occurred during the years 1946 to 1950, inclusive.On September 4, 1953, the parties to said civil action entered into an agreement providing for a disposition of*41 this civil action without trial.Said agreement reads, in part, as follows:2. The parties have concomittantly herewith executed a stipulation of dismissal providing for the dismissal upon the merits, with prejudice and without costs, of the above entitled action. (a) after a so-called "Consent Decree" has been entered in the case of United States of America v. Minneapolis Electrical Contractors Association, et al., Civil No. 3715, in the United States District Court for the District of Minnesota, Fourth Division, in substantially the form previously discussed and agreed upon between the defendants therein and the Department of Justice and dated on or about August 18, 1953; and,(b) upon the payment to plaintiff and his counsel of the sum of $ 32,000.00 by certified check on or about October 12, 1953.3. Upon the payment of said consideration to plaintiff and his counsel, plaintiff and his counsel will execute and deliver releases in the usual form of all claims arising out of any of the transactions or matters referred to or alleged*326 in the complaint herein as to all of the undersigned defendants and such others as undersigned counsel for the defendants*42 may designate. [Emphasis added.]Petitioner executed the release referred to in said agreement, the terms of the release reading, in part, as follows:It is acknowledged that the payment of the above mentioned sum is not and shall not be construed as or taken to imply any admission by any of the parties to whom this release is given of any liability to me or of the truth of any allegation in the complaint in the above entitled matter. It is further acknowledged that the payment of the foregoing sum shall not be construed as the payment of a penalty, but as a compromise payment in full satisfaction of all actual or statutory damages, costs, and attorney's fees suffered and incurred by me, or claimed to be suffered and incurred by me, on account of the transactions, matters, or events referred to or alleged in the said complaint and in and about the prosecution of said action. [Emphasis supplied.]On October 14, 1953, the United States District Court for the District of Minnesota entered its order dismissing this civil action, upon the merits, with prejudice and without costs, pursuant to the stipulation of dismissal entered into by the parties to that action.Petitioner*43 received $ 32,000 in settlement of the above-noted action. Eight thousand dollars of said amount was paid for attorney's fees, leaving a balance of $ 24,000 received by petitioner.Petitioners reported the $ 24,000 received from the settlement of the lawsuit in a schedule attached to their 1953 income tax return, as follows:Received in settlement of lawsuit for treble damages under ShermanAct$ 24,000Amount taxable in accordance with court decisions, 1/38,000Nontaxable16,000Petitioners' attorney, who filed the complaint in the aforesaid antitrust suit, assisted in the preparation of the petitioners' return for the taxable year 1953.Freeman Electric Company did not have a goodwill account on its books and records during the year 1953.Respondent, in his statutory notice of deficiency, determined that the full amount of $ 24,000 was includible in taxable income of petitioners under the provisions of section 22(a) of the Internal Revenue Code of 1939, and, accordingly, increased petitioners' taxable income for the year 1953 in the amount of $ 16,000.OPINION.The sole issue presented is the taxability of the payment*44 in the amount of $ 24,000 (of a total of $ 32,000) which petitioners received during the taxable year 1953 in the compromise settlement of the claim they asserted against several distributors of electrical equipment. Petitioners contend that the sum of $ 16,000 in controversy *327 (of the aforesaid $ 24,000 payment) is taxable as an amount received from the disposition of a capital asset under the provisions of sections 111 and 117(a)(1) and (b) of the Code of 1939. 1 In essence, they argue that the amount of $ 16,000 was not a recovery of treble damages under the Sherman and Clayton antitrust laws, but was compensation for "loss of increase in value of the business" or loss of capital, and loss of capital gain that would have otherwise been realized and, hence, nontaxable as a return of capital. Respondent, in opposition, maintains that the sum of $ 16,000, which petitioners did not report as taxable income, represented a payment for punitive damages for violation of the Federal antitrust laws and was taxable as ordinary income within the intendment of section 22(a) of the Code of 1939. In the alternative, respondent urges that said amount is taxable as ordinary income*45 since it constitutes a recovery of lost profits because petitioner failed to establish that he had assets during the period involved upon which a return of capital could be based. For reasons hereinafter stated, we agree with respondent.*46 The taxability of the proceeds of a lawsuit or of a sum received in settlement like the one involved herein depends upon the nature of the claim and the actual basis of recovery. If the recovery represents damages for lost profits, it is taxable as ordinary income. However, if the recovery is received as the replacement of capital destroyed or injured rather than for lost profits, the money received is a return of capital and not taxable. Raytheon Production Corporation, 1 T.C. 952">1 T.C. 952 (1943), affd. 144 F. 2d 110 (C.A. 1, 1944), certiorari denied 323 U.S. 779">323 U.S. 779 (1944); Nicholas W. Mathey, 10 T.C. 1099">10 T.C. 1099, 1104 (1948), affd. 177 F. 2d 259 (C.A. 1, 1949), and cases *328 cited therein. Also, it is well settled that amounts received as punitive damages for fraud or the exemplary two-thirds portion of treble damages provided for under section 4 of the so-called Clayton Act 2 constitutes taxable income and must be reported as gross income under section 22(a), supra. *47 Commissioner v. Glenshaw Glass Co., 348 U.S. 426">348 U.S. 426 (1955), rehearing denied 349 U.S. 925">349 U.S. 925 (1955), reversing 18 T.C. 860">18 T.C. 860 (1952) and 19 T.C. 637">19 T.C. 637 (1953).Respondent's determination that the amount in controversy is all taxable as ordinary income is, of course, presumptively correct and the burden of proof is upon petitioner to show error therein by a preponderance of the evidence. *48 Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Crown Iron Works Co. v. Commissioner, 245 F.2d 357">245 F. 2d 357, 360 (C.A. 8, 1957); Meyer v. Commissioner, 243 F. 2d 262 (C.A. 8, 1957), each affirming a Memorandum Opinion of this Court; H. Liebes & Co. v. Commissioner, 932">90 F. 2d 932, 935 (C.A. 9, 1937), affirming 34 B.T.A. 677">34 B.T.A. 677 (1936).At the outset, it is to be noted that the parties to the compromise settlement in 1953 merely agreed to a lump-sum payment, i.e., $ 32,000, without specifying in their written agreement to what extent, if any, the money involved herein was allocable to recovery for loss of profits, loss of capital (whether tangible or intangible), punitive or exemplary damages, and attorney fees. The last item was subsequently settled and determined by an actual payment of attorney fees in the amount of $ 8,000, leaving $ 24,000 unallocated.The complaint alleges that the proceedings were instituted to recover damages for injury to the property and business of the plaintiff. The complaint refers quite generally to loss of sales, loss of sources of supply, inability to get merchandise installed, *49 increase in cost of doing business, and impairment of normal expansion and growth.The only practical issue before us is whether petitioner has established that any part of the $ 24,000 (excess of settlement figure over attorney's fees) is entitled to capital gains treatment.It is to be noted that petitioner, in his return, made no claim to capital gains treatment of any part of the settlement money. He returned $ 8,000 as taxable and regarded $ 16,000 as "nontaxable." It is quite apparent that he did this in the light of what then appeared to be the state of the law with respect to nontaxability of the exemplary two-thirds of treble damages under the Clayton Act. *329 Later, in Commissioner v. Glenshaw Glass Co., supra, the Supreme Court held that such exemplary damages were taxable as ordinary income. Under the circumstances, it is not surprising that petitioner altered his position, and that he now asks for capital gains treatment of $ 16,000 of the settlement figure. The question before us is whether or not the evidence and the law support his present claims in relation thereto.The only factors referred to in the complaint, the settlement agreement, *50 and the release have been referred to above. The release adds that the payment of the amount called for "shall not be construed as the payment of a penalty."The allegation of injury to property and business does not support a claim for capital gains treatment. There is nothing which requires us to conclude therefrom that there had been a capital loss or destruction of a capital asset, or that there had been some closed capital transaction to be recognized for tax purposes. Mere fluctuation in value of an asset, tangible or intangible, does not give rise to gain or loss. The amount of such capital loss, if there was any, is nowhere fixed by this record. (The expert testimony on this subject will be discussed, infra).Loss of sales is also referred to in the complaint. It is too obvious to require discussion that any amount attributable thereto in the settlement must be taxed as ordinary income.Reimbursement (if any) attributable to loss of sources of supply, inability to get merchandise installed, increased cost of doing business, and impairment of normal expansion does not give rise to capital gains treatment. Moreover, there is no basis in the record on which some identifiable*51 amount of the settlement may be attributed to these factors. The same may be said with respect to the nebulous claim of loss of increased value of the business.A brief reference to the expert testimony appears appropriate. The witness assumed that an amount of $ 24,000 represented loss of earnings for the 4 years 1947 to 1950, inclusive. He then capitalized this amount at 12 1/2 per cent and assumed that the result represented an intangible business loss or injury to capital and goodwill. He concluded from this that four-twelfths of the loss as determined by him was to be attributed to actual loss of profits and eight-twelfths to the intangible injury to capital and goodwill. He therefore allocated $ 8,000 of the net amount of $ 24,000 received in the settlement to compensation for loss of profits and $ 16,000 to loss of capital or goodwill. Whether or not such a computation might be helpful in other settings, it has no force here. There is no evidence in this record of a loss of capital, or goodwill, or any tangible or intangible capital asset or evidence of any closed transaction disposing of or *330 destroying such an asset recognizable for tax purposes. No goodwill*52 is established, and, by the same token, there is no proof of loss of goodwill. As stated supra, fluctuation in the value of assets, tangible or intangible, does not give rise to gain or loss under any circumstances here present or involved.Under all of the circumstances, we think that the principles applied in Chalmers Cullins, 24 T.C. 322">24 T.C. 322 (1955), are likewise to be applied here. In that case, the plaintiffs, including the taxpayer, received the amount of $ 200,000 in settlement of their antitrust suit. The releases, as in the instant case, did not specify any fixed amounts for the different components of damages alleged in the complaint. Respondent held that the entire amount recovered constituted lost profits. In sustaining respondent, we said, in part (p. 328):There is no evidence to establish the purpose or purposes for which the money was paid to petitioners. * * * Neither the complaint, nor the settlement agreement, nor the releases, nor the evidence as a whole provides a basis for making an allocation of the recovery and finding that all or part of the sum recovered represented a return of capital.*53 Similarly, in Armstrong Knitting Mills, 19 B.T.A. 318 (1930), we had before us the precise question involving a settlement of two lawsuits, one, in effect, for damage to business and the other for breach of contract. Concluding that the suits did not involve damage to capital, we said (p. 321) --The amount in question was paid to the petitioner in compromise and settlement of two suits, and there is no evidence to indicate in what proportion the amount could be allocated between the actions. Also, there is no evidence to establish the specific purpose for which the money was paid, other than that it was paid as a lump sum in compromise and settlement of the litigation. Whether the amount represented damages for wrongful injury to the petitioner's good will, or whether it represented damages for loss of profits, or indeed whether the amount was simply paid by the defendants to avoid further expense and harassment resulting from long continued litigation, does not definitely appear.Petitioners, in support of their position, rely on *54 Farmers' & Merchants' Bank v. Commissioner, 59 F. 2d 912 (C.A. 6, 1932), reversing 20 B.T.A. 622">20 B.T.A. 622 (1930), and Durkee v. Commissioner, 162 F. 2d 184 (C.A. 6, 1947), reversing 6 T.C. 773">6 T.C. 773 (1946). We have carefully considered these cases and find them distinguishable on their facts and not controlling herein. Unlike the instant proceeding, in Farmers' & Merchants' Bank, supra, the taxpayer did not seek even in part a reparation for loss of profits, but only for tortious injury to its goodwill. Likewise, in Durkee, no claim was made for lost profits in the complaint, the gravamen being damage to goodwill of the company. In both cases, the allegations as to profits both before and after the acts complained of "were only an evidential *331 factor in determining actual loss and not an independent basis for recovery."In further support of their position, petitioners contend, citing Herbert's Estate v. Commissioner, 139 F. 2d 756 (C.A. 3, 1943), affirming a Memorandum Opinion of this Court, that their claim against defendants constituted a "chose in action" for injuries to their*55 business and property (and as such was a capital asset) and that when the lawsuit was settled and the money received, said capital asset was disposed of within the meaning of section 111, supra, providing that the gain from the sale or other disposition of property for tax purposes shall be the excess amount realized over the adjusted basis of the capital asset. In the instant case, there is no support for the view that the chose in action was for an injury to capital rather than for loss of profits. This distinction is so clearly recognized and analyzed in H. Liebes & Co., 34 B.T.A. 677">34 B.T.A. 677, 682 (1936), affd. 90 F. 2d 932 (C.A. 9, 1937), that we feel it is unnecessary to extend our discussion beyond reference to the latter case.Since we cannot accept the allocation offered by petitioners, and the record does not afford any other basis upon which we can make an allocation to his advantage, we hold that the entire sum received in settlement of those claims, i.e.,$ 24,000, represents a recovery for loss of anticipated profits and is taxable to petitioners in full as ordinary income under section 22(a), supra. *56 Phoenix Coal Co. v. Commissioner, 231 F. 2d 420 (C.A. 2, 1956), affirming a Memorandum Opinion of this Court; H. Liebes & Co. v. Commissioner; Chalmers Cullins; and Armstrong Knitting Mills, all supra.We add for completeness that respondent's determination of the deficiency is not, in our opinion, unrealistic, arbitrary, and excessive, as urged by petitioners, but rather follows the only course he could take upon the facts (and lack of facts) presented by the record.Decision will be entered under Rule 50. Footnotes1. SEC. 111. DETERMINATION OF AMOUNT OF, AND RECOGNITION OF, GAIN OR LOSS.(a) Computation of Gain or Loss. -- The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.(b) Amount Realized. -- The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.(c) Recognition of Gain or Loss. -- In the case of a sale or exchange, the extent to which the gain or loss determined under this section shall be recognized for the purposes of this chapter, shall be determined under the provisions of section 112.SEC. 117. CAPITAL GAINS AND LOSSES.(a) Definitions. -- As used in this chapter -- (1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include --* * * *(b) Deduction From Gross Income. -- In the case of a taxpayer other than a corporation, if for any taxable year the net long-term capital gain exceeds the net short-term capital loss, 50 per centum of the amount of such excess shall be a deduction from gross income. In the case of an estate or trust, the deduction shall be computed by excluding the portion (if any), of the gains for the taxable year from sales or exchanges of capital assets, which, under section 162(b) or (c), is includible by the income beneficiaries as gain derived from the sale or exchange of capital assets.↩2. Section 15. Suits by persons injured; amount of recovery.Any person who shall be injured in his business or property by reason of anything forbidden in the antitrust laws may sue therefor in any district court of the United States in the district in which the defendant resides or is found or has an agent, without respect to the amount in controversy, and shall recover threefold the damages by him sustained, and the cost of suit, including a reasonable attorney's fee. [Oct. 15, 1914, ch. 323, sec. 4, 38 Stat. 731.]↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619520/ | C. J. Anderson and Ellen E. Anderson, Husband and Wife v. Commissioner.Anderson v. CommissionerDocket No. 48989.United States Tax CourtT.C. Memo 1955-43; 1955 Tax Ct. Memo LEXIS 296; 14 T.C.M. (CCH) 148; T.C.M. (RIA) 55043; February 21, 1955*296 Held, in 1949 and 1950, petitioner operated a farm for the purpose of making a profit but realized net operating losses in both years, which are fully deductible on his returns for such years. John Wiseman, C.P.A., 1291 Chapline Street, Wheeling, W. Va., for the petitioners. Theodore E. Davis, Esq., for the respondent. RICEMemorandum Findings of Fact and Opinion This proceeding involves deficiencies determined by respondent in petitioners' income tax for the years 1949 and 1950 in the respective amounts of $1,108.44 and $689.82. The only issue to be decided is whether petitioner, C. J. Anderson, operated a farm for profit during such years so as to entitle him to deduct in full the net operating losses realized from such operation. Some of the facts were stipulated. Findings of Fact The stipulated facts are so found and are incorporated herein by this reference. C. J. Anderson (hereinafter referred to as the petitioner) and Ellen E. Anderson, his wife, filed joint Federal income tax returns for the years 1949 and 1950 with the collector of internal revenue for the eighteenth district of Ohio. In 1943 petitioner purchased an 80-acre farm near Barnesville, *297 Ohio, for $12,750, where he and his wife resided from July 1944 to and throughout the years in issue. During such years, petitioner was president of the United Dairy Company of Barnesville, Ohio. He received an annual salary of $25,000 from such company in 1949, and $30,000 in 1950. Petitioner purchased the farm in question with the purpose of establishing a herd of registered Hereford cattle, from which he hoped to sell beef cattle at a profit. Immediately following the purchase of the farm in 1943, petitioner purchased 14 registered Hereford cows and later in the year purchased a bull and another cow. All but 3 acres of the farm were tillable or usable for pasture. He subsequently acquired various items of farm equipment in addition to a binder, mower, cultivator, plows, harrows, a wagon, and corn planters, which he acquired with the purchase of the farm. Petitioner had a total of 26 head of cattle on the farm at the end of 1950. Prior to the years in issue, a number of farm buildings were demolished and additions made to 2 barns. A new 3-car garage was constructed to house farm equipment at a cost of $3,000, and the tenant house was remodeled. Petitioner employed a tenant*298 farmer who lived on the farm. Petitioner consulted with him daily, usually for several hours in the evening. Petitioner kept separate records of income and expenses on the operation of the farm. For many years prior to the acquisition of the farm, petitioner had loaned money on farm properties and had often supervised their operation. On his return for 1949, petitioner reported farm income from the sale of cattle and wheat of $543.05. He claimed a net operating farm loss of $2,623.39 for that year. On his return for 1950, he reported farm income from the sale of cattle of $625.00, and claimed a net operating farm loss of $2,663.54. None of the expenditures claimed in computing such losses were, directly or indirectly, related to petitioner's living expenses or to the upkeep or maintenance of the residence on the farm. Petitioner operated his farm for the purpose of making a profit during the years in issue. Opinion RICE, Judge: Whether petitioner operated his farm during the years in issue for purposes of making a profit, so as to entitle him to the losses claimed, is a question of fact. Even though petitioner's farming operations were relatively small and in both years here*299 in issue resulted in net operating losses, we think it clear from the record that he purchased the farm in 1943 and operated it thereafter in the expectation of making a profit and not as a mere hobby. Norton L. Smith, 9 T.C. 1150">9 T.C. 1150 (1947). He intended to raise a herd of registered Hereford cattle, from which he hoped to sell beef cattle at a profit. Immediately after purchasing the farm he bought 16 head of cattle. By 1950 his herd had increased to 26 head, after sales in both 1949 and 1950. He maintained books and records of his farming operations, and none of his personal living expenses were deducted in computing the losses in issue. Petitioner was generally familiar with farming operations; and, even though he continued to be a full time employee and officer of the United Dairy Company, he actively managed his farm with the help of an experienced tenant farmer. The conclusion seems inescapable that petitioner was attempting to farm at a profit and we so hold. Because other adjustments in the deficiency notice were not contested, Decision will be entered under Rule 50. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619522/ | Arthur S. Janpol, Petitioner v. Commissioner of Internal Revenue, Respondent; * Donald Berlin, Petitioner v. Commissioner Internal Revenue, RespondentJanpol v. CommissionerDocket Nos. 5586-92, 5587-92United States Tax Court102 T.C. 499; 1994 U.S. Tax Ct. LEXIS 18; 102 T.C. No. 17; 17 Employee Benefits Cas. (BNA) 2515; March 28, 1994, Filed *18 Decisions will be entered under Rule 155. Ps were held liable for sec. 4975(a), I.R.C., excise taxes on prohibited transactions in an earlier opinion, Janpol v. Commissioner, 101 T.C. 518 (1993). Held, Ps are liable for sec. 6651(a)(1) additions to tax for failure to file excise tax returns. John N. Lieuwen and Patricia Tucker, for petitioners.Thomas F. Eagan, for respondent. Cohen, Judge. COHEN*499 SUPPLEMENTAL OPINIONCohen, Judge: In Janpol v. Commissioner, 101 T.C. 518">101 T.C. 518 (1993), we held that petitioners were liable for section 4975(a) excise taxes on prohibited transactions. We incorporate and rely on the findings of fact set forth in that opinion. Briefly, we held that petitioners' loans to the Imported Motors Profit Sharing Trust (the trust) were prohibited transactions giving rise to excise tax liability in accordance with respondent's method of computation. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.We now consider whether petitioners*19 are liable for additions to tax under section 6651(a)(1) because of their failure to file excise tax returns on Form 5330. Petitioners contend that (1) the section 6651(a)(1) addition to tax does not apply to section 4975(a) excise taxes on prohibited transactions; (2) the filing of Form 5500-R, Registration Statement of Employee Benefit Plan, for 1987, and Form 5500-C, Return/Report of Employee Benefit Plan, for 1988, for the trust precludes section 6651(a)(1) additions to tax; and (3) they had reasonable cause for failure to file excise tax returns.*500 1. Application of Section 6651(a)(1)Section 6651(a)(1) provides for an addition to tax in the case of failure to file any return required under the authority of subchapter A of chapter 61, unless it is shown that such failure is due to reasonable cause and not due to willful neglect. Section 6011(a), which is part of subchapter A of chapter 61, provides that, when required by regulations prescribed by the Secretary, any person made liable for any tax shall make a return according to the forms and regulations prescribed by the Secretary. Section 54.6011-1(b), Pension Excise Tax Regs., provides that every disqualified*20 person (as defined in section 4975(e)(2)) liable for tax under section 4975(a) with respect to a prohibited transaction shall file an annual return on Form 5330. Because the prohibited transaction excise tax filing requirement as specified in the regulations is made under the authority of section 6011(a), which is part of subchapter A of chapter 61, petitioners' failure to file Form 5330 for the years in issue may subject them to liability for an addition to tax under section 6651(a)(1).2. Effect of Filing Entity ReturnThe parties have stipulated that petitioners did not file returns for 1986 through 1988 reporting section 4975(a) tax liability. The parties have also stipulated that the trust filed Form 5500-R for 1987 and Form 5500-C for 1988.Section 6058(a) requires every employer who maintains a profit-sharing plan, or plan administrator, to file an annual return stating such information as the regulations may prescribe with respect to the qualification, financial condition, and operations of the plan. Section 301.6058-1(a)(1), Proced. & Admin. Regs., states that the annual return required to be filed for the plan is the appropriate Annual Return/Report of Employee*21 Benefit Plan (Form 5500 series).If a disqualified person with respect to a plan has participated in a prohibited transaction, two separate returns are required to be filed with respect to profit-sharing plans. A Form 5330 is required to be filed by the disqualified person, reporting the tax imposed by section 4975(a). Whether or not prohibited transactions have occurred, a Form 5500 must be filed by the employer or plan administrator, providing *501 information relating to the plan's continued qualification, financial condition, and operations.Section 6501 provides the general rule that requires assessment of tax within 3 years of the date a return is filed. Section 6501(l)(1) provides that, for purposes of tax imposed by section 4975, "the return referred to in this section shall be the return filed by the private foundation, plan, trust, or other organization (as the case may be) for the year in which the act (or failure to act) giving rise to liability for such tax occurred." (Emphasis added.) Thus, even though petitioners failed to file Forms 5330 for the years in issue, the period of limitations on their liability for the section 4975 tax began running when Forms*22 5500-R and 5500-C were filed.Petitioners contend that a return that is adequate to begin the running of the period of limitations is also adequate to prevent a section 6651(a)(1) addition to tax. Petitioners rely on a series of cases that create a judicial line of authority for treating certain documents as returns for statute of limitations purposes. See, e.g., Martin Fireproofing Profit-Sharing Plan & Trust v. Commissioner, 92 T.C. 1173">92 T.C. 1173, 1189-1193 (1989).We have held that certain documents that do not comply with requirements contained in the regulations will nevertheless be treated as "returns" for statute of limitations purposes when the documents satisfy a four-part Supreme Court test applied in Badaracco v. Commissioner, 464 U.S. 386">464 U.S. 386 (1984), Zellerbach Paper Co. v. Helvering, 293 U.S. 172">293 U.S. 172 (1934), and Florsheim Bros. Drygoods Co. v. United States, 280 U.S. 453 (1930):First, there must be sufficient data to calculate tax liability; second, the document must purport to be a return; third, there must be an honest and reasonable attempt to satisfy the*23 requirements of the tax law; and fourth, the taxpayer must execute the return under penalties of perjury. [Beard v. Commissioner, 82 T.C. 766">82 T.C. 766, 777 (1984), affd. 793 F.2d 139">793 F.2d 139 (6th Cir. 1986).]Petitioners argue that these statute of limitations cases are significant because, in the Beard case, we said that returns that are considered to be sufficient to trigger the running of the period of limitations under this four-part test will also be considered to be filed for section 6651(a)(1) purposes.*502 The circumstances here, however, are distinguishable from those in Beard. Here, the Forms 5500-R and 5500-C that were filed were sufficient to start the period of limitations running because section 6501(l)(1) provides for such a result, not because these forms satisfy the judicially created four-part test. Thus, unless we find that these forms satisfy the four-part test, Beard does not require us to hold that the Forms 5500-R and 5500-C are sufficient returns for section 6651(a)(1) purposes.The forms filed by the trust for 1987 and 1988 are not in the record. Thus, petitioners have failed to prove that *24 those returns contained sufficient data to calculate their excise tax liability. We have, however, taken judicial notice of the Form 5500-R for 1987 and Form 5500-C for 1988 prescribed by the Internal Revenue Service (IRS). The 1987 Form 5500-R, on line 7, requires the plan to report fiduciary information in a "yes or no" format. We have no reason to believe that the trust answered these questions in a way that would disclose petitioners' transactions with the trust. The dollar amounts of the transactions engaged in with fiduciaries are not requested on the 1987 Form 5500-R. Because the section 4975 tax is computed as a percentage of the dollar amount involved with respect to the prohibited transaction, the required data for computation of this tax is not provided by the 1987 Form 5500-R.The 1988 Form 5500-C, on line 29, does request dollar amounts of certain transactions entered with employers, fiduciaries, and the five highest paid employees. We have no reason to believe that petitioners' transactions with the trust were disclosed on the Form 5500-C filed by the trust for 1988. Thus, we cannot conclude that the trust's return would provide sufficient data, in this case, *25 for the computation of the section 4975 tax.Petitioners cite California Thoroughbred Breeders Association v. Commissioner, 47 T.C. 335 (1966), as support for their argument that an information return need not contain each item of information necessary to compute the proposed tax liability in order to start the period of limitations running. In that case, we recognized that, under section 6501(g)(2), the filing of a Form 990, Return of Organization Exempt From Income Tax, commenced the period of limitations on tax on unrelated business income, even though the required Form *503 990-T was not filed. California Thoroughbred Breeders Association is distinguishable from the circumstances here, however, because the information returns filed in that case contained "considerable data" relating to the potential tax liability. Id. at 339.Even though the Form 5500 series returns do not provide for the calculation of excise taxes, we have held that the 6-year period of limitations applies when excise tax liabilities are not disclosed on such returns. Thoburn v. Commissioner, 95 T.C. 132">95 T.C. 132, 146-148 (1990).*26 In Pearland Investment Co. v. Commissioner, T.C. Memo. 1991-562, we recognized distinctions between Form 5500-C and Form 5330 and held that a 6-year period of limitations was applicable because the Form 5500-C that was filed did not disclose that a prohibited transaction had occurred. In that case, we also held that the taxpayer was liable for the section 6651(a)(1) additions to tax for failure to file excise tax returns, even though the plan had filed a Form 5500-C for some of the years in issue. Any relationship between these issues apparently was not raised and was not addressed.We conclude that the Forms 5500-R and 5500-C that were filed here do not satisfy the judicially created test of what constitutes a return for statute of limitations purposes.Respondent contends that, in any event, section 6501(l)(1) relates solely to the statute of limitations and operates independently of the return and payment requirements of section 54.6011-1(b), Pension Excise Tax Regs., for disqualified persons who have participated in prohibited transactions. Respondent compares section 6501(l)(1) to section 6501(g)(2), which also relates to time limitations *27 on assessment and collection and provides:If a taxpayer determines in good faith that it is an exempt organization and files a return as such under section 6033, and if such taxpayer is thereafter held to be a taxable organization for the taxable year for which the return is filed, such return shall be deemed the return of the organization for purposes of this section. [Emphasis added.]Subsections (l)(1) and (g)(2) of section 6501 are similar in that both permit "noncomplying" returns to constitute returns for statute of limitations purposes. Moreover, both sections seem to limit their scope to statute of limitations purposes. Subsection (g)(2) of section 6501 provides that the *504 noncomplying return will constitute a return "for purposes of this section", while subsection (l)(1) of section 6501 provides that "the return referred to in this section" will be the non-complying return.We addressed the interaction of section 6501(g)(2) with the section 6651(a)(1) addition to tax in Knollwood Memorial Gardens v. Commissioner, 46 T.C. 764">46 T.C. 764, 794 (1966). In that case, we held that, although a taxpayer's good faith belief that it was a tax-exempt*28 entity was sufficient to permit its Form 990 return to start the running of the period of limitations, such a return was not sufficient to avoid the section 6651(a)(1) additions to tax for failure to file Form 1120, Corporation Income Tax Return. We specifically held that the filing of Form 990 information returns does not constitute reasonable cause or demonstrate absence of willful neglect in failing to file the Form 1120 returns as required by the regulations. Id. at 795.Subsection (l)(1) (then (n)(1)) of section 6501 was added to the Code by the Tax Reform Act of 1969, Pub. L. 91-172, sec. 101(g)(1), 83 Stat. 525. Thus, Congress enacted section 6501(l)(1) after publication of Knollwood Memorial Gardens v. Commissioner, supra, and Rev. Rul. 60-144, 1 C.B. 636">1960-1 C.B. 636, which states the Commissioner's position that the provisions of section 6501(g)(2) relate solely to the statute of limitations. Nevertheless, section 6501(l)(1) makes no reference to the failure to file addition to tax, and we have no indication of congressional intent to affect application of section 6651(a)(1). *29 Accordingly, we conclude that a document is not a return for section 6651(a)(1) purposes solely because it is a return for statute of limitations purposes under section 6501(l)(1). Therefore, the Forms 5500-R and 5500-C that were filed by the trust do not preclude petitioners' liability for the additions to tax under section 6651(a)(1).3. Reasonable CauseTo avoid liability for section 6651(a)(1) additions to tax, petitioners must thus demonstrate that they had reasonable cause not to file excise tax returns. Petitioner Donald Berlin did not testify and presented no evidence as to his reasons for failing to file the required returns. Petitioner Arthur S. Janpol (Janpol) testified that he engaged in his own research *505 and concluded that the statute did not apply to loans to a plan by disqualified persons, even though the U.S. Department of Labor had expressly advised him that such loans were prohibited. He testified that, when he was advised by the U.S. Department of Labor that he could not lend money to the plan:I said, That doesn't mean that. I said, That is the silliest thing I ever heard of. And -- but they kept insisting that I was doing something wrong, *30 and I still to this day know that I haven't.Janpol also testified that none of his attorneys or accountants advised him to file excise tax returns. He did not, however, testify that any competent tax professional advised him that it was not necessary to file the returns. See United States v. Boyle, 469 U.S. 241">469 U.S. 241, 251 (1985); Zabolotny v. Commissioner, 97 T.C. 385">97 T.C. 385, 400-401 (1991), revd. on another issue 7 F.3d 774">7 F.3d 774 (8th Cir. 1993); Knollwood Memorial Gardens v. Commissioner, supra at 794-796. We are not persuaded that petitioners made a reasonable effort to ascertain their liability for excise taxes. Petitioners' disagreement with the interpretation of the statute by the U.S. Department of Labor, and now by the IRS and the Court, without any affirmative evidence of an attempt to comply with the excise tax filing requirements, is not reasonable cause.To reflect the agreement of the parties and our determinations in 101 T.C. 518">101 T.C. 518 (1993) and this opinion,Decisions will be entered under Rule 155. Footnotes*. This opinion supplements Janpol v. Commissioner↩, 101 T.C. 518 (1993). | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619524/ | C. M. NUSBAUM, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Nusbaum v. CommissionerDocket No. 7046.United States Board of Tax Appeals10 B.T.A. 664; 1928 BTA LEXIS 4044; February 13, 1928, Promulgated *4044 Petitioner and another party employed a geologist to investigate the oil possibilities of a certain tract of land. After investigation the geologist advised the acquisition of a lease on such land. It was agreed that the remuneration of the geologist should be the right to receive one-third of any profits resulting from the operation of the lease. Later in the year, as a result of disagreement, the lessees of record paid the geologist certain amounts as consideration for his right to receive profits. Held, that the amounts so paid were capital expenditures. Phil D. Morelock, Esq., for the petitioner. L. A. Luce, Esq., for the respondent. LANSDON *664 The respondent has asserted deficiencies in income tax for the years 1920 and 1921 in the respective amounts of $1,860.71 and $127.90. The petitioner alleges that the respondent erred in disallowing a certain payment as an ordinary business expense and in determining that such payment was a capital transaction. No evidence was adduced as to the deficiency asserted for 1921. FINDINGS OF FACT. Some time in the taxable year the petitioner and one G. S. Tucker became interested in the*4045 oil possibilities of a certain 40-acre tract of land in Marion County, Kansas. Prior to the acquisition of a lease of such property, they secured the services of one A. B. Carney, an oil geologist, who made an extended investigation and study of the same and advised its purchase. As payment for his services as investigator and oil geologist, it was agreed that Carney should receive one-third of any profits that should result from operations under the lease, but no assignment or transfer of any interest in such lease was made to him. Later in the year the record owners of the lease, the petitioner and Tucker, had a disagreement with Carney as to the method of determining the said Carney's share of the profits resulting from operations. Following such disagreement, Carney surrendered his right to receive any profits and received therefor the amount of $23,000, of which the petitioner paid $7,640. In his income-tax return for 1920, the petitioner deducted from his gross income the amount paid to Carney as a business expense for that year. Upon audit of such return, the respondent disallowed the deduction and held that amount paid should be regarded as part of the capital cost*4046 of the lease and determined the deficiency here in controversy. *665 OPINION. LANSDON: The only question here is whether the amount paid by the petitioner to Carney was a capital expenditure or an expense in the nature of a fee for professional services. Even if the payment was a fee for services rendered, the respondent maintains that it was not an expense deductible from gross income of the petitioner for the taxable year, but a capital outlay incident to the acquisition of the lease. Upon authority of many cases already decided by the Board, we must approve the determination of the respondent. ; ; . No evidence relating to the deficiency for 1921 having been presented, the determination of the respondent is approved. Reviewed by the Board. Judgment will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619525/ | Anton L. Trunk and Clara P. Trunk, Petitioners, v. Commissioner of Internal Revenue, RespondentTrunk v. CommissionerDocket No. 63380United States Tax Court32 T.C. 1127; 1959 U.S. Tax Ct. LEXIS 100; August 26, 1959, Filed *100 Decision will be entered under Rule 50. Petitioner C owned real estate in New York City consisting of a lot improved by a building 80 feet deep with regard to which C had a cost basis of $ 135,000. C leased this property to the K chain store company, which intended to wreck the existing building and erect another adapted to its business. By the terms of the lease K agreed to erect a new building according to plans approved by C. The plans thus approved called for the erection of a building 80 feet deep. Before K started on this project the city proposed to widen the street on which the property stood and take 9 feet from the front of the leased property. C saw an opportunity to collect a substantial condemnation award from the city provided K did not wreck the building first. C refused to permit K to erect a building 9 feet smaller than the one approved and obtained a restraining order prohibiting K from wrecking the building pendente lite. K, being anxious to proceed with the building, purchased from C for $ 80,000 all her rights to a condemnation award. At the same time the lease was modified to provide slightly higher rentals to C and to permit K to erect a smaller *101 building. Held, the $ 80,000 received by C constituted capital gains and, since basis to C of the right to a condemnation award sold by C was impractical to ascertain, the $ 80,000 should be applied in reduction of C's cost basis to the entire property. Jerome Kamerman, Esq., for the petitioners.Colin C. Macdonald, Jr., Esq., for the respondent. *102 Kern, Judge. KERN*1127 The Commissioner determined a deficiency in the income tax of petitioners, Anton L. Trunk and Clara P. Trunk, for the taxable year 1950 in the amount of $ 47,431.46. This deficiency insofar as it is herein contested results from respondent's determination that the receipt during 1950 of $ 80,000 by petitioner Clara P. Trunk from a lessee constituted ordinary taxable income. No part of this sum was reported as income by petitioners in their return for the taxable year.The principal issue for decision in this case is whether a payment by S. S. Kresge Company to petitioner Clara P. Trunk in 1950 was a payment by a lessee to a lessor for modification of a lease which constituted ordinary taxable income, or represented proceeds from the sale of a capital asset, proceeds from the involuntary conversion of real property, or compensation for damage to a capital asset, to be treated as a capital transaction for tax purposes.*1128 FINDINGS OF FACT.Most of the relevant facts herein were stipulated by the parties. All facts so stipulated and the exhibits attached to the stipulation are made a part of our findings by this reference.Petitioners, Anton*103 L. Trunk and Clara P. Trunk, are husband and wife, residing at New Rochelle, New York. Petitioner Anton is a real estate broker with an office at 25 West 43d Street, New York 18, New York, and conducted all negotiations and made all business decisions concerning the real property owned by his wife which is involved herein. Petitioners filed a joint Federal income tax return for the taxable year ended December 31, 1950, with the then collector of internal revenue for the third district of New York.Petitioner Clara acquired title to the land and buildings at 85-65 to 85-71 164th Street, Borough of Queens, City of New York, hereinafter sometimes referred to as the property, on August 5, 1943. The cost basis of the property was $ 135,000 at the time of its acquisition. The property consisted of a tract of land on the easterly side of 164th Street, 80 feet in depth and 85 feet in width, beginning at a point 115 feet north of the corner formed by the intersection of Jamaica Avenue and 164th Street, and containing a building known as the Clinton Building which was built up to the street line in existence at the time of acquisition in 1943. Petitioners' deduction*104 for depreciation on this building in their 1950 return indicated a cost basis with regard to the building of $ 70,000.By lease dated January 23, 1946, the property was rented by S. S. Kresge Company, hereinafter sometimes referred to as Kresge, for an initial term commencing September 1, 1946, and expiring April 30, 1965, at an annual net rental of $ 20,000. Paragraph 6 of the lease agreement set out the terms whereby the lessee might demolish the building on the property and erect a new one thereon. This paragraph was in pertinent parts as follows:6. During the initial term of this lease the LESSEE, subject to the conditions hereinafter set forth, may demolish the existing building covering the demised premises, provided that at its sole cost and expense it shall proceed forthwith to erect a new building on the demised premises, free of all liens and encumbrances of any nature whatsoever and which shall fully and completely comply with all laws, ordinances and statutes of state, federal or municipal government and of the rules and regulations of the Board of Fire Underwriters applicable thereto. Said building shall consist of three (3) stories and basement and be of fireproof*105 construction throughout. * * * The building so erected upon the demised premises shall be the absolute property of the OWNER. The LESSEE covenants and agrees throughout the term of this lease, at its sole cost and expense, to make all repairs, interior and exterior, structural and otherwise, in and about the demised premises, whenever required or necessary to maintain them in good working order and condition. The OWNER agrees to cooperate with the LESSEE for the purpose of securing any consents, authorizations and permits as may be necessary to enable the LESSEE to comply with its obligations *1129 under this lease concerning demolition, construction, alteration or repair. Prior to or simultaneous with the execution of this lease by the OWNER, the LESSEE will present to the owner for her written approval, which approval is to be endorsed thereon, a blueprint of a preliminary plan (dated and otherwise identified as being the one referred to herein) showing in particular the area to be built on and the general scheme with regard to the location and arrangement of the ground or street floor elevation of the contemplated new building on the westerly side thereof. When and if*106 the LESSEE erects a new building on the demised premises, said plan, approved as aforesaid, shall be adhered to provided, however, that the LESSEE shall have the right to change or modify said plan so long as such change or modification does not decrease the floor area, reduce the height of the building to less than three (3) stories and basement or less than the overall width of the windows and display space as shown on said preliminary plan.The lease dated January 23, 1946, also provided for renewal upon notice for 2 successive terms of 21 years each at an annual rental of 6 per cent of the appraised value of the land but not less than $ 20,000. Prior to entering the lease Kresge operated a retail store adjacent to the property on the 115-foot plot of land extending to Jamaica Avenue. Kresge's purpose in entering into the lease was to obtain land space for expansion of its business premises by constructing a new and enlarged retail store extending over both lots and necessitating the removal of the Clinton Building. This purpose was understood by petitioners at the time the lease agreement was signed.On April 4, 1946, the president of the Borough of Queens, City of New York, *107 submitted for approval to the Board of Estimate of the City of New York proposed changes in the city map which included a modification of the lines of 164th Street between 89th Avenue and Jamaica Avenue by extending the easterly line of that street for a distance of 9 feet. This proposal was approved by the City Planning Commission, City of New York, on August 14, 1946, and on March 13, 1947, the Board of Estimate of the City of New York adopted the proposed change in the city map, pursuant to sections 26 and 29 of the General City Law of New York.The effect of this change in the city map was to extend the existing street line 9 feet into the property. Upon adoption of the change by the board of estimate, Kresge was prohibited by section 35 of the New York General City Law from constructing such a building on the property as was described in a preliminary plan of a new building on the property approved by petitioners and attached to the lease signed by Clara P. Trunk in accordance with paragraph 6 thereof. The preliminary plan called for the contemplated new building to be situated in part in the bed of the newly mapped street.On June 16, 1947, Kresge applied for a building permit*108 from the Department of Housing and Buildings of the Borough of Queens requesting permission to erect on the property a new building which *1130 would be 80 feet in depth and 85 feet in width. This department refused to approve the application on the basis that 9 feet of the proposed new building would stand in the bed of the mapped street in violation of section 35 of the General City Law of New York State, which provides in part:For the purpose of preserving the integrity of such official map or plan no permit shall hereafter be issued for any building in the bed of any street or highway shown or laid out on such map or plan, * * *On January 6, 1949, Kresge amended its application for a building permit by filing a revised building plan incorporating the 9-foot reduction in size required by the city. This application was approved by the Department of Housing and Buildings on February 1, 1949. It was in part as follows:It is requested that an approval be issued covering the erection of a new building at the above location in view of the fact that with the amendment indicated on the revised plans the building is now in complete compliance with all building requirements. *109 The changes made to the plans -- indicate loading space for merchandise shipments and the omission of the 9'-0" setback required by the city.Kresge by letter proposed to petitioners the construction of a new building of reduced dimensions so as to comply with the law, but this proposal was rejected on behalf of Clara P. Trunk, the owner of the property. The proposal was repeated in a letter to her from Kresge dated September 16, 1949, which expressed the lessee's intention to demolish the existing building and construct a new one with a depth of 71 feet and which in substance was as follows:It is our intention to demolish the existing building and erect a new building on premises leased from you by lease dated January 23, 1946. The new building will be 71 feet in depth to comply with the Resolution and map change which was adopted by the City of New York on March 13, 1947.We desire to proceed with this work as soon as the property has been vacated by the present tenants which is expected on October 31, 1949. In order that we will be prepared to so proceed, we request that you consent to the demolition of the existing building and the erection of a building 71 feet in depth, and*110 that you authorize us to secure the necessary permits for these purposes.At some time shortly after June 21, 1949, petitioners, with reference to the proposed condemnation, sought legal advice and obtained various valuations of the property from an attorney experienced in condemnation proceedings and from an expert building appraiser. They were informed by the attorney that should the city acquire a part of the property by condemnation as contemplated the owner thereof would be entitled, at the time title vested in the city, to an award representing: (a) The reproduction cost of the part of the building condemned less depreciation; (b) the cost of restoring to economic use the remaining part of the building; and (c) the loss resulting from the reduction in size of the remaining part of the building. *1131 They were informed by the appraisal expert that the reproduction costs less depreciation of the part of the building subject to the proposed condemnation (the front 9 feet) was $ 35,000, and the cost of reconstructing the remaining part of the building in order to make it tenantable would be $ 54,000. The appraisal expert also estimated that "the cost of the total destruction*111 effected by the 9 foot widening" was $ 135,000. 1 None of these figures included an amount representing the value of the land.Petitioners consulted their attorney upon receiving Kresge's letter of September 16, 1949, and were advised that if they agreed to Kresge's request and permitted demolition of the existing structure prior to condemnation and construction of the 71-foot building in its place, whatever right to an award petitioner Clara P. Trunk would have for damages and reconstruction costs with regard to the old building would be forfeited. They were advised they would only be entitled to an award for the land. Petitioners asked Kresge to postpone demolition until the condemnation. Kresge refused. Petitioners in a letter addressed to Kresge, signed by petitioners' attorney, *112 and dated September 19, 1949, set forth their position in opposition to Kresge's intended demolition. The body of that letter is as follows:As the attorney for Mrs. Clara P. Trunk, receipt is acknowledged of your letter of September 16, 1949 which was received this morning. The owner declines to accede to the request made in the second paragraph for the following reasons among others:1. She has already approved a set of plans as required by the lease, a copy of which is attached to that document, initialed and made a part thereof;2. The City of New York is about to condemn the nine-foot frontage of the property, the matter appeared on the calendar of the Board of Estimate in June last and the necessary proceedings have been initiated to bring this matter to a conclusion;3. Under condemnation, the owner is entitled to a substantial award for that part of the building that will be taken, the reconstruction of the remaining part, to put it again in a usual rentable condition, the value of the land so taken and consequential damages to the land and building;4. As under street widening proceeding (March 13, 1947) no award is payable to an owner, this loss to the owner in complying*113 with your request would be not only considerable but very substantial in the absence of condemnation.Please be advised therefore that the owner adheres to the position taken by her in the letter sent to you on her behalf under date of July 13, 1949 and expects that you shall comply strictly with it.At the time of the execution of the lease agreement of January 23, 1946, the existing building on the property was occupied by tenants. At some time prior to October 13, 1949, Kresge evicted the tenants in possession under terms provided in that lease agreement.*1132 On October 13, 1949, petitioner Clara P. Trunk filed a petition in the Supreme Court of the State of New York, County of Queens, for an injunction against Kresge's demolishing the existing building on the property. On November 14, 1949, she moved for an injunction pendente lite in a special term of that court. This motion was in part as follows:Plaintiff's written approval of the building plan having been obtained pursuant to the terms of the agreement, the plan could be changed or modified only provided that the floor area was not decreased or the height reduced as shown by such preliminary plan. Defendant now*114 threatens demolition and the erection of a new building pursuant to a changed plan which is at variance with the preliminary plan as to the floor area to which plaintiff has not consented. Furthermore, under the terms of the lease defendant is not obligated to demolish the building. Since such contemplated action by the defendant is contrary to the expressed agreement of the parties and which, if carried out, may cause irreparable injury, defendant should be restrained pending the trial. Settle order providing for a sufficient undertaking.On November 29, 1949, the court granted that motion in an order which --Ordered, that pending the trial and determination of the above entitled action, the defendant and its agents, servants and employees and any and all persons acting in aid of or in conjunction with them be and hereby are enjoined and restrained during the pendency of this action and until the entry of final judgment herein from commencing or undertaking demolition, in whole or in part, of the building located on the premises known as and by the street number 89-71 164th Street, Jamaica, County of Queens, City and State of New York, or the construction of a new building *115 to be located on the aforesaid premises as described in the Complaint herein.The basis of this order was fundamentally that "commission of said acts [of demolition] during the pendency of this action would produce irreparable injury and harm" to petitioner Clara P. Trunk. The court did not determine whether demolition and construction of a building of smaller size than that described in paragraph 6 of the lease agreement would be in violation of that agreement.Following the issuance of that order of the Supreme Court of the State of New York, business negotiations were commenced between petitioners and Kresge which resulted in petitioners' accepting an offer of Kresge to pay a sum of money in return for the assignment by Clara P. Trunk of whatever right she might have to receive an award from the city upon condemnation of the property with the understanding that the lease should immediately be modified to permit Kresge to proceed with demolition and construction. The sum agreed to was $ 80,000. The agreement dated January 10, 1950, and signed by Clara P. Trunk described as "Owner" and a vice president of Kresge described as "Lessee," is in material parts as follows:Whereas, *116 the Owner by a certain indenture of lease bearing date the 23rd day of January, 1946, did lease to the Lessee the premises therein described, *1133 commonly known as No. 89-65 to 71 164th Street, Jamaica, Queens County, New York, for an initial term commencing on the 1st day of September, 1946 and expiring on the 30th day of April, 1965, on the terms and conditions therein set forth; andWhereas, subsequent to the execution of said lease, the City of New York modified the lines and grades of 164th Street as shown on Map No. 3083, adopted by Resolution of the Board of Estimate of the City of New York on March 13, 1947; andWhereas, the City of New York has instituted proceedings for authorization to acquire title to a strip approximately nine feet along the westerly line of said demised premises; andWhereas, the Owner has a valuable property right in and to any award to be made to Owner on the condemnation of said premises, and Lessee is desirous of obtaining said award, and it is to Lessee's best interest to do so,Now, Therefore, in consideration of the premises and of the covenants and agreements herein contained and the sum of One Dollar ($ 1.00) by each of the parties to*117 the other in hand paid, the receipt of which is hereby acknowledged, the parties covenant and agree as follows:1. The Owner hereby assigns to the Lessee, its successors or assigns, free and clear of all liens and encumbrances, all her right, title and interest in and to any and all condemnation awards for the land and building demised by said lease, hereafter made to the present or subsequent owners by reason of the modifications of the lines and grades of 164th Street as shown on Map No. 3083 adopted by Resolution of the Board of Estimate of the City of New York on March 13, 1947. The Owner grants to the Lessee full power and authority for its own use and benefit but at its own cost and expense, to ask, demand, claim, collect, receive and give acquittances for such award or awards or any part thereof in the Owner's name or otherwise and to prosecute all claims or proceedings therefor and the Owner agrees to furnish the Lessee any and all pertinent papers and documents and to fully cooperate with the Lessee in all matters and things connected with such proceedings and awards.The Owner represents to the Lessee that the sole existing mortgage affecting said premises is held by the*118 Bowery Savings Bank or assigns and that there are no judgments or other liens against said property and simultaneously with the execution of this agreement the Owner will deliver to the Lessee a written consent and agreement to the foregoing assignment and waiver of any and all claims to such awards or any part therof, duly executed and acknowledged by said Bowery Savings Bank or assigns, or a satisfaction of such mortgage.The Owner further agrees that any mortgage hereafter placed upon said premises prior to the date of the completion of said condemnation proceeding and payment of the award therefor shall be subject to the foregoing assignment.2. Upon the execution of this agreement the Lessee will pay by check to the Owner the sum of Eighty Thousand ($ 80,000.00) Dollars.3. This agreement may not be changed orally but only by a written agreement signed by the party to be charged thereby.At the same time the Bowery Savings Bank, as the mortgagee of the property, waived whatever right it might have in a condemnation award from the city.On January 23, 1950, Kresge recorded the assignment to it of the prospective right to an award in the Liber of Conveyances, Register of Queens*119 County.*1134 Simultaneously, with the execution of the agreement of January 10, 1950, petitioners and Kresge executed an agreement modifying certain provisions of the lease of January 23, 1946. The pertinent provisions of this agreement are as follows:1. The Owner consents to the demolition by the Lessee of the existing building and the erection of a new building in conformance with the plan annexed hereto insofar as the same applies to the demised premises, which plan is approved by the Owner simultaneously with the execution of this agreement subject to the provisions of paragraph "6" of said lease except as hereby modified. The Lessee shall have the right, subject to the provisions of said paragraph "6", to modify or change such plan except that such modification or change shall not reduce the heighth [sic] of such building on the demised premises to less than three stories and basement or reduce the overall width of the windows and display space of the building on the demised premises as shown thereon, said windows to be used actively for display purposes or maintained so that interior of demised premises is readily visible from sidewalk until February 1, 1960, provided*120 always that the Lessee shall have the right to decrease the area to be built upon as shown on said plan to comply with all laws, statutes, ordinances, resolutions of Federal, State and Municipal governments and with the lawful orders, rules, regulations of any of the bureaus, departments or subdivisions thereof, and with the orders, rules and regulations of the Board of Fire Underwriters.* * * *3. Subject to the provisions of paragraph "6" hereof and the provisions of paragraph "17" of said lease agreement, the first sentence of paragraph "3" of said lease is hereby amended to read as follows, said amendment to be effective beginning February 1, 1950:"Throughout the balance of demised term the Lessee covenants and agrees to pay annually Twenty Three Thousand ($ 23,000.00) Dollars (hereinafter referred to as 'fixed rent') absolutely net to Owner."4. Under the provisions of paragraph "14" the lease is hereby extended and renewed for the additional term of twenty-one years commencing May 1, 1965 and ending April 30, 1986 at an annual fixed rent (subject to the provisions of paragraph "6" hereof) of TWENTY-FIVE THOUSAND ($ 25,000.00) DOLLARS net for the said renewal term of twenty-one*121 years.5. The last paragraph of Paragraph "14" of said lease is hereby modified to read as follows:"At the end of such renewal term, provided and upon condition that the LESSEE shall then not be in default and also shall have served upon the OWNER at least one year before the end of the renewed term a notice in writing by registered mail, stating that the LESSEE desires a further renewal, the LESSEE shall be entitled to a second and final renewal hereof, for a further term of twenty-one years (21), the annual fixed rent for such renewal term to be determined in the same manner as above provided for the first renewal, except that the minimum annual fixed rent during the term of such second renewal shall not be less than Twenty-Five Thousand ($ 25,000.00) Dollars net. All other terms, conditions and covenants including, but in no manner limited to, additional rent to be and remain in full force and effect in such second renewal period as during the first renewal period, but the LESSEE shall not be entitled to any other or further renewal."6. As the Lessee plans to erect a new building on the demised premises and as there is some doubt as to whether the Emergency Business Space Rent*122 Control *1135 Law does or does not apply, the parties hereby agree to submit to arbitration the fixation of the reasonable rent for the demised premises based on the fair rental value of Lessee's business space for the term expiring April 30, 1965, and for the renewal term (option for which is being presently exercised by Lessee) and which runs for a term of twenty-one (21) years commencing on the first day of May, 1965. It is agreed to conduct the arbitration by submitting the same to two named arbitrators, one being selected by the Owner and one being selected by the Lessee. Except as herein provided, the respective parties agree that the particular provisions of paragraphs "3" and "4" hereof specifying the annual rents for the respective terms are not binding nor controlling upon either of the parties. When such reasonable rent is fixed by the award of said arbitrators, the same shall be substituted for the aforesaid rentals specified by the parties in paragraphs "3" and "4" hereof and become the rents payable during the said terms unless the rents so awarded are less than the aforesaid rentals specified by the parties in which event such lesser rents shall be paid only*123 until the State Emergency Business Space Rent Control Law expires or becomes or is inapplicable to the demised premises or said lease of January 23, 1946, after which time (anything hereinabove to the contrary notwithstanding) Lessee covenants and agrees to pay the said annual rents set forth in paragraphs "3" and "4" hereof. If the award of said arbitrators shall be less than the annual emergency rent of $ 21,210, said Lessee covenants and agrees to pay said emergency rent until the aforesaid State rent law expires or becomes or is inapplicable to the demised premises or said lease of January 23, 1946, after which time (anything hereinabove to the contrary notwithstanding) Lessee covenants and agrees to pay the said annual rents set forth in paragraphs "3" and "4" and "4" [sic] hereof, and in the event that the award of rents of said arbitrators is in excess of the rents specified for the respective terms by the parties themselves as aforesaid, Owner covenants and agrees to be bound by said specified rents and to waive so much of the award of the arbitrators as exceeds the same. In the event that said arbitration, the award rendered in connection therewith or any order of confirmation*124 is set aside or declared a nullity or invalid for any reason whatsoever, the same shall in no wise affect or be construed to affect the validity of the said agreement of lease of January 23, 1946 but said lease shall continue in full force and in effect and binding upon the parties subject only to the fixation of said reasonable rent in excess of the emergency rent by further arbitration in accordance with the terms, conditions and procedure hereinabove set forth.* * * *8. Except as herein provided the terms, provisions and conditions of said agreement of lease of January 23, 1946 shall continue in full force and effect.The city of New York instituted proceedings in the Supreme Court of the State of New York, County of Queens, on October 4, 1951, to acquire title to the 9-foot area of the property. Title was subsequently acquired by the city on June 24, 1955, after a judicial hearing. Incident to that proceeding Kresge, by its vice president, filed an affidavit with the court which stated that Kresge was "the holder of an assignment of the award made or to be made for" the area therein involved. Also as part of that proceeding Kresge by its attorneys filed an affidavit to show*125 a claim for the condemnation award. This affidavit is in part as follows:*1136 II. As to said Lot 20, Block 9794 also identified as Damage Parcel No. 7, Block 12397 of Land Map, the owner Clara P. Trunk by agreement in writing bearing date the 10th day of January, 1950 and recorded on January 23, 1950 in the New York City Register's Office, County of Queens, in Liber 5887, page 35 of Conveyances, Sec. 50, Block 12397, for good and valuable consideration duly assigned to S. S. Kresge Company, lessee of said property and claimant herein, all her right, title and interest in and to any and all condemnation awards for the land and building by reason of the taking of said property by the City of New York.* * * *IV. The taking of this property is greatly to its damage and it therefore prays a hearing in support of this petition and a just and equitable award for such property.Dated: New York, N.Y. November 27, 1951.Kresge, by settlement agreement with the City of New York, received $ 25,000 as a result of the city's acquiring the 9 feet of the property. This award was for vacant land since by the time title vested in the city on June 24, 1955, Kresge had demolished the Clinton*126 Building and constructed a building with a depth of 71 feet leaving the 9 feet of land empty.OPINION.Petitioner Clara P. Trunk, who was owner and lessor of the real estate described in our findings, received $ 80,000 from her lessee simultaneously with her assignment to the lessee of whatever right she might have to a condemnation award and the execution of a modified lease which permitted the lessee to proceed at its option with the construction of a new building of lawful dimensions and which set forth the rental upon renewal in terms of a sum certain. The primary question presented by the facts here present is whether petitioners realized ordinary taxable income upon receipt of the $ 80,000 or realized proceeds from a capital transaction in the nature of a sale, conversion, or recovery of damages.In substance petitioners' argument is as follows: The right to a condemnation award, even though not vested in a determined amount, is a capital asset. Petitioner Clara sold such a right to Kresge for $ 80,000 and this sum is taxable to her as a capital gain to the extent that it exceeds the basis to her of such right. In the alternative, the $ 80,000 received from Kresge represents*127 compensation for damages to a capital asset and is taxable as a capital gain only to the extent that this amount exceeds the basis to Clara of the asset damaged. In the instant case it is impossible or impractical to find the basis of the separate property sold or damaged and therefore the $ 80,000 should go to reduce Clara's cost of the entire property before any part can represent taxable income.In substance the respondent argues as follows: The conditional "right" of Clara to compensation if and when a part of her property *1137 should be taken by condemnation proceedings was not "property" nor was there any "sale or exchange" thereof in 1950 within the meaning of any provision of the Internal Revenue Code so as to qualify the transaction here in question for capital gains treatment. To the contrary, the substance of the transaction as distinguished from its form was the modification of the terms of the lease in return for $ 80,000, and therefore this sum represented ordinary income.In our opinion the right of an owner of property to compensation in the form of a condemnation award upon the taking by the sovereign of such property or a part thereof, even though conditional, *128 is a property right incident to ownership. Respondent recognizes on brief that the assignment of such a right "is recognized as creating an equity in the assignee enforceable against the subject matter of the assignment when, and if, it comes into existence," i.e., when as a result of condemnation proceedings the sovereign has taken title to the property condemned. That such a right did in substance exist and that an effective sale thereof was made are indicated by the fact that Kresge collected $ 25,000 from the city for the sole reason that it had purchased this right from Clara.Respondent's argument to the effect that the substance of the transaction between Clara and Kresge was the modification of the lease in return for $ 80,000, and consequently that that sum constituted ordinary income requires an analysis and interpretation of the facts.The principal and motivating concern of Clara in her transactions with Kresge subsequent to April 4, 1946, and March 13, 1947, was to realize as much money as possible from the threatened condemnation of a part of her property. It was apparent to her (or to her advisers) that if the condemnation occurred while the building still stood *129 upon her property and covered the entire area the condemnation award would amount to a handsome figure, but, conversely, if the building was wrecked by Kresge before the award was granted (pursuant to Kresge's design to erect another building on her premises), the amount of the award would be much less. The prospects of receiving a large condemnation award from the City of New York in compensation for damages to a building which was shortly to be wrecked anyway would be fascinating to most property owners whose civic virtue was not equal to that of Cato the Censor. Kresge, however, was anxious to proceed with the wrecking of the old building and the erection of the new building adapted to its use of the leased premises without regard to the effect of its proposed actions on the amount of the condemnation award which Clara might receive from the city. Under these circumstances and for the purpose of delaying 2*1138 Kresge in its proposed wrecking of the building which had suddenly become valuable to her as a potential subject of damage, Clara advanced the somewhat technical argument that since Kresge after March 13, 1947, could not erect on the premises a building with the*130 dimensions originally agreed upon, it could not erect any building, and obtained a temporary restraining order enjoining Kresge from demolishing the old building. Thus Kresge could not proceed with its plans to erect a new building until after protracted litigation, unless it provided some satisfactory compensation to Clara for her inability to collect the full amount of the potential award which she hoped to receive upon the condemnation of the 9-foot strip of this property while it was covered by the old building. Therefore and after bargaining and negotiations, an agreement was worked out whereby Kresge paid Clara $ 80,000 for "all her right, title and interest in and to any and all condemnation awards for the land and building" here in question. Clara, being satisfied that she had thereby realized all that was then possible from her conditional right to a condemnation award, immediately consented to a modification of the lease which, inter alia, permitted Kresge to proceed with its plan to wreck the old building and construct a new one of smaller dimensions, and also provided for slightly higher rentals to Clara.*131 As we interpret the transaction, what Kresge bought and paid for was Clara's conditional right to a condemnation award. The reason it paid the price it did may have been to induce Clara to accept a modification of the lease which would permit Kresge to proceed with its building plans without waiting for the end of protracted litigation. What Clara sold and received payment for was her conditional right to a condemnation award. She sold this right for the price paid because she thereby avoided the risk of an unfavorable result in the litigation, because the price paid represented a reasonably discounted equivalent of all she could hope for from the condemnation award, even on the assumption that the city would proceed with its taking of the property and that Kresge could be prevented from wrecking the building pending such taking, and because this solution gave her the reasonable equivalent of an award against the city for damages to the old building and at the same time provided for the erection of a new building on her property at the expense of Kresge. The reason she was able to get the price she did from Kresge without waiting for the institution and termination of condemnation*132 proceedings was that she had Kresge "over a barrel" because of clause 6 of the lease and the temporary restraining order. Regardless of their reasons, what the parties to the transaction did was to buy and sell a conditional right to a condemnation award for $ 80,000.No element in the transaction related to matters customarily connected with income. No part of the payment could be considered as *1139 representing anticipated income or as in lieu of income. No modification of the lease occurred which affected income items adversely to the interests of petitioner so as to warrant a conclusion that any part of the $ 80,000 paid to Clara related to such items.We conclude that this sum constituted payment for the effective transfer to Kresge of a property right of Clara. Respondent has argued that this right was not property and there was no sale or exchange thereof. He has made no alternative contention that even though the right was property and was sold by Clara it was not a capital asset within the meaning of the Internal Revenue Code. We see no reason why it is not a capital asset.Since we hold that the $ 80,000 was received by Clara from Kresge as payment for the transfer*133 of a capital asset, it constitutes a capital gain to the extent that it exceeds Clara's basis with regard to the property sold. However, it is impossible or impractical to ascertain the cost basis to Clara of this property right sold which was derived from her right of ownership to the entire property. 3 Her cost basis to the entire property was in excess of $ 80,000. We conclude that this latter sum was a return of capital and should be applied in reduction of Clara's cost basis to the entire property. See Inaja Land Co., Ltd., 9 T.C. 727">9 T.C. 727.*134 Decision will be entered under Rule 50. Footnotes1. Damages based upon the cost of total destruction would not seem to be available to Clara since it was possible to reconstruct the part of the building remaining after the taking of the 9 feet in such a way as to make it tenantable.↩2. That a considerable delay on Kresge's part was necessary if Clara was to collect the full amount possible from the city is indicated by the fact that while the taking of the 9-foot strip of petitioner's property was proposed in 1946, the city did not acquire title to it until 1955.↩3. In his reply brief respondent argues that the right transferred to Kresge could only be the right to a condemnation award for the taking of the front 9 feet of the land and since the cost basis of the land was treated by petitioners as $ 65,000, the cost basis of the right transferred was the part of that sum representing the ratio of the part of the land taken to the total area of land. As we interpret the facts, the right transferred was the right to condemnation awards covering damages direct and indirect to the entire property including damages to the building located on the front 9 feet and consequential damages to the remainder. We have found it impractical to make an allocation of Clara's cost basis to the entire property in such a way as to even approximate her cost basis to the right transferred.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619527/ | Glenn E. Stevenson and Cherie Fenske Stevenson, Petitioners v. Commissioner of Internal Revenue, RespondentStevenson v. CommissionerDocket No. 3464-68United States Tax Court51 T.C. 970; 1969 U.S. Tax Ct. LEXIS 173; March 12, 1969, Filed Donald W. Geerheart, for the respondent. Drennen, Judge. DRENNEN*970 OPINIONOn May 3, 1968, respondent mailed a joint notice of deficiency to petitioners wherein deficiencies were determined in petitioners' income tax and additions to tax for the years 1961 and 1962.On October 31, 1967, petitioner Cherie Fenske Stevenson filed a voluntary petition in bankruptcy in the U.S. District Court for the Western District of Missouri. On December 26, 1967, Cherie Fenske Stevenson was granted a discharge in that bankruptcy proceeding and the proceeding was closed and terminated on January 24, 1968.On July *174 8, 1968, petitioner Glenn E. Stevenson filed a voluntary petition in bankruptcy in the U.S. District Court for the Western District of Missouri. On September 3, 1968, Glenn E. Stevenson was granted a discharge in that bankruptcy proceeding and the proceeding was closed and terminated on September 4, 1968. 1On July 11, 1968, petitioners filed a joint petition for redetermination of the deficiencies in their income taxes and additions to tax for the years 1961 and 1962.On August 29, 1968, respondent filed a motion to dismiss the petition for lack of jurisdiction on the grounds that the petition was filed in this case after both petitioners had been adjudicated bankrupt, relying on the provisions of section 6871(b) of the Internal Revenue Code of 1954. A hearing on the motion was originally set for October 2, 1968. Petitioners*175 filed no objection to respondent's motion to dismiss *971 and did not appear at the hearing. 2 However, respondent requested and was granted permission to file a memorandum in support of his position and to argue the motion orally because he considered the matter to be of importance and wanted the Court to reconsider its recent rulings in Pearl A. Orenduff, 49 T.C. 329">49 T.C. 329, and John V. Prather, 50 T.C. 445">50 T.C. 445. Respondent's memorandum was filed and further oral argument by respondent was heard on January 15, 1969, after which the Court took the motion under advisement.Respondent has not assessed the taxes or additions to tax here involved and did not *176 file a claim for those taxes and additions to tax in either of the above-mentioned bankruptcy proceedings.On the authority of, and for the reasons stated in both the majority and concurring opinions in, Samuel J. King, 51 T.C. 851">51 T.C. 851 (1969), and the opinion in Pearl A. Orenduff, supra, which cases we consider to be controlling here, respondent's motion to dismiss is denied.An appropriate order will be entered. Footnotes1. Both of the bankruptcy proceedings appear to have been closed prior to the expiration of the 6 months within which creditors would have the right to file claims under the bankruptcy law.↩2. The statute of limitations was raised as a defense for both years in the petition, but that issue is not before us at this stage of the proceedings; nor is the applicability of sec. 35 of the Bankruptcy Act, as amended by Pub. L. 89-496 (July 5, 1966), 11 U.S.C. sec. 35↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619528/ | Jay D. Reynolds and Shirley M. Reynolds v. Commissioner.Reynolds v. CommissionerDocket No. 2092-71.United States Tax CourtT.C. Memo 1972-84; 1972 Tax Ct. Memo LEXIS 173; 31 T.C.M. (CCH) 331; T.C.M. (RIA) 72084; April 10, 1972, Filed. Jay D. Reynolds, pro se, 10154 Rainier Ave. South, Seattle, Wash. Millard D. Iesch, for the respondent. FAYMemorandum Findings of Fact and Opinion FAY, Judge: Respondent determined a deficiency in petitioners' income tax for taxable year 1969 of $1,620.44. The only issue to be decided is whether a portion of petitioners' income is excludable from income under section 112. 1Findings of Fact Some of the facts have been stipulated and are, together with the exhibits*174 attached to the stipulation, incorporated herein by this reference. Jay D. and Shirley Reynolds, at the time of filing the petition herein, resided in Seattle, Washington. They filed a joint income tax return for taxable year 1969 with the district director of internal revenue for the district of Washington in Ogden, Utah. Shirley Reynolds is a party to this action solely by virtue of having filed a joint return; consequently, Jay D. Reynolds will hereinafter be referred to as petitioner. During 1969 petitioner was employed as an airline pilot for Northwest Airlines (hereinafter referred to as Northwest). For the year 1969 petitioner received a salary of $44,857 paid entirely by Northwest. For seven months of the year part of petitioner's duties consisted of flying civilian aircraft chartered by the United States military between the United States and South Vietnam. 332 Prior to these Vietnam flights petitioner and other members of the crew were cleared for security and given military briefings. Petitioner carried an identification card classifying him as a "civilian noncombatant serving with the Armed Forces of the United States." The card also provided that in the event*175 of enemy detention he was entitled to the same treatment as a member of the Air Force with the rank of colonel. At no time during the year in question was petitioner a member of the Armed Forces nor was any compensation paid him by the United States military. Petitioner, relying on section 112, excluded from income $500 per month for seven months. In the statutory notice of deficiency respondent included these amounts in income resulting in the deficiency here in issue. Opinion The issue to be decided is whether any portion of petitioner's salary is excludable from income under the combat pay exclusion of section 112. That section provides in pertinent part: SEC. 112. CERTAIN COMBAT PAY OF MEMBERS OF THE ARMED FORCES. (a) Enlisted Personnel. - Gross income does not include compensation received for active service as a member below the grade of commissioned officer in the Armed Forces of the United States for any month during any part of which such member - (1) served in a combat zone during an induction period, or * * * (b) Commissioned Officers. - Gross income does not include so much of the compensation as does not exceed $500 received for active service as a commissioned*176 officer in the Armed Forces of the United States for any month during any part of which such officer - (1) served in a combat zone during an induction period, * * * Section 1.112-1(g), Income Tax Regs., in amplifying the statute provides: "As to who are members of the Armed Forces of the United States, see section 7701(a)(15)," which in turn says: [The] term "Armed Forces of the United States" * * * includes all regular and reserve components of the uniformed services which are subject to the jurisdiction of the Secretary of Defense, the Secretary of the Army, the Secretary of the Navy, or the Secretary of the Air Force, and * * * also includes the Coast Guard. The members of such forces include commissioned officers and personnel below the grade of commissioned officers in such forces. In addition, the statute requires an individual to be in active service to qualify for exclusion. Section 1.112-1(i), Income Tax Regs., provides: "A member of the Armed Forces is in active service if he is actually serving in the Armed Forces of the United States." We think it clear that petitioner herein was not a member of the Armed Services and obviously did not receive compensation for*177 active service as a commissioned officer or otherwise. Petitioner received his compensation from Northwest as a civilian pilot. The assigned flights into combat zones were merely a part of his civilian employment and do not constitute a military endeavor. He is not under military jurisdiction of any kind and does not serve in the Armed Forces in any capacity. That he carries an identification card and receives military briefings are insufficient to bring him within the terms of the statute. See Commissioner v. Connelly, 338 U.S. 258">338 U.S. 258 (1949). 2There are many capacities in which civilians and quasi-military personnel perform services in combat zones. Surely Congress is aware of their existence, their peril, and the absence of favorable tax treatment. Congress has not granted them the benefit of the exclusion, and it is not the function of this Court to fill the void. Nor is the statute in question unconstitutional. The classification made by Congress permitting an exclusion only*178 for members of the Armed Services in active service is neither arbitrary nor capricious. See Brushaber v. Union Pac. R.R., 240 U.S. 1">240 U.S. 1 (1916). While those who approach but fall short of coming within the privileged class feel they should have been included, such sentiments exist whenever lines of classification must be drawn and alone cannot render a statute unconstitutional. Decision will be entered for the respondent. 333 Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954.↩2. For a recent and strikingly similar case see David D. Fagerland [Dec. 30,817(M)],T.C. Memo. 1971-134. See also Lee M. Prusia [Dec. 29,666(M)], T.C. Memo. 1969-148↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619529/ | ESTATE OF THOMAS E. JONES, JR., Deceased, BY THE FIFTH THIRD BANK and INA S. JONES, CO-Executors, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Jones v. CommissionerDocket No. 7755-75United States Tax CourtT.C. Memo 1977-87; 1977 Tax Ct. Memo LEXIS 357; 36 T.C.M. (CCH) 380; T.C.M. (RIA) 770087; March 29, 1977, Filed William E. Rathman, for the petitioner. Andrew M. Winkler, for the respondent. TANNENWALDMEMORANDUM OPINION TANNENWALD, Judge: Respondent determined a deficiency in the Federal estate tax due from the Estate of Thomas E. Jones, Jr., in the amount of $13,944.11. The sole issue before us is the valuation of an annuity payable to the decedent's spouse under an agreement between decedent and his employer. This case was submitted to the Court upon a full stipulation of facts (Rule 122, Tax Court Rules of Practice and Procedure) which is incorporated herein by this reference. Thomas E. Jones, Jr. (decedent), a resident of Middletown, Ohio, died testate on October 24, 1972, at the age of 47. He was survived by his wife, Ina S. Jones (Ina), and a son. Ina and The Fifth Third Bank*358 are the duly qualified and acting co-executors of the decedent's estate. At the time of filing the petition herein, The Fifth Third Bank maintained its principal office in Cincinnati, Ohio, and Ina maintained her residence in Middletown, Ohio. The Federal estate tax return for the decedent's estate was filed with the district director of internal revenue, Cincinnati, Ohio. Upon decedent's death, Ina became entitled to a monthly annuity of $1,083.33 pursuant to an agreement between decedent and his employer. Ina was 47 years of age at her husband's death. Approximately six months prior to his death, on March 23, 1972, she underwent a radical mastectomy for cancer of the right breast. The post-operative pathology report showed no evidence of metastasis. Two years later, Ina similarly showed no signs of metastatic carcinoma. The parties agree that the annuity is includable in the decedent's estate at its date-of-death value. Respondent determined that the value of the annuity should be computed pursuant to the normal annuity valuation procedure and tables set forth in section 20.2031-10, Estate Tax Regs., and therefore should be included in the gross estate at a value of*359 $155,654.78. Petitioner contends that, because of Ina's experience with cancer, Ina had a five-year life expectancy from the date of her husband's death and that the annuity should be valued at $56,250.70. The tables provide the normal basis for valuing annuities, but it has long been recognized that they should not be applied where the result would be unreasonable. E.g., Continental Ill. Nat. B. & T. Co. of Chicago v. United States,504 F.2d 586">504 F.2d 586 (7th Cir. 1974); Estate of Nellie H. Jennings,10 T.C. 323">10 T.C. 323 (1948). The burden of proof is on the petitioner to show that the application of those tables herein would produce such a result. Miami Beach First National Bank v. United States,443 F. 2d 116, 120 (5th Cir. 1971); Rule 142, Tax Court Rules of Practice and Procedure. We hold that petitioner has not sustained that burden. What evidence there is shows that immediately following surgery there was no evidence of cancer; that two years later there was no indication of any recurrent or residual malignancy; that on February 12, 1974, Ina's doctor stated in a letter that "[there] is a possibility that she will not survive five*360 years following her surgery"; that in a letter dated May 20, 1974, the doctor stated that he considered "her problem a surgical success as of this moment" and that his professional opinion was "that she is probably cured," although he cited some qualifying conclusory statistics with respect to persons who had undergone similar surgery; and that a Xeromammography report dated February 28, 1975 showed a marked mammary dysplasia and calcifications of the breast which are "most frequently those seen in sclerosing adenosis" and "occasionally * * * in carcinoma." Such evidence is simply not enough. If anything, it indicates that Ina's chances of living a normal life span were substantial. In any event, it does not constitute that degree of testimonial confirmation that Ina's life expectancy was only five years, such as was present in the cases relied upon by petitioner. Estate of John P. Hoelzel,28 T.C. 384">28 T.C. 384 (1957); HuntingtonNational Bank,13 T.C. 760">13 T.C. 760 (1949); Estate of Nellie H. Jennings,supra;Estate of John Halliday Denbigh,7 T.C. 387">7 T.C. 387 (1946); Estate of T. G. Hendrick, a Memorandum Opinion of this Court*361 dated July 7, 1950. 1 Beyond this all of these cases involved situations where the person whose life expectancy was in issue was figuratively, if not literally, inextremis. See also Estate of Nicholas M. Butler,18 T.C. 914">18 T.C. 914 (1952); Estate of James W. Douglas, a Memorandum of this Court dated Mar. 31, 1953; Rev. Rul. 66-307, 2 C.B. 429">1966-2 C.B. 429. Compare Continental Ill. Nat. B. & T. Co. of Chicago v. United States,supra;Chauncey Stillman,T.C. Memo 1965-94">T.C. Memo. 1965-94. Petitioner seeks to satisfy the degree of proof required by the decided cases by pointing to statistics showing survival rates for women with breast cancer over five, ten, and twenty-year periods. Without expressing any opinion as to the relevancy in general of such statistics, we conclude*362 that they have no probative effect in the context of this case. The most that can be gleaned from them is an expression in percentage terms of a median life span in a sample population from the date of diagnosis and treatment. Such statistics do no more than show the obvious, namely, that survival rates of various population subgroups are bound to differ. The median they reveal is not a substitute for proof of the actual life expectancy of a particular individual under a particular set of circumstances and it is that expectancy which is at issue herein. See Estate of Gloria A. Lion,52 T.C. 601">52 T.C. 601, 606 (1969), affd. 438 F. 2d 56 (4th Cir. 1971). The long and the short of this case is that it is not "unmistakable to one in possession of the facts that [Ina's] life would be radically shorter than predicted in the actuarial tables." See Estate of Lion v. Commissioner,438 F. 2d 56, 62 (4th Cir. 1971). Consequently, respondent's determination is sustained. To permit computation for attorneys' fees, Decision will be entered under Rule 155. Footnotes1. Compare Dalton v. Campbell, an unreported case ( S.D. Ind. 1956, 52 AFTR 1919↩, 56-2 USTC par. 11,621), where the court relied on an annuitant's actual life expectancy, which was determined to be 10 years, in valuing her annuity under her husband's employment contract. The court's findings of fact are skeletal, offering no guidance herein. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619530/ | Appeal of GILLIAM MANUFACTURING CO.Gilliam Mfg. Co. v. CommissionerDocket No. 964.United States Board of Tax Appeals1 B.T.A. 967; 1925 BTA LEXIS 2737; April 7, 1925, decided Submitted January 29, 1925. *2737 In determining the taxable gain on the sale of patents which had been developed by the taxpayer, expenditures in such development work may be capitalized and added to costs of patents. On the evidence, held, that the taxpayer is not entitled to a deduction on account of an alleged bad debt. Jesse I. Miller, Esq., for the taxpayer. A. Calder Mackay, Esq., for the Commissioner. TRAMMELL *967 Before JAMES, STERNHAGEN, and TRAMMELL. This appeal involves income and profits taxes for 1918 and 1919 and is based upon the action of the Commissioner in determining the *968 profit on the sale of patents which were sold during 1919 by excluding from the cost thereof amounts alleged to have been expended in developing the patents and capitalized by the taxpayer on its books and in disallowing a deduction on account of a debt alleged to have been ascertained to have become worthless and charged off during 1918. FINDINGS OF FACT. The taxpayer was an Ohio corporation, with its principal office in Canton in that State. It was engaged in the business of manufacturing saddlery equipment and during the years 1911, 1912, 1913, 1914, and*2738 1915, was experimenting and developing certain features in connection with automobile tops. The taxpayer employed a competent mechanical engineer named White to work out problems in manufacturing and to experiment with and to develop a new automobile top and supports for automobile tops. He received a salary of $200 per month from 1911 to 1916, when his salary was increased to $2,500 a year. One Haynes, designer and draftsman, was also employed. Seven other men were employed to assist and work with Haynes and White in connection with the experimentation and development of the automobile tops and parts thereof. All of these men devoted about one-half of their time to this work. Haynes also received a salary of $200 per month. The salaries paid to the men who were engaged in this work prior to August 31, 1915, amounted to $31,640. This amount does not include expenditures for materials used in the work, overhead or other expenses. In August, 1915, the taxpayer set up on its books as a capital charge representing the cost of the patents acquired prior to that date, the amount of $10,000. This was arrived at by a conservative estimate based upon the expenses incurred in connection*2739 with the development and procurement of the patents. The patents were issued from time to time until 1918 when twelve or fourteen had been issued. In 1914, one patent was issued on a bow rest and clamp. White worked out the idea. He began on it in 1908 or 1909. The patent was issued to him and was assigned by him to the corporation for a nominal consideration. Another patent was issued on February 16, 1915, on a body clamp device. Steiner, the president of the corporation, first conceived the idea and gave White a sketch of it. White then developed the idea after a great deal of work and experimentation. Another patent was issued on September 7, 1915, on what was known as a bow rest and clamp device. This was issued to White and assigned by him to the corporation for a nominal consideration. Other patents were issued from time to time until 1919. At the time of the capitalization of the patents on the books of the corporation on August 31, 1915, the corporation had only two patents which had been issued as the result of the development work and expenses incurred in connection therewith, although there were as many as twelve or more patents pending at that time. *2740 The patent which was issued in 1914 was a basic patent and some of the patents subsequently issued, which were included in the sale in 1919, were improvements based upon this basic patent. *969 The patents acquired in 1915 and prior thereto, as well as the other patents subsequently acquired, making a total of fifteen, were sold together in 1919 for $80,000. The taxpayer paid a commission on this sale of $5,000, paid out $755.58 for patent dies which were included in the sale, and had paid out in acquiring patents subsequent to August 31, 1915, $8,882.97. These amounts were added to the amount of $10,000 which was capitalized on the books as patent costs. The amount of $10,000 was disallowed by the Commissioner and was deducted from the cost of patents sold, as reported by the taxpayer in its income and profits tax return. On January 15, 1915, one McKinley purchased from Steiner sufficient stock in the corporation to give him the controlling interest. He paid Steiner $10,000 in cash as the initial payment. On the same date there was a meeting of the stockholders to elect new officers. McKinley was elected president and treasurer. On January 20, 1915, five days*2741 afterwards, McKinley drew a check as treasurer of the corporation for $10,000 payable to the Union National Bank of Cleveland, Ohio. This check was for his personal benefit. He also gave the corporation's checks for $1,900 and $500, respectively, to one Seabury. Abut three months later Steiner, who was away at the time, returned. He was informed by a friend that it would be well for him to look into the affairs of the corporation as it was getting into financial difficulties and was borrowing money. He made inquiry and McKinley acknowledged that he had taken the $10,000 for his personal use which he agreed to repay as well as the amount paid to Seabury which he acknowledged was his own personal matter. McKinley later entered into a contract with Steiner in which he agreed to pay the amounts of the checks and gave security for the same consisting of a section of land in Wisconsin, certificates of preferred stock of the Houchin-Bippus Company of Chicago, certain certificates of stock in the McKinley Townsite Company, a Minnesota corporation, and also assigned a certain claim against Charles M. Backus Company of Chicago, for salary amounting to $4,200. McKinley at the same time*2742 surrendered to Steiner the stock which he had purchased and on which he had paid $10,000 as the initial payment. The land in Wisconsin had tax liens against it amounting to between $300 and $400, but Steiner knew nothing of its value. No attempt was made to sell the land and no definite information was secured as to its value. The $2,400 paid to Seabury was paid back by McKinley, $1,000 in 1917, and $1,400 in 1918. Nothing was realized from any of the securities. McKinley resigned as an employee of the corporation in 1918 and the securities were given to him when he left. The taxpayer considered that since he had left the employ of the company it could not collect the debt which he owed. DECISION. The deficiency should be determined in accordance with the following opinion. Final decision will be settled on consent or on 10 days' notice in accordance with Rule 50. *970 OPINION. TRAMMELL: The Commissioner disallowed the amount set up on the books of the taxpayer as being the cost of patents acquired to the extent of $10,000, upon the ground that the taxpayer had originally deducted the expenditures made in the development of patents as expense, and upon*2743 the further ground that it was not shown that an expenditure to the extent of $10,000, which was capitalized upon the books of the taxpayer, had been actually made in acquiring said patents. We think the evidence establishes the fact that the amount claimed as capital expenditures in acquiring the patents was actually expended for that purpose. The patents had been in the process of development for a long period of years beginning prior to 1913. The taxpayer had seven men who devoted at least one-half of their time in the development of the improvements and the patent ideas. The actual expenditure attributable to patents was at least the amount claimed by the taxpayer. With reference to the question as to whether the taxpayer should be permitted to capitalize expenditures in the development of patents which had previously been deducted as an ordinary and necessary expense, we held, in the , that the provisions of the statute with reference to depreciation deductions was not in the alternative, and the fact that a taxpayer had not taken depreciation on patents but had permitted its invested capital to remain*2744 intact, would not prevent it from subsequently claiming the depreciation which had actually been sustained. The same is true with reference to the capitalization of patents. If the amounts expended were actually paid out in acquiring patents, the deduction of such amounts as ordinary and necessary expenses of carrying on a trade or business was not proper. The fact that a taxpayer did deduct such items or considered them as expenses does not alter the situation. Such treatment was erroneous. The taxpayer has no option to treat expense items as capital or capital expenditures as ordinary and necessary expenses of carrying on a trade or business and had a right, as it did, to change its erroneous accounting methods. The patents, when acquired, formed a part of the capital investment of the taxpayer and the costs thereof were not ordinary and necessary expenses of carrying on its trade or business. The amount of $10,000 set up by the taxpayer on its books on August 31, 1915, is as much a part of the cost of patents as the attorneys' fees or other expenses incurred in the actual procurement of said patents. With respect to the debt of McKinley, alleged to have been ascertained*2745 to have become worthless in 1918 and for which a deduction in that year is claimed, the Board is not convinced, from the facts, that the said debt was ascertained to be worthless in that year. McKinley signed an affidavit in which he stated that on February 1, 1915, he was connected with the Gilliam Manufacturing Company and about that date secured $10,000 from the company; that this amount was immediately turned over to B. T. Steiner and that he *971 had no knowledge as to whether it was retained by him or turned back to the company. After the discovery of the fact that McKinley had secured the money from the corporation he surrendered the stock which he had purchased and gave securities to guarantee the payment of the amount due by him. He was retained in the employ of the company until 1918 when he resigned. When he left the company all of the securities which he had given, including the land, were turned back to him. There is no evidence that the securities which were given back to him were worthless or that the taxpayer corporation made any effort to realize on such assets before they were turned back to McKinley or to ascertain the value thereof. There is no evidence*2746 that the assets given as security were not sufficient to save the taxpayer from loss if it had undertaken to realize thereon. A taxpayer is not permitted voluntarily to surrender securities not known to be worthless and given for the purpose of protecting it from loss on an indebtedness and charge off the debt. The fact that McKinley surrendered the stock on which he had paid $10,000, the fact that all the property which he had given for the purpose of indemnifying the taxpayer against loss was surrendered to him voluntarily when he left the company, and the fact that the taxpayer had no knowledge as to the value of the assets and made no effort to realize thereon, lead the Board to the conclusion that there was no actual bona fide debt existing when the amount was charged off on the books. The taxpayer is, therefore, not entitled to a deduction on account of a debt ascertained to be worthless. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619541/ | ESTATE OF MURIEL F. RICHINS, DECEASED, BRUCE RICHINS AND MARILYN ALLISON, CO-EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Richins v. CommissionerDocket No. 14740-89United States Tax CourtT.C. Memo 1991-23; 1991 Tax Ct. Memo LEXIS 27; 61 T.C.M. (CCH) 1706; T.C.M. (RIA) 91023; January 22, 1991, Filed *27 Decision will be entered under Rule 155. John L. Burghardt, for the petitioner. Shellyanne W. L. Chang, Rebecca L. Harrigal, and Richard L. Carlisle, for the respondent. COHEN, Judge. COHENMEMORANDUM OPINION Respondent determined a deficiency of $ 156,284 in the Federal estate tax of Muriel F. Richins, deceased. After concessions, the sole issue for decision is whether proceeds of an insurance policy on the life of decedent are includable in decedent's gross estate for purposes of section 2035. All section references are to the Internal Revenue Code, as amended and in effect at the date of death. Bruce Richins, co-executor of the estate of Muriel F. Richins (decedent), resided in California and co-executor Marilyn Allison resided in Virginia at the time the Federal estate tax return was filed. Decedent was a resident of California at the time of her death on January 3, 1985. Decedent created the Muriel F. Richins 1983 Irrevocable Trust (the Trust) effective July 21, 1983. Carol C. Curry, C.P.A., was designated trustee. The Trust was created to hold an insurance policy on the life of decedent. The Trust was funded with $ 1.00. On August 1, 1983, *28 the trustee applied for a flexible premium adjustable life policy (the policy) on the life of decedent. Central Life Insurance Company policy no. 2500057 was effective November 1, 1983, with a face amount of $ 300,000. Decedent was named as the insured, and the Trust was named as the owner and beneficiary of the policy. Decedent did not possess at the time of her death or any time prior to her death the right to change the beneficiary of the policy, to transfer any beneficial interest in the policy or to cancel or terminate the policy. She did not have any contractual rights in the policy or express powers under the policy. Decedent paid the premiums for the policy. She received no consideration for the premium payments. Respondent determined that the proceeds of the policy were includable in decedent's estate for estate tax purposes. Respondent argues that decedent held incidents of ownership within the meaning of section 2042(2) that were constructively transferred to the beneficiaries within the meaning of section 2035(d)(2) within 3 years of decedent's death. Respondent recognizes that his position in this case has been rejected in , affd. , and , affd. . Respondent argues, however, that "these courts' analyses are faulty." When this case was submitted, respondent's counsel represented that respondent intended to make new arguments under California law. Respondent's brief, however, did not contain any arguments unique to this case. The Court therefore did not request a brief from petitioner. Section 2035(a) generally requires that the gross estate of a decedent include the value of any property in which the decedent had transferred an interest within 3 years of death (the 3-year inclusionary rule). Section 2035(d), which applies to decedents dying after 1981, was added by the Economic Recovery Tax Act of 1981 (ERTA), Pub. L. 97-34, sec. 424, 95 Stat. 172, 317. Because decedent herein died in 1985, section 2035(d) applies to her estate. (For a discussion and application of prior law, see .) Section 2035(d)(1) provides that the general rule of section 2035(a) shall not apply to the estates of decedents dying after *30 December 31, 1981, except in cases of those transfers enumerated in section 2035(d)(2). Section 2035(d)(2) excepts transfers of an interest in property that is included in the value of the gross estate under section 2042 (or various other sections not applicable here) or that would have been included under any of those sections "if such interest had been retained by the decedent." Section 2042 provides that the gross estate includes (1) the proceeds of insurance on decedent's life receivable by or for the benefit of the estate, and (2) the proceeds of insurance on decedent's life receivable by other beneficiaries if decedent possessed at decedent's death any "incidents of ownership" in that insurance policy. Sec. 2042; sec. 20.2042-1(b) and (c), Estate Tax Regs. In , we held that the proceeds from an insurance policy were not includable in the insured's gross estate where the insured did not possess at the time of his death, or at any time within the 3 years preceding his death, any of the incidents of ownership in the policy. Specifically, we held that section 2035(d)(1) overrides section 2035(a). Because the proceeds of the policy*31 were not includable under section 2042, we held that the section 2035(d)(2) exception to section 2035(d)(1) was not applicable. Similarly, in , we held that the proceeds of an insurance policy were not includable in the insured's gross estate because the insured never possessed incidents of ownership in the policy within the meaning of section 2042. Although the decedent contributed cash annually to an irrevocable inter vivos trust in amounts sufficient to meet the trust's cumulative monthly premium obligations, we held that "the premium payment test is 'now abandoned' under section 2042." . Inasmuch as respondent has not argued that this case is distinguishable from Estate of Leder or Estate of Headrick, we see no reason to reexamine our prior holdings. See, e.g., , on appeal (11th Cir., Oct. 12, 1990), and , on appeal (5th Cir., July 2, 1990). We therefore conclude that the subject life insurance proceeds are not includable in decedent's taxable estate. To reflect the agreement of the parties as*32 to other issues, Decision will be entered under Rule 155. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619542/ | Grenada Industries, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent. National Hosiery Mills, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentGrenada Industries, Inc. v. CommissionerDocket Nos. 24571, 24640United States Tax Court17 T.C. 231; 1951 U.S. Tax Ct. LEXIS 104; August 22, 1951, Promulgated *104 Decisions will be entered under Rule 50. Two corporations, Industries and National, and two partnerships, Hosiery and Abar, were owned or controlled directly or indirectly by the same interests. On respondent's allocation of the income of the two partnerships to the two corporations, held, (1) allocation of Abar's income to the two corporations disapproved; (2) allocation of Hosiery's income to Industries approved; (3) allocation of Hosiery's income to National disapproved. Robert A. Littleton, Esq., for the petitioners.Lester M. Ponder, Esq., for the respondent. Raum, Judge. RAUM*231 The Commissioner determined the following deficiencies:DeclaredPenaltyvalue excess-Excesson excessDocket No.YearIncome taxprofitsprofits taxprofits taxtax24571 11941$ 25,019.41$ 10,265.16$ 22,352.95194213,772.0917,183.9819435,931.6643,946.6419449,060.0362,835.392464019407,708.931,794.2419417,510.3214,467.34194210,535.141,870.812,650.2419431,570.6834,485.08$ 1,724.25These proceedings were consolidated for hearing. They present the issue whether respondent erred in allocating to petitioners income claimed to have been earned by two other enterprises. In both proceedings, *105 the determined deficiencies rested in part on other adjustments, but the validity of these other adjustments is conceded by both petitioners. In Docket No. 24640, a 5 per cent penalty, amounting to $ 1,724.25, was added because of late filing of an excess profits tax return for the taxable period ending December 31, 1943, and the validity of this penalty is also conceded.*232 FINDINGS OF FACT.Petitioner in No. 24571, Grenada Industries, Inc. (hereinafter sometimes referred to as "Industries"), is a corporation organized under the laws of the State of Mississippi, with its principal office at Grenada, Mississippi. For its fiscal years ending March 31, 1941, 1942, and 1943, it filed its tax returns in question with the collector of internal revenue for the district of Mississippi. For its fiscal year ending March 31, 1944, it filed its returns with the collector of internal revenue for the district of Indiana. Petitioner in No. 24640, National Hosiery Mills, Inc. (hereinafter sometimes referred to as "National"), is a corporation organized under the laws of the State of Indiana, with its principal office at Indianapolis, Indiana. For its tax years under review, it filed its returns *106 with the collector of internal revenue for the district of Indiana.The ladies' hosiery industry consists of a number of recognized and distinct phases, which include: (1) Manufacturing unfinished and undyed hosiery, or hosiery "in the grey," 1 for which there is a market; (2) dyeing and finishing hosiery "in the grey"; (3) developing and furnishing, to manufacturing and finishing mills, expert styling and merchandising specifications and ideas; (4) selling finished hosiery to the trade; (5) salvaging yarn and defective hosiery, by reclaiming yarn from waste and defective hosiery, and by mending defective hosiery and selling it to the trade. Many persons and businesses engage only in one or more of these phases of the industry.Jacob A. Goodman (hereinafter also referred to as "J. A. Goodman") and Lazure L. Goodman (hereinafter also referred to as "L. L. Goodman") were brothers who had been engaged in the ladies' hosiery industry since 1915. At that time they operated their own business *107 as hosiery distributors in Indianapolis and North Carolina. In or about 1920 they organized Real Silk Hosiery Mills, Incorporated (hereinafter referred to as "Real Silk"), which came to engage in all the above-described phases of the industry. The Goodmans dominated and controlled Real Silk as long as they continued their affiliation with it, until 1937, and they acquired eminent reputations in the industry. They were responsible for Real Silk's successful merchandising and sales operations, and had extensive experience in merchandising and selling ladies' hosiery.In 1925 Real Silk opened a salvaging department, prior thereto having sold its waste and defective hosiery. Abraham J. Barskin (hereinafter referred to as "Barskin"), who at one time had independently been in the business of dealing in waste and defective merchandise, *233 was put in charge of that department. Barskin was related to the Goodmans through marriage to their sister, who died in 1940.Henry V. Kobin (hereinafter referred to as "Kobin") had been associated with the Goodmans at Real Silk. He entered Real Silk's employ in 1921. Theretofore the Goodmans had taken his brother, William Kobin, into the business. When *108 William died in 1928, Kobin left Real Silk and, with the participation of the Goodmans, organized National. The Goodman family made investments in National. National engaged in the production, dyeing, finishing, and merchandising phases of the industry. In 1937 National organized a sales force; up to that time National sold its product through the sales organization of the Trojan Division of Real Silk. Kobin was familiar with all phases of National's operations and he, like the Goodmans, attained wide experience in the industry. In 1928 Barskin also left Real Silk and joined Kobin at National, where he held executive office and assisted in the manufacturing phase of the business.Israel E. Solar (hereinafter referred to as "Solar") likewise was associated with the Goodmans at Real Silk. He was hired by Real Silk in 1923, at the age of sixteen, and advanced rapidly in the organization. He remained with Real Silk, except for a brief period, until 1937. Almost his entire business career was spent in the hosiery industry, and during this period he had close business relations with the Goodmans and was associated with companies with which the Goodmans were connected. While at Real *109 Silk, he also knew Kobin and Barskin.Charles E. Stevens (hereinafter referred to as "Stevens") was an accountant, who was employed by Real Silk in 1928. Prior to that time he had miscellaneous accounting experience. He remained as an employee of Real Silk until about 1932, when he left to go into the private practice of accounting, with his office at Indianapolis. Shortly thereafter he was retained by National, and supervised its accounting affairs. In his practice of accounting he specialized in tax and estate matters. He knew the Goodmans since about 1926 or 1927, and he advised the Goodmans and Kobin respecting the arrangement of their business affairs. Stevens had no technical training or experience in the hosiery industry.At Stevens' advice, the Goodmans and Kobin created certain trusts for their children. L. L. Goodman had two children, Elliot R. and Sue Ellen, about 27 and 19 years of age, respectively, at the time of the hearing. J. A. Goodman had three children, Robert A., Ruth Elaine, and Jacqueline, about 25, 22, and 23 years of age, respectively, at the time of the hearing. Kobin's children were William and Anne, about 22 and 19 years old, respectively, at the *110 time of the hearing. Esther M. Goodman was the wife of L. L. Goodman; Sarah W. Goodman *234 was the wife of J. A. Goodman; Florence Kobin was the wife of Henry V. Kobin. The Goodmans and Kobin set up the following trusts:Date of trustTrustindentureGrantorElliot R. Goodman:Trust No. 1May 31, 1929L. L. Goodmanand E. M. Goodman.Trust No. 2July 1, 1940L. L. GoodmanTrust No. 3Jan. 2, 1942L. L. GoodmanTrust No. 4Jan. 2, 1942L. L. GoodmanSue Ellen Goodman:Trust No. 1July 25, 1931L. L. GoodmanTrust No. 2Oct. 14, 1940L. L. GoodmanTrust No. 3Oct. 8, 1941L. L. GoodmanRobert A. Goodman:Apr. 27, 1931J. A. GoodmanTrust No. 1Ruth Elaine Goodman:Trust No. 1Apr. 27, 1931J. A. GoodmanTrust No. 2Oct. 14, 1940J. A. GoodmanJacqueline Goodman:Trust No. 1Apr. 27, 1931J. A. GoodmanTrust No. 2July 1, 1940J. A. GoodmanTrust No. 3Oct. 8, 1941J. A. GoodmanTrust No. 4Jan. 2, 1942J. A. GoodmanTrust No. 5Jan. 2, 1942J. A. GoodmanAnne Kobin Trust.June 3, 1932H. V. KobinWm. Kobin Trust.June 3, 1932H. V. KobinSuccessorSuccessorTrustOriginal trusteetrusteetrusteeElliot R. Goodman:Trust No. 1L. L. GoodmanSecurity TrustC. E. Stevensto 9/30/41.Co. to 12/21/42.to date.Trust No. 2J. A. GoodmanSecurity TrustC. E. Stevensto 9/30/41.Co. to 12/21/42.to date.Trust No. 3Security TrustC. E. StevensCo. to 12/21/42.to date.Trust No. 4Security TrustC. E. StevensCo. to 12/21/42.to date.Sue Ellen Goodman:Trust No. 1Esther GoodmanSecurity TrustC. E. Stevensto 9/30/41.Co. to 12/21/42.to date.Trust No. 2J. A. GoodmanSecurity TrustC. E. Stevensto 9/30/41.Co. to 12/21/42.to date.Trust No. 3Security TrustC. E. StevensCo. to 12/21/42.to date.Robert A. Goodman:Trust No. 1Sarah GoodmanSecurity TrustC. E. Stevensto 9/30/41.Co. to 12/21/42.to date.Ruth Elaine Goodman:Trust No. 1Sarah GoodmanSecurity TrustC. E. Stevensto 9/30/41.Co. to 12/21/42.to date.Trust No. 2A. J. Barskin toSecurity TrustC. E. Stevens9/30/41.Co. to 12/21/42.to date.Jacqueline Goodman:Trust No. 1Sarah GoodmanSecurity TrustC. E. Stevensto 9/30/41.Co. to 12/21/42.to date.Trust No. 2A. J. Barskin toSecurity TrustC. E. Stevens9/30/41.Co. to 12/21/42.to date.Trust No. 3Security TrustC. E. StevensCo. to 12/21/42.to date.Trust No. 4Security TrustC. E. StevensCo. to 12/21/42.to date.Trust No. 5Security TrustC. E. StevensCo. to 12/21/42.to date.Anne KobinH. V. Kobin toSecurity TrustC. E. StevensTrust.1/1/42.Co. to 12/21/42.to date.Wm. KobinH. V. Kobin toSecurity TrustC. E. StevensTrust.1/1/42.Co. to 12/21/42.to date.*111 The Goodmans sold their stock interests in Real Silk in 1937, and in or about September 1937 they organized Industries at Grenada, Mississippi. An executive committee, appointed by Industries' board of directors, consisted only of J. A. Goodman and L. L. Goodman, and it guided and advised Industries, arranging for the acquisition of facilities by Industries and for the extension of bank credit to Industries. 2 Stevens was placed in charge of Industries' accounting affairs. L. L. Goodman became treasurer of National and supervised all its financial affairs, and J. A. Goodman became president of National and assumed supervision of the manufacturing, dyeing, and *235 finishing at National of its own hosiery. During the years involved, Kobin was vice-president and general sales manager of National.When Solar left Real Silk in the same year, he also became associated with National; he took charge of its purchases of raw materials, and in this connection had close contact with *112 its production activities. In the discharge of his duties at National, he was responsible to J. A. Goodman. In the early part of 1938, Solar paid several visits to Industries' plant at Grenada to advise on difficulties in production which were being experienced. These visits were made at the request of J. A. Goodman. In about May or June 1938, Solar became general manager of Industries, and subsequently, in 1940, he became its president and held that office until about 1945.Industries' plant was established at Grenada through an arrangement by which that city provided building facilities at a nominal rental, subject to certain minimum requirements as to employment and operations. Industries engaged in the manufacturing of hosiery in the grey. It lacked dyeing and finishing facilities, and did not have a sales organization. The machinery with which the plant was equipped was purchased by J. A. and L. L. Goodman and leased by them to Industries. It was a new type of knitting machinery imported from Europe. At that time the common method of manufacture of ladies' hosiery consisted of knitting the leg on one machine, and then transferring the leg to another machine which knitted *113 the foot, resulting in a "double-unit" stocking. The machinery installed at Industries' plant, however, was equipped to knit the entire stocking in one operation on a single machine, producing a "single-unit" stocking. In 1938 Industries began operations experimentally in this new type stocking, working with employees new and inexperienced in the manufacture of this type of hosiery. During this period J. A. Goodman advised Industries respecting the design of this hosiery. Industries did not get into substantial operations until some time in 1938.Industries' first operations were in silk hosiery, but it later began to work with nylon. However, nylon yarn was not readily obtainable, but the Goodmans, who enjoyed the confidence of the du Pont company which controlled the source of nylon, were able to obtain such yarn for Industries.The capacity of National's dyeing and finishing facilities exceeded the quantity of its own grey goods production, and National used those facilities to process hosiery in the grey manufactured by other mills. Industries entered into an agreement with National, dated April 12, 1938, for the dyeing and finishing of Industries' hosiery by National, and thereafter *114 substantially all Industries' hosiery was dyed and finished at National's plant at Indianapolis. J. A. Goodman and Barskin executed the agreement for National as president *236 and secretary respectively, and J. B. Perry, as president, and E. L. Morrow, as secretary, executed the agreement for Industries. It provided:* * * *(1) Said First Party [Industries] agrees from time to time to ship the incompleted hosiery to the factory of said Second Party [National] at Indianapolis, Indiana.(2) Said Second Party agrees to process and complete such hosiery in accordance with such instructions as said First Party may from time to time give to said Second Party.(3) First Party's hosiery when completed and processed shall be held by said Second Party subject to orders of disposition which said First Party shall from time to time deliver to said Second Party.(4) The charge for said Second Party's services shall be based upon the schedules of charges which said Second Party shall have in effect throughout the term of this agreement, or any renewals thereof.(5) Second Party shall make no charge whatsoever for storing First Party's hosiery, either complete or incomplete. Title to First Party's hosiery, *115 whole on the premises of said Second Party, shall remain vested in said First Party.(6) Second Party, at the request of First Party, in addition to processing and completing such hosiery, shall perform such other services in connection therewith as said First Party may require, such as boxing, shipping, etc., and said First Party shall pay said Second Party for such additional services any additional cost and expense accruing by reason of such services.(7) Second Party shall cause First Party's hosiery to be covered by insurance against loss or damage by fire and water, and to be secured by such other types of insurance as said Second Party may deem desirable. Such policies of insurance shall be paid to said First and Second Parties as their interests may appear. Any increase in the cost of Second Party's insurance by reason of this provision shall be borne by said First Party.(8) All moneys owing to said Second Party by said First Party by reason of any of the terms and conditions enumerated in this agreement shall be payable on or before the 10th day of the month next succeeding that in which said indebtedness was incurred.* * * *The common stock of National (19,450 shares outstanding) *116 and Industries (1,000 shares outstanding), for the periods indicated, was held as follows:NATIONAL7/1/40 to9/30/41 to1/2/42Period9/30/4112/31/41et seq.J. A. Goodman family:Per centPer centPer centSarah W35 9.18 9.18Robert A. Trust #123 23 Ruth Elaine Trust #12.82 2.82Total35 35 35 L. L. Goodman family: Elliot R. Trust #135 35 35 Kobin family:Anne Trust6 2/36 2/39.63William Trust6 2/36 2/39.12Florence S6 2/36 2/31.23Total20 20 20 H. V. Kobin(1) (1) (1) Barskin10 10 10 *237 INDUSTRIESPeriod7/1/40 to9/30/41 to1/2/429/30/4112/31/41et seq.J. A. Goodman family:Per centPer centPer centSarah W35 Robert A. Trust #118.518.5Ruth Elaine Trust #114.714.7Jacqueline Trust #11.81.8Total35 35 35 L. L. Goodman family: Elliot R. Trust #135 35 35 Kobin family:Anne Trust6.76.710 William Trust6.76.710 Florence S6.66.6Total20 20 20 Barskin10 10 10 Both National and Industries had preferred stock outstanding, which did not appear to play a significant part in the control of either corporation. The preferred stock outstanding, on the dates indicated, was held as follows:NATIONALYears ending12/31/37, 12/31/38,12/31/41, 12/31/42,12/31/39, 12/31/4012/31/43, 12/31/44J. A. Goodman family:Sarah W97 1/2Jacqueline Trust #197 1/2L. L. Goodman family:L. L. Goodman, trustee127 1/2Sue Ellen Trust #1127 1/2Kobin family:Anne Trust40 1/2William Trust40 1/2Florence S40 1/2Barskin91 1/2INDUSTRIESYears ending12/31/3812/31/39,12/31/41, 12/31/42,12/31/4012/31/43, 12/31/44J. A. Goodman family:J. A. Goodman185315Sarah W345Ruth Elaine Trust #197Jacqueline Trust #1563L. L. Goodman family:L. L. Goodman30Esther M6557Elliot R. Trust380Sue Ellen Trust #1418Dorothy G. Adler909090*117 Grenada Knitting Mills, Inc. (hereinafter referred to as Knitting"), was a corporation organized under Indiana law in or about March 1938. The Goodmans participated in the organization of Knitting. Knitting employed both J. A. and L. L. Goodman, and the Goodmans held executive office in Knitting and were responsible for *238 its management. On September 8, 1939, Knitting had 100 shares of stock outstanding, which had been issued as follows: 35 shares to the wife of J. A. Goodman; 35 shares to a trust for L. L. Goodman's son (Elliot R. Goodman Trust No. 1); 6 2/3 shares to each of the trusts for Kobin's two children (Anne Kobin Trust and William Kobin Trust), and 6 2/3 shares to Kobin's wife; and 10 shares to Barskin.Knitting did not at any time have any machinery, mill, finishing plant, or any production facilities whatever, nor did it have a sales force. It had no inventory, nor did it at any time purchase or acquire any hosiery for resale, or otherwise. It had no officers or employees who were not also officers or employees of Industries or National. By oral agreement, some time prior to June 30, 1940, the Goodmans, representing Knitting, undertook to furnish to Industries their *118 ideas as to merchandising, styling, and design of the hosiery to be made by Industries. They also undertook to find a market for Industries' hosiery, as finished and dyed by National; such market consisted of several large purchasers, such as Sears, Roebuck and Company, procured directly by the Goodmans, as well as a larger number of smaller purchasers who were obtained by National's sales organization. Industries was to receive only the fair market price for its hosiery in the grey (plus reimbursement for any finishing or dyeing charges that it may have paid to National). Knitting was to be compensated by retaining what was left from the full price paid by the ultimate purchasers of the finished product, after subtracting the price for the hosiery in the grey which Knitting transmitted to Industries and after subtracting also the costs of dyeing, finishing, and selling which were paid to National. Title to the hosiery remained in Industries at all times until it passed to the purchaser. Neither Knitting nor National purchased the hosiery from Industries. Knitting did not guarantee that it would furnish a market for Industries' products or undertake to assure Industries of any *119 profit or return on Industries' products, but it was anticipated that the "know-how" of the Goodmans, acting for Knitting, would result in a market for Industries' products and that Industries could reasonably count upon receiving a fair price for its hosiery. In connection with making available National's sales organization to sell Industries' finished products to the trade, Knitting entered into a written agreement with National dated January 14, 1939. The agreement was signed for National by J. A. Goodman as president and by Barskin as secretary, and for Knitting by George P. Doyle as president and Samuel J. Mantel as secretary. Mantel was a lawyer who represented the Goodmans at various times. The agreement provided:* * * *WHEREAS, the parties hereto have found it to be more economical to have one group of salesmen engaged in selling the products of the parties hereto, rather than having separate groups sell such products; and*239 WHEREAS, it is to the mutual interests of the parties hereto that purchasers of the products of said parties receive one billing for the merchandise so purchased; andWHEREAS, said First Party [National] has no interest of any nature whatsoever in the proceeds *120 of the sales of Second Party's [Knitting's] merchandise, and Second Party has no interest whatsoever in the proceeds of the sales of First Party's merchandise;NOW, therefore, in consideration of the sum of One Dollar paid by each of the parties hereto to the other and other valuable considerations, receipt of which is hereby acknowledged, and in the further consideration of the covenants and promises hereinafter set out, it is agreed as follows:(1) All merchandise sold by salesmen who may jointly represent the First and Second Parties hereto shall be billed by the party in whose name such order is placed.(2) All expenses incident to the filling of such orders shall be prorated between the parties hereto in accordance with the expense incident to the shipping of such party's merchandise.(3) The party receiving any remittance in payment of any such merchandise so billed shall hold that part of such remittance(s) representing payment of the merchandise of the other party in trust, and within 10 days of the receipt of such remittance(s) shall deliver such trust receipts to the other party.(4) In the event it shall become necessary to institute any legal action for the collection of any *121 of the accounts, then in such event that party in whose name such merchandise has been billed shall institute such legal actions and prosecute same to their termination. The expense of such legal actions shall be prorated between the parties hereto in accordance with their financial interest in the accounts involved.(5) In the event that any buyers may make claims against either of the parties hereto by reason of defects in the merchandise shipped, or otherwise, no adjustment shall be made except with the consent of that party whose merchandise is involved.(6) Any and all expense of any nature whatsoever incurred by either of the parties hereto by reason of this agreement, or any of the terms and conditions herein enumerated, shall be prorated in accordance with the actual interest of the parties hereto.* * * *Although the foregoing agreement purported to deal with products belonging to National and Knitting, such was not the fact: Knitting had no products; the products attributed to Knitting belonged to Industries, and the agreement in fact dealt with the products of National and Industries. It was only the oral agreement between Industries and Knitting, mentioned above, that furnished *122 the basis for Knitting's entering into the written agreement with National.Such business activity as Knitting carried on was discontinued on or about June 30, 1940, although Knitting was not dissolved. It was succeeded in that activity by Grenada Hosiery Mills (hereinafter referred to as "Hosiery"). Hosiery was organized as a partnership, under Indiana law, pursuant to articles of partnership dated July 1, 1940. Knitting was replaced by Hosiery because it was believed that Knitting's small capital put it at a disadvantage under the excess *240 profits tax, applicable to corporations, adopted in 1940. Knitting assigned to Hosiery its interest in the written agreement of January 14, 1939, between National and Knitting; National consented to the assignment, and Hosiery agreed to comply with the terms and conditions of the agreement.The Goodmans participated in the decision to replace Knitting by Hosiery, as did Stevens. The Goodmans and Kobin were not partners of record in Hosiery, just as they had not been stockholders of record in Knitting. But the Hosiery partnership agreement was executed by J. A. Goodman as trustee for the son of L. L. Goodman (Elliot Goodman Trust No. 2); Barskin *123 as trustee for a daughter of J. A. Goodman (Jacqueline Goodman Trust No. 2); Kobin as trustee for his children (Anne Kobin Trust and William Kobin Trust), and as attorney-in-fact for his wife; and Barskin as an individual.The partnership interests in Hosiery, for the periods indicated, were as follows:Period7/1/40 to9/30/41 to1/2/42 to7/17/439/30/4112/31/417/17/43et seq.Per centPer centPer centPer centJ. A. Goodman family: JacquelineTrust #235 35 35 31.82L. L. Goodman family: Elliot R.Trust #235 35 35 31.82Kobin family:Anne Trust6 2/36 2/36 2/36.06William Trust6 2/36 2/36 2/36.06Florence S6 2/36 2/36 2/36.06Total20 20 20 18.18Barskin10 10 10 9.09Solar family: Ronia L. (wife ofIsrael E. Solar9.09The Hosiery partnership agreement provided:* * * *(4) By reason of the fact that A. J. Barskin is a partner in such Grenada Hosiery Mills, and is Trustee for the Jacqueline Goodman Trust, owner of an interest in such partnership, and in order to avoid any conflict of interest which may arise, A. J. Barskin hereby designates and appoints L. L. Goodman as representative (for the purpose of this agreement only) of the interest of said Jacqueline Goodman Trust.(5) *124 All checks, notes and other evidences of indebtedness pertaining to the partnership may be executed for and on behalf of said partnership, by J. A. Goodman, L. L. Goodman, H. V. Kobin and A. J. Barskin, or by any nominee or designee which any of them may name in writing. The salaries to be paid to any partner or employee of said partnership shall be based upon services rendered to said partnership and contribution to the administration and success of the business and shall be in such amounts as may from time to time be determined by said partners.(6) All expenses pertaining to the operation of said partnership shall be borne, paid and discharged by the parties hereto in the following ratio: By the First Party [J. A. Goodman, as trustee] 35%; by the Second Party [Barskin, *241 as trustee] 35%; by the Third Party [Kobin, as trustee and attorney] 20%; and by the Fourth Party [Barskin] 10%; and all gains, profits and increases that shall come or arise from or by means of such partnership business shall accrue to the parties hereto in such percentages, and all losses resulting from depreciation, bad debts or otherwise, shall be borne and paid by the parties hereto, in accordance with such *125 percentages.* * * *(13) The business policy of this partnership shall be determined by J. A. Goodman, Trustee, L. L. Goodman, H. V. Kobin, Trustee, and A. J. Barskin, each of whom shall have as many votes as the percentage of interest owned by him bears to the total interests of all partners. The majority (based on percentage) shall prevail. * * ** * * *Paragraph 13 of the Hosiery partnership agreement was amended to read as follows by a written agreement dated September 22, 1941:(13) The business policy of this partnership shall be determined by J. A. GOODMAN, L. L. GOODMAN, H. V. KOBIN and A. J. BARSKIN, who shall be designated as "Policy Makers." In determining such business policy J. A. Goodman shall have 35 votes; L. L. Goodman shall have 35 votes; H. V. Kobin shall have 20 votes; and A. J. Barskin shall have 10 votes. The majority (based on percentage) of all votes shall prevail. * * *The Parties hereto agree that the management of the business affairs of this partnership requires the services of those experienced in the business to be engaged in by this partnership. Accordingly, it is agreed that in the event any of the parties hereto shall dispose of his interest in this *126 partnership, the assignee of such interest shall not be entitled to have a voice in the business policy of this partnership nor shall any heir, executor, administrator, successor, or assign, have any right to participate in the determination of the business policy of this partnership unless and until the Policy Makers then retaining voting power shall consent thereto in writing.By a written agreement date July 17, 1943, Ronia L. Solar, wife of Solar, was formally made a partner in Hosiery to the extent of a 9.09 per cent interest, and the interests of the other partners were proportionately modified.Capital was not a factor in the operation of either Knitting or Hosiery. Hosiery's capital at its organization consisted of $ 4,286.25 in notes receivable contributed for or by its partners. Two of these notes, for $ 1,500 each, were issued by J. A. and L. L. Goodman and were given by them to the respective trusts for their children which became partners of record in Hosiery. No cash was included in the original investment in Hosiery. On or about May 17, 1941, these notes were paid by their makers in the face amount, $ 4,286.25. On or about the same date, May 17, 1941, the partners withdrew *127 cash from Hosiery in the total amount of $ 25,000, the withdrawal of each partner being proportionate to his respective partnership interest.As in the case of Knitting, Hosiery did not at any time own, lease, or use any machinery, mill, finishing plant, or production facilities; it had no inventory nor did it at any time purchase or acquire any *242 hosiery for resale, or otherwise; it had no sales force, but both Knitting and Hosiery relied upon National's sales organization, which was supervised by Kobin, to sell hosiery manufactured and owned by Industries. Hosiery's business address, as reported on its partnership tax returns, was the same as that of National. There were no persons employed by either Knitting or Hosiery who were not also employed by Industries or National. Both Knitting and Hosiery were dependent on the services of the Goodmans and Kobin, who continued to serve Hosiery as they had Knitting.A written agreement was entered into between Hosiery and Industries dated June 24, 1940. In making this agreement, Industries was represented by Solar, and Hosiery was represented by the Goodmans. The agreement provided:* * * *WHEREAS, Industries maintains a plant in the City *128 of Grenada, County of Grenada, State of Mississippi, in which it partially manufactures hosiery up to the stage in process known as "in the greige"; andWHEREAS, Mills [Hosiery] is a partnership thoroughly competent in all phases of the sale, manufacture and merchandising of hosiery; andWHEREAS, Industries does not wish to create its own sales organization and merchandising plan, and does not have the facilities for finishing its hosiery.* * * *Article IIndustries will manufacture hosiery to the stage of process known as "in the greige" to the standards and specifications recommended by Mills.Article IIMills will supervise the finishing, merchandising and sale of such hosiery either by developing the facilities for so doing, or by engaging facilities for the purpose. However, Mills shall not engage or enter into any contract for such facilities unless the terms and conditions of such engagement, and/or, contracts have been approved by Industries.Article IIIWhen Mills engages or contracts with other facilities for the purpose of finishing or merchandising, the expense thereof, may, at the discretion of Mills, be charged either directly to Industries by such facilities, or paid for *129 by Mills, in the latter of which event, Industries shall reimburse Mills for such expense. In either event, such expense shall be added to the "cost of sales" of Industries, as hereinafter defined.Article IVAny expense incurred in connection with the sale of the products of Industries, shall be borne by Mills and if incurred by Industries, shall be charged to Mills and shall be deducted by Mills from proceeds of sales in arriving at "net sales proceeds" as hereinafter defined.*243 Article VMills agrees to make available immediately to Industries upon request, the entire proceeds of sales of Industries' products which Mills receives, less such disbursements as Mills may make in connection with the expense incidental thereto, (including such payments as Mills makes to Industries in payment of charges incurred under Article IV hereunder), or such other expense as Mills may incur for the account of Industries in connection with merchandising and finishing. It is agreed by both parties that Mills does not, by so doing, surrender its right to compensation as hereinafter set forth.Article VIFor the supervision of the finishing, merchandising and sale of Industries' products, Mills shall be compensated *130 for its services in the manner set forth in this agreement and according to the following formula: -- (A) To the cost of manufacturing, including administration costs, and all costs incidental to the operating of its business, Industries shall add such charges as have been made by Mills under Article III of this agreement and shall thereby arrive at a "cost of sales".(B) From the gross proceeds of sales of Industries' products, Mills shall deduct such trade discounts as have been granted to customers, and such losses as have been sustained by "bad debts", and the expense involved in selling the products of Industries, and shall thereby arrive at a "net sales proceeds".(C) In the event that Industries' "Cost of sales" are equal to or in excess of Mills' "net sales proceeds", then Industries shall bill Mills for the full amount of Mills' "net sales proceeds" according to Mills' books and Mills shall receive no compensation for its services.(D) In the event Industries' "cost of sales", as heretofore described, are less than Mills' "net sales proceeds", then a computation shall be made of the difference between the two for the purpose of determining the proportion that is 1. Attributable *131 to efficiency in greige manufacturing, or other operations performed and/or supervised by Industries.2. Attributable to low cost and efficient finishing as supervised by Mills.3. Attributable to a fair and reasonable estimate of the value of any merchandising plans that have, or shall have been developed by Mills.4. Attributable to efficient selling as supervised by Mills.(E) Industries shall forthwith bill Mills for its "cost of sales" as described in Paragraph A of this Article, plus the amount that has been allocated as attributable to efficiency in greige manufacturing, or other operations performed and/or supervised by Industries, as described in Paragraph D-1, and the balance between this amount and Mills' "net sales proceeds" shall be accrued on the books of Industries to the benefit of Mills, and shall, upon request, be paid to Mills.Article VIIFor the purpose of making the computation in Article VI, paragraph D, Mills shall be represented by Mr. L. L. Goodman, or in the event of his failure or inability to serve, Mr. J. A. Goodman, Mr. H. V. Kobin, and Mr. A. J. Barskin, in the order named, and Industries shall be represented by Mr. I. E. Solar, or in *244 the event of his failure *132 or inability to serve, by Mr. Samuel J. Mantel, and Mr. J. B. Perry, Jr., in the order named.Article VIIIIn the event that the representatives of each of the parties shall fail to come to an agreement acceptable to both of them, then they shall select a third party, mutually agreeable to both of them, as arbitrator, and his decision shall be final and binding on both parties.Article IXNothing in this agreement shall exclude Industries, at any time, from making such provisions as it may decide to make for finishing or selling its own products, but Industries agrees that the merchandising rights shall be exclusively granted to Mills for the term of this agreement.Article XThe computation described in Article VI, Paragraph D, shall be made at least once annually as of the close of business of the fiscal year of Mills, but can be made more often, if convenient and agreeable to both parties.Article XIThis agreement shall expire on the 30th day of June, 1945.* * * *The Industries-National agreement did not fix specific charges for the services to be performed by National, but left the charges to be worked out in the future according to such criteria as were mentioned in the provisions quoted *133 from the agreement. Periodically the amounts owed by Industries to National were settled by agreement between them, and in the settlement of these amounts Industries was represented by Solar and National was represented by L. L. Goodman and Kobin. On occasion, J. A. Goodman also participated in the settlement of these amounts.While the National-Knitting agreement, later taken over by Hosiery, provided that expenses incident to filling of orders should be prorated between the parties, it did not describe the expenses with any particularity and was ambiguous as to the manner in which proration was to be made. When there was any question as to allocation of such expenses, the matter was submitted to Stevens. Usually, however, there was no dispute. The amounts which were allocated to Hosiery are evidenced by Hosiery's partnership returns. Those returns, for the fiscal periods 1942-1943 and 1943-1944, respectively, report "other deductions" of $ 72,264.53 and $ 42,302.88, and these sums are explained on the returns as including sales expense billed by National in the amounts of $ 70,764.46 and $ 40,691.14 for those respective periods. "Other deductions" were reported in the returns *134 for 1940-1941 and 1941-1942, without breakdown, in the respective amounts of $ 112,028.98 and $ 122,595.64.*245 The Industries-Hosiery agreement, in providing for the division of proceeds derived from the sale of the finished product, used such flexible terms as "efficiency in greige manufacturing," "low cost and efficient finishing as supervised by Mills," "efficient selling as supervised by Mills," and "a fair and reasonable estimate of the value of any merchandising plans * * * developed by Mills." Such terms remained to be interpreted, and in the settlement between the parties their interpretation and specific application was left to Stevens, who was given a free hand in this regard although he might consult with such persons as L. L. Goodman and Kobin. In practice, an agreement was always reached as to the amounts to be paid Industries.The relationships between Industries, Hosiery, and National developed as follows: Industries manufactured hosiery in the grey and shipped it to National for dyeing and finishing. The hosiery finished by National for Industries was kept by National separately from National's own hosiery. Except for the few large customers obtained directly by the Goodmans *135 and Kobin, the Industries hosiery was sold by National's sales organization and by the same salesmen who sold National's hosiery. Customers were invoiced by National and usually in National's name, but some invoices were made out in Hosiery's name. Some customers made payment to Hosiery; others paid National. National deducted from the proceeds it received a charge for the use of its sales force, including therein an allocated portion of its sales expenses and an amount for a reasonable profit, and remitted the balance to Hosiery. National's charge for finishing and dyeing, consisting of the costs of finishing and dyeing plus a reasonable profit, was paid by Industries. Notwithstanding the provisions of Article VI of the agreement of June 24, 1940, Industries "billed" Hosiery for the hosiery in the grey, its charge consisting of an amount representing the fair market price for hosiery in the grey but in no event an amount less than the total costs of Industries attributable to production of the hosiery in the grey, plus the cost to it of dyeing and finishing the hosiery at National, plus such other charges as Industries might incur after the point of manufacture. The amount so "billed" *136 was remitted to Industries by Hosiery out of the sales proceeds received from National, and the balance was retained by Hosiery as its "profit" or "compensation." There were inter-company accounts between Hosiery and Industries, and when remittance by check was received by Hosiery from National, Hosiery in turn might endorse the check to Industries in liquidation of those accounts.Although the hosiery in the grey was "billed" by Industries to Hosiery, and although there was reference in the evidence to the "price" paid by Hosiery for the hosiery and the "cost" to Hosiery of *246 goods sold, Industries retained title to the hosiery when finished, and in fact, Hosiery never purchased or acquired any hosiery from Industries. The hosiery involved belonged to Industries, and was sold to the trade by National's sales organization, except in the case of several large purchasers (such as Sears, Roebuck & Co.) who dealt directly with the Goodmans or Kobin, purporting to represent Hosiery. But even in the latter situation it was Industries' hosiery that was being sold. The only other function performed by Hosiery in relation to Industries' product was to provide styling and "merchandising" services.L. *137 L. Goodman, J. A. Goodman, and Kobin, during the tax years here involved, rendered valuable services in the styling, merchandising, marketing, and selling of the hosiery produced by Industries. In rendering these services, the Goodmans and Kobin were acting as employees of Hosiery, and Hosiery provided these services to Industries. No other employees of Hosiery, if there were any, rendered any services of consequence in relation to Industries' product, nor did the partners of Hosiery render any such services.Generally, a good price is available for hosiery in the grey when the market is strong, but such hosiery promptly feels the effect of a weakening in the market. When the demand for hosiery is weak, the seller of hosiery in the grey is at a disadvantage because of the lack of a brand name to support its selling power. Branded hosiery is better able to retain a market and maintain its prices. The services of the Goodmans and Kobin established brand names and a market for Industries' hosiery, assuring Industries of steady operation and the sale of its product in the finished market at the best prices, thereby reducing the insecurity and uncertainty otherwise attending the manufacture *138 and sale of hosiery in the grey. The Goodmans and Kobin supervised the merchandising aspects of the manufacturing, dyeing and finishing operations so as to create products which most appealed to the public; they styled and designed the hosiery and were responsible for features being incorporated in the course of these operations which attracted the public; and they introduced and supervised sales ideas and programs which provided wide distribution for the finished hosiery. This was particularly important in view of the novelty of the single-unit type hosiery Industries undertook to manufacture, the quality and worth of which had to be proven to the trade and a market for which had to be created.During the tax years in question, the Goodmans and Kobin received salaries paid by Hoisery. The amounts of the salaries paid them by Hosiery were established with their agreement, and they took part in deciding what those amounts would be. The amounts so decided upon were considered fair salaries. For the fiscal year *247 ended June 30, 1941, the partnership return of Hosiery disclosed salaries and wages in the aggregate amount of $ 82,908.44, substantially all of which was paid to the Goodmans *139 and Kobin. The aggregate wages and salaries similarly paid by Hosiery for the succeeding fiscal years ending June 30, were as follows: 1942, $ 20,000; 1943, $ 8,151.29; 1944, $ 8,320.During the years involved there were in the United States independent experts in the hosiery industry who provided merchandising and styling services for fees ranging from $ 10,000 to $ 25,000 a year.Waste is a common by-product of the manufacture and processing of hosiery. Salvage of such waste in the manner earlier described is one of the phases of the hosiery industry. Ordinarily an individual mill does not have enough waste to justify organizing a salvage department. Most mills do not have their own salvage department, although Real Silk did have such a department.Neither Industries nor National had such a department, and up to 1942 they sold their waste to dealers. By that time, however, nylon yarn, which had come into use in the manufacture of hosiery, was very scarce, and salvage operations therefore became increasingly important. In January 1942, Abar Process Company (hereinafter referred to as "Abar") was formed, as a partnership under Indiana law, to engage in the salvage of hosiery waste. *140 The Goodmans and Kobin were instrumental in the formation of Abar, and Barskin, who was then associated with National, also became the operating head of Abar. The partners of record in Abar at the time of its formation were the two Goodmans, Kobin's wife and Barskin. They executed a partnership agreement dated January 2, 1942, which provided:THIS INDENTURE entered into this 2nd day of January, 1942, WITNESSETH AN AGREEMENT by and between J. A. GOODMAN, hereinafter referred to as First Party, L. L. GOODMAN, hereinafter referred to as Second Party, FLORENCE S. KOBIN, hereinafter referred to as Third Party, and A. J. BARSKIN, hereinafter referred to as Fourth Party, all of Indianapolis, Marion County, Indiana.* * * *(3) The initial capital of this partnership shall be $ 1,000.00, of which the First and Second Parties agree to contribute $ 350.00 each, the Third Party $ 200.00, and the Fourth Party $ 100.00. Should further capital be required for carrying on the business, such additional capital shall be advanced by the partners in the above ratio. * * *.(4) All checks, notes, and other evidence of indebtedness pertaining to the partnership may be executed, for and on behalf of said *141 partnership, by J. A. Goodman, L. L. Goodman, A. J. Barskin, and H. V. Kobin, whom Florence S. Kobin has designated as her attorney-in-fact for such purpose, or by any nominee or designee which any of the foregoing may name in writing. The salaries to be paid to any partner or employee of said partnership shall be based upon services rendered to said partnership and contribution to the administration *248 and success of the business, and shall be in such amounts as may from time to time be determined by said partners.(5) All expenses pertaining to the operation of said partnership shall be borne, paid and discharged by the parties hereto in the following ratio: By the First Party 35%; by the Second Party 35%; by the Third Party 20%; and by the Fourth Party 10%; and all gains, profits and increases that shall come or arise from or by means of such partnership business shall accrue to the parties hereto in such percentages, and all losses resulting from depreciation, bad debts or otherwise, shall be borne and paid by the parties hereto, in accordance with such percentages.* * * *(11) The First Party and the Second Party are each creating trusts and contemplate assigning to such trusts their *142 respective interests in and to this partnership. Each of the partners hereby consent to such assignments upon the condition that the provisions of this partnership agreement shall be binding upon the trustees of such trusts, and upon the further provision that any distribution by the Trustees of such trusts shall, for the purpose of this agreement, be considered as a sale of a partnership interest, and shall be subject to the terms and conditions herein set out and pertaining to the sale of any partnership interest.(12) The business policy of this partnership shall be determined by J. A. Goodman, L. L. Goodman, H. V. Kobin, as Attorney-in-Fact for Florence S. Kobin, and A. J. Barskin. In determining such policy J. A. Goodman and L. L. Goodman shall each have 35 votes; H. V. Kobin 20 votes; and A. J. Barskin 10 votes. The majority vote shall prevail. * * *.It is the sense of this agreement that the business policy of this partnership shall be determined by those above designated, subject to the terms and conditions hereinabove set out, and that no heir, executor, administrator, successor, beneficiary, or assign shall have any right to participate in the determination of such policy *143 unless and until those who still retain voting power shall in writing consent thereto.* * * *Subsequently, Ronia Solar was made a partner of record in Abar to the extent of a 9.09 per cent interest by an agreement dated October 9, 1943, and the interests of the other partners were changed proportionately.The interests of the partners of record in Abar, for the periods indicated, were as follows:Period1/2/42 to 10/9/4310/9/43 et seq.Per centPer CentJ. A. Goodman family: Jacqueline Trust #535 31.82L. L. Goodman family: Elliot R. Trust #435 31.82Kobin family:Anne Trust6 2/36.06William Trust6 2/36.06Florence S6 2/36.06Total20 18.18Barskin10 9.09Solar family: Ronia L9.09*249 Abar's machinery consisted essentially of several old coning machines formerly used by National and Fulton Hosiery Mills (hereinafter referred to as "Fulton"), adjusted to unravel and rewind yarn according to a method invented by Barskin. Fulton had been organized by the Goodmans who, by 1937, transferred their Fulton interests to their wives or to certain of the trusts for their children. Abar either did not acquire or did not retain ownership of the machines so used by it. Depreciation does not appear as *144 a claimed deduction on the tax returns of Abar introduced in evidence.After Abar was organized, Industries and National sold their waste to Abar, and purchased reclaimed yarn from Abar. The prices paid to and by Abar in these transactions were the established market prices. Abar also purchased waste from other sources, and, during the scarcity in materials, bought waste wherever it could be found. While Abar sold reclaimed yarn to other buyers, most of its sales of yarn were made to Industries, National, and Fulton. Defective hosiery purchased by Abar was mended by it and was finished by National, and then was sold by Abar to jobbers. National's charge to Abar for finishing this hosiery was at the prevailing market price.During the tax years here in issue, separate books of account were kept for Industries, National, Hosiery, and Abar. Preparation and maintenance of their accounting records and reports were all under the control and supervision of Stevens at Indianapolis. The books of National, Hosiery, and Abar were kept at Indianapolis; the general ledgers of Industries were kept at Indianapolis and its subsidiary records, which were usually kept in Mississippi, at times were *145 sent to Indianapolis. The tax returns of all these companies, including the returns of Industries, were prepared at Indianapolis under Stevens' direction. Stevens also prepared the Goodman's tax returns, and advised the Goodmans and Kobin as to arrangement of their business affairs so as to incur the minimum taxes. The returns for the trusts created by them were also prepared by Stevens.From at least July 1, 1940, to the last half of 1943, the J. A. Goodman, L. L. Goodman, and Kobin families and Barskin were the record owners of all the common stock of Industries and National, substantially all the preferred stock of Industries and National, and the entire partnership interests in Hosiery and Abar. During this period, the proportionate interests of the J. A. Goodman, the L. L. Goodman, the Kobin families, and Barskin were, with insignificant variation, identical in the common stock of Industries, the common stock of National, and in the Hosiery and Abar partnerships. These proportionate interests were as follows: J. A. Goodman family -- 35 per cent; L. L. Goodman family -- 35 per cent; Kobin family -- 20 per cent; Barskin -- 10 per cent.*250 These interests in the common stock of Industries*146 and National continued unchanged during 1943 and throughout the remainder of the tax years here in issue. By a written agreement dated July 17, 1943, Solar's wife, Ronia, was admitted to a 9.09 per cent interest of record in Hosiery, and by a written agreement dated October 9, 1943, she was also admitted to a 9.09 per cent record interest in Abar. The other record interests in both Hosiery and Abar were then adjusted accordingly to the following: J. A. Goodman family -- 31.82 per cent; L. L. Goodman family -- 31.82 per cent; Kobin family -- 18.18 per cent; Barskin -- 9.09 per cent.The interests of the J. A. Goodman, L. L. Goodman, and Kobin families were held, as record owners, in the names of their wives or the trusts for their children. But those family interests were in fact owned or controlled directly or indirectly by J. A. Goodman, L. L. Goodman, and Kobin respectively. Similarly, when Ronia Solar was made a record partner in Hosiery and Abar, the interests ascribed to her were in fact owned or controlled directly or indirectly by her husband, Israel E. Solar. Thus, although Kobin's wife and the trusts for his two children were the record holders of an aggregate 20 per *147 cent interest in National's common stock, the true situation was reflected in National's income tax returns for 1940 and 1942, which state that Kobin owned 20 per cent of the common stock of National.The ultimate control over the management and operation of Industries, National, Hosiery and Abar, was exercised by J. A. Goodman, L. L. Goodman, Kobin and Barskin.None of the Goodman and Kobin children, whose trusts were record owners of interests in these businesses, ever had any experience or training in the hosiery industry, or took any part in the business affairs of Industries, National, Hosiery, or Abar. There is no evidence that the Goodman, Kobin, or Solar wives had any such experience or training or participated in the affairs of these businesses. The Goodmans and Kobin originally were the trustees under some of the trusts they set up for their children; by the end of 1942, Stevens was the sole trustee under all these trusts for the Goodman and Kobin children. Control of the accounting and tax affairs of all these businesses as well as of the trusts for the children was concentrated in Stevens.Hosiery's "Gross receipts from business or profession" and its "net" income as reported *148 on its returns, and its "net" income as adjusted by respondent, were as follows:Gross receiptsNet incomeYear ended June 30from businessNet Incomeas adjustedor profession1941$ 1,933,429.92$ 101,928.57$ 103,486.3019421,628,582.382,533.174,033.2419431,203,672.3548,415.9649,916,3819441,585,425.3855,473.3855,473.38*251 These reports of gross receipts consisted largely, if not entirely, of the receipts from the sales of Industries' hosiery, and belonged to Industries rather than to Hosiery. It was thus necessary, in computing net income on Hosiery's returns to subtract large amounts each year ($ 1,631,293.46 for 1941, $ 1,478.81 for 1942, $ 1,071, 262.49 for 1943, and $ 1,492,153.36 for 1944) as the cost of "merchandise bought for sale," notwithstanding the fact that Hosiery did not buy any goods for sale, and therefore had no such costs.Abar reported the following net income in its returns:Tax periodNet income1/2/42 -- 9/30/42$ 10,210.3310/1/42 -- 9/30/4320,140.2910/1/43 -- 9/30/4414,423.75Respondent attributed to Hosiery an annual allowance of 10 per cent on a capital of $ 4,286.25, amounting to $ 428.63, plus $ 1,000 as salary for Barskin. Respondent attributed to Abar an annual allowance *149 of $ 1,000 on a capital of $ 1,000, plus a salary of $ 1,000 for Barskin. The remainder of Hosiery's adjusted income and Abar's reported income were allocated to Industries and National in the following amounts:ALLOCATED TO INDUSTRIES 1FromFromYearHosieryAbar1941$ 62,068.57194229,164.11$ 116.14194330,189.53338.85194445,893.73547.70ALLOCATED TO NATIONAL1940$ 3,819.9419416,329.4319424,581.77$ 12,335.4319435,394.3316,071.71The notices of deficiency sent to petitioners each stated:Pursuant to the provisions of section 45 of the Internal Revenue Code portions of the gross income attributed to "Grenada Hosiery Mills", a purported partnership, have been allocated to you and included in your net income for the taxable years and in the amounts set forth below, to-wit:* * * *In the alternative it is held that said purported partnership is without substance and that said portions of the income which were attributed to said purported partnership are taxable to you under the provisions of section 22 (a) of the Internal Revenue Code.Each notice of deficiency also made the same statement respecting the allocations of Abar's income to petitioners.*252 The notices of deficiency *150 did not show the method of allocation of Hosiery's and Abar's income. There were introduced in evidence, however, a revenue agent's reports on Industries and on National. The amounts allocated to them by respondent were identical with the allocations made of Hosiery's and Abar's income in these reports, and these reports show the computations by which these allocations were reached.National, Industries, Hosiery, and Abar were separately existing and functioning organizations, trades, or businesses, but were owned or controlled directly or indirectly by the same interests. Allocation of Abar's income to petitioners was arbitrary and unreasonable, and such allocation was not necessary to prevent evasion of taxes or clearly to reflect petitioners' income. Allocation of Hosiery's income to National was likewise arbitrary and unreasonable. But respondent's allocation of Hosiery's income to Industries was reasonable and was necessary to prevent evasion of taxes or clearly to reflect Industries' income. The value of the services rendered by Hosiery to Industries was no greater than the salaries and wages paid by Hosiery during each of the years involved.OPINION.1. At the outset, we *151 dispose of respondent's contention that the asserted deficiencies are supported by section 22 (a) of the Internal Revenue Code. Throughout the argument based upon section 22 (a) there is implicit the suggestion that the entities of Hosiery and Abar should be disregarded and that their income be attributed to Industries and National. We cannot accept that position.Hosiery and Abar were functioning entities. Each in fact rendered valuable services. True, all four organizations were actually controlled by the same persons, and neither Hosiery nor Abar had any employees who were not also officers or employees of Industries or National, so that all of the functions discharged by Hosiery and Abar could have been performed just as readily by Industries and National. But the fact is that Hosiery and Abar were valid partnerships, and they actually did play real parts in the hosiery business. Hosiery did furnish styling and merchandising services to Industries: Abar did engage in the business of salvaging defective hosiery. There is no basis, upon this record, for disregarding the organizational entities of Hosiery and Abar. Cf. Chelsea Products, Inc., 16 T. C. 840; Estate of Julius I. Byrne, 16 T. C. 1234; *152 Seminole Flavor Co., 4 T. C. 1215, 1234-1235.The income actually earned by Hosiery and Abar may not be attributed to Industries or National under section 22 (a). This does not mean, however, that either Industries or National was at liberty, taxwise, *253 to deflect to Hosiery or Abar any portion of the income really earned by Industries or National. In such circumstances the general provisions of section 22 (a) are undoubtedly sufficient to charge the income to the one that actually earned it. Cf., e. g., Lucas v. Earl, 281 U.S. 111">281 U.S. 111; Griffiths v. Commissioner, 308 U.S. 355">308 U.S. 355; Helvering v. Eubank, 311 U.S. 122">311 U.S. 122; Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591; Lyman A. Stanton, 14 T. C. 217, affd. (C. A. 7, 1941) 189 F. 2d 297. But in the case of organizations under common control, the detailed provisions of section 45 of the Code 3*153 *154 explicitly authorize the Commissioner to unscramble any such situation, so that income may be charged to the organization that earned it. Thus, to the extent that section 45 may be applicable, section 22 (a) adds nothing to the strength of respondent's position here. We pass, therefore, to a consideration of section 45. 2. That all four organizations were "owned or controlled directly or indirectly by the same interests" within the meaning of section 45 is abundantly clear on this record. All four organizations were dominated primarily by the two Goodmans, and to a lesser degree by Kobin and Barskin. We are satisfied that Solar and Stevens were subservient to the wishes of the Goodmans and Kobin. 4*155 It is immaterial that the record ownership of the various stock and partnership interests may not have been in the identical persons or trusts at the same times. Throughout the years in question the J. A. *254 Goodman family owned 35 per cent, the L. L. Goodman family 35 per cent, the Kobin family 20 per cent, and Barskin 10 per cent of the common stock of Industries and National. The same percentage interests were applicable to both partnerships, Hosiery and Abar, until 1943, when they were changed slightly (but in the same proportion) so as to admit Solar's wife as a record partner with a 9.09 per cent interest -- an event which in no way affected the control or management of either enterprise. Although it is true that the record ownership of the stock or partnership interests may not have been in the same persons or the same *156 family trusts, the fact is that the 35-35-20-10 ratio (representing the proportionate interests of the Goodman and Kobin families and Barskin in relation to each other) was at all times maintained and that the actual control at all times material, represented by those interests, was really exercised by J. A. Goodman, L. L. Goodman, Kobin, and Barskin. Section 45 speaks in sweeping terms. It refers to "two or more organizations, trades, or businesses (whether or not incorporated, * * * and whether or not affiilated) owned or controlled directly or indirectly by the same interests." The type of control contemplated by these provisions is reflected in the regulations which deal with the concept in all-embracing language as follows (Regulations 111, sec. 22.45-1 (3)):The term "controlled" includes any kind of control, direct or indirect, whether legally enforceable, and however exercisable or exercised. It is the reality of of the control which is decisive, not its form or the mode of its exercise. * * *It is wholly unimportant that the Goodman trusts which owned stock in National and Industries were not the same Goodman trusts which were the record partners in Hosiery and Abar. The *157 significant thing is that each of the two Goodmans in fact exercised control that was commensurate with the holdings of his family, and that Kobin in fact exercised control commensurate with the holdings of his family. We have no doubt that all four organizations were "owned or controlled directly or indirectly by the same interests." Cf. Forcum-James Co., 7 T. C. 1195, 1215-1216. 3. The existence of the requisite common ownership or control is not sufficient, however, to justify the application of section 45. The Commissioner may make a distribution, apportionment or allocation under section 45 only "if he determines [that it] is necessary in order to prevent evasion of taxes or clearly to reflect the income of such [owned or controlled] organizations, trades, or businesses." The purpose of section 45 is not to punish the mere existence of common control or ownership, but to assist in preventing distortion of income and evasion of taxes through the exercise of that control or ownership. It is where there is a shifting or deflection of income from *255 one controlled unit to another that the Commissioner is authorized under section 45 to act to right the balance and to keep tax collections *158 unimpaired. Asiatic Petroleum Co. v. Commissioner (C. A. 2), 79 F. 2d 234, 236, certiorari denied 296 U.S. 645">296 U.S. 645; Treas. Regs. 111, sec. 29.45-1; cf. Gordon Can Co., 29 B. T. A. 272.It has been said many times that the Commissioner has considerable discretion in applying section 45, and that the determinations required of him under the statute must be sustained unless that discretion has been abused. Our review of those determinations is not de novo, and we may reverse them only where the taxpayer proves that they are unreasonable, arbitrary, or capricious. See, e. g., G. U. R. Co. v. Commissioner (C. A. 7), 117 F. 2d 187, 189; National Securities Corp., 46 B. T. A. 562, 564, affd. (C. A. 3) 137 F. 2d 600, 602, certiorari denied 320 U.S. 794">320 U.S. 794; Seminole Flavor Co., 4 T. C. at 1228.Applying this standard, we conclude that the allocations of Abar's income were arbitrary as to both Industries and National, that the allocation of Hosiery's income to Industries was reasonable and justified by section 45, and that the allocation of Hosiery's income to National was not authorized by section 45.a. Abar. Abar purchased waste and defective hosiery from Industries and National, as well as from *159 other sources, paying established market prices therefor. It either repaired the hosiery or reclaimed the yarn. In the case of the repaired hosiery, Abar would have it dyed and finished by National, paying standard charges for such services, and would then sell the hosiery to jobbers. The reclaimed yarn it would sell primarily to Industries, National, and Fulton (an organization controlled by the Goodmans), although it made some sales to other purchasers. It received established market prices for its reclaimed yarn. We think that the Commissioner's attempt to make allocations of Abar's income was arbitrary and unauthorized by section 45.Nor is a contrary conclusion warranted because it was not shown that independent capital was an important factor in Abar's operations, or that it had any employees independently of those of petitioners or some other similarly controlled organization; or because its machinery was owned by petitioners or another similarly controlled organization, and its operations were carried on at the premises of one of those organizations; or because its mended hosiery was finished by National. Cf. Miles-Conley Co., 10 T.C. 754">10 T. C. 754, affirmed on another issue (C. *160 A. 4), 173 F.2d 958">173 F. 2d 958; Buffalo Meter Co., 10 T. C. 83; Seminole Flavor Co., 4 T. C. 1215; Briggs-Killian Co., 40 B. T. A. 895. The area in which Abar operated was a separate and distinct phase of the industry, and it was, moreover, a phase never before entered either by National or Industries. And despite all the intertwining relationships, *256 the fact remains that Abar paid and received fair market prices, as though its transactions had been carried on with strangers. No more could be expected of it. While the interests controlling Industries and National could have set up salvage departments within those corporations, the uncontradicted testimony was that a single mill usually did not have enough waste to justify such a step, and, in any case, there was no obligation to adopt the course which carried the greater tax burden. Cf. Central Cuba Sugar Co., 16 T. C. 882, at p. 892.b. Hosiery. It is important that Hosiery's position in the scheme of things be clearly understood. Industries had a so-called grey mill at Grenada, Mississippi. It had no facilities for dyeing or finishing its product. It shipped its hosiery in the grey directly to National at Indianapolis, where the hosiery *161 was dyed and finished, at standard prices for such services, which included a fair profit above costs to National. Title to the hosiery remained in Industries. This arrangement was worked out directly between Industries and National as early as April 1938.Hosiery's predecessor, Knitting, was first organized in March 1938. At some undisclosed time, Knitting entered into an oral agreement with Industries to furnish styling and merchandising services to Industries and to arrange for the sale of Industries' products. Neither Knitting nor Hosiery had any machinery or plant; neither had a sales organization; there is no evidence that either of them had any tangible physical assets of any consequence; the address of both was the same as National's address; neither Knitting nor Hosiery had any employees who were not also officers or employees of Industries or National; the initial capital of Hosiery was fixed at the comparatively nominal amount of $ 4,286.25, and even that amount was not contributed in cash or assets other than notes. Capital was not a factor in Hosiery's operations which consisted almost entirely, as far as we have been able to determine from this record, of part-time *162 or occasional services rendered by the two Goodmans and Kobin.The foregoing summary is not intended to suggest that Hosiery should be disregarded as a sham; indeed, we have already concluded that Hosiery's separate entity will be recognized. But it is highly relevant to examine the functions performed by Hosiery in correct perspective, in order to determine whether income that was really earned by Industries has been artifically diverted to Hosiery; and a helpful guide in seeking the answer to that inquiry is whether the charges made by Hosiery for its services were disproportionate to the value of such services.What was the nature of the services performed by Hosiery? There is no evidence that any of the record partners in Hosiery performed services; we are informed only of services alleged to have been performed *257 by the two Goodmans and Kobin, as employees of Hosiery. Each of these three persons, however, was also actively engaged in the hosiery business as an officer or employee of other organizations, such as National. Thus, National's returns for 1941 state that Kobin devoted full time to its business, and its returns for 1942 disclose that he devoted three-fourths of his time *163 to its business. It is plain that the services of the two Goodmans and Kobin, as employees of Hosiery, were only on a part-time or occasional basis.These were, nevertheless, valuable services, and included furnishing ideas for design and styling of Industries' product, the establishment of various brand names for that product, as well as the development of other merchandising ideas and plans. In addition, they procured directly several large purchasers for Industries' product, such as Sears, Roebuck & Company. However, apart from the few large purchasers, Hosiery did not, through its employes, do any selling. The great bulk of the sales was made by National's sales organization, and for those services National was paid its costs plus a fair profit. Petitioners contend that Hosiery "engaged" National's services. Certainly, this is not true as to National's services in dyeing and finishing Industries' hosiery, for, by contract of April 12, 1938, National agreed directly with Industries to perform such services for Industries. And although Hosiery may have gone through the formality of "engaging" National's sales organization, we think it contributed nothing of value to Industries *164 in that respect, for Industries could have arranged that matter directly with National, just as it had made direct arrangements with National to dye and finish its hosiery.Petitioners contend that this is an inappropriate case for the application of section 45, since Industries received a fair price for its hosiery in the grey. But the fatal defect of that contention is that Industries did not sell its hosiery in the grey. Had Hosiery purchased Industries' product in the grey, thereby assuming all responsibility as well as the risk of the market from that point forward, there would be substance to that position. But that was not the case. Industries manufactured hosiery in the grey; it shipped the hosiery to National for dyeing and finishing, for which it paid standard charges; and it at all times retained title to its product. Hosiery did render styling and merchandising services, as well as sales services in the case of a few large purchasers. But Hosiery did not buy Industries' product for resale. Nor did it guarantee that Industries would receive any fixed or minimum return on its product. It was Industries' finished product that was being sold to the trade, not the product *165 of Hosiery. And it is wholly fallacious to contend that Industries was entitled to receive only a fair price for its hosiery in the grey. It was entitled to receive the full price paid for its finished *258 product minus such fair charges as may have been incurred for dyeing, finishing, and sales services furnished by National, and minus also such fair charges for styling, merchandising, and other services actually rendered by Hosiery. To the extent that the arrangement between Hosiery and Industries resulted in a larger concentration of profits in the hands of Hosiery, to the detriment of Industries, this case presents a typical situation for the application of section 45.What, then, was the fair value of the services rendered by Hosiery? As we have indicated above, the partnership, as such, furnished nothing of value to Industries, apart from the services of the two Goodmans and Kobin -- services which Industries could have engaged directly, if Hosiery (or its predecessor, Knitting) had not been created. However, Hosiery was entitled to receive the fair value of the services rendered by the two Goodmans and Kobin as its employees. The evidence as to that value was not entirely satisfactory, *166 and the best measure we can find, in the evidence before us, of the value of those services is the salaries that were in fact paid for them. Cf. Welworth Realty Co., 40 B. T. A. 97, 100-101. There was testimony that those salaries were fixed by agreement with the Goodmans and Kobin; that they participated in determining the amounts of the salaries; that in fixing those salaries they considered the reasonable value of their services; and that the salaries as fixed were considered fair compensation.It may be that the amounts of these salaries were in some way affected by the fact that the employer, Hosiery, was controlled by the employees, the Goodmans and Kobin, and that its profits would directly or indirectly benefit them or persons closely related to them. The fact that the salaries declined in later years is not enough to establish that any special concession was made; another plausible explanation for the decrease appears in the evidence. L. L. Goodman testified that the major merchandising job came in the earlier years, with the task of establishing a market for Industries' product, and that "once the brand got established and the public repeated on it, it from then on went *167 on its own momentum." In the later years, therefore, the Goodmans' and Kobin's services were reduced, and a reduction in their compensation was not at all surprising. This, in substance, seems to be affirmed by petitioners in their brief, where they say that "These compensations were not in the category of 'salaries' for continuing services, which ordinarily are more or less uniform through the years."In any event, the burden was on Industries to prove the value of the services Hosiery rendered, and it has provided no more convincing evidence of that value than the salaries in question. Petitioners insist that once they have shown application of section 45 and the allocations thereunder to be arbitrary, the burden shifted to respondent *259 to prove a proper allocation. While there may be doubt as to the validity of this contention, we need not consider it, because we do not believe that Industries can establish that the allocation of Hosiery's income made to it by respondent was arbitrary without showing the value of the services it received from Hosiery.L. L. Goodman's testimony suggests in a general and undefined fashion that Hosiery's services to Industries extended beyond the merchandising *168 and other services already noted, performed by the Goodmans and Kobin, and that therefore it was not unreasonable for Industries to pay Hosiery more than just the value of those services. We find nothing in that testimony or in other evidence to show exactly what these additional functions were, and we are not convinced that in fact there were any. The claim itself seems to amount to little more than that the experience, interest, and resources of the Goodmans and Kobin were marshalled behind Industries' product. To the extent that this was reflected in the services they rendered, compensation therefor must be taken to be included in the salaries they received. Over and beyond that there was nothing Industries did not already derive from its own connections and relations with the Goodmans and Kobin. Cf. R. O. H. Hill, Inc., 9 T. C. 153, 157-158.Petitioners challenge the deficiencies on the further ground that the respondent made allocations of Hosiery's "net" income, and not of its "gross" income. Cf. Chelsea Products, Inc., 16 T. C. 840. There is confusion in the record as to the label to be applied to the amounts allocated by respondent. The respondent's deficiency notices, *169 which form the basis for these proceedings, refer to the amounts as "gross" income, whereas reports of a revenue agent, introduced in evidence to show the detailed computations, refer to the amounts as "net" income. We think that respondent's explicit determination in his statutory notices of deficiency that he was allocating "gross" income cannot be reversed, in view of the nature of the transactions carried on between Hosiery and Industries. Hosiery itself neither bought nor sold the product manufactured by Industries, but only provided certain services respecting that product. Therefore, contrary to the manner in which it executed its tax returns, the amounts at which Industries' finished product was sold were not Hosiery's "gross receipts" but those of Industries; Hosiery had no "cost of goods sold," and no "inventory"; and the expense of finishing, dyeing, and selling Industries' product was in fact the expense of Industries and not of Hosiery. Hosiery's returns, which were based upon the theory that it sold its own goods, were therefore misleading. In fact, other than the salaries paid by Hosiery and some small tax liability, 5 it is not clear that *260 Hosiery had any expense *170 of operation. We approve an allocation of Hosiery's gross income to the extent that such gross income in fact exceeded the fair value of the services rendered by Hosiery to Industries, and we think that, in essence, respondent did substantially that here (after making an allowance of a 10 per cent return on the partners' capital). The deficiencies proposed against Industries are no greater than they would have been, had Hosiery filed returns which accurately set forth its gross income and had the Commissioner made explicit allocations of portions of those amounts -- allocations which we approve. In the circumstances, we find no error in the proposed deficiencies against Industries. However, the Commissioner did more than make an allocation of a portion of Hosiery's income to Industries; he also allocated a portion thereof to National. We think that *171 action was unauthorized by section 45. National received a fair price, including a reasonable profit, for the dyeing, finishing, and sales services which it rendered with respect to Industries' product. Thus, National's earnings in relation to such services were accurately reflected in its returns, and there is no basis on which to attribute to National any further profits growing out of the sale of Industries' product. We therefore disapprove the deficiencies asserted against National to the extent that they reflect allocations from Hosiery.Decisions will be entered under Rule 50. Footnotes1. Fiscal years ending Mar. 31.↩1. "Grey" is sometimes used interchangeably with "gray" and "greige." In the "grey" stage, the hosiery has been fully knitted, looped and seamed from the raw yarn, but remains to be dyed and finished.↩2. This committee appears to have been in existence and still functioning by 1944. Industries' returns for its fiscal year ending in 1944 show administrative expense of $ 4,200.04 attributable to the executive committee.↩1. 2 qualifying shares.↩1. Fiscal years ending Mar. 31.↩3. SEC. 45. ALLOCATION OF INCOME AND DEDUCTIONS.In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.Section 45 was amended by Section 128 of the Revenue Act of 1943 (c. 63, 58 Stat. 21) as follows: Section 128 (b). Technical Amendment. -- Section 45 (relating to allocation of income and deductions) is amended by striking out "gross income or deductions" and inserting in lieu thereof "gross income, deductions, credits, or allowances."Section 128 (c). Taxable Years to Which Applicable. -- The amendments made by this section shall be effective with respect to taxable years beginning after December 31, 1943. The determination of the law applicable to prior taxable years shall be made as if this section had not been enacted and without inferences drawn from the fact that the amendment made by this section is not expressly made applicable to prior taxable years.4. In an attempt to show Solar's independence, petitioners presented testimony that in one instance Solar vigorously complained about the repairing of certain of Industries' defective hosiery by National at Indianapolis rather than returning the hosiery to Grenada where it could have been repaired at lower cost by non-union labor. That incident surely does not establish or even indicate that Solar was not at all times subject to the complete domination of the Goodmans and Kobin. For, if Solar were correct in his contention that the repairing of the defective hosiery in Indianapolis resulted in higher costs, it is only too clear that the Goodmans and Kobin, as well as Barskin, would have acquiesced in his position. He was sponsoring a position that was in their interest, and it would strain our credulity to suggest that Solar would have persisted in any course of action contrary to the considered judgment of the Goodmans and Kobin and antagonistic to the interests which they were protecting.5. Hosiery's tax returns claimed deductions for taxes for its fiscal years ending in 1941, 1942, 1943 and 1944 in the following respective amounts: $ 413.21, $ 550.18, $ 618.05, $ 724.80. Except for $ 3.21 for state personal property tax in the 1941 return, these amounts consisted of social security taxes and state gross income taxes.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619543/ | JAMES F. DORROH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDorroh v. CommissionerDocket No. 26482-91United States Tax CourtT.C. Memo 1994-373; 1994 Tax Ct. Memo LEXIS 383; 68 T.C.M. (CCH) 337; August 8, 1994, Filed *383 Decision will be entered under Rule 155. For petitioner: Herman D. Baker. For respondent: John W. Sheffield III. SCOTTSCOTTMEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in petitioner's Federal income tax and additions to tax for the calendar years 1983 through 1988 in the amounts as follows: Additions to TaxSec.Sec.Sec.YearDeficiency6651(a)(1)6653(a)(1)6653(a)(2)1983$ 4,126$ 949$ 2061198411,4382,8605721198513,6703,3616841198613,2253,275----198710,5272,579----198817,2794,287864--Additions to TaxSec.Sec.Sec.Year6653(a)(1)(A) 6653(a)(1)(B) 6654(a) 1983----$ 2281984----7181985----7671986$ 6611633198752625511988----1,090Some of the issues raised by the pleadings have been disposed of by agreement of the parties, leaving for decision: (1) Whether certain payments petitioner received under Eastern Airlines retirement plans during the years 1983 through 1988 may*384 be excluded from petitioner's gross income pursuant to section 105(c) 1 as amounts received as disability payments in connection with his employment as an airline pilot; (2) whether petitioner is liable under section 6651(a)(1) for an addition to tax for failure to timely file a return for each of the years 1983 through 1988; (3) whether petitioner is liable for the additions to tax for negligence under section 6653(a)(1) and (2) for the years 1983, 1984, and 1985, under section 6653(a)(1)(A) and (B) for the years 1986 and 1987, and under section 6653(a)(1) for 1988; and (4) whether petitioner is liable for the addition to tax under section 6654(a) for each of the years here in issue. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. At the time he filed his petition in this case, petitioner*385 resided in Clayton, Georgia. Petitioner was employed as a pilot with Eastern Airlines, Inc. (Eastern), until sometime around December 1981. During petitioner's employment with Eastern, he participated in the Eastern Airlines Fixed Benefit Retirement Income Plan for Pilots (Plan A) and the Eastern Airlines Variable Benefit Retirement Plan For Pilots (Plan B). Plan A and Plan B are very similar plans. Plan A and Plan B are collectively referred to herein as the plans. Plan A provides for the payment of benefits to participants of Plan A upon the retirement of the participant or upon the participant's becoming permanently disabled. To fund Plan A, each month Eastern contributed an amount equal to the sum of the following amounts: (1) 2-1/4 percent of each participant's monthly compensation not in excess of $ 100; (2) 3-3/4 percent of the portion of the participant's monthly compensation in excess of $ 100 but not in excess of $ 250; and (3) 5-1/4 percent of the portion of the participant's monthly compensation in excess of $ 250. According to section 3.6(a) of Plan A, a participant is eligible to receive a benefit upon becoming permanently disabled before having attained the normal*386 retirement age. Permanent disability is defined in Plan A as: the complete inability of such Participant as a result of physical or mental reasons to continue in employment with Eastern as a Pilot, provided that such disability did not result from any of the causes enumerated * * * below: (i) Intentionally self-inflicted injuries, attempted suicide or any attempt thereat. (ii) Habitual use of narcotics or alcoholic beverages * * *. (iii) An Act of War where the Pilot is on military leave of absence.The amount of a disability benefit for a participant who is disabled after August 1, 1981, shall equal the greater of either the participant's accrued benefit reduced by 3 percent for each year by which the date of the disability precedes the participant's 60th birthday or the actuarial equivalent of such accrued benefit. The calculation of the amount of a disability benefit of a participant that is disabled prior to August 1, 1981, is similar. Also, Plan A provides for minimum disability pension amounts. For a participant who has less than 2 years' active service, the minimum disability pension amount is 30 percent of the disability retirement earnings base. For a*387 participant who has 2 or more years of active service, the minimum disability pension amount is 30 percent of the disability retirement earnings base, plus 2-1/2 percent times the disability retirement earnings base times the number of years of active service over 2 years. Disability retirement earnings base is defined as the amount of the 12 consecutive months of highest compensation of a participant during the last 36 months of active service preceding the disability retirement date. Plan B also provides for the payment of benefits to participants of Plan B upon the retirement of the participant or upon the participant's becoming permanently disabled. To fund Plan B, Eastern contributed an amount equal to 11 percent of each participant's compensation. Each participant of Plan B could also elect to contribute up to 10 percent of his or her compensation. Under Plan B, each participant had an account in his or her name, to which the contributions were credited on behalf of that participant. According to section 3.5(a) of Plan B, a participant is eligible for payment of a benefit upon becoming permanently disabled before having attained the normal retirement age. Permanent disability*388 is defined in Plan B as: the complete inability of such Participant, as a result of physical or mental reasons, to continue in employment with Eastern as a Pilot, provided that such disability did not result from any of the causes enumerated * * * below: (i) Intentionally self-inflicted injuries, suicide or any attempt thereat. (ii) Habitual use of narcotics or alcoholic beverages. (iii) An act of war where a pilot is on military leave of absence.All benefits are calculated upon the basis of payment in the form of a monthly modified single life annuity commencing on the effective retirement date. Sometime around December 1981, petitioner's employment at Eastern was terminated because of his arthritis. Petitioner was on sick leave for all of the time in 1981 that he was employed by Eastern. After petitioner was terminated at Eastern, he lost his first-class pilot's license. Three years later, petitioner received his second-class pilot's license, and that license remained current until sometime in 1991. At the time of the trial of this case, petitioner was not current on his flying time and also needed to pass a physical in order to be current for the second-class*389 pilot's license. Petitioner still has a driver's license and continues to drive. Petitioner drove from Clayton, Georgia, to Atlanta, Georgia, for the trial of this case, a distance of about 120 miles. Petitioner lives alone and does his own grocery shopping. Since being terminated by Eastern, the only work petitioner has done is repairs to houses petitioner was renovating. In the past, petitioner has enjoyed spending as much time as possible during the summers in North Carolina. Petitioner's aunt owned a home in North Carolina which was in bad shape. Sometime in the early 1980s, petitioner painted the outside of the house. Eventually, petitioner moved to North Carolina. Petitioner used a U-Haul van, which he drove, to move his personal items to North Carolina. Petitioner is involved with various activities in his community. Petitioner planned to set up the electrical wiring for a gem and mineral show some time after the trial of this case. Petitioner has never filed for Social Security disability payments. During 1983, petitioner did not receive any payments under Plan A. During 1984 through 1988, petitioner received $ 25,293 each year under Plan A. During 1983 through*390 1988, petitioner received the following payments under Plan B: YearPayments1983$ 7,10819847,89019858,09719869,754198710,749198811,002Petitioner did not file a Federal income tax return for any of the calendar years 1983 through 1988. Petitioner's accountant lived in Miami, Florida, during the years here in issue. During part of this time petitioner lived in West Palm Beach, Florida. During 1983 through 1988, petitioner received the following amounts of dividends: YearDividends 1983$ 5,55019845,51219854,76919864,24219872,84219883,195During 1983 through 1988, petitioner received the following amounts of interest income: YearInterest Income 1983$ 2,28519841,48519853,587198693519872,91319882,857Petitioner is entitled to the following exemptions, deductions, losses, or credits for the years indicated: YearDescriptionAmount1983Dependant exemptions$ 5,4921983Legal fees deduction2,2501983Net rental loss deduction4691983Net short term capital loss3,0001983Withholding tax credit3301984Medical care deduction2,6001984Other itemized deductions2,1101984Net rental loss deduction3511984Net short term capital loss2,4101985Itemized deductions8,0151985Net rental loss deduction2,2031985Foreign tax credit1241985Withholding tax credit2251986Itemized deductions16,2791986Foreign tax credit1261987Itemized deductions5,0181987Foreign tax credit971987Withholding tax credit1061988Itemized deductions8,0261988Foreign tax credit571988Withholding tax credit131*391 Petitioner is entitled to two personal exemptions for each of the years 1983 and 1984, and is entitled to one personal exemption for each of the years 1985, 1986, 1987, and 1988. Petitioner is eligible for head of household filing status for each of the years 1983 and 1984, and single filing status for each of the years 1985, 1986, 1987, and 1988. Respondent in the notice of deficiency included in petitioner's income the amounts petitioner received from Plan A and Plan B for the years 1984 through 1988 and from Plan B in 1983. Petitioner contends such amounts are excluded from his income under section 105(c). Respondent disagrees, contending that the payments do not meet the requirement in section 105(c)(1) that petitioner have permanent loss of use of a member or function of the body, or of section 105(c)(2) as to method of computation of the amount of the payments. OPINION Gross income includes all income from whatever source derived, unless specifically excluded from income under the exclusion provisions of the Internal Revenue Code. Secs. 61, 101-136. Section 61 specifically lists "pensions" as a source of gross income. Sec. 61(a)(11); sec. 1.61-11, Income Tax Regs.*392 Pursuant to section 105, 2 amounts received by an employee under accident or health insurance funded by the employer are generally to be included in a taxpayer's income. However, section 105(c) permits the exclusion from gross income of payments from accident or health insurance if the following two requirements are met: (1) The payments are for the permanent loss or loss of use of a member or function of the body or permanent disfigurement, of the taxpayer, his spouse, or a dependent; and (2) the payments are computed with reference to the nature of the injury without regard to the period the employee is absent from work. Amounts received through an accident or health plan are generally equated with amounts received through accident or health insurance. Sec. 105(e)(1). *393 In order for the first requirement of section 105(c) to be satisfied, the payments received must constitute payment for one of the following: (1) The permanent loss or loss of use of a member of the body; (2) the permanent loss or loss of use of a function of the body; or (3) permanent disfigurement. Hines v. Commissioner, 72 T.C. 715">72 T.C. 715, 718 (1979). The first category refers only to loss of extremities such as arms, legs, or fingers, while the third category refers only to external bodily appearance. Id. at 718-719. Therefore, the first and third categories are not applicable to the present case. The intent of Congress when it enacted section 105(c) was "to provide a tax benefit to one who receives a severe physical injury which permanently and significantly lessens the quality of life which he had enjoyed prior to the injury." Id. The regulations provide insight as to the injuries included in the first two categories. Section 1.105-3, Income Tax Regs., provides: For purposes of section 105(c), loss or loss of use of a member or function of the body includes the loss or loss of use of an appendage of the body, *394 the loss of an eye, the loss of substantially all of the vision of an eye, and the loss of substantially all of the hearing in one or both ears. * * *We have held, for example, that the loss of muscle tissue of the heart caused by a heart attack does not constitute a loss of a member or of a bodily function. Hines v. Commissioner, supra. In that case, we noted that not every injury that permanently robs an individual of his principal means of livelihood qualifies for the section 105(c) exclusion. Id. at 719-720; see also Watts v. United States, 703 F.2d 346">703 F.2d 346, 351-352 (9th Cir. 1983). Petitioner's arthritis problems do not constitute the loss of a member or a bodily function within the terms of the section 105(c) exclusion. As the evidence establishes, petitioner is able to perform many other activities and is still eligible to qualify to fly a private airplane. Therefore, petitioner is capable of selecting work which requires less strenuous demands than that which was required of him as a commercial airline pilot. The payments at issue also fail to satisfy the second requirement*395 of section 105(c). The following must be true in order to satisfy the second requirement: (1) The payments must be computed with regard to the nature of the injury, and (2) the payments must not be computed with regard to the period the employee is absent from work. Hines v. Commissioner, supra at 720. Where the benefits do not vary according to the type of injury and participants with different injuries receive the same benefit, then the second requirement is not met because the payments are not computed with reference to the nature of the injury. Beisler v. Commissioner, 814 F.2d 1304">814 F.2d 1304, 1308 (9th Cir. 1987), affg. T.C. Memo. 1985-25; Hines v. Commissioner, supra at 720; see also S. Rept. 1622, 83d Cong., 2d Sess. 183-184 (1954). In determining the amount of benefit paid a disabled participant, the plans under which petitioner received payments make no distinction between types of injuries. The payments received by petitioner under the plans were not predicated upon the type and severity of the injury suffered. Petitioner received benefits under the*396 plans because it was determined he was disabled within the definitions used in the plans. The amounts of the benefits petitioner received were determined by the length of time petitioner had been an employee of Eastern. The determining factor of the amount of the benefit paid to petitioner was the amount of petitioner's accrued benefit or contributions made on petitioner's behalf to the particular plan, and not the nature or extent of the injury. Therefore, the requirement in section 105(c)(2) has not been satisfied. Petitioner relies on two cases in support of his position that the benefits paid should be excluded from his income. The first case on which petitioner relies, Wood v. United States, 590 F.2d 321">590 F.2d 321 (9th Cir. 1979), dealt with a taxpayer's receipt of a lump-sum payment from a profit-sharing plan upon his termination of employment due to disability. Originally, the Government argued that the lump-sum payment came from a profit-sharing plan and therefore was not from an accident or health plan. The District Court rejected this argument. The Court of Appeals for the Ninth Circuit in Wood stated: On appeal the government concedes*397 that the nonvested 15 percent of the payment was excludable from income as an amount received through an accident or health plan. Thus, the status of the plan as an accident or health plan under § 105 is not in dispute. The government contends, however, that the vested 85 percent was not a payment "for" disability, since this portion represented taxpayer's earned share of profit under a plan qualifying under § 401 and, as such, was taxable when received by him. [Id. at 323.]The Court of Appeals held that the lump-sum payment could be excluded from the taxpayer's income under section 105(c) since the taxpayer's "entitlement to payment came as a result of disability pursuant to the company's accident or health plan." Id. at 323. The Court of Appeals in Wood did not discuss the section 105(c)(2) requirement. In a later opinion, decided en banc, the Court of Appeals stated that Wood did not adequately address section 105(c)(2) and the Wood opinion "evidently assumed, without explanation, that * * * [the section 105(c)(2)] requirements were met." Beisler v. Commissioner, supra at 1308.*398 Under the facts present in this case, we have held that the payments received from the plans did not meet the requirements of section 105(c)(1) and (2). Therefore, the facts of the present case are distinguishable from the facts present or assumed in the Wood case. If that case were interpreted as petitioner contends it should be, it would be contrary to our holding in Hines v. Commissioner, supra. Therefore, even if Wood were not distinguishable from the present case on the basis of petitioner's contention, we would not follow it, since we are not bound under Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), to follow Wood v. United States, supra, in this case, which would be appealable to the Court of Appeals for the Eleventh Circuit. It might be added that even in the Ninth CircuitWood is of dubious authority on this point given the later en banc decision in Beisler. The second case petitioner relies on is Masterson v. United States, 478 F. Supp. 454">478 F. Supp. 454 (N.D. Ill. 1979). *399 That case also dealt with a lump-sum payment from a profit-sharing plan. In the Masterson case, the District Court for the Northern District of Illinois relied on the analysis in Wood in holding that the payment was properly excluded from income under section 105(c). The opinion in Masterson contains no discussion of the requirements of section 105(c)(1) or (2) in reaching the conclusion that the lump-sum distribution is "excludable from gross income because it represents compensation for disability." Id. at 456. The District Court in Masterson seemed to ignore the legislative scheme. Gordon v. Commissioner, 88 T.C. 630">88 T.C. 630, 638 (1987) (citing Caplin v. United States, 718 F.2d 544">718 F.2d 544, 547 (2d Cir. 1983)). As was true with respect to the Wood case, the facts of the present case are distinguishable from the facts assumed in Masterson. See Gibson v. United States, 643 F. Supp. 181">643 F. Supp. 181 (W.D. Tenn. 1986); Christensen v. United States, 57 AFTR 2d 86-533, at 86-996, 86-1 USTC par. 9254, at 83,461 (D. Minn. 1986).*400 The next issue for decision is whether petitioner is liable for the section 6651(a)(1) addition to tax. Section 6651(a)(1) imposes an addition to tax for failure to timely file a return, unless the taxpayer establishes: (1) The failure did not result from willful neglect; and (2) the failure was due to reasonable cause. Willful neglect has been interpreted to mean a conscious, intentional failure, or reckless indifference. United States v. Boyle, 469 U.S. 241">469 U.S. 241, 245-246 (1985). Reasonable cause requires the taxpayer to demonstrate that he exercised ordinary business care and prudence and was nonetheless unable to file a return within the prescribed time. Id. at 246; sec. 301.6651-1(c)(1), Proced. & Admin. Regs. In the present case, petitioner failed to file Federal income tax returns for the years 1983 through 1988. Petitioner argues that his reliance on Wood v. United States, 590 F.2d 321">590 F.2d 321 (9th Cir. 1979), and Masterson v. United States, 478 F. Supp. 454">478 F. Supp. 454 (N.D. Ill. 1979), was reasonable cause for his failure to file his returns. We disagree for several *401 reasons. First, there is no evidence that petitioner actually relied on these two cases. Secondly, even if he did rely on these two cases, such reliance was not reasonable since other cases which we have discussed above discussed the facts that distinguish petitioner's situation from the Wood case. Finally, as we have set forth in our facts, petitioner had sufficient income aside from the payments under his plans with Eastern to require the filing of a return whether or not a tax would be due. We, therefore, hold that petitioner is liable for the additions to tax under section 6651(a)(1). The next issue for decision is whether petitioner is liable for the addition to tax under section 6653(a). Section 6653(a) imposes an addition to tax for negligence or intentional disregard of rules or regulations. Negligence encompasses any failure to reasonably attempt to comply with the Internal Revenue Code, including the lack of due care or the failure to do what a reasonable or ordinarily prudent person would do in a similar situation. McGee v. Commissioner, 979 F.2d 66">979 F.2d 66, 71 (5th Cir. 1992), affg. T.C. Memo. 1991-510; Marcello v. Commissioner, 380 F.2d 499">380 F.2d 499, 506 (5th Cir. 1967),*402 affg. in part and remanding in part 43 T.C. 168">43 T.C. 168 (1964). Petitioner bears the burden of proving that he was not negligent. Rule 142(a); Patterson v. Commissioner, 740 F.2d 927">740 F.2d 927, 930 (11th Cir. 1984), affg. T.C. Memo. 1983-655; Luman v. Commissioner, 79 T.C. 846">79 T.C. 846, 860-861 (1982). Based on this record, we conclude that petitioner was negligent in his underpayment of tax, since he did not act reasonably or use due care in determining his Federal tax obligations. Therefore, petitioner is liable for additions to tax under section 6653(a)(1) and (2) for the years 1983, 1984, and 1985, under section 6653(a)(1)(A) and (B) for the years 1986 and 1987, and under section 6653(a)(1) for the year 1988. Petitioner has offered no evidence and made no argument in support of his position that he is not liable for the addition to tax under section 6654(a). We, therefore, sustain respondent's determination of this addition to tax. Decision will be entered under Rule 155. Footnotes1. 50 percent of the interest due on the full deficiency.↩2. 50 percent of the interest due on $ 10,430.↩1. All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩2. SEC. 105. AMOUNTS RECEIVED UNDER ACCIDENT AND HEALTH PLANS. (a) Amounts Attributable To Employer Contributions. -- Except as otherwise provided in this section, amounts received by an employee through accident or health insurance for personal injuries or sickness shall be included in gross income to the extent such amounts (1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or (2) are paid by the employer. * * * * (c) Payments Unrelated To Absence From Work. -- Gross income does not include amounts referred to in subsection (a) to the extent such amounts --(1) constitute payment for the permanent loss or loss of use of a member or function of the body, or the permanent disfigurement, of the taxpayer, his spouse, or a dependent (as defined in section 152), and (2) are computed with reference to the nature of the injury without regard to the period the employee absent from work.* * * * (e) Accident And Health Plans. -- For purposes of this section and section 104 -- (1) amounts received under an accident or health plan for employees, and (2) amounts received from a sickness and disability fund for employees maintained under the law of a State, or the District of Columbia,shall be treated as amounts received through accident or health insurance.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619544/ | HENRY DEFORD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.De Ford v. CommissionerDocket No. 10114.United States Board of Tax Appeals7 B.T.A. 630; 1927 BTA LEXIS 3130; July 13, 1927, Promulgated *3130 Deduction for loss resulting from sale of residence disallowed. Herbert P. Mason, Esq., for the petitioner. J. L. Deveney, Esq., for the respondent. SMITH *630 This proceeding involves a deficiency in income tax for the year 1921 in the amount of $639.89. FINDINGS OF FACT. The petitioner is an individual residing in Brookline, Mass. In 1890 he purchased a residence at 3 Fillmore Terrace, later 340 Tappan Street, Brookline, Mass., for $17,500. The house was a detached brick house in a subdivision that was being developed by one Knapp. It had twelve rooms outside of servants' rooms. The house, with other houses of the subdivision, was to be heated from a central heating plant. This proved impracticable, however, and the petitioner had a furnace installed in the house and also an additional bath room. At the time of purchase the petitioner was desirous of *631 acquiring a house in the country but he thought that with all of the restrictions on the place the property would appreciate in value, and that within a few years he would have an opportunity to turn the property over at some profit. Knapp failed in 1890 or 1894 and never*3131 developed the entire subdivision as originally planned. The petitioner made some effort to sell his house prior to 1900 but could not find a purchaser. In 1900 he listed it with a real estate broker. During the winters of 1900 and 1901 the house was vacant and the petitioner with his family was in Porto Rico. The house was again vacant for certain periods in 1904 and 1905. Not being able to find a purchaser for the house the petitioner occupied it as his permanent home for practically the entire period from the date of purchase to 1920, when he permanently left it. He succeeded in selling it in 1921 for $8,300. At the time of purchase the property was encumbered with a mortgage of $15,000. In 1913 the mortgage was $9,000. This was subsequently reduced to $8,000 or $6,500. The fair market value of the property on March 1, 1913, was $12,800. In his income-tax return for 1921 the petitioner claimed as a deduction from gross income $4,500 as a loss upon the sale of the property. This amount was obtained by deducting from the March 1, 1913, value, $12,800, the amount for which the property was sold in 1921, $8,300. The deduction of this loss was disallowed by the respondent. *3132 OPINION. SMITH: The Revenue Act of 1921 permits an individual to deduct from gross income in his income-tax reutrn "losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business." (Section 214(a)(5).) The petitioner deposed as follows: Q. Would you say that when you purchased this real estate you did or did not have a view to its subsequent sale for pecuniary profit? A. I expected to sell it at a pecuniary profit. Q. Do you say that this was or was not a transaction entered into by you for profit? A. Well, that was the main object in my buying the place. I expected to live somewhere, of course, meantime. It was not bought solely as a speculation in real estate, but I expected to live there for a couple of years and to look around and to make a profit while I was there. What the petitioner did in 1890 was to purchase a residence for himself and family. The surrounding and attendant circumstances are not persuasive that the purchase was a transaction entered into for profit. Reviewed by the Board. Judgment will be entered*3133 for the respondent. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619546/ | ELBE OIL LAND DEVELOPMENT COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Elbe Oil Land Development Co. v. CommissionerDocket Nos. 54773, 60157.United States Board of Tax Appeals34 B.T.A. 333; 1936 BTA LEXIS 712; April 14, 1936, Promulgated *712 DEPLETION - OIL & GAS WELLS. - In 1927 petitioner under a contract of sale, conveyed its interest in certain leases, permits, drilling agreements, and all of the oil and gas produced from the properties to another corporation in consideration for cash payments to be made in the years 1927 to 1931, inclusive, totaling $2,000,000 (all of which has been paid), and in addition thereto the promise of future payments of one-third of the latter's net profits wholly contingent upon the happening of indeterminable events which had not occurred up to the year 1933. Held, that the cash payments received by petitioner in the years 1928 and 1929 constituted proceeds from the sale of a capital asset and were not gross income from the property within the meaning of that phrase as used in section 114(b)(3) of the 1928 Act and therefore are not subject to a percentage allowance for depletion. Fred R. Angevine, Esq., W. L. E. O'Bryan, Esq., and C. Wm. Wittman, C.P.A., for the petitioner. Elden McFarland, Esq., for the respondent. TYSON *333 OPINION. TYSON: These consolidated proceedings seek redetermination of income tax deficiencies in the*713 amounts of $16,626.09 for the year 1928 and $12,149.50 for the year 1929, asserted by respondent as the result of several adjustments made by him in the income reported by petitioner for those years. All issues, except one, have been waived or stipulated and effect thereto will be given upon the recomputation under Rule 50. The stipulation of facts and exhibits attached thereto are included herein by reference. The sole remaining issue, as to both years, involves the question of whether petitioner is entitled to a deduction of $110,000 for depletion at the rate of 27 1/2 percent of a $400,000 payment received in each of those years under the terms of a written contract relative to certain oil and gas properties, executed on October 3, 1927. Petitioner, a California corporation, was organized on February 4, 1924. It acquired certain properties consisting of oil and gas prospecting permits, drilling agreements, leases, and equipment. Development work carried on by it resulted in the discovery of oil on its properties and on October 3, 1927, oil was being produced in commercial quantities. As of October 3, 1927, under the terms of the written contract executed on that date, *714 the petitioner sold, transferred, and conveyed all of its right, title, and interest in and to certain described prospecting permits, drilling agreements, leases, and equipment, unto *334 the Honolulu Consolidated Oil Co., a California corporation, the latter to "have the sole ownership of and the right to sell or otherwise dispose of, all oil and/or gas and derivative products produced in, on or upon said properties", it being "the intention of the parties to this agreement that the full and complete ownership, control and operation of said properties shall vest, upon execution hereof, in Honolulu * * * and Elbe shall have no interest in or to any of said properties whatsoever." The consideration to be paid to petitioner, as set forth in paragraph 7 of said contract, was $350,000 cash upon the execution of the contract and thereafter, if the Honolulu Consolidated Oil Co. did not elect to abandon the purchase of the properties and execute reconveyances as provided by paragraph 9 of the contract, the sum of $400,000 on the 14th day of March of each of the years 1928, 1929, and 1930 and $450,000 on March 14, 1931, together with interest as specified. Of such $2,000,000 to be*715 received by petitioner in cash and notes, the amount of $1,963,672.95 was consideration for the oil and gas rights in the leases and the remainder was consideration for equipment and other property conveyed. The stated consideration for such sale was fixed at the definite amount of $2,000,000, to be paid without reference to, and without being in any manner based upon, the production of oil from the properties conveyed. The petitioner has received each of the payments, in the amounts and on the dates specified in the contract, totaling $2,000,000. The cost of all of the assets transferred under the contract was less than the amount of $350,000 received in 1927 and for that year petitioner reported a taxable gain, from the transaction, by applying the entire basis against the $350,000. In its returns for 1928 and 1929 petitioner claimed the deduction herein sought for depletion on the ground that the payment of $400,000 received in each of those years constituted a bonus on a sublease. The contract, in paragraph 8 thereof, provided that, "from and after the time" when the Honolulu Consolidated Oil Co. should have been fully reimbursed from its sales of oil and gas produced*716 from the properties, for all expenditures made in the acquisition, development, and operation thereof, it should pay to petitioner 33 1/3 percent of its net profits, as defined in the contract, resulting thereafter from the continued production, if any, from the properties. During the years here in controversy, and up to the date of hearing herein in September 1933, no payments became due or were made to petitioner by the Honolulu Consolidated Oil Co. upon the latter's wholly contingent obligation for future payments under its contract of purchase. Such contingent obligation of the Honolulu Consolidated Oil Co. is separate and apart from its obligation for the payments totaling $2,000,000 and does not impart to such payments the *335 character of being income realized from the retention by petitioner of an economic interest in the oil and gas produced during the period covered by such payments. We do not have before us the question of the character of such future payments if and when made or whether or not they might be subject to depletion under the then applicable revenue acts. Therefore, the only issue now before us involves the question of whether, under the provisions*717 of section 114(b)(3) of the Revenue Act of 1928, 1 petitioner is entitled to deduction of 27 1/2 percent of $400,000 for each of the years 1928 and 1929, as an "allowance for depletion * * * of the gross income from the property during the taxable year." Petitioner contends that this proceeding is controlled by the decision in . In that case the taxpayer was the member of two partnerships which in 1921 executed writings by which it "does sell, assign, set over, transfer and deliver * * * unto the Ohio Oil Co." certain leased premises in consideration of a present payment of a cash bonus, future payments to be made*718 "out of one-half of the first oil produced and saved" to the extent of a specified sum and an additional excess royalty of one-eighth of all oil produced and saved. The District Court and the Circuit Court held that the transaction constituted a sale of a capital asset, that no interest was retained in the oil and gas, and that the taxpayer was not entitled to depletion. The taxpayer in the Palmer case, supra, contended that the instrument was a lease and invoked the rule in , that a lessor is entitled to a depletion allowance on both bonus (advance royalties) and royalties. The Supreme Court held that it was immaterial whether the instrument constituted a sale, an assignment or a lease; that the question involved merely the application of section 214(a)(10) of the Revenue Act of 1921, which provided for a deduction of a reasonable allowance for depletion "in the case of * * * oil and gas wells, * * * according to the peculiar conditions in each case"; that the language of the section did not restrict such allowance "to any particular class or to any special form of legal interest in the oil well", but is broad*719 enough to include "every case in which the taxpayer has acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his *336 capital", whether the taxpayer be vendor, lessor, lessee, or their transferee, so long as by the terms of the transaction involved the taxpayer retains "a right to share in the oil produced", that is, "an economic interest in the oil, in place, which is depleted by production." The Supreme Court decided that "when the two lessees (partnerships) transferred their operating rights to the two oil companies, whether they became technical sublessors or not, they retained, by their stipulations for royalties, an economic interest in the oil, in place, identical with that of a lessor", and because of this retention of an economic interest through the medium of royalties was, to the extent of such interest, entitled to a reasonable allowance for depletion. The ground upon which the opinion in the Palmer case, supra, was based, was the retention of an economic interest by the taxpayer of the oil in place. The holding in that*720 case then is not controlling in the instant case because the taxpayer herein retained no economic interest in the oil in place, so far as the payments here in controversy are concerned. The contract of October 3, 1927, constituted an absolute sale of not only its interest in the leases, permits, and drilling agreements transferred, which might be termed operating agreements, but also all of the oil and gas in place, for the contract specifically provided that the Honolulu Consolidated Oil Co. acquired "the sole ownership of and the right to sell or otherwise dispose of, all oil and/or gas and derivative products produced in, on or upon said properties" and further that the petitioner "shall have no interest in or to any of said properties whatsoever." The consideration in the definite amount of $2,000,000 was not in any way dependent upon the production of oil from the properties. It is therefore obvious that the petitioner did not retain any economic interest or investment in the oil and gas, in place, so far as the payments here in controversy are concerned, subject to depletion on extraction, but looked only to the independent personal liability of the purchaser for*721 the receipt of the agreed purchase price of $2,000,000 pursuant to the terms of the contract of sale. We conclude that the cash payments of $400,000 received by petitioner in each of the years 1928 and 1929 constituted proceeds from the sale of a capital asset and were not gross income from the property within the meaning of that phrase as used in section 114(b)(3), supra, and therefore petitioner is not entitled to a depletion allowance of 27 1/2 percent thereof under the provisions of that section. ; affd., ; and . Cf. ; affd., ; certiorari denied, . Decision will be entered under Rule 50.Footnotes1. SEC. 114(b). BASIS FOR DEPLETION. * * * (3) PERCENTAGE DEPLETION FOR OIL AND GAS WELLS. - In the case of oil and gas wells the allowance for depletion shall be 27 1/2 per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph. ↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619547/ | Bechara Nader, Transferee v. Commissioner.Nader v. CommissionerDocket No. 71470.United States Tax CourtT.C. Memo 1962-156; 1962 Tax Ct. Memo LEXIS 155; 21 T.C.M. (CCH) 867; T.C.M. (RIA) 62156; June 26, 1962*155 Held, that the fair market value of certain unimproved realty which was transferred to the petitioner by his brother-in-law and sister-in-law for $11,500, was not less than $35,000. Held, further, that said transfer was made when the transferors were insolvent and heavily indebted to the Government for unpaid income taxes, and was without adequate consideration; and that petitioner is liable as a transferee to the extent of the excess of the fair market value of the property over the consideration which he paid therefor. Lucien L. Dunbar, Esq., and Thomas C. Collier, Esq., for the petitioner. George H. Becker, Esq., for the respondent. PIERCE Memorandum Findings of Fact and Opinion PIERCE, Judge: The respondent determined in 1957 that petitioner was liable as a transferee of the*156 assets of George J. Deeb, Sr., and his wife Charline Deeb, for unpaid deficiencies in the Deebs' income taxes, for the following years and in the following amounts (together with interest thereon according to law): YearAmount1948$4,036.441949137.3419522,391.7619533,510.70The principal issue for decision is whether the petitioner is liable as such transferee. The underlying question raised by this issue is whether the conveyance to the petitioner by the transferors of a certain 24-acre tract of unimproved real estate was for a consideration that was less than full, fair and adequate; and this question in turn largely hinges on a determination of the fair market value of said 24-acre tract on August 2, 1955, the date of the conveyance thereof to the petitioner. The above-listed deficiency for the year 1949, together with interest thereon, was paid in full in 1958; and accordingly said 1949 liability is no longer involved. As to the amounts of the unpaid tax liabilities of the Deebs for the remaining years, the parties in the instant case have stipulated that "these liabilities are not being contested in this proceeding." Findings of Fact Some*157 of the facts were stipulated. The stipulation of facts, together with the exhibits identified therein, is incorporated herein by reference. The petitioner, Bechara Nader, is an individual who resides in Brooklyn, New York; and he is now, and was during the year 1955, married to Zakieh Nader, the sister of George J. Deeb, Sr., who is one of the transferors here involved. On August 2, 1955 (hereinafter called "the material valuation date"), George J. Deeb, Sr., and Charline Deeb, his wife, transferred to the petitioner a certain parcel of real estate (hereinafter called "the subject property") situated in Washington Township, in the northwestern part of Marion County, Indiana. The consideration paid by the petitioner for the transfer of the subject property to him was $11,500. The subject property contained 24 acres. It was situated at the southeast corner of 42nd Street and Kessler Boulevard, in the suburban area of Indianapolis, Indiana; but the record does not disclose its exact distance from the city limits. The topography of the subject property may be described as follows: It was generally flat, but it had a slight depression or valley in the southeast corner. It consisted*158 mostly of open fields, with only a few trees in the northern portion. There were no streams through the property. Its borders were all straight lines; and its shape was almost a square, except for a small 2-acre tract containing three lots that had been carved out of what would have been the southwest corner, and except also for a second tract (known as Sun Meadow Addition) of approximately 4 acres that had been carved out of what would have been the northeast corner. The western boundary of the subject property fronted on Kessler Boulevard, while about one-half of the northern boundary fronted on 42nd Street. Situated on each of the three above-mentioned lots at the southwest corner, there was a frame house which was about 40 to 50 years old. Kessler Boulevard is a rather heavily traveled arterial roadway running in a northsouth direction. It interesects with 38th Street, another rather heavily traveled highway running in an east-west direction, at a point about 660 feet south of the subject property. Kessler Boulevard, like all other boulevards in Marion County, was under the control of the county park board; and this board would only permit the erection of residential dwellings*159 on boulevards, and within 500 feet on each side thereof. For several years prior to the material valuation date there had been speculation in the Indianapolis area that a bridge would be erected over the White River into Indianapolis at 38th Street, which would thereby increase the traffic along 38th Street near the subject property. Construction of the bridge was not actually begun however until about 1960. The highest and best use of the subject property on the material valuation date was development as a residential subdivision. In 1955, the area in and around 42nd and Kessler was not densely developed. However, one residential subdivision (Arbordale Highlands), directly across Kessler Boulevard from the subject property, had been completed in 1953; and various builders were on the lookout for other property in the neighborhood, which could be developed. Louis Frosch, the builder who had developed Arbordale Highlands, was interested in acquiring the subject property; and in 1955 and prior to the transfer here involved, he had instructed an individual named William Beattie, who was handling his real estate acquisitions, to offer $1,500 per acre or "a little more" for the subject*160 property. However, when Beattie telephoned the real estate agent with whom the property was listed, he was informed that the asking price was $3,000 or $5,000 per acre - a price which both Frosch and Beattie considered to be too high. In addition to Arbordale Highlands, another development had been begun shortly prior to the transfer here involved, in a subdivision known as the Fourth Section of Burris Second Subdivision, which lay about one block to the north of the subject property. The Burris Fourth Section consisted of 15.36 acres, and it had been purchased by the developer in July 1954 at a price of $22,500, or $1,460 per acre. This Burris property was heavily wooded and had a creek running through it. It lent itself to a more expensive type of housing than did the subject property; but also it was more expensive to develop than the subject property, owing to its more rugged terrain. Also, just to the east of the Burris Fourth Section, across a street named Cooper Road, lay the Second and Third Sections of Burris Second Subdivision, on which development had started during 1955. Adwin Burrssis, the developer of the just mentioned subdivisions bearing his name, also was interested*161 in acquiring the subject property; and he authorized the above-mentioned Beattie to offer $1,500 per acre therefor. However, as before stated, Beattie was advised by the real estate agent who had a listing for the subject property, that the asking price therefor was $3,000 or $5,000 per acre. Lying just to the south of the Burris Fourth Section and between it and the subject property was a tract of land known as the Churchman property. 1 The Churchman property consisted of 18.723 acres; and it was sold on May 2, 1955, at a price of $20,000, or $1,068 per acre. The Churchman property had no frontage on Kessler Boulevard; and it had a rolling contour and was rather heavily wooded. Its terrain, like that of Burris Fourth Section, would be more expensive to develop than that of the subject property; and by reason of such terrain, both it and the Burris Fourth Section would yield less lots per acre upon being subdivided, than would the subject property. In September 1957, 8 unimproved lots (averaging in size, 1/2 acre*162 per lot) located in the above-mentioned Sun Meadow Addition at the northeast corner of the subject property, were purchased for the sum of $17,500. Land values, in the vicinity of 42nd Street and Kessler Boulevard, were rising throughout the period from 1951 through 1956. The fair market value of the subject property on August 2, 1955, the material valuation date, was not less than $35,000 (or about $1,458 per acre). At the time that the Deebs transferred the subject property to the petitioner for $11,500, they were insolvent. A list of their assets and liabilities on August 1, 1955, just prior to said transfer, is as follows: ASSETSCash in bank$ 861.81Cash value of 4 policies of life insurance4,969.24Proprietor's equity in Steel or Bronze Sealing Ring Co.5,203.87Real estate -Residence *$15,000.00Subject property *35,000.0050,000.00Household furnishings *1,000.001953 Lincoln automobile2,000.00Securities -U.S. Government Bonds (Series E)$14,980.00Affiliated Funds, Inc. (105 shs.) *670.42Studebaker Corp. stock (20 shs.) *160.00Bennett Bros. stock (15 shs.) *15,810.42Value of Total Assets$ 79,845.34LIABILITIESNotes payable$ 2,000.00Real estate taxes376.97Personal property taxes624.42Federal income tax liabilities and interest thereon(as hereinafter specified) -George J. Deeb, Sr., and Charline Deeb$ 12,297.91George J. Deeb, Sr.145,029.05Charline Deeb46,718.92204,045.88Total Liabilities$207,047.27*163 The following schedule contains the details of the Deebs' Federal tax liabilities, as listed in the foregoing table: Amount ofAccruedTotalDeficiencyInterestLiabilityYearKind of TaxHow DeterminedDeterminedto 8/1/55as of 8/1/55George J. Deeb, Sr., and Charline Deeb1948IncomeT.C. Docket No. 52580 *$ 4,036.44$ 1,545.13$ 5,581.571949IncomeT.C. Docket No. 52580 *137.3444.35181.691952IncomeAgreement Form 8702,391.76341.532,733.291953IncomeAgreement Form 8703,510.70290.663,801.36Totals$ 10,076.24$ 2,221.67$ 12,297.91George J. Deeb, Sr.1945IncomeT.C. Docket No. 52579 *$ 18,836.13$10,600.87$ 29,437.001946IncomeT.C. Docket No. 52579 *10,900.565,480.7416,381.301947IncomeT.C. Docket No. 52579 *1,257.70556.901,814.60George J. Deeb, Sr., Transferee (Steel or BronzePiston Ring Corp., Transferor)1945Excess profitsT.C. Docket No. 43983 **97,396.15(Included in97,396.15deficiency)Totals$128,390.54$16,638.51$145,029.05Charline Deeb, Transferee (Steel or Bronze PistonRing Corp., Transferor)1944IncomeT.C. Docket No. 43982 **$ 1,212.77Included in$ 1,212.771944Excess profitsT.C. Docket No. 43982 **8,104.29deficiency8,104.291945Excess profitsT.C. Docket No. 43982 **37,401.8637,401.86Totals$ 46,718.92$ 46,718.92*164 During September 1955, a revenue officer representing the respondent, personally contacted George J. Deeb, Sr., and Charline Deeb; and he made demand upon them at that time for payment of their Federal income tax liabilities. Thereafter, several offers in compromise were filed by the Deebs, either individually or jointly, for the purpose of settling their Federal tax liabilities for amounts less than the outstanding balances thereof, for the stated reason that their assets were insufficient to pay such liabilities in full. The respondent suspended his collection activity during the times that these offers were pending, in order that the information contained therein could be investigated. However, active attempts at collection were made by the respondent at all other times when the offers in compromise were not on file; and these*165 attempts included levying jeopardy assessments, filing of notices of Federal tax liens, and distraint and sales of certain assets. The only portion of the above-listed Federal tax liabilities that has been paid since the Deebs' transfer of the subject property to the petitioner on August 2, 1955, was that for 1949 in the amount of $137.34, together with interest thereon; and this was paid in 1958, as mentioned in the preliminary statement hereinabove. On October 10, 1957, the respondent issued a notice of liability to petitioner, in which he determined that petitioner was liable as transferee of assets of the Deebs in the amount of $10,076.24 (plus interest thereon as provided by law), in respect of the Deebs' income taxes, as assessed against and due from the Deebs for the years 1948, 1949, 1952 and 1953. Opinion The principal issue for decision in the instant case is, as above stated, whether the petitioner is liable as a transferee of George J. Deeb, Sr., and Charline Deeb, husband and wife, for their tax liabilities for the years 1948, 1952 and 1953 (including interest) - to the extent of the excess of the fair market value of the subject property over the $11,500 consideration*166 which petitioner paid to said transferors therefor. The respondent proceeded against the petitioner under section 311 of the Internal Revenue Code of 1939, which provides, so far as here material as follows: SEC. 311. TRANSFERRED ASSETS. (a) Method of Collection. - The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, collected, and paid in the same manner and subject to the same provisions and limitations as in the case of a deficiency in a tax imposed by this chapter (including the provisions in case of delinquency in payment after notice and demand, the provisions authorizing distraint and proceedings in court for collection, and the provisions prohibiting claims and suits for refunds): (1) Transferees. - The liability, at law or in equity, of a transferee of property of a taxpayer, in respect of the tax (including interest, additional amounts, and additions to the tax provided by law) imposed upon the taxpayer by this chapter. * * *Any such liability may be either as to the amount of tax shown on the return or as to any deficiency in tax. The burden of proving that petitioner is liable as a transferee of the*167 Deebs' assets is on the respondent. Section 1119(a) of the 1939 Code. The Supreme Court has held that the existence of transferee liability is governed by state law. Commissioner v. Stern, 357 U.S. 39">357 U.S. 39. Concerning the elements that the respondent must prove to make out a case of transferee liability for Federal taxes, we recently stated in Blanche S. Sharp, 35 T.C. 1168">35 T.C. 1168, 1175, as follows: The respondent in meeting his burden must prove that the transferor was liable for unpaid Federal taxes, and that all reasonable efforts were made to collect the tax liability from the transferor before proceeding against the transferee. He must further prove that property of value was transferred to the alleged transferee without adequate consideration during or after the period for which the liability accrued; and that the transferor was either insolvent at the time of the transfer or was rendered insolvent thereby. Bartmer Automatic Self Service Laundry, Inc., 35 T.C. 317">35 T.C. 317; Robert Leslie Bowlin, 31 T.C. 188">31 T.C. 188, affirmed per curiam 273 F. 2d 610 (C.A. 6, 1960). Bearing in mind the foregoing elements, we turn to the facts of the instant*168 case to ascertain if the respondent has established the liability of the petitioner as a transferee, for the income tax liabilities, plus interest, of the Deebs for the years 1948, 1952 and 1953. There is no question in this case as to the Deebs' liability for said income taxes, for the parties have stipulated that these liabilities are not being questioned in this proceeding. Also, the Deebs admitted in several offers in compromise that they did not have the means for paying their Federal tax liabilities which, parenthetically we note, were then and still are many times greater than the amount sought to be collected from petitioner in this case. (See the table in our Findings of Fact showing the full extent of the Deebs' Federal tax liabilities.) Furthermore, we are satisfied that the respondent made every reasonable effort to collect these liabilities from the Deebs, before he proceeded against petitioner as a transferee. Although respondent temporarily suspended collection efforts during the pendency of the Deebs' offers in compromise, he at all other times since 1955 has actively sought, without success, to collect the amounts owing from the Deebs. Indeed, the respondent made demand*169 on them for payment; levied jeopardy assessments against them; filed notices of tax liens against certain of their property; and distrained and sold certain of their assets. Finally we note that the transfer of the subject property by the Deebs to the petitioner in 1955 was made after their above-mentioned unpaid tax liabilities had accrued; and also at a time when the Deebs were hopelessly insolvent - as the schedule of their assets and liabilities in our Findings of Fact shows beyond peradventure. So far as the foregoing facts are concerned, no serious question was raised in this case; and the point of real controversy has been rather, whether the transfer of the subject property by the Deebs to the petitioner on August 2, 1955, was made without adequate consideration. This controversy generated widely varying opinion testimony as to the fair market value on the material valuation date, of the 24 acres of subject property. The petitioner's witnesses, Sexton and Hurt, testified that in their respective opinions the fair market value of the subject property on said date was $562 and $570 per acre, or $13,488 and $13,680 for the tract as a whole. On the other hand, the respondent's*170 witness Teckemeyer stated that in his opinion, the fair market value on the material valuation date of said property as a whole was $35,000, or approximately $1,500 per acre. The respondent also adduced the testimony of a builder named Frosch, who had desired to acquire the subject property shortly prior to the transfer here involved, that he would have been willing to pay therefor in 1955, $1,500 per acre or "a little more." In addition, respondent presented as a witness a realtor named Beattie, who testified that he had in 1955 attempted without success to purchase the subject property on Frosch's behalf, for $1,500 per acre; and that he had another client (Adwin Burris) who likewise was willing at that time to pay $1,500 per acre for this property. After considering and weighing all the evidence of record relating to the fair market value of the subject property on the material valuation date, we have concluded and hereinabove found as a fact, that such fair market value was not less than $35,000. Most persuasive to us was the evidence that, shortly prior to the material valuation date, there were at least two financially responsible persons who were willing and actually had attempted*171 to purchase the subject property at $1,500 per acre. Also, we have accorded greater weight to the opinion testimony of the respondent's witness Teckemeyer than to that of petitioner's witnesses, Sexton and Hurt; for Teckemeyer not only was much more experienced than the other two, but also he was in our judgment better qualified to express an opinion of the subject property's fair market value. The impact of our finding that the fair market value of the subject property on the material valuation date was not less than $35,000, is that said property was transferred to petitioner without adequate consideration, inasmuch as he paid only $11,500 therefor, or less than one-third of its true value. We next must determine whether the conveyance of the subject property by the Deebs, in the circumstances of the instant case, was fraudulent under Indiana law - so that creditors of the Deebs (including the United States Government) could hold their transferee liable, to the extent of the excess of the fair market value of the property over the consideration paid therefor. Such excess, in the instant case, amounts to at least $23,500 (fair market value of at least $35,000, less consideration*172 paid of $11,500). We have concluded from an examination of Indiana judicial authorities that the latter question should be answered in the affirmative; and petitioner has cited no authority to the contrary. In Jameson v. Dilley, 27 Ind. App. 429">27 Ind. App. 429, 61 N.E. 601">61 N.E. 601, the court held that, where property has been conveyed by an insolvent person for a grossly inadequate consideration, the conveyance may be declared fraudulent as to creditors of the vendor, and be set aside. And in Smith v. Selz, 114 Ind. 229">114 Ind. 229, 16 N.E. 524">16 N.E. 524, the Supreme Court of Indiana recognized that, in the case of such a fraudulent conveyance, creditors of the transferor might elect, if they chose, to let the conveyance stand and hold the transferee liable to the extent of the difference between the fair market value of the property and the amount paid therefor. See also in this connection, First Nat. Bank v. Smith, 149 Ind. 443">149 Ind. 443, 49 N.E. 376">49 N.E. 376; and Griffith State Bank v. Clark, (Ind. App.) 199 N.E. 447">199 N.E. 447. The effect of the above-cited authorities is that petitioner is liable as a transferee in the instant case for the amounts of the Deebs' income tax liabilities for the years*173 1948, 1952 and 1953, which respondent determined against petitioner in the notice of transferee liability herein; and that he also is liable for interest thereon according to law. The maximum overall extent of such liability is $23,500 - being the excess of the fair market value of the property on the material valuation date over the amount of consideration which petitioner paid therefor. We so hold. Decision will be entered under Rule 50. Footnotes1. The Churchman property is also known, and is sometimes referred to in the exhibits and the testimony in the instant case as the Green Meadows-3d Section property.↩*. Assets marked with asterisk are stated at their fair market value on August 1, 1955.↩*. Decision entered by the Tax Court on November 30, 1956, pursuant to stipulation of the parties. ↩**. Decision entered by the Tax Court on November 30, 1956, pursuant to stipulation of the parties. The tax liabilities of the Deebs' transferor was decided by this Court in the case of Steel or Bronze Piston Ring Corporation, 13 T.C. 636">13 T.C. 636↩. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619548/ | Elmer Irvin Trust, Elmer Irvin, Trustee, Petitioner, v. Commissioner of Internal Revenue, RespondentIrvin's Trust v. CommissionerDocket No. 65495United States Tax Court29 T.C. 846; 1958 U.S. Tax Ct. LEXIS 260; February 14, 1958, Filed *260 Decision will be entered for the respondent. Trust was created by purchasing and executing "form" instruments to own and operate certain properties. Held, the Elmer Irvin Trust is an association taxable as a corporation where trust agreement, among other things, contemplated continuity, limited liability, and authorized trustees to manage property through a general manager. W. A. Gossage, Jr., Esq., for the petitioner.Sylvan Siegler, Esq., for the respondent. Mulroney, Judge. MULRONEY *846 The respondent determined a deficiency in income tax of the petitioner for the taxable year 1951 in the amount of $ 751.29. The single issue before us is whether petitioner, Elmer Irvin Trust, during the taxable year 1951, was an association taxable as a corporation, as determined by the respondent.FINDINGS OF FACT.Some of the facts *261 were stipulated and are found accordingly.On April 2, 1951, the Elmer Irvin Trust, hereinafter referred to as the petitioner, was created by a declaration of trust executed by Mary E. Brown, creator, and Vernon K. Irvin, Robert L. Irvin, and Mary E. Brown, acceptors and trustees. On April 3, 1951, the declaration of trust was signed and sworn to by Elmer Irvin as trustee.*847 The principal place of business for petitioner was listed as the city of Goodland, county of Sherman, and State of Kansas. Petitioner timely filed a fiduciary income tax return (Form 1041) for the taxable year 1951 with the then collector of internal revenue for the district of Kansas. The tax return showed total income of $ 6,538.47, total expenses of $ 4,054.03, and a resulting profit of $ 2,484.44. The return further showed the amount of $ 5,146.53 as distributable to beneficiaries, resulting in no net income being taxable to the fiduciary.The "trust" instrument under which petitioner was created, was a form prepared and distributed by an organization known as the National Pure Trust Service. The instrument was described as a "Declaration of Trust" and authorized the trustees to operate under the*262 name of the Elmer Irvin Trust. It was provided that Mary E. Brown, Vernon K. Irvin, and Robert L. Irvin, acceptors in joint tenancy and children of Elmer Irvin, should compose the board of trustees and executive officers for conducting the business of the trust.The instrument provided for the appointment of a specified number of trustees, the term of office to be held by them, and the manner in which they could be removed and successor trustees appointed. Provisions were made for trustees' meetings, and a majority vote was necessary for the conduct of business. The trustees were empowered to exercise exclusive management of the trust property and business affairs. Provisions were made for the election or appointment of a successor trustee in the event of death of any of the present trustees.The trustees were empowered to elect from among themselves a president, secretary and treasurer, or any other officer. The trustees were authorized to fix and pay the compensation for officers, employees, or agents of the petitioner.The instrument authorized the trustees, in whom the property of the trust vested, to enter into and conduct any imaginable business or enterprise under the *263 name of Elmer Irvin Trust. The trustees were to be guided by the instrument, resolutions of the trustees as recorded in the minutes, or by bylaws, rules, or regulations, as are deemed expedient and consistent with the orderly conduct of business.Negotiable certificates of interest were issued. On these certificates, and also in the trust instrument, it was provided that neither the trustees nor the beneficiaries were liable in contract or in tort beyond the assets of the trust. It was provided that neither death, insolvency, or bankruptcy of any certificate holder, or the transfer of his certificate by sale, gift, devise, or descent, shall affect the operation of the trust.At the first meeting of the trustees (as shown by the minutes of said meeting), it was provided for the creation of a general manager whose duties were described as being analogous to a "President, Chairman of *848 the Board and General Manager." Elmer Irvin was elected to this office and as such, ran the business of the trust in the year before us.On April 23, 1951, Elmer Irvin conveyed certain property to the trust in accordance with the terms of the trust instrument. The property consisted primarily*264 of unimproved farmland, a business building, vacant lots, and a small house. The income received by the trust in 1951 was primarily rental payments. All of such income was distributed to, or was retained by, Elmer Ervin.In the statutory notice of deficiency, respondent determined that petitioner was an association taxable as a corporation. Certain other adjustments were conceded by the petitioner. During the taxable year 1951, petitioner was an association taxable as a corporation.OPINION.Our only issue is whether, during 1951, petitioner was an association taxable as a corporation.By statutory definition, the term "corporation" includes "associations." Sec. 3797 (a) (3), I. R. C. 1939. Many opinions of this and other courts have given some precision to the meaning of the term "association." Most prominent among these opinions are Morrissey v. Commissioner, 296 U.S. 344">296 U.S. 344, and three companion cases decided by the Supreme Court on the same date. 1 See also Regs. 111, sec. 29.3797-2.*265 Two major considerations in determining that a trust is an association which should be taxed as a corporation evolve from the cited cases and regulations. First, it must be found that the purpose for which the trust was organized was to associate together in a joint enterprise for the transaction of business. Then it must be found that the organization resembled a corporation. As was stated in the Morrissey case, supra, the "inclusion of associations with corporations implies resemblance; but it is resemblance and not identity." Some of the salient features of a trust, created as a medium for carrying on a business enterprise, which make it analogous to a corporate organization are suggested in the Morrissey case, supra. They are in part: Trust property vested in trustees, as a continuing body with provision for succession or self-perpetuation; centralized management; trustees who are authorized to act in much the same way as directors; trust not affected by death, resignation, etc., of owners of beneficial interests; negotiability of beneficial interests; and limited liability of members of the trust.Applying these principles to the instant case, it is so obvious*266 that the trust in question is such an association that little discussion is *849 merited. As to the purposes for which the trust was created, we must find that purpose from the instrument itself. Helvering v. Coleman-Gilbert Associates, supra.The instrument with which we are dealing is a copyrighted, printed instrument prepared by the National Pure Trust Service. It is provided that it is to be administered by "Natural Persons, Holding Title in Joint Tenancy, Acting Under Their Constitutional Rights as Citizens of the United States of America." The masthead on each page of the instrument shows an eagle perched on an open book, in which it is written "U. S. Constitutional Protection for Home Business Family Estate."The body of the instrument is a wilderness of high-sounding words and phrases, obviously designed as selling points for the service by the author, rather than to serve a genuine trust need. It is solemnly proclaimed that the "Purport" of the instrument is to convey property to trustees "to provide for a sane and economical administration by natural persons acting in a fiduciary capacity," the parties thereto "preferring that *267 the Trustees act solely within their constitutional rights as based upon their common law rights and immunities vouchsafed to citizens of the United States of America and defined in Article IV, Section 2 [quoting], and Article VI, Section 2 [incorrectly quoting a portion of the Article]; and the 14th Amendment thereof, Providing, that 'No state shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States.'"We refrain from extensive quotes from the 11-page printed instrument but feel that we must set out the following paragraph:Trustees' powers shall be construed as general powers of citizens of the United States of America, to do anything any citizen may do in any state or country, subject to the restrictions herein noted. They shall continue in business, conserve the property, commercialize the resources, extend any established line of business in industry or investment, as herein specially noted, at their discretion for the benefit of this Trust, such as, viz.: buy, sell or lease land for surface or mineral rights; buy or sell mortgages, securities, bonds, notes, leases of all kinds, contracts or credits, of any form, patents, *268 trademarks or copyrights; buy, sell, or conduct mail-order business, or branches thereof, operate stores, shops, factories, warehouses, or other trading establishments or places of business of any kind, construct, buy, sell, lease or rent suitable buildings or other places of business; advertise different articles or business projects; borrow money for any business project, pledging the Trust property for the payment thereof; hypothecate assets, property, or both, or the Trust in business projects; own stock in, or entire charters of corporations, or other such properties, companies or associations as they may deem advantageous.As if the above quote is not deemed a broad enough grant of power to enter and conduct any conceivable business, there is added this neat little clause: "Resolutions of the Board of Trustees authorizing a *850 special thing to be done shall be evidence that such act is within its powers." Under similar powers granted to a corporation, it would have been virtually impossible for the corporation to have committed an ultra vires act.As to the similarity of form of the instant trust to a corporation, we have found that the title to the properties was vested*269 in the trustees; centralization of management was effected by directing that the collective action of the trustees was to exercise exclusive control of the property and business affairs, and further, the office of general manager was created, whose duties were described as analogous to "a President, Chairman of the Board and General Manager." There were provisions setting the number and term of office of trustees, the manner in which they were to be removed from office, appointed, or elected. There were provisions whereby the effective operation of the trust would not be affected by the death, resignation, or removal of any trustee. Negotiable certificates of interest were issued and the liability of the trustees, officers, or agents was strictly limited to the assets of the trust on such certificates as well as on the declaration of trust.It would serve no useful purpose to further detail the ridiculously worded instrument. It is perfectly obvious that the Elmer Irvin Trust is even more similar in form to a corporation than the organization in the Morrissey case, supra. We think that the trust instruments in evidence conclusively demonstrate that in substance as well*270 as in form the petitioner falls within that category of associations to be taxed as corporations within the meaning of section 3797 (a) (3) of the Internal Revenue Code of 1939.Decision will be entered for the respondent. Footnotes1. Swanson v. Commissioner, 296 U.S. 362">296 U.S. 362; Helvering v. Combs, 296 U.S. 365">296 U.S. 365; and Helvering v. Coleman-Gilbert Associates, 296 U.S. 369">296 U.S. 369↩. | 01-04-2023 | 11-21-2020 |
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M A N D A T E
TO THE COUNTY COURT AT LAW NO. 4 OF WILLIAMSON COUNTY, GREETINGS:
Before our Court of Appeals for the Eighth District of Texas, on December 2, 2020, the cause
upon appeal to revise or reverse your judgment between
IN THE MATTER OF THE Appellant,
GUARDIANSHIP OF JANET CHURCH, AN
INCAPACITATED PERSON,
No. 08-20-00047-CV and
, Appellee,
was determined; and therein our said Court made its order in these words:
The Court has considered this cause on the record, and concludes the appeal should be
dismissed for want of prosecution. We therefore dismiss the appeal for want of prosecution. We
further order that Appellant pay all costs of this appeal, for which let execution issue. This decision
shall be certified below for observance.
WHEREFORE, WE COMMAND YOU to observe the order of our said Court of
Appeals for the Eighth District of Texas, in this behalf, and in all things have it duly recognized,
obeyed and executed.
WITNESS, the Clerk of the Court of Appeals, with the Seal thereof affixed, at the City of
El Paso, this March 12, 2021.
Elizabeth G. Flores, Clerk
Trial Court No. 18-0190-CP4 | 01-04-2023 | 03-18-2021 |
https://www.courtlistener.com/api/rest/v3/opinions/4619582/ | EDMOND A. HUGHES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Hughes v. CommissionerDocket No. 44113.United States Board of Tax Appeals21 B.T.A. 1075; 1931 BTA LEXIS 2253; January 8, 1931, Promulgated *2253 Lloyd Anderson, Esq., for the petitioner. C. R. Marshall, Esq., for the respondent. TRAMMELL *1075 OPINION. TRAMMELL: The petitioner moves for judgment on the pleadings, upon the ground, first, that the Commissioner has not determined a statutory deficiency under section 273 of the Revenue Act of 1926 or section 271 of the Revenue Act of 1928; second, that the alleged deficiency in tax represents an attempt on the part of the Commissioner to recover a tax erroneously refunded; third, that the amount of all taxes involved in this proceeding has been determined, assessed, and paid. It was stipulated that the pertinent facts set out in the respondent's brief, which was prepared before and submitted at the hearing, were the true facts in this case as disclosed by the pleadings. They are as follows: (1) Return for 1922 was filed on March 15, 1923 showing a net income of $43,676.43 wherein a loss of $22,900 was deducted on account of stock of the Beulah Coal Mining Co. (2) Field audit for 1922 suggested acceptance of return 8-9-26. (3) An amended return for 1922 was filed about November (9) 1926 showing an additional loss of $38,882.92 on*2254 the account of advances to the Beulah Coal Company. (4) Claim for refund for 1922 for $3,685.95 filed about October 1926 based on amended return and $38,882.92 loss. (5) Audit of 1922 return on 1-3-27 disallowed loss of $22,900 because no loss was sustained due to reorganization. (6) Claim for refund $3,685.95 was rejected 1-3-27 on ground of reorganization and no loss. (7) Amended return for 1924 filed about January 17, 1927 wherein a loss of $38,882.92 was claimed - this loss is same claimed for 1922. (8) Claim for refund for 1924 in amount of $7,418.10 filed about 1-21-27 on basis of amended 1924 return and loss of $38,882.92. (9) Protest submitted by taxpayer on 1-17-27 to disallowance of losses in 1922. *1076 (10) Protest acknowledged 2-1-27. (11) After consideration of protest and affidavits loss of $22,900 was allowed for 1922 in letter dated 2-15-27. (12) Amended return for 1924 audited about March 1927 and loss of $38,882.92 allowed on basis of affidavit and amended return. (13) Overassessment issued for $7,780.36 plus interest for 1924 in May 1927. (14) Agent's reports for 1924 made 2-28-29 and recommended disallowance of loss in 1924*2255 as no loss was sustained - new facts disclosed. (15) Notice of deficiency for 1924 mailed taxpayer on March 8, 1929 showing a proposed deficiency of $7,780.36 computed as follows: Tax assessed (and paid)$8,357.72Less overassessment (Rf.)7,780.36Net assessed577.36Correct tax liability8,357.72Deficiency7,780.36Above audit discloses that revised audit was based on agent's report of 2-28-29. (16) Taxpayer filed appeal 5-6-29. (17) Answer filed 6-24-29 (all material allegations as to errors and facts denied). (18) Amended petition filed 6-25-29. (19) Answer to amended petition filed 8-21-29 (Denied all material allegations of error and facts). (20) Motion to dismiss filed by taxpayer 7-9-30. (31) Set for hearing on motion 8-13-30. The real question presented is whether there was a statutory deficiency asserted by the respondent for the year 1924. The respondent's letter in which he notified the petitioner of the proposed deficiency for 1924 was mailed on March 8, 1929, and the petition was filed May 6, 1929. The Revenue Act of 1928, section 271, defines a deficiency as follows: As used in this title in respect of a tax*2256 imposed by this title "deficiency" means - (a) The amount by which the tax imposed by this title exceeds the amount shown as the tax by the taxpayer upon his return; but the amount so shown on the return shall first be increased by the amounts previously assessed (or collected without assessment) as a deficiency, and decreased by the amounts previously abated, credited, refunded, or otherwise repaid in respect of such tax; * * * The Revenue Act of 1924 and the Revenue Act of 1926 contain the same definition. Under the terms of the above definition the respondent has asserted a deficiency in this case. The statute does not require that the amount asserted by the Commissioner exceed the amount shown on the return as the tax, but the amount shown on the return decreased by the amounts previously credited, refunded or otherwise *1077 repaid should be considered together in determining whether there is a deficiency. The amount now asserted by the Commissioner as a deficiency exceeds the amount shown as the tax on the return decreased by the amount previously refunded. The petitioner relies upon section 610(b) of the Revenue Act of 1928 as being the exclusive remedy afforded*2257 the Commissioner for the recovery of amounts erroneously refunded. That provision, however, has no application to this proceeding. It relates only to collections of amounts previously refunded erroneously under the provisions of section 608; that is, where a refund was made after the enactment of the 1928 Act after the expiration of the period of limitation for filing of a claim therefor, with certain exceptions not here pertinent. This case does not involve a refund erroneously made under section 608, but was a refund which the Commissioner subsequently determined to have been erroneously made wholly independent of the statute of limitations. Section 610 of the 1928 Act in any event was not intended to deprive the Board of jurisdiction to hear and determine deficiencies as defined by the statute. The petitioner also contends that the Commissioner is estopped from determining a deficiency in tax for the calendar year 1924, upon the ground that he had previously allowed a refund in the same amount. The question on this issue does not involve the right of a succeeding Commissioner to revise the action of his predecessor, but whether the Commissioner himself could revise his own*2258 action within the statutory period applicable thereto. We think that our previous decisions are conclusive on this issue, to the effect that the Commissioner had the right to reconsider the petitioner's tax liability, and the fact that he had granted a refund does not estop him from revising such action and asserting a deficiency. ; . See also ; ; . For the reasons aforesaid, it is our opinion that the Commissioner has asserted a deficiency for the year involved and that the Board has jurisdiction to hear and determine the issues. The motion of the petitioner entitled a "Motion for judgment on the pleadings," which is in effect a motion to dismiss for lack of jurisdiction, is denied. The proceeding will be restored to the calendar for hearing in due course on the merits. | 01-04-2023 | 11-21-2020 |
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BILL OF COSTS
TEXAS COURT OF APPEALS, EIGHTH DISTRICT, AT EL PASO
No. 08-18-00181-CV
Steve Juen and CSDT America, Inc.
v.
Noe Rodriguez
(No. 2016DCV2973 IN COUNTY COURT AT LAW NO 3 OF EL PASO COUNTY)
Type of Fee Charges Paid By
MOTION FEE $10.00 E-PAID MICHAEL C BYNANE
MOTION FEE $10.00 E-PAID MICHAEL C BYNANE
MOTION FEE $10.00 E-PAID VIRGINIA MUNOZ
MOTION FEE $10.00 E-PAID VIRGINIA MUNOZ
REPORTER'S RECORD $194.75 UNKNOWN MICHAEL C. BYNANE
CLERK'S RECORD $193.00 UNKNOWN
FILING $205.00 PAID MICHAEL C. BYNANE
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 11,
2021.
Elizabeth G. Flores, Clerk | 01-04-2023 | 03-18-2021 |
https://www.courtlistener.com/api/rest/v3/opinions/4619584/ | DOROTHY L. BRADFORD, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBradford v. CommissionerDocket No. 5933-80.United States Tax CourtT.C. Memo 1983-62; 1983 Tax Ct. Memo LEXIS 711; 45 T.C.M. (CCH) 638; T.C.M. (RIA) 83062; February 2, 1983. Dorothy L. Bradford, pro se. Dennis R. Onnen, for the respondent. WILESMEMORANDUM FINDINGS OF FACT AND OPINION WILES, Judge: Respondent determined the following deficiencies in, and additions to, petitioner's Federal income tax: Addition to TaxYearDeficiencySec. 6653(a) 11975$8,183.89$409.19197613,839.81691.99197712,119.37606.0019785,699.70284.99At the trial of this case the parties informed the Court that they are in agreement that there are deficiencies in the instant case in the following amounts: YearDeficiency1975$6,321.50197611,389.9019778,034.6819784,102.67The sole issue for decision is whether*712 petitioner is liable for the 5 percent negligence addition to tax under section 6653(a) for each of the years 1975 through 1978. 2FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioner resided in Sheldon, Texas, when she filed her petition and amended petition in this case. During 1975 through 1978, petitioner owned and operated a drive-in bar located on State Highway 90 in Sheldon, Texas. Petitioner neither purchased the building in which she operated her bar nor any equipment for her bar until 1973 and therefore. During 1975 through 1978, she lived in a trailer home which was on the same lot as her bar. During all years in issue, petitioner failed to report various items of income and she erroneously claimed certain deductions on her Federal income tax returns. Petitioner's Schedule C's (Form 1040) for all years in issue do not include income which petitioner received*713 from individuals who used the pool tables which were located in her bar. Depreciation on equipment and a building located at 8800 Telephone Road, Houston, Texas, which constituted a business owned and operated by petitioner's son, was erroneously claimed on the Schedule C's of petitioner's Federal income tax returns for all years in issue. In addition, petitioner's returns for 1975 through 1978 show purchase dates of 1968, 1969, and 1972 for several items on the depreciation schedules with respect to her bar business. Petitioner claimed depreciation deductions on these items which represent equipment which was used in petitioner's son's business. Petitioner erroneously claimed personal telephone and utility expenses on the Schedules C's of her income tax returns during the years in issue. Finally, petitioner received rental income in 1975, and income from the sale of land in 1977 which were not reported on her Federal income tax returns for those years. Petitioner's income tax returns for all of the years in issue were prepared by employees of Gene Bagley Co., Houston, Texas. In computing petitioner's gross receipts from her bar business, petitioner furnished her return preparers*714 monthly summaries on sheets of notebook paper showing her daily receipts. Petitioner did not inform her return preparers that she had rental income in 1975 and income from the sale of land in 1977. Petitioner never read her income tax returns for the years 1975 through 1978 prior to filing them. In the notices of deficiency, 3 respondent determined that petitioner had understated her bar business income and overstated the deductions attributable thereto for each of the years in issue. Respondent further determined that only $23 of a claimed $5,220 casualty loss should be allowed on petitioner's 1976 return, and that petitioner had received unreported capital gain income of $4,435 from the sale of land during 1977 which was not reported on her return for that year. Finally, respondent determined that all a part of the underpayment of tax for each of the years 1975 through 1978 was due to negligence or intentional disregard of the rules and regulations. Consequently, respondent determined that petitioner is liable for the section 6653(a) addition to tax for all of such years. *715 Based on the foregoing determinations, respondent determined that petitioner was liable for the deficiencies and additions to tax as initially set forth herein. Due to a subsequent agreement by the parties, respondent has reduced the deficiencies and thus the additions to tax as originally determined. Petitioner has conceded that she is liable for such reduced deficiencies (see supra for the deficiencies upon which the parties agree), but the additions to tax are still in issue. OPINION Section 6653(a) imposes an addition to tax if any part of any underpayment is due to negligence or intentional disregard of the rules and regulations of the Internal Revenue Code. Petitioner has the burden of proving that no part of each of the underpayments was due to negligence. Ma-Tran Corp. v. Commissioner,70 T.C. 158">70 T.C. 158, 173 (1978); Enoch v. Commissioner,57 T.C. 781">57 T.C. 781, 802 (1972); rule 142(a), Tax Court Rules of Practice and Procedure.This is a classic case for the imposition of the negligence addition to tax. The substance of petitioner's testimony is that she simply signed the returns as prepared by the employees of Gene Bagley Co. because she*716 thought "all the bookkeepers * * * knew what they were doing, and I left it to them what I owed [the Internal Revenue Service] * * *." As in Enoch and Ma-Tran petitioner's sole justification is reliance on the bookkeepers who prepared her returns. No evidence was presented to show the Court that she supplied her bookkeepers with the correct information or that the filing of the incorrect returns was the result of the bookkeepers' errors. On the record before us, we must uphold respondent's determination that petitioner is liable for the negligence addition to tax for the years 1975 through 1978. See Ma-Tran Corp. v. Commissioner,supra at 173. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended.↩2. Petitioner's returns were timely filed for all years in issue. Consequently, the section 6653(a) additions, in the event we hold for respondent, will be 5 percent of each of the deficiencies agreed upon by the parties. See secs. 6211, 6653(a) and (c).↩3. Respondent sent two statutory notices to petitioner. One of such notices was for petitioner's 1975 taxable year, and the other notice was for petitioner's 1976 through 1978 taxable years.↩ | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619585/ | JOSEPH SIMON, LATE EXECUTOR, ESTATE OF ANNA M. MAXWELL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Simon v. CommissionerDocket No. 2732.United States Board of Tax Appeals9 B.T.A. 84; 1927 BTA LEXIS 2669; November 14, 1927, Promulgated *2669 Petitioner, formerly executor of estate of decedent, is liable for estate tax regardless of his discharge as such executor, and in determining the amount of the tax, property situate in a jurisdiction foreign to that granting letters testamentary may properly be included in the gross estate. Joseph Simon, Esq., pro se. Warren F. Wattles, Esq., for the respondent. ARUNDELL*84 Proceeding for the redetermination of a deficiency in estate tax under the Revenue Act of 1921 in the amount of $87.58. The petition alleges error in the action of the respondent in asserting a deficiency against an executor appointed by an Oregon court in respect of real property situate in the State of Washington. The petition was amended to allege that the real estate in controversy was sold by decedent's heirs and offering to pay a tax based on the sales price as the value of the property. FINDINGS OF FACT. Anna M. Maxwell died September 7, 1923, a resident of Portland, Oreg. On October 11, 1923, petitioner was appointed executor of decedent's estate by the Circuit Court of Multnomah County, Oreg. *85 At the time of the death of decedent she owned*2670 certain real estate in Moore's addition to the City of Spokane, Wash., described as follows: Fractional lots, 1, 2 and 3 in block 4; Fractional lots 5 and 6 in block 9; Fractional lots 2, 3, 4 and 5 in block 21; All of lots 8 and 9 in block 21; All of lots 1 and 2 in block 12; North 60 feet of lots 11 and 12 in block 12; South 40 feet of lots 5 and 6 in block 18. During decedent's lifetime, a friend, one Joseph T. Peters, made several unsuccessful efforts to dispose of the real estate for her. There were some assessments or liens in undisclosed amounts against the property. In an appraisal of decedent's estate filed in October, 1923, by the appraisers appointed by the Circuit Court of Multnomah County, the real estate above described was not listed nor was any reference made to it. By order of the Circuit Court dated May 23, 1924, the final account of petitioner was approved and he was discharged as executor of the estate. There was included in the order approving the final account a written agreement among the heirs agreeing to an equal distribution of the Spokane real estate. The final account of the executor showed cash on hand in the amount of $7,911.50*2671 and a number of stocks and bonds. During the period that petitioner served as executor of decedent's estate he filed a Federal estate-tax return and paid the tax disclosed thereby. The respondent added to the gross estate as returned an amount not disclosed by the record as representing the value of the Spokane real estate. By reason of such addition, respondent determined a deficiency in the amount of $87.58 and notified the petitioner thereof by letter dated February 16, 1925, which letter contained the following statement: No adjustment is made of real estate located in Spokane, Washington, as a further investigation discloses that the value of this property, as set out in Bureau's tentative audit dated July 31, 1924, is correctly determined. The protest is accordingly denied. OPINION. ARUNDELL: Petitioner questions the right of respondent to enforce a deficiency in the estate tax of decedent against him after his discharge as executor. The Revenue Act of 1921 places upon the executor of the estate of a decedent the duties of notifying the Federal Government of his *86 appointment, of filing the estate-tax return, and of paying the estate tax. Sections 404*2672 and 406. By section 407 it is provided: If the executor files a complete return and makes written application to the Commissioner for determination of the amount of the tax and discharge from personal liability therefor, the Commissioner, as soon as possible and in any event within one year after receipt of such application, shall notify the executor of the amount of the tax, and upon payment thereof the executor shall be discharged from personal liability for any additional tax thereafter found to be due, and shall be entitled to receive a receipt or writing showing such discharge. As far as the record shows the petitioner made no effort to secure a discharge of his liability for the tax by the method described by section 407, and it is inconceivable that an executor by hastening administration and ignoring the prescribed means of absolution from liability can evade any tax liability. . In the recent case of , the court discusses the liability of executors in the following language: All the Revenue Acts provide that the executor*2673 shall pay the tax. This establishes a direct and primary liability upon him which is necessarily personal. By Section 3467 of the Revised Statutes, any executor who pays any debt due by the estate before he satisfies debts due the United States becomes answerable in his own person or estate to the United States. The limitation provided by Section 407 of the Revenue Act of 1918 (1921?) was designed to terminate this personal liability after the Commissioner had finally fixed or had had reasonable time and opportunity to finally fix the amount of tax due. The second point raised by petitioner is that as his appointment as executor was made by an Oregon court his possession and control of decedent's property were limited to the boundaries of that State and he therefore can not be charged with a tax liability arising from property situate in the State of Washington. We agree that the Oregon letters testamentary have no extraterritorial force. The estate tax act, however, does not tax property as such but is an excise on the transfer of the net estate of a decedent. *2674 ; ; . The property itself is only a means of measuring the value of the net estate, the transfer of which is taxed. It is upon this principle that the law imposing the Federal estate tax looks primarily to the domiciliary representative of a decedent, and not to a number of ancillary representatives, for a return listing the "* * * value * * * of all property * * * wherever situated." Executors are presumed to know the requirements of law regulating the return which they are required to make. ; 5 Am.Fed. Tax Rep. 5935, 5940. *87 We do not have here any question as to whether the domiciliary representative might be liable for tax in excess of the amount of funds or property coming into his hands, as the final account filed with the probate court shows cash on hand far exceeding the tax liability. We are without competent evidence as to the value of the Washington real estate and the value placed thereon by respondent must accordingly be allowed to*2675 stand as found by him. After issue was joined petitioner filed an amended petition alleging that the real estate in controversy was sold in the current year by decedent's heirs, and setting forth his willingness to pay a tax measured by the amount received on such sale. Respondent denied the averments of the amended petition and no proof thereof was offered. Judgment will be entered for the respondent.Considered by STERNHAGEN and GREEN. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619586/ | Appeal of CENTRAL CONSUMERS WINE & LIQUOR CO.Central Consumers Wine & Liquor Co. v. CommissionerDocket No. 646.United States Board of Tax Appeals1 B.T.A. 1190; 1925 BTA LEXIS 2634; May 21, 1925, decided Submitted March 27, 1925. *2634 1. A stock subscription agreement of itself is not property, can not be regarded as such under the invested capital provisions of the Revenue Act of 1918, and a corporation may not include in invested capital the amount of unpaid subscriptions to its capital stock. 2. Under the Revenue Acts of 1917 and of 1918, actual values only may be included in invested capital, and the burden of proving actual value is on the taxpayer. 3. Where taxpayer corporation entered into cooperative agreements with retail liquor dealers whereby they became purchasers of its capital stock, and, in consideration of their agreement to purchase their supply of liquor from taxpayer, they received for each two shares of capital stock purchased one share of bonus stock, issued full paid and nonassessable, held, in the absence of evidence of actual value, that the bonus stock, charged on the taxpayer's books as good will, may not be included in its invested capital at par value. 4. A formula for computing the value of good will by attributing to tangible property a rate of 8 per cent and capitalizing the balance of the earnings on the basis of 15 per cent, will not be applied in computing obsolescence*2635 for loss of good will of a business rendered unlawful by prohibition legislation, where it appears that a rate of 10 per cent upon tangible property would substantially cover all the net earnings of the taxpayer upon the average for the 5-year period prior to March 1, 1913. 5. Special discounts paid to stockholders as an inducement to them to purchase goods from a corporation, being expenses and in no sense net earnings, may not be considered in determining the value of good will. Arthur B. Hyman, Esq., for the taxpayer. John D. Foley, Esq., for the Commissioner. JAMES *1190 Before JAMES, PHILLIPS, and GREEN. This is an appeal from a determination of income and profits taxes for the years 1917 and 1918, the Commissioner having determined an overassessment in 1917 of $17,544.63, and an additional tax for 1918 of $7,285.30. FINDINGS OF FACT. The taxpayer is a New York corporation organized in 1902 as a cooperative dealer in wines and liquor. In the beginning of its organization the taxpayer undertook to secure customers by a cooperative agreement with retail liquor dealers under which agreement they became purchasers of its stock*2636 and, in consideration of an agreement on their part to purchase their supply of liquor from the taxpayer, they received for every two shares of stock purchased by them one additional share of stock, called "bonus" stock, which was issued fully paid and nonassessable without other consideration than the agreement above referred to. The material portion of the subscription agreement read as follows: I, the undersigned, subscribe hereto my name, post-office address and the number of shares of stock hereinafter stated at the par value of $100 each, *1191 which I agree to take in the CENTRAL CONSUMERS WINE AND LIQUOR COMPANY, a corporation organized and incorporated under the laws of the State of New York, and I hereby agree to pay for such stock in monthly installments of Ten (10) per centum, and I further agree that I will not sell or transfer any such stock of this Company to any individual, copartnership, association or corporation, unless the transferee be a licensed saloon-keeper, and that I will not transfer nor sell any such stock without giving to the Company the option to purchase the same. It was further provided in the by-laws of the taxpayer, with respect to the*2637 holding and transfer of the stock and with respect to the purchase of liquor by the stockholders, as follows: ARTICLE 23, Section 1. No stock of this Company shall be sold or transferred on its books to any individual, copartnership or corporation unless the transferee be actually engaged in the retail wine and liquor trade at the time of such transfer. ARTICLE 27, Section 2. Every stockholder while in business shall agree to purchase goods from the company provided the quality and price of the goods offered are equal to the general standard. In accordance with the above plan, stock was sold from time to time, and in the early years of the organization of the taxpayer, "bonus" stock was issued in various amounts. In the case of "bonus" stock so issued, the asset account charged was called "good will," and there was outstanding on such asset account in the taxable year 1917 the sum of $97,131.31, and in the year 1918, $92,631.31, the difference between the years being occasioned by the purchase of stock by the company in accordance with the above-quoted portion of the by-laws. Conformably with the subscription agreement, capital stock was sold from time to time on the*2638 partial-payment plan, 10 per cent of such stock subscription being paid in conformity with the New York law at the time the stock was subscribed for. Stock so subscribed for was not issued until fully paid. In 1917, there was due and unpaid, as shown by the books of the company, on account of such stock subscriptions, the sum of $9,572.88, and for 1918, the sum of $9,100.00. The taxpayer, virtually from its organization, enjoyed a successful and profitable business, selling liquor, substantially without exception, to stockholders only. Upon the basis of sales to stockholders it paid from year to year, during the period of its existence, special discounts of from 5 to 15 per cent of the stockholders' purchases. In addition the corporation paid dividends at the rate of 6 per cent annually upon the capital stock, including the "bonus" stock above mentioned. For the five years, January 1, 1908, to January 1, 1912, inclusive, the taxpayer had for each year a net worth in tangible assets as follows: 1908$275,388.421909285,377.241910330,495.131911367,705.421912365,951.81Average$324,983.60*1192 For the five years, 1908 to 1912, *2639 inclusive, the taxpayer earned net income, after paying special discounts to stockholders, in the following amounts: 1908$18,920.45190959,015.72191046,322.44191115,079.01191232,462.88Average$34,360.10During the said years, 1908 to 1912, inclusive, the special discounts paid to stockholders in the manner above set forth were: 1908$22,155.57190917,504.44191021,512.82191141,072.42191231,548.08Average$26,758.26The net tangible worth of the taxpayer for the years 1913 to 1917, inclusive, as of January 1 of each of said years, was as follows: 1913$479,491.001914503,549.751915478,509.041916469,798.561917479,970.02Average$484,263.67The net income for the period 1913 to 1917, inclusive, was: 1913$39,868.751914 (loss)$4,829.71191520,825.52191627,233.26191757,409.87Average$28,101.54The taxpayer employed no salesmen, did no advertising, and obtained business in no other way than through the inducements offered to its original stockholders by reason of the "bonus" stock issued to them and to all of its stockholders*2640 by reason of the special discounts distributed upon their purchases. The Commissioner, in computing the income and profits taxes of the taxpayer for the years 1917 and 1918, excluded from invested capital the sums of $97,131.31 and $92,631.31, above mentioned, and carried on the books of the taxpayer as good will. The Commissioner also excluded from invested capital the sums of $9,572.88 and $9,100.00, respectively, on account of amounts unpaid on subscriptions to capital stock. The taxpayer further alleges that it is entitled to an allowance for obsolescence for loss of good will and going value in its business which was rendered unlawful as a result of the Eighteenth Amendment and the statutes adopted in pursuance thereof. As a consequence of the adoption of the Eighteenth Amendment the taxpayer ceased doing business on or about January 16, 1920. DECISION. The determination of the Commissioner is approved. *1193 OPINION. JAMES: The taxpayer alleges three grounds of appeal from the deficiency determined by the Commissioner. The taxpayer appears not to have claimed obsolescence of good will of its business in connection with its original returns for the*2641 years here in question, but it did make such claim in the course of its negotiations with the Commissioner concerning the deficiency here in issue. The taxpayer claims that the Commissioner erred in refusing to include in its invested capital good will, so called, in the sums respectively for two years of $97,131.31 and $92,631.31. The origin of this account has been set forth in the findings of fact. It consists of the asset account set up to offset stock issued in the early years following the taxpayer's organization as a "bonus" to prospective purchasers of its wares and as a special inducement to them to become sharers in the enterprise. As evidence of value the taxpayer relies upon the fact that the stock was issued in consideration of the contracts of the stockholders to purchase liquor from the taxpayer, provided the taxpayer was able to furnish liquor of a quality equal to that which could be obtained elsewhere. That these contracts were a substantial asset is unquestionable. The only evidence of value, however, is contained in the fact that stock was issued therefor and remained outstanding in the amounts above set forth as of the beginning of the taxable years here*2642 in question. The taxpayer submits that that fact establishes a prima facie case of value which must be met by the Commissioner by proof to the effect that the stock did not issue for such value, and that, in the absence of such proof, the taxpayer is entitled to include these sums in invested capital. Whether the stock so issued was issued to induce trading with the taxpayer, or whether it was issued in actual exchange for the stockholders' agreements to trade, is not regarded by the taxpayer as important, except as bearing upon the limitation of intangible values which may be included in invested capital as set forth in section 326 of the Revenue Act of 1918 and section 207 of the Revenue Act of 1917. The taxpayer contends that to require proof of value other than the issue of capital stock fully paid and nonassessable is to presume irregularity amounting to fraud in the issue of such stock. Congress, however, has provided that invested capital includes only actual cash, actual cash value of tangible property and intangible property bona fide paid in for stock or shares in an amount not exceeding the actual cash value of such property, the par value of the stock*2643 or shares issued therefor, or, with respect to intangible property, in the aggregate 25 per cent of the par value of the total stock or shares of the corporation outstanding. It is clear that Congress, in the above provisions, was carefully providing for the inclusion of actual values only and must have intended to impose the burden of proof of such value upon the taxpayer claiming the invested capital. To such an extent is this intent apparent that an arbitrary limitation was placed upon intangible values paid in for stock or shares without regard to the actual values which might in some instances have exceeded this arbitrary limitation. If there is any implication in these provisions of the act with respect to improper *1194 conduct upon the part of directors of corporations, that implication is in the act itself since, had Congress not intended the language used to have a special significance, it could and doubtless would have provided that property paid in for stock should be included in invested capital at the par value of the stock issued therefor. To construe the statute in the manner contended for by the taxpayer is to exclude all consideration of, and to give no*2644 effect to, the emphatic word "actual," repeatedly used in connection with property paid in for stock. We are of the opinion that the taxpayer has failed to prove that the contracts or the good will paid in for stock of the taxpayer had a value, and we must therefore affirm the determination of the Commissioner in this regard. The taxpayer also claims invested capital for the years in question of $9,572.88 and $9,100 for balance due on stock subscriptions on which 10 per cent or more had been paid. In support of this position, it relies upon the decision in the Appeal of Hewitt Rubber Co.,1 B.T.A. 424">1 B.T.A. 424, and upon cited cases in the courts of New York to the general effect that subscription agreements, accompanied by an initial payment of 10 per cent, are enforceable and are included in the assets available for the use of the corporation. Kohlmetz v. Calkins,16 App.Div. 518; 44 N.Y.Supp. 1031; Stoddard v. Lum,159 N.Y. 265">159 N.Y. 265; 53 N.E. 1108">53 N.E. 1108; Rochester & K. F. Land Co. v. Raymond,158 N.Y. 576">158 N.Y. 576; *2645 53 N.E. 507">53 N.E. 507; Beals v. Buffalo Expanded Metal Construction Co.,49 App.Div. 589; 63 N.Y.Supp. 635; Rathbone v. Ayer,84 App.Div. 186; 82 N.Y.Supp. 235. We do not believe that the Appeal of Hewitt Rubber Co. supports such a position. In the Hewitt Rubber Co. case the stock was actually issued for the note in question and simultaneously with the making and delivery thereof. It is true that, as the taxpayer in this appeal urges, under ordinary circumstances notes given in payment of stock subscriptions are void and unenforceable. Hapgoods v. Lusch,123 App.Div. 27; 107 N.Y.Supp. 334; Van Schaick v. Mackin,129 App.Div. 335; 113 N.Y.Supp. 408; Harriman National Bank v. Palmer,93 Misc. 431">93 Misc. 431; 158 N.Y.Supp. 111. But in Harris v. Wells,57 Misc. 172">57 Misc. 172; 108 N.Y.Supp. 1078, it was held that, where a subscription was accompanied by delivery of stock simultaneously with the delivery of a note in payment, this transaction would support an action on the note on the ground*2646 that the delivery of the note and the delivery of the stock constituted an express promise to pay, and that "where there has been an express promise, that promise may be enforced by action as in the case of any other contract liability," citing in support of this position Rochester & K.F. Land Co. v. Raymond, supra, and Sanger v. Upton,91 U.S. 56">91 U.S. 56. It is unnecessary to cite authority to the effect that a promissory note is property, but the Court of Appeals of the State of New York, in at least one well considered opinion, has held that a stock subscription agreement is not in itself property. In the case of the Bank of China v. Morse,168 N.Y. 458">168 N.Y. 458; 61 N.E. 774">61 N.E. 774, action was brought by a corporation, a successor to the corporation in which defendant had subscribed for stock, to collect an unpaid balance on his subscription. The predecessor company transferred to the plaintiff in the case "all of its business and property," and plaintiff *1195 claimed that that transfer enabled it to collect upon the unpaid subscriptions to the stock of its predecessor. In deciding that the action could not be maintained*2647 upon this ground, the court said: When the meaning of the words "business or property" is considered, it is obvious that "business" does not include uncalled capital, and the word "property" has not only been construed as not including calls upon stockholders holders in the Clinch Case, [5 Eq.Cas. 450; 4 Ch.App. 117,] but a similar principle of construction has been established by other cases in the English courts. (The plaintiff there in question was an English company.) If, for the Purpose of such a case as the one just cited, a stock subscription agreement is not property, certainly it can not be regarded as property under the invested capital provisions of the Revenue Act of 1918. Upon this point, therefore, the case here is distinguishable from the Hewitt Rubber Co. appeal, and stock subscriptions may not be included in invested capital until the actual time when payment is made on account thereof. Finally the taxpayer claims that it is entitled to an obsolescence allowance for loss of good will as a result of prohibition legislation. In support of this claim it sets forth its net earnings for the period prior to March 1, 1913, and*2648 by the use of an 8 per cent allowance on tangible property and a 15 per cent rate of capitalization of the balance of the income arrives at an alleged value of good will which it claims it should be permitted to amortize. On an average of $324,983.60 of tangible property it computes an allowance of $25,998.69 at the rate of 8 per cent, and, capitalizing the balance at 15 per cent, the value of the good will is computed at $55,742.73. The above are the rates which this Board has heretofore allowed in the Appeal of Dwight & Lloyd Sintering Co.,1 B.T.A. 179">1 B.T.A. 179, where it was said: In view of the known stability of the business of the taxpayer with reference to its earning power it is the opinion of the Board that the value of its patents and intangible assets taken together should be determined by attributing to tangible property a return of 8 per cent and capitalizing the balance of the earnings on the basis of 15 per cent instead of by attributing 10 per cent to tangible assets and capitalizing the balance of the earnings on the basis of 20 per cent as was done by the Commissioner. The Dwight & Lloyd Sintering Co. appeal is not applicable here. In this appeal*2649 a rate of 10 per cent upon tangible property would substantially cover all the net earnings of the taxpayer upon the average for the five-year period prior to march 1, 1913. Such being the case, it does not appear that there was any substantial amount of good-will value owned by the taxpayer and used in its business on March 1, 1913. The taxpayer urges that the special discounts paid its stockholders on their purchases should be considered in determining the value of the good will, but the special discounts were the very basis of the taxpayer's business. Its special discounts were expenses of the business, just as advertising and the cost of salesmen were expenses of its competitors. Being expenses and in no sense net earnings, the amounts of such special discounts can not by their very nature enter into any computation to measure good will or going value of the petitioner's business. It follows from the foregoing that the determination of the Commissioner must be affirmed. | 01-04-2023 | 11-21-2020 |
https://www.courtlistener.com/api/rest/v3/opinions/4619587/ | Robert C. Enos and Clara M. Enos, Petitioners, v. Commissioner of Internal Revenue, RespondentEnos v. CommissionerDocket No. 65059United States Tax Court31 T.C. 100; 1958 U.S. Tax Ct. LEXIS 59; October 21, 1958, Filed *59 Decision will be entered for the respondent. The petitioner in 1947 received from his employer, E. W. Bliss Company, an option to purchase 25,000 shares of its unissued stock at a stated price. Petitioner subsequently purportedly assigned his rights thereunder to his wife and two daughters for a nominal consideration. In 1952 petitioner's wife and daughters surrendered the option rights to E. W. Bliss Company for $ 2 for each share covered thereby. Held, that the gain realized from the cancellation of the stock options constituted compensation taxable to petitioner in 1952. Thomas J. McManus, Esq., for the petitioners.Albert J. O'Connor, Esq., for the respondent. Withey, Judge. WITHEY*100 OPINION.Respondent determined a deficiency in the petitioners' income*60 tax for 1952 in the amount of $ 60,495.57. The issue presented for our decision is the correctness of the respondent's action in determining that gain realized from the cancellation of stock options during 1952 constituted compensation for the services of petitioner Robert C. Enos and was therefore taxable to him as ordinary income.The case was submitted upon a stipulation of facts which is hereby adopted as our findings of fact and which may be summarized as follows:Petitioners are husband and wife and residents of Miami, Florida. During 1952 petitioners resided in Sewickley, Pennsylvania. They filed their joint income tax return for 1952 with the director of internal revenue at Pittsburgh, Pennsylvania.Robert C. Enos, sometimes hereinafter referred to as petitioner, became a director of the E. W. Bliss Company, sometimes hereinafter referred to as Bliss, in 1945. Bliss is a corporation organized under the laws of the State of Delaware. It is engaged in the manufacture of metal-working machinery, rolling mill equipment, and can-making machinery. During 1947 Bliss had 800,000 shares of authorized common stock, of which 341,639 shares were issued and outstanding. The common*61 stock of Bliss is listed on the New York Stock Exchange.On December 1, 1946, petitioner became chairman of the executive committee of E. W. Bliss Company at a salary of $ 1,500 per month. On March 20, 1947, he was elected chairman of the board of directors of Bliss. On May 15, 1947, his salary was increased to $ 20,000 a year. Petitioner resigned from the board of directors of Bliss on September 4, 1952. During the years 1947 through 1952, inclusive, he was also president and a director of the Standard Steel Spring Company.*101 On August 8, 1947, petitioner and Bliss executed an option agreement under the terms of which Bliss granted petitioner an option to purchase 25,000 shares of unissued stock of Bliss on or before December 31, 1950, at a price of $ 31.25 per share, subject to the following provisions:(1) * * * If you are employed by us during the period from the date hereof until the expiration of six (6) months from the date hereof, you shall have the right and option, while, but only while, you are employed by us, to purchase all or any part of 4,166 of said shares of our said Common Stock at said price. If you are employed by us during the period from the date*62 hereof until the expiration of twelve (12) months from the date hereof, you shall have the right and option, while, but only while, you are employed by us, to purchase all or any part of 4,166 additional shares of our said Common Stock at said price. If you are employed by us during the period from the date hereof until the expiration of eighteen (18) months from the date hereof, you shall have the right and option, while, but only while, you are employed by us, to purchase all or any part of 4,166 additional shares of our said Common Stock at said price. If you are employed by us during the period from the date hereof until the expiration of twenty-four (24) months from the date hereof, you shall have the right and option, while, but only while, you are employed by us, to purchase all or any part of 4,166 additional shares of our said Common Stock at said price. If you are employed by us during the period from the date hereof until the expiration of thirty (30) months from the date hereof, you shall have the right and option, while, but only while, you are employed by us, to purchase all or any part of 4,166 additional shares of our said Common Stock at said price. If you are*63 employed by us during the period from the date hereof until the expiration of thirty-six (36) months from the date hereof, you shall have the right and option, while, but only while, you are employed by us, to purchase all or any part of 4,170 additional shares of our said Common Stock at said price. If your employment by us shall be terminated prior to December 31, 1950, this option shall thereupon become void as to any shares not theretofore purchased, except that you or your legal representatives in the event of your death shall have the right to purchase any of such shares, purchasable during the period within which the date of such termination of employment shall occur and not theretofore purchased, on or before the close of business on the 30th day following such termination of employment.(2) It is understood and agreed between us that your employment by us has been and will be subject to your commitments to Standard Steel Spring Company. It is further understood and agreed between us, however, that subject to your commitments as aforesaid, we will employ you to render and you will render during the period from the date hereof until the expiration of six (6) months from the*64 date hereof such advisory and managerial services as we may reasonably request at the same rate of salary you now receive, and we will afford you the opportunity to be employed by us to render the same services at the same rate of compensation for such consecutive period of time thereafter until the close of business on December 31, 1950, as you may elect. Any cessation of employment by you by reason of our failure to afford you the opportunity of being so employed shall not be construed as a termination of employment for the purposes of paragraph 1 hereof.* * * *(5) This option may be assigned by you at any time, in whole or in part, by an assignment specifying the number of shares in respect of which the right to purchase has been assigned, the period within which the right to purchase such *102 shares is exercisable, and the name of the assignee. Such assignment shall not be effective until a copy thereof, duly executed by you and accepted by the assignee, shall have been filed with us at our office at No. 450 Amsterdam Street, Detroit 2, Michigan or at such other of our offices as we may designate. The right of any such assignee to purchase shall be subject to your continued*65 employment by us to the same extent as if such right had been retained by you and any such portion of this option so assigned shall expire at the close of business on the 30th day following the termination of your employment.(6) Until the expiration of this option we agree to reserve a sufficient number of authorized but unissued shares of Common Stock as shall be required to fulfill our obligations hereunder. * * *The price of the Bliss stock on the New York Stock Exchange on August 8, 1947, the date of the option agreement, was 29 3/4 High and 29 Low.On or about August 18, 1948, E. W. Bliss Company split its stock on the basis of 2 shares for 1. Consequently, under the provisions of the foregoing option agreement, the number of shares subject to the option was increased from 25,000 to 50,000 and the price per share was correspondingly reduced from $ 31.25 to $ 15.625.The option agreement was amended by a supplemental agreement dated January 5, 1950. The supplemental agreement, in addition to other amendments, made the following changes in the original agreement:(1) We hereby grant to you the right and option, upon the terms and conditions herein set forth, to purchase *66 from us at any time before the close of business on December 31, 1952 the following number of authorized but unissued shares of our Common Stock at a price of $ 15.625 per share: (a) 33,328 shares; plus(b) 8,332 shares, if you shall be employed by us from the date hereof until the close of business on February 7, 1950; plus(c) 8,340 shares, if you shall be employed by us from the date hereof until the close of business on August 7, 1950.If your employment by us shall be terminated prior to December 31, 1952, other than as the result of your death or incapacity by sickness or accident, this option shall terminate, in respect of any shares not theretofore purchased hereunder, at the close of business on the 30th day after such termination of employment. If your employment by us shall be terminated prior to December 31, 1952 as the result of your death or incapacity by sickness or accident, this option shall terminate, in respect of any shares not theretofore purchased hereunder, at the close of business on such date which shall be such number of days after December 31, 1950 as shall equal twice the number of days which you shall be employed by us during the calendar year 1950. *67 (2) Subject to your commitments to Standard Steel Spring Company, we will employ you to render and you will render during the period from the date hereof until December 31, 1950 such advisory and managerial services as we may reasonably request at the same rate of salary which you received during December 1949. We will also afford you the opportunity to be so employed by us for such consecutive period of time after December 31, 1950 and until December 31, 1952 as you may elect. Any cessation of your employment by us by reason of our failure to afford you the opportunity of being so employed shall *103 not be considered a termination of employment for the purposes of paragraph (1) hereof.The price of the Bliss stock on the New York Stock Exchange on the date of execution of the supplemental option agreement was 14 3/4 High and 14 1/2 Low.Petitioner assigned his rights under the option agreements to his wife, Clara M. Enos, with respect to the number of shares indicated below:SharesAmountPrice of BlissDate of assignmentsubject topaid bystock on N. Y.optionassigneeStock Exchange(total)(per share)Feb. 9, 19481,766$ 2526 1/2 High26 1/2 LowApr. 29, 19483,5322531 1/2 High31 LowApr. 29, 19507,0645013 3/8 High13 1/4 LowIncrease because of 2 for 1 stock split onAug. 18, 19485,298Total17,660100*68 The assignment of rights to Clara M. Enos was recorded on the books of Bliss.Petitioner assigned his rights under the option agreements to his daughter, Betty E. Wisner, with respect to the number of shares indicated below:SharesAmountPrice of BlissDate of assignmentsubject topaid bystock on N. Y.optionassigneeStock Exchange(total)(per share)Feb. 9, 19481,200$ 2526 1/2 High26 1/2 LowApr. 29, 19482,4002531 1/2 High31 LowApr. 29, 19504,8005013 3/8 High13 1/4 LowIncrease because of 2 for 1 stock split onAug. 18, 19483,600Total12,000100The assignment of rights to Betty E. Wisner was recorded on the books of Bliss.Petitioner assigned his rights under the option agreements to his daughter, Martha E. Miller, with respect to the number of shares indicated below:SharesAmountPrice of BlissDate of assignmentsubject topaid bystock on N. Y.optionassigneeStock Exchange(total)(per share)Feb. 9, 19481,200$ 2526 1/2 High26 1/2 LowApr. 29, 19482,4002531 1/2 High31 LowApr. 29, 19504,8005013 3/8 High13 1/4 LowIncrease because of 2 for 1 stock split onAug. 18, 19483,600Total12,000100*69 *104 The assignment of rights to Martha E. Miller was duly recorded on the books of Bliss.The option agreement originally executed August 8, 1947, was further amended by an agreement dated November 1, 1950, which provided that any rights which theretofore had not been assigned by petitioner were not transferable by him except by will or by virtue of the local laws of descent and distribution. Further, the stock rights which he retained were exercisable only by petitioner during his lifetime. The price of Bliss stock on the New York Stock Exchange on November 1, 1950, was 13 3/8 High and 13 1/8 Low.At a meeting of the board of directors of Bliss, held April 22, 1952, the officers of the corporation were authorized to purchase from the assignees of petitioner the stock options upon the payment of $ 2 for each share of common stock covered by the options assigned to them. The minutes of the meeting of the board of directors of Bliss held April 22, 1952, read, in part, as follows:The Chairman stated that the agreement gave Mr. Enos options to purchase at any time prior to December 31, 1952, an aggregate of 50,000 shares of Common Stock of the Corporation at a price of $ 15.625*70 per share. The Chairman further stated that the options were originally assignable and that prior to November 1, 1950, Mr. Enos assigned to his wife, Clara M. Enos, and his daughters, Elizabeth Enos Wisner and Martha Enos Miller, his rights under the agreement to purchase 17,660 shares, 12,000 shares and 12,000 shares, respectively. He further stated that under the terms of the amendment dated November 1, 1950, the options relating to the remaining 8,340 shares of Common Stock were made non-assignable. The Chairman then stated that it was deemed desirable from the standpoint of the Corporation that the assigned options be acquired by the Corporation thereby preventing the dilution of the equity of the present stockholders which would result from the issuance of stock pursuant to the exercise of the options. He informed the meeting that a proposal had been made by the assignees of the options to sell the options to the Corporation upon the payment of Two [sic] ($ 2.00) for each share or Common Stock covered thereby.The options to purchase stock which were received under the option agreement executed August 8, 1947, and amendments thereto were never exercised by petitioner *71 or his assignees. On May 1, 1952, Clara M. Enos entered into a letter of agreement with Bliss which provided as follows:Reference is made to the agreement originally entered into with you by Robert C. Enos under date of August 8, 1947 (as the same was amended under dates of January 5, 1950 and November 1, 1950). This will advise you that the right granted to Mr. Enos under said agreement to purchase 50,000 shares of the Common Stock of your Corporation at a price of $ 15.625 per share was, to the extent of 17,660 shares, duly assigned by Mr. Enos to the undersigned.The undersigned hereby assigns to you all of her rights under the aforementioned agreement with respect to 17,660 shares of Common Stock of your Corporation. It is understood that provided you receive similar assignments from Elizabeth Enos Wisner and Martha Enos Miller covering options on an *105 aggregate of 24,000 additional shares, you will pay to the undersigned the sum of Two Dollars ($ 2.00) for each share covered by the options, or an aggregate of $ 35,320. If for any reason you fail to make such payment, this assignment shall be null and void.Clara M. Enos received $ 35,320 from Bliss and reported a *72 profit of $ 35,220 as long-term capital gain in the joint income tax return filed by her and Robert C. Enos for 1952. The price of Bliss stock on the New York Stock Exchange on May 1, 1952, was 16 7/8 High and 16 1/2 Low.Agreements similar to that entered into by Bliss with Clara M. Enos were likewise executed with Betty E. Wisner and Martha E. Miller as a result of which each received $ 24,000 from Bliss for the cancellation of the stock options assigned to them and each reported $ 23,900 as long-term capital gain for 1952.The petitioners did not report either the receipt of the stock options under the option agreement executed August 8, 1947, or the receipt of any rights under the amendments of January 5, 1950, and November 1, 1950, as income in their income tax returns for the years 1947 and 1950. The petitioners did not report the receipt of any income or the incurrence of any losses arising from the transfer of the option rights in 1948 and 1950 in their income tax returns for those years.In its Federal income and excess profits tax return for 1952 Bliss reported the payments made to Clara M. Enos, Betty E. Wisner, and Martha E. Miller in the aggregate amount of $ 83,320 *73 as a short-term capital loss, thereby reducing its long-term capital gain for that year. It did not deduct the foregoing payments as compensation.The stock option acquired by petitioner on August 8, 1947, had no ascertainable market value on that date. The issuance of the foregoing option was not itself intended as compensation to petitioner. The amounts realized as a result of the assignments of the option rights to Bliss in 1952 were compensation for services rendered by petitioner.The respondent has determined that the stock option granted the petitioner by E. W. Bliss Company on August 8, 1947, was without value on that date and that any gain realized from the surrender by the assignees on May 1, 1952, constituted compensation to petitioner for his services, the taxable character of which cannot be changed by an anticipatory assignment to his wife and daughters.The petitioner first contends that the grant of the stock option in 1947 constituted compensation taxable to him in that year. In the alternative, petitioner contends that any additional compensation was realized upon the assignment of option rights in 1948 and 1950. In any event, petitioner maintains that he is *74 not taxable with the proceeds received by the assignees resulting from the cancellation of the option in 1952.*106 Under the terms of the option agreement executed August 8, 1947, petitioner's right to exercise the option was expressly contingent upon his continued employment with Bliss. The rendition of services by the petitioner was the consideration for his right to purchase stock at the stated price. If his employment by Bliss terminated, his opportunity to exercise the option also ceased. Petitioner did not acquire the right to purchase any stock until he continued for 6 months in the employ of Bliss. Such a provision constituted an unpredictable contingency on August 8, 1947, thereby making it impossible to ascribe any value to the option at the time it was granted. Commissioner v. LoBue, 351 U.S. 243">351 U.S. 243; Van Dusen v. Commissioner, 166 F. 2d 647, affirming 8 T. C. 388. There is no evidence in the record here from which a market value for the option could be determined. Since at the time the option was granted the purchase price stated in the option was higher than the market*75 value of the stock and inasmuch as the option was granted on August 8, 1947, and consequently could not acquire value within that year, it does not appear that the issuance of the option to petitioner in 1947 was intended as compensation. The fact that petitioner did not report on his income tax return for 1947 any income arising from the receipt of the option in that year indicates that he did not regard it as compensation at that time.It is apparent from the foregoing that the option agreement executed on August 8, 1947, did not represent compensation to petitioner in that year.However, since the issuance of the option could not itself compensate the petitioner and since he was a salaried employee of E. W. Bliss Company at the time the option was canceled in 1952, it is clear that the gain realized from the cancellation of the option in 1952 represented the compensation contemplated by the parties for services rendered by petitioner. Commissioner v. LoBue, supra.Petitioner contends, however, that if the grant of the option to him in 1947 did not give rise to the realization of the full compensation intended by the parties, any additional compensation*76 would be realized in 1948 and 1950 (to the extent of $ 300) when, petitioner insists, he sold the option in question to his wife and daughters. Further, petitioner argues that he disposed of the option in 1948 and 1950 and, consequently, in no event is he taxable with the proceeds of the sale received by Clara M. Enos, Betty E. Wisner, and Martha E. Miller in 1952. We are not convinced, however, that the transfers of the option rights by petitioner to his wife and daughters during 1948 and 1950 were actually bona fide arm's-length transactions. The consideration received was only $ 300 for the option to purchase 41,660 shares of stock, or a little less than 1 cent per share, at a time when the stock of E. W. Bliss Company was selling on the New York *107 Stock Exchange at prices ranging from $ 26.50 per share to $ 31.50 per share (1948), and at approximately $ 13 per share (1950). In view of the close family relationship existing between the petitioner and the assignees and the nominal consideration received by petitioner, the transactions, in our opinion, were not at arm's length and were not bona fide sales. Since petitioner did not report on his income tax returns for*77 either 1948 or 1950 any gain resulting from the transfers of the option rights in those years, it does not appear that he himself really regarded those transactions as sales.The general purpose of the compensatory stock option plan here in question appears to be that the employee, petitioner, will retain the option until it increases in value and will then either exercise or dispose of it, thereby realizing additional compensation for his services. If the petitioner had either exercised the stock option in question or had surrendered or disposed of it in an arm's-length transaction, he would have been taxable on any gain resulting from the exercise, surrender, or disposition thereof as compensation. Commissioner v. Smith, 324 U.S. 177">324 U.S. 177; Commissioner v. LoBue, supra;Estate of James S. Ogsbury, 28 T. C. 93, affd. 258 F.2d 294">258 F. 2d 294; Charles E. Sorensen, 22 T.C. 321">22 T. C. 321.Since any income realized by petitioner from the exercise, surrender, or disposition of the option would have constituted compensation for his services, the proceeds received*78 by others as the result of an ineffective disposition of the option pursuant to a transaction not at arm's length is likewise taxable as compensation to him. Compensation for services is taxable to the person rendering the services and the tax upon the realization of such income cannot be avoided by an anticipatory assignment. 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.Our decision in Joseph Kane, 25 T. C. 1112, affd. 238 F. 2d 624, certiorari denied 353 U.S. 931">353 U.S. 931, is in point here. In that case, a stock option was granted directly to the taxpayer's wife by the chairman of the board of directors and chief stockholder of Bulova Watch Company as an inducement to the taxpayer to accept a position as assistant to the president of that company. The option agreement was contingent upon the continued employment of the taxpayer with Bulova Watch Company and was intended as additional*79 compensation to him. At the time the option was granted to the taxpayer's wife the option price exceeded the market value of the stock. We there held that the gain subsequently realized upon the exercise of the option by the taxpayer's wife constituted compensation for his services and was therefore taxable to him under section 22 (a) of the Internal Revenue Code of 1939. In so holding, we stated, in part, as follows:*108 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 rule established by Commissioner v. Smith, supra, 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*80 the taxpayer. * * *In the instant case, Robert C. Enos personally received the stock option in question and subsequently assigned his rights thereunder to his wife and two daughters, whereas, in Joseph Kane, supra, the option was granted directly to the wife and was never in the taxpayer's name. In our opinion, our holding in Joseph Kane, supra, is controlling of the situation here presented. As we view the transactions here in question, no taxable event occurred until the petitioner's wife and daughters surrendered the option agreement to E. W. Bliss Company in 1952 in consideration of the payment by Bliss of $ 2 for each of the 41,660 shares of stock covered by the agreement. We accordingly hold that the gain realized from the cancellation of the stock option in question constituted compensation to petitioner and was taxable to him in 1952. Sec. 22 (a), I. R. C. 1939.Decision will be entered for the respondent. | 01-04-2023 | 11-21-2020 |
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